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1.3.3. Pricing Strategies - Coggle Diagram
1.3.3. Pricing Strategies
price elastic - the demand for a product is highly responsive to price changes.
% change in demand divided by the % change in income
price inelastic - the demand for a product is not very responsive to price changes. The range of a demand curve where elasticities of demand are less than 1.0.
% change in price divided by the % change in income
market share
the portion of a market controlled by a particular company or product.
Pricing
Price-skimming
a pricing method where a business sets a relatively high initial price and then gradually lowers it over time. This is often used before a business faces competition in the market. Once competition arrives, there will be downward pressure on the price to fall
maximises revenue
- Price skimming is used to try and maximise revenue.
Consumers who buy early on are willing to pay a higher price but the business can still attract other customers who can pay a lower price later on in the product’s lifecycle
cover fixed costs (r&d)
- Price skimming can help to recover the costs of research and development, which can be expensive for technology products.
For example, the Apple iPhone X reportedly cost over $1bn in research and development costs.
slower unit sales growth
- A disadvantage of price skimming is that it can slow down the growth of a product and this can give competitors more time to launch a competing product or service.
A business does not maximise the number of sales at the start so competitors can get more of a chance to enter the market.
Price penetration
a business tries to increase market share by offering a low initial price. Loss leaders work in a similar way to price penetration
Increase market share
- When these goods or services enter the market, a business can attract customers from established competitors.
Price penetration was used by Apple when they entered the market for activity trackers by launching the Apple Watch. The Apple Watch competed with products by businesses like Fitbit
Lower short-term profits
- In the short term, price penetration can lead to lower average profits than would be earned with a higher price.
However, market share may be more important for the long-term profitability of a business.
Loss leaders
Loss leaders are products or services that are sold by a business at a price where the business makes a loss (average revenue < average cost).
Loss leaders can attract new customers or sell to existing customers, in the hope that they make extra (incidental) purchases.
Dollar Shave Club offered to deliver a razor and new razor blades to your house for $1 every month. This was loss making, but it attracted customers who bought extra products.
Cost-plus pricing -
Cost-plus pricing is a pricing strategy where a business charges the customer based on what it costs to produce the product or service.
They work out exactly what it costs to produce the product (or service) on average and then add a “mark-up” (extra amount) on top of this cost to make sure that the business makes a gross profit.
For example, if Kwik Fit bought a Dunlop tyre from its suppliers for £80, then if they added a 25% mark-up, then the tyre would be sold to customers for £100.
Competitive pricing
Competitive pricing is when a business sets its prices for its products and services based on what other businesses in the market are charging.
Competitive pricing is used when the products in a market are similar.
The petrol sold at petrol stations is usually based on competitive prices. In February 2018, all the petrol stations within 3 miles of Derby city centre were charging 121.9p per litre of petrol.
psychological pricing
- based on the belief that customers perceptions of a product are strongly influenced by price
prestige pricing
- higher-than-average prices are used to suggest status and quality to a customer
odd/even pricing
- odd numbers, such at $19.99 are employed to suggest a bargain. the odd numbers convey a bargain image, whereas the whole numbers ($20.00) suggest higher quality
4 Key Factors affecting pricing decisions
Cost
Costs influence business' pricing decisions because businesses usually aim to make a profit.
A business' price and costs determine how much profit the business will make. Businesses cannot afford to set a price lower than their costs forever
Product Life Cycle
Where a product is in the product life cycle determines whether the business will charge a high or low price for the product.
When a new product is launched, businesses may charge higher prices to take advantage of exclusivity.
When Apple launches new iPhones (like the iPhone X), they charge higher prices. The iPhone X cost $1,000 in Autumn 2017, but this price fell to $850 by February 2018.
Nature of Product
Whether a good is a luxury good will affect how much a business charges.
Whether the good is hard to differentiate from competitors affects how much a business can charge. If it is similar (homogenous), then businesses usually price at a similar level to competitors.
For example, in the crude oil market, oil is the same no matter who produces it. This means that there is a uniform price (same price for all businesses and customers) in the market.
Degree of Competition
The degree of competition affects the pricing decision of businesses because the more competition a business faces, the more options customers have.
When customers have lots of options for similar products, businesses must compete to attract customers using a lower price.
Palich et al. - Long Pocket Strategy, their research concluded that the business with the most money in the bank normally wins a price war between businesses
Product Life Cycle
Stages
introduction stage
sales volume is relatively low, marketing costs are high, and profits are low (or negative)
growth stage
sales climb rapidly as unit costs decrease rapidly
maturity stage
sales begin to slow, and profits peak
decline stage
sales and profits continue to fall. business should cut prices to generate sales or clear inventory