PRICING FINAL
Services have __________ and ___________ perishability
infinite and immediate
the assumption of mixed margin retailing and the use of loss leaders
"cherry picking" is unlikely due to the high effort required - the genius of mixed margin retailing is that it makes price comparison for market basket of goods difficult
%CM
$CM/Price x 100
unit BESC necessary to cover IFC formula
$change in fixed costs/New $CM per unit
if another firm initiates a price change, and you want to defend your current profit position, a slightly different calculation is necessary
% BESC for reactive price change
expected % sales change formula
% price change of competitor x cross-elasticity quotient
Cross-Elasticity formula
%change in quantity of product A/%change in quantity of product B
% BESC
($change in FC)/(New $CM x initial unit sale) x 100
% BESC for reactive price change
(Competitor's % change in price)/(own % contribution margin) x 100
change in $ profit
(actual unit sales change - BE Unit sales change) X New $CM
other conditions for skim pricing success
- often good for highly differentiable products - higher incentive where low economies of sale exist
captive-product pricing
- "hardware" is sold near or below cost - requisite software is sold at high profit margin - sometimes referred to as the printer and ink pricing model
guild health care
- (<1970s) - high variable costs - lengthy doctor/patient interaction
fordist health care
- (> 1970s) - high fixed costs - short doctor/patient interaction
corvette production figures for the first 4 years
- 1953: 300 cars - 1954: 3640 cars - 1955: 700 cars - 1956: 3467 cars
when the retail assortment is widely available manufacturer brands that can be purchased at many stores
- EDLP or hi-lo ex: walmart, best buy, toys r us
Traditional breakeven graph says:
- If I'm making/selling less product....I have a total loss -If i make more product...I make profit
retaliatory pricing
- a competitor may retaliate to a price attack asymmetrically
market research or retail buying errors
- a failure to recognize or respond to market trends - overestimation of future demand - purchasing products that are a poor fit with the store target market - merch was purchased or delivered or stocked too late - aggressive discounting by competitors
skim pricing
- a high-price strategy - high initial price lowered only as the result of competitive pressures or evaporating demand (sequential skimming) - assumes at least part of market is price insensitive - works best where competitive barriers exist or when a strong price/quality association can be exploited
penetration pricing
- a low-price strategy - price is low relative to value - may be reduced further if costs can be lowered - assumes price elastic demand - works best where competition can easily follow
fixed component of the price
- a one-time fee often used as a retail sales incentive or commission - a once-per-period fee
example of capital intensive industry
- airlines - costs are fixed - high levels of price comp - product is difficult to competitively differentiate - industry is only moderately concentrated - service is highly perishable
more coupons as a strategic tool
- allow price discrimination (2nd or 3rd degree) on the part of the manufacturer (only targeted to, or redeemed by some consumers) - the typical strategy of coupons is an attempt to get consumers to switch to your brand, then remain loyal
impacts of simple incremental fixed costs examples
- an advertising campaign - an additional salary-only salesperson - a new truck to distribute your product
example of retaliatory pricing
- an airline is attacked on price in one segment - it chooses to retaliate by lowering prices in a different segment - the goal is to pit your strengths against your competitors' weaknesses
coupons
- approx. 300 billion coupons are distributed each year - part price, part promotion
overall conclusions for price reduction strategies under break-even analysis
- assuming equivalent total costs, relatively low variable costs allow a company to benefit from price-cutting strategies more easily
how can customer reactions and pricing changes be predicted
- can be predicted with some precision because customer motives are typically understood with some clarity
operational leverage
- can be tremendously beneficial, multiplying your returns many times over - or, it can be tremendously harmful, multiplying your losses many times over - the net outcome of your use of this tool is highly dependent upon (and thus sensitive to) sales/production volume
when is the opportunity to price "later" units lower?
- cannibalization can be completely avoided (probably thru price discrimination) - share of overall market size can be expanded (there is price elasticity in either the overall market or for your brand) - competitors are unlikely or unable to retaliate
product bundling in supermarket items
- cents-off packages - multiple-packs or extra quantities - banded products
market signaling and the threat of disciplinary pricing
- chrysler held the largest market share in the US for minivans in 1990, giving it strong profit margins
market segmentation strategy
- companies can maintain high margins by finding markets where no or few competitors exist - by avoiding competition, firms can avoid price pressure - this strategy may or may not also require product differentiation
some fordist companies can escape the profit squeeze of fordism and increase prices by:
- competitive differentiation - avoiding direct competition through segmentation - in other words, by evolving into sloanists
example of the psychological power of price points
- conAgra foods: banquet frozen dinners - remove more expensive items - substitute cheaper side dishes - shrink portion sizes
the two factors which most significantly influence whether or not these break-even volumes will be achieved are:
- consumer reactions - competitor reactions
why is predatory pricing extremely difficult to prove?
