How to Price Your Products

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1 How to Price Your Products Robin G. Brumfield, PhD Specialist in Farm Management Rutgers University http//:aesop.rutgers.edu/~farmmgmt Photo by Lawrence S. Martin

2 Agenda Economic Terms Demand Pricing Strategies Product Differentiation Value Pricing

3 Price and Equilibrium Price Price Price is derived by the interaction between supply and demand. It depends on both the supply available and the demand of consumers. Equilibrium Price Sometimes referred to as market clearing price. The agreed upon price when an exchange occurs. It is not necessarily a fair price.

4 Supply and Demand Curve P1 Price Quantity Q1

5 Movement Along Demand Curve P1 P2 Price Demand Quantity Q1 Q2

6 Movement Along the Supply Curve P2 Demand 1 Demand 2 P1 Price Quantity Q1 Q2

7 Elasticity Price Elasticity of Demand The measure of sensitivity of one variable to another. The effect price changes have on demand.

8 Elasticity Demand is said to be less elastic when There are few or no substitutes or competitors. Buyers do not readily notice higher prices. Buyers are slow to change buying habits and search for lower prices. Buyers think higher prices are justified by quality improvements or inflation.

9 Price Elasticity Price elastic (sensitive) items customers shop for price. Slight change in price results in large change in quantity demanded. If prices are raised, competitors step in to fill the void. Price inelastic (insensitive) items purchase governed by other factors. Quantity demanded changes only slightly when prices change.

10 Determining demand for your products will take some research. Trade Magazines Government Statistics Private Marketing Research Firms Internet Searches The Competition Your Customer

11 Product Life Cycle Dollars Introduction Growth Maturity Decline Sales 0 Profits Time

12 Product Life Cycle Pricing Strategies Introductory stage: Low price (entices more consumers, lowers risk) Skimming (high price to reap high margin). Growth stage: similar Mature stage: Competition (numbers and size) forces prices down. Key factor is differentiation. Decline stage: Cut your losses!

13 Pricing Strategy 1. Know your production and marketing costs so that you can establish a price floor. 2. Equally important is knowing what your customers want and how much they are reasonably willing to pay to establish a price ceiling. 3. Push the pencil on paper (or spreadsheet) to determine sales and profit goals and develop a strategy to meet them.

14 COST ACCOUNTING OBJECTIVES Identify items with low cost - Comparative Advantage Identify items with high cost - Reduce them! Determine the price floor.

15 Costs Vary From Grower to Grower Because of: Size of operation Location Time of year Market channel Volume of production Product mix Size of permanent crew Availability of parttime labor How quickly you pay suppliers Managerial practices

16 Everyone s Costs are Different! Calculate Your Costs for Your Farm!

17 Income Statement Spreadsheet Tools for Cost Accounting

18 Overhead Costs Also called Fixed Costs Total overhead costs remain constant as production increases Costs per unit decrease as more units are produced

19 Overhead Costs Salaries Interest Taxes Advertising/Marketing Travel & Entertainment Land Rental Depreciation Utilities Repairs Insurance Office Expenses Dues & subscriptions Professional Fees Bad Debt

20 Variable Costs Variable Costs Also called Direct Costs Total variable costs increase as production increases Cost per unit is constant

21 Steps to determine costs per unit Enter Direct Costs Program will allocate these to each crop Other costs will be treated as Overhead Costs

22 Are grower specific. Costs : Vary with production and marketing decisions. Vary with market conditions, labor supply, age & condition of facilities, & managerial skill. Should be calculated for your firm! See: for a free cost accounting program.

23 Product Differentiation Add value by adding service Credit Delivery Special Wrappings Special Containers Cards Product information Return Privileges Warranties Brand Names

24 Percent of managers indicating they were well-informed regarding factors affecting pricing decisions Consumer willingness to pay 21% Consumer response to price changes 34% Value of product to consumer 71% Price of competing products 75% Fixed costs 81% Variable costs 84% Source: Note on Behavioral Pricing, Harvard Business School,

25 Value Pricing and the Economic Perspective Marketing efforts Prices of substitutes { Consumer s incentive to purchase (PV-P) { Firm s incentive to sell (P-COGS) Objective value (OV) Perceived value (PV) Product price (P) Cost of goods sold (COGS) Source: Note on Behavioral Pricing, Harvard Business School, $0

26 Scenario #1 It is Mother s Day and you are driving to visit your Mom. You pass a roadside stand and remember that you forgot to buy flowers for your mother. How much are you willing to pay for a dozen red roses? Scenarios developed on information from Dr. Charlie Hall.

27 Scenario #2 It is Mother s Day and you are driving to visit your Mom. You pass an upscale florist shop and remember that you forgot to buy flowers for your mother. How much are you willing to pay for a dozen red roses?

28 Scenario #3 You set off to buy a 10-inch poinsettia at what you believe to be the cheapest store in the area. Upon arriving, you find that the 10-inch poinsettia you want costs $29, a price consistent with your prior expectations. As you are about to make the purchase, a reliable friend tells you that the very same 10-inch poinsettia is selling for $10 less at a store approximately 10 minutes away. Do you go to the other store to buy the 10-inch poinsettia?

29 Scenario #4 You set off to buy a dwarf cut-leaf maple tree at what you believe to be the cheapest store in the area. Upon arriving, you find that the dwarf cut-leaf maple tree you want costs $495, a price consistent with your prior expectations. As you are about to make the purchase, a reliable friend tells you that the very same dwarf cut-leaf maple tree is selling for $10 less at a store approximately 10 minutes away. Do you go to the other store to buy the dwarf cut-leaf maple tree?

