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[Instructor] Hello and welcome

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to this week's topic which is pricing.

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So we'll think about

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how do you price your product

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or your service.

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How do you know what's a good price?

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What are the strategies involved here

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to get an effective price?

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So we'll start with the basic parameters

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and I'm gonna talk about three of them.

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Cost-based, competition-based,
and customer-based.

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And then wanna walk through

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some basic strategies and vocabulary.

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So why does it matter?

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Why are we spending whole week on this?

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Why is it important

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to have the right price?

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What happens if the price is too low?

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And what happens if the price is too high?

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I'll let you think about it

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at this minute.

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So a price too low, it might mean

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that it doesn't even cover your costs.

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So you're selling something at a loss

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or just if it's below what people

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can reasonably expect to pay,

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then you lose that little bit

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of margin on every sale.

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And also, price can be
an indicator of quality.

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And what happens if you price it too high?

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Well, it might be so high

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that nobody will buy it.

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So there are some basic parameters here.

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The price ceiling

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is consumer willingness to pay.

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So what is the most

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that anybody is willing to pay?

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Then in economics,

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we call this the reservation price.

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So if you could read somebody's mind

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and learn what is the
absolute maximum price

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that they would be willing to pay.

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That's called the reservation price.

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And the very bottom,

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the price floor are your costs

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that for the most part,

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if the price that you charge

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doesn't cover all of your costs,

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you're going to be losing money

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and you will not be in business for long.

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And then in the middle,

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there's a lot of,

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a lot of middle ground here

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but you can think about

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what do your competitors charge?

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What is the going rate

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in the marketplace for a product

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or service like yours?

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I imagine a lot of you

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have had this already

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but I wanna make sure

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that you know it.

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So variable costs are those that change

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depending on how much you produce.

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So if you're a farmer,

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the more that you grow,

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the more labor that you use

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and the more you'll
have to spend on labor.

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The more you grow,

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you'll need to spend more

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on inputs like seeds.

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If you're a coffee shop,

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the longer that you're open

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or the more busy that you are,

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the more you have to pay for little labor,

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the more coffee and other supplies.

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And in many times,

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marketing is a variable cost.

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And so if you are spending a percentage

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And so if you are spending a percentage

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of income on marketing,

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then that would clearly
be a variable cost.

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In contrast, fixed costs

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also known as overhead costs

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are those that do not change.

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So no matter what you do,

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how much you produce,

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some things are kind of fixed

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like your rent or your mortgage,

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the cost of equipment, in many cases,

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the cost of office supplies.

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Whether you grow and sell a lot

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or don't grow or sell anything,

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just being in business,

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you have these overhead costs.

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And in some cases,

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marketing might be fixed too.

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So if you buy an advertisement

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on some media for a
fixed amount over time,

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then this would be a fixed cost.

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So it's kinda depend.

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So one example of cost-based pricing

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is to add up all of your costs.

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And we'll see a few examples.

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So you add up all your fixed costs.

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You add up all your variable costs

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to get your total costs

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and then you divide

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by the expected volume.

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So this is what we call
the break-even price.

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This is what that which you would charge

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which would just cover all

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of your costs and no more.

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So at the end of the day,

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if you sell everything,

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you don't make any money.

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You don't lose any money.

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You exactly break-even.

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So you can think about

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what would be cost like this

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for a business like a restaurant?

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What would be for a service business?

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For your business?

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So think about what would
be the various fixed

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and variable costs that you might incur

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for your business.

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So two pricing strategies based on cost

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are cost-plus and target based.

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And I will run you through each one.

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So cost-plus is where you
have a standard markup

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and this is fairly common

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in the retail industry.

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So you base it on how much

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you are buying something for.

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So you say that you're
buying an item for $20

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and this is what we call COGS

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or cost of goods sold.

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So you might have a fixed 50% markup.

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So you take that $20 to multiply

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So you take that $20 to multiply

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times 0.5 and add it on.

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So you sell the good for $30.

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This is a 50% markup.

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And since your margin is $10

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on a $30 good, your margin is 33%.

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And these are terms

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that you will hear a lot

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if you use this model.

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A more interesting one perhaps came about

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and I'm going to cite an example

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of work I did with a number

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of organic farmers some years ago.

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So imagine that there's a farmer.

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Her name is Sue.

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And she raises fresh produce on 10 acres.

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She decides that $60,000 is her goal.

