The Marketing Mix: Advanced Pricing Strategies (DP IB Business Management)

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Lisa Eades

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Dynamic Pricing Strategy

Dynamic pricing involves charging different prices to match demand patterns
It aims to maximise revenue whilst making full use of capacity available
- Prices are raised if demand is high and limited capacity remains
- Prices are lowered if demand is low and needs to be stimulated to maximise capacity utilisation

Examples of Dynamic Pricing

Disneyland Paris Resort	American Airlines

Disneyland Paris Resort charges more for school holiday getaways than term-time breaks	American Airlines' fares are lower the further in advance they are booked

Dynamic pricing can be used very effectively online
- Demand is tracked in real time and prices can be programmed to change accordingly
- Using artificial intelligence (AI) Amazon can change prices on products several times a day according to market demands
  - Advanced algorithms analyse sales data, detect patterns and make price changes at a fraction of the speed of competitors
  - This allows Amazon to nearly always have the most compelling offers faster than other retailers

The Advantages & Disadvantages of Dynamic Pricing

Advantages	Disadvantages
Maximises revenue Charge higher prices during peak times when demand is high Lower prices during off-peak times to attract more customers Revenue that might be lost with a fixed pricing strategy is captured	Customer backlash Can lead to customer dissatisfaction if customers perceive it as unfair Price changes may erode customer trust and loyalty if they feel they are being taken advantage of
Optimal use of resources Airlines can fill empty seats during off-peak times by offering lower prices Hotels can maximise room occupancy by adjusting rates based on demand	Complex Dynamic pricing systems may require sophisticated algorithms and technology Small businesses may lack finance to invest in and manage these effectively
Competitive advantage Can respond quickly to changes in the market Particularly important when prices are highly variable and experience supply and demand fluctuations	Ethical concerns If prices are increased significantly during emergencies or crises a business may be accused of price gouging which can harm its reputation.
Consumer behaviour insights Analysing how consumers respond to price changes can inform future pricing strategies and marketing tactics	Lack of transparency Secret pricing algorithms can create distrust among customers who are uncertain about the fairness of the pricing strategy

Exam Tip

Students often confuse the negative sign of the answer to PED questions. Do not assume that the negative is mathematical such that an elasticity of -1 is smaller than, for example, -0.3. It is larger (more price elastic).

When interpreting the value of PED do not say that ‘the product is elastic or inelastic’, it is better to say that ‘demand for the product is price elastic or price inelastic’.

Competitive Pricing Strategy

Competitive pricing involves matching or undercutting the prices charged by competitors in order to increase sales
Businesses can use a range of pricing tactics
- Price matching is commonly used by UK supermarkets to highlight products that are sold at a lower price than rivals
- Refund the difference matches the price of rivals if customers find a product at a lower price in a comparable retail outlet
- Discounts for new customers attract sales away from rivals

Diagram: supermarket price matching

Tesco and Sainsbury's use the Aldi Price Match tactic to emphasise products that are sold at the same or lower price than their budget rival — **Tesco and Sainsbury's match some prices with budget retailer Aldi**

The above image illustrates how businesses engage in a competitive pricing strategy
- Businesses with many products may price some competitively, while raising prices on others
  - E.g. supermarkets will often use competitively priced alcohol to bring customers in, but then raise the prices on other products such as deli meat

Advantages & Disadvantages of Competitive Pricing

Advantages	Disadvantages
Consumer familiarity Customers may be more likely to accept products because they align with their expectations Seen as fair and reasonable, which can improve brand image and increase customer loyalty	Lower profit margins If prices are constantly pushed down to match/beat competitors, it is difficult to maintain healthy profits Challenging to increase prices even if there are increases in production costs
Market share Helps gain or maintain market share by offering prices that are in line with or slightly below those of rivals Particularly important in price-sensitive markets	Brand differentiation May not allow for differentiation based on features or quality If products are perceived as similar, consumers make purchasing decisions solely based on price
Flexibility If a competitor lowers prices, a business can adjust its own prices accordingly Avoids losing market share whilst waiting for the pricing strategy to be changed	Race to the bottom Constantly adjusting prices can lead to a situation where prices keep dropping regardless of the actual value of the product Limits a businesses ability to set prices based on costs or USP

Contribution Pricing

Contribution pricing involves setting prices that cover direct costs associated with producing a product and also contribute to covering indirect costs
- This method ensures that a business does not make a loss on each product sold
- It requires a business to be able to accurately allocate indirect costs to products in its range
- Care must be taken to ensure that the price set is competitive and meets market expectations

