AGENDA

Determinants of Price

What influences the price most?

 Determinants of Price
1.Internal factors
Factors which are controllable by the
company and, if necessary, can be altered .
They Include:
• The company’s marketing objectives
• Marketing mix strategy
• Costs
• Organization of pricing- who sets the price
 Determinants Of Price
2. External Factors
Factors which are not controlled by the
company but impact pricing decisions
They include:
• Nature of the market and demand
• Competition
• Environmental factors-government regulations,
economic policy, economic situation etc.
 Pricing Considerations

Demand Factors (Value to Buyers)

(Price Ceiling)

Competitive Factors
Final Initial
Pricing Pricing
Discretion Corporate objectives and Discretion
regulatory constraints

Direct Variable Costs)

(Price Floor)
 Setting Pricing Policy

1. Selecting the pricing

objective

2. Determining demand

3. Estimating costs

4. Analyzing competitors’
costs, prices, and offers

5. Selecting a pricing
method

6. Selecting final price

 The Three C’s Model
for Price Setting

Customers’
Competitors’ assessment High Price
Low Price Costs prices and of unique
prices of product No possible
No possible substitutes features demand at
profit at this price
this price
 Marketing Strategy Over the Product Life Cycle
INTRODUCTION GROWTH MATURITY DECLINE
Marketing strategy Market development Increase market Defend market Maintain efficiency in
emphasis share share exploiting product
Pricing High price/unique Lower price Price at or below Set price to
strategy product / cover over time competition remain profitable
production costs or reduce to
Low price/gain liquidate
market share
Promotion Mount sales Appeal to Emphasize Reinforce loyal
Strategy promotion for mass market brand differences, customers; reduce
product awareness benefits & loyalty promotion costs

Place strategy Distribute through Build intensive Enlarge Be selective in

selective outlets network of distribution distribution, trim
outlets network unprofitable outlets
CONSUMER SURPLUS
 Consumer Surplus
• How much are you willing to pay for a pair of
jeans?
• As an individual consumer, you have no say in
determining the market price; you take the market
price as given.
• If the market price is at or below what you are
willing to pay for a good, you buy it.
• If the market price is below what you are willing to
pay for a pair of (your favorite) jeans, your
purchase will result in consumer surplus: the
difference between the price that you were willing
to pay and the (market) price you actually paid.
 Consumer Surplus
• Willingness to pay: the maximum amount that a
buyer will pay for a good.
• It measures how much the buyer values the good
or service.
• Consumer surplus: a buyer’s willingness to pay
minus the amount the buyer actually pays.
• Consumer surplus is still the area above the price
and below the demand curve
 Consumer Surplus
• Individual consumer surplus = net gain from the
purchase of a good= the difference between the
maximum price a consumer is willing to pay for
a good and the actual price paid

• Total consumer surplus is the sum of all

consumer surpluses gained by all buyers of a
good in the market
How the Price Affects Consumer Surplu
(a) Consumer Surplus at Price P
Price
A

Consumer
surplus
P1
B C

Demand

0 Q1 Quantity
 Consumer surplus = the area above the
price and below the demand curve
100 Consumer surplus = {400(100-35)}/2
= 13000

Consumer Surplus

35 P = 35

0 400
How the Price Affects Consumer Surplus
(b) Consumer Surplus at Price P
Price
A

Initial
consumer
surplus
C Consumer surplus
P1
B to new consumers

F
P2
D E
Additional consumer Demand
surplus to initial
consumers
0 Q1 Q2 Quantity
 Consumer Surplus and a Price Increase

100 Consumer surplus = {270(100-60)}/2

= 5400

Consumer
Surplus
60 P = 60

35

0 270 400
 What Does Consumer Surplus Measure?

