Professor Chip Besio Cox School of BusinessSouthern Methodist University

Pricing Considerations Objectives:

Enhance brand imageProvide customer valueObtain an adequate ROIMaximize profitsMaintain price stability in an industry or

market

Factors Affecting Pricing Internal Factors

CostsProduct, Strategy

Internal FactorsCosts

Product, Strategy

PricingDecisionsPricing

Decisions

External FactorsCompetitorsCustomers

External FactorsCompetitorsCustomers

Pricing Considerations

Factors Effecting Pricing:Demand sets price ceilingCost sets price floorConsumer value perceptionsConsumer price sensitivityGovernment regulations

Pricing Considerations

Factors Effecting Pricing:Product/Service differentiationOrganization’s financial goalsStage of Product Life CycleMarketing Channel margin impactPrices of other products in mix

Customer ConsiderationsPRICE SENSITIVITY Product categories are not uniformly

responsive to prices -- some are more sensitive to price levels than others

Customers also may respond differently than one another to price levels

Price sensitivity (price elasticity) reflects how purchase behavior changes with changes in price

Pricing ConsiderationsPRICE SENSITIVITY

Pri

ce

Quantity Demanded per Period

A. Inelastic Demand - Demand hardly changes with a small change in price

P2

P1

Q1Q2

Pri

ce

Quantity Demanded per Period

P2P1

Q1Q2

B. Elastic Demand - Demand changes greatly with a small change in price

Product-Based Pricing Approaches

Product Line PricingProduct Line PricingSetting price steps between product line items

i.e. $299, $399

Product Line PricingProduct Line PricingSetting price steps between product line items

i.e. $299, $399

Optional-Product PricingOptional-Product PricingPricing optional or accessory products sold with

the main product *** i.e. car options

Optional-Product PricingOptional-Product PricingPricing optional or accessory products sold with

the main product *** i.e. car options

Captive-Product PricingCaptive-Product PricingPricing products that must be used with the main

Product***i.e. Razor Blades, Film, Software

Captive-Product PricingCaptive-Product PricingPricing products that must be used with the main

Product***i.e. Razor Blades, Film, Software

By-Product PricingBy-Product PricingPricing low-value by-products to get rid of them

***i.e. Lumber Mills, Zoos

By-Product PricingBy-Product PricingPricing low-value by-products to get rid of them

***i.e. Lumber Mills, Zoos

Product-Bundle PricingProduct-Bundle PricingPricing bundles Of products sold together

***i.e. season tickets, computer makers

Product-Bundle PricingProduct-Bundle PricingPricing bundles Of products sold together

***i.e. season tickets, computer makers

Source: Prentice Hall

Cost Considerations

Recall that costs may depend on the production level

Total CostsSum of the Fixed and Variable Costs for a Given

Level of Production

Total CostsSum of the Fixed and Variable Costs for a Given

Level of Production

Fixed Costs(Overhead)

Costs that don’tvary with sales or production levels.

Executive SalariesRent

Variable Costs

Costs that do varydirectly with the

level of production.

Raw materials

Cost BasedPricing Strategies

Full Cost Strategies Variable Cost Strategies New-Offering Strategies Competitive Bidding

Cost BasedPricing Strategies

Full Cost StrategiesMarkup PricingBreak-even PricingROR Pricing

Cost BasedPricing Strategies

Variable Cost StrategiesStimulate DemandShift Demand

Cost-Based Pricing Approaches

Cost-Plus PricingCost-Plus Pricing - Adds a standard mark up to the cost of the productUseful when there are a great many products or

demand is hard to forecastSimple to implement

Breakeven or Target Profit PricingBreakeven or Target Profit Pricing - Price is set to meet a specific profit targetAlso takes consumer demand into account

Cost-Based PricingCOST-PLUS

Minimizesprice

competition

Minimizesprice

competition

Perceivedfairness forboth buyersand sellers

Perceivedfairness forboth buyersand sellers

Sellers are morecertain aboutcosts than

demand

Sellers are morecertain aboutcosts than

demand

Pricing Strategies

Competitive BiddingDemand is Known & ConstantMarketing Mix Variables UncontrollableSophisticated Mathematical Models

○ Calculate Profit Levels○ Calculate Probability of Winning at

Different Price Levels

Cost BasedPricing Strategies

New-Offering StrategiesSkimmingPenetrationIntermediate

New Product Intro Strategies

Capture “cream” – less price sensitive buyers

High Profit Margin – sacrifice volume

Invite Competitors, Short-term Profits

Sell Whole Market – no “elite” market

High Volume –sacrifice profit margin

Keep Competition Out – B.O.E.

INTENT

FOCUS

RESULT

SKIMMING PENETRATION

New Product Intro Strategies

Skimming StrategyPrice High Initially

Reduce Over Time

Inelastic Demand - Buyers Price Range

Unique Offering

New Product Intro Strategies

Skimming StrategyProduction or Marketing Costs

Unknown

Limited Capacity to Deliver

Realistic Perceived Value

New Product Intro Strategies

Penetration StrategyPrice Low Initially

Elastic Demand

Offering Not Unique

Competition Entering Quickly

New Product Intro Strategies

Penetration StrategyNo Distinct Price Segments

Volume Increases Dramatically Impact Costs

Objective - Large Market Share

New Product Intro Strategies Intermediate Strategy

More PrevalentLess Dramatic

Pricing Strategies Experience Curve

Pricing below cost in short-term○ Build volume thus lowering costs

Costs decline because○ Learning by labor○ Labor specialization○ New process adoption○ Product re-design○ Materials substitution○ Ability to spread fixed costs

Pricing Strategies Experience Curve

Advantages could be mitigated by○ Technology innovation – competitor○ Key patent control – competitor○ Material-supply limitations○ Government regulations

Pricing Strategies

Pricing Strategies

Competitive BiddingDemand is Known & ConstantMarketing Mix Variables UncontrollableSophisticated Mathematical Models

○ Calculate Profit Levels○ Calculate Probability of Winning at

Different Price Levels

Customer ConsiderationsPRICE AS A SIGNAL

Price not only has the traditional economic role of negatively affecting demand but also offers the customer information about product quality

When is price used as a signal?When there is little information about

product quality availablePrimarily for experience or credence goods

Customer ConsiderationsVALUE PRICING

ProductProduct

CostCost

PricePrice

ValueValue

CustomersCustomers

CustomerCustomer

ValueValue

PricePrice

CostCost

ProductProduct

Cost-Based Pricing Value-Based Pricing

General Price Adjustment Strategies

• Adjusting Prices for Psychological Effect.•Price Used as a Signal

•Temporarily Reducing Prices to Increase Short-Run Sales.• i.e. Loss Leaders, Special-Events

•Adjusting Prices to Account for the Geographic Location of Customers.• i.e. FOB-Origin, Uniform-Delivered, Zone Pricing, Basing-Point, & Freight-Absorption.

• Adjusting Prices for International Markets.• Price Depends on Costs, Consumers, Economic Conditions & Other Factors.

Psychological Pricing

Promotional Pricing

Geographical Pricing

International Pricing