Pricing Strategy

1
Pricing Strategy Tactics Chs. 4-6

• Understand the role of pricing policies in
  developing a strategic approach to pricing
• Establish the link between a firms pricing
  actions and customer expectations future
  purchase behaviors
• Provide frameworks for understanding customer
  behaviors and establishing policies to ensure
  profitable pricing outcomes
• Understand the major stages of the price setting
  process and the role of value and cost at each
  stage
• Demonstrate the three factors shaping the choice
  of a price point
• Strategic alignment, Price-volume tradeoffs,
  Customer response
• Introduce dynamic pricing (Rick Lester, TRG,
  September 27)
• Examine how to develop value-based communication
  messages to reflect key product characteristics

2
Chapter 5 Pricing Policy (Management of
customer expectations and behaviors)

• Most managers have difficulty communicating their
  firms pricing policies because they dont have
  any.
• Lack of proactive (not reactive) pricing policies
  reduces firm negotiating power with potential
  buyers who devise purchase strategies to gain
  discounts. This has led to a large number of
  firms that have created strategic sourcing
  programs.
• One problem is that purchasers tend to research
  and understand the competitive landscape better
  than the firms sales representatives.
• Compounding the competitive landscape issue is
  the fact that many firms provide incentives based
  on units sold and not on margin gained off each
  sale.

3
The Interaction of Expectations and Behaviors
4
Benefits Of Policy Driven Pricing

• Provides greater consistency across customer base
• Mitigates costs associated with ad-hoc
  discounting
• Forces give-get trade-offs value recognition
• Increases perceptions of price integrity
• Creates more efficient selling process

5
How Pricing Policy Leads to Certain Behaviors
Policy Your firm only offers discounts to
customers when they have a betterprice from your
competitor(s). Behavioral Implication Your
loyal customers get nothing in return, while
non-loyal customers are rewarded for searching
for better deals from your competitors. Loyal
and non-loyal customers begin to develop
strategic relationships with your competitor(s)
to keep your firm honest (i.e., press for the
lowest price from your firm).
6
How Pricing Policy Leads to Certain Behaviors
Policy Your firm offers greater than normal
discounts only to achieve sales goals (usually
sales quotas). Behavioral Implication Discounts
tend to pile up at the end of a reporting period
since achievement of sales goals are not clear at
the beginning of the reporting period. Customers
figure the timing issue out and migrate their
purchases toward the end of your firms reporting
period to secure discounts. Inventories tend to
be greater than normal since sales tend to become
cyclical with the reporting period.
7
How Pricing Policy Leads to Certain Behaviors
Policy Your firm provides discounts for annual
volume, regardless of order volume or the share
your buyers total need your sales
represent. Behavioral Implication This policy
tends to lead to buyers centralizing their
purchases with your firm. Centralization takes
the value proposition away from those who
understand it and places it with those who do not
(i.e., order makers). This policy also benefits
buyers by allowing them to assemble into buying
groups in order to secure the discount or to hunt
for better prices from your competitor(s).
8
How Pricing Policy Leads to Certain Behaviors
Policy Your firm publishes list prices, but your
firms discounting patterns are inconsistent so
as to keep your competitor(s) guessing as to
yoursales price(s). Behavioral
Implication Competitors cannot benchmark prices.
Instead, competitors use information from
purchasing agents to determine your prices, which
leaves your firm with little to no power to
influence your competitors pricing.
Consequently, your customers take advantage of
the situation by manipulating information between
your firm and your competitors for their own
benefit.
9
Structuring Your Firms Pricing Policies
Remove Inconsistency in Policies Centralize the
pricing policy development and monitoring so that
allsales representatives operate under the same
policy and use the same metrics. Provide
Incentives Reconsider commission compensation
since it tends to focus salesrepresentatives on
short-term goals. Sales representatives should
beinformed as to what is good/bad for the
company. In general, focus on higher margin sales
should be one goal for sales representatives. Pro
vide Analytical Performance Data Data should be
provided to management and sales representatives.
10
Buyer Types - Exhibit 5-3
11
Cues for Identifying Customer TypeConsider
these Characteristics in Each Case
Price
Relationship
Value
Convenience

• Desire for interaction
• Emotional Involvement
• Loyalty
• Number/type of considered vendors
• Involved decision-making
• Fast decisions
• Switching Costs
• Operational importance of differentiation

12
See Reading on Price Positioning
Convenience Driven
Price Driven
Brand (Relationship) Driven
Value Driven
13
Pricing Strategy Tactics Chs. 5-6