- cost shifting - cross-business subsidization - most difficult to prove in capital intensive industries, since variable costs are so low
example of using loss leaders
- costco, walmert, target often sell new-release DVDs below their wholesale cost in order to lure shoppers into stores - virgin megastores had to sell dvds at a reasonable margin in order to make a profit, since that is its primary line of business
examples of "deals" that companies offer
- coupons - rebates - product bundling and price-packs - promotional or volume discounts
use of coupons as a strategic tool
- coupons do not result in negative price/quality associations on the part of consumers (so it doesnt lower perception of product) - allow rapid and significant price changes while still being transparent to consumers and competitors - relatively reversible as a price cut - allow price competition while not requiring a price competition focus or strategy - can be provided to consumers with complete certainty
cost structure of competitors and strategic approach
- degree of operational leveraging - capacity utilization levels - growth aspirations of competitors
utilities also apply 2nd-degree price discrimination through tiered pricing
- each customer is assigned a baseline monthly allocation for usage - consumption over baseline is priced significantly higher
sometimes fixed costs are also incremental
- fixed costs typically remain fixed only with certain ranges of production/sales - if a price change causes sales to move outside that range, certain fixed costs may increase or decrease - these incremental fixed costs must be incorporated into any pricing decision
fordist competitor pricing approaches
- focus on enlarging or maintaining sales volume - utilization of capacity is essential - fordists are typically willing to sacrifice some of their margins to maintain volume - competitors are willing and capable of competing on price, and thus attempt to undermine sloanist or guild strategies of differentiation or unique value
guild competitors pricing approaches
- focus on maintaining high per-unit profit margins - they have little power to cut price, due to small CM - competition is addressed largely thru product and distribution - high price may be used in positive way to exploit consumers price/quality associations or create impression of positional value
the chevrolet corvette
- for the first 3 years of corvette production (1953-1955), only the glass-fiber body parts were uniquely fabricated for the car. Nearly all other parts for the Corvette were borrowed from other general motors cars
Gillette example
- founded upon the notion of disposability - makes little profit on razors, but very high profits on blades - buyers are encouraged to updgrade and gilette replacement blade prices are expensive
other conditions for penetration pricing success
- good for products which are undifferentiated (commodities) - high incentive where high economies of scale exist (high contribution margin, or variable costs as a small proportion of total costs)
modified breakeven chart
- have multiple breakeven points for different prices - higher price means a higher breakeven point
henry ford & the model-t
- henry ford used price reductions primarily as a method of expanding primary demand for automobiles, rather than simply as a method of completely enlarging market share - at many times, he sold automobiles below his total costs, understanding that the vast elasticity in the market would result in increased sales, and thus production volume, and would thus ultimately lower total costs
when retail assortment is primarily private label products that are of average quality and easily compared to popular brands
- hi-lo works bet - ex: jc penney, radio shack, old navy, forever 21
the reactive % BESC is a strategic guide in competitive pricing
- identifying this theoretical point of no difference and then comparing it to what is actually likely to happen to your sales in the event that a competitor raises or lowers its price, provides you with a strategic guide for your most logical reaction
each night, the cumulative number of seats sold on each flight is compared to a sales forecast for that flight
- if sales are right near forecast, no changes - if sales lead forecast, discount fares are increased, or seats removed from discount block - if sales trail are below forecast, blocks of seats are moved from higher-priced fares to lower-priced fares
are price decreases likely to be matched by competitors? If yes:
- if yes: are price reductions likely to be effective in expanding the size of the overall market? - can price cuts convert non-users to users?
the profitability of captive-product pricing: hewlett-packard
- in 2003, printer and ink business accounted for 8% of HP's sales revenue, but 74% of its operating profit - ink is way more expensive than printer since you have to continuously buy it
Pricing decisions with incremental fixed costs
- in many marketing situations, price cuts are accompanied by special advertising campaigns - in many forms of retailing, such as mass-merchandising, advertising efforts are largely justified by price cuts - other times, price reductions necessitate expenditures for new equipment
example of strategic dumping
- in order to increase production to more fully utilize capacity and thus achieve greater scale economies - alternatively, firms may price some output below break-even in order to partially cover overhead costs, such that more profitable markets may continue to be served - it is also cheaper to distribute products in foreign countries, thus allowing a company to charge a lower price
factors impacting strategic actions and outcomes of competitive reactions and potential outcomes
- inter-brand substitutability - industry structure - cost structure of competitors and strategic approach
potential goals of using deals
- introduce new product and stimulate trial - generate new interest in an old product - accelerate demand for products - achieve geographic strategic goals - help moderate fluctuations in demand or supply - help smaller sellers compete against larger rivals with large advertising budgets - complement advertising campaigns
perishability is desirable for sloanists because:
- it improves velocity or turnover among consumers, resulting in higher sales per customer per year - reduces the perceived use value of used older models, thus allowing higher prices to be charged
typical examples of retailers that regularly employ psychological discounting
- jewelry stores - furniture stores - automobile dealers
benefits to marketers over coupons
- less likely to be used fraudulently - can limit offers to one per family - provide purchase incentives to buyers, but require more work on the part of consumers - enable record-keeping and data analysis by marketers
downstream channel member behaviors and reactions
