PRICING
What is Price
Fare
Rent
Interest
Tuition
Donation
Fee
Monthly Payment
The Importance of Price - Price is a direct determinant of profits (or losses) - Price indirectly affects costs (through quantity sold) -Price
determines the type of customer and
competition the organization will attract - Price affects the image of the brand - A pricing error can nullify all other marketing mix activities
Setting the Price 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
Factors Affecting Price Internal Factors
Pricing Decisions
External Factors
Internal Factors • • • • •
1.Marketing Objectives Survival Current Profit Maximisation Market Share Leadership Product Quality Leadership
• 2.Marketing Mix Strategy • 3.Cost Fixed Cost •
Variable Cost
• 4. Organisational Considerations
External Factors 1.Market Pure Competition - many buyers/sellers trading in same commodities Monopolistic Competition - many buyers/sellers trading over range of price Oligopolistic Competition - few sellers who are highly sensitive to prices Pure Monopoly - only one seller
2.Demand 3.Other Factors Economic Factors Government Influence Reseller / Distributor
3. Competition
Pricing Approaches
Cost-Plus Pricing Increased Certainty
Minimise Price Competition
Key Reasons for Cost-Plus Popularity Perceived Fairness
Cost-Plus Pricing Selling price is determined by adding a fixed amount, usually a percentage, to the (total) cost of the product
Most commonly used pricing method (e.g., groceries and clothing)
Cost-Plus Pricing A toaster manufacturer had the following costs and expected sales: Variable Cost $ 10 Fixed Cost $ 3,00,000 Unit Sales 50000 Mark up 20% Calculate Mark up Price , Break even volume
Variable Cost $ 10 Fixed Cost $ 3,00,000 Unit Sales 50000 Mark up 20%
Break-even Analysis and Target Profit Pricing
Break-even Volume and Profits at Different Prices (1)
(2)
(3)
(4)
(5)
(6)
Price Unit Demand Needed to Break Even
Expected Unit Demand at Given Price
Total Revenues (1) × (3)
Total costs*
Profit (4) – (5)
$14
75,000
71,000
$ 994,000
$ 1,010,000
–$ 16,000
16
50,000
67,000
1,072,000
970,000
102,000
18
37,500
60,000
1,080,000
900,000
180,000
20
30,000
42,000
840,000
720,000
120,000
22
25,000
23,000
506,000
530,000
–24,000
Value-Based Pricing Cost-Based Pricing
Product
Value-Based Pricing
START
Customer
Cost
Value
Price
Price
Value
Cost
Customers
Product
Competition-Based Pricing Costs
? ? ?? ? Bid / Tender ? Contract
Pricing Strategies
New Product Pricing Strategies SKIMMING STRATEGY Price initially set very high and reduced over time
When Appropriate Demand is likely to be price inelastic There are different price-market segments The offering is unique enough to be protected from competition by patent, copyright, or trade secret Production or marketing costs are unknown A capacity constraint in producing the product or providing the service exists An organization wants to generate funds quickly There is a realistic perceived value in the product or service
Penetration Pricing Strategy Price is initially set low to gain a foothold in the market When Appropriate : -Demand is likely to be price elastic -The offering is not unique or protected by patents, copyrights, -Competitors are expected to enter market quickly -There are no distinct and separate price-market segments -There is a possibility of large savings in production and marketing costs if a large sales volume can be generated -The organization’s major objective is to obtain a large market share
Product Mix Pricing Strategies Product Line Pricing Setting Price Steps Between Product Line Items
Captive-Product Pricing Pricing Products That Must Be Used With The Main Product
Product-Bundle Pricing Pricing Bundles Of Products Sold Together
Optional-Product Pricing Pricing Optional Products Sold With The Main Product
By-Product Pricing Pricing Low-Value By-Products To Get Rid of Them
Adjustment Strategies - I Price Price Adjustment Adjustment Strategies Strategies Discount Discount
Segmented Segmented Psychological Psychological
Cash Cash
Customer Customer
Quantity Quantity
Product Product Form Form
Seasonal Seasonal
Location Location
Functional Functional
Time Time
Allowances Allowances
Adjustment Strategies - II
More Price Adjustment Strategies
Geographical
Value
International
Promotional
Price Changes Initiating Price Cuts
Initiating Price Increases
Issues in Price Change Strategies
Buyer Reactions
Competitor Reactions
Assessment & Response to Competitor Pricing
Has Competitor Cut Price?
