Key demand side factors affecting price

INTRODUCTION:

This part of the coursework aims to identify and explain the various key demand side drivers which influence the price of a product or service. The price of a good or service is basically the sum of the cost of material, Processing costs and profit margins but in the real time the Price is largely affected by the demand of the product. For example for the Precious stones like gold, platinum the demand is high and the price is also high. The Price of the product and demand of the product are directly proportional to each other.

DEMAND:

Demand is a major factor which affects the price of a product or service. This represents the quantity demanded for a particular product at a particular price. There is a negative relationship between price and quantity demanded. (Begg & Ward, 2010)

Demand Curve: The Graph shows the price along Y-axis and Quantity along X axis and it shows that when the price changes from P0 to p1 there is a rise in the demand of the quantity (Q1- Q0) demanded for a product or service .There is negative relationship between the Demand and the price of the product.

Source: Lowes, 2010

INCREASE IN DEMAND Vs PRICE:

The Graph shows the price along Y-axis and Quantity along X axis and it shows that when the Demand raises from D0 to D1 there is a rise in the Price from P0 to P1 the quantity also rises from Q0 to Q1.Thus increase in demand increases the price of the product.

DECREASE IN DEMAND VS PRICE:

Source: Lowes, 2010

The Graph shows the price along Y-axis and Quantity along X axis and it shows that when the Demand falls from D0 to D1 there is a fall in the Price from P0 to P1 the quantity also falls from Q0 to Q1.Thus decrease in demand decreases the price of the product.

Qd is the quantity demanded

P – Product Price

Ps – Price of substitutes

Pc – Price of the complements

I – Consumer income

N – Number of consumers

…. Other factors. There are various demand side drivers which affect the price of the good or service.

Source: Call & Hollahgan, 2008

CONSUMER INCOME:

Consumer income is one of the main factors affecting the demand and the price of the product. The disposable income increases when income increases and it changes the consumption pattern. Demand of Normal Products is more during Boom and consumer income increases, whereas during Recession and when the income falls, more of inferior goods are sought and less of superior products. This change in consumption pattern which rises due to the consumer income affects the demand of the product and its price. But then for certain products which fall under the Autonomous consumption demand is always high.

CONSUMERS PREFERENCE AND CHOICES:

Preferences and tastes change over the period of time and change is the constant thing. A positive change in the consumers’ preference or taste will bring in a demand for the product and vice versa. This change also affects the demand and finally affecting the price of the product. For instance In Bradford, Mumtaz the Indian Restaurant is demanded more than Karachi another Indian restaurant because of the consumers taste and the prices are also evident because of the demand.

AVAILABILITY AND PRICE OF SUBSTITUTES:

The demand for Walkmans were high during the mid nineties and even in the early 2000 but at the advent of MP3 Players and i-Pods the demand for them dropped as well the prices of those products and eventually wiped them out of the market. Thus the availability and price of substitutes will affect the demand and the price of the product. Another example is the Digital Cameras replacing the Film roll based Kodak cameras.

AVAILABILITY AND PRICE OF COMPLEMENTS:

A classic example is generally whenever there is a rise in the oil prices the demand of the cars drops. Thus there is a relation between the main and the complementary product because it is to be used together. During 2008 when the oil prices were $148, Car manufacturers concentrated on CNG, LPG Cars. (Market line, 2008) Thus the availability and the price of complements affect the demand and finally drive the prices.

PRICE EXPECTATIONS:

Median_and_Average_Sales_Prices_of_New_Homes_Sold_in_United_States_1963-2008_annual.png

(Source: Government census- Housing Crisis, 2010)

The Graph shows the price of the house along Y-axis and Year along X axis and it shows that during 2006 and 2007 there was a expectation among People that Prices of the Houses will fall and hence demand for Houses fell followed by the prices because of the future price expectations that Price will fall.

Price Expectations will always drive the demand and the price of the product. When customers expect that the price will rise, there is rush to buy more and the demand increases. For example: House demand in US in mid 2000. When customers expect prices will fall they withhold and postpone buying and thus the demand falls and the price also falls. The aftermath of the Sub Prime crisis was when houses were sold even for 1$. (Telegraph, Property Crisis, 2010)

PRICE OF THE PRODUCT:

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The Graph shows the revenue from Apple’s i-pod along Y-axis and Time line along X axis and it shows that revenue increased drastically in 2005 when the Apples Average Price per unit is reduced. Thus the Price of the Product itself can create a demand and increase sales.

Source: Apple revenues -2010

The Price is directly in relationship with the demand and the more the price the less is demanded when the price falls more is demanded and there is a negative relationship between the price and demand.

ADVERTISING AND PROMOTION:

Advertising conveys the information of the products to the customers and develops the consumer behaviour. Promotion also lures the customers and increases the demand of the product. In both the cases the prices will be affected and will follow demand. The impact of Advertisements on the customer buying pattern is given below.