• Consumer surplus, the amount that buyers are

willing to pay for a good minus the amount they
actually pay for it, measures the benefit that
buyers receive from a good as the buyers
themselves perceive it.
Producer Surplus
 Producer Surplus
• The seller’s cost: the lowest price a seller is
willing to accept for a good: (marginal cost of
production)
• Producer surplus: the difference between the
(market) price a seller actually receives and
his/her (seller’s) cost
• A seller would not sell below his/her cost
• If the market price is below a seller’s cost the
seller will leave the market
 Producer Surplus
• Producer surplus is the amount a seller is paid
for a good minus the seller’s cost.
• It measures the benefit to sellers participating
in a market.
• Cost: the value of everything a seller must give
up to produce a good.
Using Supply Curve to Measure Producer
Surplus
• Just as consumer surplus is related to the
demand curve, producer surplus is closely
related to the supply curve.
• The area below the price and above the
supply curve measures the producer surplus in
a market.
 How a Higher Price Raises
Producer Surplus
As price rises, producer surplus increases for two reasons:
1.Those already selling the product will receive additional
producer surplus because they are receiving more for the
product than before
2.Since the price is now higher, some new sellers will enter
the market and receive producer surplus on these additional
units of output sold
 How the Price Affects
Producer Surplus
(a) Producer Surplus at Price P

Price
Supply

B
P1
C
Producer
surplus

0 Q1 Quantity
 Producer Surplus and The Market Supply
P Producer surplus = 6750
S

60 P = 60

Producer
Surplus

10

0 270
 How the Price Affects
Producer Surplus
(b) Producer Surplus at Price P

Price
Additional producer Supply
surplus to initial
producers

D E
P2 F

B
P1
Initial C
Producer surplus
producer to new producers
surplus

0 Q1 Q2 Quantity
Consumer and Producer Surplus in
the Market Equilibrium
Price A

D
Supply

Consumer
surplus
Equilibrium E
price
Producer
surplus

Demand
B

0 Equilibrium Quantity
quantity
 Total Surplus
S
100

Consumer
Surplus
60
Producer
Surplus

10 D

0 270
Total surplus is maximized at the market
equilibrium
Price
Supply

Value Cost
to to
buyers sellers

Cost Value
to to
sellers buyers Demand

0 Equilibrium Quantity
quantity

Value to buyers is greater Value to buyers is less

than cost to sellers. than cost to sellers.
 Total surplus is maximized at the market
equilibrium
• At any quantity of output smaller than the
equilibrium quantity, the value of the product to
buyers is greater than the cost to sellers so total
surplus would rise if output increases
• At any quantity of output greater than the
equilibrium quantity, the value of the product to
buyers is less than the cost to sellers so total surplus
would rise if output decreases.
 Remember
• Consumer surplus equals buyers’ willingness to pay
for a good minus the amount they actually pay for it.
• Consumer surplus measures the benefit buyers get
from participating in a market.
• Consumer surplus can be computed by finding the
area below the demand curve and above the price.
 Remember
• Producer surplus equals the amount sellers receive
for their goods minus their costs of production.
• Producer surplus measures the benefit sellers get
from participating in a market.
• Producer surplus can be computed by finding the
area below the price and above the supply curve.
 Remember
• An allocation of resources that maximizes the
sum of consumer and producer surplus is said
to be efficient.
• Policymakers are often concerned with the
efficiency, as well as the equity, of economic
outcomes.
 Remember
• The equilibrium of demand and supply maximizes the
sum of consumer and producer surplus.
• This is as if the invisible hand of the marketplace leads
buyers and sellers to allocate resources efficiently.
• Markets do not allocate resources efficiently in the
presence of market failures.
 Individual task
• Why is it important to analyze consumer
surplus and producer surplus in marketing?
 Efficient Market
The efficient Market Performs Four Key Functions
•It allocates consumption of the good to the potential buyers
who value it the most,
•It allocates sales to the potential sellers who most value the
right to sell the good (i.e., those who have the lowest cost)
•It ensures that every buyer values the good more than every
seller who sells the good (i.e., there is a surplus from the trade)
•It ensures that every consumer who doesn't buy the good
values it less than every seller who does not sell the good (i.e.,
there are no additional gains from trade).
PRICING STRATEGIES
 Overview

The pricing strategies of the firm depends

on many factors including;
• The product life cycle

• Other marketing mix

• Marketing objectives

• External factors
 New-Product Pricing Strategies
1. Skimming pricing
– Charging a high price initially and reducing the price
over time
– Commonly used when introducing new & innovative
products
– Can be used as a tool for segmenting a product’s
market on a price basis
– 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: jewellery, digital technology, new
DVDs, etc.
38
 When to Use Skimming Pricing

