pricing strategy - sites at penn...
TRANSCRIPT
Upcoming Schedule Product Strategy
Tuesday 3/22 Lecture
Thursday 3/24 Class Discussion on “TruEarth Healthy Foods: Market Research for a New Product Introduction”
Pricing Strategy
Tuesday 3/29 Lecture
Thursday 3/31 Class Discussion on “A.1. Steak Sauce: Lawry’s Defense”
Distribution Strategy
Tuesday 4/5 Lecture
Tuesday 4/7 Class Discussion on “Natureview Farm”
Promotion Strategy
Tuesday 4/12 Lecture
Thursday 4/14 Class Discussion on “Giant Consumer Products: The Sales Promotion Resource Allocation Decision”
Price Influencers
1. Methods for Determining Price
2. Supply Factors (producers, distributors,…)
3. Competitive Environment
4. Consumer Behavior
5. Legal-Political Environment
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Methods for Determining Prices
• Prices traditionally determined in two basic ways:
1. Price Theory (supply and demand analysis)
2. Cost-Oriented Analysis
• But there are other factors that may adjust prices further
– consumer psychology
– competition
– regulation
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Economic Pricing Depends on the Competitive Environment
• Monopoly
– one seller
– high barriers to entry / regulated by government
p = price, c = unit cost, = price elasticity of demand
• Oligopoly
– few sellers
– barriers to entry
– i = firm index, = market share
• Monopolistic Competition
– heterogeneous/differentiated products
– marketers have some pricing power
– some barriers to entry
• Perfect Competition
– many sellers
– prices accepted by the market
– 0 profits
– no barriers to entry
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Ma
rk U
p
1p c
p
i i
i
p c s
p
is
0
i
i
i
p c
p
p c
Marginal Revenue = Marginal Cost
Pricing Rule Example
Small farmer of undifferentiated ag commodities
Sucralose was; GM seeds protected by patents
Baby Formula - 3 producers
Competing brands; local retailers
Cost and Revenue Curves • Supply and Demand price determination finds the price so that
marginal revenue = marginal cost
• Cost Curves
– Variable Costs change with the level of production
– Fixed Costs remain stable at any production level within a certain range.
– Total Production Cost = total variable costs + total fixed costs.
– Average Total Cost = (variable + fixed costs)/(no. of units produced).
– Marginal Cost: change in total cost that results from producing an additional unit of output.
• Revenue Curves
– Total Revenue: units of output times their price.
– Average Revenue is calculated by dividing total revenue by the quantity of goods or services sold
– Marginal Revenue is the change in total revenue that results from selling an additional unit of output
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Problems with Econ Theory Pricing
• Marketers may thoroughly understand price theory concepts but still encounter difficulty in applying them in practice.
• Practical limitations interfering with price determination include: – Many firms don’t attempt to maximize profits
• Then what…?
– Estimating demand curves is a difficult process
– Dynamic effects such as habit formation are really hard to measure
– Requires a lot of consumer behavior data
– Relationships that existed yesterday might not exist today • Changes in the market may have shifted demand curves
• New products may be introduced
• Consumer preferences and perceptions might change
• Competition changes their price
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Price Elasticities Are Predictive
• Own-Price Elasticity
– tells you the shape of your demand curve (near a price)
• Cross-Price Elasticity
– the effect on demand from a change in another good’s price
– tells you how your demand curve is going to shift as a result of your competitors price changes
– same formula as above, but now use the other good’s price
1 0
0 0
1 0
0 0
percent change in demand %
percent change in the price of %DP
D D D
D DD
P P P P
P P
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Cost-Plus Pricing • Takes some measure of costs and adds a percentage to it.
– Many variations that differ in complexity
– Not inconsistent with price theory methods
• Is especially effective for low-cost producers
– Ex: Walmart. Why?
Ex 1: Full-Cost Pricing uses average total costs as the basis
• Ex: fixed costs = $100,000
– making 200,000 omelets will cost $300,000
– you want a 20% markup.
