Pricing Strategies

Product and Customer Management

Professor Rui de Carvalho

JeongWon Lee

João David Carvalho

João Rodrigues
 Product and Customer Management - Pricing Strategies

Índice
Introduction .................................................................................................................. 3
Differential pricing strategies ........................................................................................ 4
Second Market discounting ....................................................................................... 4
Periodic discounting .................................................................................................. 5
Random discounting .................................................................................................. 6
Competitive Pricing ....................................................................................................... 7
Penetration Pricing .................................................................................................... 7
Experience Curve Pricing ........................................................................................... 9
Price Signaling ......................................................................................................... 10
Geographic Pricing .................................................................................................. 11
Product line pricing strategies ..................................................................................... 13
Price Bundling ......................................................................................................... 13
Premium Pricing ...................................................................................................... 14
Image Pricing ........................................................................................................... 15
Complementary Pricing ........................................................................................... 16
Conclusion .................................................................................................................. 18

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 Product and Customer Management - Pricing Strategies

Introduction

The objective of this group-work is to study and analyse several price strategies. In
order to do it in a more deep and comprehensive way, it was requested to present an
example for each price strategy.

The most conceptual part of this work was based on the paper of Gerald J. Tellis,
“Beyond the many faces of price: An integration of pricing strategies” and the
examples for each strategy were selected by the group, based on the information
available on the web for the respective product or service.

In this globalized world-wide context when we are faced everyday by so many stimuli,
it is important to know why and how companies face their price strategies in order to
attract and discriminate customers. The price is the visible cost to clients, but in fact,
the price strategy that each company chooses is not only determined by adding a
margin to a variable cost but also determined by its context, their positioning and the
type of customers to whom they want to sell.

There were analyzed 11 different types of pricing strategies, according to 3 different

groups:

 Differential pricing strategies

 Competitive pricing
 Product line pricing strategies

Being a price strategy a “a reasoned choice from a set of alternative prices (or price
schedules) that aim a profit maximization within a planning period in response to a
given scenario”, this work aims to identify and clarify the most common pricing
strategies according to the referred groups.

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Differential pricing strategies

The main goal of this kind of pricing strategies is to discriminate prices due to
the existence of different kind of customers for the same product or service. If a
company wants to maximize its profit, it must not only discriminate its price (in order
to take advantage of its client’s heterogeneity) but also to be perceived by different
types of customer as the most valuable product.

Second Market discounting

This pricing strategy is much related to the opportunity costs that companies
may face. When a company has unused capacity (when it produces less than it could),
every offer of buying that outperforms the variable costs is a good one. This fact is
explained by the existence of fixed costs that, as its name indicate, they are the same
independently of the sales, so they must be covered. Every cent that overpays the
variable costs it’s a profitable one.

In general, this efficient and economic option goes along with companies that
have the opportunity to sell to different markets (exportation, during production
proposals, “white brands” of the same brand, special prices for a segment, etc.) and to
segments that have high transactional costs.

Some economists criticise this kind of strategy considering it dumping, but in

general the idea of covering the fixed costs by reducing the price even with a higher
variable cost is accepted. However, explicit price discrimination is illegal in most
countries.

Example:

Nestle has its well known coffee brand

Nescafé Gold that, in average, sells at 6.49€.
However, the same brand has created a variance
of this kind of product with a different name,
brand and positioning: Belmont Gold, which is
sold at 3.29€.

Due to its huge capacity of production,

Nestlé intended to create a new brand that could reach a different type of customers
in a different and much lower price. With this strategic option, Nestle can not only
cover its fixed costs as also satisfy a new segment.

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Periodic discounting
In markets that have unpredictable demand, the periodic discounting (that
includes price skimming) might seem like a secure way of getting its production costs
covered.

This strategy consists in differentiating the price of the same product in

different time spaces and for different types of costumers. In the beginning of the
selling period, the company starts by putting a high price to its product or service,
usually having a big margin. However, and it has not to be necessarily in a year, the
price gets slowly lower and, sometimes, in the end of the product life cycle, it is being
sold with a minimal margin, reaching the customer “reservation price”, the value of a
product to a customer.