- manufacturers often have little control over the ultimate selling price of their products. Thus, manufacturers who cut prices may only hope that these price cuts are passed on to consumers, and/or must devise incentives or controls to help insure that these price cuts are passed on - also, manufacturers must consider the potential for inter-channel conflict which may result from pricing decisions applied asymmetrically
reasons its unlikey consumers will switch to your brand then remain loyal
- many coupons are used by those already loyal to that brand - many coupons are used by switchers and deal-prone individuals
promotional pricing
- many retailers pair promotional events with price reductions - these events are used to build store traffic, to clear out older merchandise, and to create consumer perceptions of value
sears failed EDLP strategy
- many shoppers learned to wait for items to go on sale at sears - sears noted walmart's much greater efficiency - sears lost some of its ability to practice price discrimination
reasons breakfast cereal is more expensive than bread
- most branded cereal is produced by one of the 4 major competitors - oligopolistic industry structure - the 4 competitors "differentiate" their products - very few big bread companies
examples of industries where most production costs are fixed, sunk, and largely non-incremental
- movies - computer software - video-game software
sloanist competitors pricing approach
- need relatively high volume, but strive to re-capture higher profit margins through market segmentation and product differentiation - price competition is vigorously avoided - promotion and perhaps products are seen as key to establishing and maintaining an image of unique value
when the retail assortment is primarily highly unique or differentiated products
- no discounting necessary - apple, harley-davidson, tiffany, louis vuitton
advantages over traditional restaurants
- no losses from no-shows - easy forecasting of both demand and also costs - the online reservation system lowers costs and minimize consumer frustration - substantial economies of scale from a single-meal menu
underlying causes of airline price competition in 1998
- northwest is extremely troubled in 1998 - many months of labor unrest and a looming strike by pilots scared customers away, resulting in lower ticket sales volumes - northwest is desperate to fill unused and under-used volume
industry structure
- number and size of competitors - market growth rate - influenced by: - the existence of barriers to competitive entry and/or growth and/or exit - industry concentration and size of competitors
dumping in practice
- occasionally, companies are accused of dumping when they sell products here at a price which is below the equivalent selling price of the product in the home country - many countries encourage exporters to dump and discourage importing companies from dumping
characteristics of coupon users
- often account for most coupon redemptions - most coupon redemptions are by non-loyal buyers and buyers of low-share brands - coupons with higher values are more likely to be redeemed by non-users - heavy coupon users are less likely to be working female heads of households - direct-mail delivery of coupons results in higher levels of redemption by non-buyers than do other methods
a variable component of the price
- often used to build profits - telephone service/other utilities - cell phone - cable - gym membership - car rentals with mileage charges
the double-edged sword of fixed costs and operational leveraging
- operational leveraging, with corollary high fixed costs (overhead) enable a firm to exploit economies of scale - however, they also tend to pose a huge threat to survival if capacity is not fully utilized - this threat is what pre-disposes an operationally-leveraged firm to engage in price discounting
many products display some degree of perishability
- packaged food and medicine - most technology products - fashion items and clothing - seasonal merch - fresh food (meat, produce, bread) - services
examples of sequential skim pricing
- polaroid cameras - dvd players
retail merchandising errors
- poor store sales training - poor display execution - flawed merchandise promotion - merch was damaged or soiled on the sales floor - insufficient retail space means that old (less valuable) inventory needs to be sold to make room for new (more valuable) items
overview of capital-intensive, commodity industries
- price reductions are very likely to be matched by competitors - thus, any increases in volume needed to justify a price reduction must come solely from market enlargement
inter-brand substitutability
- price/quality market position of brands - level of product differentiation - the degree to which a brand is perceived to offer unique benefits - presence and magnitude of switching costs must be considered - substitutability can often be reduced through product differentiation -brands that are not perceived to be substitutable engender low price sensitivity and high brand loyalty
cannibalization can be kept to a minimum with careful product positioning
- pricing - product differentiation - distribution - promotion
loss leaders for which most purchasers have strong reference prices
- products for which buyers easily remember the prices - frequently purchased products - products where buyers can easily reference and compare the prices of offered by competitive stores - products for which buyers are price sensitive
high/low pricing strategy
- profit margins per item are high, and then frequent advertised sales promote marked-down prices on some items
operational leverage is similar to financial leverage in that it must be used judiciously in order to be effective
- purchasing new capacity and failing to use it productively is no different from borrowing money at 8% and putting it in the bank at 6% - leverage is very powerful: either in a beneficial way or a deleterious way
price can be used to manipulate demand into conforming to the supply of the fixed capacity available
- raise prices in high demand situations - lower prices in low demand situations
logical reaction options
- reduce your price or not, following the price reduction of a competitor - raise your price, or not, following the price increase of a competitor
services are produced and consumed simultaneously
- services cannot be stockpiled in inventory - the facet of services makes production scheduling very difficult, and often leads to consumer frustration - their value ultimately declines immediately at point of consumption/production (movie tickets, sporting event ticket, plane ticket)
rebates
- similar to coupons (most are not redeemed)
a dutch auction
- similar to sequential skimming - implementation of first degree price discrimination
2 common demand-based pricing strategies
- skim pricing - penetration pricing
advantages of EDLP strategy (over high/low strategy)
