Chapter 15

1. Chapter 15 Product-line Pricing

2. Nature of Decision Problem • Demand interrelationships • Complementarity • Substitute relationships • Cost interrelationships • Common resources • Common support structure • Nature of marketing strategy • Segmentation issues

3. Behavioral Issues • Acceptable price range(s) • Low-price product (low absolute threshold) • High-price product (high absolute threshold) • Differential prices and positioning • Segmentation strategy and tactics • Consumer surplus • Price bundling

4. Types of Pricing Decisions • Determining the lowest priced product and its price (low-end product) • Determining the highest price product and its price (high-end product) • Setting the price differentials for all intermediate products

5. Determining Price Differentials • Rank products in ascending order of expected prices, i.e., from low to high price. • Determine the low-end price, Pmin. • Determine the high-end price, Pmax.

6. Determining Price Differentials • The price of the j th ordered product is

7. Determining Price Differentials • The problem is to determine k: wheren is the number of products in the line

8. Price Differential Example • Pmin= $25; Pmax= $150; n = 6

9. Price Differential Example • PA =$25 • PB = $25(1.431) = $ 35.78 ($ 36) • PC = $35.78(1.431) = $ 51.19 ($ 55) • PD = $51.19(1.431) = $ 73.25 ($ 79) • PE = $73.25(1.431) = $104.82 ($109) • PF = $150

10. Guidelines • Segmented pricing strategy: • Noticeable differences should be equivalent to perceived value differences. • Highest and lowest prices in line have a special complementary relationship to other offerings – priced to encourage desired buyer perceptions. • Price differentials should get wider as price increases over product line.

11. Guidelines • Trading-up pricing strategy: • Decide which products are to be designed and priced similar to each other. • Higher-priced product should have a feature or observable benefit perceived to be of value, but the incremental price is less than its perceived value (a smaller price differential).

12. Price Bundling • Price bundling is the tactic of marketing two or more products and/or services for a price below the sum of the individual prices • It creates an incentive for purchasers of one product to also buy other(s). • Examples: • Weekend hotel packages • Vacation packages • Cable TV plans • Season ticket plans

13. Types Of Price Bundling • Pure bundling • The products or services are offered only as a bundle. • Mixed bundling • The products or services can be purchased singly or as a bundle. • Mixed leader bundling - The price of the second product is discounted in the first product is purchased at regular price. • Mixed joint bundling - A single price is formed for the combined set. • Tie-in sales – Requires the buyer to purchase a main product and then one or more complementary products • Add-on bundling

14. Rationale For Price Bundling Objective: stimulate demand to achieve cost economies and increase profits. • Cost structure • High ratio of fixed to variable costs. • Shared or common costs for producing or selling multiple products or services. • Implies that the incremental cost of selling additional products is relatively low. • Demand • Demand for the products is interdependent; i.e., the products are complementary.

15. Principle Of Price Bundling • Different buyers value each product offering differently. • At any specific price, some buyers would be willing to pay more, and some buyers would be willing to spend less. • By packaging products at special prices, the goal is to shift some of the consumers’ surplus for products they would be willing to pay more for to products they would be willing to pay less for.

16. Principle Of Price Bundling • The ability to transfer consumer surplus depends on demand complementarity • Joint purchases reduce search costs. • Using one product enhances satisfaction with the other. • Full-service or product line may enhance perceived value of entire offering.

17. Developing A Price Bundling Strategy • Four basic steps • 1. Define customer segment targets • 2. Determine bundling objectives • 3. Determine demand conditions for each objective • 4. Determine profitability of alternative strategies

18. Selecting Products To Bundle • 1. Select products that have relatively low unbundled sales volume. • 2. Select products that will generate new customers. • 3. Mixed-leader bundling - the leader (A) should be both the lower margin product and the higher volume product. The increase in volume of (B) will contribute more to profits than the loss in contributions in (A).

19. Selecting Products To Bundle • 4.Mixed-joint bundling - both contribution margins and unbundled volumes should be about equal. • 5. Products should be functionally related to each other and of equivalent quality. • Buyers evaluate the lead product first. • Then adjust evaluations based on assessment of other items in the bundle. • Buyers tend to evaluate bundles of related products higher than those of unrelated products.

