Bennett And Wilkinson Estimating Demand Curves

these are difficult to estimate, ht emphasizing current performance, the company may sacrifice long-run performance by ignoring the effects ofqLhcr marketing-mix variables, com pet i-tnrs' reactions, and legal restraints on price,

?KE hake Some companies want lo Hííüf¡írtKeíi¡CírrnífnteíííniíKThey believe that a higher sales volume will lead to lower unit costs and higher long-run profit. They set the Lowest price, assuming the market is price sensitive. Tesa i Instruments (Ti) has practiced ill is market-penetration pricing. TI would build a large plant, set its price a* low as possible, win a large market share, experience falling costs, and cm its price further as costs fall.

The foil (living conditions favor setting a low price: (Ij The market is highly price sensitive, anda low price stimulates market growth; (2) production and distribution costs fall with accumulated production experience: and (.31 a low price discourages actual and potential com pet i I ion.

OtlMUM Market skijvijv ng companies unveiling a new technology favor setting high prices to maximize market skimming. Sony is a frequent practitioner of in artel-skimming pricing, where prices start high and are slowly lowered over time. When Sony introduced the world's first high-definition television (HDTV) to tlie Japanese market in lí)í)[), it was priced at $43,000. So that Sony could "skim" the maximum amount of revenue from the various segments of the market, the price dropped steadily through (he years—a 2S-inch HDTV coil just over $6;000 in 1and a -12-inch IIIJIVensi aliouf SI¿W in 20\M.-T

Market skitnming tnates sense under the fallowing conditions: U) A sufficient tuunheTof buyers have a high current demand; (2) the unit costs of producing a small volume are not so hi[>li that they cancel the Advantage ofChatging what the trafile will heart CM the high initial price does not attract more competitors to the market; (4) I he high price communicates the image of a superior product.

product-quality leadership a company might aim tq be the product-quality teenier in the market. Many brands strive 10 he 'affordable luxuries'—products or services characterized by high levef-s of perceived Quality, taste, and status with a price just high enough not to be nut of consumers' reach. Brands such as Starbucks coffee, a veda shampoo, Victoria's Secret lingerie, BMW cars, and Viking ranges have been able to posiiion themselves as quality leaders in their categories, combining quality, luxury, and premium prices with an in tensely loyal customer base,'18 Grey Coose and Absolut car,«! out a superpriemttim niche in (he essentially odorless, colorless, and tasteless vodka category through clever on-premise and oft"-] j remise marketing that made the brands seem hip a tit! exclusive,1'

Monprofit and public organisations may have other pricing objectives. A university aims tor partial cost recovery, knowing thai it must rely on private gills and public grants to cover the remaining costs. A nonprofit hospital may ¡lim for mil cost recovery iti its pricing, A nonprofit theater company may price its productions to fill the maximum number «["theater seats. A social .service agency may set a service price geared to client income.

Whatever the specific objective, bus in esse* that use price as a strategic tool will profit more than those who simply fet costs or the market determine their pricing

Step 2: Determining Demand

Each price will lead to a different level of demand and therefore have a different impact on a Company's marketing objectives. The relation between alternative prices and the resulting current demand is captured hi a demand curve (see Figure 14.2), hi the tiormalcase, demand and price are inversely related; The higher the price, the lower the demand, hi the case of ¡ires 11 ye goods, the demand curve so i net iines slope* Upward. A perfume company raised iti price and sold more perfume rather than less! Some consumers take die higher price to signify a better product hfOwevcr; ff the price is too bi^h, the level of demand may fall.

The demand curve shows the market's probable purchase quantity at alternative prices. It sums the reactions of many individuals v/htt have different ¡trice sensitivities. The first step in estimating demand is to understand what affects price sensitivity. Generally speaking, customers are mosl price sensitive to pro ducts ill at cosi a lot or itre bought frequently. They are less price sensitive to low-cost Items or items they buy infrequently. Tlwy are also less pricc sensitive when price is only a small pail of the total cost of obtaining operating, and servicing the product over its lifetime. A seller can charge a higher price 11 Kin competitors and .slill get the business if the company can convincc the customer that it offers the lowest total cosi of ownership (TCQ).

Companies, of course, prefer customers who are less price sensitive, Table 14.3 lists some characteristics (hat are associated with decreased price sensitivity. On il"1 other hand, tin: internet has tiie potential to increase customers' price sensitivity, ¡n buying a specific book online, for example, a Customer can compare the prices offered by over |Sm dozen Online bookstores by ¡usi elk ir.\ Sinion.nim. I ticsr pEit es can differ hy as ¡mic h as >(J percem.

Although the Internet increases the opportunity for price-sensitive buyers to find and favor lomri-pricc siicv many buyers may ni« be that price sensitive. McKinsey conducted a study and found 'h3t 89 percent of a sample of Internet customers visited only one hook site, HJ percent visited only one toy site, and fll percent visited only one music site, which Indicates that there is less price-com par ¡soil shopping taking place on the internet than is possible.

Companies need to understand the price sensitivity of ¡heir customers and prospects and the trade-offs people are willing to make between pricc and product characteristics, Targeting only price-sensitive consumers may in fad he "leaving money on the table."

(a) Inelastic Demand

(b) Elaitii Demand

(a) Inelastic Demand

(b) Elaitii Demand

100 105 Quantity Demanded per Period

SO 150

t] :i :i rilhtv Demanded per Period

100 105 Quantity Demanded per Period

SO 150

t] :i :i rilhtv Demanded per Period

iiieiaslic Elaslic C-iinaiiii

TABLE 14,3 Factors Leafing lo Less Price Sgnrfivily w The pncxJucC is mete d-sliflcl'.ve. n Buyers are less aware substitutes

■ Buyers cannol easily aware the Quality of substitutes,

■ The e*pcntl.1ure is a smaller pari of 1!ie buyer's lolsl income,

■ i he Kpertdiiura is small compared ig Die tutai cast the emi product. m Part of the cast s borne by ancte party.

h fhe product is used in conjunction wiiti asscls pnetiotisty bought, n fhe product is assumed lo have more quality, preside, or escclusi^nGSJ?.

