Pricing Strategy & Tactics – Chs. 4-6
– Understand the role of pricing policies in developing a strategic
approach to pricing
– Establish the link between a firm’s 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
Chapter 5 – Pricing Policy
(Management of customer expectations and behaviors…)
• Most managers have difficulty communicating their firms
pricing policies… because they don’t 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
firm’s 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.
The Interaction of Expectations and Behaviors
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
How Pricing Policy Leads to Certain Behaviors
Policy:
Your firm only offers discounts to customers when they have a better
price 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).
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 firm’s reporting period to
secure discounts.
Inventories tend to be greater than normal since sales tend to
become cyclical with the reporting period.
How Pricing Policy Leads to Certain Behaviors
Policy:
Your firm provides discounts for annual volume, regardless of order
volume or the share your buyer’s 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).
How Pricing Policy Leads to Certain Behaviors
Policy:
Your firm publishes list prices, but your firm’s discounting patterns
are inconsistent so as to keep your competitor(s) guessing as to your
sales 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.
Structuring Your Firm’s Pricing Policies
Remove Inconsistency in Policies
Centralize the pricing policy development and monitoring so that all
sales representatives operate under the same policy and use the
same metrics.
Provide Incentives
Reconsider commission compensation since it tends to focus sales
representatives on short-term goals. Sales representatives should be
informed as to what is good/bad for the company. In general, focus
on higher margin sales should be one goal for sales representatives.
Provide Analytical Performance Data
Data should be provided to management and sales representatives.
Buyer Types - Exhibit 5-3
Cues for Identifying Customer Type
Consider these Characteristics in Each Case
Relationship Value
•
•
•
•
•
•
•
•
Desire for interaction
Emotional Involvement
Loyalty
Number/type of considered vendors
Involved decision-making
Fast decisions
Switching Costs
Operational importance of
differentiation
Price Convenience
See Reading on Price Positioning
Convenience Driven
Price Driven
Brand (Relationship) Driven
Value Driven
Pricing Strategy & Tactics – Chs. 5-6
– Understand the role of pricing policies in developing a strategic
approach to pricing
– Establish the link between a firm’s 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
The Price Setting Process - Exhibit 6-1
Define Price
Window
Set
Initial Price
Set initial price range
based on differential
value & relevant costs
Determine amount of
differential value to be
captured
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 pricevolume tradeoffs and
what is their impact on
profitability?
•What are the non-value
related determinants of
price sensitivity?
Communicate Prices
to Market
Develop
communication plan to
ensure prices are
perceived to be fair
Key Questions:
•What is the best
approach to
communicate price
changes to
customers?
•What are the
considerations for
implementing
significantly higher
prices?
Defining Price Windows
Springfield Case: Weighted Average Economic Value
Exhibit 6-2a:
Positively Differentiated Offering
Exhibit 6-2b:
Negatively Differentiated Offering
Neutral Pricing
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.
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.
Consistent with Business Strategy?
Competitive Advantage
The unique position a firm develops through resource &
capability deployments that leads customers to choose the
firm’s 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 firm’s competitive advantage?”
Conditions for Alternative Pricing Objectives
Product Differentiation Cost Leadership Marketing Differentiation
Skim
Penetration
Neutral
CUSTOMERS •Difficult Comparison
Effect
•Price Quality Effect
•Low Price Sensitivity
•Reference Price Effect
COMPETITION •Sustainable
COSTS
•Little differentiation
•High price sensitivity
•Total Expend Effect
•Large Part of EndBenefit
•Customers are sensitive
to other elements of
the marketing mix
differentiation
•Limited threat of
opportunism
•Limited opportunity
for scale economies
•Low threat brands
•Sustainable cost &
•Large share brands w/ a
resource advantage
lot to lose (Oligopolies)
•Financial strength
•Sustainable mktg mix
•Competitors not willing advantages
to retaliate
•Avoid threat of
•Aggressive small share
retaliation
brands
•Changes in Unit Price
Drive Profit
•Low CMs
•Low Volumes
•Large BE Sales Changes
•At or near capacity
•Changes in volume
drive profitability
•High CMs
•High volumes
•Small BE Sales Changes
•Excess capacity
•Sufficient CM to finance
advertising...