– so price = (1+.2)×($100,000+$300,000)/200,000 = $2.40
• Deficiencies
– does not take into account consumer response at all
– fixed costs should have nothing to do with it (see previous pricing theory) • this pricing method does not maximize profits
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Cost-Plus Pricing Ex 2: Incremental Cost Pricing considers only costs attributable to production (not overhead, fixed, and sunk costs)
• Provides more flexibility
• Ex: it costs you $1.50 to make additional omelets.
– your average total cost so far is $2.00 per omelet
– an opportunity falls in your lap to sell an additional 20,000 omelets for $1.80 apiece.
– Do you do it?
– What does full cost pricing tell you to do? • If you do it average total cost = $1.95
markup is negative
– What about the incremental cost pricing rule? • Markup = ($1.80-$150)/$1.50 = 20%
• Do it!
– Additional $6,000 profit with Incremental Cost Pricing
– Accounts for economies of scale
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Breakeven Analysis
• Breakeven Analysis finds the number of units that needs to be sold in order to make a profit at a hypothetical price.
– a target profit can be used instead of the breakeven point
– Advantages • easy to understand
• relates to profit
• motivates revenue goals
– Disadvantages • does not consider demand
• assumes constant fixed costs
• considers 1 price at a time
breakeven
(Breakeven point in Units) (Per-Unit Contribution to Fixed Costs)
Total Fixed Costs
or
( ) Total Fixed CostsQ p c
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Modified Breakeven Analysis
• Modified Breakeven Analysis – do breakeven analysis for an array of hypothetical prices.
• Can include consumer responses (demand)
• Demand considerations include:
– Degree of price elasticity
– Consumer price expectations
– Existence and size of specific market segments
– Buyer perceptions of strengths and weaknesses of substitute products
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Modified Breakeven Analysis
• Advantages – incorporates more than one price and includes demand
• .
MR=MC Max profit
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Modified Breakeven Analysis
• Advantages – incorporates more than one price and includes demand
• Criticism – we’re back to pricing theory!
MR=MC Max profit
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Pricing Strategies
• Skimming – setting prices initially high and slowly decreasing prices to attract people with decreasing willingness-to-pay
– form of price discrimination (for nondurables)
– typically used with new and novel products
– most effective with durable goods but can be useful for food
– Ex: Pom has had high prices but they are decreasing
• first adopters tend to have high willingnesses-to-pay and be evangelical about the product
• has allowed them to ramp up production
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Competitive Pricing Strategy • Simply matching the prices of comparable competitors.
• 2/3 of firms use competitive pricing
• De-emphasizes price as a competitive variable – unless you have a production cost advantage, it is unlikely you can
maintain a low price advantage for very long any ways
– avoids price wars • Who wins in a price war?
• Characteristic of “old” market spaces where price battles have been played out (mature markets)
• Allows for marketing resources to be used elsewhere
• Step Out – raises prices to see if competitors follow – if they don’t, prices are lowered back to original levels
– is this tacit collusion?
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Penetration Pricing Strategies
• Sets an artificially low price as a marketing weapon
– used when increasing volume or market share are the objectives
– not a long-term strategy
• Examples:
– Set a low price during introduction to gain consumer recognition • works best with elastic demand
– Set a low price to attract a large market before competitors mimic • increases first movers advantage and creates solid brand loyalty
– Set a low price to deter a potential entrants
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EDLP vs. Hi-Lo
• Everyday Low Pricing (EDLP) uses continuously low and stable prices rather than short-term price cuts – You know that Walmart will have the lowest prices
– Is not a sure fire way to gain an advantage because competitors can easily counter and low prices might mean lower profit • requires a cost advantage
• Contrast with Hi-Lo Pricing – high prices with short periods of sales – a way to price discriminate
• price sensitive consumers will wait for deals while insensitive consumers will pay the high prices
• Examples?
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Temporary Discounts
• Manufactures often give retailers discounts so that the retail price will be lowered – Called Trade Allowances
• Pass-Through: The amount of a manufacturer’s discount that is passed though the retailer to the consumer (the intended target)
• Retailers take ownership of products when they obtain them from producers, distributors, etc. – it’s up to them if they want to pass a discount on
– Why wouldn’t the retailer pocket all the discount?
