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Price HL IB Business & Management IB2 Higher Level Recap What is price penetration? What is price skimming? What is price leadership? What is cost plus pricing? What is a variable cost? What is a fixed cost? Lesson objectives By the end of the lesson, students should be able to: - Understand the difference between cost based pricing, competition based pricing and market based pricing. Identify the different pricing strategies available to businesses Cost-based strategies Marginal-cost pricing The marginal cost is the addition to the total cost for producing one extra unit of output. Some businesses have very high fixed costs and very low variable costs, so when their fixed costs have been recovered, they can sell at any price above the variable. Any extra units sold will only add a small amount to their total costs. Examples are utility companies It is important not to publicise this low price Cost-based strategies Contribution pricing This is similar to marginal-cost pricing in that it mainly considers the variable costs of production. Businesses will want to make sure that their variable costs, such as raw materials, are covered but also need a contribution towards the fixed costs of the business, such as rent. Fixed cost= $400 and variable costs = $6 per unit, $600 for 100 units sold. The business prices the product at $11. This gives a contribution to fixed costs of $5 $400 $5 = 80 The fixed costs will be covered by the first 80 sold, any more sold beyond that will add $5 profit. This method is often used for large orders. Competition-based pricing Predatory pricing This method is deliberately selling a product below average cost with the intention of forcing a competitor out of the market. In many countries this is illegal, but it is very hard to prove. In France in 2004 Amazon was convicted of predatory pricing by offering free delivery on books. Amazon did not change its policy but simply kept paying the $1000 a day fine. Competition-based pricing Going-rate pricing This is where the business price their products at whatever the prevailing market price may be. This is likely to be if the market is highly transparent, the business would lose most of its sales if they charged a higher price. They would not want to charge a lower price as it will earn a lower profit per unit and may even start a price war. Agricultural markets are a good example of this. Market-based pricing Price discrimination Most markets can be broken down into different sub-groups. It is likely that customers in these groups may be prepared to pay slightly higher prices that those in other groups. Examples include phone calls, it is more expensive to call during the day than in the evening and weekend. WHY??? Market-based pricing Loss leaders Loss leaders are products sold at very low prices to tempt customers into a store. Most supermarkets offer a low-cost range, which in itself may not be profitable. The supermarket knows though that someone coming is unlikely to only buy products in the low cost range. A business can use loss leading products in its promotional activity. Walmart offer new CD albums at half the RRP. Market-based strategies Psychological pricing The price gives the customer information about the product. You would expect a luxury product to be priced at the higher end of the market. Pricing too cheaply may perceive a lack of quality. Psychological pricing also refers to setting the price just under the currency unit $19.99 Market-based pricing Promotion pricing Special offer pricing is used to clear excess stock or to try and gain market share BOGOF Task: Price Wars The world’s largest supermarket chains (such as Wal-Mart, Carrefore and Tesco) have huge market power to reduce prices. Price reductions are a key technique used by supermarkets. E.g. the UK consumer has gown accustomed to supermarket price wars, with over a £1billion of price reductions each year. Price wars are also increasingly common in the airline and mobile phone industries. 1. Describe what is meant by a price war [2 marks] 2. Examine the winners and losers of a price war in the short run and the long run. [6 marks] 3. Justify two forms of non-price competition that supermarkets might use to increase their competitiveness Task 2: Sony PlayStation 3 Sony launched the PlayStation 3 in late 2006. It was quick to win positive reviews, although analysts questioned the price which was set over $100 more than the Xbox 360 from Microsoft, its main rival. Sony said its state of the art console with a built in Blu-ray DVD player made the premium price value for money. Despite higher prices charged by Sony, the Japanese manufacturers loses money on each console sold. It makes up for this when customers buy several games and other software products during the PS3’s product life-cycle. 1. Define the term premium price [2 marks] 2. In the context of the case study, examine the relationship between a product’s cash flow position and its life cycle. [8 marks] Task 3: Virgin Blue Virgin Blue is the creation of Richard Branson, founder CEO of the Virgin Group. The airline carrier was launched in 2000 by Sir Richard Branson and Virgin Blue CEO Brett Godfrey, to enter the Australian market. Initially set up as a low fare carrier, the company only flew between Brisbane and Sydney. Since then it has become Australia’s second largest airline, catering for all major cities in Australia. Customers pay for their in flight meals and drinks. To cut further costs, Virgin Blue uses a system of e-ticketing. 1. Describe three potential pricing strategies that airline companies can adopt when entering a new market. [6 marks] 2. Evaluate two possible pricing strategies that airline carriers such as Virgin Blue could use to increase their sales revenue.
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