P2 Advanced Management Accounting

Module: 09

Pricing Strategies

1. Pricing

Think about the products you buy and how much they cost, if they cost more

would you still buy them? If they cost less would you think the quality wasn't

there? Now think about how a business would set its price, too high and no

one would buy it, too low and people may think it is not good quality or they

may not cover their costs well enough.

Deciding on the right price is a key decision any business needs to take. As

already covered elsewhere, it is crucial that the price covers all costs, and

knowing the marginal cost, full cost and relevant costs of a product or project

are key to ensure costs are covered and a profit made.

In the 2000s Pets.com did exactly that! In an effort to boost struggling sales

the company sold products for less than it cost to produce them. Sales did

not pick up quickly enough and the company went so long without profit that

even a multi-million-dollar investment from Amazon couldn't save them.

In addition to costs, there are a whole range of other issues when

finalising the price of a product that must also be taken into account. To

name a few, the price elasticity (how much demand will fall if we raise

prices), competitor prices, the image projected by a particular price,

marketing strategies (such as charging a low price to penetrate a new

market) as others too. It is these that are the key focus of this chapter.

Remember it is a combination of all these factors that will end up

determining the final price charged, and no one alone.

2. Price elasticity

Price elasticity of demand

Bob is running a doughnut stand at his local market. He charges $1 for each

of these and typically sells 200 a day. So – what’s going to happen to his

sales if he puts his prices up to, say $2?

Sales will drop of course, and if he doubles his price, probably by quite a lot.

The key question that Bob needs to know though is by how much will they

drop and what will the impact on his profitability be? After all, he’s also

making a lot more profit per doughnut, so it’s still quite possible that although

sales will drop that he high might actually increase his profits.

The extent of falling of demand when prices are increased (or increasing

demand when prices reduce) is known as the price elasticity of a

product.

Price elasticity is calculated using the following equation:

The price elasticity of a product can be either ‘elastic’ or ‘inelastic’;

An elastic product is one where the change in either demand or price

can have a significant effect on the other. If Bob increases his price from

$1 to $1.10 and as a result loses half his sales – then this is a very elastic

product. Perhaps he’s right next to another doughnut selling who sells very similar

doughnuts at $1 – well this situation is highly likely. A few loyal customers will

stay, but most will go next door.

An elastic product will usually have a PE % greater than 1 meaning that

a change in price will cause a disproportionately large change in

demand. This is often the case for luxury items that people can do without,

like wine or fancy biscuits.

An inelastic product is the opposite, with a PE % of less than 1. This

means that price will have little to no effect on demand. If putting his

price up to $2 resulted in Bob only losing 5% of sales, then his product would

be inelastic. Perhaps he’s the only seller of any kind of snack in the market, so

if the customer gets a little peckish and Bob’s their only choice, they will buy

from him anyway.

Inelastic products are often associated with essential daily items, such as milk

and bread or products which people find it hard to replace such as petrol.

Factors

Tap water. How much does it cost? Do you even think about it? Most of us

probably don't but just turn on the tap for a drink, wash, shower knowing that

whatever the current price is we'll just pay it! So, here we have a relatively

price inelastic product. I'm sure if price got too high we'd maybe seek out

alternatives, drink milk or maybe even bathe in it, but the rise would no

doubt have to be quite high before any significant effect on demand was

seen. Why is this? Well, there's a factor influencing the price elasticity of

demand going on here…

Looking at these in more detail:

Percentage of income spent on the good/service

If spending on the company’s good or service only represents a small

percentage of a consumer’s income, demand for such goods is likely to be

inelastic, e.g. salt and rice. If spending represents a high percentage of

consumer’s income, demand for such goods is likely to be elastic, e.g. cars

and holidays.

The availability of substitutes

OK what if Heinz decided to put the price of their tomato soup up by 50p.

They would probably see a significant fall in demand as consumers would

turn to other brands. Therefore as the number of substitutes for a

product or service increase, the price elasticity is likely to rise. If the

number of substitutes is low or the company has a monopoly of the market,

the price elasticity of that good is likely to be inelastic.