Appropriate when:
1. Demand is likely to be price inelastic
2. There are different price-market segments
3. The offering is unique enough to be protected from
competition by patent, copyright, or trade secret
4. Production or marketing costs are unknown
5. A capacity constraint in producing the product or
providing the service exists
6. An organization wants to generate funds quickly
7. There is a realistic perceived value in the product or
service
8-39
 New-Product Pricing Strategies
1. Penetration pricing
– Charging a low price when entering the market to
capture market share
– Used when competitors are closing in with similar or
better products
– 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
 When to Use Penetration Pricing

Appropriate when:
1. Demand is likely to be price elastic
2. The offering is not unique or protected by patents,
copyrights, or trade secrets
3. Competitors are expected to enter market quickly
4. There are no distinct and separate price-market
segments
5. There is a possibility of large savings in production
and marketing costs if a large sales volume can be
generated
6. The organization’s major objective is to obtain a large
market share 8-41
 New-Product Pricing Strategies
3. Intermediate pricing
– Pricing somewhere in between the skimming
strategy and the penetration strategy

42
 Product Mix Pricing Strategies

1. Product Line Pricing

• Setting price steps between product line items
• When pricing products in different lines, must
take cross-elasticities of demand across the
set of products into consideration
• The idea is to maximize the profits of the
entire organization rather than that of a single
product or a single
 Product Mix Pricing Strategies

2. Optional-product pricing
• Pricing optional products to be sold with the
main item
3. By-product pricing
• Pricing low value by-products to get rid of
them
4. Product bundling pricing
• Pricing bundles of products sold together
 Product Mix Pricing Strategies

• Using product bundle pricing, sellers often

several products and offer the bundle at a
reduced price.
 Product Mix Pricing Strategies
5. Captive-product pricing sets a price for
products that must be used along with a main
product, such as blades for razor and games for
a video-games console.
 Price Adjustment strategies

1. Discount and allowance pricing

• Reducing prices to reward customer responses like paying
early
2. Segmented pricing
• Adjusting prices to allow for differences in customers or
locations
3. Psychological pricing
• The price is used to say something about the product >
Product’s price signal’s quality 2%10 / N30
• 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
 Price Adjustment strategies

4. Promotional pricing
• Temporarily reducing prices to increase short-run
sales
5. Geographical pricing
• Adjusting prices to account for geographical location
of the customers
6. International pricing
• Adjusting prices for international markets
 Geographic Pricing
Strategies
• F.O.B. Point-of-Production pricing: Price quoted
at factory-- buyer pays transportation.
• Uniform delivered pricing: Same delivered price
quoted to all; works if transportation costs
small.
• Zone-delivered pricing: Set same price within
several zones
• Freight-absorption pricing: Seller absorbs
transport cost to penetrate market.

14 - 49
 • Geographic Considerations
– FOB (free on board) plant or FOB origin:
origin Price
quotation that does not include shipping
charges. Buyer pays all freight charges to
transport the product from the manufacturer
– Freight absorption:
absorption system for handling
transportation costs under which the buyer may
deduct shipping expenses from the costs of
goods

19-50
 – Uniform-delivered price:
price system for handling
transportation costs under which all buyers are
quoted with the same price, including
transportation expenses
– Zone pricing:
pricing system for handling transportation
costs under which the market is divided into
geographic regions and a different price is set in
each region
– Basing-point system:
system system for handling
transportation costs in which the buyer’s costs
included the factory price plus freight charges
from the basing-point city nearest the buyer.
Seeks to equalize competition between distant
marketers.