- smoother, more predictable customer demand (fewer stockouts, improved scheduling of inventory deliveries, lower warehousing costs) - reduced personnel requirements - improved customer service - reduced advertising expenditures - reduced price wars with competitors
disadvantages of EDLP strategy
- some shoppers enjoy bargain hunting and feel as if they are getting a better deal when allowed to purchase products on sale - high/low pricing and promotional sales can effectively target price-sensitive shoppers, thus providing some price discrimination effect -EDLP strategies often create consumer perceptions that the store is low service or even low quality
the obvious model for pricing services
- start off by selling capacity at a high price - lower the price as the time point of production nears, in order to fill unused capacity
price points typically derive from 1 of 3 sources
- substitution price points (price of closest sub to this product) - customary price points (what people are accustomed to paying for this type of product) - perceptual price points (related to consumer interpretations of value and perceptual bias)
the cost structure of a business forms its strategic foundation
- that foundation is "cast in concrete" in that it is difficult to ignore or change - decisions regarding operational leveraging, infrastructure, capacity, and automation must be central to strategic planning - company brand strategies must be concordant with cost structure evolution - the strategic fork in the road comes at the time that structural decisions are made
yield management programs are most effective when
- the business has a large proportion of fixed costs - business capacity is fixed and infinitely perishable - the business caters to different market segments that purchase different times and can be operationalized - those customers that purchase early are more price sensitive than those who purchase later (airlines, hotels, car rental firms)
what are the pricing issues in industries where most production costs are fixed, sunk, and largely non-incremental?
- the emergence of new strategies: - giving your product away - captive-product pricing
3 major price lines of goods
- the flagship brand (premium product, oldest brand, where most profits come from) - the fighting brand (high value product, when competitors threaten market share) - the halo brand (super-premium product, used to reinforce position or image of brand, not for making profits)
the price elasticity of demand for the product class (primary demand)
- the level of market penetration achieved by the product (the likelihood that non-users can be converted to users) - demand factors - relationship to other product classes (cross elasticity)
strategic success and markdowns at the retail level
- the percent volume of a product that is sold at full price is known as sell-through
strategic dumping
- the practice of dumping is quite common and may be based upon strategically legitimate reasons other than to eliminate competition
mixed-margin retailing
- the predominant form of retail business model for broad-line retailers-- especially supermarkets - profit margins are low on some "traffic builders" - profit margins are high on more unique or impulse items
factors impacting strategic outcomes of the brand-market relationship solely
- the price elasticity of demand for the brand (secondary demand) (issues such as switching costs, price/quality perceptions) - the price elasticity of demand for the product class (primary demand)
optimum environments for penetration pricing or an aggressive price warfare strategy
- the product has a high contribution margin an/or high economies of scale in production or marketing - price reductions are unlikely to be matched by competitors - a significant proportion of consumers are price sensitive - converted customers are likely to remain loyal after switching
firms tacitly cooperate to avoid price competition and instead engage in less destructive forms of differentiation
- the trust - informal collusion - administered pricing or price leadership/follower-ship
ryanair
- thrives on a two-part pricing strategy - has inexpensive seats - but extra fees for everything else (luggage, water, check-in fees, etc)
coupon users now network and share information, personally or on the internet
- thus, deals are broadcast to others not intended as targets - geographic strategies are thwarted - test marketing may be invalidated - some fraud is typical, though has been reduced with supermarket scanners
reasons that costs are important to consider in pricing decisions
- to assure you set price sufficiently high enough to make a profit - to understand how costs can change due to changes in product, promotion, and place - because pricing should be considered from a dynamic perspective
guidelines for determining the size of markdowns
- too-high markdowns can elicit social proof behavior among some buyers - consumers can view merch as flawed or un-fashionable - small markdowns are typically ineffective (markdowns should be at least 20% to gain consumer interest) - sieries of small markdowns is typically much less effective than a single large markdown - first markdown should be substantial enough to move substantial amounts of merch
tradeoff issues for acupuncturist
- tradeoff point for making decision is 150 patient visits per month - must decide if she is likely to build her business to 150 patient visits per month in a reasonable period of time - if not, option 2 is best - if yes, option 1 is best
pricing at the margin
- useful when a business is already profitable, but has unused capacity - since fixed costs are already paid off, the marginal profit from additional units sold is greater - thus, after the breakeven point, a smaller amount of contribution margin can be accepted to contribute to profits (ex. walmart)
utility companies manipulate demand patterns
- utilities are fixed-capacity service businesses - capacity is pushed to limit during high consumption periods, nearly idl during low consumption periods - through variable-rate pricing
examples of captive product pricing
- video games (nintendo, microsoft, sony) - gillete razors - polaroid instant cameras (10% gross margin on cameras, 60% gross margins on film)
important questions when considering competitive influences on pricing
- what are the differences in production and overhead costs among competitors? - how capable of responding are competitors organizationally? - how much unutilized production or distribution capacity do competitors possess? - can competitors subsidize some product lines with profit from others? - are competitors distribution strategies different from ours? - what differences exist with regard to target markets and product differentiation - do competitors differ with regard to multinational distribution or production? - how do strategic objectives differ among competitors? - what contractual constraints do our competitors have? - do competitors differ with regard to financial solvency?
