Chapter 14: Pricing for capturing value & Chapter 15: Strategic Pricing Methods and Tactics | MKTG-300

Three ways companies set prices

• Cost-based

• competitive-based

• customer value-based

Cost-based pricing

• The practice of setting prices by estimating the avg cost of producing and selling the product plus a profit margin

  1) Design a product

  2) Calculate the cost of producing the product

  3) set price to cover full cost (variable cost and fixed cost) plus a profit target

  4) Articulate the value of the product at the set price

  5) Find customer who will purchase the product

Product —> Cost —> Price —> Value —> customer

Price Formula

Price = [Variable cost + fixed cost/N] * [1 + %profit margin] | Where N=Expected Sales Units

Drawbacks of Cost-based pricing

• to calculate costs company must assume how many units they will sell (# is unknown)

• cost-based price may be different from what customers are willing to pay

• cost-based price may not be as competitive (a much lower price than our competitor might not be a good price)

Profit Margin Formula

Profit Margin = (Price - Unit Cost)/Price

Gross Margin Formula %

=(Revenue/COGS)/Revenue

or

= (Avg price - Avg unit cost)/Avg price

Profit margin is also known as…

contribution margin and % gross margin

Markup vs Margin

Markup = Profit / Cost

Margin = Profit / Retail Price

Markup rate formula and is it different from profit margin

= (Price - Cost) / Cost

Yes!

Competitor-based pricing

the practice of setting prices by selecting a competitor’s product price and pricing at the same level, or slightly below or above…

Why to implement and benefit:

• Easy to implement

• when the competitor’s price is well accepted in the market

• when customers compare prices among choices

Drawbacks of competitor-based pricing

• Matching prices could mean copying competitors’ strategy and positioning

• lowering below competitor’s price could lead to price war

3 reaction choices when competitors cut prices & factors that are considered before reacting

• focused price response

• non-price response

• don’t respond

Factors considered:

• the magnitude of our sale loss

• the strength of the competitor

The loss will be severe if you would lose…..

• exclusive and loyal customers

• customers who are easy to serve

• customers who pay full prices (not asking discount)

• those who buy a lot from you

• referene accounts

• innovative accounts

• high growth potential accounts

When would we do focused price response

When we estimate that

1) our revenue loss will be severe

2) competitor is weaker than we are

therefore we…

• proactively discount to customers at risk

• discount vulnerable products and non-core markets

When should we do non-price responses

When we estimate that:

1) our revenue loss will be severe

2) competitor is stronger than we are

Features of Non-price response

• improve differentiation

• strengthen relationship with market collaborators

• communicate the risks of switching to a low-price and low-quality competitor

• cut-cost for long-term survival

• switch business model from selling to service

When to react as “don’t respond”

• when our revenue loss will be minimal

• the threat is not credible

customer value-based pricing

The practice of setting prices by estimating the willingness to pay for our customers

1) define our target customers

2) identify the benefits we will provide to those customers

3) design a product to deliver the benefits

4) set the price of the product

5) Ensure the product is viable given our cost structure

customer—> value —> product —> price —> cost

Apple product Positioning and Branding, Pricing

• Customer value pricing

• odd number pricing

3 different company objectives and pricing

• Sales oriented goal:

  • if the company’s goal to increase sales, set the price to maximized sales revenue

• Profit Oriented goal:

  • Set the price to maximize gross margin

• Market share oriented goal:

  • In general, set the price to maximize unit sales

Elastic v. Inelastic

Elastic: price sensitive

Inelastic: price insensitive

Price Elasticity of Demand Formula and what it measures

= % change in quality demanded / % change in price

• measures how changes in a price affect the quantity of the product demanded. Specifically it is the ratio of the % change in quantity demanded to thee % change in price

when the customers are price sensitive……

• price elasticity is HIGH

  • if you raise your price sales will decrease

  • if you lower your price, the sales will increase

• in general there is a short-term illusion that raising prices increase the total sales revenue

• but, eventually the sale revenue decreases with raising price

when the customers are price insensitive…..

• Price elasticity is low

  • if you raise your price the sales will not change much

  • if you lower your price, the sales will not change much

• In general firms are inclined to raise prices. Government typically intervenes pricing of necessity goods

Price elasticity depends on (3 things)

• Customer income

  • as customer income increases, customers become price insensitive (price elasticity drops). they will buy higher priced alternatives

• Substitution

  • the greater the availability of substitute products, the customers become price sensitive (price elasticity increases)

• Price change of other products

  • if the price Mountain Dew rises, the demand for Doritos will decrease and the demand for Sprite will increase