A price for the Station Road breakfast: The Station Road shop opens in September 2026, next to the railway station. Between 6.30 and 9.00 in the morning, 1,850 people pass the station.
Lena's sells them a breakfast deal: a coffee and a pastry. Inside the station, Crumbline sells the same thing for $3.50.
Marco does not start from the cost. He starts from Crumbline's price.
Setting your price from what rivals charge for similar products is competitive pricing. The rivals' price is the benchmark: you match it, or go a little above or below it. Marco prices the breakfast deal at $3.00, 50 cents under Crumbline's $3.50. A commuter comparing the two now has a reason to cross the road to Lena's.
It is the same $3 deal as in 4.5.2. What makes it competitive pricing is where the number came from: Crumbline's price, not the cost of the coffee.
What it looks like (features)
- Market-driven: the price is set by the market, not by the cost sheet
- Rivals' prices are the benchmark: match them, or go just above or below
- It still watches the profit margin: the price must leave something over
- Flexible: when rivals move, the price moves
- Built around the customer: the price the customer expects to pay
- Often uses promotions and discounts to stay in line with rivals
When it fits
- Many rivals sell much the same product
- Customers can compare prices easily, as commuters can on one platform
- The business cannot show why it is worth more
What it can cost (drawbacks)
- The price depends on what rivals do, not on the business's own costs
- A rival with lower costs can cut, and matching squeezes the margin
- Extra quality or features cost money the matched price may not cover
- Every business charging the same price makes it hard to stand out
The rival sets the price, and the rival's costs are lower: Lena's pays $1.50 for the coffee, milk, pastry and cup in each deal, so at $3.00 it keeps $1.50.
Crumbline is a fast-growing chain that buys coffee for many kiosks, so it pays less for each cup. If it cuts its deal to $2.80, Lena's must go lower again or lose the reason commuters cross the road. At $2.70 only $1.20 is left on each deal: a fifth less, set by a rival's decision.
Notice what Lena's does not do. Her slow-risen loaf is not priced against Goldcrust's $2.20 loaf near Market Square. Customers do not see those two loaves as the same product: the loaf has a unique selling point (4.2.1). Competitive pricing fits the breakfast deal, where Lena's has nothing that Crumbline lacks, and not the loaf, where it does.
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Station Road is busy for two and a half hours, then quiet. At 4 p.m. there are loaves on the shelves that nobody will buy tomorrow. Marco wants the shop's prices to follow that pattern.
Prices that move with demand: Changing the price of the same product as demand changes is dynamic pricing. When demand rises, the price goes up; when it falls, the price comes down.
When prices jump at a peak it is called surge pricing. When they follow the time of day or the time of year it is called time-based pricing.
| Time at Station Road | Demand | Breakfast deal | Loaf |
|---|---|---|---|
| 6.30 to 9.00 | The commuter rush: 1,850 people pass | $3.00 | $3.00 |
| 9.00 to 16.00 | Steady, far fewer customers | $2.40 | $3.00 |
| 16.00 to closing | Quiet, loaves left on the shelves | $2.40 | $2.00 |
Small screens on the shelves (digital price labels), linked to the till, change the prices at the set times. A loaf sold for $2.00 at five o'clock still brings in more than the $0.90 of flour, yeast, salt and bag it cost to make. Whatever is still unsold at closing goes to Second Helpings, as before.
Why it helps
- Flexible: the price follows the pattern of demand, high in the rush and lower when it is quiet
- More money from the peak, when commuters will pay the full price
- Quiet hours bring in extra customers instead of empty tables
- Bread that would be left over is sold, which matters for a product that lasts one day
- More control over price in a market where Crumbline sits on the platform
What can go wrong
- A regular who paid $3.00 at eight sees $2.00 at five and feels cheated
- Customers learn to wait for the lower price, so the full-price sales fall
- It needs technology and data: labels, till links and sales hour by hour
- Frequent changes can make a trusted local brand look greedy
Say where the demand pattern is: Dynamic pricing only makes sense where demand really rises and falls: by hour, by day or by season. An answer names the pattern in the case (the commuter rush, a festival, a holiday) and says which way the price moves.
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Crumbline's offer, priced: In 4.2.1 Crumbline asked for 2,000 sliced loaves a week at $1.50 each. The shops charge $3.00.
Half the price looks like a loss. Lena asks a different question: does $1.50 pay for what each extra loaf costs to bake, and leave something over?
From 3.3.1, each loaf costs $0.90 in flour, yeast, salt and a bag: the variable cost per loaf. Wages, rent, electricity and the van cost Lena's $19,900 a week whether or not Crumbline's order is taken: the fixed costs. Mill Lane has spare capacity, so the order adds only the variable cost.
Pricing the order from the variable cost
Variable cost per loaf
$0.90. Below this price, every loaf baked for Crumbline loses money.
The price offered
$1.50 a loaf, which is $0.90 plus a mark-up of $0.60.
Contribution per loaf
Price minus variable cost per unit: $1.50 − $0.90 = $0.60. In the shops it is $3.00 − $0.90 = $2.10.
