Pricing

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Pricing
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Pricing Playing Field
Economic Value
Competition
Customer Company Competition Collaborators
Situation Market Share Costs Cooperation Differ
entiation
Distribution Channels
Price Sensitivity Fairness
Goals Situation Market Share Costs
Company Policies, Goals
Variable Costs
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Managing a price decrease PG and EDLP
Demand for greater value
Superior quality Value price
Prisoners Dilemma
High cost of promotions
Promotions Switching excuse
Rationalize product line
Private labels
Channel inefficiency
Customer confusion
Rise of the discounter
Rise of EDLP
Strain on manufacturing
Strategy
Customer
Competitor
Costs
Price reduction Value pricing
Brand image through advertising
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Why is Price so Critical?

• Consider a company with an 8 profit margin
• Suppose the company could raise its price by 1
  without it having any impact on sales?
• What will the increase in margin be?
• Sales X Pts
• Margin 0.08X Pts Cost 0.92X Pts
• New sales 1.01X Pts Cost 0.92X Pts
• Margin 0.09X Pts
• Increase in margin 100(0.09X-0.08X)/0.08X
• 12.5 !

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Two Key Requirements of a Pricing Policy

• Policy should complement companys marketing
  strategy
• Swatch 40 price on basic model has not changed
  in 10 years
• Saturn No negotiation pricing
• Process of price setting must be coordinated
  across departments
• Issue There are many participants in the process
  - Accounting provides cost estimates, Marketing
  communicates the strategy Sales provides
  customer input Production sets supply
  boundaries Finance establishes requirements for
  the bottom line

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Coordinating the Pricing Process

• What is our pricing objective?
• Do all participants in the process understand the
  objective?
• Do all participants have an incentive to work in
  pursuit of the objective?

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Profit Growth, Volume Growth, or Both?
Profit growth positive
Quadrant I
Quadrant II
Managers Dream
Tradeoff Zone
Volume growth negative
Volume growth positive
Quadrant IV
Quadrant III
Tradeoff Zone
Managers Nightmare
Profit growth negative
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Pricing Goal Matrix
Reduction of too high price
Increase of too low price
Profit growth positive
Volume
Volume
Profit
Profit
Volume growth negative
Volume growth positive
Volume
Volume
Profit
Profit
Profit growth negative
Increase of price beyond optimum
Decrease of price below optimum
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8 Steps to a Pricing Decision

• I. Assess what value your customers place on the
  product or service
• II Look for variation in the way customers value
  the product
• III Assess Customers Price Sensitivities
• IV Identify an Optimal Pricing Structure
• V Consider Competitors Reactions
• VI Monitor Prices Realized at Transaction Level
• VII Assess Customers Emotional Response
• VIII Analyze Whether Returns are Worth the Cost
  to Serve

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8 Steps to Better Pricing STEP 1

• I. Assess what value your customers place on the
  product or service.
• What should the appropriate process be?
• From company ...... To marketplace or
• From marketplace ...... To company?
• The trouble with Cost Pricing
• Expected sales level 100 units
• Suppose cost/unit 10 markup 20
• Price 12. Suppose you sell only 80 units
• New cost 11 markup 20 price 13.2
• How many units will be sold?

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Examples of Value-Based Pricing

• Glaxo pricing of Zantac in the US market in 1983
• Competition with SK Bs Tagamet (1 drug in the
  world)
• Additional value offered by Zantac
• Easier schedule of doses
• Fewer side effects
• Taken safely with other medication unlike Tagamet
• Based on greater perceived value, Glaxo charged a
  50 premium over Tagamet instead of pricing at
  parity or below (as in Follower pricing)
• In 4 years, Zantac was the market leader.

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How to assess value?

• Economic Value-In-Use
• Market research
• Conjoint Analysis
• Employees with direct customer contact
• Salesforce

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Determining Economic Value-In-Use

• DuPont, Alathon 25 - polyethylene resin used in
  the manufacture of flexible pipe. Competes with
  other resins
• Failure rates of 1-3 compared to 7-8 for
  competition
• Economic ValueReference Value Differentiation
  Value
• Reference Value Cost of competing product that
  the customer views as the best substitute for the
  product being evaluated
• RV Price of Competing product adjusted for any
  difference in quantity used
• Differentiation Value Value of product
  attributes that are different from those of the
  best substitute
• DV Positive if customer likes differentiating
  attribute, Negative otherwise

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Economic Value Analysis from 2 Perspectives

