Pricing Strategies (resources mainly taken from e-book fundamental of managerial economics)
PRICING
STRATEGIES
( R E S O U RC E S M A I N LY TA K E N F R O M E -B O O K
F U N DDepartement
A M E N TA L O F Mof
A NManagement
A G E R I A L E C O Nand
O M I CBusiness,
S)
Faculty of
Economics, Universitas Padjadjaran
English Class
TOPICS
I.
Mark Up Pricing
II.
Proft Maximiaation
III. Price Discrimination
IV. Multiple-Unit Pricing Strategies
V.
Transfer Pricing
WHAT IS PRICING
STRATEGIES?
(FROM MANY PERSPECTIVES)
https://
www.youtube.com/watch?v=XBmWEduod5k
From the video, how do you reckon to set a
proper price ?
INTRODUCTION
Why do Business Week, Forbes, Fortune, and The Wall
Street Journal ofer bargain rates to students but not to
business executives?
It is surely not because it costs less to deliver the
Journal to students, and it is not out of goodwill; it is
because students are not willing or able to pay the
standard rate.
MARK UP PRICING
Regular prices, discounts, rebates, and coupon promotions
are all pricing mechanisms used to probe the breadth and
depth of customer demand and to maximiae proftability.
Although proft maximiaation requires that prices be set so
that marginal revenues equal marginal cost, it is not
necessary to calculate both to set optimal prices. Just
using information on marginal costs and the point price
elasticity of demand, the calculation of proft-maximiaing
prices is quick and easy.
Flexible markup pricing practices that refect diferences in
marginal costs and demand elasticity constitute an
efcient method for ensuring that MR = MC for each line
of products sold.
MARKUP ON COST
Markup on cost is the proft margin for an individual
product or product line expressed as a percentage of
unit cost.
MARKUP ON COST
MARKUP ON PRICE
Proft margins, or markups, are sometimes calculated
as a percentage of price instead of cost.
Markup on price is the proft margin for an individual
product or product line expressed as a percentage of
price, rather than unit cost as in the markup-on-cost
formula.
MARKUP ON PRICE
HOWEVER,
Markup pricing is sometimes criticiaed as a naive
pricing method based solely on cost considerations—
and the wrong costs at that. Some who employ the
technique may ignore demand conditions, emphasiae
fully allocated accounting costs rather than marginal
costs, and arrive at suboptimal price decisions.
Although inappropriate use of markup pricing formulas
will lead to suboptimal managerial decisions,
successful frms typically employ the method in a way
that is consistent with proft maximiaation.
Markup pricing can be viewed as an efcient rule ofthumb approach to setting optimal prices.
ROLE OF COST IN
MARKUP PRICING
Fully allocated costs are determined by frst estimating
direct costs per unit, then allocating the frm’s
expected indirect expenses, or overhead, assuming a
standard or normal output level. Price is then based on
standard costs per unit, irrespective of short-term
variations in actual unit costs.
Unfortunately, use of the standard cost concept can
create several problems. Sometimes, frms fail to
adjust historical costs to refect recent or expected
price changes. Also, accounting costs may not refect
true economic costs.
ROLE OF DEMAND IN
MARKUP PRICING
Successful companies diferentiate markups according
to variations in product demand elasticity. Foreign and
domestic automobile companies regularly ofer rebates
or special equipment packages for slow-selling models.
Similarly, airlines promote diferent pricing schedules
for business and vacation travelers. The airline and
automobile industries are only two examples of sectors
in which vigorous competition requires a careful
refection of demand and supply factors in pricing
practice.
In the production and distribution of many goods and
services, successful frms quickly adjust prices to
diferent market conditions.
ROLE OF DEMAND IN
MARKUP PRICING
“Price sensitivity” of an item is the primary
consideration in setting margins. Staple products like
bread, cofee, ground beef, milk, and soup are highly
price sensitive and carry relatively low margins.
Products with high margins tend to be less price
sensitive.