No
Hold current price monitor competitor prices
Yes Will lower price negatively affect No our share and profits Yes No Can/should Effective action be taken? Yes
Reduce Price Raise Perceived Quality Improve Quality & increase price Launch low-price ‘fighting brand”
Responding to Competitor Price Changes- Example
No
Has competitor cut his price? Yes Is the price likely to significantly hurt our sales?
Hold our price at present level; continue to watch competitor’s price
No
Yes
No Is it likely to be a permanent price cut?
Yes
How much has his price been cut?
By less than 2%
By 2-4%
By more than 4%
Include a cents-off coupon for the next purchase
Drop price by half of the competitor’s price cut
Drop price to competitor’s price
PRICING APPLICATION
A producer distributed its bicycles through wholesalers & retailers. The retail selling price was Rs 800 and the manufacturing cost to company was Rs 312. The retail mark-up was 35 % & wholesale markup was 20% a. What was the cost to the wholesaler & to retailer ? b. What percentage markup did the producer take ?
Retail price
Rs 800 X 0.65
W.Sale price
Rs 520 X 0.80
Manufacturer’s Selling price Rs 416 Mftr.Cost a. Rs 416
Rs 312
Gross Margin Rs 104
Rs 520
b. 104 X 100 = 25% on selling price 416
If total fixed costs is Rs 2 lacs & total variable costs is Rs1 lac at the output of 20000 units, what are probable total fixed costs & total variable costs at an output of 10,000 units ? What are the average fixed costs, average variable costs & average costs at these 2 output levels ? Explain what additional information you would want to determine what price should be charged.
Total Fixed Costs Total Variable Costs Total Costs
20,000 Units 200,000 100,000 300,000
Average Fixed Costs Average Variable Costs Average Costs
10.00 5.00 15.00
10,000 Units 200,000 50,000 250,000 20.00 5.00 25.00
Estimates about quantity to be produced, expected target return, demand etc.
Assume you and your friend have decided to go into business together manufacturing wrought iron birdcages. You know that your fixed costs (rent on a building, equipment, et cetera) will be Rs 60,000 a year. You expect your variable costs to be Rs 12 per birdcage. a. If you plan on selling the birdcages to retail stores for Rs 18 how many must you sell to breakeven; that is, what is your break-even quantity? b. Assume that you and your partner feel that you must set goal of achieving Rs 30,000 profit with your business this year. How many units would you have to sell to make that amount of profit?
a. Break-even point in units = TFC divided by Contribution Rs 60,000 / 6 (Rs 18 - Rs12) BEP in units = 10,000 units.
b.
BEP
BEP =
=
total fixed cost + target profits contribution per unit to fixed costs
60,000 + 30,000 6
= 15,000 units
XYZ Company’s fixed cost for the year are estimated at Rs 2,00,000. Its products sells for Rs 250. The variable cost per unit is Rs 200. Sales for the coming year are expected to reach Rs 12,50,000. What is the break even point ? If sales are forecast at only Rs 8,75,000, should the company shut down its operations ? Why ?
BEP (in units)
=
200,000 250 - 200
=
200,000 50
= 4,000 units
BEP (in Rs ) 4,000 unit x Rs 250/unit = Rs10,00,000 Expected Sales 12,50,000 Fixed Costs 2,00,000 Variable Costs 10,00,000 (80% of 12,50,000) Total Costs Expected Profit
12,00,000 50,000
If sales were forecast at Rs 8,75,000 Total variable costs would be Rs7,00,000 (.8 x 875,000). Thus, although there would be an accounting loss of Rs 25,000 the contribution to fixed costs of Rs 1,75,000 is better than nothing and the firm should operate.
