Price calculation

Question 1

Price calculation Def

Accepted Answer

Finding “price points” (numerical value expressed in a specific currency)Price calculation becomes necessary in different situations When the seller wants to or needs toprovide an information to potentialbuyers concerning the price at whichhe would be willing to sell--> Can be fix or the starting point for anegotiation process When the buyer communicates pricesat which he would be willing to buy--> Price calculation leads to aninformation about- the minimum price required in orderto achieve an intended level ofprofitability (break even + margin)- the level of profitability achieved atprices above the minimum price(break even + margin)

Question 2

Finding “price points”

Accepted Answer

• Basic pricing decisions concern the pricing for every individualoffering (product or service)• In many cases, companies publish price lists (printed lists,catalogues, online price lists etc.) containing a standard price forevery single item they offer to customers or shelf prices• Many companies need to set thousands of product or service prices(for basic products, for additional equipment, for added services etc.)• On markets where companies do not sell directly to their finalcustomers, they also need to determine the price point they want theirproducts to be sold at by intermediaries, i.e. the store price.• The difference between the final store price point and the price atwhich the intermediary purchases the product is referred to asdistributor margin.• The distributor margin comprises • an amount allowing the intermediary to cover his own costs and • the intermediary‘s profit.

Question 3

possible anchor points for Finding “price points”

Accepted Answer

• Own costs plus margin (mark-up pricing)• Customers’ willingness-to-pay (target pricing)• Competitor prices (e.g. market leader, most relevant competitor)• Historic prices (prices the firm used to charge in the past plus mark-up)• Etc.

Question 4

Example: Mark-up price calculation (cost-plus)

Accepted Answer

1 Costs for input resources 2 Production costs3 Wages4 Administrative costs5 Marketing costs6 Service / recycling costs Ci =total costs C forproducing andselling product i pi = Ci x (1 + r / 100)where:• p is the price for product i• and r is the mark-up the firm expects (e.g. 30%)e.g.: 130 = 100 x (1 + 30/100)

Question 5

Advantages and disadvantages of simple mark-up (cost-plus) calculation

Accepted Answer

Advantages• Easy to handle• Low information requirements• May prevent price competitionon markets• “Moral legitimacy” (???) Disadvantages• Passive approach to pricing• Doesn‘t take into account thatdemand is a function of price (risk ofdownward spiral)• The way how costs are calculatedand attributed to individual productsor customers has a strong influenceon the price that is calculated

Question 6

The target pricing process

Accepted Answer

[Value proposition and willingness to pay] [Cost Structure] Development of new product concept ->Market research on potential customer's wtp ->Target Price -->Product Design = value engineering & ->Profit margin <------------------------------>Target cost->Production=process improvements -> Market launch

Question 7

The target pricing process: Attaining target costs

Accepted Answer

Value enginering:• Reduction of product costs through theanalysis of the value that customersperceive in the different dimensions /functions / features of the product• Value engineering requires customerorientation and will often involve marketresearch in order to identify value-addingfeatures and non-value adding features.• In order to reduce costs and meet thetarget cost / target price, non-valueadding features are eliminated unlessthe product can‘t be used without them.

Question 8

Value-Added Costs

Accepted Answer

A value-added cost is a cost that customers perceive as adding value, or utility, to a product or service. Wifi accessIroning servicesPrinter servicesMini bar A non value-added cost is a cost that customers do not perceive as adding value, or utility, to a product or service. Large flower bouquet in the roomOrganised bycicle toursMeditation sessions Example: Hotel servicesfor business travellers

Question 9

Cost-plus pricing vs. target pricing

Accepted Answer

• Both methods have to consider customer, competitor, and cost• The difference lies in the starting point• Target pricing reduces the need to go back and forth among prospectivecost-plus prices, customer reactions, and design modifications• It depends on market structure

Question 10

Differential pricing - Basics of DP

Accepted Answer

In case of differential pricing§ goods / services of the same or avery similar nature§ are sold side by side§ at the same time§ to different customer(group)s§ at different prices. Contribution margin =price per unit – variable costs per unit =contribution to cover fixed costs andgenerate a profit The potential contribution margin (CM) is similar to a triangle "Passed-up profit“Customers WTP is smaller than current price "Money Left on the Table“:Customers pay less than their WTP With a uniform price, the CM is a rectangle,the unused profit potential is the rest of the triangle check skript ob dus checkst

Question 11

Differential pricing - Managerial aspects of DP (Drivers and Barriers)