MARKUP PRICING AND
PROFIT MAXIMIZATION
There is a simple inverse relation between the optimal
markup and the price sensitivity of demand.
The optimal markup is large when the underlying price
elasticity of demand is low; the optimal markup is
small when the underlying price elasticity of demand is
high.
OPTIMAL MARKUP ON
COST
To maximiae proft, a frm must operate at the activity
level at which marginal revenue equals marginal cost.
It follows that MR = MC
OPTIMAL MARKUP ON
COST (CONT’D)
The equation states that the proft-maximiaing price is
found by multiplying marginal cost by the term
To derive the optimal markup-on-cost formula,
EXAMPLE
Consider the case of a leading catalog retailer of casual
clothing and sporting equipment that wishes to ofer a
basic two-strap design of Birkenstock leather sandals
for easy on-and-of casual wear.
Assume the catalog retailer pays a wholesale price of
$25 per pair for Birkenstock sandals and markets them
at a regular catalog price of $75 per pair.
This typical $50 proft margin implies a standard
markup on cost of 200 percent because
EXAMPLE
EXAMPLE
In a pre-season sale, the catalog retailer ofered a
discounted “early bird” price of $70 on Birkenstock
sandals and noted a moderate increase in weekly sales
from 275 to 305 pairs per week.
This $5 discount from the regular price of $75
represents a modest 6.7 percent markdown.
EXAMPLE
In the absence of additional evidence, this arc price
elasticity of demand EP = –1.5 is the best available
estimate of the current point price elasticity of
demand.
Using equation in the previous slides, the $75 regular
catalog price refects an optimal markup on cost of 200
percent because
OPTIMAL MARKUP ON
PRICE
Just as there is a simple inverse relation between a
product’s price sensitivity and the optimal markup on
cost, so too is there a simple inverse relation between
price sensitivity and the optimal markup on price.
The proft-maximiaing markup on price is
determined using relations derived previously.
easily
EXAMPLE
The catalog retailer pays a wholesale price of $25 per
pair for Birkenstock sandals, markets them at a regular
catalog price of $75 per pair, and the arc price
elasticity of demand EP = –1.5 is the best available
estimate of the current point price elasticity of
demand.
This typical $50 proft margin implies a standard
markup on price of 66.7 percent because,
EXAMPLE
If it can
elasticity
available
elasticity
again be assumed that the arc
of demand EP = –1.5 is the
estimate of the current point
of demand, the $75 regular catalog
price
best
price
price
CONCLUSION
The more elastic the demand for a product, the more
price sensitive it is and the smaller the optimal margin.
Products with relatively less elastic demand have
higher optimal markups. In the retail grocery example,
a very low markup is consistent with a high price
elasticity of demand for milk.
Demand for fruits and vegetables during their peak
seasons is considerably less price sensitive, and
correspondingly higher markups refect this lower price
elasticity of demand.
PRICE DISCRIMINATION
With multiple markets or customer groups, the
potential exists to enhance profts by charging diferent
prices and markups to each relevant market segment.
Market segmentation is an important fact of life for
frms in the airline, entertainment, hotel, medical,
legal, and professional services industries.
Firms that ofer goods also often segment their market
between wholesale and retail buyers and between
business, educational, not-for-proft, and government
customers.
REQUIREMENTS FOR
PROFITABLE PRICE
DISCRIMINATION
Price discrimination occurs whenever diferent classes
of customers are charged diferent markups for the
same product.
Price discrimination occurs when diferent customers
are charged the same price despite underlying cost
diferences, and when price diferentials fail to refect
cost discrepancies.
DEGREES OF PRICE
DISCRIMINATION
Under frst-degree price discrimination, the frm
extracts the maximum amount each customer is willing
to pay for its products. Each unit is priced separately at
the price indicated along each product demand curve.
Second-degree price discrimination, a more
frequently employed type of price discrimination,
involves setting prices on the basis of the quantity
purchased.
