The need for a single index that aggregates over heterogeneous consumers with different incomes, tastes, and needs casts serious doubt on the cost-of-living approach. Citation Deaton, Angus. DOI: This is possible if no information on the product can be exchanged and if the product cannot be resold between markets. If information does flow between segments or if the product might be resold from one segment to another, product customization obviously would be necessary before prices could be customized.
However, such an investment—in different brand names, software preloads, or added features—can well be worth it. Elasticities vary widely across product categories and even across brands within a category. Therefore, companies should analyze each individual situation. The most sophisticated pricing managers use market research procedures such as conjoint analysis to measure elasticities, but a good first step is simply to examine the important factors influencing price sensitivity in three broad areas: customer economics, customer search and usage, and the competitive situation.
First, consider customer economics. Should an amusement park operator charge admission to the park, a fee for each ride, or both? Answering these questions incorrectly can be very costly. The resources allocated to thinking about pricing are often misallocated; most companies invest too little time, money, and effort in determining a pricing structure, and too much in determining the pricing at different levels within a given structure. Two important issues to consider when creating a pricing structure are whether to offer quantity discounts and whether to offer bundle pricing.
Quantity discounts are frequently offered in industrial selling situations. For example, consider a manufacturer that must create a pricing policy given Buyer A and Buyer B, who value successive units of the product differently:. The astute pricing manager, on the other hand, asks, What is the optimal pricing schedule? The insight lies in asking the right question. With the given cost and value parameters, the optimal pricing schedule will be as follows:. Bundle pricing is the second factor managers should consider when creating a pricing structure.
For a manufacturer providing complementary products, like cameras and film, for example, the strategy should be to give up some of the initial profit potential on the hardware to increase the volume sold and consequently increase the potential demand for software. Astute managers can gain a further advantage by also considering proper product configurations.
The two products need not have a camera-and-film-type relationship to be bundled. Movie distributors often sell packages of films rather than selling individual film rights because the package values vary less across buyers than do the individual film values. Take the following two movies and their corresponding value to buyers:. Asking the question Should we price the bundle or the individual components?
Pricing is more like chess than like checkers. A seemingly brilliant pricing move can turn into a foolish one when competitors have had their chance to respond. Price wars, for example, can easily be set off by poorly designed pricing actions. The lens through which pricing decisions are considered must be broad enough to permit consideration of second- and third-order effects. Managers should ask themselves how any change in price will affect competitors.
They also should ask themselves, What would I do if I were the competition? And, Do I have an effective response to that action? Consider how Eastman Kodak Company addressed its continuing share loss in the U. Kodak could have cut prices but that would have been a very expensive move. Kodak instead introduced a low-priced brand, Funtime film, in larger package sizes and limited quantities—priced lower than Fuji film on a per roll basis. Most often, any pricing action a company takes will provoke some response by major competitors.
The total set of pricing terms and conditions a company offers its various customers can be quite elaborate. They include discounts for early payment, rebates based on annual volume, rebates based on prices charged to others, and negotiated discounts. Marn and R. The real net revenue earned by a product can also be heavily influenced by factors such as returns, damage claims, and special considerations given to certain customers. Treating the real price so casually can cost a company substantial forgone profits, especially in an intensely competitive marketplace.
Price setters must analyze the full impact of the pricing program, measuring and assessing the bottom-line impact. The interaction of the various pricing terms and conditions must be managed as a whole. Every transaction influences how a consumer thinks about a company and talks to others about it. The pricing forgoes some profits now to create an important benefit down the road. If customers believe that a price is unfair, their negative reaction can be devastating for business.
Of course, the same lesson cuts both ways. The problem was communication: The company was not properly explaining how it justified its price. The solution was to increase awareness of the massive investment required in reformatting, indexing, and storing the data to make the service possible. Simple market research procedures can be used to assess consumer reaction in terms of both perceived fairness and purchase intention.
An article by B. Shapiro, V. What biases enter into this process, and why? How can a business debias its price setting to become more productive, strategic, and profitable?
Combining perceptive insights from behavioral economics with leading-edge ideas on price management, this book offers a new approach to pricing. He explores how pricing actually happens in practice and shows how to identify and remove the psychological blinders that cause suboptimal decisions and policies.
Smith details how to improve pricing orientation by combining the soft behavioral skills that intuitively shape and refine pricing practice with the hard analytic skills that guide and structure pricing strategy. The result is more rational and more profitable pricing—with respect to not only revenue and profitability but also employee productivity and customer satisfaction.
Offering an accessible and actionable model, Getting Price Right is the first book to apply behavioral economics to managerial price setting. It is a must-read for corporate business leaders, thought leaders, and professionals interested in advances in pricing and for managers, entrepreneurs, proprietors, and small and midsize business owners whose everyday work involves pricing. An insightful and engaging integration of behavioral theory and pricing practice.
Reed K. Holden, founder, Holden Advisors Pricing continues to be one of the most powerful yet underused strategic levers to drive sustainable earnings growth.
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