Accepted Answer

Drivers: -Differences in value perceptions-Inflexible capacities-Fierce competition-Markets can be isolated Barriers: -Importance of price fairness-Costs of differential pricing-Legal restrictions

Question 12

Forms of differential pricing

Accepted Answer

1st degree DP: Price individualisation e.g. price negotiations e.g. auctions 2nd degree DP Value-related DP e.g. delivery vs. take-away prices, seat categories Quantity-related DP e.g. volume discounts, boni Price bundeling e.g. set prices 3rd degree DP: Geographic DP e.g. international DP Channel-specific DP e.g. online prices vs. shop prices Time-related DP e.g. weekend tariffs, night-time tariffs, season tickets

Question 13

First degree differential pricing

Accepted Answer

“An auction is a price mechanism where bidders can makecompeting offers for a good under a set of trading rules and thehighest bidder usually is awarded the transaction”. - Potential buyers submit price offers (bids)- different mechanisms for the submission of offers are available- different mechanisms for the selection of the winning customer exist Negotiations and auctions are forms of differential pricing because they mostlylead to different prices for comparable offerings sold to different customers Open auctions: English Auctions• Ascending• First Price->Auctioneer begins at lowest bid price and increases the bid in small increments->Highest bid wins Dutch Auctions• Descending• First Price->Auctioneer begins at the highest bid price and lowers in small increments->First bid wins Closed auctions: First Price Sealed Bid Auctions• Ascending• First price Vickrey Auction• Ascending• Second price Reverse AuctionReverse: The buyer invites several potential sellers to submit price offerso Sealed-bid auction: Bidders do not see the price of their rivalso Open-bid auction: Bidders can observe the price ₋ Hard-close rule: Fixed end time ₋ Soft-close rule: Close time processo English format: Competing bidders lower the price at which they sello Dutch format: The buyer raises the price at which he buys until asupplier accepts to sellOnline RA:Use of the internet for a more efficient reverse auction proce

Question 14

Second degree differential pricing - Value-related differential pricing

Accepted Answer

Value-related differential pricing refers to modifications of the valueoffered to the customers at a given price point.Objective:to achieve a higher degree of perceived value and thus a higherwillingness to pay for a part of the customer base by means ofrelatively small modifications of quantity and quality without causingfundamental cost consequences. p = expenses / value received („price as a ratio“) Possible parameters for a value-related differentiation:• product differentiation• package differentiation• information differentiation• service differentiation• delivery differentiation• payment and financing differentiation

Question 15

Second degree differential pricing - Discounts, allowances, rebates etc.

Accepted Answer

Cash discount:Price reduction offered to a consumer, industrial user, or marketing intermediaryin return for prompt payment of a bill, 3/10 net 30, a common cash discount notation, allows consumers to subtract 3 percent fromthe amount due if payment is made within 10 days Trade Discount:Payment (price reduction) from a manufacturer to a channel member orbuyer for performing marketing functions; also known as a functional discount• for promotional support given to the brands of a manufacturer already listed by aretailer (products appear in retailer catalogues, on flyers etc.)• for accepting to list certain products in addition to the current products from amanufacturer (innovations, less attractive products or brands etc.)• for allowing the manufacturer to organize own promotional activities (e.g. in-storeproduct testing, games, sales ladies / men)• for providing a manufacturer’s products with attractive shelf space or specialplacements (central aisles, near check-out or entrance etc.)• for taking over logistics tasks Volume discount (non-linear tariff without basic fee)Incentives for the customer to buy larger quantities per order or period.The objective for the seller is to achieve reduction of costs per order or per volumeunit sold (administrative costs, shipping costs, handling costs etc.). Price systems (or tariffs) are referred to as:• linear when an increase in purchase volume orusage intensity does not modify the price paid perunit• non-linear when an increase in purchase volumeor usage intensity leads to a change of the pricepaid per unit Objectives pursued with coupons:• Reward loyal customers• Call attention to new sizes or packages• Have the customers try a new product• Facilitate price increases• Convince a retailer to list a manufacturer’s products, part. innovations• Market research or direct marketing purposes (data, addresses etc.)

Question 16

Second degree differential pricing- Two-part-tariffs

Accepted Answer

Linear tariff: With every additional unit the customer buys or uses, the total amount he pays increases by the same number of monetary units Two-part tariffs Def.: Tariffs that combine two price components:Ø a fixed „basic rate“ andØ a usage-dependent (variable) fee per unit consumed or at least bought of the good. Objective:- Loyalty effect- Liquidity effectExamples: electricity tariffs, telephone tariffs, train cards (Deutsche Bahn, SBB) etc.