19-51
 Competition Based Pricing

1. Going rate pricing

• used when costs difficult to measure competitors lack
differential advantage.
• 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
 Competition Based Pricing

2. Sealed bid
Forces competitors to lowest price
 Price-Quality Strategies

• Philip Kotler identified 9 price-quality

strategies
High Price Low Price

High Quality High Super

Premium
Value Value

Over Mid Good

Charging Value Value

False
Rip-off Economy
Economy
Low Quality
54
 Price Changes
• After developing their pricing structures and
strategies, companies often face situations in
which they must initiate price changes or
respond to price changes by competitors.
 Initiating Price Changes
• In some cases, the company may find it
desirable to initiate either a price cut or a
price increase.
• In both cases, it must anticipate possible
buyer and competitor reactions.
 Initiating Price Cuts
• Several situations may lead a firm to consider
cutting its price.
• One such circumstance is excess capacity.
• Another is falling demand in the face of strong
price competition or a weakened economy.
REACTIONS TO PRICE CHANGES
 Reactions to Price Change
• Customers are more sensitive to price changes if
the products cost a lot and/or are bought
frequently
• Competitors may see each of your price change
as a fresh challenge and react according to its
self-interest at the time.
• Need to estimate each close competitor’s likely
reaction

59
 Buyer Reactions to Price Changes
• A price increase, which would normally lower sales, may have
some positive meanings for buyers.
• A brand’s price and image are often closely linked.
• A price change, especially a drop in price, can adversely affect
how consumers view the brand.
Competitor Reactions to Price Changes

• The competitor can interpret a company price

cut in many ways.
– It might think the company is trying to grab a
larger market share or that it’s doing poorly and
trying to boost its sales.
– Or it might think that the company wants the
whole industry to cut prices to increase total
demand.
Responding to Competitors’ Price Change
• If competitors lower price for homogenous

products
– Try augmenting the product

– If it doesn’t work or if it is not likely to work,

then meet the price cut head-on

62
Responding to Competitors’ Price Change
• If competitors raise price
– In a homogeneous market, follow if you think the
whole market is likely to follow
– In a non-homogeneous market, evaluate
• The reason for the competitor price change

• If the price increase is temporary

• The effect on your market share & profit

• The likely response(s) from the other competitors 63

ways to ‘increase’ prices without increasing price
• Revise the discount structure
• Change the minimum order size
• Charge for delivery and special services
• Invoice for repairs on serviced equipment
• Charge for engineering, installation
• Charge for overtime on rushed orders
• Collect interest on overdue accounts
• Produce less of the lower margin models in the line
• Write penalty clauses into contracts
• Change the physical characteristics of the product
 Conditions Under Which Consumers
are Less Price Sensitive
• Product is more distinctive • Part of the cost is borne by
• Buyers are less aware of substitutes
another party
• Buyers cannot easily compare quality of
substitutes • The product is used with
• The expenditure is a lower part of buyer’s assets previously bought
total income
• The expenditure is small compared to the • The product is assumed to
total cost have more quality, prestige,
or exclusiveness
• Buyers cannot store the
product
 Price vs. Non-price
Competition
• In price competition, a seller regularly offers
products priced as low as possible and
accompanied by a minimum of services.
• In non-price competition,
competition a seller has stable
prices and stresses other aspects of marketing.
• With value pricing,
pricing firms strive for more benefits
at lower costs to consumer.
• With relationship pricing, customers have
incentives to be loyal-get price incentive if you do
more business with one firm.

14 - 67
 Non-price Competition
• Some firms feel price is the main competitive tool,
that customers always want low prices
• Other firms are looking for ways to add value,
thereby being able to avoid low prices
• Sometimes prices have to be changed in response to
competitive actions
• Many firms would prefer to engage in non-price
competition by building brand equity and
relationships with customers

14 - 68
 Relationship Pricing
• Uses price as a method to build long-term
relationships with the best customers
• Focuses on giving better deals to better customers
• Goal is to price relative to the value of the
customer to the firm, while building loyalty and
stimulating repeat buying

14 - 69
 Price Quotations

• List prices:
prices Established prices normally
quoted to potential buyers

• Market price:
price Price that an intermediary
or final consumer pays for a product after
subtracting any discounts, rebates, or
allowances from the list price

19-70
• Reductions from List Price
– Cash discount:
discount price reduction offered to a
consumer, industrial user, or marketing
intermediary in return for prompt payment of a
bill
• 2/10 net 30, a common cash discount notation,
allows consumers to subtract 2 percent from the
amount due if payment is made within 10 days