ron johnson post-mortem
- what works in one organization is unlikely to work in a different type of organization - acquiring new customers is fine, but don't wholesale discard your existing customers
are price increases likely to be matched by competitors? If yes:
-if yes: what proportion of primary demand will be lost as a result of our price increases? - will demand shift among the competitors if all raise prices by the same % amount?
fordist businesses as evolutionarily adapted
-need mass markets in order to sell the prodigious outputs they typically generate. Because they are generally willing to sacrifice margins in order to increase or preserve volume, this suits the majority of the market that is price sensitive (the price-elastic mass market)
price competition
-typically very destructive and only rarely strategically beneficial - best avoided
guild businesses as evolutionarily adapted
-will generally sacrifice volume for margins. At the same time, they are likely to compete in "higher-end" markets. Thus, their low volume output and higher costs/prices are ideally suited to the niches of low price sensitivity (price-inelastic market segments)
monopoly
0 competitors, complete control over prices
oligopoly
1 or 2 competitors, high control over prices
the 2 major problems with service management and pricing
1. because most service businesses have high fixed costs and fixed capacity, maximal utilization of capacity is essential to achieving profitability 2. many service businesses have demand that fluctuates (difficult to match)
7 methods of manipulating price
1. change the quantity of money to be paid by the buyer (the price) 2. change the quantity of goods or services provided by the seller for a given price (the weight out, change quantity instead of price) 3. change the quality of goods or services provided by seller for a given price 4. change the time or place of transfer of ownership (ex: pizza delivery, amazon free shipping) 5. change the time or place of payment 6. change the acceptable form of payment (stores that dont accept checks, discounts for paying cash) 7. apply premiums or discounts to the purchase (quantity discounts, coupons, premiums with purchase)
the contribution margin is that share of the product's price which can be used to:
1. help pay for a firm's fixed costs and reduce company losses 2. add to company profits
preliminary questions for assessing the strategic value of competitive price actions
1. is demand price elastic for my brand? - would price reductions be effective as a tool for increasing revenues or market share? or would price increases be effective as a tool for increasing revenues? 2. are price increases or decreases likely to be matched by competitors?
yield management is a sophisticated method for
1. maximizing capacity utilization 2. maximizing profit per customer - more advance form of dynamic pricing as applied to service businesses - must optimize overall profitability by balancing these goals and comparing tradeoffs among these goals
the ultimate goal of an airline's yield management system
1. maximizing the number of full-fare seats sold on given flight while 2. minimizing the number of empty seats left on the plane - airline pricing is really competitive
other than the creation of an actual monopoly, there are 3 general methods of creating monopoly power in order to avoid the price competition that typically results in capital intensive industries:
1. product differentiation strategy 2. market segmentation strategy 3. collusion (these represent movement away from fordism and toward sloanism)
the costs of market share gains are typically measured as one or a combination of:
1. promotional expenditures (additional fixed costs) 2. reductions in profits resulting from price cuts (price reduction) 3. R&D expenditures for developing new products that offer competitive advantages (additional fixed costs) 4. acquisition of a competitor (likely additional fixed costs) 5. the dilution of brand equity by moving "down-market" (lower prices and lower variable costs)
3 potential results from price reduction
1. reduced margins and lowered revenues 2. reduced margins and market expansion 3. reduced margins and market share gains
yield management provides 2 major benefits
1. smoothes demand to match capacity 2. maximizes overall profits - ym is both an operational tool and competitive tool or strategy
competitive pricing decisions must be considered from 3 perspectives
1. the brand-market relationship solely (in a vacuum) 2. competitive reactions and potential outcomes 3. downstream channel member behaviors and reactions
the Chevrolet corvette and breakeven strategy
1953: in designing the corvette, general motors had to consider ultimate production volume - originally, the corvette was conceptualized as a limited-volume vehicle and was to be sold only to VIP's (movie stars, political figures, preferred customers) - steel-body production for automobiles requires very high fixed costs for stamping presses and dies. Thus, a high breakeven volume is necessary - glass-fiber car body production requires much lower fixed costs, but requires much human labor (high variable costs)
clinic owners offer choice to acupuncturist: *Avg. billing per patient visit is $40 1: acupuncurist pays $3000 per month for clinic overhead, but she keeps 100% of her patient billings for acupuncture services 2: the acupuncturist pays no part of business overhead, but she pays $20 per patient visit to the clinic
1: higher risk. BEP: 3000/40= 75 patients per month 2: lower risk, lower potential payoff BEP: 0/20= 0 patients per month
the typical redemption rate for newspaper-insert coupons:
2%
power of price point
5 dollar footlong at subway
perils of odd pricing
99 cents only stores move price to 99.99 cents and was named in 2 lawsuits alleging unfair and deceptive business practices and misleading advertising bc they didnt change it on the sign
price points and competitive practices
PP are primary cause of companies utilizing weight-outs and lowering quality in order to maintain a particular price - formerly influenced significantly by vending machines
perceptual bias
a human tendency to overrule logic or experience due to the erroneous interpretation of cultural, environmental, social, or psychological cues
operational leverage definition/formula
a measure of the degree to which operating profits are sensitive to changes in sales volume %change in operating profits/% change in sales volume
every day low prices (EDLP)
a retail strategy where the retailer keeps all prices at low levels and has minimal sales or promotional events - was popularized by walmart, montgomery ward, home depot, ikea, costco - ex: costco never has sale events
all airlines jointly publish airfares thru ATPCO
accepts fare changes 3 times every weekday
airline pricing: a highly competitive industry
airlines focus largely on competitors in their pricing practices by boosting their margins in those areas that have little significant competition
the ultimate competitive insight for pricing
all too many managers know more about winning pricing battles than about preventing those that are not worth fighting
product differentiation strategy
allows firms to avoid or reduce perceived substitutability and thus price competition
just as price elasticity analysis allows you to determine how a pice change will affect your sales revenue, Break-even sales change analysis...
