Chapter 5 other pricing strategies

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PRICING OF MULTIPLE PRODUCTS: Product Line Pricing Peak Load Pricing Transfer Pricing :

PRICING OF MULTIPLE PRODUCTS: Product Line Pricing Peak Load Pricing Transfer Pricing

Slide 2:

We have considered pricing by the firms of a single product. In reality firms produce multiple products. Such multiple products create 4 different kinds of relationships. Demand relationships : The multiple products produced are complementary or substitutes Cost relationships : Cost sharing by multiple products Production relationships : More than one product results from a single production process. Capacity relationships : Firms can use excess or idle capacity to produce one or more additional products. PRICING OF MULTIPLE PRODUCT

Product Mix Pricing Strategies:

Product Mix Pricing Strategies Product line pricing Optional-product pricing Captive-product pricing By-product pricing Product bundle pricing Peak Load Pricing Transfer Pricing

PRICE LINING OR PRODUCT LINE PRICING:

PRICE LINING OR PRODUCT LINE PRICING Product line is a collection of products, offered by a firm, that satisfy similar needs for different target audiences. Thus all products within a product line are related, but may vary in terms of size, color, quality etc. Primarily uses price to create the separation between the different models. Pricing different products within the same product range at different price points . Price lining is the use of a limited number of prices for all your product offerings. It has the advantage of ease of administering, but the disadvantage of inflexibility, particularly in times of inflation or unstable prices Sets price steps between various items in a product line based on: Cost differences between products Customer evaluations of different features Competitors’ prices

Slide 5:

Gramophone sells a line of high-end sound systems ranging in price from $5,000 to $120,000. Video manufacturer offering different video recorders with different features at different prices.

Slide 6:

EXTRA INFORMATION Price Lining or Product Line pricing: Where there is a range of products, the pricing reflect the benefits of parts of range. Product lining is the marketing strategy of offering for sale several related products. Price lining or product line pricing is a method that primarily uses price to create the separation between the different models. With this approach, even if customers possess little knowledge about a set of products, customers may perceive they are different based on price alone. The key is whether the prices for all products in the group are perceived as representing distinct price points (i.e., enough separation between each). For instance, a marketer may sell a base model, an upgraded model and a deluxe model each at a different price. If the differences in features for each model is not readily apparent to a customer, such as differences that are inside the product and not easily viewed (e.g., difference between laptop computers), then price lining will help the customer recognize that differences do exist as long as the prices are noticeably different.

Optional- and Captive-Product Pricing:

Optional- and Captive-Product Pricing Optional-Product Pricing optional or accessory products sold with the main product (e.g., ice maker with the refrigerator). Captive-Product Pricing products that must be used with the main product (e.g., replacement cartridges for Gillette razors).

By-Product and Product Bundle Pricing Strategies:

By-Product and Product Bundle Pricing Strategies By-Product Pricing Pricing low-value by-products to get rid of them (e.g., molasses). Product Bundle Pricing Pricing bundles of products sold together (software, monitor, PC, and printer).

Slide 9:

Peak-load pricing is a pricing technique applied to public goods. It is a policy of raising prices when the demand for a service is at its highest. Instead of different demands for the same public good, we consider the demands for a public good in different periods of the day, month or year, then finding the optimal capacity (quantity supplied) and, afterwards, the optimal peak-load prices. This has particular applications in public goods such as public urban transportation, where day demand (peak period) is usually much higher than night demand (off-peak period). By subtracting the marginal costs of operation from the original demands we find the marginal benefits of capacity, which must then be vertically aggregated and equated to the marginal cost of increasing capacity. With the optimal capacity found, the optimal peak-load prices are found by adding the marginal costs of operation to the marginal benefit generated, in each period, by the optimal capacity. It may happen, however, that the optimal capacity is not fully used during the off-peak period. In that case, the capacity expansion will be totally supported by the peak demanders. PEAK LOAD PRICING

Slide 10:

Peak-load pricing is often used by electricity and telephone utilities as a means of reflecting the investment they have made to meet peak demand for their services. A developing country needs, among other things, access to telecommunications, rail-based mass transport, water and electricity. Consumption of these services is marked by significant periodicity. That is to say, consumption is high during peak periods, and lower in off-peak periods. More electricity, for instance, is consumed in the daytime, when offices and factories operate. The pricing of these services, coupled with the fact that they have to be provided when needed, regardless of high or low demand, can lead to inefficiency in these markets. This is because efficiency happens when producers follow normal profit maximizing behavior, i.e., when they charge higher prices for consumption during peak periods, and lower prices during off-peak hours. The effect of peak-load pricing is to induce some consumption to shift, away from the times of peak demand, and toward times of lower demand. Consumers are rewarded -- in the sense that they payless -- for using the service when there is ample unutilized capacity, rather than when demand takes up or even exceeds all the capacity. This makes for more efficient use of existing capacity. PEAK LOAD PRICING

Transfer Pricing:

Transfer Pricing Vertically integrated firms “sell” intermediate goods from one division to the other. The internal price used is called the transfer price . Fisher Body automobile Frames (a division of GM) sells to Chevrolet (another division of GM) Car Frames Transfer prices paid GM Chevy Division Fisher Body GM Chevrolet Division Buys Fisher Body Car Frames

Create Transfer Prices Similar to Competitive Market Prices:

Create Transfer Prices Similar to Competitive Market Prices Disagreements across divisions are common “Selling” Division wants a HIGH transfer price! “Buying” Division wants a LOW transfer price! When External Markets exist, use those prices for transfer (a market-based competitive price) motor assembly final car assembly sell to others @ “P” purchase motors from others @ “P”

Transfer Pricing With No External Markets:

Transfer Pricing With No External Markets When no external markets exist, use the MC of the transferred good . Often, however, the MC is a function of output. Marketing and Production steps (M & P) Transfer price is P T = MC P

Slide 14:

Transfer Pricing serves two functions : It measures of the marginal value of the resource. It provides a performance measures of resources used, including the total value of resources Each division can be a profit center. For International Firms , transfer pricing may assist in reducing worldwide taxation. Once a firm uses the transfer price, either from external markets or from analysis of the MC , the whole firm maximizes profits.

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