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Pass Through Findings (Supermarkets) • Retailers claim:
– 62% pass-through
– 24% goes to promotion
– 14% pocketed
• Manufacturers think retailers are lying
– say only 52% is passed through
• Usually > 60% of a manufacturer’s discount is passed through
– 9 of 11 categories had >60% pass-through
• Brands with large market share get greater pass- through…why?
• No pattern for cross-brand pass-through
– i.e. lowering all prices within a product category in response to 1 brand’s discount
• When would a retailer be more likely to pass discounts through?
Source: Besanko, D., Dube, J.-P., Gupta, S., 2005, “Own-Brand and Cross-Brand Retail Pass-Through”, Marketing Science 24(1):123-137.
Important because it means trade allowances can be used as a competitive tool
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Opening Price Point
• The practice of retailers setting a low price for an item within a category thereby giving consumers a high value option
• Gives the impression more expensive items in the category are also a good bargain
• Grocers increasingly use their private labels to set opening price points – “The opening price point is clearly a foundation of
who we are and how we interact with our customers” – Ray Bracy, Walmart VP
– Gives the impression the entire store is full of bargains Why? • Private labels are tightly tied to the store’s brand image
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Loss Leaders • Products that are offered below supplier costs to attract consumers
to the store
• Often placed in the far back of the store to induce consumers to walk past other goods
• Consumer stockpiling is often deterred by… What?
– using highly perishable foods (e.g. milk, bananas)
– imposing purchasing maximums
• Frequently purchased items are used. Why?
– so people are familiar with typical prices and recognize the opportunity
– will attract more shopping trips
• Fast food restaurant discount menu items are loss leaders
– they make their money off the pop
• Gas is a loss leader for many gas stations!
– gas accounts for 70% of revenue but 30% of profit
– they make their money on food and tobacco on the inside of the store
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Pricing Strategies
• Quantity Discounts – lower unit prices for larger purchasing orders Why? – a way to implement a multi-segmentation strategy to
product-related market segments
– reflects potential per item production/marketing cost savings from larger orders
– accommodates decreasing marginal rates of substitution of consumer utility (i.e. diminishing returns)
– careful, ~10% of larger sizes cost more per unit. Why? • sometimes larger sizes provide convenience or are desired by
inelastic segments
• Ex: larger cans of tuna fish are often more expensive than smaller cans on a per ounce basis
$3.64/gal
$3.74/gal
21.75 cents/oz
19.8 cents/oz
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Bundling
• When 2 or more goods and services are sold together at a price that is less than the sum of their separate prices
• A form of quantity discount – Even if the margins are smaller per bundle item, the
increased volume makes up for it
• Some bundles create value. How? – supply convenience
– make valued suggestions
– reduce search costs
• Why Value meals?
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Customary Pricing • Firms try to balance consumer pricing
expectations with the realities of rising costs.
• Customary Prices: traditional prices that consumers expect to pay for a good or service
• Consumers get angry when prices move a lot
• Firms try to keep prices constant to avoid consumer’s from experience negative disconfirmation – when reality falls short of expectations
– Ex: Recall how container sizes (oz.) were decreased but prices remained the same during the recession as a way to raise unit costs ($/oz.)
– Ex: Tropicana after a harsh Florida winter
= 8.4% unit price increase = $.34 30
Unit Pricing • Listing the price in terms of dollars per physical
quantities
• Makes it easier to compare prices across different sizes
• What effect does unit pricing have on grocery retail sales?
– Reduces total expenditures by 1-3%
– Profits are converted to consumer welfare
• Who pays attention to listed unit prices?
– highly educated, high income, price sensitive people
• Why do grocers display unit prices?
– Increases sales of store brands
– Is desired by consumers • makes it more likely they will shop at their store.
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Coupons • Used to give temporary price reductions with minimal effect on consumer price
expectations.
• Allows for targeted discounts. How?
• Increases own-price elasticities. Why?
– Attracts new price sensitive consumers
– Makes existing consumers more price aware
• Used to induce repeat purchases
– Recall learning theory (a.k.a. behavior modification) purchase customer satisfaction repeat purchasing will occur.
• the more times a behavior results in a positive outcome, the more likely the behavior will be repeated.
