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# Pricing approach

Published on: Mar 4, 2016
Source: www.slideshare.net

#### Transcripts - Pricing approach

• 1. Pricing Approach #1: Cost-based pricing There are essentially two models of Cost-Based pricing; ”break-even” and “markup“. The break-even pricing approach is used to determine when you can expect a profit on your product or service. The point at witch you will start making a profit is known as the “breakeven point”. To determine the breakeven point you will need to use the breakeven formula. To find the breakeven point, do so by dividing total cost by number of units produced plus variable costs. Some major pitfalls of the breakeven formula and the breakeven point: 1. Lacks the complete picture – using the breakeven formula to calculate your breakeven point is a great place to start. However, understanding your breakeven point is only useful if you can actually generate the appropriate consumer demand. In other words, if you can’t generate enough consumer demand to actually hit your breakeven point, why even utilize the breakeven formula to begin with? In most cases, it’s almost always best to consider how much consumer demand you can actually generate. 2. Not 100% accurate over the long haul – the breakeven formula assumes that your “fixed costs” will always remain the same. While this is true in the present, in most cases, your fixed costs will actually go up as you scale your business. That’s the goal, right? The markup pricing approach is often used by retailers due to its simplicity. The easiest and most common use is to speak in terms of the “markup percentage”. For example, an investor may ask you, “what is your markup percentage on the product“.
• 2. To find the markup percentage of a product simply subtract the total cost from the sales price and divide again by the total cost. Pricing Approach #2: Profit-based pricing Probably the most popular model of profit-based pricing is what’s known as “target profit pricing“. To use this pricing approach, take the following steps: 1. Determine the amount of profit you would like to make – the profit figure will be calculated into the pricing equation just like an additional cost. 2. Find the sum of your total cost and profit. 3. Divide that number by the total number of units. *As I mentioned before, the main concern with cost-based and profit-based pricing is that the competition and consumer demand is ignored. Pricing Approach #3: Demand-based pricing
• 3. There are many models of “demand-based pricing“. Let’s take a quick look at market skimming, penetration pricing, prestige pricing, and bundle pricing. 1. Market skimming – market skimming is when the initial price is extremely high and reduced slowly over time. This allows for businesses to recoup from production quicker but only in markets where consumers are willing to pay higher prices (think about flat screen TVs). 2. Penetration pricing – penetration pricing is, essentially, the opposite of marketing skimming. Penetration pricing is when a business is try to “penetrate” the market using pricing in order to capture market share. To increase their market share, a company will typically offer discounts and rebates and then gradually remove them once they approach their market share goal. 3. Prestige pricing – is used to try to communicate the value of the brand (think about Tiffany). 4. Bundle pricing – has become wildly popular due to the home cable and phone companies. Bundling combines complimentary products to add to volume. *A major benefit of “demand-based pricing” is just that; it takes into consideration consumer demand and your strategy for gaining market share. Pricing Approach #4: Value-based pricing The last of the pricing approaches may have been the most relevant for the subject of the opening story. In value-based pricing it is important to understand the use of the product and analyze the benefits. Sports teams use the value-based pricing option by charging more for tickets versus major competitors. Pricing is one of the most important elements of the marketing mix, as it is the only mix, which generates a turnover for the organisation. The remaining 3p’s are the variable cost for the organisation. It costs to produce and design a product, it costs to distribute a product and costs to promote it. Price must support these elements of the mix. Pricing is difficult and must reflect supply and demand relationship. Pricing a product too high or too low could mean a loss of sales for the organisation. Pricing should take into account the following factors: 1. Fixed and variable costs.
• 4. 2. Competition 3. Company objectives 4. Proposed positioning strategies. 5. Target group and willingness to pay. An organisation can adopt a number of pricing strategies. The pricing strategies are based much on what objectives the company has set itself to Types of Pricing Strategies
• 5. Pricing Strategy Definition Example Penetration pricing: Here the organisation sets a low price to increase sales and market share. Once market share has been captured the firm may well then increase their price. A television satellite company sets a low price to get subscribers then increases the price as their customer base increases. Skimming pricing: The organisation sets an initial high price and then slowly lowers the price to make the product available to a wider market. The objective is to skim profits of the market layer by layer. A games console company reduces the price of their console over 5 years, charging a premium at launch and lowest price near the end of its life cycle. Competition pricing Setting a price in comparison with competitors. Really a firm has three options and these Some firms offer a price matching service to match what their competitors are offering.
