Optimal Pricing Strategy, Essay Example

Introduction

Optimal pricing strategy experiences significant variation across different market structures. The pricing guidelines in a monopoly market are generally straightforward as the company is the only producer that offers it product it may markup the price as far as is bearable to the customer. Pricing guidelines for a producer operating in a perfect competition structure are also fairly intuitive. They are the price takers and therefore price is set at the marginal cost of the product. This is because there are many firms that offer products that are nearly identical to one another.

However, there exists an optimal pricing strategy for market structures offering differentiated products with any competitors (oligopoly) or a few producers (monopolistic competition). These are much more complex and involved. Tests of differentiation in products that create differences in valuation of customers are the most prevalent type of competition. In such markets pricing strategies may include the three C’s of cost, competition and customer. This work in writing will conduct a detailed analysis of optimal pricing strategy followed by a specific company.

Microsoft Xbox 360 Pricing Strategy

For the purpose of this study the pricing strategy of Microsoft Xbox 360 will be examined as reported in the work of Chris McLachlin (2005) who reports that Microsoft launched its second entry into the video gaming console market on Tuesday, November 22, 2005. The video gaming console market is comprised by three competitors:

1. Sony (PlayStation);
2. Nintendo (GameCube) and
3. Microsoft. (McLachlin, 2005)

Sony is sated to have sold 96 million PlayStation 2 boxes since 2000 and Microsoft’s Xbox, has sold 22 million units since 2001 with Nintendo’s GameCube trailing with only 19 million in sales.   The hopes of Microsoft to improve its market share was focused on achieving the goal of moving first in the latest release of consoles in what is an oligopolistic market and to have competitive advantage as compared to Sony and Nintendo. Microsoft launched its console first in the hopes that it would attract a key segment of the gaming market and specifically the “die-hard gamers (early adopters) and get those consumers who are planning to replace their last generation of gaming consoles with an Xbox 360.

Managerial Pricing Strategies

Pricing strategies in managerial pricing strategy content include those of:

1. Limit pricing strategy that sets less than monopoly prices to deter competitors entry into the market;
2. Predatory pricing is pricing below marginal cost. Should Microsoft wish to become familiar with their community. (McLachlin, 2004)

Since Microsoft has an inability in meeting the initial demand when the Xbox 360 is launched, the low supply also helps them justify the higher price of the  Xbox 360

The game console market is best described, according to McLaughlin (2004) as an oligopolistic market. The ogliopolistic market in this particular case is differentiated by the various products and services although the Sony, Nintendo and Microsoft game consoles while differentiated from one another also results in the competitor gaining market share focused don the gain of additional economic profits due to games and peripherals sale within the Oligiopolistic market there is often competition therefore the strategic analysis and pricing strategies that are effective. There are two primary groups of consumers in the gaming console market:

1. Early adopters; and
2. Followers. (McLachlin, 2004)

Microsoft Pricing Strategy

The pricing strategy used by Microsoft is one in which a “skimming strategy” has the advantage of allowing early-stage adopters focus on customers for who the product holds the highest value and who pay the next most.” (McLachlin, 2004) After Microsoft has secured a significant number of the early adopters, they will reduce the Xbox 360 price and meet the reservation price of even more consumers.

The optimal pricing strategy is a ‘fixed markup over marginal costs’ in which the optimal markup is determined by the elasticity. As marginal costs increase the price of a product the degree of competitive serves to decrease the price. The price is therefore determined by the marginal costs and the degree of competition.

According to the work of  Kelly (2005)  on price elasticity and the optimal pricing policy “A Price Elasticity of Demand Elasticity measures the degree of pricing power or the degree of competition in the industry” (Kelly, 2005) Furthermore, “If the elasticity is between 0 and -1, the _rm can increase prices and lose relatively few customers, thus increasing profits.”(Kelly, 2005)

Determinants of elasticity are stated to include:

1. The level of competition;
2. The degree of product differentiation which increases elasticity;
3. The level of income which decreases elasticity; and
4. The length of time which decreases elasticity

The optimal pricing policy is a fixed markup over marginal costs and is determined by the elasticity therefore, marginal costs increase the price and the degree of competition decreases the price.

When evaluating pricing strategies and specifically price discrimination it is stated that there are digress of discrimination which is listed as follows:

1. First degree: discriminate against every customer.
2. Second degree: discriminate based on quantity purchased.
3. Third degree: discriminate against a group.

Pitfalls of Pricing Discrimination are stated to include those as follows:

1. Discrimination requires a lack of competition.
2. There are costs to acquiring information about customers.
3. A target group is not always easy to identify.
4. Arbitrage can sometimes result.
5. Price discrimination can be illegal. (Kelly, 2005)

Stated to be an example of a ‘simple markup rule’ is that as follows:

Suppose the elasticity of demand for the firm’s product is E?

Since MR =P[1+E?]E?.

Setting MR=MC and simplifying yields its simple pricing formula

P=[E?.(1+E?)] x MC.

The option price is a simple markup over relevant costs. When used the demand is more elastic and markup is lower as well as the costs being more elastic. The less elastic the demand then the higher the markup. (Managerial Economics and Business Strategy, 2005)

Summary and Conclusion

This brief study has indicated that the optimal pricing strategy is determined is a ‘fixed markup over marginal costs’ in which the optimal markup is determined by the elasticity. As marginal costs increase the price of a product the degree of competitive serves to decrease the price. The price is therefore determined by the marginal costs and the degree of competition as well as the price elasticity in pricing. That which determines elasticity include such as: (1) the level of competition; (2) the degree of  (2) the degree of product differentiation which increases elasticity;  (3) the level of income which decreases elasticity; and (4) the length of time which decreases elasticity. The optimal pricing policy is a fixed markup. The optimal pricing policy is a fixed markup over marginal costs and is determined by the elasticity therefore, marginal costs increase the price and the degree of competition decreases the price.

References

Kelly, David L. (005) Managerial Economics. Spring 2005. Retrieved from : http://moya.bus.miami.edu/~dkelly/teach/eco685/mid2study.pdf

Mclachlin, Chris (2005) Microsoft Pricing Strategy
Xbox 360. 23 Nov 2005. Retrieved from: http://www.chrismclachlin.com/wp-content/uploads/2009/07/PricingStrategyXbox.pdf

Managerial Economics & Business Strategy. Chapter 11 Pricing Strategies for Firms with Market Power. Retrieved from Slideshare online at: http://www.slideshare.net/Alistercrowe/managerial-economics-4076903