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

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Lisa Eades

Written by: Lisa Eades

Reviewed by: Steve Vorster

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 and American Airlines use dynamic pricing strategies
  • 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

Examiner Tips and Tricks

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
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

begin mathsize 14px style text PED =  end text fraction numerator percent sign space change space in space quantity space demanded over denominator percent sign space change space in space price end fraction space equals space fraction numerator percent sign triangle space in thin space QD over denominator percent sign triangle in space straight P end fraction end style

Interpretation of PED Values

Numerical Value 

Explanation

Examples

> 1

ELASTIC

  • Demand is more responsive to a change in price

  • The %∆ in QD is more than proportional to the %∆ in P

  • An increase in selling price reduces the total amount of revenue generated from sales

  • A reduction in selling price increases the total amount of revenue generated from sales

  • 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

  • An increase in selling price increases the total amount of revenue generated from sales

  • A reduction in selling price reduces the total amount of revenue generated from sales

  • 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 understand 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

Price elastic demand

  • The ratio outcome is greater than 1 (Between 1 and ∞)

  • An increase in price will lead to a decrease in revenue

  • A decrease in price will lead to an increase in revenue

screen-shot-2023-02-27-at-3-15-24-pm

Price inelastic demand

  • The ratio outcome is between 0 and 1

  • An increase in price will lead to an increase in revenue

  • A decrease in price will lead to a decrease in revenue

screen-shot-2023-02-27-at-3-15-58-pm

Factors Influencing Price Elasticity of Demand

The factors which determine if a product is more price elastic or price inelastic in 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 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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Lisa Eades

Author: Lisa Eades

Expertise: Business Content Creator

Lisa has taught A Level, GCSE, BTEC and IBDP Business for over 20 years and is a senior Examiner for Edexcel. Lisa has been a successful Head of Department in Kent and has offered private Business tuition to students across the UK. Lisa loves to create imaginative and accessible resources which engage learners and build their passion for the subject.

Steve Vorster

Author: Steve Vorster

Expertise: Economics & Business Subject Lead

Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.