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That is a viable income for her family.

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That is the minimum

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that she will wanna earn

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to make it worth her while.

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So she has to earn 6,000 an acre.

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60,000 net divided by 10 acres.

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And she grows a lot of things

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including one fourth acre of carrots.

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So she adds up all her costs.

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She pays 200 for seeds

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and fuel and stuff.

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She pays 300 for marketing

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for all the farmers market stalls fees

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and fixed costs of 500.

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And so her cost

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of growing this crop is $1,000

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and she expects a yield of 4,500 pounds.

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So if you take this 1,000

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and divide it by 4,500,

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that is her break-even price.

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Now, since she wants

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to earn 6,000 net per acre

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on one fourth of an acre,

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she wants to add 1,500.

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So she adds this the thousand

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to the thousand costs

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to 1,500 target net

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and provides this yields
56 cents per pound.

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So this should be sort of the minimum

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that she should charge

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to earn what she hopes to earn.

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And note that this assume

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that she sells all that she grows.

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So as in almost everything else in life,

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this approach has pros and cons.

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The pros is it's fairly straightforward.

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If it's done right,

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it will show our profit

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and it stems from break-even analysis

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and knowing your costs.

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So it's really important

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to know your costs.

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The con are, it doesn't really look

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at what your customers wanna pay,

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what your competitors are charging.

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And again, there's no signal of quality.

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So as I had said,

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price can be a powerful signal of quality.

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And if it doesn't reflect that,

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it could send the wrong signal.

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That might be that you charge too little

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and someone will think
there's something wrong

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with your good and won't buy it.

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We're gonna spend some time in class

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but think about and come

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with a number of reasons.

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Why is it important for a business

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to know its costs?

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And be ready to discuss this in class.

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So another thing that
you should think about

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is how much someone is willing to pay?

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So here is a demand curve.

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So you can see,

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price is on the y-axis

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and quantity is on the x.

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And it basically tells

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how much will you sell

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if you offer at this price?

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Or what is the demand?

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So you can see, at a very high price,

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hardly anybody will be
willing to pay this.

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But then at a low price, a lot are.

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The slope of this line

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is determined by the elasticity.

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And we will talk in class

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about what elasticity means

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and some examples of this.

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But it might be good

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to bone up on this concept

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if you haven't had it in class

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or maybe haven't had it in a while.

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But what determines elasticity?

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So here are a number of factors that

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determine what is a good price.

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So and this is from the supplier's

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or the seller's standpoint.

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Hopefully, these all make sense.

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Have a look.

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Bring a list of any questions

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that you might have to class.

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But in each case,

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these are from the seller's standpoint.

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What you can expect from the price?

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The final set is competition-based.

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So it looks at

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what are similar products

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being sold for in the marketplace?

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What is the going rate?

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So you can think about the going rate

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is sort of,

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that if you wanna charge the same amount.

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And then if you want

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to charge slightly above that

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where you're positioning it

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as a higher quality good,

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this is called skimming.

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And if you sell it slightly below that,

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positioning as a bargain,

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then this is called penetration.

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And I will discuss each one.

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So a skimming strategy.

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So you can think of this sort

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of skimming a little bit

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of profit off the top.

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So you're charging a slightly higher price

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so you can skim a little bit of profit.

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So you're positioning your good

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as a premium good, high quality

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that there will be a strong desire,

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high value, high perceived benefit.

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They're gonna tend to sell this to folks

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that are not quite as price-sensitive.

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So in a more inelastic market

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maybe at times

281
00:13:44,244 --> 00:13:47,488
when you have fewer direct competitors

282
00:13:47,488 --> 00:13:51,894
and this is often used in the beginning

283
00:13:51,894 --> 00:13:55,004
that if you wish to recoup
your development cost,

284
00:13:55,004 --> 00:13:56,618
you position it

285
00:13:56,618 --> 00:14:01,375
as a new unique premium product

286
00:14:01,375 --> 00:14:03,253
and sell slightly above

287
00:14:03,253 --> 00:14:06,663
what you think would be the going rate.

288
00:14:10,320 --> 00:14:11,380
On the other side,

289
00:14:11,380 --> 00:14:15,625
if you sell it slightly
below this going rate

290
00:14:15,625 --> 00:14:18,930
so you can position it as a bargain.

291
00:14:18,930 --> 00:14:19,763
Here, you will sell

292
00:14:19,763 --> 00:14:22,882
to more price-sensitive customers.

