Price Strategies

Choosing and setting your prices is a task that takes on many dimensions. One way to look at it is by identifying three basic decision factors:

• Method 1 - Set (Calculate) price to cover your operating expenses and profit goals
• Method 2 - Set price based upon competition and their strategies
1. Follow suggested channel (trade) pricing
• Method 3 - Set price according to what the market will bear and how it will respond

We've spent a lot of time on the first factor, expenses and profit goals. Let's review Method 1 - Calculate Price:

Revenue = SP x Quantity of Demand

• Use a Range
  • Retail $30,000-$120,000 monthly
  • Service performer 50hrs x 4 weeks x $50 per hr = $10,000 monthly
• Use three methods to estimate demand

Less: Expenses (fixed Overhead)

• CGS (cost of inventory sold) sample data ; Ask someone in business or a supplier (non-cash expense)
• Rent (about 8% of sales is a suggested goal; 7-21% range)
• Marketing/Advertising (1-8% of sales is typical)
• Employees 10 employees x $10 per hour x 40 hrs x 4 weeks = $16,000
  (include commissions, payroll taxes and Worker's Comp Ins.)
• Depreciation of Capital Assets (non-cash expense)
• Insurance $100-200 monthly (non-cash expense)
  The following may be 5-20% as a range for their total based upon income:
• Utilities
• Maintenance/Cleaning
• Supplies
• Legal Fees/Accounting/Bookkeeping Fees
• Others

= Your Projected Profit

Example: Setting Price via Method 1 - Where you know Revenue, CGS Expenses, Overhead Expense and Profit Goal

Revenue = $50,000 Estimate (Sp x Q in units or customers)

-CGS of $20,000

= Gross Profit of $30,000

- Overhead of $20,000

= Profit of $10,000 (your goal)

Price calcualation if you Know Quantity of Demand

$50,000/2000 units = $25

Quantity calculation if you know Price (method 2 or 3 above)

$50,000/$25 = 2000 units

Let's look at some ideas that fall under the other two methods where you don't calculate price but base oprice uppon the channel, the competitors or the customer.

When entering a new market or offering a new product or service, there are two basic strategies to choose from, penetration pricing or price skimming.

Penetration Pricing - The idea of penetration pricing is to charge a price below what the competition charges. If you are offering a new product you price it low, perhaps at or below your costs. The advantages are:

• gain high market share quickly
• establish volume sales with revenue from low markup but high sales volume
• establish brand familiarity and loyalty; your the brand setterand the one to beat, competitors must try to take sales from you
• can raise price later, usually slowly, as you become competitively establish

Price Skimming - The idea of price skimming is to charge a price that is higher than the competitors charge. If you are offering a new product you price it initially high compared to costs. The advantages are:

• price high to recover the costs of developing the product, establishing its brand and cultivating the market
• establish an image of high quality
• establish your brand name as the best
• reap initial profits from high markup on low volume sales
• sell to customers that are "early adopters", not price sensitive and willing to try new products or services
• lower price later as you become competitive or as competitors enter the market

This is the standard macro economics class view of price dynamics in the market place based upon supply available (competition) and demand from consumers. The basic idea is that changes in price may result in changes in demand...or not!

A typical Demand Curve looks likes this:


Price

Units

P x Q = TR (total revenue)

For instance: 5 x 100 = $500

Normally:
If you raise price, demand decreases.
If you lower price, demand increases.

Sometimes demand curves flip and behave the opposite way to a price change:

Price

Units

Sometimes demand fails to react much to changes in price:

Price

Units

Demand is often described as being elastic or inelastic to changes in price. Elasticity is measured by the Total Revenue (TR)

Retail Pricing tactics Article | Video File

Depending upon the reactions of customers and their perceptions of what value they recieve, price setters may make adjustment to the price they charge.

Odd/Psychological/Charm Pricing - Set price just below the next whole dollar; end in an odd number. When the price of an item ends with:.

• $9.95, $13.97, $149.99

We are conditioned to see it as a deal or bargain. Studies show that people like the odd numbers over 5 better than any even number for the ending digit in prices. And oddly, Mosre people will read the price as $9.00 or $13.00 instead of the closer $$10.00 or, $14.00 respectively.

Price Lining - Set prices to cover a group of products including a variety of sizes all at the same averaged price OR set price to cover a type of product but in steps, adding value each time but making the step up a reasonble price jump for a buyer to take.

• Shoes - $ 49.95 (sizes 5AAA thru 14EEEE)
• Appliances - $ 149.00, 189.00, 225.00, 295.00

(Loss) Leader Pricing - Set a price at or below cost to bring customers into your business. While they are there they will likely buy other items. It is a promotional price, often more effective than spending the same amount of money on advertising because the customer engages in purchase behavior, seeks out the store location and becomes familiar with it and your brands.