• 6. are to price lower, price the same or price higher Product Line Pricing: Pricing different products within the same product range at different price points. An example would be a DVD manufacturer offering different DVD recorders with different features at different prices eg A HD and non HD version.. The greater the features and the benefit obtained the greater the consumer will pay. This form of price discrimination assists the company in maximising turnover and profits. Bundle Pricing: The organisation bundles a group of products at a reduced price. Common methods are buy one and get one free promotions or BOGOF's as they are now known. Within the UK some firms are now moving into the realms of buy one get two free can we call this BOGTF i wonder? This strategy is very popular with supermarkets who often offer BOGOF strategies. Psychological pricing: The seller here will consider the psychology of price The seller will therefore charge 99p instead £1 or \$199 instead of \$200. The reason why this methods work, is because buyers will still say they purchased their product under £200 pounds or dollars, even thought it was a pound or dollar away. My favourite pricing strategy.
• 7. and the positioning of price within the market place Premium pricing The price set is high to reflect the exclusiveness of the product. An example of products using this strategy would be Harrods, first class airline services, Porsche etc. Optional pricing: The organisation sells optional extras along with the product to maximise its turnover. T This strategy is used commonly within the car industry as i found out when purchasing my car. Cost Based Pricing: The firms takes into account the cost of production and distribution, they then decide on a mark up which they would like for profit to come to their final pricing decision. If a firm operates in a very volatile industry, where costs are changing regularly no set price can be set, therefore the firm will decide on their mark up to confirm their pricing decision. Cost Plus Pricing: Here the firm add a percentage to costs as profit margin to come to their final For example it may cost £100 to produce a widget and the firm add 20% as a profit margin so the selling price would be £120.00
• 8. Pricing - Pricing Strategies Author: Jim Riley Last updated: Wednesday 24 October, 2012 Marketing - Pricing approaches and strategies There are three main approaches a business takes to setting price: Cost-based pricing: price is determined by adding a profit element on top of the cost of making the product. Customer-based pricing: where prices are determined by what a firm believes customers will be prepared to pay Competitor-based pricing: where competitor prices are the main influence on the price set Let’s take a brief look at each of these approaches; Cost based pricing This involves setting a price by adding a fixed amount or percentage to the cost of making or buying the product. In some ways this is quite an old-fashioned and somewhat discredited pricing strategy, although it is still widely used. After all, customers are not too bothered what it cost to make the product – they are interested in what value the product provides them. Cost-plus (or “mark-up”) pricing is widely used in retailing, where the retailer wants to know with some certainty what the gross profit margin of each sale will be. An advantage of this approach is that the business will know that its costs are being covered. The main disadvantage is that cost-plus pricing may lead to products that are priced un-competitively. pricing decisions.
• 9. Here is an example of cost-plus pricing, where a business wishes to ensure that it makes an additional £50 of profit on top of the unit cost of production. Unit cost £100 Mark-up 50% Selling price £150 How high should the mark-up percentage be? That largely depends on the normal competitive practice in a market and also whether the resulting price is acceptable to customers. In the UK a standard retail mark-up is 2.4 times the cost the retailer pays to its supplier (normally a wholesaler). So, if the wholesale cost of a product is £10 per unit, the retailer will look to sell it for 2.4x £10 = £24. This is equal to a total mark-up of £14 (i.e. the selling price of £24 less the bought cost of £10). The main advantage of cost-based pricing is that selling prices are relatively easy to calculate. If the mark-up percentage is applied consistently across product ranges, then the business can also predict more reliably what the overall profit margin will be. Customer-based pricing Penetration pricing You often see the tagline “special introductory offer” – the classic sign of penetration pricing. The aim of penetration pricing is usually to increase market share of a product, providing the opportunity to increase price once this objective has been achieved. Penetration pricing is the pricing technique of setting a relatively low initial entry price, usually lower than the intended established price, to attract new customers. The strategy aims to encourage customers to switch to the new product because of the lower price.