293
00:14:22,882 --> 00:14:26,730
You may discourage competitors

294
00:14:26,730 --> 00:14:29,872
that this is good for elastic demand

295
00:14:29,872 --> 00:14:32,493
and things that have a low entry costs.

296
00:14:38,878 --> 00:14:41,634
Here's an approach that I think

297
00:14:41,634 --> 00:14:45,030
is interesting and has some merit.

298
00:14:45,030 --> 00:14:49,744
So there is a non-profit

299
00:14:49,744 --> 00:14:52,470
fresh produce broker

300
00:14:52,470 --> 00:14:56,610
in the northeast here called Red Tomato

301
00:14:56,610 --> 00:15:00,502
and their job is to sell farmer's produce

302
00:15:00,502 --> 00:15:02,502
to local buyers.

303
00:15:02,502 --> 00:15:05,673
In many cases, to supermarket chains.

304
00:15:06,540 --> 00:15:09,493
And they have a conversation

305
00:15:09,493 --> 00:15:12,273
with farmers each year.

306
00:15:14,987 --> 00:15:17,610
They ask for three things.

307
00:15:17,610 --> 00:15:20,871
First, what is their aspirational price?

308
00:15:20,871 --> 00:15:23,506
What's a really good price

309
00:15:23,506 --> 00:15:26,010
that they hope that they can get?

310
00:15:26,010 --> 00:15:28,880
Realistic but optimistic.

311
00:15:28,880 --> 00:15:30,730
What would be a really good price?

312
00:15:30,730 --> 00:15:34,635
What would they really
realistically hope to get?

313
00:15:34,635 --> 00:15:37,894
Two, what was last year's average price?

314
00:15:37,894 --> 00:15:40,500
What did you get last year for it?

315
00:15:40,500 --> 00:15:42,237
And three, and this is kind

316
00:15:42,237 --> 00:15:45,135
of the interesting part.

317
00:15:45,135 --> 00:15:47,619
What is their dignity price?

318
00:15:47,619 --> 00:15:52,155
So they define this as the price,

319
00:15:52,155 --> 00:15:55,886
the lowest price that a farmer can accept

320
00:15:55,886 --> 00:15:57,480
without feeling like they're losing

321
00:15:57,480 --> 00:15:59,653
both money and dignity.

322
00:15:59,653 --> 00:16:02,260
So what is the lowest price

323
00:16:02,260 --> 00:16:04,504
that the farmer will accept

324
00:16:04,504 --> 00:16:06,867
and feel like they're not being had,

325
00:16:06,867 --> 00:16:10,001
that they're not being taken advantage to?

326
00:16:10,001 --> 00:16:12,901
And of course, when Red Tomato goes out

327
00:16:12,901 --> 00:16:15,755
and negotiates prices,

328
00:16:15,755 --> 00:16:18,960
they wanna get as close to one

329
00:16:18,960 --> 00:16:20,190
and as far away

330
00:16:20,190 --> 00:16:24,879
and always be preferably above

331
00:16:24,879 --> 00:16:27,903
or at very worst at three.

332
00:16:33,493 --> 00:16:35,142
Here's another heads up

333
00:16:35,142 --> 00:16:38,635
for a discussion we will have in class.

334
00:16:38,635 --> 00:16:41,460
So here are two approaches

335
00:16:41,460 --> 00:16:44,505
where each time you go out to sell,

336
00:16:44,505 --> 00:16:47,746
you bargain with multiple buyers

337
00:16:47,746 --> 00:16:49,882
and find the highest price

338
00:16:49,882 --> 00:16:51,002
that you can get

339
00:16:51,002 --> 00:16:53,670
for that batch of goods.

340
00:16:53,670 --> 00:16:56,883
Or two, working with a single buyer

341
00:16:56,883 --> 00:16:57,814
to get a fair

342
00:16:57,814 --> 00:16:59,753
but maybe slightly lower price

343
00:16:59,753 --> 00:17:03,363
but a more consistent price each time.

344
00:17:04,680 --> 00:17:05,513
Both of these may work.

345
00:17:05,513 --> 00:17:06,346
I'm not saying one

346
00:17:06,346 --> 00:17:08,131
is better than the other

347
00:17:08,131 --> 00:17:11,504
but there are some
clear pros and cons here

348
00:17:11,504 --> 00:17:12,388
and I would like you

349
00:17:12,388 --> 00:17:13,895
to think about what they are

350
00:17:13,895 --> 00:17:17,583
and be ready to discuss them in class.