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(Source: Relationship between Sales and Advertising, Scott m smith &William, 05.04.10)

The Graph shows the relationship between sales and advertising. Demand can be created by means of advertising and sale of the product can be increased and the traditional expectations for Advertising Sales relationship are shown above.

PRODUCT QUALITY:

Quality speaks for itself in the product. Sellers choose between producing high quality goods which gives low profits today but increases probability of future survival in the market and low quality ones which give higher returns today but lowers future survival. Demand drives the quality of the Products. The economy may move into high demand, high Quality Products or low demand, low quality products. Additionally Quality drives buyers to buy repeatedly which increases the demand of the Product. For example the demand of the services of a Neurosurgeon will be high because of the perceived high quality of his work.

DEMOGRAPHY:

The various demographic segments also contribute to the demand of the products. For instance Japan where there is 20.1% elderly population will demand less of Young fashionable products but more of health care products. Thus the demography of the country will drive the demand for different products and affects the Price of the Products also.

The percentage to which demand changes by the percentage of change in price is known as Price elasticity of demand.

PRICE ELASTICITY OF DEMAND:

PriceQuantity

Price

30 GBP

100

20 GBP

200

Inelastic Demand

30 GBP

20 GBP

800

100

Quantity

Elastic Demand

The Graph shows the Price of the product along Y-axis and quantity demanded on X axis and left graph shows a small change in the price brings a small change in the quantity sold (Inelastic Demand) whereas in the graph at the right shows a small change in the price brings on a big change in the quantity demanded which is elastic demand. The table down below demonstrates the Important elasticity measures.

Source: Begg and Ward,2010

PRODUCT LIFE CYCLE AND DEMAND:

Source: Lowes 2010

The demand of the Product varies over the different stages of the Product Life cycle. As the demand varies the prices also changes accordingly. During the Launch, Growth the demand of the product constantly increases and in the latter stage of maturity and during decline stage the demand falls and hence the prices will also follow the demand.

CONCLUSION:

Thus we clearly identify that it’s just not the cost of the Product but also various demand side drivers which rives the Prices of the services or Goods. There are other various supply side factors in additional to numerous other factors which drives the Price of the Product.

1B. EVALUATE HOWW EFFECTIVE WILL BE THE PRICE DISCOUNTING IN RAISING REVENUES DURING RECESSION:

INTRODUCTION:

During a economic slowdown various strategies are implemented by different companies to boost their revenues. This essay evaluates the Price discounting strategy followed by companies by critically analyzing the pros and cons of it and its effectiveness short term and long term.

BUSINESS CYCLE:

saupload_econ1.jpg

Source: Signs of recession, 2010

The typical economic cycle consists of two main phases: Boom and Recession. The phase leading to a boom is called expansion and that leading to a recession is called contraction. During the recession the National output goes down and the disposable income contracts and Demand in the market comes down.

During Recession Demand reduces because the Expenditures by consumers go down and the buying behaviour of the consumers changes accordingly. Hence the sale of the products during the recession drops.

ci_fig1.gif

Source: The consumer Board, 2009

This Graph shows the Consumer confidence index and how sharply it has fallen during the time of recession. The consumer confidence index refers to the activities of Spending and savings and reflects the health of economy during a period.

The above table shows the Car sales in UK for the period 2008 and it clearly shows that the Car sales in UK reduced and there was no Demand in the Market for the cars especially the Luxury cars and there was a relatively a small decline in the Ordinary Cars or Budget cars. Because of its low sales, revenues of different Companies have reduced drastically.Source: Begg and Ward,2010

Eventually many companies cut down its operations during this period. One of the strategies, companies use during the times of recession is Price discounting.

WHAT IS PRICE DISCOUNTING?

Selling Price = Marked Price – Discount

Where marked price is the normal price and Discount is the percentage of the marked price and selling Price is what customers pay for.

During normal days the selling price is the marked Price but during the recession stage the selling price is marked price – discounts.

Total Revenue = Price times Quantity demanded

The fashion houses like Valentino and A. Testoni avoid discounts to its customers. During the recession of 2008-09, as many stores it’s cancelled orders, they sent its members e-mail alerts about a sale from a specific designer. New York marketing manager Nancy King recently found a Valentino cocktail dress for $198 whose Retail price is $950.Source:Business week, 2009Revenues depend more on the demand of the product in the market. If the product is price inelastic because of monopoly or essential in its nature, then Companies don’t revise the prices. However in case of the product being price elastic, strategies need to be in place to effectively rise in the revenues. Many companies follow Pricing strategy such as discounting as a strategy to raise their revenues.

WHY DISCOUNTING THE PRICES ? – A GENERAL PERCEPTION

The purpose of discounts is basically to push short-term sales, clear out-of-date stock, reward loyal customers and encourage distribution channel members to perform functions. But when done during the time of recession it raises a lot of concerns.