An example would be tap water, tap water generally comes from one

company and there is no substitute. You cannot wash your clothes or shower

in anything other than water!

Product status

Goods can be classified as necessities or luxury items. Demand for

necessities is likely to be relatively inelastic as consumers need the good

regardless of the price, e.g. medicine. Demand for luxuries is likely to be

relatively elastic as a large part of the demand is made of of “want” rather

than “need!” e.g. sports cars and holidays.

Time since price changed

If the price of the good has only just increased, consumers may be

unaware of the increase or cheaper alternatives. Therefore, the demand

is likely to be relatively inelastic (depending on the other factors) in the

short term. The more time that passes, the more likely consumers are to

realise the price increase and act on it by switching to a substitute good.

Therefore, demand will become more elastic as time passes since the price

change.

Brand loyalty

If consumers are very loyal to a particular brand, price increases are

likely to have a relatively low influence on demand. Therefore, demand is

likely to be relatively price inelastic, e.g. Apple's products, designer clothing.

If consumers do not have much or any brand loyalty for a particular product,

price increases are likely to have more of an effect on demand. Therefore,

demand is likely to be relatively price elastic, e.g. some food items although,

I'm sure we can all name some products which just have to be a certain

brand!

Competitor pricing

Competitors can match or exceed price changes or keep prices stable. If

competitors do not increase prices in light of a competitor increasing theirs,

the company raising its prices is likely to encounter elastic demand for its

goods at the higher price. A competitor may choose to match a price

reduction, which is likely to lead to relatively inelastic demand at the lower

price.

Habit

Some goods are habit-forming, such as tobacco and gambling products. These goods fall into a similar category as necessities as consumers

can become dependent on a product. Demand for habit-forming goods is

likely to be inelastic.

Summary

As you can see there are a lot of factors which influence the price elasticity of

demand. It is important for any company to understand the nature of their

product and which of these factors has a significant impact on their pricing. They may even test out the market at different prices in order to work out

the change in demand and help set a price which maximises profits.

Demand function graph

A demand function graph shows the relationship between price and sales.

it will often be downwards sloping (as more units are sold as the price falls)

and the extent of the slope (the gradient) will depend on the elasticity of the

product. With the price along the Y axis and the demand along the X it looks

like this:

The price for a particular level of demand (units sold) can be calculated using

the following formula:

P = A - BX

P = Price

X = Demand (number of units that will sell at that price)

The price for a particular level of demand (units sold) can be calculated using

the following formula:

P = A - BX

P = Price

X = Demand (number of units that will sell at that price)

A = Maximum price (i.e. the lowest price you could charge and not sell any

units. This is where the demand line cuts the price axis).

B = Line gradient = Change in price

Change in quantity

So for instance if the maximum price was £100, and B = 0.5 and we wanted to

know what price to charge to sell 50 units, perhaps because that was the most

we could make, we would use:

P = 100 – 50×0.5 = £75

135

3. Pricing for maximum profitability

Profit maximisation

So returning to our previous example, Bob’s challenge is to understand exactly what price he should be selling his product for. However, wouldn't it

be good if he could work out the absolute perfect price to sell at to

maximise his profits? After all it’s no good him getting an enormous margin

on his doughnuts if he barely sells any – nor is there any value in selling

millions if he is not making money from them!

This section outlines the approach to calculating that ‘maximum profit’ point.

To start with, we need to understand two key terms, marginal revenue and

marginal costs.

Marginal revenue = calculates how much sales revenue will go up/down

from selling one more unit.

Let’s say Bob’s friend at the market, Chris sells coats, and typically each

month he sells 100 coats at $100 each. His total revenue is $10,000.

However, in order to sell one more coat, he has to reduce his prices to

$99.50. His revenue now is 101 coats x $99.50 = $10,050. The increase in

revenue is $50 – that is Chris’ marginal revenue.

Marginal cost = the increase to total costs of buying/making one more

unit.