Geographical Pricing - price is set based upon:

• where the customer is located relative to your business - factors like transportation are often averaged into the price so that the cost is evened out for the customer
• where your business is located and the surrounding trade area - different trade areas will support higher or lower prices based upon the customer demographics and lifestlyes

Opportunity Pricing - price is set based upon:

• current circumstances such as the weather
• temporary needs
• customer motivation
• special events
• disaster
• social and cultural fads
• time of day
• right place, right tim

Often prices are suggested by a large and powerful intermediary in the marketing channel in order to affect the competitive environment and control prices throughout the channel to some degree. Often this intermediary is controlling the branding and advertising for the products it makes or distributes. This business is risking a lot, spending a lot and is attempting to lead the marketing effort and establish product positioning to the benefit of all intermediaries. A secondary goal is to make sure that customers everywhere are being charged the same or similar prices.

In general, a business can charge whatever price it chooses, change price at will, charge different prices to different customers and make as much money as possible.

What are the exceptions?

• price fixing amongst marketers and intermediaries
• monopolizing the market
• proscribed discrimination - race, gender, ethnicity, ageism, religion

Trade Pricing looks at the marketing channel members as participants that are interactive and dependent upon each other for economic success. Tpgether they offer consumers the best choices and value.

A typical marketing channel looks like the system below for Nike:

What role does NIKE play in the marketing channel above? Sometimes a company will engage in vertical integration, wherein they own participants at differing channel levels or engage in more than channel levels operations. This is also an attempt to control costs and influence pricing practices.

All participants in a distribution system buy or make the product or produce their service at a per item or per sale cost. The difference between their cost per item and their selling price is called mark-up.

This example shows where the money goes for a CD sold at a retail price of $15.99.

Exercise: see if can sketch the distribution system (participants) for this CD and their CGS and SP.

This example shows where the money goes for a Cup of Coffee sold at a retail price of $3.75.

Exercise: Make a simple income statement for this coffee retailer using the per cup data avove. Choose a local coffee shop (Surf City, Aptos Coffee Roasting Company, etc.) and guess its daily demand. Would it make a profit or loss at that demand level for a typical month? How many cups would you have to sell to make Sales Revenue of $1 million in a year?

Consumers react in a variety of ways to prices and price changes.

1. Value of the Product/Service - Every product is realy a bundle of benefits. Value comes from the sum of benefits derived out of 3 basic motivational categories:

Physical benefits
Functional benefits
Phychological benefits

2. Perceived Benefits and their value. Key Benefits - Of all the benefits of buying and using a product there are usually a few key benefits that are key motivators in a purchase decision. The others are like prerequisites or foundations. They provide no particular motivation or satisfaction in themselves. However, without them the customer won't buy the product. The key benefits are the real motivators in selection, brand loyalty and competitive positioning. (sunglasses)

3. Affluence of the Market - Affluence is a way to look at purchasing power and what we are willing to pay for as consumers. The more affluent we are the more likely we are to emphasize wants over needs and the more likely we are to be less rational in our decision making. Some factors that affect affluence are:

• Income
• gross income
• disposable income
• discretionary income
• Maslow's Hierarchy of Human Needs
• Wants versus Needs
• Lifestyle
• Peer influence
• Cultural influences
• Self Concept - actual vs. ideal

4. Price Consciousness/Awareness - Some consumers pay close attention to the price of products. However, we are often price aware for some purchase but not so aware for others.

5. Price Importance - Though similar to price consciouness, consumers can be very price conscious without letting price be an important factor in the buying process. This tends to be the case when we have generic competition or competition for the same dollars. see competition

Other times, price is the Key benefit in the buying process.

6. Price Standards & Ranges (Price Expectations) - Whenever you identify a product category you can segment the market into price expectations. These expectations are based upon:(sunglasses)

• Price Standards - different consumers have a different price standard or expected sales price (bread or cars)
• Price Ranges - around that standard the consumer will have a high and low price range within which they will continue to buy the product if the price varies but with decreased motivation as the price approaches the range limits. If the price varies outside the range, either above or below, then the consumer will stop buying or switch products or brands.

7. Quality Indicator/Surrogate Indicator - Often a consumer is unable to know or judge the quality of a product. In that case, price becomes a surrogate indicator by which the consumer makes an assumption of high or low quality.

Of course, when setting price we must consider our market:

• Individual DMU's
• Informal Groups
• Businesses and organizations

Motivations, rationality and objectivity will all change in regard to price factors for differing DMU's.