Pricing to optimize revenues
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3. Pricing to Optimize Revenues. How should prices be set relative to cost – benefits? When should a firm lower or raise its prices? What is the reaction of competitors and customers likely to be when a firm adjusts its prices? When can a firm give away its products?.

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Pricing to Optimize Revenues

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Pricing to optimize revenues

3

Pricing to Optimize Revenues


Pricing to optimize revenues

How should prices be set relative to cost – benefits?

When should a firm lower or raise its prices?

What is the reaction of competitors and customers likely to be when a firm adjusts its prices?

When can a firm give away its products?


A brief history of pricing

A Brief History of Pricing

  • Barter

  • One-on-one bargaining

  • Menu (fixed) pricing

  • Auction pricing

  • Reverse auction


Setting prices for an optimal revenue model

Setting Prices for anOptimal Revenue Model

  • Objective – to maximize profits

  • Contribution of Price to Profitability

    Profits= revenues - variable costs - fixed costs

    = PQ - VCQ – FC

    = ( P - VC)Q - FC

    = Contribution margin – FC

    = (Contribution margin per unit) Q – FC


Table 3 1 contribution margin and profits as a function of number of units sold

The price (column A), per-unit variable cost (B), and quantity sold (C) are given. Revenues (E) are the product of price (A) and quantity sold (C). Variable costs (F) are the product of per-unit variable cost (B) and quantity sold (C). As defined in the text, the contribution margin (G) is equal to the revenues (E) minus variable costs (F). The product’s operating income is the contribution margin minus fixed costs.

ABCDEFGHI

Per-UnitContribution

VariableQuantityMarginVariableContributionFixedOperating

PriceCostSoldper UnitRevenuesCostsMarginCostsProfits

A - BA X CB X CE - FG – H

$100$525,000$95$2,500,000$125,000$2,375,000$10,000,000$(7,625,000)

100550,000955,000,000250,0004,750,00010,000,000(5,250,000)

1005200,0009520,000,0001,000,00019,000,00010,000,0009,000,000)

1005500,0009550,000,0002,500,00047,500,00010,000,00037,500,000)

1005800,0009580,000,0004,000,00076,000,00010,000,00066,000,000)

10051,000,00095100,000,0005,000,00095,000,00010,000,00085,000,000)

10051,200,00095120,000,0006,000,000114,000,00010,000,000104,000,000)

10051,500,00095150,000,0007,500,000142,500,00010,000,000132,500,000)

10052,000,00095200,000,00010,000,000190,000,00010,000,000180,000,000)

10052,500,00095250,000,00012,500,000237,500,00010,000,000227,500,000)

Table 3.1Contribution Margin and Profits asa Function of Number of Units Sold


Cost based pricing

Cost-Based Pricing

A firm sets its prices by adding a markup to its costs or subtracting a markdown from the costs.

  • Markup over Cost

    • Return-on-Sales Markup

    • Return-on-Investment Markup

  • Contribution to Fixed Costs


Table 3 2 price and profits as a function of forecasted sales

Table 3.2Price and Profits as a Functionof Forecasted Sales


Table 3 3 investment based prices under different scenarios

Table 3.3Investment-Based PricesUnder Different Scenarios


Customer value based pricing 1 of 10

Customer Value-Based Pricing (1 of 10)

  • Price and Performance: Value-Based Fixed Pricing

    • The benefits (product characteristics) that customers value in the firm’s product.

    • The benefits from competitors’ products and their prices.

    • The firm’s pricing strategy.


Pricing to optimize revenues

Customer Value-Based Pricing (2 of 10)Figure 3.1Honda, Nissan, and Toyotain the U. S. Luxury-Car Market


Customer value based pricing 3 of 10

Customer Value-Based Pricing (3 of 10)

  • Customer Reservation-Price Pricing

    • The Appropriability Challenge

    • The Practicality Challenge

  • Segment Pricing

  • Quantity-Bought Pricing

  • Bundling

  • Two-Part-Tariff Pricing


Customer value based pricing 4 of 10 figure 3 a the appropriability challenge

Not all demand curves are linear and slope downward as in this example demand curves for luxury goods may slope upward since more people buy luxury items at higher prices.

Customer Value-Based Pricing (4 of 10)Figure 3.AThe Appropriability Challenge


Customer value based pricing 5 of 10 table 3 4 bundling example

*For simplicity, we assume that when products are sold separately, each customer will buy only the product that he or she values most; Good = 30,000,000 x $60, Excellent = 20,000,000 x $70.

Reservation Price

Type ofNo. ofGood +Firm’s

CustomerCustomersGoodExcellentExcellentBundle Price

Quantitative20 mil$20$70$90$85

Verbal30 mil$60$25$85$85

Revenues1.8 bil*1.4 bil*

Total Revenues3.2 bil4.25 bil

Customer Value-Based Pricing (5 of 10)Table 3.4Bundling Example


Customer value based pricing 6 of 10

Customer Value-Based Pricing (6 of 10)

  • Pricing Strategy

  • Price Cuts and Increases

    • Role of Price Elasticity of Demand

    • Competitors Reaction

    • Cost of Producing Extra Units


Customer value based pricing 7 of 10 figure 3 2 elastic market

Customer Value-Based Pricing (7 of 10)Figure 3.2Elastic Market


Customer value based pricing 8 of 10 figure 3 3 inelastic market

Customer Value-Based Pricing (8 of 10)Figure 3.3Inelastic Market


Customer value based pricing 9 of 10

Customer Value-Based Pricing (9 of 10)

  • Skimming

  • Penetration Pricing

  • Everyday Low Prices vs. Changing Prices

  • Pricing To Avoid Confrontation

  • Bundling and Two-Part-Tariff Pricing


Pricing to optimize revenues

Customer Value-Based Pricing (10 of 10)Table 3.5Market Share and Profitabilityfor Knowledge-Based Products

200220032004

MarketMarketMarket

ShareShareShare

Market(1000ProfitsMarket(1000ProfitsMarket(1000Profits

Shareunits)(millions)Shareunits)(millions)Shareunits)(millions)

Firm A050%0,500-$500080%8,000$1,060080%80,000$15,100

Firm B0500,500-402.50202,000-11002020,0003,400

Total1001,000-902.510010,000950100100,00018,500


Information technology and pricing back to the future

Information Technology and Pricing(Back to the Future)

  • Impact On Determining and Capturing Reservation Price

  • Impact On Pricing Schemes


Pricing to optimize revenues

Pricing to Optimize Revenues

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Questions


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