19-71
 • Trade Discounts:
Discounts payment to a channel member or buyer
for performing marketing functions; also known as a
functional discount

19-72
 • Quantity discount:
discount price reduction granted
for a large-volume purchase
– Justified on the grounds that large orders
reduce selling expenses, storage, and
transportation costs
– Cumulative quantity discounts reduce prices in
amounts determined by purchases over stated
time periods
– Non-cumulative quantity discounts provide
one-time reductions in the list price

19-73
 • Allowances
– Trade-in: credit allowance given for a used item
when a new item is purchased
– Promotional allowance: advertising or promotional
funds provided by a manufacturer to other channel
members in an attempt to integrate the
promotional strategy within the channel
• Rebates:
Rebates refund for a portion of the purchase
price, usually granted by the product’s
manufacturer

19-74
Special Pricing Strategies
 Cartel
• Agreement among competing firms to fix
prices, output and marketing.
• Occurs in oligopoly markets
• Can be explicit or Implicit
 Price Leadership
• Barometric price leadership
– One firm in an industry will initiate a
price change in response to economic
conditions
– The other firms may or may not follow
this leader
– Leader may vary
 Price Leadership
• Dominant price leadership
– One firm is the industry leader
– Dominant firm sets price with the
realization that the smaller firms will follow
and charge the same price
– Can force competitors out of business or
buy them out under favorable terms
 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
 Block Pricing
• The practice of packaging multiple units of
an identical product together and selling
them as one package.
• Examples
– Paper.
– Six-packs of soda.
– Different sized of cans of green beans.
• By packaging the product and selling it as
one unit the firm earns more than if it sold
all of the units at a simple per unit price.
 Peak-Load Pricing
• When demand is not evenly distributed, a firm needs to
have facilities to accommodate periods of high demand.
• Even with large facilities, the firm may experience times
when the demand is greater than can be handled.
• During off-peak times (periods of lower demand), there is
excess capacity.
• The firm charges less at off-peak times.
• Example: More phone calls are made during business hours
than in the evenings and on weekends.
• So, the phone companies charge more during business
hours.
 Cross-Subsidies
• Prices charged for one product are subsidized
by the sale of another product.
• May be profitable when there are significant
demand complementarities effects.
• Examples
– Browser and server software.
– Drinks and meals at restaurants.
 Cannibalization
• Occurs when sale of one product reduces the
demand for another product with a higher
incremental margin
• e.g. business travelers flying on restricted economy
class fares
wealthy families buying basic sedans instead of high
end luxury cars
• Fundamental reason for cannibalization is that seller
cannot discriminate directly.
• The discriminating variable does not perfectly
separate the buyer segments.
Price Bundling
 Bundling
• Bundling is packaging two or more products to
gain a pricing advantage.
• Conditions necessary for bundling to be the
appropriate pricing alternative:
– Customers are heterogeneous.
– Price discrimination is not possible.
– Demands for the two products are negatively
correlated.
 Price bundling
• Firms often bundle the goods which they offer
– Microsoft bundles Windows and Explorer
– Office bundles Word, Excel, PowerPoint, Access
• Bundled package is usually offered at a discount
• Selling products together (bundle) typically at a price that
is less than sum of components
• Possible motives:
- quality enhancing
- Strategic advantage (extend an advantage from one
market to the other)
- Price discrimination
 Price bundling
• Three commonly used terms:
• Pure bundling-Only the bundle is offered by the
seller (at a bundle price).
• Pure components-Only the components are
offered (at their separate prices).
• Mixed bundling – The bundle as well as some or
all components, or smaller bundles, are priced and
offered for sale.
 Transfer Pricing
• Sometimes firms are organized into separate
divisions.
• One division may produce an intermediate
product and supply it to another division to
produce the final product.
• How does the firm determine the efficient
price at which the intermediate product
should be sold. That is, what is the transfer
price?
 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

• Most government contracts

Estimating work involves dealing with

• Measurements and quantities

• Pricing and rates

• Subcontract packages

• Tender preparation
Types of contract

-Lump Sum or Hard Money contracts

-Cost plus %-age contracts

-Cost plus fixed fee contracts

END