Question 17

Second degree differential pricing - Bonus systems

Accepted Answer

Bonuses are monetary or non-monetary rewards.• A supplier offers a bonus to a customer in case the customer fulfils certain criteria.• The reward is only granted after a criterion is fulfilled (not a direct discount)• Objectives are to make the customer loyal and increase his share of wallet.Bonus accounting:• Different supports: paper systems, electronic systems (e.g. customer cards)• Different accounting methods: Monetary systems:- monetary units spent by customer- replacement currency (points, miles) Non-monetary systems:- number of purchases- number of products bought- etc. The reward (bonus) representsadditional value transferred fromthe seller to the customer.For the customer, it improves therelationship between hisexpenses and the value receivedand, hence, reduces price (both:total price and price per unit) § Typical rewards:• Money (refunds)• Free products / services (free flights etc.)• Presents without direct link to the core product / servicesold by the seller Examples:• Industrial companies (B2B markets)• Coffee shops• Airlines’ miles programs (Air France, Lufthansa etc.),• Retailer's Frequent Shopper Programs etc.

Question 18

Second degree differential pricing - Price bundling

Accepted Answer

Price bundling usesØ a combination of several partial offers (products, services, rights)Ø of one or several suppliersØ to form one offer bundle („set“)Ø sold at a total price. Types of price bundling:Ø Pure vs. mixed price bundling Conditions:Ø heterogeneous demand,Ø possibility to unbundle former or to bundle existing partial offers,Ø lack of competition with specialised suppliers for partial offers,Ø lack of free riders.

Question 19

3rd degree DP - Geographic DP

Accepted Answer

Ø For customers purchasing at different locations (e.g. countries)Ø reasons for geographic differentiation are: § differences in costs (transport, taxes, exchange rates) and § differences in the customers‘ willingness-to-pay which can be shown by specific demand curves (price-sales functions) reflecting different consumer preferences; § differences in competition.Common problem: market isolation!

Question 20

3rd degree DP - Channel-specific DP

Accepted Answer

Ø In multi-channel sales systems, avoiding unplanned salesstreams requires a harmonization of channel-specific prices (e.g.between online and physical channels).Ø Differential pricing is possible but requires coordination.Ø The price corridor method can also be used in other contexts,such as in international DP, but is useful for coordinating channelprices.

Question 21

3rd degree DP - Time-related DP

Accepted Answer

Ø Market isolation is relatively easy to achieve through usage /ticket controlsØ Depending on the market characteristics, there are different formsof price reductions given at one fixed point in time.Ø The most important are: § seasonal price reductions, § discounts for travelling during night time. § When customers in different markets or segments use aproduct / service at different times§ Of special interest • for markets with strong seasonal variations of sales, e.g. hotels, restaurants, telephone companies and airlines, • in order to ensure the best possible use of available capacities over the operating hours.

Question 22

3rd degree DP - individual characteristics

Accepted Answer

Ø When customers have clearly distinct characteristicsØ examples: students, disabled people, retired people, membersof associations, parties etc.Ø in order to ensure a maximum use of available capacities.Ø market isolation can be relatively well achieved ð obligation to provide proof of individual characteristicsrequiredØ Applied for example: § at movie theatres, operas, etc., § hotels, airlines, train companies etc..

Question 23

Long-term vs. short-term pricing - Price limits

Accepted Answer

• Many prices that companies calculate and put in their price list only serveas starting point for price negotiations, sales bids, reverse auctions etc.• Particularly on business markets (industrial marketing, marketing toretailers, professional services marketing) - customers may come up with price intentions situated below the list price - sales people may get the impression that specific customers could be willing to pay higher prices than the list price• Hence, once the initial price calculation has been done the company mustalso determine what its upper and lower price limits are. Lower price limits are those prices per unit of a product which stillallow the company to achieve a pre-specified financial performanceobjective (e.g. a certain % contribution margin)In determining the company’s lower price limit, the time horizon ofthe pricing decision plays an important roleLong-term perspective:• break-even point (all fixed and variable costs must be covered)Short-term perspective:• for an additional order of x units: variable costs per unit

Question 24

Assortment pricing

Accepted Answer

Three major decisions need to be taken• Margin equilibration (cross-subsidizing) betweenindependent elements or between interdependentelements in an assortment• Spaces between different levels of price points in anassortment (price lining, price extension/expansion)• Long-tail pricing