So, Chris pays $45 each for the coats he buys. His total cost for 100 coats is

therefore $4,500, and 101 is $4,545, and so his marginal cost is $45.

So now we can ask the question – is it worth Chris putting his price down to

$99.50? Well yes – he has an increase in revenue (marginal revenue = $50)

greater than his increase in costs (marginal costs = $45). He’s $5 up!

Let’s see if it’s worth him selling 102 coats! To sell 102 he needs to reduce his

prices a little more to $98.75. So now marginal revenue = 102 x $98.75

($10,073) - $10,050 = $23 while marginal cost stays at $45 again. So that

102nd coat is not worth buying.

Chris should therefore sell 101 coats to maximise his profits.

So – notice what we were doing here. We were increasing sales by one unit and then comparing marginal revenue and marginal cost. MR was higher

than MC for a while and then reached (and in this case went beyond) the

point where MR = MC at which point it wasn’t worthwhile increasing

sales.

As a general rule then you must learn that:

The optimum price is reached when we get to the point where marginal

cost and marginal revenue is equal (MR = MC).

There are two primary methods for applying the MR = MC rule for profit

maximisation. Let’s look at each.

Method 1: Algebraic method

We’ll use an example to demonstrate this method.

Example

Company Z sells its product at £20 and sells 20,000 units, recent market

research has shown that a £1 change to the price changes the amount of

units sold by 1,800. The product has variable costs of £7 per unit, the

marginal revenue of the product in this case is MR = A – 2BX where:

X = Demand (at a particular price)

A = Maximum price (the lowest price at which no units are sold)

B = Line gradient =

Change in price

Change in quantity

Company Z has asked for your help to:

1) Calculate the demand function

2) Find the output level that will maximise profit

3) Calculate the optimum price to maximise profit

Question 1

First up we need to use the demand function we saw earlier, which we know is

P = A – BX. We have the price (P) and the demand (X) but we still need to

work out A and B;

B = Line gradient =

Change in price

Change in quantity

From the question, if Z changes the price by £1 the change in units sold is

1,800, so:

1 B =

1,800

B = 0.00055

We can now re-arrange the formula to work out A: P

= A – BX

Company Z sells its product at £20 and sells 20,000 units so:

20 = A – (0.00055 x 20,000)

20 = A – 11

A = 31

So the correct demand function for the above information is:

P = 31 – 0.00055X

Question 2

Now, we know that the optimum profit is calculated at the point that marginal

revenue and marginal cost are the same: MR = MC

We also know that the marginal costs are £7 and that the marginal revenue

formula is MR = A – 2BX.

As MR = MC at the point of profit maximisation, we can re-write this formula

to give us: MC = A - 2BX. Then we substitute in the numbers we know.

7 = 31 – 2×0.0005X

24 = 0.001X

X = 24,000 units

So the demand level where Z will get maximum profit is 24,000 units.

Question 3

To work out the optimum price we use the demand function formula: P = A –

BX

We know the maximum price A is £31 and the gradient B is 0.00055 and the

optimum level of production is 24,000 units. We put these figures into the demand

function and that will give us the price:

P = 31 – (0.00055 × 24,000)

P = 31 – 13.2

P = £17.80

As you can see the optimum price is actually lower than the current price of

£20 and so Company Z will actually need to take £2.20 off of their selling price

in order to maximise profits.

Tabular method of profit maximisation

Alternatively the tabular method can be employed this involves a bit of trial and error. You have to work out the revenue and profit at a variety of

output levels until you find the one where profit is maximised.

Example

The following table shows a tabular function, as you can see the units are

increasing in a perfectly linear fashion increasing by 10 every time, the total

cost is increasing but by less each time (probably due to economies of scale

such as bulk purchasing), and sales prices are decreasing by £2 for every ten

additional units:

Output Cost total Selling price per unit Revenue total Profit

10 15 20

20 25 18

30 40 16

40 60 14

50 85 12

60 115 10

70 150 8

80 190 6

90 235 4

100 285 2

Now we have our base units we can calculate the missing figures which

should reveal the optimum production level:

Output Cost total Selling price per unit Revenue total Profit

10 15 20 200 185

20 25 18 360 235

30 40 16 480 440

40 60 14 560 500

50 85 12 600 515

60 115 10 600 485

70 150 8 560 410

80 190 6 480 290

90 235 4 260 25

100 285 2 200 (85)

As you can see, profit is at its highest when 50 units are produced; this is

the optimum production volume.

