Pricing Strategies and Elasticity
As we learned in the Marketing
Mix section, Kellogg’s intention was to add value to the
new breakfast cereal through price. During the pricing process, Kellogg’s
studied customers’ opinions about the product price, the competitors' price, and finally implemented a
price that added more value for customers and generated profit to the company.
The following illustration presents the three major pricing strategies companies must evaluate during the pricing process: customer value-based price, cost-based price, and competition-based price.
The following illustration presents the three major pricing strategies companies must evaluate during the pricing process: customer value-based price, cost-based price, and competition-based price.
Copyright ©2014 by Pearson Education, Inc. All rights reserved
The
illustration above, underlines the company’s dilemma at the time of setting the
price. Usually they have to avoid a price that it is too low to produce a
profit (below price floor), and a price that it is too high to prevent a good
customer’s demand (above price ceiling). To balance the situation, companies
must look for a price strategy that brings both, value to the customer and
profit to the company.
Customer value-base pricing sets the price “based on buyer’s
perceptions of value rather than on seller’s cost” (Kotler and Armstrong, p.
291). For example, Amazon is offering the Apple iPhone 6, for $ 755 with a 29%
discount include it. This price might be too high for a low income customer who
might perceive no benefit in making such a purchase. However, those customers
that are able to afford it, and see the new device’s features as a solution to
their problems, the price would be irrelevant and they will not miss the
opportunity to purchase it. The strategy uses for the iPhone 6, is based on the
valued-Added pricing, which object
is to differentiate Apple’s products and services throughout attaching
value-added features to the new iPhone6 that justify its high price in the
market. In summary, customer-value perceptions set the ceiling price.
Cost-based pricing sets the price floor the company is
intended to charge in the market. According to Kotler and Armstrong, this price
is “based on the cost of producing, distributing, and selling the product, plus
a fair rate of return for effort and risk” (p. 295). For example, most of
people visit Walmart because it is a place where they can find good merchandise
at lower price. In this case, Walmart is expecting to generate bigger sales
with low prices that will end up increasing its profit’s levels.
But things are not easy as they seem, for any given product Walmart put up for sale in its stores, the company has to keep control of Fixed costs (overhead) including monthly rent, heat, electricity, loan interest, executive salaries and many other cost that are independent of Walmarts’ level of outputs sold. Besides, the company has to pay attention to Variable costs that depend of the number of item expected to sell to final consumer. The goal of any company is to cover the Total cost resulting from the combination of Fixed and Variables cost, and finally set a price that brings customers satisfaction, and profits to the company.
But things are not easy as they seem, for any given product Walmart put up for sale in its stores, the company has to keep control of Fixed costs (overhead) including monthly rent, heat, electricity, loan interest, executive salaries and many other cost that are independent of Walmarts’ level of outputs sold. Besides, the company has to pay attention to Variable costs that depend of the number of item expected to sell to final consumer. The goal of any company is to cover the Total cost resulting from the combination of Fixed and Variables cost, and finally set a price that brings customers satisfaction, and profits to the company.
Competition-based pricing set the price based
on competitor’s strategies, prices, costs, and market offering. Under this
pricing strategy, the company must evaluate competitor’s offerings in terms of
customers’ value. In other words, consumers’ perception of value will justify
the company increase or decrease in price.
It is important to notice that every strategy described before is linked to customers’ value. Then, it does not matter if the company sets the price high, low, or in the middle, at the end the right price will be that one that provides the most superior value for the customer.
It is important to notice that every strategy described before is linked to customers’ value. Then, it does not matter if the company sets the price high, low, or in the middle, at the end the right price will be that one that provides the most superior value for the customer.
Price Elasticity of Demand
Price elasticity is defined as “a measure of the sensitivity of demand to changes in price” (Kotler & Armstrong, p.304).
The price elasticity of demand is determined by using the following formula:
Price elasticity of demand = % change in quantity demand
% change in price
This concept is explains by the following illustration:
Price elasticity is defined as “a measure of the sensitivity of demand to changes in price” (Kotler & Armstrong, p.304).
The price elasticity of demand is determined by using the following formula:
Price elasticity of demand = % change in quantity demand
% change in price
This concept is explains by the following illustration:
Copyright ©2014 by Pearson Education, Inc. All rights reserved
In the illustration, a price increase from P1 to P2
leads to a relatively small drop in demand from Q1 to Q2. Nevertheless, the same price increase leads to a large drop in demand from Q’1 to Q’2.
If demand hardly changes with a small change in price, we say the demand is inelastic.
An example of a product with inelastic demand is gasoline. In the case, when demand changes greatly, we say the demand is elastic. With elastic demand, might be convenient for the seller if lower the price to generate more demand, and increase revenues but always taking into consideration that the cost of producing more units do not exceed the extra revenue (p. 304).