Question 25

Assortment pricing - Cross-Subsidies

Accepted Answer

• Prices charged for one product are subsidized by the sale ofanother product• May be profitable when there are significant demandcomplementarity effectsExamples o Razors and razor blades o Drinks and meals at restaurants

Question 26

Assortment pricing - Product Mix-Pricing Strategies: Product Line Pricing

Accepted Answer

Price lining (product line pricing)Price lines are systems of prices for an assortment.They are composed of:• the lowest price point in an assortment (entry price)• the highest price point in an assortment• the distances between the price points in an assortment - for different models, product/service types, or equipment levels - for different package sizesThe objective is - to define a sufficient number of price points to propose attractive offerings to different segments - not to propose too many different offerings at different price points (because of complexity costs, transparency of the assortment for the customer etc.) Horizontal proliferation• Coke used to be the “anytime, anywhere”drink for anybody – one undifferentiated product• Today: product differentiation = Classic Coke,Diet Coke, Cherry Coke, Vanilla Coke ... etc.(horizontal proliferation)Vertical proliferation• Car companies have extended their productlines vertically (Volkswagen, BMW, Mercedesetc.)--> Identical prices for all product models? Price line extensions:Price line extension: Permanent change of anassortment‘s lower/upper price border through a reduction/increase of theprice of the products sold at the lowest/highest price points (LPP/HPP)Price line expansions:Price line expansion: Permanent change of an assortment‘slower/upper price border through the introduction of additionalproducts sold at an even lower/higher price point as compared tothe former lowest/highest price point (LPP/HPP) Long-tail pricing:Among other factors, the size of an assortment depends on the cost ofstock-keeping and the transaction costs for objects sold at lowfrequency.In particular in online contexts (e.g. streaming services) these costsare extremely low and, hence, stock keeping and transactions can beensured even for offerings that are rarely sold.These objects are referred to as “long-tail” of the assortment becausetheir share of the total revenue of a company is typically low.

Question 27

Price variation - Definition and how-to

Accepted Answer

A price variation is ...• an intentional modification (increase or decrease)• of the price for an offering• for a specified planning period• with the aim of modifying customers‘ buying behavior• in order to better achieve the company’s economic objectivesPractical relevance:• Companies are constantly modifying prices.• Price changes are often motivated by competitors‘ activities• They are more or less well prepared / managed. How to vary prices? Based on the definition of price as a ratio (relationship between twocomponents), price variations can be implemented in different waysp = customer expenses/value received by customer • Expenses can be modified in several ways• Value received can be modified in several ways (Windelbeispiel)

Question 28

Types of price variations

Accepted Answer

1) Life cycle pricing 2) Price promotions 3) Yield management

Question 29

Price Variation - Life-Cycle Pricing

Accepted Answer

• A product life-cycle spans the time from initial R&D on a product to when customer serviceand support are no longer offered on that product (phase out) (Introduction, Growth, Maturity, Decline)• Life cycle costs (LCC) are the total costs estimated to be incurred in the design,development, production, operation, maintenance, support, and final disposition of aproduct/system over its anticipated useful life span.• The best balance among cost elements is achieved when the total LCC are minimized.• Life-Cycle Budgeting involves estimating the life-cycle revenues (LCR) and LCC attributable to each product from its initial R&D to its final customer service and support. Important Considerations for Life-Cycle Pricing: Costs• Development period for R&D anddesign is long and costly• Many costs are locked in at the R&Dand design stages, even if R&D anddesign costs are themselves small• Nonproduction costs are large• Costs may fluctuate over the lifecycle(raw material, wages,transportation etc.) Price• Customers value perceptions maychange during the product life-cycle• Competitive pressure may change• When penetration pricing is intended,consider impact on liquidity• Price phase out towards the end ofthe life cycle• sales of left-over stock of oldmodel• spare part pricing• recycling pricing Long term price variations: 1)Premium strategy2)Penetration pricing3)Pulsation strategy4) Skim pricing5) Discount strategy Skim pricing:• Setting a High Price for a NewProduct to “Skim” MaximumRevenues from the TargetMarket.• Results in Fewer, But MoreProfitable Sales.• Example: Appel IPhoneFavorable Conditions• Considerable product / service differentiation• Quality-sensitive customers• Sustainable competitive advantage• Few competitors• Few product / service substitutes• Difficult competitor entry Penetration pricing• Setting a Low Price for a NewProduct in Order to “Penetrate”the Market Quickly and Deeply.• Attract a Large Number ofBuyers and Win a LargerMarket Share.Favorable Conditions• No/limited differentiation• Price-sensitive customers• No sustainable advantage• Many competitors• Many substitutes• Easy competitor entry