• Pipe buyers who purchase pipes made of Alathon
• Pipe extruders who purchase Alathon to make pipes

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Analysis for Below-Ground Irrigation (/100ft)
Cost of Substitute6.50 Failure Rate from 8 to
3 Value6.51.08/1.036.81 Failure Rate from 7
to 1 Value6.51.07/1.016.89 Added
Value0.31-0.39 Labor cost of pipe
replace- ment60. Failure rate drops 5-6,
Savings3.00 to 3.60 Crop damage cost
0-40 Probability of 40 0.2 Failure rate drops
5-6 Savings400.20.050.40
400.20.060.48
Crop Loss Reduction 0.40 - 0.48
Labor Savings 3.00 - 3.60
Differentiation Value
Replacement Savings 0.31-0.39
Total Economic Value 10.21-10.97
Cost of Substitute 6.50
Reference Value
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Analysis for Pipe Extruders (per pound)
Added Value to Extruders Product 0.228-0.275
Sales Decline -0.01
Negative Differentiation Value
Risk -0.020
Positive Differentiation Value
Higher Sales Expense -0.080
Cost of Substitute 0.280
Total Economic Value 0.398-0.445
Reference Value
Cost of cheapest resin 0.28 / lb. lbs. per
100 feet of pipe 16.25 Value of 100 feet
10.21 (min.) Added value / lb
(10.21-6.5)/16.250.228 Sales decline due to
lower replacement Risk due to single supplier
(DuPont)
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Interpreting Economic Value

• A products market value is determined not only
  by the economic value but also by the accuracy
  with which buyers perceive that value
• Weakness of EVDoes not indicate the appropriate
  price to charge. Gives the maximum price
  consumers will be willing to pay if they were
  perfectly cognizant of the economic value and
  were motivated by economic value to make their
  purchase decisions
• Strength of EV Enables a firm to determine
  whether a product is selling poorly because it is
  overpriced relative to its true economic value or
  because it is under-promoted and consequently,
  under-appreciated by the market
• DuPont used this to increase sales by raising
  price and educating consumers

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Other Uses of Economic Value Analysis

• Indicates which attribute improvements will
  result in the greatest enhancement of value
• Can be used by sales reps to highlight the
  benefits of the product
• Help firm identify market segments that value the
  products attributes differently
• Works well for industrial products and for
  consumer durable goods
• Not very useful for FPP products and for those
  with fuzzy attributes
• Use methods like Conjoint Analysis

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8 Steps to Better Pricing STEP 2

• II Look for variation in the way customers value
  the product
• Polaroid SX-70 instant photography camera
• Segmentation over time. Initially those placing a
  high value (in the photo ID card business) were
  sold product at a high price. Then prices
  reduced to accommodate others
• Segmentation and Airline fares Business Vs.
  Leisure
• Magazines Single issue Vs. Subscriptions
• Software Upgrades (low cost) Vs. New Users
• Heavy users Vs. Light users
• Different applications Sealed Air Corporation
• Business computers Vs. Home computers

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What to do with the variation Price Customization

• Product-line sort develop a product line and
  have customers sort themselves among the various
  offerings based on their preferences
• Controlled availability
• Coupons
• Direct-Mail Catalogs
• Geographic Pricing
• Restriction on place of purchase (high end
  products at high end stores)
• Negotiating with provider (long distance
  telephone calls)
• Sort on Buyer Characteristics
• Eurodisney Kinder Gratis - vom 1.1.96 bis zum
  4.4.96
• Munich airport landing fees (747-200 DM 18600
  747-400 DM 10100)
• Sort on Transaction Characteristics

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Price Customization Translates As .

• Segmenting by Buyer Identification
• Coupons Student Discounts Automobile prices
• Segmenting by Purchase Location
• Hair Salons have different prices in different
  locations
• Large grocery stores Vs. convenience stores
• Freight absorption in industrial product markets
• Segmenting by Time of Purchase
• Theaters Matinee Vs. Evening rates
• Restaurants Fixed price lunches (Restaurant next
  door)
• Peak-Load pricing (Airlines, Electric Utilities,
  Telephones)
• Problem of Peak Reversal with long distance
  calling

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8 Steps to Better Pricing STEP 3

• III Assess Customers Price Sensitivities

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Methods for Price Response Estimation
1. Expert Judgement

• New consumer nondurable introduced in 3 European
  regions. Managers for the 3 markets were selected
  as the best experts and asked to provide
  estimates of 3 points on the response curve
• Lowest realistic price and year 1 sales volume at
  that price
• Highest realistic price and sales volume
• Expected sales volume at a medium price

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Methods for Price Response Estimation
2. Customer Surveys a) Direct price response
surveys b) Preference-based Inference Conjoint
Analysis a)

• What is the likelihood that you would buy this
  product at 25
• At what price would you definitely buy this
  product?
• How much would you be willing to pay for this
  product?
• How much of this product would you buy for 0.99?
• At what price differential would you switch from
  brand A to brand B?

