Variable Pricing

What is Variable Pricing?

Variable Pricing is a marketing strategy that allows a different price to be charged to different customers or at different times. This type of pricing is common among street vendors, antique dealers, and other small, independently owned businesses but is not practical for direct marketers, who rely upon preprinted promotion forms. Variable pricing risks the loss of customer goodwill when one customer discovers another paid less. Federal and state laws protect competing retailers from discriminatory pricing that gives competitors an unfair advantage
Most firms use a Fixed price policy. That is, they examine the situation, determine an appropriate price, and leave the price fixed at that amount until the situation changes, at which point they go through the process again. The alternative has been variable pricing, a form of first degree price discrimination, characterized by individual bargaining and negotiation, and typically used for highly differentiated, high value items (like real estate).

Two variants of variable pricing are price shading (in which sales people are given the authority to vary the price by a certain amount or percentage), and auctions (in which potential buyers have the option of bidding on a product and thereby varying the price). Consumers generally prefer fixed prices because they don’t need to worry about being out-negotiated by a professional with expert knowledge and skills. The exceptions are people that enjoy the social aspect of negotiating, and people that think they might have an advantage due to their product knowledge or negotiating skills.

Due to advances in technology, another variant of variable pricing, called real time pricing, has arisen. In some markets events occur so fast that there is insufficient time to either set a fixed price or engage in lengthy negotiations. By the time you have all the information to determine a price, everything has changed. Examples include Airline tickets, equity markets and currency markets. In each case prices can change in less than a second. By linking all the market participants through internet connections, price changes are disseminated instantly as they occur.
A variant of real time pricing is online auction business model (such as eBay). All participants can view the price changes soon after they occur (technically this is not quite real time pricing because there is a delay built into the eBay system). Traditional auctions are inefficient because they require bidders (or their representatives) to be physically present. By solving this problem, online auctions reduce the transaction costs for bidders, increase the number of bidders, and increase the average bid price.

In addition to these examples of variable pricing in the short term, there are long term pricing practices that could be considered instances of variable pricing. They are price skimming, penetration pricing, and seasonal discounts.
This kind of price discrimination is largely and widely used by rental car companies. Usually those firms need to know what your country of residence is so they can adjust the price. Depending on the answer you can get significantly different quotes for the same vehicle, date and time of rental. It is also true when accessing the rental car site through the .com main site


Profit Maximization

Definition
•A process that companies undergo to determine the best output and price levels in order to maximize its return. The company will usually adjust influential factors such as production costs, sale prices, and output levels as a way of reaching its profit goal. There are two main profit maximization methods used, and they are Marginal Cost-Marginal Revenue Method and Total Cost-Total Revenue Method. Profit maximization is a good thing for a company, but can be a bad thing for consumers if the company starts to use cheaper products or decides to raise prices.

Basic Definitions

Any costs incurred by a firm may be classed into two groups: fixed cost and variable cost. Fixed costs are incurred by the business at any level of output, including zero output. These may include equipment maintenance, rent, wages, and general upkeep. Variable costs change with the level of output, increasing as more product is generated. Materials consumed during production often have the largest impact on this category. Fixed cost and variable cost, combined, equal total cost.
Revenue is the total amount of money that flows into the firm. This can be from any source, including product sales, government subsidies, venture capital and personal funds.

Marginal cost and revenue, depending on whether the calculus approach is taken or not, are defined as either the change in cost or revenue as each additional unit is produced, or the derivative of cost or revenue with respect to quantity output. It may also be defined as the addition to total cost as output increase by a single unit. For instance, taking the first definition, if it costs a firm 400 USD to produce 5 units and 480 USD to produce 6, the marginal cost of the sixth unit is approximately 80 dollars, although this is more accurately stated as the marginal cost of the 5.5th unit due to linear interpolation. Calculus is capable of providing more accurate answers if regression equations can be provided.


Total Cost-Total Revenue Method

To obtain the profit maximizing output quantity, we start by recognizing that profit is equal to total revenue (TR) minus total cost (TC). Given a table of costs and revenues at each quantity, we can either compute equations or plot the data directly on a graph. Finding the profit-maximizing output is as simple as finding the output at which profit reaches its maximum. That is represented by output Q in the diagram.
There are two graphical ways of determining that Q is optimal. Firstly, we see that the profit curve is at its maximum at this point (A). Secondly, we see that at the point (B) that the tangent on the total cost curve (TC) is parallel to the total revenue curve (TR), the surplus of revenue net of costs (B,C) is the greatest. Because total revenue minus total costs is equal to profit, the line segment C,B is equal in length to the line segment A,Q.

Computing the price at which to sell the product requires knowledge of the firm's demand curve. The price at which quantity demanded equals profit-maximizing output is the optimum price to sell the product

Marginal Cost-Marginal Revenue Method

If total revenue and total cost figures are difficult to procure, this method may also be used. For each unit sold, marginal profit equals marginal revenue minus marginal cost. Then, if marginal revenue is greater than marginal cost, marginal profit is positive, and if marginal revenue is less than marginal cost, marginal profit is negative. When marginal revenue equals marginal cost, marginal profit is zero. Since total profit increases when marginal profit is positive and total profit decreases when marginal profit is negative, it must reach a maximum where marginal profit is zero - or where marginal cost equals marginal revenue. This is because the producer has collected positive profit up until the intersection of MR and MC (where zero profit is collected and any further production will result in negative marginal profit, because MC will be larger than MR). The intersection of marginal revenue (MR) with marginal cost (MC) is shown in the next diagram as point A. If the industry is competitive (as is assumed in the diagram), the firm faces a demand curve (D) that is identical to its Marginal revenue curve (MR), and this is a horizontal line at a price determined by industry supply and demand. Average total costs are represented by curve ATC. Total economic profits are represented by area P,A,B,C. The optimum quantity (Q) is the same as the optimum quantity (Q) in the first diagram.
If the firm is operating in a non-competitive market, minor changes would have to be made to the diagrams. For example, the Marginal Revenue would have a negative gradient, due to the overall market demand curve. In a non-competitive environment, more complicated profit maximisation solutions involve the use of Game Theory.


Suppose that a firm is Competitive Market

A competitive market is one in which there are many buyers and sellers trading homogeneous goods so that each buyer and seller is a price taker. Firms can freely enter or exit this type of market.
Marginal revenue is the change in revenue from an additional unit sold.


For a competitive firm, the demand curve is perfectly elastic.

The marginal cost curve is also the firm’s supply curve because the marginal cost curve determines the quantity of the good the firm is willing to supply at any price.

Short-Run Decision to Shut Down

Shut down if…



The competitive firm’s short-run supply curve is the portion of its marginal-cost curve that lies above average variable cost.
Sunk cost is a cost that has already been committed and cannot be recovered.

Long-Run Decision to Exit/Enter a Market

Exit if…

TR < TC
TR/Q < TC/Q
P < ATC

Enter if…

P < ATC

Measuring Profit

At the end of enter/exit, firms that remain in the market must be making zero economic profit.
Entry and exit ends only when P and ATC are driven to equality.