• Pavlovian response
– Problem: getting customers to initiate the desired behavior
– Solutions
• make barriers to purchase unusually low
• lower price
• make more salient
• increase reinforcement
• induce greater purchasing quantities to increase more eating occasions
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Coupons and Learning Theory Example • Customer: me
• Setting: Rosauers Supermarket; Spokane, WA 2009
• Method: Customized coupons printed with receipt
• Product 1: Morning Star Veggie Patties
– Shop 1 (6/18)
• bought 1 box
• store gives receipt-coupon for $.75 off when purchasing 2 boxes (exp. 8/13)
• discount: $.38/box
– Shop 2 (6/27)
• bought 2 boxes using coupon
• store gives receipt-coupon for $1 off when purchasing 3 packages (exp. 8/22)
• discount: $.33/box
• Product 2: Cheerios
– Shop 1 (6/19)
• bought 1 box
• store gives receipt-coupon for $1.50 when purchasing 3 packages (exp. 8/13)
• discount: $.50/box
– Shop 2 (6/27)
• bought 3 boxes using coupon
• store gives receipt-coupon for $1.50 when purchasing 4 packages (exp. 8/22)
• discount: $.38/box
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Odd Pricing
• Setting prices to odd numbers just under round whole numbers.
• Originally was used to prevent pilfering
– forced cashiers to use the cash register to get change
• 60-90% of products have odd retail prices
• Used to give the impression of lower prices
– Ex: $1.99 may be associated with a $1 price range while $2.00 may be associated with a $2 price range
– Theory: People read left to right and do not want to waste their time on smaller digits*
* Basu, K., 2006, “Consumer Cognition and the Pricing in the Nines in Oligopolistic Markets,” Journal of Economics and Management Strategy, Vol 15(1) 125-141.
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Does Odd Pricing Work?
• Historically, evidence has been weak.
• Odd pricing results in people recalling lower prices*
• Recent well designed studies have shown significant increases in demand
– Catalogs with carefully varied prices found a 35% increase in demand**
* Shindler, R., and Wiman, A., 1989. “Effects of odd pricing on price recall,” Journal of Business Research, 19(3): 165–17. ** Anderson, E., and Simester, D., 2003, “Effects of $9 Price Endings on Retail Sales: Evidence from Field Experiments,” Quantitative Marketing and Economics, 1(1): 93-110. 35
Pricing New Products
• Because the quality is unknown, prices play an especially strong role as quality signals.
• Because quality expectations have a powerful effect on taste perception, low prices may result in lower taste evaluations and satisfaction
• Subjects in an fMRI machine were given identical wines but told they were differently priced.*
– Subjects reported higher flavor satisfaction for the “high” priced wines.
– The part of the brain where “experienced pleasantness during experiential tasks” was more active when they thought the wine was high priced
* Plassmann, H., O'Doherty, J., Shiv, B., & Rangel, A. (2008). “Marketing actions can modulate neural representations of experienced pleasantness.” Proceedings of the National Academy of Sciences, 105(3), 1050-1054. 36
Are Prices a Good Signal of Objective-Quality?
• Surprisingly, prices and Objective Quality measures are not often correlated
• Objective measures: laboratory tests, controlled-use tests, expert judgment of purchased samples, and user opinion surveys
• Riesz (1979) uses Consumer Reports for 679 brands in 40 packaged food categories over 15 years and concludes the correlation was near zero
– Subsequent research has found the correlation to be weak at best* - 30 other research papers
– For frozen foods it was negative. Why?
• This does not stop people from believing and perceiving higher priced goods are superior
• Prices that signal low quality may end up being self-fulfilling
– especially with food!
Riesz, P. 1979, “Price-Quality Correlations for Packaged Food Products.” Journal of Consumer Affairs 13(2):236-247. * Gerstner, E., 1985, “Do Higher Prices Signal Higher Quality?” Journal of Marketing Research 22(2):209-215. See handout
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Anchoring • When an initial reference value is used as the basis for a quantity decision.
• Biases decisions towards the anchor value.
• Ex: Expensive wines are often mixed in not to be sold, but to anchor prices higher
• Anchors are persistent.
– Newer information is weighted less than initial info.