■ Buyets cannol store fhe producl.

Soutvs: AflajHwi i'Qffl Thomas i MS0!c- srfl n.xd k. ffcHdcti. Me SBstegyantf tactics of Frit*ijj. 3nc a) jUppw Snfln o n.\o kl: Rrenl.oo Hsfl 2Mll,«h :

ESTIMATING DEMAND CURVES Mösl companies make some attempt 10 measure their demand curves using several different methods.

d Statistical analysts ol past prices, quantities sold, a tu I other factors can reveal their relationships. The data can he longitudinal (over time] or cross-sectional (different locations at the same time], Building the appropriate model and fitting the data With the proper statistical techniques colls for considerable skill.

.; Price expcriptenis ean be conducted- Bennett and Wilkinson systematically varied the places of several products sold in a discount store and observed the results,'M An alternative appmach is ro charge different prices in similar territories to see hotvsitl&s are affected, Still another approach is to use the Internet. An tj-business could test the impact Of a 5 percent price increase by quoting a higher price to every fortieth visitor tu compare the purchase response, However, it must do this carefully and not alienate customers, as happened when Amazon price-tested discounts -of HU percent, 35 percent, and >10 percent for DVD buyers, only to find that those receiving the 30 percent discount wore upset,31 ■ .Siweej's can explore how many units consumers would buy at different proposed prices, although there is always the chance that they might understate ilieir purchase intentions at higher prices to discourage the company from setting higher prices.-^

In measuring I he price-demand relationship, the market tcseatchcr musr control for various factors that will influence demand, f he competitor's response will make a difference. Also, if die company changes Other marketing-mix factors besides price, the effect of the price change itself will he hard to isolate. Xagle presents an excellent summary of (he van* ous methods tor estimating price sensitivity and demand.-14

■füCE EL AS! iCiry of [ Ef 1AND Marketers need to know how responsive, or elastic, demand Would be to a change in price. Consider rhu two demand curves in Figure M.2. With demand curve (a), a price increase from 3] 0 to $15 leads to a relatively small decline In dem a t^d from lOfi to 100, With demand curve [bf, the same price Increase 1 earls io a substantial drop in demand from 150 tu 30, IT demand hardly changes with a small change in price, we say the demand is inelastic. If demand changes considerably, demand is tfastiC- The higher the elasticity, the greater the volume growth resulting from a 1 percent price reduction.

Demand is likely to be less elastic under [lie following conditions: (1) There are few ur no substitutes or competitors; (21 buyers do not readily notice the higher price; (3) buyers arc slow Lo change their buying habits; (-11 buyers think [he higher prices are justified. If demand is clastic, sellers will Consider towering ibe price, A lower price will produce more toial revenue. "f'his makes sense as long as the costs of producing and selling more units (to not i nerease d is proporti nnatety.*'

ft ls a mistake to not consider ibe price elasticity uf customers and their needs in devd-

>.:; ■ i! I! M.;i:krii-;: program*. Ill I M7, ihr MeuupthliMii run sit Aullmi i*;-. in Ymk -

ducedanew purchase plan (or subway riders that discounted fares-after passes were Vised -17

times in ;t month- Critics pointed gut that (tic spccial fare did nut benefit tho^e customers whose demand was most elastic, suburban off-peak riders who used the subway the least. Commuters' demand curve is perfectly inelastic; po matter what happens in the fare, these people must get to work and gel hack htune.-*-'1

Price elasticity depends on the magnitude and direction or the contemplated price change. It may be negligible with a small price change and substantial with a Large price change. It may dilier for a price cut versus a price increase, and die re may tie a price indifference band within which price changes have little or no effect, A McKinsey pricing study estimated thai the price in difference band can range as large as 17 percent for mouthwash, 13 percent fur batteries, i) percent for Small appliances, and 2 percent for certificates of deposit.

Finally, lung-run price elasticity may differ (torn short -run elasticity. Buyers may continue to buy from a current supplier after a price increase, but they may eventually switch suppliers. Here demand is more elastic in the long run than in the short run, or the reverse may happen: Buyers may drop a supplier after being notified of a price increase but return litter. The distinction between short-run and long-run elasticity means that sellers will not know the total elfecl rrf a price change until time passes.

Step 3: Estimating Costs

Deityand sets a ceiling on the price the company can charge for its product. Costs set the floor, the company wants to charge a price that covers its cost of producing, distributing, and selling the product, including a fair return fur its effort and risk. Yet, when companies price products to cover full costs, the net result is noi always profitability. See "Marketing Memo: Three Myths About Pricing Strategy," for vnnre on common pricing Strategy errnrs.

TYPES OF COSTS AND LEVELS OF PRODUCTION A company's costs take twO forms, fixed and variable. Fbtcd costs (also known as overhead) are Costs that do not vary with production or sales revenue. A company must pay bills each month for rctll, beat, imerest, salaries, and so on, regardless of output.

Variable costs vary directly with the level of production. For example, each baud calculator produced by Texas Instruments involves the cost of plastic, microprocessor chips, packaging, and the like. These costs tend it} be constant per unit produced, I hey are called variable because their total varies with the number of units produced.

Continue reading here: Initiating and Responding to Price Changes

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