Pricing Strategy & Tactics – Chs. 1-3
• Define Strategic Pricing & 5 elements of a pricing strategy:
(1) Value creation, (2) Price and offer structure (3) Value
communication, (4) Pricing policy, & (5) Price setting;
• Define Value and explain its role in pricing strategy;
• Show how value-based segmentation enables companies
to more profitably align its offerings with differences in what
consumers are willing to pay; and
• Examine mechanisms to maintain segmented structures:
(1) Price-offer configuration, (2) Price metrics, & (3) Price
fences.
MKTG 6214
Glenn Voss
MKTG6214 Course Materials
Textbook:
• The Strategy and Tactics of Pricing, 5th edition,
2011, Nagle, Hogan, and Zale
Cases:
• 2 Cases in course packet at Study.net
Password:
MKTG6214
• Springfield Nor’easters case available online
User Name:
Password:
Lectures and Discussions:
• In conjunction with cases & handouts of slides
Assessment & Grade Distribution
• 2 Written Case Analyses
20
(completed in groups of 1-6)
• Final Examination
• Total
Cox Recommended Grade Distribution
A/AB/B+
B-…
10
30
40%
50%
10%
Date
Topics
Text Readings
8/23
Strategic Pricing & Value Creation
Chapters 1-3
8/30
9/6
Price Setting & Value
Chapters 4-6
Communication
Pricing Strategy over the Life Cycle Chapters 7-8
9/13
Case Analysis
9/20
Financial Analysis & Costs
Chapters 9-10
9/27
Competition
Chapter 11
10/4
Final Review
10/11
Final exam
Class Discussion
Russian
Technology
Akash Rathod
B2B Pricing
Atlantic
Computers Case
Springfield Case
Rick Lester
TRG Arts
Virgin Mobile
Case
Modeling the Marketing Process
SWOT Analysis
Company Customers Competitors Collaborators Context
Market
Segmentation
Create
Value
Communicate,
Capture &
Share Value
Selection &
Targeting
Product/Service
Offering
Product/Service
Offering Positioning
Place/
Pricing
Channel
Promotion/
Communication
Customer
Acquisition
Customer
Retention
Revenue & Profits
Customer
Relationship
Management
Sustain
Value
The Strategic Pricing Pyramid
Price
Level
Price setting
Pricing
Policy
Negotiation Tactics &
Criteria for Discounting
Price/Value Communication
Communication, Value Selling Tools
Communicate,
Capture, &
Share Value
Price Structure
Metrics, Fences, Controls
Value Creation
Economic Value, Offering Design, Segmentation
Create
Value
Price setting is just the “tip of the iceberg” of a profitable pricing strategy.
Value-Based Pricing
Effective pricing strategies should be based on three factors:
Competition
Costs
Pricing
Strategy
Customers
Objective: Maximize the difference between the value created for
the customer and the company’s costs to provide that value.
The Value-based Pricing Process
CUSTOMER
VALUE
PRICE
COST
PRODUCT
Value Creation
Defining VALUE
Use Value (Utility)
• Monetary gain (or savings) from using a product/service offering
• Psychological benefits (or costs) associated with using a
product/service offering
Economic Value
• Calculated using reference value and differentiation value
Reference Value
Refers to the price of the consumer’s “best” alternative.
Differentiation Value
Refers to the value of whatever differentiates the offering from the
alternative(s). Can be positive or negative.
Total economic value represents the maximum price that a fully-informed
consumer would be willing to pay for a product/service offering.
Economic Value Estimation Framework
Your unique
value
delivery
Price of
Customer’s
Next Best
Alternative
Positive
Differentiation
Value
Reference
Value
Negative
Differentiation
Value
Price to
capture a
share of
this value
Costs unique to doing
business with you
Total
Economic
Value
Economic Value Estimation
Example – Heavy equipment manufacturer
Higher residual
value = $1200
Parts inventory
program savings =
$1250
Invoice processing
consistency savings
= $1500
Fuel economy
savings = $2200
Add’l warranty
cost = -$1050
Differentiation
Value = $7,450
Increased revenue
from higher
uptime = $2350
Competitive
alternative for
this customer
= $72,500
Reference
Reference price
= $72,500
Total offering
economic value
$79,950
How much of the
Differentiation
Value do you
Capture versus
Share with your
Customers
Economic Value Analysis
Step 1: Identify Reference Value
• Reference value is calculated as the price of the best perceived alternative, not
necessarily the next best competitive alternative, with regard to form, function,
effectiveness, and/or efficacy.