By doing this, the company can not only stabilize demand (because it is usually
applied to “one time buy” products) but also can discriminate prices for early adopters,
covering its fixe cost in a faster manner (for example, at the 3 rd month of sells, the
company may have already 70% of the profits).

This kind of pricing strategy is very predictable and sometimes the customers
themselves already know that it will happen, but because there are different kind of
need (fast or more rational) for a product, it is nor a disadvantage. It is vey common to
happen with airplane tickets, game consoles (like Playstation or Xbox) or even happy
hour drinks in a party.

Example:

In 2007, the release price in Portugal of Playstation 3

(Ps3), Sony’s game console, was on average 650€. However,
periodically, Sony reduced its price, and today (5 years
passed) it is nearly 350€ in its “slim” version.

Even though the same situation had happened with

the release of Ps2, there were thousands of people waiting in
line to be the first ones to get the new console, happily
spending much more than the minimum wage for a game console.

By doing this all over the world, Sony had the

capacity to gain a huge margin in its first years of sales
and also nowadays can reach a more reserved and a
spender segment.

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Random discounting
The strategy known as random discounting has a lot to do with customer
search and its search costs.This is the third type of differential pricing and its objective
is to descriminate the customers buy its cost of search for a different price.

Some customers are more rational and more price sensitive, so they will
perceive their benefit of finding a lower price as much superior when comparing to the
time they spend looking for an alternative. They are the informed customers.

In the other hand, there are some customers that due to their price insentivity
or to having less time for shopping, buy the first product that they see. These are the
uninformed customers.

By doing a random discounting, for example, stablishing a lower price A and a

higher price B, the company makes sure that the informed customers will buy their
products because this price A will be lower than its competitors. At the same time, by
having a price B, the company ensures that there will be some uninformes customers
that will buy at a higher price, providing a higher margin.

Example:

A new type of business that is emerging are

the “discounting websites”, where it provides some
daily or weekly products at a very low price
(sometimes 70% discount). These kind of websites
put in their platform some products from
companies that use the random discounting strategy.

The most informed and price sensitive

customers will frequently use this websites (like
groupon, planeo, etc.), being a way to the
companies to discriminate by segment. The
uninformed custumers don’t have the time or
the patience to search in this web pages, being
able to pay a higher price at local stores.

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Competitive Pricing

Competitive Pricing is used more often by businesses selling similar products,

since services can vary from business to business while the attributes of a product
remain similar.

Inside this Competitive Pricing, there are four main strategies. First, the
Penetration pricing; in second place, the Experience Curve Pricing; in third place, the
Price Signalling; and at last, the Geographic Pricing.

Penetration Pricing
Penetration pricing is a marketing
strategy used by companies to attract
customers to a new product or service. This
strategy consists by offering a low price for a
new product or service during its initial
offering in order to leave customers away
from competitors. The reason behind this
marketing strategy is that customers will buy
and become conscious of the new product
owing to its lower price in the marketplace relative to rivals.

This strategy pricing can be a successful marketing strategy when applied

correctly. It can often increase both market share and sales volume. It calls for a
sacrifice of short-term profits in order to establish a certain amount of market share.
One objective is to obtain a committed customer. Farther, the high sales volume can
also lead to lower production costs and higher inventory turnover, both of which are
positive for any company with fixed overhead.

Developing your product or service and increasing sales typically involves

market penetration. Market penetration refers to the successful selling of a product or
service in a specific market. Companies that establish an effective market penetration
strategy can ultimately increase their customer base and the quantity of products sold.
As any strategy, this one has advantages and disadvantages.

The main advantage is the gain market share, the increasing sales and volume
product, the product diffusion and the formation of a hedge that discourages the entry
in the market by other competitors.