allows you to determine how price changes affect profits
odd pricing
an attempt to take advantage of individuals' perceptual bias - the practice of pricing just under an even dollar amount
price leadership
an informal form of price collusion - price collusion is technically illegal, and is the primary focus of anti-trust legislation - nonetheless, price leadership is common on concentrated or oligopolistic industries
why is fordism extremely demanding and a difficult strategy for ensuring long-run profitability?
because competition on price ultimately devolves into competition on costs. This narrows your strategic options and creates a dependency solely upon sourcing, production, and distribution efficiency as the driver for profits - especially risky in global business
why are competitor behaviors difficult to predict
because competitors will actively defy your efforts at prediction
how can costs be predicted
because suppliers exist within a competitive market (exceptions: occur when major disruptions occur within economy)
what is discounting used to do
bring prices in line with competitive products
private companies may attempt to increase demand for complementary products
by effectively decreasing the price to consumers - decreasing price thru subsidies
gov. entities can attempt to manipulate demand for products
by effectively increasing or decreasing price to consumers - increasing price thru sales and consumption taxes - decreasing thru subsidies
service businesses
can be dominated by either variable or fixed costs - high variable-cost service businesses are most similar to guild firms - high fixed-cost service businesses are most similar to fordist or sloanist businesses
register coupons
can be specifically targeted to purchasers of other products (typically competing brands)
loss leaders
can be used to further entice shoppers into stores and to create an image of overall low prices - items that have small or negative profit margins - club prices at supermarkets, black friday deals
price framing
can be utilized in order to create additional points of comparison for the consumer - marketer creates higher-price alternatives and/or lower price alternatives in order to guide consumer into purchasing model which produces the most overall profit
individual investments
can often be evaluated apart from other investments. Consequently it is appropriate to use traditional break-even analysis, which compares the total sales revenue from the investment with its total cost
example of weigh out
candy-bar makers adjust net weight of bars to reflect changes in ingredient cost - peanut butter ounces
strategic approach refers to the...
choice of guild, fordism, or sloanism, and is directly related to cost structure - fordists and sloanists are highly operational - guild competitors have pre-dominantly variable costs
the weight out
companies can effectively increase prices by reducing quantities while maintaining prices - these adjustments are invisible to consumers
collusion
companies may be able to find shelter in markets where a few other "well behaved" competitors exist - market positions in a highly concentrated or oligopolistic industry--with barriers to new entry
because price-competition is risky and often unprofitable,
companies often seek to escape from this strategic platform (seek to escape fordism and evolve into sloanism) - this evolution is accomplished through the pursuit of monopoly power
if markdowns are too frequent...
consumers can become trained to wait for markdwons
the assumption of odd pricing
consumers have "price points" that likely correlate with even dollar amounts - thus, consumers will perceive slightly lower odd numbers as much lower than they really are - some research says that odd pricing communicates a low-quality image - gas prices have 9/10
large contribution margins allow
cost concessions
example of a highly capital intensive industry with differentiable products:
costs of universities are almost completely (probably 95% +) fixed in nature
gradual evolution of YM system applications
developers have adapted yield management systems to more diverse service businesses - become more creative at bending model parameter requisites or limitations
reduced margins and lowered revenues
either competitors' match price cut or downstream channel members do not pass them on to consumers result: lower profits
break-even sales change analysis
employs the dynamic perspective necessary to achieve strategic goals - incorporates the effects of demand and costs, and also sets the foundation of competitive analysis - allows you to determine the point at which you improve you profitability as the result of price change
market-driven pricers
estimate achievable prices and sales volumes first, and then think about how they can offer products with costs low enough to achieve adequate profits
the goal of disciplinary pricing is educational
ex: price leader responds to a price attack with much lower prices in an attempt to signal to that competitor that the leader is not going to give up market share
other retailers hold sales, but avoid...?