• Unavoidable:
– People asked, “Did Gandhi die before age 9”, afterward guessed his death age to be 50.
– People asked, “Did Gandhi die after age 140,” afterward guessed his death age to be 67.
• Even random numbers bias decisions…
– What about PSU student ID numbers?
“I was going to get the $6 bottle instead of the $15, but now that I see this $99 bottle, maybe I’ll get the $15 one after all.”
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Class Results
• Two Groups
– ID < 31 (13 peops)
– ID > 31 (13 peops)
• 62% higher!
• Statistically, this difference* could have occurred randomly only 2 out of 1000 times.
• Pattern remains if we remove outliers
$5.31
$8.58
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
$7.00
$8.00
$9.00
$10.00
Means
Average Prices Bid Based on Last 2 Digits of Student ID #s
Small IDs
Big IDs
* or larger Design based on: Ariely, D., Loewenstein, G.& Prelec, D., 2003. “Coherent Arbitrariness: Stable Demand Curves Without Stable Preferences,” The Quarterly Journal of Economics, 118 (1):73-106
(Subjects were Fall 2013 AG BM 302 students)
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Anchoring Marketing Applications 1. Multiple Pricing: “10 for $5” (instead of 50 cents each)
– An alternative way to state the price
– Anchors the purchase quantity at 10
– Does not need to be a promotional discount
– Increased sales of grocery items by 32% (Wansink, 1998)
– Alternative Explanations? • Shopper Confusion – they believe they need to purchase in greater quantities to get the discount
Wansink, B., Kent, R. J., & Hoch, S. J. (1998). “An anchoring and adjustment model of purchase quantity decisions.” Journal of Marketing Research, 71-81.
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Anchoring Marketing Applications 2. Purchase Maximums: “12 unit maximum”
• Alternative Explanations?
– Limits signal an anticipated stockout
– Scarcity Signal - psychology has found that when something is unavailable, people increase their desire of it.
– Price Signal: suggests it’s a great price
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Anchoring Marketing Applications
3. Suggestive Selling: “Buy 18 for your freezer”
• 120 undergrads asked how many they would buy given the suggestion “Snickers bars – buy [them/18] for your freezer”
• Various discount scenarios given
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Prestige Pricing and Behavior • Prestige pricing involves setting high prices to maintain a
desirable image
– Ex: Your over-priced fancy restaurant
• Prestige can augment a product in (at least) 2 ways:
1. Direct increase in social prestige
2. Change perception of the product through individual factors • recall perceptions are composed of (i) stimulus factors (physical
attributes of the product), and (ii) individual factors that reflect all the non-sensory stuff that affects how people view the object.
• Would a person be willing to pay the same amount for the same product at 7-Eleven as they would at Whole Foods?
• How about soda at a run-down grocery store versus a fancy hotel?
– Doing the same thing but with beer, it was found that* • Fancy resort hotel median price = $2.65
• Run-down grocery store median price = $1.50
* Thaler, R. (1985). Mental accounting and consumer choice. Marketing science,4(3), 199-214.
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Prices and Laws
• Federal, state, and local laws all influence pricing decisions.
• Government Regulations that Affect Prices – Robinson-Patman Act (1936) – Cannot have different prices for
different buyers that are at the same level of the food chain for the purpose of harming competition. • limits third degree price discrimination (different prices for different
commercial segments)
– Resale Price Maintenance (a.k.a. “Fair Trade Law”) is NOW LEGAL. • Upstream firms can force resale prices on downstream firms if doing so
follows the “rule of reason” (Supreme Court, 2007)
– Unfair-Trade Laws - State laws requiring sellers to maintain minimum prices for comparable merchandise. • Protect producers and retail specialty stores from Loss Leaders
• Ex: Pennsylvania Milk Price floors
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Tariffs and Taxes
• Tariffs affect food prices – Tariff: a tax on imported goods and services
– Implemented to protect domestic producers
– Average tariff on fruits and veggies: >50%
– US fruit and veggie tariffs • 10-20% from EU (likely to be eliminated)
• 0% with Mexico and Canada (NAFTA)
– No state tariffs
• Food Taxes – “Food at home” food is not taxed (in most jurisdictions)
– Restaurant food is taxed
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