• Understand the role of pricing policies in
  developing a strategic approach to pricing
• Establish the link between a firms pricing
  actions and customer expectations future
  purchase behaviors
• Provide frameworks for understanding customer
  behaviors and establishing policies to ensure
  profitable pricing outcomes
• Understand the major stages of the price setting
  process and the role of value and cost at each
  stage
• Demonstrate the three factors shaping the choice
  of a price point
• Strategic alignment, Price-volume tradeoffs,
  Customer response
• Introduce dynamic pricing
• Show how to communicate new prices to maximize
  perceived fairness and minimize adverse customer
  response

14
The Price Setting Process - Exhibit 6-1
Define Price Window
Set Initial Price
Communicate Prices to Market
Determine amount of differential value to be
captured
Develop communication plan to ensure prices are
perceived to be fair
Set initial price range based on differential
value relevant costs

• Key Questions
• What is the best approach to communicate price
  changes to customers?
• What are the considerations for implementing
  significantly higher prices?

• Key Questions
• What is the appropriate price ceiling for this
  product?
• How should I incorporate reference prices into my
  price window?
• What is the role of costs in setting my initial
  price range?

• Key Questions
• Is price point consistent with my business
  strategy objectives?
• What are the price-volume tradeoffs and what is
  their impact on profitability?
• What are the non-value related determinants of
  price sensitivity?

15
Defining Price WindowsSpringfield Case Weighted
Average Economic Value
Exhibit 6-2a Positively Differentiated Offering
Exhibit 6-2b Negatively Differentiated Offering
Neutral Pricing
Penetration pricing sets price far enough below
economic value (not below cost!) to attract and
hold a large base of consumers. Generates sales
volume ( lower marginal costs) at the expense of
higher margins.
Price skimming captures high margins at the
expense of sales volume. Prices are high relative
to what the middle market is willing to pay.
Viable when the profit from the price-insensitive
segment exceeds profit from sales to larger
market at lower price.
16
Consistent with Business Strategy? Competitive
Advantage

• The unique position a firm develops through
  resource capability deployments that leads
  customers to choose the firms products over
  competitors. Advantage can be based on
• Cost Leadership (Low cost price)
• Product Differentiation offering superior
  economic value by creating superior
  product/service features quality through
  innovation product development capabilities
• Marketing Differentiation offering superior
  perceived value by developing
• Unique image (brand-centric differentiation)
  achieved through targeting, positioning
  communication capabilities
• Close relationships with customers
  (customer-centric differentiation) achieved
  through CRM capabilities customization

For each case, ask What is the focal firms
competitive advantage?
17
Conditions for Alternative Pricing Objectives
Product Differentiation Skim
Cost Leadership Penetration
Marketing Differentiation Neutral
CUSTOMERS

• Customers are sensitive to other elements of the
  marketing mix

• Little differentiation
• High price sensitivity
• Total Expend Effect
• Large Part of End-Benefit

• Difficult Comparison Effect
• Price Quality Effect
• Low Price Sensitivity
• Reference Price Effect

COMPETITION

• Large share brands w/ a lot to lose (Oligopolies)
• Sustainable mktg mix advantages
• Avoid threat of retaliation

• Sustainable cost resource advantage
• Financial strength
• Competitors not willing to retaliate
• Aggressive small share brands

• Sustainable differentiation
• Limited threat of opportunism
• Limited opportunity for scale economies
• Low threat brands

COSTS

• Sufficient CM to finance advertising...
• Costs similar to competitors
• Little excess capacity
• Incremental capacity is expensive

• Changes in volume drive profitability
• High CMs
• High volumes
• Small BE Sales Changes
• Excess capacity

• Changes in Unit Price Drive Profit
• Low CMs
• Low Volumes
• Large BE Sales Changes
• At or near capacity

18

• PENETRATION
• Little differentiation
• Sustainable cost resource advantage
• Changes in volume drive profitability

• NEUTRAL
• Customers are sensitive to other elements of the
  marketing mix
• Large share brands w/a lot to lose (Oligopolies)
• Sufficient CM to finance advertising...

• SKIM
• Difficult Comparison Effect
• Price Quality Effect
• Sustainable differentiation
• Changes in Unit Price Drive Profit

19
Setting Price The Price-Volume Trade-off
Price optimization is a complex process that
involves 2 distinct components (a) the firms
current price and cost structure, and (b)
customer response to price offerings and changes.
Estimating customer response requires deep
understanding of customers and competitors, a
difficult and imprecise problem at best.

• Instead, start with 2 relatively easy questions
  to answer
• How much volume could I afford to lose before a
  price increase would decrease my profitability?
• How much volume would I have to gain for a price
  decrease to improve my profitability?