STOCK TURN RATE
Cost of Sales for 1 year Opening Inventory Closing Inventory Calculate Stock Turn rate
Rs 10 lacs Rs 2.50 lacs Rs 1.50 lacs
A measure of number of times the average inventory is sold during a year - it shows how rapidly the firm’s inventory is moving. 3 Methods Cost of Sales Avg. Inventory at Cost Net Sales Avg. Inventory at selling price Sales in Units Avg. Inventory in Units
Average Inventory Rs 2 lacs Cost of Sales / Average Inventory 10,00,000 / 2,00,000 Stock turn rate = 5
Return On Investment
Company has Investment of Rs 1.5 lacs Sales Rs 3 lacs Profits Rs 25,000 a. calculate ROI b. sales has doubled while investments & profits have stayed same. c. by cutting cost - profits have doubled. d. by decreasing investments
Net Profit / Investment ROI =
NP
x Sales Sales Investment
a. b. c. d.
16.6 % 16.6 % 33.2 % 33.2 %
Which major costing method to use: (1) Direct costing / Variable costing
or (2) Absorption costing / Full costing
To show how gross profit and contribution margin appear in an income statement, note the following example
Direct costing
Absorption costing
Sales revenue
$770,000
$770,000
Variable manufacturing costs
550,000
550,000
Add: Fixed manufacturing costs
-
100,000
Total costs of goods produced
$550,000
$650,000
Variable cost
- 100,000
-
Fixed and variable cost
-
- 115,000
Cost of goods sold
$450,000
$535,000
CONTRIBUTION MARGIN
$320,000
-
GROSS PROFIT
-
$235,000
Variable selling & Adm. exp.
60,000
60,000
FINAL CONTRIBUTION MARGIN
$260,000
-
Fixed manufacturing costs
$130,000
-
Capacity variance*
-
$ 40,000
Fixed selling & Adm. exp.
$ 60,000
$ 60,000
Total
$190,000
$160,000
Net income before taxes
$ 70,000
$ 75,000
Less inventory at year’s end:
How would these two techniques be used in pricing? Here is an example, with four different prices sampled to see how they fare in terms of either gross profit or contribution margin.
Possible Prices $4.00
$3.80
$3.60
$3.40
Estimated unit sales
10,000
12,000
16,000
20,000
Estimated dollar sales
$40,000
$45,600
$57,600
$68,000
(includes fixed cost)
$34,000
$40,800
$54,000
$68,000
Gross profit in dollars
$ 6,000
$ 4,800
$ 3,200
0
Gross profit %
15.0%
10.6%
5.5%
0
Estimated unit sales
10,000
12,000
16,000
20,000
Estimated dollar sales
$40,000
$45,600
$57,600
68,000
Variable costs @ $2.70 a unit (no $27,000 fixed costs)
$32,400
$43,200
54,000
Variable selling cost @2% sales
800
912
1,152
1,360
Total Direct Cost
$27,800
33,312
44,352
55,360
Marginal contribution $
12,200
12,288
13,448
12,640
ABSORPTION COSTING
Mfg. cost @ $3. 40 unit
DIRECT COSTING
Which Is Best for Marketing? Analysts think that neither of these is better. They both present different values. There is a strong argument that direct costing is best for market planning.
Here are some of the reasons for using direct costing: It is easier than absorption costing to find the most profitable price, especially when lowering the price will increase sales. Many times companies sell their products at different prices in different territories. Each territory may have a different contribution margin. The marketer, therefore, can concentrate efforts in more profitable territories and minimize efforts in others. In absorption costing, the effects on profits of a change in price that cause an increase in volume will be more difficult to calculate.
Problem A manufacturing company produced a product costed by the absorption method. The data for the absorption method and the pricing are shown below: Absorption Costing Cost of materials Labor costs Estimated tool maintenance Total cost Plus 10% markup Target selling price
Rs 2,891 1,479 430 Rs 4,800 400 Rs 5,200
Armed with a Rs 5,200 selling price, the salesman for this product went into the marketplace, only to find that there was a great deal of protest about the price. Almost everyone told the salesman that the “going” price for this product on the market was Rs 4,400, and that his product clearly was overpriced. In response, the marketer recalculated the costs using the direct costing method and arrived at a lower price as shown below.
