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Lecture-12. Pricing strategies

PhD., Elbek Khodjaniyazov

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Pricing Strategies

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Penetration Pricing

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Penetration Pricing

Price set to ‘penetrate the market’
‘Low’ price to secure high volumes
Typical in mass market products – chocolate bars, food stuffs, household goods, etc.
Suitable for products with long anticipated life cycles
May be useful if launching into a new market

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Market Skimming

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Market Skimming

High price, Low volumes
Skim the profit from the market
Suitable for products that have short life cycles or which will face competition at some point in the future (e.g. after a patent runs out)
Examples include: Playstation, jewellery, digital technology, new DVDs, etc.

Plasma screens: Currently at

high prices but for how long?

Title: Thin-shaped television. Copyright: Getty Images,

available from Education Image Gallery

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Value Pricing

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Value Pricing

Price set in accordance with customer perceptions about the value of the product/service
Examples include status products/exclusive products

Companies may be able to set prices according to perceived value.

Title: BMW At The Frankfurt Auto Show. Copyright: Getty Images, available from Education Image Gallery

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Loss Leader

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Loss Leader

Goods/services deliberately sold below cost to encourage sales elsewhere
Typical in supermarkets, e.g. at Christmas, selling bottles of gin at £3 in the hope that people will be attracted to the store and buy other things
Purchases of other items more than covers ‘loss’ on item sold
e.g. ‘Free’ mobile phone when taking on contract package

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Psychological Pricing

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Psychological Pricing

Used to play on consumer perceptions
Classic example - £9.99 instead of £10.99!
Links with value pricing – high value goods priced according to what consumers THINK should be the price

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Going Rate (Price Leadership)

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Going Rate (Price Leadership)

In case of price leader, rivals have difficulty in competing on price – too high and they lose market share, too low and the price leader would match price and force smaller rival out of market
May follow pricing leads of rivals especially where those rivals have a clear dominance of market share
Where competition is limited, ‘going rate’ pricing may be applicable – banks, petrol, supermarkets, electrical goods – find very similar prices in all outlets

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Tender Pricing

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Tender Pricing

Many contracts awarded on a tender basis
Firm (or firms) submit their price for carrying out the work
Purchaser then chooses which represents best value
Mostly done in secret

A European consortium led by Airbus recently won a contract to supply refuelling services to the RAF – priced at £13 billion!

Title: Air refuelling. Copyright: Getty Images, available from Education Image Gallery

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Price Discrimination

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Price Discrimination

Charging a different price for the same good/service in different markets
Requires each market to be impenetrable
Requires different price elasticity of demand in each market

Prices for rail travel differ for the same journey at different times of the day

Title: Inter-City 125. Copyright: Getty Images, available from Education Image Gallery

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Destroyer Pricing/Predatory Pricing

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Destroyer/Predatory Pricing

Deliberate price cutting or offer of ‘free gifts/products’ to force rivals (normally smaller and weaker) out of business or prevent new entrants
Anti-competitive and illegal if it can be proved

Microsoft – have been accused of predatory pricing strategies in offering ‘free’ software as part of their operating system – Internet Explorer and Windows Media Player - forcing competitors like Netscape and Real Player out of the market.

Title: Bill Gates speaks at UNIX convention. Copyright: Getty Images, available from Education Image Gallery

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Absorption/Full Cost Pricing

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Absorption/Full Cost Pricing

Full Cost Pricing – attempting to set price to cover both fixed and variable costs
Absorption Cost Pricing – Price set to ‘absorb’ some of the fixed costs of production

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Marginal Cost Pricing

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Marginal Cost Pricing

Marginal cost – the cost of producing ONE extra or ONE fewer item of production
MC pricing – allows flexibility
Particularly relevant in transport where fixed costs may be relatively high
Allows variable pricing structure – e.g. on a flight from London to New York – providing the cost of the extra passenger is covered, the price could be varied a good deal to attract customers and fill the aircraft

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Marginal Cost Pricing

Example:

Aircraft flying from Bristol to Edinburgh – Total Cost (including normal profit) = £15,000 of which £13,000 is fixed cost*

Number of seats = 160, average price = £93.75

MC of each passenger = 2000/160 = £12.50

If flight not full, better to offer passengers chance of flying at £12.50 and fill the seat than not fill it at all!

*All figures are estimates only

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Contribution Pricing

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Contribution Pricing

Contribution = Selling Price – Variable (direct costs)
Prices set to ensure coverage of variable costs and a ‘contribution’ to the fixed costs
Similar in principle to marginal cost pricing
Break-even analysis might be useful in such circumstances

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Target Pricing

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Target Pricing

Setting price to ‘target’ a specified profit level
Estimates of the cost and potential revenue at different prices, and thus the break-even have to be made, to determine the mark-up
Mark-up = Profit/Cost x 100

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Cost-Plus Pricing

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Cost-Plus Pricing

Calculation of the average cost (AC) plus a mark up
AC = Total Cost/Output

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Influence of Elasticity

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Influence of Elasticity

Any pricing decision must be mindful of the impact of price elasticity
The degree of price elasticity impacts on the level of sales and hence revenue
Elasticity focuses on proportionate (percentage) changes
PED = % Change in Quantity demanded/% Change in Price

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Influence of Elasticity

Price Inelastic:
% change in Q < % change in P
e.g. a 5% increase in price would be met by a fall in sales of something less than 5%
Revenue would rise
A 7% reduction in price would lead to a rise in sales of something less than 7%
Revenue would fall

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Influence of Elasticity

Price Elastic:
% change in quantity demanded > % change in price
e.g. A 4% rise in price would lead to sales falling by something more than 4%
Revenue would fall
A 9% fall in price would lead to a rise in sales of something more than 9%
Revenue would rise

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John Lewis Pricing Policy

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