pricing Flashcards
(25 cards)
what are the two extremes of the price/demand trade off?
if demand is unresponsive to changes in price (inelastic), supplier will just keep increasing it
other option is above a certain price there is 0 demand - completely elastic.
what is the formula for elasticity of demand?
elasticity = -(% change in qty demanded) / % change in price
don’t use absolutes to avoid distortions caused by use of different units of measurement. given slope, negative numerator makes outcome positive for conveniency.
when is demand considered elastic or inelastic?
elasticity over 1 = elastic. means fall in price increases demand considerably so total revenue increases, but increase in price decreases demand enough to affect revenue too. less than 1 = inelastic. fall in price will inc demand but not sufficiently to maintain previous revenue level. rise in price will increase total revenue.
elasticity will differ between points on the curve as it’s rarely a straight line!
when elasticity is high how can inflation cause issues?
when elasticity is high, problems arise with cost inflation being higher than price inflation. in times of inflation, better to put up prices frequently by a small amount each time where customers will pay less notice. in practice, prices of many products like consumer durable products need to fall over time in order to increase demand. it is therefore vital to make costs fall by same percentage if margins are to be maintained. customers rarely react evenly to price increases.
what psychological barriers do companies need to consider on top of elasticity of demand?
$1 or $2 may be a psychological barrier and if price is increased over this level demand will drop rapidly. if product is sold in the supermarket orgs need to know how customers react to different prices to determine which points are crucial. to complicate this, orgs don’t act in isolation and the effect of decrease in price on volume will depend on how competitors react to the price change and on current desirability of products.
how can products in the same industry have different elasticity?
because they are sold in slightly different markets due to product differentiation. high performance care may be less elastic, e.g.
what is price stickiness?
type of competitor reaction, idea is that competitors follow price cuts with cuts of their own, but not rises. rises mean demand falls sharply, cuts mean little is gained in demand and competitors will follow suit. firms then reluctant to change prices and result is stickiness
what factors effect elasticity?
scope of market - larger market = less elastic demand
information within the market - consumers may not know of competitors to reassess purchasing behaviour. growth of internet purchasing increasing this awareness
availability of substitutes - less differentiation between competing products = greater elasticity. differentiated products benefit from customer awareness and preference.
complementary products - interdependency of products = higher elasticity because volume sales of dependent good rely on sales of primary good.
disposable income - luxury = high elasticity
taste and fashion -necessities - same reason as disposable income
habit - e.g. cigarettes
what are the two types of competition in markets?
perfectly competitive - no ppt influences the price of the product. every buyer/seller is a ‘price taker’. this also means:
zero entry/exit barriers
perfect information - price and quality known to all
companies aim to maximise profits
homogeneous products - goods and services don’t vary between suppliers
imperfect competition
monopoly
oligopoly - firms must consider reactions of rivals to changes in price - e.g. uk supermarkets
monopolistic competition - products are similar but not identical. many producers/price setters and many consumers, no one has total control. e.g. every soap brand
what is the profit maximisation model?
mathematical model can be used to determine optimal selling price. this is based on idea that profit maximised where marginal cost = marginal revenue.
basic principles: worthwhile for a firm to produce and sell further units when the increase in revenue gained from sale of next unit exceeds the cost of making it (MR>MC). so, produce units up to the point where MR=MC.
what is the formula for price and marginal revenue in the profit maximisation model?
p = a -bx
p = price, x = quantity
b = change in price / change in quantity
a = constant.
Marginal revenue = a - 2bx.
what are the limitations of the profit maximisation model?
does make some attempt to take account of the relationship between the price of a product and the resulting demand, but it is of limited practical use because:
unlikely orgs determine demand functions for their products with any accuracy
majority of orgs aims to achieve a target profit rather than theoretical maximum
determining accurate and reliable figure for marginal or variable cost poses difficulties for mgment accountant
unit marginal costs are likely to vary depending on quantity.
other factors in addition to price will affect demand
what are the pricing strategies based on cost?
total cost-plus
marginal cost-plus
what are the 12 market based pricing strategies?