4. Maximum revenue

Let's return to the example Chris our coat-seller from the previous section.

Perhaps, rather than maximising profits, Chris is interested in maximising his

revenues in the short term to build a loyal following of customers. In this case

profit maximisation is not suitable and a different approach must be used. We

calculated earlier that Chris should stop at 101 units to maximise profits, but

also noted that when he makes 102 units his marginal revenue was positive

at $23. i.e. he is making £23 more revenue selling 102 units than selling 101

units.

To maximise revenues Chris should continue selling more products until

the point where marginal revenue is equal to or falls below zero (MR=0).

Let’s say that to sell 103 coats Chris has to reduce his prices to $97.50. His

revenues are then 103 x $97.50= $10,043. So total revenue is down on 102

coats which was $10,073, so his marginal revenue is -$30. To maximise

revenues then he should make 102 coats (where the marginal revenue was

still positive).

Example

Here’s the same example that we had in the algebraic method for profit

maximisation. We'll now apply it to revenue maximisation.

Company Z sells its product at £20 and sells 20,000 units, recent market

research has shown that a £1 change to the price changes the amount of

units sold by 1,800. The product has variable costs of £7 per unit, the

marginal revenue of the product in this case is MR = A – 2BX where:

X = Demand (at a particular price)

A = Maximum price (the lowest price at which no units are sold) = £31

B = Line gradient = Change in price

Change in quantity

This time the requirement is slightly different though as Company Z has asked

for your help to calculate the price that maximises revenue.

Solution

To maximise revenue the company’s marginal revenue must be equal to

zero. We know the formula for MR in this instance is MR = A – 2BX which we

can write as 0 = A – 2BX, we can then substitute the A and B values into the

equation! From the earlier calculation for profit maximisation we have

already worked out that A = £31 and B = 0.0005. Let’s substitute those in

here:

0 = 31 – 2×0.0005X

We can rearrange to get:

X = 31,000 units

We can then use this and the demand function to work out the price which

maximises revenue.

P = A – BX

P = 31 – (0.00055 × 31,000)

P = 31 – 17.05

P = £13.95

5. Product life cycle

What is the product life cycle?

Just as humans might go through different stages in their life (babies,

children, teenagers, single, married, old and then ghosts), as products are

developed, taken to market and sold, they are seen to go through discreet

stages too. Different strategies are appropriate in each of these stages.

After a period of development a product is introduced into the market. If

the product meets customer needs, consumers recognise this, new

customers are gained and revenues grow.

Eventually the market reaches saturation and the product becomes

mature and revenues level off. After a period of time the product is

overtaken by development and the introduction of superior products, so the

sales of this product go into decline and it is eventually withdrawn.

Pricing strategies for different stages of the product life cycle

At each stage of the product life-cycle different pricing strategies are

typically recommended. Let's review each stage and see how companies

should typically price at each stage.

Development

The time between development and launching the product should be as

short as possible so it can establish its place in the market. Competitors will

attempt to launch their own products if it the market appears to be growing,

so it is essential to be able to launch quickly without wasting time. There are no pricing strategies here as it is yet to launch.

Introduction – Price skimming

In the introduction stage significant costs are incurred in continued product

development and marketing, and sales volumes are often low. As such a price skimming strategy is often followed, where a high price is

charged to attract the early adopters who often purchase new products

or people who have a highly specific need that they are willing to pay more

for.

Growth – Market penetration

As the product’s sales rise, competitors are attracted into the market with

similar offerings. As a result the typical strategy followed here is market

penetration, where prices are lowered and marketing increased. The aim

is to win market share and become one of the leading players in the market.