Question 30

Price Variations - Price promotions

Accepted Answer

Price variations – Short-term price modifications Promotions directed at intermediaries / distributors:• the producing company (producer ofgoods or services) reduces prices forintermediaries (wholesalers or retailers)during a limited period of time;• the retailer does not necessarily pass onthe price reduction to final customers Promotions directed at final customers:• the producing company (of goods orservices) intends to reduce prices for finalcustomers;• in case distribution takes place throughintermediaries (retailers, wholesalers etc.),the cooperation of these actors is required Parameters:• Basic decision for or against price promotions (EDLP-programs),• Defining the article and the target group,• Modality of price reduction,• Amount of price reduction,• Accompanying activities,• Timing: starting date, duration and frequency, (daily deals)• Maximum amount of products to be sold during promotion. EDLP (every day low price):This strategy appeals to• the cost-conscious buyers• who are infrequent purchasers• and shop in bulk at one go.It benefits those who have lesstime at their disposal to shop andcompare prices.They benefit from the averagecost savings on each item. HILO (promotional pricing):This strategy appeals to those purchasers who are• frequent visitors to a store• and shop in small quantities.They can benefit from the disparity in prices, whichfluctuate every day.• If the price of the product is high, they can defertheir purchase for a later date.• When the price drops they stock up.HILO shoppers are vulnerable to switchingbecause they buy in smaller quantities and fromdifferent stores. Objectives of price promotions:• Internal objectives • Short-term increase of liquidity • Reduction of stock (e.g. selling out-dated or perishable goods) • Sales force motivation• Intermediary-directed objectives (retailers / wholesalers etc.) • Gaining market share against competitors • Increasing distribution rate • Support retailers during introduction of new products• Customer-directed objectives • Trigger impulsive purchases • Sales increase through customer stock building or brand switching • Increasing customers‘ intensity of use Potential disadvantages and problems of price promotions:• increase customers‘ price interest,• decrease customers‘ willingness to pay,• prevent customers from being loyal.• negative carry-over effects in the post-promotion phase, (sales evolution)• risk of retailers absorbing (parts of) the price reduction,• choice of articles (interest for consumer vs. product image) Typical sales evolution before (decrease due anticipation), during (increase due to sales promotion)and after (decrease due to promotion stocks) price promotions

Question 31

Price Variations - Yield management

Accepted Answer

“Yield management is an integrated, continuous and systematicapproach to maximising revenue through the manipulation of aproduct’s price in response to forecasted patterns of demand.” o Importance of time / experience -> follows the evolution of situationbased on previous informationo Importance of information technology -> allows decision-making andproblem-solving based on predefined functions Conditions under which YM is often used: Fixed capacity (hotel beds or airport slots) Perishable inventory (fixed date) Reservation made in advance Appropriate cost structure (very low marginal cost of a new customer) Variable demand (e.g. holidays) Process: Input, Planning models and Optimisation models: siehe skript AdvantagesFinancial advantages Maximization of revenues Increase in profitCompetitive advantages: Identifies customer order and cancellation patterns demand Anticipates future demand Shifts demand from a peak to slack periods

Question 32

Problems in international price calculation

Accepted Answer

Specific cost types in export price calculation:- Country-specific production costs (product adaptation,special packaging requirements etc.)- Export extra charges (insurances, freight, stockage /warehousing etc.)- Administrative overhead (establishment of exportdepartment, training etc.)- Country-specific marketing costs (costs for distributionchannels, communication etc.) International pricingRisks of price calculation--> neglecting unexpected costs, e.g.- information- and travel expenses- costs for product and package adaptation- unknown commissions, charges, fees--> difficult valuation of external factors, e.g.- underestimation of inflation rates for parts- technical risks in investment business--> danger of “price escalation effect“ when fully including the risks into pricesDifferences to home market--> wrong judgments of competitor, dealer and customer behavior in theforeign market--> changing exchange rates--> changing customs tariffs, quotas etc. Approaches to reduce price escalation Lower Cost of Goods o Eliminate Functional Features o Lower Manufacturing Costs o Lower QualityLower Tariffs o Tariff Reclassification o Product Modification o Partial Assembly in country of destination o RepackagingLower Distribution Costs o Shorten Channels of Distribution o Lower Shipping CostsForeign Trade Zones / Common Markets (e.g. EU, NAFTA)

Price (Fach) / Price calculation (Lektion)