Price Strategy
About the company
The BMW Group is one of the global leaders in the production of premium cars. The company is based in Germany and it focuses on the production and sale of automobiles and motorcycles. It was founded in 1913 and started production in 1916 (The Economist Newspaper Limited, 2016). Currently, it employs about one million people across the globe. Besides, it also has a presence in more than 40 countries that all located in all the continents.
The business strategy of the Group focuses on having a strong brand image. The success of the company since its formation can be significantly attributed to the marketing and pricing strategy that it has employed over the years. The company has continuously used aggressive advertising to build a strong brand image over the years. The pricing strategy that is employed by the company is largely based on the key market trends. Thus, a company can use several strategies in a single product. It is worth mentioning that the pricing of a product is closely associated with the brand (The Economist Newspaper Limited, 2016).
Pricing strategies
The first pricing strategy that is used by the company is value pricing. The BMW Group often charges a premium price which is intended to assure consumers a high quality of the products. In this scenario, the company makes use of the price-quality relationship to set prices of products. This relationship implies that high prices match with high quality. The second strategy is prestige pricing. This strategy makes it possible for the company to charge prices based on customer perception of the product and not the costs. In this scenario, the consumers will be willing to pay higher prices for the right image rather than the actual value of the product.
Therefore, the brand of the product communicates the value. Under prestige pricing, BMW can take advantage of the consumer perception that the brand is of higher quality than the others in the market. It is more of a psychological strategy that seeks to convince consumers that there is value added to the cost of the product. The company makes use of this strategy to charm the customers’ sense of value and grow their bottom line (Kotler, Burton, Deans, Brown, & Armstrong, 2015).
Therefore, the company makes use of this strategy to leverage its products in the market. For this prestige pricing to be successful, a company needs to create an impressive image of its brand. This is a significant factor that underpins higher prices. Consistency in the quality of products and other related services is an important ingredient in building a brand image. This partly explains why the company incurs a lot of cost in building and promoting their brand image across the globe through advertising (Kotler et al., 2015).
Another strategy that is used by the company is product line pricing. This strategy is convenient for companies that produce a variety of products. In this case, BMW puts sufficient price gaps between various categories of products to notify consumers of differences in quality. Under this strategy, the price of one product is not set separately. The strategy aims at maximizing the bottom line by creating more complementary products. At BMW major price gaps exists between BMW 1, 3, and 7 series.
For instance, a new i3 was priced at $42,275 while the price of a new i8 was $125,000 (The Economist Newspaper Limited, 2016). Such price gaps enable the company to maximize profit. This pricing strategy tends to be consistent with the product life cycle and skimming. Under the product life cycle, the price of older car models often declines in anticipation of the arrival of new models in the market. For instance, if the company wants to launch a BMW 7 series, then the prices of the BMW 6 series are bound to drop. Under skimming, the company reduces the prices of car models that are not for the current year. This explains why 2015 car models are more expensive than 2014 or models of earlier years (Kotler et al., 2015).
The fourth pricing strategy that is used by the company is competitive pricing. This is a scenario where the company compares the prices of competitors for cars that are in the same class and makes it price similar to similar products in the market. This ensures that its product is neither over nor underpriced. Besides, it enables the company to compete fairly with other products in the market. Another strategy that is used by the BMW Group is the willingness to pay.
Under this strategy, the entity measures the willingness to pay of the consumers by test drives and responses. For this strategy to be effective, the company often survey target customers to estimate the precise willingness to pay. This can be achieved by narrowing down the respondents to the desired target market when conducting surveys. This strategy is commonly used before the launch of a new product (Kotler et al., 2015). The entity introduced penetration pricing at the bottom of its range, based on the company’s standards, to expand its market share and attract new customers who seek to own its products especially in emerging markets.
To achieve this goal, the company introduced low priced cars to tap such markets. For instance, the company launched cars that cost as low as 26lacs in India. Penetration pricing has massively contributed to the localization of its products (Kotler et al., 2015).
Illustration
BMW makes use of a combination of the various pricing strategies that are discussed above. For instance, when estimating the price of new i8, the company made use of the competitor’s prices, the extra value of the product’s services and features, the willingness to pay of the target consumers, product line pricing, economic value calculations, and existing practices. Based on existing practices in the market, the price of the BMW i8 was set equal to the price of Tesla S. The estimated price was $100,000.