The most commonly observed form of price
discrimination, third-degree price discrimination,
results when a frm separates its customers into several
classes and sets a diferent price for each customer class.
CUSTOMER
CLASSIFICATION
Customer classifcations can be based on for-proft or
not-for proft status, regional location, or customer age.
Barron’s, Forbes, The Wall Street Journal, and other
publishers routinely ofer educational discounts that
can be in excess of 30 percent to 40 percent of list
prices.
These publishers are eager to penetrate the classroom
on the assumption that student users will become loyal
future customers.
Many hospitals also ofer price discounts to various
patient groups. If unemployed and uninsured patients
are routinely charged only what they can easily aford
to pay for medical service, whereas employed and
insured medical patients are charged maximum
allowable rates, the hospital is price discriminating in
favor of the unemployed and against the employed.
TRANSFER PRICING
The transfer pricing problem results from the difculty
of establishing proftable relationships among divisions
of a single company when each separate business unit
stands in vertical relation to the other.
Vertical integration occurs when a single company
controls various links in the production chain from
basic inputs to fnal output.
RIDDLES IN PRICING
PRACTICE
99¢ is much more commonly employed than $1
because buyers feel they are getting a “bargain” for
99¢.
A $1 price seems “signifcantly” more expensive. For
buyers, 99¢ often “feels” more than 1¢ cheaper than
$1.
One innovative explanation for the popularity of oddnumber pricing is that readers of Latin-based
languages like English process written material from
left to right.
Thus, in the English-speaking world, a price of $6.99
often seems “signifcantly” less than $7.
ASSIGNMENT
1.
2.
3.
4.
5.
MULTIPLE-UNIT PRICING STRATEGIES
MULTIPLE-PRODUCT PRICING
JOINT PRODUCT PRICING
TRANSFER PRICING
DEMAND ELASTICITY FORMULA
Brief explanation and examples from the fve topics.
Resources, you may use the e-books from my e-learning sites
Email me by tomorrow afternoon 11.59AM
wardhanawardhana3@gmail.com
EMAIL SUBJECT: PRICING
STRATEGIES
( R E S O U RC E S M A I N LY TA K E N F R O M E -B O O K
F U N DDepartement
A M E N TA L O F Mof
A NManagement
A G E R I A L E C O Nand
O M I CBusiness,
S)
Faculty of
Economics, Universitas Padjadjaran
English Class
TOPICS
I.
Mark Up Pricing
II.
Proft Maximiaation
III. Price Discrimination
IV. Multiple-Unit Pricing Strategies
V.
Transfer Pricing
WHAT IS PRICING
STRATEGIES?
(FROM MANY PERSPECTIVES)
https://
www.youtube.com/watch?v=XBmWEduod5k
From the video, how do you reckon to set a
proper price ?
INTRODUCTION
Why do Business Week, Forbes, Fortune, and The Wall
Street Journal ofer bargain rates to students but not to
business executives?
It is surely not because it costs less to deliver the
Journal to students, and it is not out of goodwill; it is
because students are not willing or able to pay the
standard rate.
MARK UP PRICING
Regular prices, discounts, rebates, and coupon promotions
are all pricing mechanisms used to probe the breadth and
depth of customer demand and to maximiae proftability.
Although proft maximiaation requires that prices be set so
that marginal revenues equal marginal cost, it is not
necessary to calculate both to set optimal prices. Just
using information on marginal costs and the point price
elasticity of demand, the calculation of proft-maximiaing
prices is quick and easy.
Flexible markup pricing practices that refect diferences in
marginal costs and demand elasticity constitute an
efcient method for ensuring that MR = MC for each line
of products sold.
MARKUP ON COST
Markup on cost is the proft margin for an individual
product or product line expressed as a percentage of
unit cost.
MARKUP ON COST
MARKUP ON PRICE
Proft margins, or markups, are sometimes calculated
as a percentage of price instead of cost.
Markup on price is the proft margin for an individual
product or product line expressed as a percentage of
price, rather than unit cost as in the markup-on-cost
formula.