Often at the end of the growth stage there is the ‘shake out’. This is

where the least successful entrants pull out of the market due to a lack of

profitability or are purchased by the larger competitors in their aim to

increase their market share. A market penetration policy throughout the

growth stage helps to avoid the organisation being one of the losers during

the shake out.

Maturity – Consolidation strategy

With fewer competitors in the market after the shake out, the remaining

competitors must continue to consolidate their position. They may do this

through differentiated products so they occupy a unique position in the

market, develop strong brands that are well known and trusted and continue

to attract customers. Prices are set at levels which are competitive but

profitable. The lower production costs at this stage, due to the economies of

scale caused by high volumes, ensure the firm remains profitable in this

stage.

Decline – Niche, Harvest or Divest

As sales start to decline a range of possible strategies are possible:

Divest – Pull out of the market if it is not profitable, or sell out to someone willing

to continue the business at lower margins. No pricing strategy here.

Harvest – Keep costs low, and continue to sell at a low, but profitable

price, making profits for as long as sales continue.

Niche – Develop the product for a specific market segment who continue to

have a need and sell at a higher price.

Limitations of the product life cycle

In reality very few products follow a predictable cycle. The length of each

stage varies enormously and stages can be affected by decisions made, so

for example the maturity phase can be lengthened by price-cutting.

In some cases product stages can be skipped. Many products fail in the

introduction phase (e.g. mini disc players) so do not complete the full cycle,

while others (e.g. bread) may have very long maturity phases and never go

into decline. Where there is a known immediate demand (e.g. iPad) the

introduction stage is almost completely missed, and the product goes

straight into the growth phase.

Maximising profits over a product’s life cycle

There are many ways to maximise the profit over the course of the product

life; here are a few key examples:

Considering costs during the design phase – The average product can

incur over 80% of its costs at the design and introduction stage, whether it

be initial costs or decisions made at that stage that commit production to those

costs from then on.

For example, a car being designed to be made in an old factory that is much

less efficient than a newer one, thus committing to larger production costs

from there on in. The costs of a new factory may be high, but are they

outweighed in the long term by ongoing cheaper production costs?

Planning on using higher quality components in a car in the development

stage may help reduce warranty claims longer term.

Reducing time to market – Getting a product to market is of vital

importance. Competitors will always look at what a company is doing and

will try to copy any innovation and so a quick release is vital in establishing

market share and if no market share is generated then the product will die out.

A McKinsey study actually showed that a late release is far more damaging

to a products profitability than going over budget in the development stage.

Extend the length of the cycle itself – Extending the length of a product’s

life is about increasing the amount of time it spends in the market as the

longer it is the longer it can generate revenue. The cost of a redesign will

be relatively low compared to a full new product design, and as such it is it is

the more profitable strategy for the business long term, taking into account

the full life cycle costs than a product new product design and launch.

For the car manufacturer, once sales growth has tailed off, the car

manufacturer may be able to extend the product’s life and potentially

increase revenues by resigning the body work or adding a few additional

features.

In the UK in 2012 EDF announced it would spend around £600m a year to

keep open two of its nuclear power stations for a further 7 years. Despite

these significant ongoing costs the upgrade and maintenance maximises the

use of these assets and makes sense given their huge building and

decommissioning costs.

6. Life-cycle costing

Costs through the life-cycle

Let's examine how costs change as products go through their life-cycle:

Stage Sales Volume Costs e.g. car manufacturing

Development

None

Research and Development e.g. salaries of

the design staff, prototype manufacturing

costs

Introduction

Very low levels

High fixed costs e.g. buying machinery to

build the cars (non current assets), some

factory overheads, some labour costs

Growth

Rapid increase

More variable costs as production levels

increase e.g. more direct labour costs,

indirect labour costs, increase in fixed

costs as new factories are built

Maturity High and stable Stable costs – no significant change.