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The chief disadvantage, however, is that the increase in sales volume may not
necessarily lead to a profit if prices are kept too low. As well, if the price is only an
introductory campaign, customers may leave the brand once prices begin to rise to
levels more in line with rivals.

Example:

This is an example of “Penetration Price Strategy”, is a

Wal-Mart’s Backyard Grill with a price of $18, 97. Wal-Mart use
penetration pricing in two ways. First, they offer new products
through their stores at prices much lower than other stores,
waiting that you will buy more than that one product once you
come in the store.

They are prepared to lose money on the new product

as a way to get more customers through the door. They use
penetration pricing in new geographic markets by underselling
their more well-established competitors. When they have a
loyal customer base, they normally begin to gradually increase
prices.

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Experience Curve Pricing

Experience Curve Pricing is a strategy where
there are a competitive market, a price sensitive
customers and a large experience of the industry.

A market leader will usually have greater

demand for its goods and services than its
competition. As a result of increased production,
the Experience Curve suggests its costs will
decrease over time. This will allow the company to decrease its prices to levels below
what is sustainable for the competition, resulting in increased competitive advantage.
As the cycle repeats itself the company should continue to strengthen its overall
position.

Of course this reduction in cost as volume increases does not happen

automatically. The relationship is the result of conscious actions taken by management
to actively bring down costs over time, usually in the face of competitive pressures.
Thus, one can think of the Experience Curve relationship as the result of a company
fully realizing it’s potential.

There are some advantages on this strategy. First, the competitors can’t follow
the company so they will quit the market. Is also important, the hypothesis of the
experienced company could acquire new market. In third, the possibility of new
customers enters in the market. At last, the fact of with this strategy the company will
sacrifice itself, but, nevertheless, could be quickly sustainable.

Example:

This is an example of
Experience Curve Pricing, is Bausch & Lomb (creator of the Ray-Ban glasses) that has
consolidated its position in soft contact lenses by automating, using computerized lens
design. Its market share climbed from 55% in 1980 to 65% in 1983 and now earns gross
margins 20 to 30 percentage points higher than its competitors.

What distinguishes the winners from the losers in the

experience curve game is their achievement of both the logic of
the experience curve and the characteristics of the competitive
arena that determine its suitability as a strategic weapon. And in
this case, Bausch & Lomb known how implement the strategy,
driving off some competitors off the market.

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Price Signaling
Price Signaling is an explicit or implicit agreement among competitors to fix
prices through coordinated action among participants, eliminating competition and
raising product prices, obtaining higher profits to the detriment of consumer welfare.

This strategy generate a premium estimated at between 10% and 20%

compared to the price in a competitive market, causing losses of hundreds of billions
of dollars annually to consumers.

Consequently, it has born an interesting problem. In terms of economic

incentives, and when combined with the partners a certain price to sell, each member
has an advantage in deceiving partners, break this agreement and sell more and
cheaper, stealing customers to competitors. Therefore, this normally ends with price
wars. The problems of some companies that use this strategy usually result from bad
behavior of its participants, which is motivated by this incentive to stick the
agreement.

So, this strategy, now illegal, is considered the most serious injury to
competition and harms consumers by raising prices and restricting supply, thus making
goods and services more expensive or unavailable.

Example:

In Portugal, the “competition law” forbids

colligations between companies that have the
objective of settle prices or other elements that
disturb the normal operation of the market. However,
one of the most difficult to be regulated is the market
of petroleum and the petrol stations.

One example of Price Signaling is the

Portuguese petrol stations (Galp Energia, BP and
Repsol). Although, they say the opposite is clear as water. The price of the tree gas
stations change exactly at the same and exactly time, having the same price
(sometimes a minimum difference).

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Geographic Pricing
Geographic Pricing is a variable pricing method in which a selling price is computed
according to the customer’s or market’s distance or transportation costs incurred.