- short term pricing
- opportunity cost
- premium
- market skimming
- penetration pricing
- price differentiation
- loss leader
- product bundling
- pricing with additional features
- using discounts
- controlled pricing
what is total cost plus pricing?
adding a markup to the total cost of the product to get selling price. since fixed costs are spread over units of production, full cost is a function of number of units produced, which is function of units sold.
sales quantity then depends on price charged, so all very circular.
price > cost > units sold > price
when may total cost plus pricing be used?
where an order is placed with a jobbing company (who makes products to order) for a specific quantity of a product made to spec, cost plus may be sole pricing method. for majority, other factors influence decision. even if this is basis, have to decide whether to use standard markup or vary according to conditions/customers etc. standard okay for gov contractors/some job costing companies but majority vary percentage depending on product.
what are the pros of total cost plus pricing?
required profit will be made if budgeted sales volumes are achieved
particularly useful in contract costing industries where few large individual contracts consume majority of annual fixed costs and fixed costs are low in relation to variable
assuming org knows its cost structures, cost plus is quick and cheap to employ. routine nature lends itself to delegation, saving mgment time
can be useful in justifying selling prices to customers - if costs can be shown to have increased then this strengthens the case for an increase in selling price
what are the cons of total cost plus pricing?
always problems selecting a suitable basis on which to charge fixed costs to individual products/services. selling prices can vary greatly, depending on apportionment basis. can lead to over-under compared to competitors causing loss of business or sales made at an unintentional loss
if prices set on basis of normal volume, if actual volume turns out to be considerably lower overheads won’t be considerably lower and will not be fully recovered from sales. predicted profits may become unattainable
takes no account of factors like competitor activity
overlooks need for flexibility in different stages of product’s life. no account of price customers are willing to pay, and elasticity of demand, and there can be an opportunity cost to this.
why should marginal cost be used over total cost in pricing?
accurate as total cost
larger markup percentage added because fixed cost and profit must be covered, but uncertainty over fixed cost per unit remains in both methods
gives option of pricing below total cost when times are bad, to fill capacity
useful in pricing specific contracts
recognises relevant, opportunity and sunk costs
recognises existence of scarce/limiting resources
when these resources are used by competing products and services it must be reflected in the selling price to maximise profit. if there’s a bottleneck resource must aim to maximise total contribution from limiting factor. each alternative contribution must be calculated and suitable profit margin calculated.
what are the drawbacks of marginal cost-plus pricing?
if there are two companies with similar products competing in the same shrinking market and one lowers its price to below total cost but well above marginal (and it works), to get market share back the other company will reduce price. both companies now have same market share on lower margins. zero sum game. even if you force the other company out, increasing prices likely to get you resistance from customers.
focussed too much on internal costs rather than external demand conditions/competitor prices/profit maximisation prices. may therefore result in suboptimal pricing
FC ignored when determining suitable price so danger they won’t be recovered in long term
may find it too hard to raise prices when margins are low especially if customers now expect the lower price
what is short term pricing and opportunity cost pricing?
- short term pricing - at each stage in lifecycle, pricing strategy used to match cost and demand profiles
- opportunity cost - charge customer with only incremental cost for project. may be used to win a new contract, but over long term company needs to cover all costs
what is premium and market skimming pricing?
- premium - above competition on permanent basis. product needs to be different and superior in some way. larger profit per unit, customer loyalty (making price relatively inelastic), but heavy initial promotion required. in competitive markets, constant heavy promotion required. establish brand based on quality, image/style, reliability, durability, after-sales etc
- market skimming - high initial price, few keen customers, then price is lowered. as demand dries up lower again etc. can maximise revenue but also prolong life of older products. books sold this way with hardbacks first. if profitable skimming is to be sustained before introductory phase, msut be significant barriers to entry to the market to deter too many potential competitors entering attracted by high prices/returns.
what is penetration, price differentiation and loss leader pricing?
- penetration pricing - low initial price, establish large market share quickly, customers keep buying as price rises in line with competition. good where barriers to entry are low.
- price differentiation - if can split market into segments, can sell same product to different customers at different prices. marketing techniques can be used to create segmentation. usually on basis of: time, quantity, outlet/function, location, product content.
- loss leader - one or more main products with series of related optional extras, which customer can add on to main. supplier can set low price for main and high for extras, get demand for main item to ensure target return from sales of the extras.
what is product bundling and pricing with additional features?
- product bundling - make a complete kit for customers. often adopted in times of recession where orgs are keen to maintain sales volume. e.g. reduce margin on some hardware - if before only half of customers would buy a printer, bundle of PC + printer at a lower combined price may work. can work on mature products too.
- pricing with additional features - allows people to opt out of full price by sacrificing some things