351
00:17:22,110 --> 00:17:22,943
I wanna talk to you now

352
00:17:22,943 --> 00:17:25,489
about two more concepts

353
00:17:25,489 --> 00:17:26,753
that of a loss leader

354
00:17:26,753 --> 00:17:28,833
and that of bundling.

355
00:17:31,738 --> 00:17:34,502
The first concept is loss leader.

356
00:17:34,502 --> 00:17:35,744
So this is a time

357
00:17:35,744 --> 00:17:37,991
where you sell a good

358
00:17:37,991 --> 00:17:40,890
at a very low price

359
00:17:40,890 --> 00:17:43,137
maybe even less than

360
00:17:43,137 --> 00:17:44,988
what you paid for it.

361
00:17:44,988 --> 00:17:46,378
But the idea is,

362
00:17:46,378 --> 00:17:50,250
it brings the customers into the store.

363
00:17:50,250 --> 00:17:51,873
And once they're there,

364
00:17:51,873 --> 00:17:55,743
they will buy a whole
bunch of other things.

365
00:17:55,743 --> 00:17:58,744
So the classic example of this

366
00:17:58,744 --> 00:18:01,590
is Thanksgiving turkeys.

367
00:18:01,590 --> 00:18:04,505
So right before Thanksgiving,

368
00:18:04,505 --> 00:18:07,257
you'll often see grocery stores

369
00:18:07,257 --> 00:18:10,240
offering a really, really
low price on turkeys

370
00:18:10,240 --> 00:18:13,140
offering a really, really
low price on turkeys

371
00:18:13,140 --> 00:18:15,500
with the hope that that bargain

372
00:18:15,500 --> 00:18:17,883
will draw people into the store

373
00:18:17,883 --> 00:18:19,619
and while they're there,

374
00:18:19,619 --> 00:18:23,495
that they will buy all
the other ingredients

375
00:18:23,495 --> 00:18:25,012
for their Thanksgiving dinner

376
00:18:25,012 --> 00:18:28,000
like cranberry sauce and sweet potatoes

377
00:18:28,000 --> 00:18:31,443
and stuffing and all the other things.

378
00:18:33,030 --> 00:18:36,144
What they hope that they do not do

379
00:18:36,144 --> 00:18:38,742
is what is called cherry picking

380
00:18:38,742 --> 00:18:42,240
which is walk into the store,

381
00:18:42,240 --> 00:18:44,670
buy the cheap turkey,

382
00:18:44,670 --> 00:18:46,992
don't buy anything else, leave,

383
00:18:46,992 --> 00:18:50,258
and buy the other items

384
00:18:50,258 --> 00:18:52,239
at another store.

385
00:18:52,239 --> 00:18:54,303
So that's the danger there.

386
00:18:57,390 --> 00:19:01,680
Another strategy is bundling

387
00:19:01,680 --> 00:19:06,134
where you offer a bundle of goods

388
00:19:06,134 --> 00:19:09,754
or services at a price that is less

389
00:19:09,754 --> 00:19:13,830
than the sum of the individual ones.

390
00:19:13,830 --> 00:19:17,400
So Burlington Telecom

391
00:19:17,400 --> 00:19:21,383
who I get my WiFi from offers this

392
00:19:21,383 --> 00:19:23,870
and so do a lot of other...

393
00:19:26,880 --> 00:19:30,899
telecom providers that
if you get all three,

394
00:19:30,899 --> 00:19:32,740
if you get cable, landline,

395
00:19:32,740 --> 00:19:35,642
phone and internet, all through them,

396
00:19:35,642 --> 00:19:37,907
that they will give you a lower price

397
00:19:37,907 --> 00:19:40,645
than you would get than if you just

398
00:19:40,645 --> 00:19:43,893
then the sum of them individually.

399
00:19:45,238 --> 00:19:47,748
Insurance is another one.

400
00:19:47,748 --> 00:19:49,397
So if you bundle your home

401
00:19:49,397 --> 00:19:51,127
and car insurance,

402
00:19:51,127 --> 00:19:53,590
they will offer you

403
00:19:56,850 --> 00:19:58,136
premiums that are less than

404
00:19:58,136 --> 00:19:59,253
what you would pay

405
00:19:59,253 --> 00:20:02,103
if you just got each one individually.