•Costs similar to
competitors
•Little excess capacity
•Incremental capacity is
expensive
PENETRATION
•Little differentiation
•Sustainable cost & resource advantage
•Changes in volume drive profitability
SKIM
•Difficult Comparison Effect
•Price Quality Effect
•Sustainable differentiation
•Changes in Unit Price Drive Profit
Setting Price: The Price-Volume Trade-off
Price optimization is a complex process that involves 2 distinct
components: (a) the firm’s 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:
1. How much volume could I afford to lose before a price increase
would decrease my profitability?
DQ ≤ DQBE?
2. How much volume would I have to gain for a price decrease to
improve my profitability?
DQ ≥ DQBE?
In effect, you change the customer response estimation problem
from a two-tailed estimate to a one-tailed estimate.
Incremental Percent Breakeven Sales Change
Current contribution =
New Price
×
P × CM% × Q = P (1 + DP%) ×
P (CM% + DP%)
P (1 + DP%)
(CM% + DP%) ×
CM%
=
BEDQ%
=
CM%
–
(CM% + DP%)
=
– DP%
(CM% + DP%)
BEDQ%
New CM%
(1 + DQ%)
(CM% + DP%)
(CM% + DP%)
×
New Quantity
× Q (1 + DQ%)
Incremental Percent Breakeven Sales Change
Current contribution = New Contribution Margin
×
New Quantity
×
(Q + DQ)
(P – C) Q
=
(P + DP - C)
PQ – CQ
=
PQ +PDQ + DPQ + DPDQ – CQ - CDQ
0
=
PDQ + DPQ + DPDQ - CDQ
0
=
DQ(P + DP – C) + DPQ
DQ(P + DP – C) =
DQ
BE
Q
-DPQ
-DP
=
(P + DP – C)
=
-DP
(CM + DP)
Incremental Percent Breakeven Sales Changes
% Change in Price
Current Contribution Margin
20%
15%
10%
5%
0%
-5%
-10%
-15%
-20%
5%
-80%
-75%
-67%
-50%
0%
10%
-67%
-60%
-50%
-33%
0%
100%
20%
-50%
-43%
-33%
-20%
0%
33%
100%
30%
-40%
-33%
-25%
-14%
0%
20%
50%
100%
40%
-33%
-27%
-20%
-11%
0%
14%
33%
60%
100%
50%
-29%
-23%
-17%
-9%
0%
11%
25%
43%
67%
60%
-25%
-20%
-14%
-8%
0%
9%
20%
33%
50%
70%
-22%
-18%
-13%
-7%
0%
8%
17%
27%
40%
80%
-20%
-16%
-11%
-6%
0%
7%
14%
23%
33%
90%
-18%
-14%
-10%
-5%
0%
6%
13%
20%
29%
Price increase: % decrease < the breakeven decrease leads to contribution increase.
Price decrease: % increase > the breakeven increase leads to contribution increase.
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 price=higher quality?
Fair price range
Gains vs. losses
Gains vs. losses
Prospect Theory
Perceived Value
100
Small Gains Overvalued
50
Large Gains Undervalued
0
Small Losses
Strongly Overvalued
Reference point
-50
-100
-100
Losses
-50
0
Objective Value
50
Gains
100
Internal Reference Price Shoppers:
Remember their favorite brand(s) & the last price they paid.
Wow! I paid $15.00 for
that Franciscan yesterday
and it’s on sale here for
$12.99. Better get a case.
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.
Price Range Shoppers:
Don’t have a favorite brand or remember prices.
Let’s see. Clos du Bois
$9.99, Voss $16.00,
Franciscan $12.99 &
Rombauer $35...
Price
Elasticity – a visual representation . . . .
P2
P1
elastic
(many substitutes – grains,
fruits and vegetables, bagged soil,
paper clips, rubber bands)
P2
P1
inelastic
unit elastic
(few substitutes – gemstones, transplant organs)
Q2 Q1 Q2
Q1
Quantity Demanded
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)
Elasticity =
Percent Change in Price (over relevant range)
E
E
=
=
% D in Unit Sales
% D in Price
(22%-49%)/Average(22%,49%)
(14-12)/Average(14,12)
Single Ticket Demand in Springfield Nor’easters
How to Estimate Volume Along the Demand Curve
1 Ticket
100%
75%
50%
1 Ticket
Use the Polynomial Trendline
Function in Excel
y = -0.0225x2 + 0.34x - 0.35
R² = 1
25%
0%
$4
$6
$8
$10
$12
$14
Elasticity – Measurement of Price
Sensitivity at the Market Segment Level
Measure of Price Elasticity
|Price Elasticity| < 1 An increase in price within the range evaluated
Inelastic
results in lower unit sales but higher revenue
(profit?).