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Price Response Estimate for a PC at Vobis
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Purchase Intentions for Instant Cameras
Kodaks analysis of a next-generation instant
camera - purchase intent on a 7-point scale
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Price Response Curve for Instant Cameras
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b) Conjoint analysis
What would you prefer? Type a number from the
scale below to indicate your preference
4-cup Capacity 9-minute Brewing Time 18
8-cup Capacity 3-minute Brewing Time 28
OR
Strongly Prefer Left
Strongly Prefer Right
1
5
9
2
8
7
6
4
3
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Methods for Price Response Estimation
3. Price Experiments

• Laboratory Simulated Shopping or In-Market
  Tests
• In-market tests Prices varied across stores,
  accounts, geographic regions
• Direct mail catalogs are another medium for
  experiments
• In-market test of a German mobile phone
  manufacturer
• Regular price of phone DM 1200
• At this price 24 of new car buyers bought the
  phone
• Company then varied prices for 3 months in 3
  different regions
• The results were as follows

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Price Experiment for Mobile Phone
3 month period before experiment 24
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Methods for Price Response Estimation
4. Analysis of Historical Market Data

• Supermarket scanners are especially useful for
  this purpose
• If prices have naturally varied over time, one
  can analyze how changes in absolute or relative
  prices affect sales volumes and market shares
• German market for RTE desserts
• 4 main competitors at the time of analysis
  Gervais-Danone, Nestle, Unilever and Dr. Oetker,
  togther had more than 80 share
• Dr. Oetkers prices varied between DM 0.60 and DM
  0.70. Unit sales varied between 7 million and 12
  million for two-month periods.

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Price Response Estimate Based on Historical Data
Volume (million units)
Profit Index
12
Profit
Sales Volume
11
120
10
9
110
8
100
7
6
Price DM
0.60 0.63 0.65
0.68 0.70
0.73
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Evaluation of Different Methods
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Empirical Estimates of Price Elasticities
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8 Steps to Better Pricing STEP 4

• IV Identify an Optimal Pricing Structure
• Should Quantity Discounts be offered?

Units Buyer A Buyer B
1 70 70 2
20 50 3
20 40 4
20 35 5
20 30
Above table gives the value of each successive
unit of the product to 2 buyers A and B. What
price should the company charge if producers
cost is 20 per unit?
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Pricing Structure.....

• Should Bundle Pricing be offered?
• Movie distributors often sell packages of films
  rather than selling individual film rights
  because the package values vary less across
  buyers than do values of individual films
• Buyer A Buyer B
• Movie 1 9000 5000
• Movie 2 1000 5000
• Total 10000 10000
• Using a la carte pricing can sell movie 1 to both
  buyers for 5000 each and movie 2 to buyer B for
  5000. Total revenue is 15000. By bundling, both
  buyers will buy the bundle for 10000. So total
  revenue 20000

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Bundling Example Mobile Phone Operator
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Optimal Pure Components Pricing
Pv 8
Group 4
Group 3
Ph8.5
Price for Hot Line
Group 2
Group 1
Price for Voice Mail
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Optimal Pure Bundling Price
Group 4
Group 3
Price for Hot Line
Group 2
Group 1
Price for Voice Mail
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Optimal Mixed Bundling Price
Pv9
Ph9
Group 4
Group 3
Pvh13
Price for Hot Line
Group 2
Group 1
Price for Voice Mail
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8 Steps to Better Pricing STEP 5

• V Consider Competitors Reactions
• In 1994, Kodaks share of the US film market was
  70 but was declining.
• Flagship product Kodak Gold sold at 17 premium
  over Fuji
• Did not because Fuji had gross margin of 55 and
  could have followed the price cut
• Launched Funtime film at price lower than Fuji
• Simple Competitive Reactions
• Multiple Competitive Reactions
• AA Value Pricing AA cut prices SouthWest
  responded by advertising Wed like to match
  their new fares, but wed have to raise ours
• Game theoretic Analysis

