Competition-based pricing

Setting the price based upon prices oI the similar competitor products.
Competitive pricing is based on 9700 types oI competitive product:
O !roducts have lasting distinctiveness Irom competitor's product. Here we can assume
4 %he product has low price elasticity.
4 %he product has low cross elasticity.
4 %he demand oI the product will rise.
O !roducts have perishable distinctiveness Irom competitor's product, assuming the product
Ieatures are medium distinctiveness.
O !roducts have little distinctiveness Irom competitor's product. assuming that:
4 %he product has high price elasticity.
4 %he product has some cross elasticity.
4 o expectation that demand oI the product will rise.
Cost-plus pricing
Main a79icl0 cos95lus 57icing
Cost-plus pricing is the simplest pricing method. %he Iirm calculates the cost oI producing
the product and adds on a percentage (proIit) to that price to give the selling price. %his
method although simple has two Ilaws; it takes no account oI demand and there is no way oI
determining iI potential customers will purchase the product at the calculated price.
%his appears in 2 Iorms, Full cost pricing which takes into consideration both variable and
Iixed costs and adds a markup. %he other is Direct cost pricing which is variable costs plus
a markup, the latter is only used in periods oI high competition as this method usually
leads to a loss in the long run.
Creaming or skimming
Selling a product at a high price, sacriIicing high sales to gain a high proIit, thereIore
skimming` the market. Usually employed to reimburse the cost oI investment oI the original
research into the product: commonly used in electronic markets when a new range, such as
DVD players, are Iirstly dispatched into the market at a high price. %his strategy is oIten used
to target "early adopters" oI a product or service. %hese early adopters are relatively less
price-sensitive because either their need Ior the product is more than others or they
understand the value oI the product better than others. In market skimming goods are sold at
higher prices so that Iewer sales are needed to break even.
%his strategy is employed only Ior a limited duration to recover most oI investment made to
build the product. %o gain Iurther market share, a seller must use other pricing tactics such as
economy or penetration. %his method can come with some setbacks as it could leave the
product at a high price to competitors.
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Limit pricing
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limit price is the price set by a monopolist to discourage economic entry into a market, and
is illegal in many countries. %he limit price is the price that the entrant would Iace upon
entering as long as the incumbent Iirm did not decrease output. %he limit price is oIten lower
than the average cost oI production or just low enough to make entering not proIitable. %he
quantity produced by the incumbent Iirm to act as a deterrent to entry is usually larger than
would be optimal Ior a monopolist, but might still produce higher economic proIits than
would be earned under perIect competition.
%he problem with limit pricing as strategic behavior is that once the entrant has entered the
market, the quantity used as a threat to deter entry is no longer the incumbent Iirm's best
response. %his means that Ior limit pricing to be an eIIective deterrent to entry, the threat
must in some way be made credible. way to achieve this is Ior the incumbent Iirm to
constrain itselI to produce a certain quantity whether entry occurs or not. n example oI this
would be iI the Iirm signed a union contract to employ a certain (high) level oI labor Ior a
long period oI time.
Loss leader
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loss leader or leader is a product sold at a low price (at cost or below cost) to stimulate
other proIitable sales.
arket-oriented pricing
Setting a price based upon analysis and research compiled Irom the targeted market.
Penetration pricing
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Setting the price low in order to attract customers and gain market share. %he price will be
raised later once this market share is gained.
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Price discrimination
Main a79icl0 57ic0 disc7imina9ion
Setting a diIIerent price Ior the same product in diIIerent segments to the market. For
example, this can be Ior diIIerent ages or Ior diIIerent opening times, such as cinema tickets.
Premium pricing
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!remium pricing is the practice oI keeping the price oI a product or service artiIicially high in
order to encourage Iavorable perceptions among buyers, based solely on the price. %he
practice is intended to exploit the (not necessarily justiIiable) tendency Ior buyers to assume
that expensive items enjoy an exceptional reputation or represent exceptional quality and
distinction.
Predatory pricing
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ggressive pricing intended to drive out competitors Irom a market. It is illegal in some
places.
Contribution margin-based pricing
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Contribution margin-based pricing maximizes the proIit derived Irom an individual product,
based on the diIIerence between the product's price and variable costs (the product's
contribution margin per unit), and on one`s assumptions regarding the relationship between
the product`s price and the number oI units that can be sold at that price. %he product's
contribution to total Iirm proIit (i.e., to operating income) is maximized when a price is
chosen that maximizes the Iollowing: (contribution margin per unit) (number oI units
sold)..