|Price Elasticity| > 1 An increase in price within the range evaluated
Elastic
results in lower unit sales and lower revenue
(profit?).
|Price Elasticity| = 1 An increase in price within the range evaluated
Unit Elastic
results in an identical change in unit sales and
the same revenue (profit?).
Elasticity Required to Breakeven
Current Contribution Margin
% Change in Price
5% 10% 20% 30% 40% 50% 60% 70% 80% 90%
20%
15%
10%
5%
0%
-5%
-10%
-15%
-20%
-4.00 -3.33 -2.50 -2.00 -1.67 -1.43 -1.25 -1.11 -1.00 -0.91
-5.00 -4.00 -2.86 -2.22 -1.82 -1.54 -1.33 -1.18 -1.05 -0.95
-6.67 -5.00 -3.33 -2.50 -2.00 -1.67 -1.43 -1.25 -1.11 -1.00
-10.00 -6.67 -4.00 -2.86 -2.22 -1.82 -1.54 -1.33 -1.18 -1.05
0%
0%
0%
0%
0%
0%
0%
0%
0%
0%
-20.00 -6.67 -4.00 -2.86 -2.22 -1.82 -1.54 -1.33 -1.18
-10.00 -5.00 -3.33 -2.50 -2.00 -1.67 -1.43 -1.25
-6.67 -4.00 -2.86 -2.22 -1.82 -1.54 -1.33
-5.00 -3.33 -2.50 -2.00 -1.67 -1.43
Price increase: |Elasticity| < the breakeven amount leads to contribution increase.
Price decrease: |Elasticity| > the breakeven amount leads to contribution increase.
Homework for Next Week
Fire Safety
BEDQ%
–
DP%
=
(CM% + DP%)
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.
Adapting the Message for Product Characteristics
Relative Cost of Search
Economic Benefits
Psychological Benefits
Type of Benefits
Low
Simple “Search” Goods
Commodity
Chemicals
Home
Equity
Loans
High
Complex “Experience” Goods
Auto
Repairs
Desktop
Computers
Pain
Medications
Digital
Cameras
Management
Consulting
Investment
Advice
Hotels
Life
Insurance
SUV’s
Sports
Cars
Cosmetics
College
Education
Blood
Pressure
Drugs
Fitness Unique work
Equipment
of Art
Designer
Clothes
Exotic
Vacations
Framework of Value Communication Strategies
Economic Benefits
Psychological Benefits
Type of Benefits
Relative Cost of Search
Low
“Search” Goods
Strategy 1
Economic Value
Communication
High
“Experience” Goods
Strategy 2
Economic Value
Assurance
Communicate
Objective Information That
Differential Economic Value
Justifies Pricing (e.g., Computers)
Communicate Assurances That
Differential Economic Value
Justifies Pricing (e.g., Investment
Returns, Hotel Guarantee)
Strategy 3
Psychological End-Benefit
Framing
Strategy 4
Psychological End-Benefit
Assurance
Associate
Differential Performance with
Subjective Psychological Value
That Justifies Pricing (e.g.,
Cosmetics)
Communicate
Assurances That Total
Psychological Value
Justifies Pricing (e.g., Art, Exotic
Vacations, Mattresses?)
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
The Price Setting Process - Exhibit 6-1
Define Price
Window
Set
Initial Price
Set initial price range
based on differential
value & relevant costs
Determine amount of
differential value to be
captured
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 pricevolume tradeoffs and
what is their impact on
profitability?
•What are the non-value
related determinants of
price sensitivity?
Communicate Prices
to Market
Develop
communication plan to
ensure prices are
perceived to be fair
Key Questions:
•What is the best
approach to
communicate price
changes to
customers?
•What are the
considerations for
implementing
significantly higher
prices?
Next Week
Akash Rathod
B2B Pricing
&
Pricing Strategy Over the Life
Cycle (Chs. 7-8)