Step 2: Estimate Differentiation Value
• Determine the value drivers – those attributes that impact customer
perceptions and purchase choice
Are they monetary gains or cost savings?
Are they psychological benefits or costs?
Comment regarding differentiation value . . . .
In most cases, the components making up differentiation
value can be quantified to some extent. Some consumers,
however, will pay more for a product simply because of the
brand name – despite the fact that the tangible value
of the product may be substantially lower than alternatives
available to them. Therefore, the brand name can often be
a component of the differentiation value (brand equity).
What type of differentiation value does a brand name provide?
Economic Value Analysis
Step 1: Identify Reference Value
• Reference value is calculated as the price of the best perceived alternative, not
necessarily the next best competitive alternative, with regard to form, function,
effectiveness, and/or efficacy.
Step 2: Estimate Differentiation Value
• Determine the value drivers – those attributes that impact customer
perceptions and purchase choice
Are they monetary gains or cost savings?
Are they psychological benefits or costs?
• Identify attributes that differentiate between your product and the
competitive reference product. What benefits or costs are associated with
your product? How can you quantify each benefit and cost?
– Gather data that can be used to assign the monetary amount to each value
driver (e.g., in-depth customer interviews, surveys, focus groups)
– Focus on the underlying customer business model (what drives the business
model will typically drive the value perceptions of the customer)
– Value drivers can vary across customers & across time
• Determine the value derived from a bundle of features
Estimating Psychological Value
Impact of Warranty Length on Willingness to Pay
MKTG 6223
Understanding What Customers Value
Segment B — Innovators
$6
Revenue
Contribution
$5
$4
$
(M)
$3
$4,041,864
(~ 10,100 units)
$2
$1
$626,904
$0
$0
$100
$200
-$1
$300
$400
$500
$600
Price ($)
Segment E — Budget Shoppers
$4
$3
$
(M)
$2
$261,496
$2,020,788
(~ 5,800 units)
$1
$0
$0
-$1
$100
$200
$300
Price ($)
$400
$500
$600
Pricing Russian Technology
Quiz
Cost of a Surge (minor)
Labor
Incremental materials, fuel
Lost Production (8 hours to restart.)
$ 9,000
$ 6,000
$80,000
$95,000
Frequency of minor surge per compressor .4 per year
Cost of a Surge (major)
Labor
Incremental materials, fuel
Equipment (new compressor)
Lost Production (24 hr. To restart)
$ 24,000
$ 11,000
$180,000
$240,000
$455,000
Frequency of major surge per compressor = .004 per year
Pricing Russian Technology
Quiz
1. What is the economic value of this product?
2. How close to this value would customers be willing to pay?
3. Why might customers object to paying the full economic
value?
4. What would you do to overcome those objections?
The price of the most basic of commodity products . . . .
Brand
Product of
Notes
Price per
Ounce ($)
Price per
Gallon ($)
Acqua Panna – Natural Spring
Italy (Florence)
1 liter glass bottle
0.13162
16.85
Arrowhead – Mountain Spring
California
Plastic 28-pack
0.02367
3.03
Dasani – Purified Drinking Water
USA
Plastic
0.08876
11.36
Evian (Nomad) – Natural Spring
France (Alps)
Plastic 6-pack
0.12318
15.77
Menehune – Purified Drinking Water
Aiea, HI
Plastic
0.07813
10.01
Perrier – Sparkling Natural Mineral
France
Green Glass
0.08333
10.67
Rosauer’s Finest – Spring Water
Canada
Plastic/Pop Top
0.02307
2.95
San Pellegrino – Sparkling Mineral
Italy (S.P.)