extreme clearance markdowns in order to avoid cluttered merch - they job-out the least marketable markdown marchandise to off-price sellers (tj max, marshalls, ross, burlington coat factory)
where is the mixed margin retailing business model especially powerful?
for defending against inter-type retail competition - often giving generalists a competitive advantage over specialists (walmart vs. toys-r-us)
for example, for a firm or product line which has a degree of operational leverage = 3....
for every 1% change in sales, there will be a 3% change in operating profits
when do we use the new contribution margin?
for incremental fixed costs to be paid with modified prices because we will be paying these fixed costs with sales obtained at the new price
pricing to manipulate demand
for reasons other than max. profits or sales - this is done by private companies/government entities
businesses are now evolving
from guild into fordist businesses. known as "Mcdonaldization" of services
two-part pricing
has a fixed component of the price, and a variable component of the price
are price increases or decreases likely to be matched by competitors?
if no: - can price cuts convert competitors' customers to your customers? or - what proportion of my customers could i retain after increasing my price?
why do some retailers avoid markdowns?
in order to preserve customer confidence in the store's fashion "authority" or the prestige of their goods - some retailers own separate chains to distribute all markdown merch (tiffanys)
some services like airlinies now have prices that ______ until point of production
increase - to better match the price to the price sensitivity of the buyer
product-driven pricers
incur costs first, and then worry about how to achieve prices and sales volumes which will be profitable
retail shoppers
incur fixed shopping costs - the higher the shopper fixed costs, the more consumers are likely to purchase during that shopping experience
sell-through
is a measure of retail strategic success - measures of sell-thru should be taken at multiple points in time - additional measures, such as total contribution per week per product should also be considered
fashionization
is the deliberately used by sloanists to increase the perishability of products
the first priority of a business as products begin to be sold....
is to use the contribution margins to pay for fixed costs
the necessity of taking frequent of severe markdowns.....
is usually a symptom of errors in executing product or price strategy
how to avoid price competition
it is important to understand characteristics of firms that make them likely to retaliate when faced with price cuts
when prices are lowered pro-actively....
it is typically assumed that significant increases in sales volume will occur
JC penny and ron johnson
johnson announced 4-year plan to transform penney into america's fav store - tried to appeal to younger people
average redemption rate for all coupons
less than 4%
typical redemption rates
mail in: 5% instant: 20-60%
product line pricing
many companies have a bunch of different products - where a company takes a porfolio approach to managing pricing in order to manipulate consumer preferences and maximize overall profitability - creates range of vertically differentiated offerings at multiple price points
pure competition
many competitors, no control over prices
firms that are capital intensive are...
more sensitive to capacity threats from any source - declining consumer demand from volatility, changes in fashion, etc - competitive threats to market share
price elasticity and price points
moving price even slightly above price point will cause demand to significantly drop off (a kinked demand function) - this is because the price elasticity of demand is relatively low at price lower than the price point, and hgih at a price higher than a price point
additional considerations in assessing the strategic value of competitive price actions
occasionally, a firm may wish to pursue a price-reduction strategy, even when break-even volume increases cannot be realistically achieved
strategic issues for acupuncturist
must consider the long-term strategic implications of each option - option 2: will likely focus on quality care, little pressure to increase patient volume - option 1: be pressured to increase patient volume as high as possible to increase profit
loss leader strategy
must: - make cherry-picking difficult - select loss leaders for which most purchasers have strong reference prices
the latest variation of two-part pricing
new ancillary model for airlines - numerous additional fees which are "optional" beyond the basic ticket price - these fees represent very high contribution margins
can one usually set a price for each individual sale independent of other sales?
no
psychological discounting
occurs when retailers incorporate extremely high profit margins into their prices and then frequently offer substantial discounts - attempts to create the perception of high value by placing a high anchor on buyer's reference price (creates an exaggerated perception of consumer surplus)
how does product differentiation reduce consumer price sensitivity
often by lowering the attractiveness or perceived substitutability of rival brands
as a result of sensitivity, firms
often resort to price competition or price reductions in order to maintain production output at high levels of volume
competition is _____ part of pricing strategy
only one
example of price cut not matched by competitors
pepsi-cola enters bankruptcy
example of successful skim pricing
pharmaceuticals - patent protection on drugs lasts 20 years - typical gross margins are 90%-95% - once patents expire, drugs can be produced generically, and prices fall to just above costs - lipitor
fordist and sloanist businesses have
predominantly fixed costs. this explains why fordist businesses must focus strategically upon production/sales volume
guild businesses have
predominantly variable costs. this explains why guild businesses must focus strategically upon profit margins
often, perishable goods require.....