Price Discounts are done to meet up the Fixed costs occurred in utilizing the capacity of the plant. When Companies have to pay Loans (Easy Monthly Instalments) it becomes as a part of the fixed costs and during the time of recession companies feel it’s better to make price discounts in order to sustain the loans rather to go bankrupt. To keep themselves in the Business for a young company and as well for a company who does not have deeper pockets needs to offer price discounts to sustain in the market during recession.

During the Recession many companies put a cap on their budgets and that limits its buying power and hence companies look for effective price discounts and will be attracted to those brands which give them good discounts. Looking at the above reasons though it may sound very logical to offer Price discounts, one has to understand the trade off that happens as price discounting is done.

DISCOUNTING EFFECT ON REVENUES:

The effects of Discounts on revenues are two sided. As the selling Price is reduced, the revenues fall automatically though it may sell more for less. Secondly during recessions the price of the commodities (Raw materials) goes up there by increasing the cost of the product. Hence any kinds of decrease in Prices will ultimately lead to reduction of profits. Also there is a decrease in the buying potential of the consumers and thus affecting the revenues of the company.

In 2006-08 during the cost push inflation Oil Prices went up high $147 a barrel and the raw materials went up high also the food prices also went up. Manufacturers were incurring higher cost to make the finished goods and on the top of it to offer more discount on the selling Price will totally wipe off all profits of the company and it can be a threat for the very existence of the companies.

FACTS ABOUT PRICE DISCOUNTING:

In “Dollars & Consumer Sense 2009 study”, conducted in January 2009 reported,”when consumers were asked: what they assume when a brand lowers its prices during economic times like these, 70 percent of consumers responded, “The brand is normally overpriced,” and 62 percent said they assumed that “the product is old, about to expire or about to be updated, and the company is trying to get rid of it to make room for the new stuff.”(Source: Yankelovich 2009)

When the prices are lowered and discounts are given it creates a negative vibe among the consumers. It also exposes the rock bottom price of the Product and when during the boom as well customers will expect to sell it at the same price and it becomes difficult to raise the Prices to the normal level. When companies offer more discounts, there is an expectations among consumers that Prices will still reduce over time so many don’t buy, but withhold their purchases postponing it. So effectively Discounts does not help much in Recession in raising revenues.

Source: Nationwide 2009

Source: Nationwide 2009

The Above graph shows the timeline of House Prices in UK. We can clearly see that because of the recession the Price of the Houses dropped. The table shows us the index falling continuously month after month. Even when the prices fell, Consumers dint buy houses but waited for the prices to still go down. Thus even with discounts on Products Consumers will always hope to fall further rather to buy.

BRAND IMAGE VS DISCOUNTING:

Price discounting can also erode the Brand image of the company when if offers loads of discounts because for most customers think price reflects the quality. In the same survey (Dollars & Consumer Sense 2009 study) Consumers were asked If a firm does not reduce its Price what does that mean? Most of respondents 64% assumed that then the quality is good. Consumers relate Price to quality and discounting could work against the brand image of the company.

PRICE WARS AND DISCOUNTING:

Once a company declare Price discounts the other competitors will also follow it and hence a price war breaks out effectively eating up the revenues and profits of the company. During Recession unemployment also rises effectively reducing the number of consumers in the Market and it becomes a rat race between companies.

CONCLUSION:

Thus having seen the pros and cons of the price discounting theory we can clearly see that Price discounts alone will not impact the revenues. Price discounting can provide support only in short runs and not in long runs. There are other strategies which when taken hand in hand with the price discounting can effectively improve the revenues of the company over the horizon of time.

REFERENCES:

Government Census, Housing Crisis – http://www.census.gov/const/uspriceann.pdf (accessed on 04.04.2010)

Property Crisis- http://www.telegraph.co.uk/news/worldnews/northamerica/2560303/House-sold-for-1-in-sign-of-US-property-crisis.html (accessed on 05 Apr 2010)

Apple Revenues – http://www.satter.org/2007/09/iphone-revenue-.html (accessed on 04.04.2010)

Relationship between Sales and Advertising – Scott m smith &William, 05.04.10-http://marketing.byu.edu/htmlpages/courses/693r/modelsbook/chapter9b.html (accessed on 03.04.2010)

Demography – Population in different countries http://www.stat.go.jp/english/data/handbook/pdf/c02cont.pdf. (Accessed on 04.04.2010)

Signs of Recession – http://seekingalpha.com/article/83860-10-signs-of-a-recession, (accessed on 04.04.2010.)

Business week- Fashion World reduces Prices-http://www.businessweek.com/magazine/content/08_44/b4106055117536.htm (accessed on 04.04.2010)

The Consumer Board 2009 -Consumer Index 2009 http://www.mastercardadvisors.com/us/advisors/en/publications/Issue_1-2009/CI.html (accessed on 04.04.2010)

Average House Prices- http://www.nationwide.co.uk/hpi/historical/Apr_2009.pdf, (accessed 04.04.2010.)

Dollar and Consumer survey – http://www.yankelovich.com/products/DCS2_March11_09.pdf, (accessed on 04.04.2010)