Flashcards in Pricing Deck (29)

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## Internal method of pricing

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- Cost plus/target pricing

- A simple way to arrive at a sales price by adding a mark-up to the cost of a product.

- Need to determine the break-even price/total price, which is the sum of all the expenses involved in creating a product (determine objective based on the scenario)

- Need to determine the target/profit goal

- Applies to product and services

- Drawbacks: ignores price strategies of competitors and role of customers

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## External methods of pricing

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Competition based

Consumer demand based

Auction based

Value based

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## Competition based pricing

### deciding how much to charge depending on what the competition charges.

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## Head on pricing

### Charge exactly the same price as competitor

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## Differential pricing

### decision to lower or increase the price vs. competition based on strategic objectives

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## Competition based pricing advantages

### intuitive appeal about how consumers might think

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## Competition based pricing disadvantages

### does not take into account competitors' internal cost structures (some competitors may have much higher efficiencies to lower price even further). Most times, you don't know how competition can set prices.

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## Consumer demand based pricing

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- Charge as much as the "market will bear" - start with charging a certain price, adjust as you go along.

- Success depends on the ability of marketers to analyse the demand

- This type of pricing can be seen in the hospitality and travel industries. For instance, airlines during the period of low demand charge less rates as compared to the period of high demand.

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## Auction based pricing

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Prices are determined by bidding customers

- English (ascending): one seller, many buyers

- Dutch (descending): one buyer, many sellers

- Sealed bid: participants don't know each others' bid

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## Auction based pricing advantages

### Real time price discovery

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## Auction based pricing disadvantages

### May alienate customers, can be risky

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## Value based pricing

### the method of setting a price by which a company calculates and tries to earn the differentiated worth of its product for a particular customer segment when compared to its competitor

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## Value based pricing considerations

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- Focus on a single segment

-Compare with next best alternative: ask the question - "what would this segment buy if my product wasn't available?" Value based pricing methodology not suitable for truly new products

- Understand differentiated worth: which product features are unique, that is differentiated, from the competitor's offering.

- Place a dollar amount on the differentiation.

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## Best solution to pricing method

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- Mixed methods: taking into account both external (macro environment, competitors and customers) and internal factors

- Setting the price point: use various methods and sources of information together to arrive at a final pricing strategy, your final number

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## Price premium purpose

### To evaluate pricing in the context of market competition

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## Benchmark price can be

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- Price of a specified competitor: simple price by competitor.

- Average price paid: unit sales weighted average of competitor prices

Average price charged: unweighted average of competitor prices.

Average price displayed: average weighted to distribution (numeric, PCV, ACV)

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## Average price paid

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- Requires knowledge of ales or shares of each competitor

- Changes in unit prices/ shares will affect the average price paid

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## Average price charged

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- Requires knowledge of prices and not the shares of each competitor; hence not impacted by changes in unit shares

- Captures how brand compares to prices set by competitors without regard to brands share; hence all competitors are weighted equally.

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## Average price displayed

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- Managers who seek a benchmark that captures differences in the scale and strength of brands' distribution might weight each brand's price in proportion to a numerical measure of distribution

- Typical measures of distribution strength include numeric distribution, ACV (%) and PCV (%).

- Sum of weighted prices of each brand to be divided by the total weighting for the average price.

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## Price premium problems

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- Competitors: who are they? Should we include own price, just leading competitors, all?

- Should we use manufacturer, distributor or retail prices?

- Prices can be calculated net (discounts, rebates, coupons deducted) or gross

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## Role of demand curves and price elasticity

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- The purpose of these metrics is to bring consumer information into the pricing process

- This group of metrics is based on microeconomic theory

- The theoretical models need to be estimated by empirical measurements

22

## Price Elasticity of Demand

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- PED measures the responsiveness of demand after a change in a product's own price. Expressed as a ratio percentage % change in quantity for a small % change in a price.

- In markets that are unresponsive to price changes, demand is inelastic

- If minor price changes have a major impact on demand, we say demand is elastic

- Elasticity becomes more negative - as price increases.

- Elasticity varies not only between different goods, but also along the demand curve for any specific good using a straight-line demand curve.

- PED will go from infinity to zero with unit elasticity in the middle

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## Price elasticity of demand purpose

### to understand market responsiveness to a small change in price

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## Price elasticity of demand considerations

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- PED will almost always be a negative number indicating that when prices increases, the quantity demand is expected to decline and vice versa.

- When demand is linear, elasticity changes with price

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## Perfectly Elastic Demand/Infinite Price Elasticity

### In perfectly elastic demand, a small rise in price results in fall in demand to zero, while a small fall in price causes increase in demand to infinity. Change in market supply will not lead to any change in price.

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## Unitary Elastic Demand

### When the change in demand produces proportionate change in the price of the product

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## Perfectly Inelastic Demand

### A perfectly inelastic demand is one when there is no change produced in the demand of a product with change in its price.

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## Implications

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- When we analyse price elasticities we're concerned with their absolute value, so we ignore the negative value.

- The number itself is just a means to an end.

- The key is to understand of demand to price

• If PED > 1 then Demand is Price Elastic (Demand is sensitive to price changes)

• If PED = 1 then Demand is Unit Elastic

• If PED < 1 then Demand is Price Inelastic (Demand is not sensitive to price changes)

- We always ignore the negative sign when analysing price elasticity, so PED is always positive.

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