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Chapter 12 Price Determination and Pricing Strategies. Professor Jason C. H. Chen, Ph.D. School of Business Administration Gonzaga University Spokane, WA 99223 After studying this chapter, you should be able to:.

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chapter 12 price determination and pricing strategies

Chapter 12Price Determination and Pricing Strategies

Professor Jason C. H. Chen, Ph.D.

School of Business Administration

Gonzaga University

Spokane, WA 99223

after studying this chapter you should be able to
After studying this chapter, you should be able to:
  • Discuss relationships among price, demand, demand elasticity, and revenue.
  • Understand methods for determining price.
  • Recognize different pricing strategies and the conditions that best the choice of a strategy.
  • Recognize the importance of adapting prices under shifting economic and competitive situations.
  • Understand the ethical considerations involved in setting and communicating prices.
opening vignette


  • What are the ingredients for eBay’s success?
  • How are prices determined for merchandise sold on eBay?
  • On eBay, buyer and seller are separated by hundreds or even thousands of miles, never see each other, and cannot show more than a picture of the item for sale. How is it possible to build relationships under these conditions?
  • How has eBay been able to offer their customers protection against fraud and bad transactions?
  • What features has the company incorporated into its Web site and how has it used the Internet to attract its target market?

Price Determination: An Overview

Exhibit 12-1

The price-setting decision process

Set strategic

pricing objectives


Estimate demand & price

Elasticity of demand


Determine costs & their

Relationship to

Volume & profits


Influences & constraints

Marketing strategies

Target market characteristics

Product characteristics

Competitor characteristics

Company strengths & weaknesses

Environmental influences

Economic trends

Legal restrictions

Evaluate competitors’

Price & costs


Select a method for

calculating price


Adopt a pricing strategy

& set a price level


Adapt price structure to

meet variations in

demand & costs across

geographic territories

or market segments









Demand Curves

price elasticity of demand
% Change in quantity demanded

Price Elasticity of Demand =

% Change in price

Elastic Demand

Inelastic Demand

Cross Elasticity of Demand

Price Elasticity of Demand
costs volume and profits
Costs, Volume, and Profits
  • Fixed Costs (FC)
  • Variable Costs (VC)
  • Total Costs (TC)
  • Marginal Cost MC)
  • Marginal Revenue (MR)
  • Total Revenue (TR)

TC = (VC X Q) + FC

Total Revenue = Price X Quantity

Profits = TR - TC

  • Dollar amount added to the cost of the products to get the selling price
  • Markup percent is the percentage of selling price that is added to the cost to get the selling price
    • percent of selling price unless otherwise noted
  • Products may be marked up several times through the channel
    • the sequence of markups is the markup chain
  • High markups don't always mean high profits
    • depends on the stockturn rate
price determination methods
Price Determination Methods
  • Markup Pricing

Price = Unit Cost + Markup


Price = Unit Cost/(1-k)*

*k = desired % markup

average cost pricing
Average-Cost Pricing
  • Adds a "reasonable" markup to the average cost of a product
  • Simplifies pricing
  • Quite common, especially among middlemen
  • Usually based on estimates or past records
    • actual average cost depends on quantity sold!
    • quantity sold depends on price

Typical Shape of Cost (per unit) Curves when Average Variable Cost per Unit Is Constant

experience curve pricing
Experience Curve Pricing
  • A type of average-cost pricing using an estimate of future average costs
  • Often leads to low prices if future economies of scale are expected
    • costs may drop with accumulated production experience
  • Can be very risky if costs do not drop, or if expected volume is not achieved

Summary of Relationships among Quantity, Cost, Price andUsing Cost-Oriented Pricing

Estimated quantity

to be sold


Quantity demanded

at selling price

Average fixed

cost per unit

Variable cost

per unit

Cost-oriented selling

price per unit

Average total

cost per unit

Profit per


break even analysis
Break-Even Analysis
  • Used to evaluate whether the firm will be able to cover costs (break even) at a particular price
  • Indicates the break-even point—sales (units or dollars) needed to break even
  • Can be modified to incorporate a target return
  • Problems:
    • assumes any quantity can be sold at a given price
    • total cost curve is assumed to be a straight line
price determination methods1
Price Determination Methods