Contribution from the order
2,000 loaves × $0.60 = $1,200 a week, or $62,400 a year, towards the $19,900 of fixed costs that Lena's pays every week anyway.
This is contribution pricing: the price is based on the variable cost per unit plus a mark-up. The difference between the price and the variable cost per unit is the contribution: the money each unit adds towards paying the fixed costs, and then towards profit. Cost-plus pricing (4.5.2) marks up the full cost of each unit; contribution pricing marks up only the variable cost.
When it fits
- There is spare capacity, so the order adds no fixed costs
- An extra or one-off order, on top of the sales that pay most of the fixed costs
- A business with many products, where each must at least cover its variable cost
- A separate market whose low price the regular customers will not see
Why it helps
- Every unit sold above its variable cost adds to paying the fixed costs
- It sets a clear floor: never below the variable cost
- It can win orders that a full-cost price would lose
The risks
- If every price is set this way, the fixed costs may never be covered
- Regular customers may ask for the same low price
- The capacity may be needed later, for Station Road's 250 loaves a day
- Lena's bread in cheap sandwiches could weaken the brand (4.2.1)
A contribution is not a profit: The $1,200 a week is not profit. It is money towards the fixed costs, and it becomes profit only once those are paid.
A price of $1.50 is sensible for an extra order that fills spare ovens. As the price of every loaf, it would not pay the rent.
The same price rise, two different shops: Lena tries a loaf at $3.30 instead of $3.00 for a month, in two shops. That is a 10% rise.
At Park Road, sales slip from 400 loaves a day to 380. At Market Square, where Goldcrust sells a $2.20 loaf around the corner, they drop from 380 to 304.
Same loaf, same rise, very different reactions.
How strongly the quantity people buy reacts to a change in price is the price elasticity of demand (PED). It is measured with one formula:
PED = percentage change in quantity demanded ÷ percentage change in price
A percentage change is the new figure minus the old one, divided by the old one, times 100.
| Park Road | Market Square | |
|---|---|---|
| Change in price | $3.00 to $3.30: +10% | $3.00 to $3.30: +10% |
| Change in quantity | 400 to 380: (380 − 400) ÷ 400 × 100 = −5% | 380 to 304: (304 − 380) ÷ 380 × 100 = −20% |
| PED | −5 ÷ 10 = −0.5 | −20 ÷ 10 = −2 |
| What it means | Inelastic: sales fell by less than the price rose | Elastic: sales fell by more than the price rose |
| Revenue a day | $1,200 to 380 × $3.30 = $1,254: up $54 | $1,140 to 304 × $3.30 = $1,003.20: down $136.80 |
PED is negative because price and quantity move in opposite directions. Read its size and ignore the sign. Above 1, demand is price elastic: customers react strongly, so a price rise cuts revenue and a price cut raises it. Below 1, demand is price inelastic: customers hardly react, so a price rise raises revenue.
Why the two shops differ
Close substitutes
At Market Square, a loaf from Goldcrust is a short walk away at $2.20. The more close substitutes there are, the more elastic demand is.
A new competitor
If Goldcrust opened a bakery next to Park Road, customers there would have a substitute too, and demand for Lena's loaves would become more elastic.
Loyalty to the brand
Park Road's regulars come for the valley flour and the slow rise. Customers loyal to a brand with a unique selling point react less to price.
A habit or a need
Bread is an everyday purchase that takes a small share of a household's spending, so demand for bread as a whole is inelastic, even when demand for one bakery's loaf is not.
Why inelastic demand is good news: With inelastic demand, a business can raise its price and keep most of its sales, so revenue rises. That lets it pass on a rise in costs, or reach a profit target when it cannot bake any more loaves.
Park Road can take the $3.30 loaf. Market Square cannot.
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How this comes up: Mostly as short two-mark questions on a case: explain one advantage of dynamic pricing, or one drawback of competitive pricing, for the business; state two features of competitive pricing.
PED questions give a figure or a change in the market: explain one impact on revenue of a price rise, one advantage of inelastic demand, or what a new competitor does to PED. Contribution pricing can be one of the methods chosen when a longer question asks which pricing methods suit a business.
The two-mark pattern with PED
- Read the PED. Ignore the sign: above 1 is elastic, below 1 is inelastic. Say which, and what it means: the percentage change in quantity is bigger, or smaller, than the percentage change in price.
- Work out the change in quantity. Multiply the PED by the price change: −2 × 20% = a 40% fall.
- Say what happens to revenue, and why. Elastic and a price rise: revenue falls. Inelastic and a price rise: revenue rises.
- Use the case. A number or a name from the stimulus in every answer.
Right, but not explained: 'Revenue will fall' on its own is right, and it is not an explanation. What the answer needs is the reason: demand is elastic, so the quantity falls by more than the price rises.
And never mix the two up: an elastic PED with a price rise cuts revenue.
The price elasticity of demand for Lena's loaves at the Market Square shop is −2. Referring to price elasticity of demand, explain one impact on the shop's sales revenue if Lena's increases the price of a loaf by 20%.
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