price reductions, or markdowns, over time, as their use value declines/expires - especially true at retail level
contribution margin
price-variable costs - similar to gross margin - represents the total contribution to overhead for that product
price points
prices for a particular product which most consumers consider fair or reasonable - they are collective in that they are highly influenced by the reference prices of groups of customers
reference points
prices that a given individual expects to pay for good or service
most difficult to prove in capital intensive industries, since variable costs are so low
pricing below variable or marginal costs in the airline industry for example, would require a firm to sell tickets for perhaps only $20
it is much more likely for a price reduction strategy to be....
profitable if the product has a relatively large contribution margin. this explains why fordists are more likely to be successful in cost-cutting situations
if markdowns are too severe or taken too early...
profits are lost due to over-expanding consumers' surplus
if markdowns are taken too late or are too small....
profits are lost due to sacrificed sales
financial leverage
refers to the use of debt to acquire additional assets
reduced margins and market share gains
result: higher or lower profits, depending on brand elasticity
reduced margins and market expansion
result: higher or lower profits, depending upon product class elasticity
fashion increases perishability
retailers are now facilitating this fashionization focus by inventing new ownership models (car dealership steering customers toward leasing, mobile phone service providers moving away from 2 yr contracts)
manufacturers/brands that run frequent coupon deals often find that....
sales volume drops significantly in the absence of deals - customers stock up - customers switch to another brand until next deal appears
monopolistic competition
several competitors, some control over prices
pricing is only predatory when it is used offensively
some court decisions have more recently wavered from a focus on price levels and instead attempt to assess the intent of the seller - general foods example
yield management operates on what principle
that different market segments have varying degrees of price sensitivity - powerful tool for effectively implementing price discrimination
in the original calculation, the break even sales change is calculated from
the base of the original unit sales
after fixed costs have been paid off....
the contribution margin is used to build profits - this occurs after breakeven point is reached
What does the reactive BESC % represent?
the exact point (in terms of sales change) at which your $ gains or losses from sales increases or declines will equal your $ gains or losses from the action of matching your competitors price change
price point anchors
the highest price point and lowest price point
competitive reactions and potential outcomes
the likely reaction by competitors to your pricing actions
in markets populated by few competitors.....
the negative effects of price competition on profit margins pressures firm toward price collusion wherever possible
product bundling
the practice of selling 2 or more products at a combined price - bundle price represents a discount, over the sum of the separate products' prices - vacation packages, season tickets, happy meals
the larger the contribution margin.....
the smaller the percentage breakeven sales change
dumping
the term used when products are sold in the domestic market at one price, and in another (foreign) market at a lower price - a form of geographic price discrimination
what happens to marginal production costs in industries whose production costs are fixed, sunk, and largely non-incremental
they fall towards zero - products in these industries are typically highly differentiated
yield management for airlines
they must utilize their capacity at a very high level - most sophisticated yield management system - approx. 50,000 fare changes are made every night - comp database for system uses 300 gigs of data - est. to add over $500 mill to american's revenues every yr
capital intensive industries
those industries where firms are required to have proportionately large investments in capital or fixed costs -- in other words, those industries where all firms must be operationally leveraged
perishability means that _____ impacts consumer use value to a great degree
time - means that buyer price sensitivity will change over time - buyer use value will change over time - thus, pricing trategy should incorporate time considerations
goal of psychological discounting
to make customers believe that the product's value is much greater than its price and to place time pressure on consumers
breakeven point in units
total fixed costs/contribution margin per unit
the breakeven point formula
total fixed costs/price-variable cost
within any given industry, competitive advantages can often be achieved by....
trading variable costs for fixed costs - in other words, improved profitability can result from increased levels of operational leverage
fighting brands
typically cannibalize some sales from the flagship brand - generally acceptable
break-even analysis
typically considers price from a fairly static perspective
what is central to good business strategy?
understanding the significance of the contribution margin
airlines and hotels formerly employed this model
used to be able to go to gate -often, those customers that desire to purchase later are less price sensitive than those who desire to purchase earlier - by lowering price as time elapsed, airlines and hotels were offering low prices to price insensitive consumers, and charging higher prices to those consumers that were price sensitive
if later purchasers are less price sensitive....
we need to raise our prices as the point of service delivery approaches - difficult to execute bc the price sensitive customers would fill capacity early, leaving no capacity for our less price sensitive buyers
when can product bundling occur
when a service is bundled with a good
when does market-driven pricing begin?
when all costs are incremental and avoidable; then, throughout the product development process, there is constant evaluation of the profit contribution required to cover additional costs
when is price leadership difficult?
when newer competitors are aggressive or where there are resource inequalities - much more difficult between rivals from different countries
predatory pricing
when the price set is below the average variable costs (or marginal costs) of production - considered anti-competitive and is illegal
price elastic primary demand and the southwest effect
whenever southwest airlines enters a new city/airport, demand for air-travel dramatically increases
where is there much less likelihood of price reductions being matched by competitors?
within industries that have a high proportion of fixed costs, but where product differentiation is possible
capital intensive industries tend to...
yield lower levels of profits -This is due to the sensitivity of firms in these industries to capacity threats
if your competitor lowers their price,
your profit will decline
if your competitor raises their price,
your profits will increase
