Types of BEP
Type I: BEP of
a price change
Type II: BEP of
a fixed-cost
investment
BEP Analysis
Type III: BEP of
the change in
variable cost
Type IV: BEP of
Cannibalization
1
Example: Type III BEP
Sun Manufacturing sells bookcases at a price of $100 a
piece.
 Variable costs per unit are $50.
 Suppose that the unit variable costs have changed to $60,
what will be the percentage increase in sales volume in
order to make the profit remains the same?

2
Formula for Type III BEP Analysis
Break-Even Point = ( Unit Contribution_oldVC ) -1
Unit Contribution_newVC
3
Solution


Margin at the old unit variable cost is $50
Margin at the new unit variable cost is $40
BEP =

50
40
-1= 25%
To make sure the profit remains the same, the sales
volume has to go up by 25%.
4
Types of BEP
Type I: BEP of
a price change
Type II: BEP of
a fixed-cost
investment
BEP Analysis
Type III: BEP of
the change in
variable cost
Type IV: BEP of
Cannibalization
5
Example: Type IV BEP
Sun Manufacturing sells bookcases at a price of $100 a
piece.
 Variable costs per unit are $50.
 Suppose that the company is considering introduce a new
brand that sells $120 and costs $60 each, what will be the
percentage of sales for the new brand that is coming from
the existing brand, so that the profit remains the same?

6
Formula for Type IV BEP Analysis
Break-Even Rate = ( Unit Contribution_old offering
Unit Contribution_new offering
)
7
Solution


Margin of the existing product is $50
Margin of the new product is $60
BEP =

50
60
= 83.3%
To make sure the profit remains the same, the new
product can take up to 83.3% of the market share from
the existing product.
8
Chapter 7
Price Levels
9
The Pricing Strategy Pyramid
Price
Level
Price setting
Pricing
Policy
Negotiation Tactics &
Pricing Setting Procedures
Value Communication
Communication, Value Selling Tools
Price Structure
Metrics, Fences, Controls
Value Creation
Economic Value, Offering Design, Segmentation
Price Setting Process
Preliminary Segment
Pricing
Optimization
Implementation
Set baseline prices
based on type of value
assessment and initial
differential value
capture rate
Refine preliminary
prices with iterative
process balancing
tradeoffs between
price, cost, and market
response
Set final prices and
ensure acceptance
among customers and
organization through
effective change
management approach
Key Questions:
How much of the differential
value should be captured for
each segment?
How much time and effort should
I invest in assessing the value of
my products?
How should I adjust segment
prices to account for different
price sensitivities?
Key Questions:
What tradeoffs should I make
between long-term strategic
objectives and short-term market
responses to price changes?
What types of analytical
techniques are best suited to my
product and market conditions?
How can I estimate customer
response to potential price
changes?
Key Questions:
What tradeoffs should I make
between long-term strategic
objectives and short-term market
responses to price changes?
What types of analytical
techniques are best suited to my
product and market conditions?
How can I estimate customer
response to potential price
changes?
11
Preliminary Segment Pricing
Positive
Differentiati
on
Negative
Differentiation
Key question: How much differential
value should be captured in each
segment?
Competitive
Reference
The answer to this question can differ substantially across
segments based on strategic considerations and differences in
price sensitivity
12
Price Setting Illustration
13
Three Generic Pricing Strategies