This facilitated the calculation of the total cost and profit of the product. The production cost was $60,000, dealers’ marginal cost was $20,000, the selling, general and administrative cost was estimated at $12,000, and the resulting profit margin was $8,000. Further, based on the willingness to pay strategy, the lower end of the price range was estimated at $155,000 while the upper range was $199,000. Another strategy was economic value calculation. The key drivers under this strategy were fuel savings, subsidy, and maintenance.
The calculations showed that the economic value premium of BMW i8 was greater than $25,900 over 4 years. The resulting price based on this strategy and other quantitative analysis was $130,800. Under product line pricing strategy, the price of a BMW i8 was calculated by evaluating the price of other products that fall in the Sedan or Coupe categories. Therefore, the estimated price based on this criterion was estimated at $130,800.
Based on competitive pricing, some of the features that were evaluated were the performance of the car, look & luxury, and the notional value. A comparison was made with other products such as Audi, Mercedes-Benz and other earlier models of BMW. Based on this strategy, the recommended price for the product was $121,000. The table presented below shows a summary of the prices estimated using the various pricing strategies.
The first three strategies show that the BMW i8 should be priced between $121,000 and $130,800. The average of these three is $125,900. Therefore, a new i8 should be priced at $125,900. This example illustrates how the BMW Group makes use of various pricing strategies to estimate the prices of the products (Kotler et al., 2015).
Price discrimination
Economic underpinning
The concept of price discrimination is a scenario where a company can charge different prices for the same commodity. This tends to contradict the law of one price which states that a product can only have one price irrespective of its location. Thus, under the law of one price, it is assumed that a consumer can purchase the same commodity at the same price across the globe. The law of one price prohibits the possibility of purchasing a commodity at a low price in one market and selling at a high price.
Therefore, arbitrage opportunities do not exist. However, in real life, it is common to have different prices for the same product, with dismal possibilities for arbitrage. This is possible because of the assumptions of the law of one price. The law assumes that there is perfect information on the prices of commodities across the globe. Also, it assumes that there is no transaction cost incurred in buying and selling commodities in different markets. These assumptions are unrealistic and make it possible to practice price discrimination.
Basic conditions for price discrimination
The first condition that is necessary for a company to practice price discrimination is the ability to have some market control. For instance, a monopoly is in a position to practice price discrimination because they have market control. Other market structures such as oligopoly and monopolistic competition can practice price discrimination only if they can control prices. Under perfect competition, undertaking price discrimination is not possible because the sellers are price takers. BWM Group falls under an oligopoly market structure and they have a significant market share in some countries.
Besides, it has some control over prices. Therefore, it can successfully practice price discrimination. The second condition that is necessary for price discrimination is that BMW Group should be able to have different groups of buyers that have different price elasticities. This will enable the company to charge different prices for the same product. Finally, price discrimination necessitates that buyers should be separated and wrapped into discrete markets. This eliminates the possibility of buying in one market and selling the same product in a different market. The market of BMW Group can be conveniently segmented based on geographical location. The possibility of resale hinders the ability of a company to undertake price discrimination and it should be eliminated. Otherwise, a company will not gain.
Ascertaining whether price discrimination exists
The idea of different prices for the same product needs to be tested to verify if price discrimination exists. First, it is important to evaluate if a BMW in the US is the same product as BMW in China or Germany. The product may appear the same from a consumer perspective, but not from a manufacturer. This can be attributed to cost variations. For instance, it will cost more to sell a BMW car (German car) in the US or China than in Germany.
This can be attributed to transportation costs and import tariffs. In such a scenario, the price of a BMW car in the US or China is likely to be higher than in Germany. This may not amount to price discrimination. The other way of ascertaining if price discrimination exists is by comparing the ratio of prices of a BMW car across the various countries with the ratio of marginal cost.
How BMW Group executes price discrimination
Companies can undertake price discrimination based on the noticeable features of buyers or by prompting buyers to self-select among the different products that are available in the market. The BMW Group makes use of important characteristics of buyers to classify them into different market segments. The company makes use of information on the willingness of consumers to pay. The process of setting different prices using this criterion is commonly known as selective by indication. Under the third-degree price discrimination, the company can separate the market into different submarkets and charges different linear price functions. This implies that a buyer will pay a constant unit price for a car but these unit prices differ across various market segments.