Break-Even Analysis


Total Revenue


Total Cost

Fixed Cost



Quantity (units)

price determination methods2
Price Determination Methods
  • Target-Return Pricing

(Desired return X Invested capital)

Price = Unit Cost +

Expected Unit Sales


price determination methods3
Price Determination Methods
  • Target-Cost Pricing
    • Define market segments for new product.
    • Product is designed based on competitive advantages and disadvantages.
    • Position product in context of overall company strategy.
    • Fine-tune product based on customer’s preferences, perceived value and willingness to pay.
    • Estimate various price-responsiveness with simulations.
    • Estimate target costs between optimal price and desired margin.
price determination methods4
Price Determination Methods
  • Income-Based Pricing
    • Real Estate
    • Marketable Securities
    • Businesses

Prices and Customer Value

Exhibit 12-6

Flow chart of BDM procedure


Initial price offer

Possibility to revise initial price offer

Final price offer (s)

Random determination of buying price (p)

Buying price ≦Final price offer

Buying price >Final price offer

Buying obligation

No buying opportunity

value in use pricing
Value in Use Pricing
  • Sets prices that will capture some of what customers will save by substituting the firm's product for the one the customer is currently using
  • Example: A construction firm that buys a new, more efficient bulldozer at a higher price might still save money on:
    • labor (operator) expenses
    • "down-time" for repairs
    • fuel consumption
    • maintenance costs
pricing strategies
Pricing Strategies

Differential Pricing

Second-market discounting

Periodic discounting

Product Line Pricing


Premium pricing

Partitional pricing

Competitive Pricing

Penetration pricing

Price signaling

Going-rate pricing

Psychological Pricing

Odd-even pricing

Customary pricing

One-sided claims

b2b pricing strategies
New Product Pricing

Price Skimming

Penetration Pricing

Experience Curve Pricing

Competitive Pricing

Leader Pricing

Parity Pricing

Low-Price Supplier

Price Line Pricing

Complementary Product Pricing

Price Bundling

Customer Value Pricing

Cost-based Pricing

Cost-plus Pricing

B2B Pricing Strategies

StrategyDescription Related Strategies

New Product Pricing Situation

Premium pricing, Value-in-

Use pricing.

Learning Curve pricing.

We set the initial price high and then systematically reduce it

over time .Customers expect prices to eventually fall.

We initially set the price low to accelerate product adoption.

We set the price low to build volume and reduce costs through

accumulated experience.

Price Skimming

Penetration Pricing

Experience Curve Pricing

Competitive Pricing Situation

Umbrella Pricing, Cooperative

Pricing, Signaling.

Neutral Pricing, Follower


Parallel Pricing, Adaptive

Pricing, Opportunistic


Leader Pricing

Parity Pricing

Low-Price Supplier

We initiate a price change and expect the other firms to follow.

We match the price set by the overall market or the price


We always strive to have the low price in the market.

Product Line Pricing Situation

We price the core product low when complementary items

such as accessories, supplies, spare parts, services, etc.

can be priced with a higher premium.

We offer this product as part of a bundle of several products,

usually at a total price that gives our customers an attractive

savings over the sum of individual prices.

We price one version of our product at very competitive levels,

offering fewer features than are available on other version.

Complementary Product Pricing

Price Bundling

Customer Value Pricing

Razor-and-Blade Pricing

System Pricing

Economy Pricing

Cost-based Pricing Situation

Contribution pricing, Rate-

of-Return Pricing, Target

Return Pricing,

Contingency Pricing,

Markup Pricing

We establish the price of the product at a point that gives us a

specified percentage profit margin over our costs.

