Chapter Seven

Introduction to – Pricing

“Pricing strategy involves more than picking a number to charge. It involves creating good value that can be produced and sold profitably, communicating the benefits to potential customers, and designing price structures that reflect differences in value among different customers and applications. It means managing customer expectations that prices reflect value, setting price levels that allow the seller to capture a share of that value, and managing price competition to achieve sustainable profitability. To create a viable pricing strategy, a firm must initiate pricing decisions proactively, base them on an estimate of economic value, and measure success in terms of bottom-line profit rather than just revenue or market share.” from a summary of the book 'The Strategy and Tactics of Pricing. -Thomas Nagel' by Deloitte retrieved from the Deloitte website.
Auctions are unusual in the 21st century most things, even luxury items such as watches and clothes, sell at fixed prices although there is some room to haggle. Even many items on eBay, the electronic platform, are sold at fixed prices. In The Dynamics of Auction, Christian Heath, a professor of work at King’s College, London, describes them as “a somewhat anachronistic method of selling goods, more common perhaps to traditional agrarian societies than post-industrial capitalism.”
“They are still used for art because every painting is different and has no intrinsic value – it does not yield anything and the cost of manufacture is usually tiny. They are also a good way to get high prices – when buyers compete against a deadline, they behave differently. The desire not only to acquire it but to beat others causes what Deepak Malhotra, a Harvard professor, terms the 'emotional arousal' of auctions. The strategy of pricing stems from the determination of the definition of value by the seller and the buyer.” reference: Eugene Wei - The art of the auction
On occasion, Christie's has a direct financial interest in the outcome of the sale of certain lots consigned for sale. This will usually be where it has guaranteed to the Seller that whatever the outcome of the auction, the Seller will receive a minimum sale price for the work. eBay allows the seller to select a reserve price that is a hidden minimum price—essentially, the lowest price you're willing to accept for your item. If the listing ends without any bids that meet the reserve price, the seller is not required to sell the item. A reserve price allows you to set a low starting price to generate interest and bidding, but protects you from having to sell your item at a price that you feel is too low.


Here is a direct link to the Christie server: The auction
As seen in the video Pablo Picasso’s Les femmes d'Alger (Version 'O') realized $179,365,000 achieving a world auction record for any work of art. The monetary value at that point in time was established by the outcome of the auction. The role of value and price communications, is to convey the value proposition in a compelling manner to accomplish three goals: enable customers to fully understand the benefits, quantify the value of those benefits, and raise customers' willingness-to-pay for differentiating features and services. The benefits to the buyer of Les femmes d'Alger are the exclusive ownership of a piece of art that identifies the owners wealth. They achive a sense of personal accomplishment from the pride of owning such a rare piece of art created by Pablo Picasso.
Pricing is one of the key marketing strategies, but product or service price is often arbitrarily determined. If competitor one is charging $40.00 US dollars, competitor two is charging $20.00 as a marketer, you might arbitrary set your price at $30.00. To determine the price of goods and services, others engage in cost plus pricing, something they should not be doing. Cost plus pricing determines a product or service price adding together the material cost, the labor cost and the mark-up percentage to set the price of the product.
The McKinsey Company conducted a study that looked at over 2,000 companies for actions they could implement in order to increase their operating profits. The study concluded one change a firm could effectuate to have the most impact on operating profit is to improve their price by only 1%. Here the potential exists that the firm could increase their operating profits by about 11%. Price is a critical factor and one that is often inaccurately determined.


Trader Joes Banner

How do you set a profitable price?


The first example we will review is Trader Joe's, a company that sells large quantities of private label product. Currently owned by the ultra-private Albrecht family of Germany, the company maintains over 365 stores worldwide and has an estimated annual sales of $8 billion dollars (roughly the same as Whole Foods). Trader Joe's boasts one-of-a-kind items such as Thai lime, white cheese popcorn, chili cashews and raw blue agave sweetener. Though not considered a "health food" chain, it does offer an array of organic and gourmet products.
Shoppers can find both national brands and private labels but most of what Trader Joe's sells are private label products. One delicious product available at their stores are dumplings that can be easily steamed for consumption. Now, let's imagine those dumplings cost about $3.99. Even though you may really like the dumplings, you might question if $3.99 is really a good price for them. Because these particular dumplings are a private label brand, this might present a problem in finding them anywhere else to comparison shop. At this stage it is difficult to know if $3.99 is a good deal or a bad deal. If you pay $2.00 for a can of Coke, you know that is a bad deal and furthermore, you can shop elsewhere for a better value. Trader Joe's recognizes that an inference problem exists in regards to products. As a result, they will price an easily obtainable product like bottled water well below their competitors price. When consumers see bottled water priced very low, they are somewhat confident that the private label Trader Joe's products are also fairly priced. This is an illustration of how some companies signal through one specific product that they offer good values for the entire product line. Read more on Trader Joe's
While shopping at Wal-Mart you might find Tide detergent for $4.73 or some other product for $2.81, why the unusual last cent digits? In the United States, most retail prices end in either a nine or a five. By ending their prices in threes and fours, Walmart is trying to convey the message that they have squeezed out every possible cent in order to deliver the best possible value to the consumer. This is another example of retailers using the product price to send a signal to shoppers.
Deca Chicago menu prices
Menus prices typically are priced at whole dollars.
Your price sends all kinds of other signals and will be one of the themes as you continue. But first we need to understand the market we operate in and how the customer and the competition will react. In this context we are refering to perfect competitive, oligopoly or monopoly. The most dynamic market is perfect competition where the customer and competing firms react to pricing and product supply changes.
How are prices set and what is the right framework? We will consider four inputs to the pricing decision. The marginal cost is the change in the total cost that arises when the quantity produced is incremented by one unit, that is, it is the cost of producing one more unit of a good. The next parameter to consider is the ceiling price, which is the maximum the customer is willing to pay. Competitor pricing is the third factor that might potentially drop the ceiling price as it prohibits charging people their absolute maximum willingness to pay. If your customer is willing to pay $10.00 but he can get the equivalent product from a competitor for $6.00, then you will have to drop your price from $10.00 down to $6.00. The fourth input is the amount prices have to be raised from marginal cost in order to pay distributors or resellers to motivate them to sell your product.