Skim

Penetration

Neutral
14
Conditions for Different Pricing Strategies
SKIM
PENETRATION
NEUTRAL
COSTS
CUSTOMERS
COMPETITION
15
Pricing Strategy
SKIM
COSTS
CUSTOMERS
COMPETITION
PENETRATION
NEUTRAL
Low CMs
Low Volumes
Changes in Unit
Price Drive Profit
Large BE Sales
Changes
At or near capacity
High CMs
High volumes
Changes in volume
drive profitability
Small BE Sales
Changes
Excess capacity
Costs similar to
competitors
Sufficient CM to
finance adv, etc.
Little excess capacity
Incremental capacity
is expensive
Low Price Sensitivity
-Reference Price
Effect
-Price Quality Effect
-Difficult Comparison
Effect
High price sensitivity
-Total Expend Effect
-Large Part of EndBenefit
Little differentiation
Customers are more
sensitive to other
elements of the
marketing mix
Limited threat of
opportunism
Limited opportunity
for scale economies
Sustainable
differentiation
Low threat brands
Sustainable cost &
resource advantage
Competitors not
willing to retaliate
Financial strength
Aggressive small
share brands
Avoid threat of
retaliation
Large share brands
with a lot to lose
Sustainable mktg mix
advantages
Oligopolies
16
Categorize These Pricing Strategies
How would you categorize the pricing strategies for the following products
and retailers? (S=skim, N=neutral, P=penetration)
Pepperidge Farm Cookies
Suave Shampoo
Land O' Lakes Butter
T.J. Maxx (Clothing)
L'Oreal Hair Coloring
Bloomingdales
Sears
_______
_______
_______
_______
_______
_______
_______
17
Analytical Approaches to Profitability Analysis
High
Number of
Transactions
Automated Price
Automated Price
Optimization
Optimization
System
System
Spreadsheet
Spreadsheet- based
basedBreak
Break- even
evenAnalysis
Analysis
Simulation
Simulation
Modeling
Modeling/ /Risk
Risk
Analysis
Analysis
Low
High
Low
Frequency of
Price Changes
18
Analyzing Profitability Using the
Breakeven Sales Change Approach
Contribution Margin
% Change in Price
5%
10%
20%
30%
40%
50%
60%
70%
80%
90%
35%
-88%
-78%
-64%
-54%
-47%
-41%
-37%
-33%
-30%
-28%
25%
-83%
-71%
-56%
-45%
-38%
-33%
-29%
-26%
-24%
-22%
15%
-75%
-60%
-43%
-33%
-27%
-23%
-20%
-18%
-16%
-14%
5%
-50%
-33%
-20%
-14%
-11%
-9%
-8%
-7%
-6%
-5%
0%
0%
0%
0%
0%
0%
0%
0%
0%
0%
0%
-5%
NA
100%
33%
20%
14%
11%
9%
8%
7%
6%
-15%
NA
NA
300%
100%
60%
43%
33%
27%
23%
20%
-25%
NA
NA
NA
NA
167%
100%
71%
56%
45%
38%
-35%
NA
NA
NA
NA
700%
233%
140%
100%
78%
64%
19
Risk Analytic Approach to Profitability
Analysis
Overlay Chart
Comparative Risk Profiles
Frequency Comparison
.036
Premium
Branding
Premium
Branding
Strategy
Strategy
.027
.018
.009
Discount
Pricing
Discount Pricing
Strategy
Strategy
.000
19,000,000.00
21,500,000.00
24,000,000.00
26,500,000.00
29,000,000.00
20
Determinants of Price Sensitivity

The Reference Price Effect

The Difficult Comparison Effect

The Switching Cost Effect

The Price-Quality Effect

The Expenditure Effect

The End-Benefit Effect

The Fairness Effect

The Framing Effect

The Shared-Cost Effect
21
Price Sensitivity Illustration
For each of the following purchase decisions, what factors are likely
to affect the consumer's price sensitivity?
 A diamond engagement ring
 Automobile repairs
 Food for meals at home
 Which university to attend
 A company car
 Draperies for your new home
 Text books
 Health insurance plan
 Souvenirs
 Vacation resort
22
Price Sensitivity Discussion Questions


What can a company do to decrease its customer's
price sensitivity?
Would all of the company's customers be likely to
react in the same way?
23
Price Sensitivity Discussion Questions


Would a company ever want to do anything to
increase its customers' price sensitivity? Why?
What steps might it take?
24
Price Sensitivity Discussion Questions





Which of the following statements are always true,
sometimes true, never true? Why?
(a) Price elasticity is generally the same for all brands in a
product category.
(b) Advertising increases price sensitivity.
(c) As a product category matures, the consumers
become more price sensitive.
(d) Each consumer has different price
sensitivities for different products.
25
Price Sensitivity Questions



The gasoline service stations in Rochester, New York
convinced the City Council to ban signs displaying gasoline
prices
Why would they want to do this?
What effect do you think this law had on gasoline prices?
Why?
26
Price Sensitivity Questions

Despite the fact that rental rates for commercial space
and labor costs are generally higher in big cities than in
small towns, the prices of many products--such as stereo
equipment and clothing--are higher in small towns than in
large cities.
27
Price Sensitivity Discussion Questions
Many local rental car agencies rent late model cars at substantially lower
prices than national companies such as Hertz and Avis. Despite their higher
prices, the national companies still retain most of the market
(a) Explain why most renters patronize the national car rental companies despite their
higher prices. How have the national companies encouraged this price insensitivity?
(b) If you were a small, local company, what factors would you look for to identify
the price-sensitive segment of renters likely to be attracted to your lower price?
(c) If you were a small company trying to become national, how might you
overcome the low price sensitivity of customers to induce them to try your cars and
evaluate the quality of your service?
28
Next Lecture

Price and Promotion
29