Decline

Falling demand

Decreasing variable costs and possible

fixed costs due to decommissioning of the

factories

In life cycle costing, the forecast profitability is determined for the

lifetime of a product. By taking into account all of the costs involved in each

stage of the life cycle, accurate resource allocation can be put into place.

The majority of a products costs often happen at the development stage and

any plans put in place (e.g. to use a particular component or technique in

production) will have knock on effects on the future stages. Therefore life

cycle costing requires teams to communicate effectively across the

various departments who will be involved.

Life-cycle costing may also highlight hidden costs. So for example the costs of

decommissioning a nuclear power station, which may be ignored in the

development stage, but which are actually be so expensive that it makes the

whole project not viable.

Decision making and pricing

The full life cycle costs of a product can be taken into account in the

pricing decision rather than simply the costs for the current period. If the

sales of the product are less than all of the costs involved in a products life

time, then then amendments would need to be made to the original plan until

the product shows profitability.

In the case of the nuclear power station, the prices agreed in the original

contract (often agreed with governments prior to the building of the power

station) would need to be high enough to cover the decommissioning costs

even though they are many years in the future.

Calculating profitability using life-cycle costing

Supercarz Ltd recently spent £10m on the development of a new electric

vehicle called the Wizz. It is expected to have a life-cycle of 5 years and sell a

total of 24,700 units. Using the following information, we can calculate the

total expected profitability and full life-cycle cost for the product.

Sales volume

Development Intro Growth Maturity Decline Total

(units)

Sales price

(£ per unit)

0 2,000

50,000

4,500

45,000

15,000

40,000

5,000

35,000

26,500

Revenue

£m £m

100

£m

202.5

£m

600

£m

175

£m

1,077.5

Variable cost (10) (20) (70) (25) (125)

Overheads (95) (120) (200) (50) (465)

Development cost (100) 0 0 0 0 (100)

Profit/(Loss) (100) 5 62.5 330 100 387.5

So we can see that over the full life-cycle, the Wizz should is expected to

make a profit of £387.5m. We can calculate the life-cycle cost of the product

with the following formula:

Total costs of product over entire life cycle Lifecycle cost of product =

Total number of units of product

Therefore, the lifecycle cost of 1 Wizz is:

125m + 465m + 100m

Lifecycle cost of 1 Wizz = 26,500

= £26,037.73 per unit

Customer life cycle

Life cycle analysis can also be used to assess the profitability of a customer or

a customer group. This may involve large costs upfront to get a new

customer but once a customer is on board they are more likely to stay with the

company longer term and the company’s profitability will grow. This follows the old saying that it is ‘twenty times more expensive to get a new

customer than keep an old one’.

An example of this would be in a restaurant - it may take a lot of marketing

before a customer tries out the restaurant, but once they have (and if they like

it) they will come back again and again without being prompted to. A

‘customer’s life cycle’ could effectively be increased by continually

ensuring customers’ needs are met – through continually updating the

restaurant and its menu for example.

This is particularly relevant for large contracts – a 5 year IT outsourcing

contract for example. The tendering and set up costs are likely to be very

high in the short term, but the revenues and costs must be viewed over the

whole 5 year project to assess full profitability. If that contract can then be

extended after that point, the contract then becomes even more profitable as

the tendering and set up costs incurred right at the start are being spread over

a longer period.

7. Pricing strategies

There are a range of other pricing strategies which we must also consider,

often for marketing or strategic purposes. These can include:

Premium pricing

This is the use of a high price where the product is unique and a

substantial competitive advantage exists (e.g. the high price of a BMW).

Premium pricing can also effect the perception of s product/brand in the

eyes of the consumer; the high price of the BMW suggests “quality” and

being “prestigious”.

Market skimming

Market skimming often occurs when a product is new and very

innovative with a certain market who will buy the product regardless of

the price you put on it. An example of this would be the latest television

technology (e.g. super high definition TVs).

A vast majority of people would not be interested enough in the new

technology to pay the high price BUT the real “tech heads” will still be willing

to pay it. Therefore you ‘skim’ for the “cream off the top of the milk” to

take advantage of these consumers. Once the cream market has dried up

you then reduce the prices to make the product accessible to the rest of the market. Often market skimming is undertaken at the introduction stage of

the product life-cycle.