MARKUP ON PRICE
HOWEVER,
Markup pricing is sometimes criticiaed as a naive
pricing method based solely on cost considerations—
and the wrong costs at that. Some who employ the
technique may ignore demand conditions, emphasiae
fully allocated accounting costs rather than marginal
costs, and arrive at suboptimal price decisions.
Although inappropriate use of markup pricing formulas
will lead to suboptimal managerial decisions,
successful frms typically employ the method in a way
that is consistent with proft maximiaation.
Markup pricing can be viewed as an efcient rule ofthumb approach to setting optimal prices.
ROLE OF COST IN
MARKUP PRICING
Fully allocated costs are determined by frst estimating
direct costs per unit, then allocating the frm’s
expected indirect expenses, or overhead, assuming a
standard or normal output level. Price is then based on
standard costs per unit, irrespective of short-term
variations in actual unit costs.
Unfortunately, use of the standard cost concept can
create several problems. Sometimes, frms fail to
adjust historical costs to refect recent or expected
price changes. Also, accounting costs may not refect
true economic costs.
ROLE OF DEMAND IN
MARKUP PRICING
Successful companies diferentiate markups according
to variations in product demand elasticity. Foreign and
domestic automobile companies regularly ofer rebates
or special equipment packages for slow-selling models.
Similarly, airlines promote diferent pricing schedules
for business and vacation travelers. The airline and
automobile industries are only two examples of sectors
in which vigorous competition requires a careful
refection of demand and supply factors in pricing
practice.
In the production and distribution of many goods and
services, successful frms quickly adjust prices to
diferent market conditions.
ROLE OF DEMAND IN
MARKUP PRICING
“Price sensitivity” of an item is the primary
consideration in setting margins. Staple products like
bread, cofee, ground beef, milk, and soup are highly
price sensitive and carry relatively low margins.
Products with high margins tend to be less price
sensitive.
MARKUP PRICING AND
PROFIT MAXIMIZATION
There is a simple inverse relation between the optimal
markup and the price sensitivity of demand.
The optimal markup is large when the underlying price
elasticity of demand is low; the optimal markup is
small when the underlying price elasticity of demand is
high.
OPTIMAL MARKUP ON
COST
To maximiae proft, a frm must operate at the activity
level at which marginal revenue equals marginal cost.
It follows that MR = MC
OPTIMAL MARKUP ON
COST (CONT’D)
The equation states that the proft-maximiaing price is
found by multiplying marginal cost by the term
To derive the optimal markup-on-cost formula,
EXAMPLE
Consider the case of a leading catalog retailer of casual
clothing and sporting equipment that wishes to ofer a
basic two-strap design of Birkenstock leather sandals
for easy on-and-of casual wear.
Assume the catalog retailer pays a wholesale price of
$25 per pair for Birkenstock sandals and markets them
at a regular catalog price of $75 per pair.
This typical $50 proft margin implies a standard
markup on cost of 200 percent because
EXAMPLE
EXAMPLE
In a pre-season sale, the catalog retailer ofered a
discounted “early bird” price of $70 on Birkenstock
sandals and noted a moderate increase in weekly sales
from 275 to 305 pairs per week.
This $5 discount from the regular price of $75
represents a modest 6.7 percent markdown.
EXAMPLE
In the absence of additional evidence, this arc price
elasticity of demand EP = –1.5 is the best available
estimate of the current point price elasticity of
demand.
Using equation in the previous slides, the $75 regular
catalog price refects an optimal markup on cost of 200
percent because
OPTIMAL MARKUP ON
PRICE
Just as there is a simple inverse relation between a
product’s price sensitivity and the optimal markup on
cost, so too is there a simple inverse relation between
price sensitivity and the optimal markup on price.
The proft-maximiaing markup on price is
determined using relations derived previously.
easily
EXAMPLE
The catalog retailer pays a wholesale price of $25 per
pair for Birkenstock sandals, markets them at a regular
catalog price of $75 per pair, and the arc price
elasticity of demand EP = –1.5 is the best available
estimate of the current point price elasticity of
demand.