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Competitive Interaction

• Asymmetric Price Tier Competition
• Superpremium
• FujiColor Reala 4.69
• Kodak Ektar 4.27
• Premium
• Kodak Gold Plus 3.49
• Agfa Color 3.49
• Economy
• FujiColor Super G 2.91
• Konica Super SR 2.91
• ScotchColor 2.69
• Prisoners Dilemma
• Cigarettes in U.S. average price increase 10
  from 1982 to 1991
• Instant cameras from 1976 to 1985 declined 76 in
  price
• Price Signaling

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8 Steps to Better Pricing STEP 6

• VI Monitor Prices Realized at Transaction Level
• A product may have only 1 list price, but can
  have several final prices
• Returns, damage claims, special incentives drive
  revenue
• Unfortunately, most companies spend 90 of their
  effort in setting list prices
• Need to devote more care and attention to Quality
  and Logistics (manage returns / damage) and
  Account Analysis (where are revenues actually
  coming from?)

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8 Steps to Better Pricing STEP 7

• VII Assess Customers Emotional Response
• Manage price perceptions
• Reference prices and Prospect Theory
• Market research required to assess customer
  reaction in terms of both perceived fairness and
  purchase intention

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Effect of purchase context

• You are lying on a beach on a hot day. All you
  have to drink is ice water. For the last hour
  you have been thinking about how much you would
  enjoy a nice cold bottle of your favorite beer.
  A companion gets up to make a phone call and
  offers to bring back a beer. He says that the
  beer may be expensive and asks the maximum price
  you are willing to pay. If the price is higher,
  he will not buy it.
• What price will you tell him if the only nearby
  place where beer is sold is a fancy resort
  hotel?
• What price will you tell him if the only nearby
  place where beer is sold is a small, run-down
  grocery store?

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Odd pricing

• For which pair of prices is the lower price more
  of a bargain?
• First pair 0.89 0.75
• --------------------------------------------------
  -------------------------
• Second pair 0.93 0.79
• Effect of Advertised Odd-Price Endings on Sales
  of Margarine
• Parkay brand Price/lb () Unit sales
• Regular price 0.83 2817
• Discount price 0.63 8283 ( 194)
• Odd discount price 0.59 14,567 (406)

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Order Effects

• Reference prices when range
• of prices shown in
• Product Ascending order Descending order
• Electric shaver 20.18 24.00
• After-shave lotion 2.28 3.56
• Dress shirt 4.85 6.69
• Sport coat 39.85 44.64
• Hair spray 1.02 1.41
• Hair dryer 21.91 21.91
• Dress shoes 15.89 17.83
• Blouse 7.37 9.27

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Prospect Theory
Utility
Reference Price
Reference Price - Actual Price
Actual Price - Reference Price
Disutility
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Reference Pricing

• put low priced good next to high priced good.
• put regular price next to sale price (- was
  999, now 799)
• order effects reference prices influenced by
  what is seen first.
• endowment effect de-couple acquisition and
  payment by first endowing buyers with the
  product. Buy now, pay later.

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Reference Price effect of a High-end Product

• Choice ()
• Microwave Oven Model Group 1 Group 2
• Panasonic II (1.1 cu ft regular -N.A. - 13
• price 199.99 sale 10 off)
• Panasonic I (0.8 cu ft regular 43 60
• price 179.99 sale 35 off)
• Emerson (0.5 cu ft regular price 57 27
• 109.99 sale 35 off)

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8 Steps to Better Pricing STEP 8

• VIII Analyze Whether Returns are Worth the Cost
  to Serve
• Create a customer grid where each customer is
  plotted at the intersection of the revenue she or
  he generates and the companys cost to serve that
  customer
• Need to manage customers for profits, not just
  sales
• Avoid Strategic Accounts

Equity Axis
High
Price Received
STRATEGIC ACCOUNTS
Low
High
Low
Cost to Serve
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The Pricing Audit
Our pricing process High/Med/Low Current
Performance Poor
Excellent (Qualities) Relevance 1 2 3
4 5 1. Complements Marketing Strategy 2.
Co-ordinated Holistic (Steps) 1. Assess value
to customers 2. Consider variation in value 3.
Assess price sensitivity 4. Optimal pricing
structure 5. Consider competitive reactions 6.
Monitors on transaction level 7. Customer
emotional response 8. Analyze revenue Vs. cost to
serve Added Comments