Geographic pricing can be seen like a selling strategy that involves

consideration of the average cost of goods in a given geographic area as well as the
expenses incurred to transport those goods to the point of sale. Using the data related
to the location and the amount of cost involved in providing goods to that area, the
manufacturer or seller will determine a unit price that covers all expenses and also
allows for the generation of an equitable amount of profit. As with any type of pricing,
the final figure in geographic pricing will also be impacted by the demand for the
goods in question and how many competitors are offering similar products in the area.

The companies have five options to settle the prices.

First, through “FOB”, that’s when the company decides to charge a large
amount because, they claim for additional shipping fee.

Second, through uniform delivered price, when the markets share the
transportation cost (the company take the same price in both zones).

Third, trough freight absorption cost, when the company take a higher price for
the foreign market because the competitive price is settled lower than the company
would choose to, if she added the transportation cost. This is the opposite of the first
one, “FOB”.

Fourth, trough basing point pricing, when certain cities are designated as
basing points, and all goods shipped from a given basis point are charged the same
amount. At last, trough zone pricing, when prices increase as shipping distances
increase. This is sometimes done by drawing concentric circles on a map with the plant
or warehouse at the center and each circle defining the boundary of a price zone.

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Example:

An example of price discrimination exists in the

market for protease inhibitors and other AIDS drugs.
Cipla (an Indian Pharmaceutical Company) is an

example of Geographic Pricing.

It all started with the famous case of Uganda and the

high price of AIDS drugs. The prices of AIDS drugs in Norway
were lower than the prices available in Uganda. A simple
reading of price discrimination theory would lead one to
expect that Norway would have higher prices, because its
citizens’ incomes were much higher and, thus, their demand for
AIDS drugs would be much more inelastic than the demand for AIDS drugs in Uganda.

The number of AIDS cases in Norway was relatively low and the causes tend to
be concentrated among those with the lowest incomes, where substantial elasticity
exists. In Uganda, the incidence of AIDS is much higher. Most Ugandans couldn’t afford
AIDS medication even at Norwegian prices. After substantial political pressure was
brought to bear, prices in Africa were reduced.

Cipla, a big producer of such

generic drugs, needed a new factory
site in a least developed country so
it could keep selling its wares. Cipla
decided on a site in Kampala due to
the East African nation's high
prevalence of HIV and malaria and
its business-friendly environment.

The plant (with that is

produced the generic drugs)
followed the most advanced manufacturing practices. Still, the cost of production in
Uganda was much lower than in Europe, the U.S., or even India. With lower production
costs and an exemption from patent regulations, the new plant could sell its drugs for
as little as 5% the cost of imports.

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Product line pricing strategies

In order to increase the sales, sometimes companies face themselves with the
option of selling different products that can be assimilated, creating different prices for
different benefits. A product with more benefits (extras) will be more expensive.

By doing this, a company can create not only the idea that sells a lot of products
but also that their services are personalized.

Price Bundling
Price Bundling is a part of product line pricing strategies. This is used when a firm is
in front of heterogeneity of demand for nonsubstitute, perishable products. This
strategy is interested in consumers to buy at the price bundle. It is easy to be broken
out with different perceived value for more than two products. For example, firm a
produce product A and B. The firm selects high prices as much as they can sell, then
make bundle to maximize more profit for customers who want to buy both products
when perceived values by consumers were different.

Through this, all consumers and sellers can be more satisfied with the mixed
bundling strategy than with the pure pricing. Profit maximizing strategy uses making
package of products. The mixed bundling strategy has the added advantage of creating
the reference price effect. This strategy is usually used in season tickets, buffet
dinners, packages of stereo equipment, and packages of options on automobiles.

Example:

The example of price bundling is Haagen-dazs. This

company is famous as ice cream which is focusing on
consumers who can pay high price
to high quality. It sells one scoop of
ice cream as 2.75 euros and coffee
as 1 euro. But if you buy two products, you can get it with 3 euros.
Consumer can buy bundle with relatively cheap price, and this firm
can maximize its profit.

