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Lecture 11

MARK301 Lecture Notes - Lecture 11: Value-Based Pricing, Elbulli, Market Power

Course Code
Utku Akkoc

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Pricing Strategy
Importance of Pricing
Air France Airlines has over 75 million passengers in 2012, at an average ticket price of 500
Euros. Charging 5 Euro, or 1% more per ticket would have transformed a loss of 210 million into
a profit of 165 million Euro
small improvements in pricing can yield significant results
What is Price?
narrow definition
price is the amount of money charged for a product of service
retail price MSRP rent commission tuition
fare sales price premium tip wage
application fee francise fee
broad definition
price is the total value that customers exchange for the benefits of having or using the product
or service
monetary costs
time, effort, energy to perform the behaviour
psychological risks or losses that may be perceived or experienced
physical discomfort associated with behaviour
Price Strategies
broad definition
1. increase monetary benefits for desired behaviour
rebates, allowances, cash incentives, price adjustments
e.g. paying people to be pill pals in Tanzania
2. decrease monetary costs for desired behaviour
discount, promotional pricing, sales
e.g. bike helmet coupons in Seattle
3. increase non monetary benefits for desired behaviour
recognition, appreciation, awards
e.g. Backyard Wildlife Sanctuary Recognition plaques
4. decrease non monetary costs for desired behaviour
reducing time, effort, physical, or psychological costs
e.g. packaging that doesn’t stigmatize clients
5. increase monetary costs for competing behaviour
increasing taxes, imposing fines, decreasing funding
e.g. Fee to pay for plastic bags
6. decrease non monetary benefits for the competing behaviour
negative recognition, fear campaigns
e.g. Grandma needs a medical alert system

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narrow definition
a company’s pricing practice in the real business world is typically a combination of these three
general approaches
1. product cost - cost-based pricing
2. consumer value perception - customer value-based pricing
3. competitor prices and other factors - competition-based pricing
Cost-Based Pricing
based on cost for producing, distributing, and selling the product plus a fair rate of return
Cost-Plus Pricing
adding a standard markup to the cost of the product
retailer’s cost for a pair of jeans - $30.00
markup percentage 40%
price = total cost + total cost x markup percentage
product driven - ignoring consumer demand and competitor prices
simple, easy to use
when all sellers use this method, prices are similar and price competition is minimized
Break-Even Pricing
setting price to break even on the cost of making and marketing a product
how many units must you sell before you break even? in order to profit?
break even point = fixed costs / (sales price — variable cost)
break even analysis - toaster company
fixed cost - $6M: rent, heat, interest, etc
variable cost - $5 per toaster: labour, component costs, etc
price - $15
break even point = $6,000,000 / ($15-$5) = 600,000 units
Issues with Cost-Based Pricing
the main challenge in cost-based pricing is the forecast of sales volume which has to take into
account competition and consumer perception
need to know all costs
does not work well with high fixed costs and near-zero variable costs
ignoring the value you create leads to underpricing
rather than asking what prices to charge to cover costs, ask how pricing strategy will affect your
cost structure
Customer Value-Based Pricing
uses buyers’ perceptions of value, not the sellers cost, as the key to pricing
customer needs and value perceptions are assessed
target price is based on value perception
subjective price perception
good value
pay what you want

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Perception of Price and Value
how much value customers place on the benefit they receive
perceived value reflects more than just the functional benefits of a product, e.g. $585 dollar pen
menu at a fancy restaurant
dinner vs. lunch
value = ingredients, taste, environment, relaxation, etc
how to calculate customer’s perceived values?
do the perceived values vary across consumers?
Good Value Pricing
the right combination of quality and good service at a fair price
EDLP pricing
keeps price consistently low, with discounts or temporary price promotions
build loyal based of one-stop shoppers
every day low prices
e.g. WalMart monday-sunday the same price everyday
HiLo pricing
high base price with frequent price specials
attract consumers with specials may result in more store switching
e.g. Macy’s monday-friday same pricing, sales on saturdays and sundays
Value Added Pricing
attacking features and services to differentiate and charge higher prices
Prestige Pricing
set high price to attract quality or status-conscious consumers, such as Rolls-Royce, Bentley,
or Swiss watches
prestige goods prices are price elastic - though not for high income consumers - or sometimes
negative price elastic in which demand increases as price increases
Problems with CVBP
customers do not reveal how they value the product
customers need to be educated about the value of the product
what are advantages of 14 karat gold over 10 karat?
why should I care about the type of wood this cutting board is made out of?
Cost-Based vs. Value-Based
Cost-based vs. value-based
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