Pricing
Price elasticity of demand
The effect on the demand for a product when the price is changed
Demand curve
Elasticity of demand = - %change in quantity demanded / %change in price
Kinked demand curve situation
if a company increases price the demand will fall, but if the company reduces the price the demand won’t increase (because the competitors would reduce their prices)
Factors effecting price elasticity
- Scope of the market (larger the market the more inelastic)
- Information within the market (if the consumers don’t know about alternatives the demand could be inelastic)
- Complementary products
- Disposable income
- Necessities (inelastic)
- Habitual/addictive products (inelastic)
Product life cycle
Depending on the stage of the product life cycle different pricing strategies would be adopted
- Introductory stage - a penetration price or a skimming price in order to establish the product in the market
- Growth stage - trying to establish a dominant market share
- Maturity stage
- Decline – prices would fall when companies try to keep the product in the market
The profit maximizing model
Profits are maximized when the MR = MC
Price equation; p = a – bX
Marginal revenue equation; MR = a – 2bX
In the above equations
b = Rate of change in demand (slop of the curve) = Change in price / Change in demand
Limitations of the profit maximizing model
- Its practically impossible to generate a demand function
- The aim of the firms are to achieve a target profit, not the theoretical maximum profit
- Accurately determining the marginal cost is not possible
- Unit marginal costs are not constant and can change with the quantity
- Demand can change due to facts other than price
Total cost-plus pricing
Adding a markup to the total cost of producing one unit
Advantages - The required profit would be made if the budgeted sales are made
- Useful in contracts
- Cheap and easy to use
- Can justify increases in selling price
Disadvantages - Finding a suitable way to apportion the fixed cost
- If expected sales volumes are not met the overheads could be under absorbed
- Competitor activities are ignored
- Ignores the different stages of product life cycle
Marginal cost-plus pricing ~ Adding a markup to the marginal cost
Premium pricing ~ Charging a superior price due to product differentiation
Market skimming ~ Initially setting a high price and reducing the price with time
Penetration pricing ~ Initially setting a lower price than cost, intending to gain market share and then increase the price to make profits
Price differentiating ~ Selling the same product to different market segments for different prices, this could be done by,
- Time (peak / off peak)
- Quantity (small orders / bulk orders)
- Type of customer (student)
- Geographical location
Loss leader pricing ~ Selling the main product at a very low price and selling its complements at a very high markup to cover the losses
Product bundling ~ Selling few products as a bundle for a lower price in order to increase the sales volume
Using discounts in pricing ~ To increase the sales volume without permanently decreasing the selling prices
Controlled pricing ~ Where the price is enforced by the law, usually to make sure monopolistic companies don’t exploit their position in the market
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