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Premium Pricing
Premium pricing is that exploits consumer heterogeneity of demand for
substitute products with joint economies of scale. Being relative to its costs, the firm
takes a premium on its higher priced version. But, because of exploiting joint
economies of scale and the heterogeneity of demand, it can profitably produce and
sell the products.

Premium pricing is used in durable goods, such as appliances, for which multiple
versions differing in price and features cater to different consumer segments, exclusive
perfumes, insurance policies, rear auditorium seating, deluxe and basic hotel rooms.
This strategy emphasizes segment differences by pricing substitutes differently, and
holds for any one time and the price variation is over related models. In retail,
Premium pricing is used for enabling retailers to carry some otherwise unprofitable
products desired only by select segments.

Example:

One of examples of Premium pricing is seats

at football match in stadium. It has R(Royal),
S(Special), A, B seats with various prices. Up to
distance and condition, the prices are becoming
different. For instance, in Korean football match
season, R seats are higher than 100,000\ in football
match, S are around 70,000\. Seats are sold at about 50,000, and B seats are lower
than 30,000\. Through providing seats with different
price, it makes segment differences. In addition,
stadium holds for any one time and the price variation.

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Image Pricing
A company can bring out an identical version of its current product with a
different name and a higher price. The intention for using this strategy is to signal
quality of products. There is this strategy between price signalling and premium
pricing.

A firm needs to use the higher priced products to signal quality for consumers
who don’t know about products well. Also, this firm requires using the profit
subsidizing the price on the products which is low price makes on the higher priced
version. In this strategy, prices are different over different brands of the same firm’s
product line. This pricing strategy can be useful in prices of alternative brands of
cosmetics, soaps, dresses.

Example:

Chateau Margaux winery which is a winery in France, produces a few kinds of

wines. The famous one is ‘Chateau Margaux’ and another one is Pavillon Rouge Du
Chateau Margaux, the second label of Chateau Margaux . Chateau Margaux was sold
at 100,000￥ in 2005. However, the second label wine was bought at 30,000￥. These
two wines are made by same procedure, but because of image, they have very big
price gap. Through this strategy, Chateau Margaux can be recognized as a very good
quality wine.

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Complementary Pricing
Complementary pricing includes captive pricing, two-part pricing, and loss
leadership.

Captive pricing is that a firm would have to include as costs a discount for
future earnings and the risk that consumers would not purchase supplies. This strategy
has limit if consumers are not source loyal and would like not to buy supplier likes from
the original source even at a higher price.

Two-part pricing has fixed fee plus variable usage fees. This strategy can be
used in libraries, health or entertainment clubs, amusement park, or rental agencies.

Loss leadership includes decreasing the price on a famous brand to generate

store traffic. The discount price should be big gap for compensating consumers for the
transaction cost such as letting extra time. For concrete a success using this pricing
strategy, retailers feature several “super buys”, products of national brands sold below
cost.

Example:

1. Captive pricing

In Korea, There is a company named Woongjin Coway renting water

purifier. This company rents water purifier making contract. In this
contract, consumers have to deposit some money, and should pay
monthly then company rents the machine with maintaining service.
After 3 years, company gives this water purifier to the consumer.

2. Two-part pricing

If a exchange student wants use cell phone, he or she has to pay 5 euros as a basic
fixed fees, and then needs to pay more for using SMS, internet, and calling.

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3. Loss leadership

The example of loss leadership is outlet of specific brand. One of

example of this pricing strategy is PRADA, very well-known as a
luxury brand. PRADA has its own outlet, the PRADA SPACE. If you go
there, you can buy the products with more than 50% discounts.

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Conclusion

According to the firm’s type of clients, demand and vision, a clear pricing strategy must
be elaborated in order to maximize its profits under its constraints. The price, has we
saw, represents much of the product or service image and positioning, being a critical
factor to determine wheter a company has a successful or unsuccsseful path.

With this work we hope to have identified the most important pricing strategies in a
clear manner, supported by pertinent and appliable examples.

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