This typical $50 proft margin implies a standard
markup on price of 66.7 percent because,
EXAMPLE
If it can
elasticity
available
elasticity
again be assumed that the arc
of demand EP = –1.5 is the
estimate of the current point
of demand, the $75 regular catalog
price
best
price
price
CONCLUSION
The more elastic the demand for a product, the more
price sensitive it is and the smaller the optimal margin.
Products with relatively less elastic demand have
higher optimal markups. In the retail grocery example,
a very low markup is consistent with a high price
elasticity of demand for milk.
Demand for fruits and vegetables during their peak
seasons is considerably less price sensitive, and
correspondingly higher markups refect this lower price
elasticity of demand.
PRICE DISCRIMINATION
With multiple markets or customer groups, the
potential exists to enhance profts by charging diferent
prices and markups to each relevant market segment.
Market segmentation is an important fact of life for
frms in the airline, entertainment, hotel, medical,
legal, and professional services industries.
Firms that ofer goods also often segment their market
between wholesale and retail buyers and between
business, educational, not-for-proft, and government
customers.
REQUIREMENTS FOR
PROFITABLE PRICE
DISCRIMINATION
Price discrimination occurs whenever diferent classes
of customers are charged diferent markups for the
same product.
Price discrimination occurs when diferent customers
are charged the same price despite underlying cost
diferences, and when price diferentials fail to refect
cost discrepancies.
DEGREES OF PRICE
DISCRIMINATION
Under frst-degree price discrimination, the frm
extracts the maximum amount each customer is willing
to pay for its products. Each unit is priced separately at
the price indicated along each product demand curve.
Second-degree price discrimination, a more
frequently employed type of price discrimination,
involves setting prices on the basis of the quantity
purchased.
The most commonly observed form of price
discrimination, third-degree price discrimination,
results when a frm separates its customers into several
classes and sets a diferent price for each customer class.
CUSTOMER
CLASSIFICATION
Customer classifcations can be based on for-proft or
not-for proft status, regional location, or customer age.
Barron’s, Forbes, The Wall Street Journal, and other
publishers routinely ofer educational discounts that
can be in excess of 30 percent to 40 percent of list
prices.
These publishers are eager to penetrate the classroom
on the assumption that student users will become loyal
future customers.
Many hospitals also ofer price discounts to various
patient groups. If unemployed and uninsured patients
are routinely charged only what they can easily aford
to pay for medical service, whereas employed and
insured medical patients are charged maximum
allowable rates, the hospital is price discriminating in
favor of the unemployed and against the employed.
TRANSFER PRICING
The transfer pricing problem results from the difculty
of establishing proftable relationships among divisions
of a single company when each separate business unit
stands in vertical relation to the other.
Vertical integration occurs when a single company
controls various links in the production chain from
basic inputs to fnal output.
RIDDLES IN PRICING
PRACTICE
99¢ is much more commonly employed than $1
because buyers feel they are getting a “bargain” for
99¢.
A $1 price seems “signifcantly” more expensive. For
buyers, 99¢ often “feels” more than 1¢ cheaper than
$1.
One innovative explanation for the popularity of oddnumber pricing is that readers of Latin-based
languages like English process written material from
left to right.
Thus, in the English-speaking world, a price of $6.99
often seems “signifcantly” less than $7.
ASSIGNMENT
1.
2.
3.
4.
5.
MULTIPLE-UNIT PRICING STRATEGIES
MULTIPLE-PRODUCT PRICING
JOINT PRODUCT PRICING
TRANSFER PRICING
DEMAND ELASTICITY FORMULA
Brief explanation and examples from the fve topics.
Resources, you may use the e-books from my e-learning sites
Email me by tomorrow afternoon 11.59AM
wardhanawardhana3@gmail.com
EMAIL SUBJECT: PRICING