BUSINESS economics

1. BUSINESS economics Class 2 18 November, 2009

2. Pricing • Determination of Price • Strategies for Pricing • Government Intervention

3. Price Determination • Develop Marketing Strategy – targeting, segmentation, analysis, positioning • Marketing Mix – product, distribution, promotion • Estimate Demand Curve – quantity vs. price • Calculate Costs • Environment Analysis – Legal, Competition • Set Pricing Objectives – price stability, profit maximization, revenue maximization • Determine Price – select pricing method, develop pricing structure, define discounts

4. Pricing Objectives

5. Pricing Strategies Low Price High Low Quality High

6. Price Skimming • Skimming – attempts to “skim the cream” off the top of the market by setting a high price for customers who are less price sensitive. • Inelastic demand for the products • Large cost savings are not expected at high volumes • No resources to finance large capital expenditure • Lower the price over time. • Also known as price discrimination

7. Limitations of Skimming • Effective only when the firm is facing an inelastic demand. • Price discrimination is illegal in many jurisdictions. • Since inventory turnover can be very low for skimmed products, this could cause problems for the distribution chain. • High margins encourage the entry of competitors. • This gives competitors time to either imitate the product or leap frog it with a new innovation. • The manufacturer could develop negative publicity if they lower the price too fast and without significant product changes. • There will be less incentive to keep costs under control.

8. Premium Pricing • Prestige pricing - is the strategy of consistently pricing at, or near, the high end of the possible price range to help attract status-conscious consumers. A few examples of companies which partake in premium pricing in the marketplace include Rolex, Bentley • People will buy a premium priced product because: • They believe the high price is an indication of good quality; • They believe it to be a sign of self worth - It authenticates their success and status - It is a signal to others that they are a member of an exclusive group • They require flawless performance in this application - The cost of product malfunction is too high to buy anything but the best - example : heart pacemaker. • Goldilocks pricing is commonly used to describe the practice of providing a "gold-plated" version of a product at a premium price in order to make the next-lower priced option look more reasonably priced • Business class vs. First class airline seats • Third class vs. second class railway coaches

9. Laws of Price Sensitivity • Reference Price Effect - Buyer’s price sensitivity for a given product increases the higher the product’s price relative to perceived alternatives. • Difficult Comparison Effect - Buyers are less sensitive to the price of a known reputable product when they have difficulty comparing it to potential alternatives. • Switching Costs Effect - The higher the product-specific investment a buyer must make to switch suppliers, the less price sensitive that buyer is when choosing between alternatives. • Price-Quality Effect - Buyers are less sensitive to price the more that higher prices signal higher quality • Expenditure Effect - Buyers are more price sensitive when the expense accounts for a large percentage of buyers’ available income or budget.

10. Laws of Price Sensitivity • End-Benefit Effect - The effect refers to the relationship a given purchase has to a larger overall benefit, and is divided into two parts: Derived demand and Price proportion cost • Shared-cost Effect - The smaller the portion of the purchase price buyers must pay for themselves, the less price sensitive they will be. • Fairness Effect - Buyers are more sensitive to the price of a product when the price is outside the range they perceive as “fair” or “reasonable” given the purchase context. • The Framing Effect - Buyers are more price sensitive when they perceive the price as a loss rather than a forgone gain, and they have greater price sensitivity when the price is paid separately rather than as part of a bundle.

11. Other Pricing Strategies • Full cost pricing – fixing the price of the product based on the cost incurred in producing and marketing • Penetrative pricing – lowering the price below the costs through discounts and promotional offers • Real-time pricing – based on market factors on a common trading platform