Direct Costing
Cost of materials
Rs 2,891
Labor costs
725
Estimated tool maintenance
430
Total cost Competitive selling price Potential contribution
Rs 4,046 4,400 Rs 354
The problem is this: What should the salesman do about the situation? Even with direct costing, the company may not break even on the product. Explain which costing method he should use and the rationale for doing so.
Answer The salesman should accept the order at the competitive selling price of Rs 4,400, if the plant is not operating at full capacity. If the plant is operating at full capacity, then taking the work may result in overtime and other extra costs that could effect a loss for the company. If the plant is not operating at full capacity, however, the sale would contribute something, potentially Rs 354, to the business. Keeping the price at Rs 5,200 in order to recover all costs probably means that the sale would be lost. After all, customers can buy competing products at lower prices. To lose the sale would mean no profit contribution. On the other hand, if other work is competing for the use of the same production facilities, then the work with the highest contribution margin should be accepted.
YIELD MANAGEMENT
A Yield Management uses historic data and mathematical models to predict demand at future points in time. - It then sets different prices at these different time points according to the predicted demand varying prices according to the actual demand. - It aims to stimulate demand when demand is, and to maximise profits when is high. - Overall, the aim is to increase profitability rather than simply increase utilisation.
Yield/Revenue Management Integrated management of capacity and pricing
◆ Objective: maximize revenue (minimize lost revenue / opportunity costs) ◆ “Science of squeezing every possible dollar from customers”
Yield Management Models applicable when supply side product or service is characterised as: capital intensive perishable. and the demand side is characterised with: variability of demand variability of value
Airlines Make Money Only When They Match Supply and Demand
Yield Management Objectives Sell the right seat To the right passenger At the right price
The Problem is Large and Dynamic Major US domestic carriers:
Operate 5000 flights per day Serve over 10,000 markets Offer over 4,000,000 fares Schedules change twice each week On a typical day, a major carrier will change 100,000 fares Airlines offer their products for sale more than one year in advance The total number of products requiring definition and control is approximately 500,000,000 This number is increasing due to the proliferation of distribution channels and customer-specific controls
YM is Essential to Airline Profitability • Annual benefit of Yield Management to a major airlines is 3% – 6% of total revenue • A major airlines’ revenue benefits from yield management exceed $500,000,000 per year • Applying this rate to the industry ($300 billion/year) yields potential benefits of $15 billion per year • The possibilities for even the most sophisticated carriers go well beyond what is achieved today
Effective Planning and Marketing is a Continuous Process Enterprise Planning
Product Planning Tactics and Operations
There Should be Continuity
Time Horizon
• 18 Months +
• 18 Months – 1 Months
• 3 months – Departure
Objective
• Maximize NPV of Future Profits
• Maximize NPV of Future Profits
• Maximize NPV of Future Profits
• Route Structure • Fleet • Maintenance Bases • Crew Bases • Facilities
• Schedule • Fleet Assignment • Pricing Policies
• Price • Restrictions • Availability
• Financial Resources • Regulation
• Route Structure • Fleet • Maintenance • Crew Bases • Facilities
• Schedule • Pricing Policies
Decisions
Constraints
PROBLEM
Capital Costs
Cost to build Cost per month over 10 years at 10% (includes risk factor)
Revenue Costs
Total Cost
Rs10m Rs 13,215
Cost per session assuming 2 sessions per day
Rs 220
Cost per seat assuming 200 seats
Rs 1.10
Cost of local property taxes, heat and light per session
Rs 20
Cost of wages for 4 staff including cleaners at Rs 8 per hour incl. overheads
Rs 96
Costs of marketing per session
Rs 33
Cost per seat assuming 200 seats
Rs 0.75
Cost per seat per session - capital and revenue
Rs 1.85
Cost per seat per session with a 50% average utilisation (100 seats)
Rs 3.70
Add in profit margin, say 7.5% before tax
Rs 4.00
Overall total cost per session
Rs 400
Overall total cost per week (14 sessions)
Rs 5,600
Session: Day: Sold at Re 1 Sold at Rs 2 Sold at Rs 3 Sold at Rs 4 Sold at Rs 5 Sold at Rs 6 Sold at Rs 7 Sold at Rs 8 Total seats sold Total income Rs
1
2 Mon
3
4 Tues
5
6 Weds
7
8 Thurs
9
10 Fri
11
12 Sat
13
14 Sun
Total / Utilis.
