Price for Profit R - VQ - F = Z PQ - VQ - F = Z Z = PQ - VQ - F. Price For Maximizing Profit. Revenue - total Variable Cost - Fixed Cost = Profit

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1 Price For Maximizing Profit by Ted Mitchell 1 Demand or Customer Based Pricing Two Major Topics 1) Maximize profit by choosing the optimal price based on the direct customer response (demand curve). 2) Maximize profit by choosing a price based on perceived value 2 Revenue - total Variable Cost - Fixed Cost = Profit R - VQ - F = Z PQ - VQ - F = Z Z = PQ - VQ - F 3

2 Expand The Profit Equation Z = PQ - VQ - F substitute Q = a - bp Z = P(a-bP) - V(a-bP) - F Z = ap - bp 2 - av + bpv - F 4 Z = ap - bp 2 - av + bpv - F Consider the Fixed Costs 5 Z = ap - bp 2 - av + bpv - F Consider the Variable Costs Consider the Fixed Costs 6

3 Revenue looks like R = ap - bp 2 With zero costs Revenue = Profit Revenue = Profit 0 Price 7 Subtract Fixed Costs from Revenue R - F = ap - bp 2 - F Revenue = Profit 0 P* Price 8 Subtract Variable Costs from Revenue R - VQ - F = ap - bp 2 - av + bpv - F Revenue = Profit 9 0 P* P* Price

4 Subtract Variable Costs from Revenue R - VQ - F = ap - bp 2 - av + bpv - F Revenue = Profit 0 P* Price Breakeven Points P* 10 Slope of Revenue Curve is Zero Revenue R R P = P Price Profit Slope of Profit Curve is Zero Z P = 0 Z 12 0 P Price

5 Profit Equation Is Z = ap - bp 2 - av + bpv - F substitute Z into Z P = 0 13 Profit Equation Is Z = ap - bp 2 - av + bpv - F substitute Z into Z P = 0 14 Profit Equation Is Z = ap - bp 2 - av + bpv - F substitute Z into Z P = 0 a 2bP + bv = 0 15

6 Profit Equation Is Z = ap - bp 2 - av + bpv - F substitute Z into Z P = 0 a 2bP + bv = 0 P = a 2b + V 2 16 The Price That Maximizes Profit P = a 2b + V 2 17 Consider Market Potential Consider The Customer s Sensitivity to Price Changes Consider Your Variable Costs The Price That Maximizes Profit P = a 2b + V 2 Is always higher than the price that maximizes sales revenue! 18

7 The Price That Maximizes Profit P = a 2b + V 2 19 Says if you get an increase in your variable costs pass half of it on to the customer. The Price That Maximizes Profit P = a 2b + V 2 20 Note: It Says Do NOT change your price just because you get an increase in your fixed costs! Perceived Value Pricing Is A Form of Demand Based Pricing Great Value! Pack 21

8 Perceived Value Pricing Customers respond to value To a customer Value = All Benefits to Customer Minus All Costs to Customer 22 Axiom of Value Pricing Is If you give your customer 50% more value than your competitor then you should be able to charge a 50% higher price before they switch. 23 Target Market Averages On Value BRAND A BRAND B BRAND C BRAND D STYLE 30% POWER 20% HANDLING 15% COMFORT 35% OVERALL SCORE

9 Target Market Averages On Value BRAND A BRAND B BRAND C BRAND D OVERALL SCORE Overall Score is a measure of perceived value. 25 Target Market Averages On Value BRAND A BRAND B BRAND C BRAND D OVERALL SCORE Average Perceived Value is Value = Target Market Averages On Value BRAND A BRAND B BRAND C BRAND D OVERALL SCORE Average Perceived Value is Brand D is higher than Average 27

10 Target Market Averages On Value BRAND A BRAND B BRAND C BRAND D OVERALL SCORE Average Perceived Value is Brand D is 0.275(100) % higher than average. Implication If Brand D is 6.9% higher than average then you should be able to charge up to a 6.9% higher price. If the average price is $200 then the maximum price for Brand D should be Max price for D = (6.9%) Max price for D = = $ Problem with Perceived value Pricing As A Form of Demand Based Pricing is To Measure Perceived Price or Cost to Purchase 30

11 Other Demand Based Pricing 31 Value Added Pricing (Industrial) Consider the value of the benefits to the customer Price the product relative to what the product does for the customer 32 Psychological Pricing 1. This is a closing out sale... This is a once in a life time sale. Limit of 4 per customer! 2. Loss-leader Pricing 3. Bait & Switch Pricing 4. Nature of Numbers (rounded or sharp) 33

12 Nature of Odd-Even Pricing Cash Rebate Coupons 2%10 net 30 Low or no finance charges % off list (functional discount) volume discount Cumulative 35 Discrimination Pricing Customer Based (young, old) Product/Image Based Geographical or Location Based Seasonal 36

13 If you cut your price Customers may not buy more because of Anticipate More Price Cuts Believe your Products are being made cheaper Your competitor reacts 37 Difficulties With Demand Based Pricing Unfair to gouge people when they need something. Price should not be the way goods and services are allocated in society. Too hard to calculate. Too hard to explain. Causes too many fluctuations and makes the industry unstable. 38 Competitor Based Pricing Cost Customer 39 Competitor

14 Expand The Profit Equation by All Four P s P s for customer pricing Z = PQ - VQ - F substitute demand function Q = a - bp + ca + ds + ek +... where A = advertising S = salesforce K = product quality 40 Expand The Profit Equation by All Four P s and Our Competitor s Four P s 41 Z = PQ - VQ - F substitute Q = a - bp + ca + ds + ek + fp c - ga c - hs c - ik c where A c = competitor s advertising S c = competitor s salesforce K c = competitor s product quality Going-rate Competitor Based Value-Pricing Value-pricing is not simply a matter setting lower prices than the competitor... it is a commitment to have one s operations designed to be the production cost leader. Bidding (Sealed-Bid, Dutch Cows) 42

15 Pricing Policy Prediction of Competitor s reaction to Your Price Changes Building Pricing Policies...How You Should React to Changes in Your competitors 43