Pricing Strategy and Elasticity

Consumer Perspective on Price

  • Consumers consider if a product's cost is justified by its problem-solving ability and convenience compared to alternatives.
  • Time and resources are factored into the cost.
  • Psychological cost: Prestige or lack thereof associated with using certain brands, especially in social situations (e.g., wearing a shirt with a disliked university's logo).
  • Price conveys value to consumers.

Factors Influencing Price

Internal Factors

  • Factors that the company can influence:
    • Marketing Objectives: Maximizing total profit per product (high margin) vs. increasing market share (lower price).
    • Marketing Mix Strategy: Price should be consistent with other marketing elements.
      • Example: Southwest Airlines - lower price reflects their customer value approach.
      • Product features (e.g., fewer first-class seats) align with the value approach.
    • Costs: Influenceable, as the product can be made with components that determine the price.

External Factors

  • Factors outside the company's control:
    • Competition: Cannot control competitors' actions in response to price changes.
    • Demand: Building a better product should increase demand.
    • Economy: Macro-level factor beyond control.

Price Elasticity

  • Definition: How changes in price affect customer demand.

  • Price Sensitivity: How sensitive customers are to price changes.

  • Formula: e = \frac{\% \text{ change in quantity}}{\% \text{ change in price}}

    • Note: The absolute value is typically used in economics, but for this purpose, focus on the ratio.

  • Elastic Demand:

    • Coefficient above one (e > 1).
    • Sensitive to price changes.
    • Example: If the price increases by 10% and quantity demanded decreases by 30%, it's very elastic.

  • Inelastic Demand:

    • Coefficient below one (e < 1).
    • Not very sensitive to price changes.
    • Example: If the price increases by 20% and quantity demanded only decreases by 5%, it's relatively inelastic.

  • Unitary Elasticity:

    • Coefficient equals one (e = 1).
    • Perfect one-to-one ratio.
    • Example: A 10% increase in price leads to a 10% decrease in sales, keeping revenue unchanged.

Visual Recap:

  • Elastic: Consumers buy more or less when the price changes significantly.
  • Inelastic: Changes in price do not significantly affect demand.
  • Gasoline example: even with price fluctuations, consumption remains relatively constant.
  • Textbook Example:
    • If a textbook is required, a small price change won't alter demand significantly.

Elasticity and Revenue

  • Revenue = Price x Quantity Purchased
  • Elastic Demand:
    • Price goes up, quantity demanded decreases significantly, revenue goes down.
    • Price goes down, quantity demanded increases significantly, revenue goes up.
  • Inelastic Demand:
    • Price changes, quantity demanded remains relatively constant.
    • Price goes up, revenue goes up.
    • Price goes down, revenue goes down.
  • Unitary Elasticity:
    • Price changes, quantity demanded changes proportionately, revenue stays the same.

Stages for Establishing a Price

1. Developing Pricing Objectives

  • Determine the strategic goals of pricing.
  • Consider maximizing profit per product (high margin).
  • Status Quo: Pricing at the average level for the product category.
  • Market Share Perception: Pricing low to sell more volume (Walmart model).

2. Assessing the Target Market's Evaluation of Price

  • Consider what consumers are looking for.
  • The type of product and target market matters.
  • Purchase situation (new product vs. improvement).
  • Example: Apple's Macintosh in 1984 priced at 2,500 (equivalent to over 6,000 today).
    • The high price conveyed quality and differentiation.

3. Evaluating the Competitor's Price

  • Set a benchmark relative to competitors.
  • Pricing above or below the competition conveys information about quality.
  • Low price may suggest a lack of quality.
  • Consumers perceive value as benefits relative to price.