406
00:20:08,135 --> 00:20:09,892
The final concept that I want

407
00:20:09,892 --> 00:20:10,989
to introduce to you

408
00:20:10,989 --> 00:20:15,243
is the idea of price discrimination.

409
00:20:15,243 --> 00:20:18,009
So this is simply
charging different prices

410
00:20:18,009 --> 00:20:20,622
So this is simply
charging different prices

411
00:20:20,622 --> 00:20:24,210
for the same item to different people.

412
00:20:24,210 --> 00:20:27,303
So there are three degrees of this.

413
00:20:28,170 --> 00:20:31,482
So the first one is so-called perfect

414
00:20:31,482 --> 00:20:35,490
or first degree price discrimination.

415
00:20:35,490 --> 00:20:38,237
This is really only a theoretical thing

416
00:20:38,237 --> 00:20:41,100
that it wouldn't be realistic

417
00:20:41,100 --> 00:20:41,986
to actually do it

418
00:20:41,986 --> 00:20:46,132
but this is to charge
everybody's reservation price.

419
00:20:46,132 --> 00:20:49,754
So whenever you encounter a buyer,

420
00:20:49,754 --> 00:20:50,999
you can read their mind

421
00:20:50,999 --> 00:20:51,985
and know what the most

422
00:20:51,985 --> 00:20:53,739
that they would ever pay was

423
00:20:53,739 --> 00:20:56,639
and charge of that.

424
00:20:56,639 --> 00:21:00,230
Next is second degree.

425
00:21:00,230 --> 00:21:03,138
This is where you charge a different price

426
00:21:03,138 --> 00:21:05,370
based on quantity bought.

427
00:21:05,370 --> 00:21:08,494
So this is an example of a bulk discount.

428
00:21:08,494 --> 00:21:10,873
So the more that you buy,

429
00:21:10,873 --> 00:21:14,888
the lower the per unit cost.

430
00:21:14,888 --> 00:21:17,900
And we see this very often.

431
00:21:17,900 --> 00:21:19,747
Say in dog food,

432
00:21:19,747 --> 00:21:22,151
the per pound price

433
00:21:22,151 --> 00:21:23,997
for a five pound bag of dog food

434
00:21:23,997 --> 00:21:25,995
is greater than the per pound price

435
00:21:25,995 --> 00:21:28,473
for a 50 pound.

436
00:21:29,610 --> 00:21:32,004
And finally, there's third degree

437
00:21:32,004 --> 00:21:34,238
which is different prices

438
00:21:34,238 --> 00:21:36,243
to different people and it's sort

439
00:21:36,243 --> 00:21:38,751
of offering different prices

440
00:21:38,751 --> 00:21:40,632
to different segments.

441
00:21:40,632 --> 00:21:43,247
So there's geographic.

442
00:21:43,247 --> 00:21:48,247
So a farmer might charge a bit more.

443
00:21:48,450 --> 00:21:49,283
If they sell

444
00:21:49,283 --> 00:21:52,386
at the Shelburne Farmer's Market thinking

445
00:21:52,386 --> 00:21:57,133
that there are more affluent
buyers in Shelburne,

446
00:21:57,133 --> 00:21:59,256
charge a bit less in the old north end

447
00:21:59,256 --> 00:22:02,739
where there are fewer well-off buyers.

448
00:22:02,739 --> 00:22:06,540
where there are fewer well-off buyers.

449
00:22:06,540 --> 00:22:08,747
There's also demographic.

450
00:22:08,747 --> 00:22:10,887
So many places will offer

451
00:22:10,887 --> 00:22:13,755
a senior citizen's discount.

452
00:22:13,755 --> 00:22:15,881
Others will offer a student discount.

453
00:22:15,881 --> 00:22:17,644
So here, it's based on age

454
00:22:17,644 --> 00:22:21,400
or by occupation where you say like,

455
00:22:21,400 --> 00:22:24,420
where they will offer you a bargain

456
00:22:24,420 --> 00:22:25,509
if you're a student

457
00:22:25,509 --> 00:22:29,013
and you may have to show your student ID.

458
00:22:30,480 --> 00:22:34,863
And last is behavioral.

459
00:22:34,863 --> 00:22:39,510
And I'm gonna talk about the hurdle model

460
00:22:39,510 --> 00:22:40,748
in the next one.