DQ DQBE?
DQ DQBE?
In effect, you change the customer response
estimation problem from a two-tailed estimate to
a one-tailed estimate.
20
Incremental Percent Breakeven Sales Change
P (CM DP)
P CM Q

P (1 DP)
Q (1 DQ)


P (1 DP)
CM


(CM DP)
(1 DQ)
CM
(CM DP)
BEDQ


(CM DP)
(CM DP)
DP
BEDQ

(CM DP)
21
Incremental Percent Breakeven Sales Change
(P C) Q

(P DP - C)
(Q DQ)

PQ CQ

PQ PDQ DPQ DPDQ CQ - CDQ
0

PDQ DPQ DPDQ - CDQ
0

DQ(P DP C) DPQ
DQ(P DP C)

-DPQ
DQ
-DP
-DP


BE
(P DP C)
Q
(CM DP)
22
Incremental Percent Breakeven Sales Changes
Current Contribution Margin Current Contribution Margin Current Contribution Margin Current Contribution Margin Current Contribution Margin Current Contribution Margin Current Contribution Margin Current Contribution Margin Current Contribution Margin
5 10 20 30 40 50 60 70 80 90
Change in Price 20 -80 -67 -50 -40 -33 -29 -25 -22 -20 -18
Change in Price 15 -75 -60 -43 -33 -27 -23 -20 -18 -16 -14
Change in Price 10 -67 -50 -33 -25 -20 -17 -14 -13 -11 -10
Change in Price 5 -50 -33 -20 -14 -11 -9 -8 -7 -6 -5
Change in Price 0 0 0 0 0 0 0 0 0 0 0
Change in Price -5 100 33 20 14 11 9 8 7 6
Change in Price -10 100 50 33 25 20 17 14 13
Change in Price -15 100 60 43 33 27 23 20
Change in Price -20 100 67 50 40 33 29
Price increase decrease lt the breakeven
decrease leads to contribution increase. Price
decrease increase gt the breakeven increase
leads to contribution increase.
23
Price Sensitivity Drivers

• Size of expenditure
• Shared costs
• Switching costs
• Importance of end-benefits
• Perceived risk
• Price-Quality perceptions
• Perceived fairness
• Price framing
• Reference prices

Relative to income Paid by employer,
parents Monetary non-monetary Economic
psychological Receive expected benefits? Higher
pricehigher quality? Fair price range Gains vs.
losses Gains vs. losses
24
Prospect Theory
Perceived Value
Small Gains Overvalued
Large Gains Undervalued
Small Losses Strongly Overvalued
Reference point
Gains
Losses
Objective Value
25
Internal Remember their favorite brand(s) the
last price they paid.
Reference Price Shoppers
Wow! I paid 15.00 for that Franciscan yesterday
and its on sale here for 12.99. Better get a
case.
26
External Reference Price Shoppers Remember
their favorite brand(s) but not the last price
paid.
OK. The Voss brand is 16.00. Just out of
curiosity, how much is the Rombauer oh, 32.
Voss it is.
27
Price Range Shoppers Dont have a favorite
brand or remember prices.
Lets see. Clos du Bois 9.99, Voss 16.00,
Franciscan 12.99 Rombauer 35...
28
Elasticity a visual representation . . . .
Price
P2
elastic
P1
(many substitutes grains,fruits and
vegetables, bagged soil,paper clips, rubber
bands)
P2
unit elastic
P1
inelastic
(few substitutes gemstones, transplant organs)
Quantity Demanded
Q1
Q2
Q2
Q1
29
Elasticity Measurement of Price Sensitivity at
the Market Segment Level
We can measure or estimate price sensitivity at
the market segment level by assessing the price
elasticity for a particular product or service.
Percent Change in Unit Sales (over relevant
range) Percent Change in Price (over relevant
range)
Elasticity
Single Ticket Demand in Springfield Noreasters
30
How to Estimate Volume Along the Demand Curve
31
Elasticity Measurement of Price Sensitivity at
the Market Segment Level
Measure of Price Elasticity
Price Elasticity lt 1 An increase in price
within the range evaluated results in lower unit
sales but higher revenue (profit?).
Inelastic
Price Elasticity gt 1 An increase in price
within the range evaluated results in lower unit
sales and lower revenue (profit?).
Elastic
Price Elasticity 1 An increase in price
within the range evaluated results in an
identical change in unit sales and the same
revenue (profit?).
Unit Elastic
32
Elasticity Required to Breakeven
Current Contribution Margin Current Contribution Margin Current Contribution Margin Current Contribution Margin Current Contribution Margin Current Contribution Margin Current Contribution Margin Current Contribution Margin Current Contribution Margin
5 10 20 30 40 50 60 70 80 90
Change in Price 20 -4.00 -3.33 -2.50 -2.00 -1.67 -1.43 -1.25 -1.11 -1.00 -0.91
Change in Price 15 -5.00 -4.00 -2.86 -2.22 -1.82 -1.54 -1.33 -1.18 -1.05 -0.95
Change in Price 10 -6.67 -5.00 -3.33 -2.50 -2.00 -1.67 -1.43 -1.25 -1.11 -1.00
Change in Price 5 -10.00 -6.67 -4.00 -2.86 -2.22 -1.82 -1.54 -1.33 -1.18 -1.05
Change in Price 0 0 0 0 0 0 0 0 0 0 0
Change in Price -5 -20.00 -6.67 -4.00 -2.86 -2.22 -1.82 -1.54 -1.33 -1.18
Change in Price -10 -10.00 -5.00 -3.33 -2.50 -2.00 -1.67 -1.43 -1.25
Change in Price -15 -6.67 -4.00 -2.86 -2.22 -1.82 -1.54 -1.33
Change in Price -20 -5.00 -3.33 -2.50 -2.00 -1.67 -1.43
Price increase Elasticity lt the breakeven
amount leads to contribution increase. Price
decrease Elasticity gt the breakeven amount
leads to contribution increase.
33
Homework for Next WeekFire Safety
DP
BEDQ