Studies that have been carried out indicate that the prices before tax for identical BWM car models vary across various countries. Some of the key factors that contributed significantly to the differences in price are price elasticities, import constraints, and costs. It is worth mentioning that different price elasticities across various countries often lead to geographical price discrimination. The table presented below shows the relative markup of the BMW 7 series and a comparison with markups for other car models.
In the table above, it is evident that different countries have different markup for the same product. Germany has the least markup for the BMW car while the United Kingdom has the highest markup. The markup is calculated based on the cost of production of the cars. Therefore, the resulting prices will differ across the various countries. It is worth mentioning that the differences in markups presented in the table do not necessarily indicate the presence of price discrimination.
Several other factors can explain the differences. The first cause is import quotas. This occurs when countries impose heavy tariffs on commodities that are imported. Countries may also limit the number of units of a product that can be imported. The import quotas often results in high prices. Therefore, countries that have restrictive import quotas are likely to have high values of markup. An example is the high markup for Nissan in Italy and the United Kingdom. These countries tend to impose restrictions on the importation of Japanese car models.
The second reason that can explain the differences in the varying price elasticities across the various countries. This prompts the manufacturers to set different prices across the various markets, thus leading to price discrimination. Another factor that can explain the differences in markups is brand loyalty. In some countries, the consumers are fond of their car brands. Such brands tend to have low price elasticity.
In such cases, the manufacturers can charge higher prices on the cars without affecting the demand of the commodity. An example is the high markup of Fiat in Italy. Under price discrimination, a manufacturer should charge low prices in submarkets that have a high price elasticity of demand because the consumers in these markets are sensitive to changes in prices. Therefore, high prices can cause low quantity demand in such markets. This explains why some markets have low markups.
The concept of price discrimination cannot be discussed in terms of prices alone when it comes to the pricing of BMW cars and other products. The pricing of products is often interrelated with other attributes such as the quality, design of a car, and product bundling. In the case of cars, the product design plays a key role in price discrimination. For instance, a small feature added in the car can create a huge price difference. This partly explains why the price of the BMW 7 Series is high in the UK. The cars that are exported to the UK are more equipped and are of higher quality than cars that are sold in other countries (Belleflamme & Peitz, 2015).
The creation of the European monetary union and the use of a common currency (the Euro) in 2002 partly contributed to the increase in price differences across the member states and other countries of the world (Eun & Resnick, 2015). The adoption of the single currency did not successfully integrate the European car market. This lack of integration is caused by vertical restraints. Vertical restraint is a scenario where the manufacturer selects authorized dealers through ordinal and numerical criteria and grants them territorial exceptionality. This system has been in operation since the 1980s (Eun & Resnick, 2015).
The BMW Group also uses this distribution system to market and sell its products. The system facilitates geographic price discrimination. In recent years, regulations have been put in place to prohibit car manufacturers from imposing both territorial exclusivity and selectivity. They can choose only one of the two.
Over the years, various antitrust laws have been put in place in various countries to reduce the occurrences of price discrimination and enhance competition in the car industry. These measures have resulted in a reduction of price dispersion in some countries. Even though the price differences have declined over the years, the differences are still large and they are not likely to vanish shortly. Therefore, large price differences for cars across various countries are a situation that is likely to persist. The studies show that the differences in prices can reach up to 80% across the various countries (Belleflamme & Peitz, 2015).
Based on the discussion above, it is evident the BMW Group practices that international price discrimination. Further, the company can undertake price discrimination because of the differences in price elasticities in various countries, collusion, and constraints that are associated with import quotas.
References
Belleflamme, P., & Peitz, M. (2015). Industrial organization: markets and strategies. UK: Cambridge University Press. Web.
Eun, C. S., & Resnick, B. G. (2015). International financial management (7th ed.). Boston: McGraw-Hill Irwin. Web.
Goldberg, P., & Verboven, F. (2004). Cross-country price dispersion in the Euro era: a case study of the European car market. Economic Policy, 19(40), 483-521. Web.
Kotler, P., Burton, S., Deans, K., Brown, L., & Armstrong, G. (2015). Marketing. Australia: Pearson Higher Education. Web.
The Economist Newspaper Limited. (2016). BMW at 100 – Bavaria rhapsody. Web.
Verboven, F. (1996). International price discrimination in the European car market. The RAND Journal of Economics, 27(2), 240-268. Web.