461
00:22:40,748 --> 00:22:44,160
But an idea is the early bird.

462
00:22:44,160 --> 00:22:49,123
So if you go into a restaurant

463
00:22:49,123 --> 00:22:50,634
and order your meal,

464
00:22:50,634 --> 00:22:54,251
let's say four o'clock or five o'clock

465
00:22:54,251 --> 00:22:57,268
when it's not really very busy,

466
00:22:57,268 --> 00:23:00,249
they may offer you a better price

467
00:23:00,249 --> 00:23:02,389
on the meal knowing

468
00:23:02,389 --> 00:23:06,630
that they have capacity there.

469
00:23:06,630 --> 00:23:09,722
They're open, they already have the cooks

470
00:23:09,722 --> 00:23:11,255
and wait staff there.

471
00:23:11,255 --> 00:23:15,009
And to sort of use that excess capacity,

472
00:23:15,009 --> 00:23:17,620
they might offer

473
00:23:18,630 --> 00:23:21,633
an early bird special on dinner.

474
00:23:26,744 --> 00:23:30,180
So the hurdle model looks at,

475
00:23:30,180 --> 00:23:32,512
again, it's different prices

476
00:23:32,512 --> 00:23:34,750
for different behavioral segments.

477
00:23:34,750 --> 00:23:38,550
And this is an example of third degree.

478
00:23:38,550 --> 00:23:41,632
And it's basically offering a lower price

479
00:23:41,632 --> 00:23:45,270
for someone who will jump over a hurdle.

480
00:23:45,270 --> 00:23:46,103
It isn't a real hurdle.

481
00:23:46,103 --> 00:23:49,633
It's a conceptual hurdle.

482
00:23:49,633 --> 00:23:54,491
So things like people really don't like

483
00:23:54,491 --> 00:23:57,510
to fly on a Saturday

484
00:23:57,510 --> 00:24:01,250
or especially fly on Christmas day.

485
00:24:01,250 --> 00:24:03,330
So if you'll fly on that,

486
00:24:03,330 --> 00:24:04,510
if you'll jump over

487
00:24:04,510 --> 00:24:06,617
that hurdle of inconvenience,

488
00:24:06,617 --> 00:24:11,232
they'll give you a lower price.

489
00:24:11,232 --> 00:24:12,900
Scratches and dents sale.

490
00:24:12,900 --> 00:24:14,991
So appliances that might

491
00:24:14,991 --> 00:24:18,628
have a slight scratch or dent

492
00:24:18,628 --> 00:24:22,506
or a second sale

493
00:24:22,506 --> 00:24:24,647
at a clothing store.

494
00:24:24,647 --> 00:24:26,634
It has a slight defect

495
00:24:26,634 --> 00:24:30,717
or slightly oddly shaped chocolates.

496
00:24:30,717 --> 00:24:32,517
or slightly oddly shaped chocolates.

497
00:24:34,496 --> 00:24:38,753
They'll offer for a lower price

498
00:24:38,753 --> 00:24:41,745
or mailing in a rebate.

499
00:24:41,745 --> 00:24:45,129
So in each case, the consumer

500
00:24:45,129 --> 00:24:49,258
has to endorse some sort of inconvenience

501
00:24:49,258 --> 00:24:51,958
or slightly lower quality

502
00:24:51,958 --> 00:24:54,505
or slightly lower quality

503
00:24:54,505 --> 00:24:56,238
to get the discount.

504
00:24:56,238 --> 00:25:00,391
And the ideal is that the hurdle

505
00:25:00,391 --> 00:25:03,372
should be such that only those

506
00:25:03,372 --> 00:25:06,767
who wouldn't pay the higher price

507
00:25:06,767 --> 00:25:08,501
will go to the bother

508
00:25:08,501 --> 00:25:09,734
and those that are willing

509
00:25:09,734 --> 00:25:12,883
to pay the higher price

510
00:25:12,883 --> 00:25:17,160
won't bother to jump over it.

511
00:25:17,160 --> 00:25:19,140
So it has to be such

512
00:25:19,140 --> 00:25:20,998
that the hurdle makes those

513
00:25:20,998 --> 00:25:23,394
who require a discount sort

514
00:25:23,394 --> 00:25:25,653
of reveal themselves.

515
00:25:29,956 --> 00:25:33,390
So you should be able to rank these

516
00:25:33,390 --> 00:25:35,403
and maybe we'll do it in class.