• 10. Penetration pricing is most commonly associated with a marketing objective of increasing market share or sales volume. In the short term, penetration pricing is likely to result in lower profits than would be the case if price were set higher. However, there are some significant benefits to long-term profitability of having a higher market share, so the pricing strategy can often be justified. Penetration pricing is often used to support the launch of a new product, and works best when a product enters a market with relatively little product differentiation and where demand is price elastic – so a lower price than rival products is a competitive weapon. Price skimming Skimming involves setting a high price before other competitors come into the market. This is often used for the launch of a new product which faces little or no competition – usually due to some technological features. Such products are often bought by “early adopters” who are prepared to pay a higher price to have the latest or best product in the market. Good examples of price skimming include innovative electronic products, such as the Apple iPad and Sony PlayStation 3. There are some other problems and challenges with this approach: Price skimming as a strategy cannot last for long, as competitors soon launch rival products which put pressure on the price (e.g. the launch of rival products to the iPhone or iPod). Distribution (place) can also be a challenge for an innovative new product. It may be necessary to give retailers higher margins to convince them to stock the product, reducing the improved margins that can be delivered by price skimming. A final problem is that by price skimming, a firm may slow down the volume growth of demand for the product. This can give competitors more time to develop alternative products ready for the time when market demand (measured in volume) is strongest. Loss leaders The use of loss leaders is a method of sales promotion. A loss leader is a product priced below cost-price in order to attract consumers into a shop or online store. The purpose of making a product a loss leader is to encourage customers to make further purchases of profitable goods while they are in the shop. But does this strategy work?
• 11. Pricing is a key competitive weapon and a very flexible part of the marketing mix. If a business undercuts its competitors on price, new customers may be attracted and existing customers may become more loyal. So, using a loss leader can help drive customer loyalty. One risk of using a loss leader is that customers may take the opportunity to “bulk-buy”. If the price discount is sufficiently deep, then it makes sense for customers to buy as much as they can (assuming the product is not perishable). Using a loss leader is essentially a short-term pricing tactic for any one product. Customers will soon get used to the tactic, so it makes sense to change the loss leader or its merchandising every so often. Predatory pricing (note: this is illegal) With predatory pricing, prices are deliberately set very low by a dominant competitor in the market in order to restrict or prevent competition. The price set might even be free, or lead to losses by the predator. Whatever the approach, predatory pricing is illegal under competition law. Psychological pricing Sometimes prices are set at what seem to be unusual price points. For example, why are DVD’s priced at £12.99 or £14.99? The answer is the perceived price barriers that customers may have. They will buy something for £9.99, but think that £10 is a little too much. So a price that is one pence lower can make the difference between closing the sale, or not! The aim of psychological pricing is to make the customer believe the product is cheaper than it really is. Pricing in this way is intended to attract customers who are looking for “value”.
• 12. Competitor-based pricing If there is strong competition in a market, customers are faced with a wide choice of who to buy from. They may buy from the cheapest provider or perhaps from the one which offers the best customer service. But customers will certainly be mindful of what is a reasonable or normal price in the market. Most firms in a competitive market do not have sufficient power to be able to set prices above their competitors. They tend to use “going-rate” pricing – i.e. setting a price that is in line with the prices charged by direct competitors. In effect such businesses are “price-takers” – they must accept the going market price as determined by the forces of demand and supply. An advantage of using competitive pricing is that selling prices should be line with rivals, so price should not be a competitive disadvantage. The main problem is that the business needs some other way to attract customers. It has to use non-price methods to compete – e.g. providing distinct customer service or better availability. Pricing Strategies Lesson Exercise Answer In terms of the marketing mix some would say that price is the least attractive element. Marketing companies should really focus on generating as high a margin as possible. The argument is that the marketer should change product, place or promotion in some way before resorting to price reductions. However price is a versatile element of the mix as we will see. Our financial objectives in terms of price will be secured on how much money we intend to make from a product, how much we can sell, and what market share will get in relation to competitors. Objectives such as these and how a business generates profit in comparison to the cost of production, need to be taken into account when selecting the right pricing strategy for your mix. The marketer needs to be aware of its competitive position. The marketing mix should take into account what customers expect in terms of price.