Pricing of Food Products

1. Pricing of Food Products APEC 4451 / 5451

2. WHAT GOES INTO SETTING A PRICE? Profit, Sales volume, Ethics, Laws, Cost, Promotions, Price discrimination First, Second, and Third Order Price discrimination Charging different prices to different consumers for the same product University of Minnesota

3. First order: Extract all consumer surplus with multiple prices Second order: charge different prices for different blocks of sales Third order: Different consumer demand elasticity in different markets - charge each a different price equating MC to MR in each market.

4. Buyers “valuation” of the product/service value P Consumer surplus Price revenue Q University of Minnesota

5. First order price discrimination

6. Second Degree Price Discrimination

7. Third Order Price Discrimination

8. Coca-Cola Vending Pricing • Price by the temperature ??? • Why not??

9. P Price elasticity %change in Q / a % change in P The slope of the demand curve Shifts in demand vs. changes in demand Price elasticity Po What makes it shift? Qo University of Minnesota

10. Consumers have an elasticity of demand => price down and quantity up (even for food) • Economic theory (Utility Maximization) & consumer psychology/behavior => get the most Quantity for the price!

11. Pricing Strategy I will raise my price to increase my revenue When will this work? (Necessities, addictive, status, Low % of income, tourist) % increase in price is 10 and % decrease in volume is 5 e = ?? -5/10 = -.5 => inelastic and revenue will increase University of Minnesota

12. P Price elasticity e = %change in Q / % change in P Pricing Strategy P1 Po Elastic demand: e >1(absolute value) Revenue loss from p increase Inelastic demand: e <1 Revenue gain from p increase Q Q1” Q1 Qo University of Minnesota

13. Pricing Strategy I will cut my price and make it up on volume! When will this work? % decrease in price is 10% and increase in volume is 20% e = ?? 20/-10 = -2 => elastic and revenue will increase University of Minnesota

14. P Price elasticity e = %change in Q/ % change in P Pricing Strategy Po Q3 = more elastic response: Gain more revenue with lower price P1 Q2= less elastic response Q Qo Q2 Q3 University of Minnesota

15. P Pricing Strategy Promotion Loyalty Premium Quality more elastic less elastic Price has less effect on quantity sold. Q University of Minnesota

17. INCOME EALSTICITY • Engle’s Law: As income goes up, the portion of the increase that is spent on necessities (food) decreases. Income elasticity: % change in quantity / % change in income Expenditure elasticity: % change in expenditure on a given food/ % change in income

18. Substitutes and complements: • Cross price elasticity: • % change in quantity of hot dog buns/ • % change in price hot dogs • e is - => complement • 2. % change in quantity of bratwurst/ % change in price of hot dogs • e is + => substitute University of Minnesota

19. How do we measure profit? Profit on sales: Revenue - Total cost = Profit TC = marketing costs+ manuf. Costs + Overhead Costs (2variable + 1fixed) At retail: COGS not a hard number Rebates, promotion dollars, slotting fees etc. Questions of where these show up in profits? University of Minnesota

20. COGS = $500,000 • Promotion $ from manuf. 5% = $25,000 • Rebate based on volume 3% on quantity over 100 cases a week ( sell 200 cases: 100x$25/case = $2500x.03=$75) • Slotting fee if new product: $100,000 • If it is accounted for as a decrease in COGS: • $500,000 – 25,000 -75 -100,000 = $374,925 University of Minnesota

21. If it is accounted for as a decrease in COGS: • $500,000 – 25,000 -75 -100,000 = $374,925 • #1 Revenue: $1,000,000 • - COGS: $500,000 = $500,000 Gross Profit • –other costs $400,000 = $100,000 Net Profit • #2 $1,000,000 - $374,925 = $625,075=> more GrossProfit (lower COGS) • $625,075 – $400,000 = $225,075 = Net Profit • BUT: tradendollaresnhave to appear somewhere. If add to #1 as revenue,get same net profit as $225,075. • Issue of timing: book promotion $ before received. University of Minnesota