Green Glass
0.08844
11.32
Talking Rain – Mountain Spring
Preston, WA
Plastic/Flavored
0.06760
8.65
Voss – Virgin aquifer
Norway
Clear glass cylinder
0.181746
23.26
Pipes/Lake Water
0.000012
0.00156
City of Dallas– Residential
The relevant question is:
Why are consumers willing to pay relatively steep prices for a commodity product?
Price Structure
Tactics for Pricing Differently Across Segments
Market Segmentation – organizing the market into homogeneous
groups (or segments) that the firm can effectively & efficiently target.
Market
Segmentation
Create
Value
Communicate,
Capture &
Share Value
Selection &
Targeting
Product/Service
Offering
Product/Service
Offering Positioning
Place/
Pricing
Channel
Promotion/
Communication
Customer
Acquisition
Customer
Retention
Revenue & Profits
Customer
Relationship
Management
Sustain
Value
The Reason for Segmented Pricing
A one-size fits all approach to pricing reduces
profitability and intensifies customer pricing pressure
2 ….leaves money on the table for these customers and
communicates that value does not have to be paid for…
High
Value
1 Setting price here
A
B
C
D
Low
Segment Size
3 ….and misses growth opportunities by
pricing these customers out of the market
Benefits of Price Segmentation
with 5 Segments (A, B, C, D, E)
Percent of Market
A
5
B
15
C
35
D
25
E
20
Total
100%
Segment Size
50
150
350
250
200
1000
$20
$15
$10
$8
$6
$10
$5
$250
$15
$5
$500
$20
$5
$750
$10
$5
$750
$15
$5
$1500
$15
$5
$1500
$10
$5
$1750
$8
$5
$1050
$10
$5
$1750
$10
$5
$0
$8
$5
$750
$8
$5
$750
$10
$5
$0
$8
$5
$0
$6
$5
$200
Reservation Price =
Maxim. contribution w/:
1 Price ($10)
VC equal to
Contribution equals
2 Prices ($15, $8)
VC equal to
Contribution equals
5 Prices ($20  $6)
VC equal to
Contribution equals
$2750
$3800
$4950
Careful Analysis is Required to Avoid Nonprofitable
Segmentation & Proliferation
SKU Velocity Analysis focuses on SKUs that drive a majority
of revenue & volume
Identify opportunities for SKU rationalization
100%
80%
60%
Cumulative
percent of
total sales 40%
Focus price improvement efforts on the
top moving SKUs
20%
0%
0
2000
4000
6000
8000
Cumulative number of SKUs
10000
Benefits of Price Segmentation Can Change with
Ambiguous Reservation Prices
Percent of Market
A
5
B
15
C
35
D
25
E
20
Total
100
Segment Size
50
150
350
250
200
1000
$20
$15
$10
$8
$6
Reservation Price ≈
30% buy next higher-priced
option if target price not available
Examples:
You stop at a gas station, get out, and discover that there is
only premium gas available. Do you buy or leave?
You go to the ballpark and discover that there are only
premium seats available. Do you buy or leave?