Our discussion of the pricing framework must include the customer willingness to pay the fluctuating price amounts that are presented by collaborators also known as the middle men and competing organizations. The five C's of marketing: customers, company, collaborators, competitors, and context are a part pricing decision. When setting a price, companies should contemplate financial considerations such as required internal rate of return. This serves as a tool in determining whether it is worth the investment. In addition, consistency in the product line is a factor as sometimes there are good, better and best products. For instance, the price charged for the Toyota Camry is related to the price charged for the Toyota Corolla. Accurate pricing involves spacing figures out in a consistent manner.
Image plays a major role when companies set prices. Known for their highly discounted pricing, imagine the challenge Walmart would face if they attempted to sell expensive merchandise. Similarly and inconsistent with their overall image, it may be unyielding for Saks Fifth Avenue to sell inexpensive items. To reiterate, from a company perspective it is imperative to consider internal rate of return, consistency and image. From a competitor point of view there is a whole litany of items, but here are several of the most important. When marketers set a price, taking into account the competitors response should be primary. Will they respond aggressively and take whatever the set price is and cut below it? Will the competitor react rationally? First and foremost, always take into account the aggressiveness of the competitor. Next consider how the competitor will or will not respond when something changes in regards to pricing. They may also react by improving their advertising (promotion), product or their distribution (place), the other 3 P's. Subsequently, as a marketer think about your position and the competitors position. As the market leader, you have a responsibility to set the standard and keep your prices high. As a follower you might employ a different kind of strategy. With respect to competitors, three important considerations regarding pricing include, advertising (promotion), product and distribution (place).
Collaborators or distributors place an emphasis on margin and return on their assets. Are you pricing in such a manner that enables the collaborator or distributor of your product to turn the product frequently enough?
Customer issues are significantly relevant in the entire overall structure. Customer price sensitivity is key and in terms of economics, this is sometimes referred to as price elasticity. Simply put in economics, price elasticity translates to the following: if the price is raised by one percent, how much does demand drop? For example if you raise the price of your product by one percent and demand drops five percent that means that the product is highly elastic. If the price is raised one percent and demand only drops 0.2 of a percent, that means that the product is very inelastic. Gasoline is an inelastic product. There are few if any substitutes for powering your car. Ice cream is an elastic product. If the price goes up people will find substitute products and the demand for ice cream will drop. If you have an elastic product you need to strategically raise prices based on an assessment of the availability of substitutions and the willingness of consumers to change suppliers or do without the product.
Marketers actually measure beyond the economic concept of price elasticity and take into account pertinent psychological issues. Interestingly some valid psychological phenomena revolves around the last digit of the price and whether it is an odd ending or an even ending. We will discuss mental accounting and how price is processed internally and present a short summary of a well-known psychological principle called Prospect Theory or Psychological Theory. This Nobel Prize winning theory maintains some compelling implications regarding pricing. Finally, we will also review another psychological principle known as the endowment effect. In psychology and behavioral economics, the endowment effect (also known as divestiture aversion and related to the mere ownership effect in social psychology) is the hypothesis that people ascribe more value to things merely because they own them.
“One of the driving factors in setting prices is understanding the issue of substitutes. If there are four kinds of bottled water and one is half the price of the others, guess which will generate all the sales? They are quite close to perfect substitutes, so take the cheap one. Even though all the movies at the multiplex cost $12 a seat, you can't often substitute one for another to save money. You don't go to Mall Cop merely because it's $2 less. Movies aren't commodities, and the substitutes aren't perfect at all.”
“I asked a photographer to license a photo for a project. The photographer asked for too much and he had every right to, it was his photo after all, and if I wanted that photo, I had to pay him. But the thing is, I didn't need ‘that’ photo, I just needed ‘a’ photo. The available substitute was, imperfect but acceptable. The reason that ebook prices are less important than in many other industries is that the substitutes for ‘Makers’ or ‘In Search of Excellence’ are quite imperfect--if you want to know what that book said, the only way to really know is to read it.”
“Your job then, isn't to merely set your price low enough to keep people from seeking substitutes. It's to create a product or service unique or connected or noteworthy enough that the other choices are ever more imperfect.” Seth Godin - Imperfect Substitutes at Link