Session:
1
Day:
2
3
Mon
4
5
Tues
6
7
Weds
8
9
Thurs
10
11
Fri
12
13
Sat
14 Sun
Sold at Re 1
10
10
5
10
5
15
10
15
10
Sold at Rs 2
10
15
10
20
15
25
5
10
15
20
40
20
15
10
Sold at Rs 3
5
10
10
15
5
10
10
30
25
25
35
50
20
20
Sold at Rs 4
5
8
10
5
14
55
25
20
35
10
40
35
30
Sold at Rs 5
1
2
5
16
10
35
10
50
20
30
25
25
5
10
25
2
20
15
20
40
35
Sold at Rs 6
10
Sold at Rs 7
3
25
15
30
25
30
Sold at Rs 8
1
5
10
10
15
10
Total seats sold
Total / Utilis.
25
40
35
65
30
90
45
144
82
180
155
200
180
170
Total income Rs 30
95
97
190
70
291
230
579
257
840
600
910
900
825
1,441 / 51% Rs 5,914
Revenue Management Example: Airline # of Seats 100
$1,000 Price
Revenue Management Example: Airline
Revenue Management Example: Airline
Revenue Management Example: Airline
Revenue Management Example: Airline
Two Challenges: • How do we make sure that the people who are willing to pay $750 will not buy the $250 ticket? • How do we make sure that we have enough seats for those willing to pay $750?
Two Answers: ◆ Create artificial hurdles: • Advance purchase: 21 days, 14 days, 7days • Use limitations: Saturday night stay, non-refundable tickets
◆ Restrict the number of seats sold at the low price • This requires a forecast of future booking by higher-paying customers and the discipline to forgo a “bird-in-hand.”
◆ Note 1: airlines do not change prices dynamically; they actually change capacity (classes) dynamically ◆ Note 2: freight can also displace passengers when RM is really optimized
Why is This Important? • American Airlines saved over $1.4B between 1989-1992 • “I believe that yield management is the single most important technical development in transportation management . . . “ • Robert Crandall, CEO AMR
Markdowns Markdowns are one of the main levers that retailers have to influence results in-season. As such, it can be a very powerful driver of performance. Markdown Opportunity:
•
Markdowns may represent more than 30% of total sales • Short-cycle product can represent up to 80% of a retailer’s assortment • In some segments, short-cyce products may represent a smaller percentage of the assortment but still have a significant impact on gross margin (up to 40%)
• Goals / Trends:
• Movement to more Localized pricing
decisions • Growing realization of the true cost of leftover inventory • Greater emphasis on inventory productivity as store base growth slows
Sales Rate-Based Discounting • • • • •
After initial sales rate (r0= i0/t0) Required sales rate: r1=i10-t1) %r required: (r1/ r0)-1 Divide by ε Get the % price change required
Price Discrimination • First degree: willingness to pay (rare) RR in late 1800-s, asking shippers for their income statement so they could determine their ability to pay College financial aid Taxes • Second degree: artificial hurdles but open Buying process (coupons, advance purchase…) Cost to serve (volume discounts, risk adjustments, "set up" costs in travel industry…) Distribution channels (Internet, outlets, etc.) Markdowns (timing of purchase, product age, selection, etc.) Value of product (in many rail movements; regeltarifklassen) Commodity type (part of tariffs; in many rail movements) Use limitations (e.g., "final sale") Bundling ("menu" vs. "a-la-cart") Time of use (e.g., peak hour, congestion pricing)
Price Discrimination • First degree: willingness to pay (rare) • Second degree: artificial hurdles but open • Third degree: based on external factors
Geography (neighborhood, state) Gender (women's clothing) Age (senior/student discounts) Profession/affiliation (small/large business business; educational,medical…)
3rd Degree Discrimination • Online shopping: Dell Computer
