Economics of Trade

Lecture 5
Pricing Strategies
 VALUE-BASED Pricing:
Customer Perceptions of
Value-based Value
• Good-value pricing: the right
pricing: combination of quality and good
service to fair price
Good-value pricing – Existing brands: redesigned for
more quality for a given price or the
Value-added pricing same quality for less price
– Everyday low pricing (EDLP): a
constant everyday low price with few or
no temporary price discounts
– High-low pricing: higher prices on an
everyday basis but running frequent
promotions to lower prices on selected
items

• Value-added pricing attaches value-

added features and services to
differentiate offers, support higher prices,
and build pricing power
• Pricing power is the ability to escape
price competition and to justify higher
prices and margins without losing market
 COST-BASED Pricing
Cost-based pricing: prices based on the costs for
producing, distributing, and selling the product plus a
fair rate of return for producer’s effort and risk
(standard markup ) – (Cost plus pricing)
Types of Costs:
– Fixed costs (FC) are the costs that do not vary with
production or sales level (rent, heat, interest, salaries)
– Variable costs (VC) are the costs that vary with the
level of production (packaging, raw materials)
– Total costs (TC) are the sum of the fixed and variable
costs for any given level of production
– Average cost (AC) is the unit cost associated with a
given level of output
Benefits:
• Sellers are certain about costs
• Prices are similar in industry and price competition is minimized
• Consumers feel it is fair
Disadvantage: Ignores demand and competitor prices
 Calculation of Cost-Plus Price
Example: Production costs of an electric toaster:
• Raw material and labour: $10 per unit of output
• Rent of production area, fixed salary of secretary:
$300000
• Expected quantity to sell: 50 000 units
• Markup: 20% on sales
• price = cost + markup, and markup = 20% of price
• i.e. cost = 80% of price, or price = cost/0.8
Per unit output
What if at $20 price
only 30 000 units are
sold?

Per unit output

 Break-Even Analysis and Target Profit
Pricing
Break-even pricing: the price at which total costs are
equal to total revenue and there is no profit
Target profit pricing: the price at which the firm will
break even, or make a specified level of profit

P x Q = 20 x Q

300000+10 x
Q
$300000
 External Factors • The Economy
influencing pricing • The Market
Demand
Economy: A boom or recession, inflation, and interest rates affect
pricing decisions because they affect:
• consumer spending, consumer perceptions, company’s costs

The market and demand: How is price related to demanded

quantity?
• Normally, demand and price are inversely related: higher price =
lower demand
• For prestige (luxury) goods, higher price can equal higher demand
when consumers perceive higher prices as higher quality
PRICE ELASTICITY OF DEMAND

Inelastic: demand hardly

changes when there is a
change in price
Elastic: demand changes
greatly for a small change in
price
 Pricing 4 types:
Strategies
1. New-product pricing
1. New product pricing
strategy
strategies: 2. Product mix pricing
strategy
3. Price adjustment
strategies
Market-skimming pricing Market-penetration
4. Price reactionpricing
strategies
is a strategy with high sets a low initial price in order to
initial prices to “skim” penetrate the market quickly and
revenue layers from the deeply to attract a large number
market of buyers quickly to gain market
share
2. Product Mix Pricing
 Product Mix Pricing Strategies
Product line pricing takes into account the cost differences
between products in the line, customer evaluation of their
features, and competitors’ prices
(Product line: a group of products that are closely related,
because they funtion in a similar manner, are sold to the
same customer group, are marketed through the same types
of outlets, or fall within a given price range,)
Optional product pricing takes into account optional or
accessory products along with the main product
Captive-product pricing involves products that must be used
along with the main product
• Two-part pricing involves breaking the price into:
– Fixed fee - Variable usage fee
By-product pricing refers to products with little or no value
produced as a result of the main product. Producers will seek
little or no profit other than the cost to cover storage and
delivery.
Product bundle pricing combines several products at a
reduced price
3. Price Adjustment Strategies:
 Price-Adjustment Strategies
Discount and allowance pricing reduces prices to
reward customer responses such as paying early
or promoting the product (Discounts – Allowances)
Segmented pricing: when a company sells a product
at different prices even though the difference is
not based on cost.
Psychological pricing : sellers consider the
psychology of prices and not simply the
economics
Buyers carry in their minds reference prices
when looking at a given product ……..noting
current prices, remembering past prices, assessing the
buying situations.
E.g.prices
Promotional pricing is when $99 isare
much lower than
temporarily $100below
priced (?); sale price or
list price is cost
lower
to increase demand (e.g.: thanevent
special list price (?) low-interest financing…)
pricing,
Geographical pricing is used for customers in different parts of the country or
the world
Dynamic pricing is when prices are adjusted continually to meet the traits and
needs of individual customer and situation
International pricing is when prices are set in a specific country based on
country-specific factors
Price Reaction Strategies: Responding
to Competitor Price Changes
 Pricing Within Channel Levels
Price fixing: Sellers must set prices without talking to
competitors
Predatory pricing: Selling below cost with the intention of
punishing a competitor or gaining higher long-term profits
by putting competitors out of business
Retail (resale) price maintenance is when a manufacturer
requires a dealer to charge a specific retail price for its
products
Deceptive pricing occurs when a seller states prices or
price savings that mislead consumers or are not actually
available to consumers (e.g. fake list price vs. discount
price)
• Scanner fraud failure of the seller to enter current or sale
prices into the computer system (e.g. the computer
charges the full price!)
• Price confusion results when firms employ pricing methods
that make it difficult for consumers to understand what
price they are really paying (e.g. very small print….)