Diagram: illustrating contribution pricing

**The toy's selling price is determined by adding total indirect costs to an appropriate allocation of direct costs**

Price Elasticity of Demand's Influence on Pricing

Understanding price elasticity of demand helps a business to know when to raise its prices - and when to lower them
Price elasticity of demand calculates how responsive the change in quantity demanded of a product will be to a change in its price
- For most products, when there is an increase in price, there will be a fall in the quantity demanded
- Similarly when there is a decrease in price there will be an increase in the quantity demanded
- Businesses want to know by how much the demand will change as this can impact their pricing strategy
The responsiveness of demand to a change in price determines if the product is price elastic or price inelastic in nature
- Where the quantity demanded changes more than the change in price, demand is price elastic
  - Businesses should avoid raising the price of these products
  - A 10% increase in price would lead to a greater than 10% decrease in the quantity demanded
- Where the quantity demanded changes less than the change in price demand is price inelastic
  - Businesses should avoid cutting the price of these products
  - A 10% increase in price would lead to a less than 10% decrease in the quantity demanded

Calculation of PED

The PED value is always negative because of the inverse relationship between price and demand (one goes up when the other goes down)
PED can be calculated using the following formula

$PED = \frac{% change in quantity demanded}{% change in price} = \frac{% △ in QD}{% △ in P}$

Interpretation of PED Values

Numerical Value	Type of Good	Explanation	Examples
> 1	Elastic	Demand is more responsive to a change in price The %∆ in QD is more than proportional to the %∆ in P	Luxury products such as cars, smart watches, foreign holidays, cinema visits, jewellery, and branded goods
Between 0 & 1	Inelastic	Demand is less responsive to a change in price The %∆ in QD is more than proportional to the %∆ in P	Necessities such as bread, milk, eggs, and potatoes; fuel; rent; toothpaste, etc. Addictive products such as cigarettes and sugary foods

Numerical Value

Type of Good

Explanation

Examples

> 1

Elastic

Demand is more responsive to a change in price
The %∆ in QD is more than proportional to the %∆ in P

Luxury products such as cars, smart watches, foreign holidays, cinema visits, jewellery, and branded goods

Between

0 & 1

Inelastic

Demand is less responsive to a change in price
The %∆ in QD is more than proportional to the %∆ in P

Necessities such as bread, milk, eggs, and potatoes; fuel; rent; toothpaste, etc.
Addictive products such as cigarettes and sugary foods

PED and pricing strategy

Businesses need to understanding the responsiveness of demand to a change in price before setting or changing their pricing strategy to maximise their revenue
- If the demand for their products is relatively price inelastic (PED < -1), raising the price will lead to an increase in total revenue. However, lowering the price will lead to a fall in total revenue
  - Price skimming strategies are best employed for products that are price inelastic in demand
- If demand for their products is relatively price elastic (PED > -1), raising the price will lead to a fall in total revenue. However, lowering the price will lead to a rise in total revenue
  - Competitive pricing strategies are best employed for products that are price inelastic in demand

The Relationship Between Price Elasticity of Demand and Total Revenue

PED	Result	Price Increase or Decrease	Impact on total Revenue
Elastic	Greater than 1 (Between 1 and ∞)	Increase	Decrease
Elastic	Greater than 1 (Between 1 and ∞)	Decrease	Increase
Inelastic	Between 0 and 1	Increase	Increase
Inelastic	Between 0 and 1	Decrease	Decrease

Factors Influencing Price Elasticity of Demand

**The factors which determine if a product is more price elastic or price inelastic in demand**

Brand loyalty

The aim of advertising and marketing expenditure by a business is to shift the demand curve to the right and make the demand more price inelastic
- E.g. Coke consumers are more brand loyal to Coke and refuse to buy Pepsi, even though their taste is very similar

Availability of substitutes

PED will be more price inelastic (lower) for goods that have fewer substitutes
- E.g. Petrol has fewer substitutes and is more price inelastic whereas chocolate bars have more substitutes and are more price elastic

The proportion of income taken up by the product

The smaller the proportion of income we spend on a product the more price inelastic the demand will be
- E.g. A small amount of income is spent on salt and so the demand for salt will be more price inelastic whereas buying a new car takes up a bigger proportion of consumer income and so is more price elastic in demand

Luxury or necessity

Necessities are required as part of consumers' daily needs and are therefore more price inelastic in demand
- E.g. Bread, milk, petrol, gas and electricity might be considered to be necessities
Luxuries are not essential and are therefore more price elastic in demand
- E.g. Smoked salmon, Nike Air Jordans, and foreign holidays might be considered to be luxuries

Time period to adjust

The longer the time period under consideration the more price elastic the demand for a good or service is likely to be (consumers have more time to search for substitutes)
The shorter the time period under consideration the more price inelastic the demand for a good or service is likely to be
- E.g. If the price of petrol increases making driving more expensive, there is little that consumers can do in the short term. However, they may switch to alternatives such as public transport or bicycles in the long term

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