Specific Example Dimension® 8200 Series, Pentium® 4 Processor at 1.7 GHz 128MB PC800 RDRAM New Dell® Enhanced QuietKey Keyboard Video Ready w/o Monitor 32MB NVIDIA GeForce2 MX 4X AGP Graphics Card with TV-Out 40GB Ultra ATA/100 Hard Drive 3.5 in Floppy Drive MicrosoftR Windows® Millennium with WinXP Home Upgrade Coupon MS IntelliMouse® 10/100 PCI Fast Ethernet NIC 56K Teephony Modem for Wndows-Sound Option 48X Max Variable CD-ROM Integrated Audio with Soundblaster Pro/16 Compatibility Harman Kardon HK-395 Speakers Upgrade to Microsoft® Office Small Business w/EducateU 3 Year Ltd. Warranty, 3 Year At Home Service, Lifetime 24x7 Phone Support
Specific Example User
Base Price
Home
$1,378
Small business
$1,238
Large business
$1,338
Student
$1,327
University
$1,427
When Does YM Work? • Economic conditions Demand (LT with signaling; Governme conference Segme No arbitrage
• Administration A A
• Product High fix
Perishability
• Discipline !
Marketing • • • • • •
Most schemes are based on 2nd degree discrimination – seems more fair (choice is available) Positioning the message: discounts are more acceptable than price increases, even if the result is the same Avoid gauging "Profiteering" is not acceptable Use open communications Some forms of 3rd degree discrimination are illegal, but many are acceptable: student/senior citizen discounts profession/use (Dell)
Carrier Portfolio of Pricing Dynamic pricing with spot market shippers Dynamic pricing with contracted shippers
Long-term fixed-rate contracts
LT fixed rate contracts with capacity commitments
Rev. Management in TL Trucking • Little opportunity during bid response No monopoly power Exceptions: good service history coupled with client strategy geared towards service Value-added services
• Only opportunity in real-time (spot) market There are limited opportunities for local/temporary monopolies: • Responses to shipper "dialing for diesels” • Requests along "power lanes"
Rev. Management in TL Trucking • Remember the twin challenges: How do we make sure that the people who are willing to pay $750 will not buy the $250 ticket? How do we make sure that we have enough seats for those willing to pay $750?
• Comes down to one question: Should we take this load? Should capacity be committed to a particular load/shipper/contract?, or should we wait for a better-paying load? Depends on the forecast…
Strategic Decisions Set the Limits for Tactical Decisions • Size of fleet • Market focus – regions, industries, equipment • Relationships with O/Os, 3PLs • Percent of business under long-term contract • Long-term contract rates • Bid-response strategies • Capacity commitments • Seasonal Pricing • Demand booking and solicitation • Dynamic pricing • Proactive empty repositioning • Driver assignment
System Contribution of a Load • Regional potential: the expected contribution of a truck in a region. • P(A) - Potential of region A • D(A-B) - Direct cost for moving a truck from A to B • R(A-B) - Revenue for the move from A to B
System Contribution of a Load S(A-B) = R(A-B) -D(A-B) + P(B) -P(A) Direct contribution
System impact
P(B) -the value of one more truck at region B P(A) -the value of one less truck at region A Order acceptance: - Take a load only if S(A-B) > 0 - Take the load with the highest S(A-B)
Analysis of Movements
Head haul: S(A-B) = R(A-B) -D(A-B) + P(B) -P(A) Back haul: S(A-B) = R(A-B) -D(A-B) + P(B) -P(A)
YM in Manufacturing • Reserve capacity to the highest paying customer • Tie the pricing to the capacity commitment • Use pricing to manage component supply (in BTO)
Final Observations • RM involves the entire enterprise Customer service Sales Reservations Scheduling • RM can be used to increase profits and serve customers better Bring in those who otherwise would not use the service Provide higher LOS to those who pay a lot by giving them more frequent service, higher probability of service, etc. Increase utilization by smoothing demand patterns • The essence of RM is the judicious management of capacity and pricing simultaneously The trick: reserve capacity to the highest paying customers