Psychological pricing
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!ricing designed to have a positive psychological impact. For example, selling a product at
$3.95 or $3.99, rather than $4.00.
ynamic pricing
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Ilexible pricing mechanism made possible by advances in inIormation technology, and
employed mostly by Internet based companies. By responding to market Iluctuations or large
amounts oI data gathered Irom customers - ranging Irom where they live to what they buy to
how much they have spent on past purchases - dynamic pricing allows online companies to
adjust the prices oI identical goods to correspond to a customer`s willingness to pay. %he
airline industry is oIten cited as a dynamic pricing success story. In Iact, it employs the
technique so artIully that most oI the passengers on any given airplane have paid diIIerent
ticket prices Ior the same Ilight.
Price leadership
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n observation made oI oligopic business behavior in which one company, usually the
dominant competitor among several, leads the way in determining prices, the others soon
Iollowing.
%arget pricing
!ricing method whereby the selling price oI a product is calculated to produce a particular
rate oI return on investment Ior a speciIic volume oI production. %he target pricing method is
used most oIten by public utilities, like electric and gas companies, and companies whose
capital investment is high, like automobile manuIacturers.
%arget pricing is not useIul Ior companies whose capital investment is low because,
according to this Iormula, the selling price will be understated. lso the target pricing method
is not keyed to the demand Ior the product, and iI the entire volume is not sold, a company
might sustain an overall budgetary loss on the product.
Absorption pricing
Method oI pricing in which all costs are recovered. %he price oI the product includes the
variable cost oI each item plus a proportionate amount oI the Iixed costs. Iorm oI cost plus
pricing
High-low pricing
Method oI pricing Ior an organization where the goods or services oIIered by the organization
are regularly priced higher than competitors, but through promotions, advertisements, and or
coupons, lower prices are oIIered on key items. %he lower promotional prices are targeted to
bring customers to the organization where the customer is oIIered the promotional product as
well as the regular higher priced products.
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Premium ecoy pricing
Method oI pricing where an organization artiIicially sets one product price high, in order to
boost sales oI a lower priced product.
arginal-cost pricing
In business, the practice oI setting the price oI a product to equal the extra cost oI producing
an extra unit oI output. By this policy, a producer charges, Ior each product unit sold, only the
addition to total cost resulting Irom materials and direct labor. Businesses oIten set prices
close to marginal cost during periods oI poor sales. II, Ior example, an item has a marginal
cost oI $1.00 and a normal selling price is $2.00, the Iirm selling the item might wish to
lower the price to $1.10 iI demand has waned. %he business would choose this approach
because the incremental proIit oI 10 cents Irom the transaction is better than no sale at all.
'alue Based pricing
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!ricing a product based on the perceived value and not on any other Iactor. !ricing based on
the demand Ior a speciIic product would have a likely change in the market place.
ine Laws of Price Sensitivity & Consumer Psychology
In their book, %0 S97a90g and %ac9ics of P7icing, %homas agle and Reed Holden outline 9
laws or Iactors that inIluence how a consumer perceives a given price and how price-sensitive
s/he is likely to be with respect to diIIerent purchase decisions:
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1. #eference Price Effect Buyer`s price sensitivity Ior a given product increases the
higher the product`s price relative to perceived alternatives. !erceived alternatives can
vary by buyer segment, by occasion, and other Iactors.
2. ifficult Comparison Effect Buyers are less sensitive to the price oI a known / more
reputable product when they have diIIiculty comparing it to potential alternatives.
3. Switching Costs Effect %he higher the product-speciIic investment a buyer must
make to switch suppliers, the less price sensitive that buyer is when choosing between
alternatives.
4. Price-Quality Effect Buyers are less sensitive to price the more that higher prices
signal higher quality. !roducts Ior which this eIIect is particularly relevant include:
image products, exclusive products, and products with minimal cues Ior quality.
5. Expenditure Effect Buyers are more price sensitive when the expense accounts Ior a
large percentage oI buyers` available income or budget.
6. End-Benefit Effect %he eIIect reIers to the relationship a given purchase has to a
larger overall beneIit, and is divided into two parts: 07iv0d d0mand: %he more
sensitive buyers are to the price oI the end beneIit, the more sensitive they will be to
the prices oI those products that contribute to that beneIit. P7ic0 57o5o79ion cos9: %he
price proportion cost reIers to the percent oI the total cost oI the end beneIit accounted
Ior by a given component that helps to produce the end beneIit (e.g., think C!U and
!Cs). %he smaller the given components share oI the total cost oI the end beneIit, the
less sensitive buyers will be to the component's price.
7. Shared-cost Effect %he smaller the portion oI the purchase price buyers must pay Ior
themselves, the less price sensitive they will be.
8. airness Effect Buyers are more sensitive to the price oI a product when the price is
outside the range they perceive as 'Iair or 'reasonable given the purchase context.
9. %he raming Effect Buyers are more price sensitive when they perceive the price as
a loss rather than a Iorgone gain, and they have greater price sensitivity when the
price is paid separately rather than as part oI a bundle.