20. Price Bundling Decisions • Pure bundle or mixed bundle? • Mixed bundles generally more profitable unless bundle purchase is “normal” or logical (e.g., Car options; Furniture suites). • Magnitude of price discounts? • Sufficient to enhance transaction value (20% or more). • For mixed joint bundles, provide some discount on individual items and additional discounts for the bundle (provides greater perceived transaction value).

21. Price Bundling Decisions • Choice and number of bundle items • Since this is a tactic to enhance sales of low-volume products, do not bundle high-volume, profitable products. • Items should be functionally related (benefits of use provide synergy to buyer/user). • Mixed leader product should be higher sales volume and lower margin product.

22. Price Bundling Decisions • Choice and number of bundle items • Mixed joint products should be equivalent in sales volume and margin. • Items should have equivalent perceptions of quality (do not load poor quality items with higher quality items). • Bundles generally should not be larger than five items.

23. Price Bundling Decisions • Presenting the price bundle • The purchase requirements to qualify for the bundle price must be as transparent as the bundle price. • This requirement is necessary to prevent customers from forming reference prices that are not much lower than the bundle price. • Otherwise, confusion, anger and perceptions of unfairness may occur.

24. Yield Management • Yield management operates on the principle that different segments of the market have different degrees of price sensitivity. • On airline flights, seats are priced differently depending on the time of day, day of the week, length of stay at destination, when purchased and other restrictions.

25. Perishable-asset Revenue Management • Generalizing from the airlines, we can call this management activity one of maximizing revenues with perishable assets. • Managing perishable assets via price segmentation can be applied outside the airlines.

26. Perishable-asset Revenue Management • Lodging and travel • Spectator events (e.g., theater, sports) • Electric Utilities • Services (e.g., photo studio, hair salon, auto repair) • Shipping

27. Perishable-asset Revenue Management • High technology products • Broadcast advertising • Banks, savings and loans • Telephone companies • Retail markdowns and scheduling sales

28. The General Problem • For a particular selling occasion, the seller has a fixed number of units (capacity) to sell by a certain date in the future, • If the units are not sold during this selling occasion, they cannot be sold at any price later.

29. The General Problem • Two price segments situation: • Some buyers have a higher acceptable price than others. • The total number of actual buyers with the high maximum acceptable price will be less than available capacity.

30. The General Problem • If a single high price is set, then some unknown portion of units will be sold: • Where is the number of units that could be sold to low-price buyers. • If units are sold at , a discounted price, revenues would increase.

31. The Decision Problems • Choose , the number of units to offer at a discount. • Choose the discount price, • Choose the full price, • To maximize revenues for the selling occasion.

32. The Decision Problems • Given the nature of demand that occurs for the discounted units, the seller must decide when, and whether to stop selling the discounted units, and only offer the high price units for the remainder of the selling period.

33. The Decision Problems Examples: • Electric utility selling power under contract. • Hotel setting aside number of rooms for convention. • Airline determining number of non-refundable discounted seats.

34. Decision Criterion Maximize contributions per selling occasion • Operating cost structure: relatively high fixed costs to total costs. • As long as is greater than unit direct variable costs, revenues will be greater than if only units are sold at

35. Total Revenues Where X = the number of units sold at full price

36. Implications • If one more unit is added to qlow , additional revenue of plow will occur. • If there is sufficient capacity to meet demand X at phigh, no other effects occur. • If (qlow+X) exceeds capacity, revenue is less than optimal by (phigh-plow).

37. Adding Discount Customers • The firm should add one more discount customer if the probability that

38. Examples • If the discount price is 50% of the high price, the firm should add discounted units for sale if the probability that total demand (qlow+x) will be less than capacity is greater than 0.5. • If the discount price is 70% of the high price, then add discount units for sale if the probability that demand will be less than capacity is greater than 0.3.

39. Conditions for Using Yield Management

40. Conditions for Using Yield Management

41. Conditions for Using Yield Management

42. Benefits of Yield Management • Continuous monitoring of demand. • Facilitates use of proactive dynamic pricing. • Focused price reductions offer leverage for increasing profits. • Focusing on revenue management shifts performance measures from averages to contributions per unit of resource.