World of Business: Focus on Business Pricing

What do prices mean and how are they set. A recent BBC World of Business podcast explored this and other issues.

The programme featured the success of Poundland - now a major presence on the high street,

Poundland (founded by Steve Smith) is now valued on the stock market at more than £650m - the founders are now diversifying into a cut price estate agency (creative destruction in action!)

The 2008-09 recession and its aftermath has seen a rapid expansion of discount price retailers who continue to threaten the dominance of established supermarkets

Morrisons has faced particular pressure with declining sales and profits. They recently announced £1bn of "price cuts" over the next three years - the "middle of the market chains" face intense pressure - how can they finance these price drop campaigns?

• Lower profit margins
• Advertise less and use the money to cut prices on key lines
• Squeeze the suppliers by asking for bigger price discounts - using supermarket monopsony power

There is increasing use of "price match" schemes - a form of tacit price collusion / price leadership

Supermarkets often make more money from what they buy than what they sell - there is huge competition among suppliers to get the right shelf space for their products into supermarkets. Many suppliers happy to pay for the promotional materials in the main supermarkets

Profit margins in the supermarkets are usually between 4-7% - low margin but high volume

Manufacturers make operating profit margins between 8-40% - a big opportunity for businesses with strong monopsony power

Theories of pricing - the importance of consumer perception

Price is central to all markets

In competitive markets, firms will usually price what the market will bear

Mark-up pricing (average wholesale or supply cost + profit) is still common - mark up depends in part on the price elasticity of demand

Price can also be an indicator of quality and exclusivity but this is not as frequent in the real world as some textbooks might suggest

Prices have a lot to do with consumer perceptions of value rather than the cost of production/supply

A classic example is the marketing of the Magnum ice-cream on a stick - reinventing vanilla ice-cream covered in chocolate and charging a premium price for it

Red Bull - charging a higher price for a smaller product - creating a perception in the minds of people

Psychology of consumer marketing

Colours of numbers on price labels make a difference to perceptions of a price discount

Women analyse prices in more detail

Airline pricing

Seats on a flight are the most perishable consumer item of all

Airlines are masters of dynamic pricing - most airlines have a yield management department

Airlines set a base fare that reflects standard market conditions and the prices of competitors

Demand factors affecting load factors e.g. special events at destinations

Previous buying history (cookies)

Low cost airlines will increasingly have to offer better services / extras to continue their growth e.g. flexible tickets, selected seats, fast track through security - typically associated with full cost airlines.