30 Behavioral Update #1 Willingness to Pay is Impacted by Relative Incentives In determining willingness to pay, a consumer will consider both the absolute economic utility from the transaction [i.e., perceived value actual price] and the relative incentive to enter the transaction [i.e., (perceived value actual price)/(actual price)].

31 Scenario #5 Your favorite poinsettia color is white. Your local florist has red poinsettias in 10-inch pots for $20 and white poinsettias in 10-inch pots for $40. Is this price increase for white poinsettias fair or unfair?

32 Scenario #6 Your favorite poinsettia color is white. Your local florist had red & white poinsettias in 10-inch pots for $20. There has been a run on white poinsettias, and the florists has raised the price of white poinsettias in 10- inch pots to $40. Is this price increase for white poinsettias fair or unfair?

33 Behavioral Update #2 Willingness to Pay is Impacted by Salient Reference Prices In determining willingness to pay, a consumer will consider economic utility from the transaction [i.e., perceived value actual price] and the consistency between the actual price and a salient reference price [i.e., actual price reference price].

34 Scenario #7 A garden center has no potted tulips in stock, but is about to receive a new shipment. Prior to delivery, the owner finds out that the wholesale price of potted tulips has increased 20% and will affect this new shipment. The owner decides to increase the price of the new potted tulips by 20%. Is this retailer s actions fair or unfair?

35 Scenario #8 A garden center has a one-week supply of potted tulips in stock, and is due to receive a new shipment in the near future. Prior to delivery, the owner finds out that the wholesale price of potted tulips has increased 20% and will affect this new shipment. The owner decides to immediately increase the shelf price on current stock by 20%. Is this retailer s actions fair or unfair?

36 Behavioral Update #3 Willingness to Pay is Impacted by Cost of Goods Sold In determining willingness to pay, a consumer will consider their own economic utility from the transaction [i.e., perceived value actual price] and that of the firm [i.e., actual price cost of goods sold].

37 Scenario #9 In 1996, baseball s Seattle Mariners made it to the American League playoffs. During the season, general admission to a Mariners game cost $15. For the playoffs, the Mariners raised the price of general admission tickets to $20. Is this fair or unfair?

38 Scenario #10 A hardware store had been selling show shovels for $15. The morning after a large snowstorm, the store raises the price of its snow shovels to $20. Is this fair or unfair?

39 Behavioral Update #4 Perceptions of Fairness Vary Across Product Categories In determining willingness to pay, the degree to which a consumer will rely on their own economic utility from the transaction [i.e., perceived value actual price] will vary across product categories [e.g. discretionary vs. necessity; luxury vs. utilitarian].

40 Scenario #11 Six months ago you saw an ad for a gala wine and cheese party at a local farm stand, a very popular, local event. You immediately called to reserve a $50 ticket. Yesterday, you went to the farm stand and paid $50 in cash for your ticket, which is non-refundable. This morning, you woke up with the flu. Will you still go to the event or stay home?

41 Scenario #12 Six months ago you saw an ad for a gala wine and cheese party at a local retail farm stand, a very popular, local event. Not wanting to take a chance on the event being sold out, you went immediately to the farm stand and paid $50 in cash for your ticket, which is non-refundable. Six months later -- this morning -- you woke up with the flu. Will you still go to the event or stay home?

42 Behavioral Update #5 Consumption closely tracks the timing of payments by customers. In determining willingness to pay, the degree to which a consumer will rely on their own economic utility from the transaction [i.e., perceived value actual price] will closely track the timing of payments by customers.

43 Scenario #13 It s early spring in New Jersey. Your local upscale garden center is offering to fill an indoor planter for you with lovely seasonal plants for $40. You think this is a great idea, and pre-pay for 3 more times at $40 for the rest of the year. It is now December, and you have had 3 lovely planters. Your children give you a pre-paid Cruise to Mexico for the holidays. They suggest you forget about the Christmas planter and pack your suitcase immediately and go. What do you do?

44 Behavioral Update #6 Price bundling influences consumption. In determining willingness to pay, the degree to which a consumer will rely on their own economic utility from the transaction [i.e., perceived value actual price] is influenced by price bundling.

45 Strategy #1 Actively Manage Price Expectations. Establish credible reference prices. Manage product price trends. Encourage favorable comparisons. Avoid unfavorable comparison through product differentiation.

46 Strategy #2 Actively Manage Perceptions of Cost of Goods Sold. Focus attention on fully-loaded cost of goods sold. Bundle products to obscure cost of goods sold. Focus attention on consumer value.

47 Combining the Economic and Behavioral Drivers of Willingness to Pay Consumer s Willingness to Pay Economic Utility of the Transaction = + Fairness of the Transaction Perceived value actual price Relative incentives to enter transaction Consistency between actual & reference price Firm s economic utility Product categories Source: Note on Behavioral Pricing, Harvard Business School, Timing of payments Price bundling

48 Common Pricing Mistakes: Pricing too high relative to customers existing value perceptions. Failing to adjust prices from one area to another based upon fluctuating costs and the customer s willingness and ability to pay from one market to another. Attempting to compete on price alone. Setting prices too low with the intention of raising the prices later. Discounting prices.

49 How to respond to low prices. Sharpen your marketing skills. Buy competitors product and resell. Match the price in the short run. Consider the nature of your product and differentiate. Focus on cost control. http//:aesop.rutgers.edu/~farmmgmt

50 Questions? Dr. Robin G. Brumfield Professor and Extension Specialist Rutgers University http//:aesop.rutgers.edu/~farmmgmt

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