Pricing strategies sl & hl content
- 1. PRICING STRATEGIES (SL & HL Content) IB BUSINESS & MANAGEMENT A COURSE COMPANION P210-212
- 2. PRICING STRATEGIES There are 3 main categories: Cost-based pricing • Cost-plus Pricing • Marginal-cost pricing • Contribution Pricing Competition-based pricing • Price Leadership • Predatory Pricing • Going Rate Pricing Market-Based pricing • Price Penetration • Price Skimming • Price Discrimination • Loss Leaders • Psychological Pricing • Promotional Pricing
- 3. COST BASED STRATEGIES Cost Plus Pricing • This method is very commonly used by businesses as it is easy to calculate and understand. • It simply involves working out the average cost per unit produced (total cost divided by output) and then adding a percentage mark up. • Eg: The average cost per unit is $100 for a product. It may decide that it wants a profit margin of 25%, meaning the selling price would be $125. • The higher the percentage mark up, the more profit per unit. • This strategy is also known as full cost pricing or absorption pricing.
- 4. COST BASED STRATEGIES Marginal Cost Pricing • The marginal cost is the addition to the total cost for producing one extra unit of output. • Some businesses have very high fixed costs (costs that do not vary with output) and very low variable costs (costs that do vary with output >> therefore once their fixed costs have been recovered, they can sell at any price above the variable (now the marginal cost) • This is because the extra units sold will only add small amount to their total costs, so the business can still be profitable as along as these costs are covered.
- 5. COST BASED STRATEGIES Marginal Cost Pricing • Utilities companies such as gas and water suppliers may do this as long as they have very low marginal costs of increasing output to one home or business. • However, it is important that the price is not well publicized as a business can’t afford to sell its output at this low price – low prices for everyone would mean an overall loss.
- 6. COST BASED STRATEGIES Contribution Pricing • This is similar to marginal-cost pricing in that it mainly considers the variable costs of production. • Businesses will want to make sure that their variable costs, such as raw materials, are covered, but also need a contribution towards the fixed costs of the business, such as rent on the factory.
- 7. COST BASED STRATEGIES Contribution Pricing Example • The fixed costs for a product are $400. • The variable costs are $6 per unit. • 100 units are sold. • The business decides to price the product at $11. • This means $5 per unit sold will go towards the fixed costs. • The fixed costs of $400 will be covered by the first 80 units sold. $400/ $5 = 80. • Any more sold beyond 80, will each add $5 to profits. • If 100 are sold the total profit would be 20 x $5 = $100.
- 8. COST BASED STRATEGIES Contribution Pricing • A business cannot guarantee profit using this pricing method – it needs to sell enough units to cover its fixed costs before making profit. • This method can be very useful when making one-off decisions, such as a special for a particularly large order. • As long as the price contributes to fixed costs, it may be worth offering a special price, but if there is no contribution then the business unlikely to take the order.
- 9. COMPETITION BASED PRICING Price Leadership • Price leadership exists where a dominant organization in a market sets a price for its products and its rivals feel compelled to match that price. • This may be because there is one large business in the industry coupled with lots of smaller competitors with far less market power to set prices. • It can also be seen in oligopolistic markets (markets with a few large businesses) where the leaders all tend to match each other’s prices.
- 10. COMPETITION BASED PRICING Price Leadership Example • Petrol/gas stations will often have policies where they agree to match local rivals prices. • This practice has brought about claims of illegal agreements by businesses to fix prices at an artificially high level and exploit customers. • However, it is very hard to prove that this collusion has actually occurred.
- 11. COMPETITION BASED PRICING Predatory Pricing • Predatory pricing is deliberately selling a product at below average cost with the intention of forcing a competitor out of the market. • In many countries this is illegal, but it is very hard to prove the intention of an organization’s behaviour – it could be simply running a loss leader. • Businesses often strongly contest accusations of this in the courts – and even if they lose, they may not change their behaviour.
- 12. COMPETITION BASED PRICING Going Rate Pricing • Going-rate pricing is where businesses price their products at whatever the prevailing market price may be. • This is likely to be because the market is highly transparent and the business would lose most of its sales by trying to charge a higher price.
