! Week 9: Pricing Dr Christopher Pokarier EB202 Introduction to Business

Transcription

1 Week 9: Pricing! Dr Christopher Pokarier EB202 Introduction to Business

2 Prices + Value! Something is worth (price-wise) only what somebody else is prepared to pay for it.! Prices are determined by supply + demand! Demand is profoundly complex needs & wants economic dynamics psychological effects! Supply can be complex too: practical supply chain considerations + tactical & strategic issues in competitive contexts

3 Pricing options! Consumer-based method: charge what customers will pay! Competition-based method: price in response to rival firms pricing especially when customers perceive rival products as close substitutes and that are readily available! Cost-based method: costs plus see next slide! Under any pricing model firms must know their Break-even Point where total revenues exceed total costs

4 Cost-based pricing! Prices are often perceived by people in terms of a cost-of-production + mark-up (addition to price) added at each subsequent stage of distribution to customer! Eg. wholesaler s & retailer s mark up (compensation/profit)! This is common in both traditional industries (agriculture, small-scale production eg. baking) & mass manufacturing! Therefore many people judge the fairness of prices based on perceived costs of production & distribution! BUT many prices are NOT set this way

5 Baumol s law: art is costly! Costs in specialised labour intensive industries rise more rapidly than manufacturing

6 Prices through auctions! Auctions are a common way of price-setting (differs greatly from markup approach)! Multiple buyers (bidders) & sellers (vendors) come together! Very efficient mechanism of price discovery if the pool of participants is sufficiently comprehensive! Works well when goods are unique (houses, art) or non-standardised (fish), second-hand, or supply is unstable! Specialised knowledge often held by bidders or their agents

7 Price as rationing! Many assets + opportunities are in scarce supply so setting a price acts to ration them! A pure auction sets a market clearing price (eg. broadcasting spectrum) but the price is not related to the cost of supply! When prices are set lower (eg. for social justice) queues will form! A price above zero is often set to create a positive incentive for people to act responsibly, not be wasteful! Eg. 100 yen deposits in coin lockers otherwise naughty schoolboys might lock them and throw away the keys!

8 A price of zero invites waste! Appeals to morality are often insufficient to secure responsible use of resources

9 Price as signal! Price may be a powerful signal of quality for consumers when product quality can t be assessed easily! Hence severe discounting may increase consumers perceived risk of the quality of a product! A price leadership strategy (rather than differentiation) must emphasise cheap BUT good! Even then, cheap is bad in some markets! In the education market, some of the best and worst schools are expensive and cheap!

10 What price peace of mind?! Paying for assurance.. Or at least diminished grounds for regret

11 Paying for what? Cheapness is often NOT the main concern of consumers. They might be valuing other attributes:! Reliability & quality ( cost/performance ; over time) + less regret! Status! Signalling effect to others (eg. a gift should often look or be known to be expensive)! Conspicuous consumption (even waste) can be a sign of strength! BUT the latter is very tacky nouveau riche!! (& common)

12 Profits + prices! Businesses pursue profit maximisation! Time frame becomes difficult: in some industries firms choose to lose money in the short-term to make money in the longterm! Common when switching costs are high for consumers (eg. lockin) eg. mobile phones, printers & cartridges! or when competitors are driven-out (price wars & dumping) eg. airlines, other high fixed-cost industries

13 Setting prices When setting prices need a strong understanding of:! Industry structure: how will competitors react?! Consumer preferences: Who are your competitors? not just in your industry but rival products for the customer s money! Your production costs: average & marginal costs what will happen to your costs at various levels of production?! Your cash position: capacity to bear losses in the short-term?! Consumer psychology

14 Price elasticity of demand! A basic micro-economics concept that measures the degree of sensitivity of demand for a product to a change in its price! Elastic demand: an increase in price causes a large decline in demand (typically, a reduction in net revenue for the firm)! Inelastic demand: a change in price has little impact on demand (firms may increase revenue with higher prices)! Income elasticity of demand: measures impact on demand of a change in income: inferior goods have negative income elasticity (with rising income there is substitution by superior goods so demand falls eg. poor quality food Engel s Law)

15 Other people s money! People may be much less price sensitive when spending money that is not their own!

16 Scarcity is value! Many people seek exclusiveness in certain goods & experiences! Shortages therefore can fuel demand! eg. Hermes Birkin bag :US $10,000 to $60,000! Firms may orchestrate shortages to suggest value! Scarcity also triggers a sometimes rational consumer impulse to hoard, in anticipation of demand from others

17 Consumer surplus! Consumers each value a product (or service) differently! With standardised pricing many consumers will pay less than they are prepared to for a product! But firms have to set the standard price relatively lower to maximise revenues by getting the more price sensitive customers to buy too! Consumer surplus refers to the value a consumer gets from a product above the purchase price! Firms would like to charge different prices to each customer, depending on their preparedness to pay

18 Capturing consumer surplus! Segmentation strategies aim to get consumers to pay differing prices for similar goods! versioning Special Limited Editions for hardcore fans, premium priced first releases, discounted products with delays, premium distribution channels, varied labelling etc! Many sales & pricing techniques reflect this logic eg. clothing sales, early conditional school/university offers

19 Price points! Why are so many things priced at 199, 298, 990, etc etc?! How much would you pay for lunch?! A mix of consumer psychology & their very rational budgeting: many products are made to a price! Initial prices may be set high in order to have a high impact discount later (reinforces versioning/segmentation too)

20 Bundling! Increase total customer spend & your cash flow through bundling together at a seeming discount things customers probably would not buy separately! Music albums rather than singles! 50% off second pair ( from a limited selection eg. A Mart)! Fast food sets how often would you buy the fries otherwise?! A lot of lousy products get sold in bundles

21 Cash is King! In recessions, or times of corporate crisis, positive free cash flow is particularly vital

22 Customer s price is not the firm s cost! A credit (eg. points or voucher) given to a customer does not cost the firm what it provides in benefit.! Eg. points cards at Bic, Yodobashi or Yamada/Labi! When retail mark-ups are high (retailer s margin above their wholesale cost) a 10% point gift is less costly than a 5% discount! Plus customers are locked in to returning, and/or they lose their points card and never claim! Shop gets cash today, customers again, & customers get to give themselves a present in the future (especially good if work paid for the initial purchase! eg. frequent flyers points)

23 The last buyer sets the price!! If there is full transparency: be careful not to cheapen your brand: discount discretely