Mobile Customer Prices Paid per Minute (Virgin Ex 9b)
70
Price per Minute Paid
60
50
100
40
300
500
30
700
20
10
0
0
100
200
300
400
500
Contract Minutes
600
700
800
Benefits of Price Segmentation Given Ambiguous
Reservation Prices
Percent of Market
A
5
B
15
C
35
D
25
E
20
Total
100
Segment Size
50
150
350
250
200
1000
$20
$15
$10
$8
$6
$10
$5
$750
$15
$5
$1500
$15
$5
$1500
$10
$5
$1750
$8-15
$5
$1785
$10
$5
$1750
$10
$5
$375
$8
$5
$750
$8
$5
$750
$10
$5
$0
$8
$5
$180
$6
$5
$200
Reservation Price ≈
30% buy next higher-priced
option if target price not available
Maxim. contribution w/:
1 Price ($10)
VC equal to
Contribution equals
2 Prices ($15, $8)
VC equal to
Contribution equals
5 Prices ($20  $6)
VC equal to
Contribution equals
$10
$5
$250
$15
$5
$500
$20
$5
$750
$3125
$4715
$4950
Benefits of Price Segmentation Given Ambiguous Reservation
Prices & Incremental VC & FC
A
5
B
15
C
35
D
25
E
20
Total
100
50
150
350
250
200
1000
$20
$15
$10
$8
$6
$10
$5.30
$720
$15
$5.40
$1440
$15
$5.70
$1395
$10
$5.20
$1680
$8-15
$5.30
$1694
$10
$5.60
$1540
$10
$5.10
$365
$8
$5.20
$700
$8
$5.50
$625
$10
$5.00
$0
$8
$5.10
$168
$6
$5.40
$120
Percent of Market
Segment Size
Reservation Price ≈
30% buy next higher-priced
option if target price not available
Maxim. contribution w/:
1 Price ($10)
VC equal to
Contribution equals
2 Prices ($15, $8)
VC equal to
Contribution equals
5 Prices ($20  $6)
VC equal to
Contribution equals
$10
$5.40
$240
$15
$5.50
$480
$20
$5.80
$710
$3000
$4482
$4390
Add $.10 in VC for each incremental price point above $6 (higher VC for higher-priced products) &
$.10 additional FC per product/price offering greater than 1.
Value Based Market Segmentation – pp. 40-45
6 Steps for Value Based Segmentation
Determine
basic
segmentation
criteria
Identify
discriminating
value drivers
Determine
operational
advantages
and
constraints
with regard to
those value
drivers
Create
primary
and
secondary
segments
Create
detailed
segment
descriptions
Develop
metrics
and fences
Three Mechanisms to Maintain Segmented
Structures
Price-offer configuration
Price metrics
Price fences
Pricing Menus Map Price Structure
Help Customers Trade Up or Trade Down
A “Fixed Price, Flexible Offer” Menu
Examples of Tiered Offers in Software
Standard SRP $219.99
Basic SRP $199.95
Professional SRP $299.99
All in Standard +
MS Access
Pro SRP $279.95
All in Basic +
Create Customized forms,
Tools to Track add’l items
Developer SRP $529.99
Development Tools to Build
Own Applications
Premier SRP $399.99
All in Pro +
Daily Sales Summary,
Retail Specific Reports
Price Offer Configuration
Principles For Offer Creation
Toilet on the plane
First to Board
Premium Seats
On-Board Entertainment
Beverages
WiFi Access
Bag Check
Price Metrics
Criteria For Evaluating Price Metrics - Exhibit 3.4
Potential Metrics
1
2
Tracks with Differences in Cost-to-Serve
3
Easy to Measure and Enforce
4
5
Tracks with Differences in Value Across Segments
Facilitates Favorable Positioning against Competition
Aligns with How Buyers Experience Value in Use
Optimal Metric
Value-based Pricing Metrics
Market
Traditional Metrics
Value-based Metrics
Real Estate Want Ads
$ / column inch
$ / property value
Aircraft Engines
$ / engine
$ / hour of use
Information service
$ / minute
$ / download
Example: Innovative Price Metrics Can
Unlock Value and Ignite Growth
iTunes
Why did this new pricing model
have such an impact on sales?
iTunes’ New Price Metric Re-Aligned Price and Value
iTunes
Old
Metric
$ / CD
New
Metric
$ / Song
Overpayment
Value
Inducement
Value
of
CD
Price
of
CD
Value
of
Song
Price
of
Song
Price Fences
– Price Fences are a means to charge different customers
different prices.
– Types include
•
•
•
•
Buyer identification fences (e.g., airlines, student/senior, membership)
Purchase location fences (e.g., grocery chains, real estate)
Time purchase fences (e.g., fashion, yield management - hotels, airlines…)
Purchase quantity fences
– Volume discount
– Order discount
– Step discount
– Two-part pricing (e.g., printer and cartridges)
Next Week:
Price Setting and Value Communications
or
How to price bottled air to morons…