- 13. MARKET BASED PRICING Price Penetration • Price penetration is where a business sells it products at a low price to try to break into a market and gain market share quickly. • The aim of this policy is to gain enough market share to be able to raise prices in the future once the business has become established.
- 14. MARKET BASED PRICING Price Skimming • This is most commonly seen with new and innovative products, such as new mobile phones and games consoles. • The price is set high initially to gain those customers who will pay almost any price to get their hands on the latest gadget. • Once the business has profited from selling to those customers, it drops the price to tempt other customers who may have been put off by the high price originally. • It is only able to do this because there is likely to be almost no competition in the market due to the cutting edge nature of the product.
- 15. MARKET BASED PRICING Price Discrimination • Most markets can be broken down into different sub groups. • It is likely that customers in some of these groups may be prepared to pay slightly higher prices than those in other groups. • Ideally the business would like to sell its product at different prices in the various segments, by charging higher prices to customers who are prepared to pay more.
- 16. MARKET BASED PRICING Price Discrimination Examples of Price Discrimination • Phone calls – it is usually more expensive to make a call during the day (Monday to Friday) that the evenings or weekend. • This is because some users will have no choice but to use the phone a lot in their work) and are therefore more likely to pay higher prices. • Conversely, those people who just wish to call for social purposes are often prepared to wait to make their calls and so only pay a lower price.
- 17. MARKET BASED PRICING Price Discrimination • Price discrimination is only possible if the product cannot be easily traded. • Eg: Selling footballs in one town at a higher price than in another town would tempt entrepreneurs to buy up the cheap footballs and drive them to the first one to sell at a profit.
- 18. MARKET BASED PRICING Loss Leaders • Loss leaders are products sold at very low prices to tempt customers into a store. • Most supermarkets offer a low cost range, which in itself may not be profitable. • The supermarket know that someone coming in is unlikely only to buy products in the low cost range and as a result the supermarket will be able to earn profit overall on consumers weekly shopping. • A business can use these loss-leading products as part of its promotional activity – they will also give the business a reputation for good value which may in turn also increase sales and profits.
- 19. MARKET BASED PRICING Loss Leaders Walmart Example • In the US Walmart has managed to combine its huge buying power with a loss-leading strategy to offer new CD albums for sale at half their recommended retail price. • The headline grabbing strategy allows Wal-Mart to attract customers from far and wide, but it has resulted in accusations of unfair market practices by music retailers where sales have been badly hit.
- 20. MARKET BASED PRICING Psychological Pricing • Psychological pricing considers the fact that price gives a customer information about the characteristics of a product. • Eg. You would expect a luxury product to be priced at the higher end of the market. If a perfume is priced too cheaply, its sales may suffer as potential consumers perceive it as of poorer quality than the higher priced rivals.
- 21. MARKET BASED PRICING Psychological Pricing Psychological pricing also refers to the practice of setting prices at just under the currency unit such as $19,99 rather than $20. This is based on a number of assumptions: • Customers only take account of the “big number” rather than the proper rounding. • If a product is $19,99 it appears that it is offered at the lowest possible cost rather than being priced up to the nearest full currency unit. • Psychological pricing pushes products into cheaper price bands. Examples of this are cars and property.
- 22. MARKET BASED PRICING Psychological Pricing • Whatever the reason, pricing at amounts ending .99 or .95 has become common place. • Most bizarre are petrol and gas prices that often end in fractions of a penny or cent – a price that is impossible to pay as we don’t have small enough coins – so the prices quoted need to be rounded up before we can pay.
- 23. MARKET BASED PRICING Promotional Pricing • Special offer or promotional pricing is used to clear excess stock quickly or to try to gain market share. • The best example is “buy one get one free” (“BOGOF”) offers, which are now common place across the world. • This enables a business effectively to halve the price without it seeming that the product is of lower quality. • It also ensures that those customers who would only have bought one product at half price have to buy twice as much. • Promotional pricing can also be used to boost sales in times of low demand, or to boost customer awareness of a new outlet that has opened in an area.