Cost-Plus pricing

Industrial (B2B) pricing strategies

Exhibit 12-9

adapting prices decreases and increases
Price Reduction Traps:

Low-quality trap

Fragile market share trap

Shallow pockets trap

Acceptable Price Range:

Prices the buyer is willing to pay.

Adapting Prices: Decreases and Increases
adapting prices reacting to competitive price changes
Adapting Prices: Reacting to Competitive Price Changes
  • Temporary retail price reductions substantially increase store traffic and sales.
  • Large-market-share brands are hurt less by price changes from smaller competitors.
  • Frequent price dealing lowers consumers’ reference prices, which may hurt brand equity.
  • Price changes for high-quality brands affect weaker brands and private-label brands disproportionately.
adapting prices price discounts and allowances
Adapting Prices: Price Discounts and Allowances
  • Cash Discounts
  • Trade Sales Promotion Allowances
  • Quantity Discounts
adapting prices geographical pricing
Adapting Prices: Geographical Pricing

FOB Origin Pricing

Uniform Delivered


Zone Pricing

Freight Absorption


competitive bidding and negotiated pricing
Competitive Bidding and Negotiated Pricing
  • Sealed-bid Pricing
  • Reverse Auctions
pricing services
Pricing Services

Price is influenced by the

nature of the service involved.

The larger the market share,

the higher the price that

can be charged.

Managing off-peak demand

makes pricing services difficult.

Bundling services into a single

package and price is a

common strategy.


B2B e-Procurement Processes

Seller/Supplier e-Marketplaces Buyer/Wholesale


Trading Platform




Trading Platform


B2B e-Procurement Process System

  • Order mgt.
  • Finance mgt.
  • Shipping mgt.
  • Customer mgt.
  • e-catalogue
  • inquiry/
  • negotiation
  • quick ordering
  • account mgt.

供應鏈Supply Chain

e-procurement process system

需求鏈Demand Chain

Material Flow

Information Flow

Money Flow


General Purchasing Process

Forecast Demand

Supplier / Seller


Request for Proposal/Quote (RFP/RFQ)


Negotiate Contract

Place Orders

Process Orders

Shipping Orders

Receiving Orders



Vender Performance Tracking & Management

Customer Service


Group Purchasing Organization Process



Forecast Demand














(Price OK)

Negotiate Contract


Place Orders


Process Orders


Shipping Orders


Receiving Orders

. . .











Shipping / Receiving Orders




Refund Process

Shipping / Receiving Orders










Refund Process

VPTM : Vender Performance Tracking & Management

ftc pricing guidelines
FTC Pricing Guidelines
  • Comparisons with former prices.
  • Comparisons with other retailer prices.
  • Comparisons with prices suggested by manufacturers or other non-retail distributors.
deceptive pricing practices
Deceptive Pricing Practices
  • Bait and Switch
  • Predatory Pricing
  • Unit Pricing
demand oriented pricing approaches
Demand-Oriented Pricing Approaches
  • Evaluating a Customer’s Price Sensitivity
  • Value-in-use pricing
  • Auctions
    • including online
  • Reference prices
  • Leader pricing
  • Bait pricing
  • Psychological pricing
    • odd-even pricing
    • price lining
  • Demand-backward pricing
  • Prestige pricing
  • Full-line pricing
    • complementary pricing
    • bundle pricing
evaluating a customer s price sensitivity
Evaluating a Customer’s Price Sensitivity
  • Are there substitute ways of meeting a need?
  • Is it easy to compare prices?
  • Who pays the bill?
  • How great is the total expenditure?
  • How significant is the end benefit?
  • Is there already a sunk investment related to the purchase?

How Customers Reference Price Influences Perceived Value (for a marketing mix with a given set of benefitsand costs)

marginal revenue and price
Marginal Revenue and Price

© 2002 McGraw-Hill Companies, Inc., McGraw-Hill/Irwin—for use only with Basic Marketing

Finding the Most Profitable (or least profitable) Price and Quantity in Pure Competition (in the short run)