Market skimming is also a strategy for products that are never going to be reduced in price and are aimed at a very niche market. An example of this

would be cat walk high fashion; clothes that no one but the rich and/or

famous would ever be able to buy, greatly reducing the market but a huge

profit is made on every item sold to compensate.

Premium pricing (above) is similar to market skimming. The key difference is

that premium pricing whilst costly will often be aimed at a broad market

whereas market skimming will be aimed at a very niche one. For example,

take a Ferrari and a BMW, both are high quality and renowned cars, but a

BMW is marketed to the general market and a Ferrari only to the super rich.

Penetration pricing

A low price is set in order to gain market share. Once this is achieved,

the price is increased. This is often implemented when a relatively new

product is released (often the growth stage of the product life-cycle) to tempt

people to take a chance on the product and the brand, then once they have

realised how good the product is they will stay with that brand in the future.

Economy pricing

Charging a low price for a no frills service. Such as UK airline service

ryaniar; they offer a very cheap price but offer none of the comforts of more

expensive airlines. Volume of sales is key, making only a small profit on each

sale.

Cost Plus pricing

Price at the cost plus a percentage mark-up. This ensures that costs are

covered on all products sold and so they are sold profitably. If the product

costs £10 and the pricing strategy is cost + 20%, the price is £12.

Psychological pricing

Taking into account the way the customer thinks as they purchase.

e.g. charging £99 rather than £100 makes the price seem substantially

cheaper when the reality is that it is only £1 less!

Product line pricing

A range of products or services where the price reflects the benefits

gained (e.g. Club membership - 5-day, 7 day, daytime, weekends). The

greater the benefit, the higher the price – here 7 days being the most

expensive of these options.

Optional product pricing

Optional extras sold alongside the main product to increase revenues and

profitability. (e.g. cars with optional upgrades to a better music system or a faster

engine).

Captive product pricing

Where a captive market exists once an initial purchase is made (e.g.

computer games after computer games consoles have been purchased).

Often the aim is to sell the basic product (e.g. the console) at a low price in

order to profit longer term (e.g. from the sales of the games).

Product bundle pricing

Combining a number of products in the same package. Returning to the

above example, a games console may be sold in a package deal with an

extra controller and a few games.

This can then be marketed in relation to the money saved compared with

buying each item separately. Consumers then feel that they are saving

money even though many may not have even bought one of the

games/controllers if they had to buy them separately.

Promotional pricing

Pricing to promote a product. e.g. Low price to introduce new customers,

reverting to a higher price longer term. This is often use for interest rates on

loans, mortgages and credit cards.

Dual pricing

Different prices for the same product to different markets

One example could be different prices in different countries. There must

always be a barrier between the markets stopping the purchaser simply

buying from the lower cost location. In this example; costs and time to go to

different locations or additional shipping costs or import taxes.

Another example is peak and off-peak train fares. It’s exactly the same

product, but a significantly different price based on the time of the day. The

barrier is for people going to work who are forced to travel at the peak time.

Predatory pricing

When a company deliberately charges a price so low that it knows

competitors will not be able to match/beat without suffering a loss. The

aim is to drive competitors out of business, with the aim of raising prices

higher again after the competitive battle is won.

Loss leader

A loss leader is a product sold so cheaply they lose money on the

product. This may sound like a poor strategy but is often used to establish a

market share which can then be leveraged against other products the

company produces or to ultimately benefit from complimentary purchases

induced by the loss leader. For example, games consoles are often sold at a

low price as producers then make money via the sales of games. Google

provide their android operating system for free, but make money via the sale

of apps.

Product differentiation

Varieties of the same product so that it can be sold to a much larger

market, an example of this may be a teddy bear. You have the base bear

but then simply put different clothes/colours on it and suddenly you have more

markets in which to sell it; blue for baby boys, pink for baby girls, corporate

clothing for businesses etc.