(CM DP)
34
Price Value Communication

• The Problem Customer generally does not know
  true value unless informed by seller.
• Value communication is important when your
  product or service creates value that is not
  readily apparent to potential consumers.
• Value communication is nothing more than
  information dissemination.
• Develop value proposition (i.e., compellingly
  unique distinctive economic or psychological
  benefits).
• Communicate the value proposition, and
• Deliver the value.

35
Adapting the Message for Product Characteristics

Relative Cost of Search
High Complex Experience Goods
Low Simple Search Goods
Management Consulting
Greater Price Dispersion
Commodity Chemicals
Investment Advice
Home Equity Loans
Auto Repairs
Hotels
Economic Benefits
Desktop Computers
Life Insurance
Type of Benefits
SUVs
College Education
Pain Medications
Blood Pressure Drugs
Sports Cars
Fitness Equipment
Unique work of Art
Digital Cameras
Psychological Benefits
Cosmetics
Exotic Vacations
Designer Clothes
36
Framework of Value Communication Strategies
Relative Cost of Search
High Experience Goods
Low Search Goods
Strategy 1 Economic Value Communication Communic
ate Objective Information That Differential
Economic Value Justifies Pricing (e.g., Computers)
Strategy 2 Economic Value Assurance Communicate
Assurances That Differential Economic Value
Justifies Pricing (e.g., Investment Returns,
Hotel Guarantee)
Economic Benefits
Type of Benefits
Strategy 3 Psychological End-Benefit
Framing Associate Differential Performance with
Subjective Psychological Value That Justifies
Pricing (e.g., Cosmetics)
Strategy 4 Psychological End-Benefit
Assurance Communicate Assurances That Total
Psychological Value Justifies Pricing (e.g., Art,
Exotic Vacations, Mattresses?)
Psychological Benefits
37
Art Assignment

• Choose a product identify (15 minutes)
• Your retail price position and the Value
  Proposition for the product i.e., what is
  compellingly unique distinctive.
• The target customers (relational, value,
  convenience, or price), the relative size of the
  market, and their desired psychological benefits.
• How you will communicate the value to customers
  given high experience characteristics
  psychological benefits. For example, what
  assurances can you offer that the product will
  deliver the desired psychological benefits?
• Price range, pricing objective (skimming,
  penetration, or neutral), price point whether
  you will negotiate discounts.
• Communicate value price in 2 minutes

38
The Price Setting Process - Exhibit 6-1
Define Price Window
Set Initial Price
Communicate Prices to Market
Determine amount of differential value to be
captured
Develop communication plan to ensure prices are
perceived to be fair
Set initial price range based on differential
value relevant costs

• Key Questions
• What is the best approach to communicate price
  changes to customers?
• What are the considerations for implementing
  significantly higher prices?

• Key Questions
• What is the appropriate price ceiling for this
  product?
• How should I incorporate reference prices into my
  price window?
• What is the role of costs in setting my initial
  price range?

• Key Questions
• Is price point consistent with my business
  strategy objectives?
• What are the price-volume tradeoffs and what is
  their impact on profitability?
• What are the non-value related determinants of
  price sensitivity?

39
Next WeekAkash RathodB2B PricingPricing
Strategy Over the Life Cycle (Chs. 7-8)