Pricing Strategies
Key Learning Points
• Pricing strategies & tactics (terminology).
• The concept of value and the price-setting process.
• Deciding how much of the strategic pricing gap to
capture.
• Linking elasticity to value and estimating the
effect of a price change
According to McKinsey, “80 to 90 percent of all poorly
chosen prices are too low… Companies habitually charge
less than they could for new offerings. It’s a terrible habit.”
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Pricing Strategies
• Customer Value Pricing (Demand-focused pricing)
Sets price based on the relative sharing of differentiation value);
Company Objectives determine how much value to share or capture:
• Penetration or Market Share Pricing
– Gives most value to customers, builds share & goodwill & erects entry
barriers; elastic demand, no sustainable advantage, market share objective…
• Skimming or Prestige Pricing
– Majority of value goes to firm to maximize profits – invites competitive
entry; inelastic demand, multiple price segments, sustainable advantage…
• Intermediate or Neutral Pricing
– Equal sharing of value
• Technical, Cost-focused Pricing
• Full-Cost Pricing – Markup, Breakeven, Rate-of-return
– Ignores competition and customer; most useful in stable supply & demand
situations or unique, bidding situations with high uncertainty
• Variable-Cost Pricing
– Ignores fixed costs; useful to stimulate or shift demand for perishable
offerings with seasonal demand.
2
Customer -- Psychological Aspects of Price
• Value Is the Ratio of Perceived Benefits to Price
– Evaluated by comparing focal offering to a reference
value
– Creates a price window for competitive offerings
3
The Price Setting Process
Define Price
Window
Set initial price range
based on differential
value & relevant costs
Key Questions:
•What is the role of costs
in setting my initial price
range?
•What is appropriate price
ceiling for this product?
•How should I incorporate
reference prices into my
price window?
Set
Initial Price
Communicate Prices
to Market
Develop
communication plan to
ensure prices are
perceived to be fair
Key Questions:
Key Questions:
•Is price consistent with my •What is the best way
business strategy &
to communicate price
objectives (skimming vs.
(changes) to
penetration)?
customers?
•What are the non-value
•What are the
related determinants of
considerations for
price sensitivity?
implementing
•What are the pricesignificantly higher
volume tradeoffs &
prices?
impact on profitability?
Determine amount of
differential value to be
captured
Using Competitive Information to Define Price Window
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?
Competitive Water Prices & the Price Window
Number of competitive offerings
6
5
4
Neutral or
Intermediate Prices
3
Penetration Prices
Skimming Prices
2
1
0
0-$2.5
$2.5-$7.5
$7.5-$12.5
$s per Gallon
$12.5-$17.5
>$17.5
Conceptualizing the Price Window and
Market Segments with a Normal Bell Curve
Value Buyers
Price Sensitive
Price Insensitive
Low Price
Hi Price
Penetration Pricing Intermediate Pricing Price Skimming
Non-normal Distributions with Kinks
Suggest Different Segments
Frequency of Observed Price Points
Observed Prices for Milwaukee’s Best, Miller, Budweiser & Michelob
160
140
120
100
80
60
40
20
0
5.00
10.00
15.00
20.00
25.00
$s per Gallon
8
Price Windows for Milwaukee’s Best,
Bud & Miller, and Michelob
Frequency of Observed Price Points
80
70
60
50
40
30
20
Price
Driven
10
Value
Driven
Brand
Driven
0
$5
$10
$10
$15
$15
$s per Gallon
$20
$20
$25
$25
The Price Setting Process
Define Price
Window
Set initial price range
based on differential
value & relevant costs
Key Questions:
•What is the role of costs
in setting my initial price
range?
•What is appropriate price
ceiling for this product?
•How should I incorporate
reference prices into my
price window?
Set
Initial Price
Communicate Prices
to Market
Develop
communication plan to
ensure prices are
perceived to be fair
Key Questions:
Key Questions:
•Is price consistent with my •What is the best way
business strategy &
to communicate price
objectives (skimming vs.
(changes) to
penetration)?
customers?
•What are the non-value
•What are the
related determinants of
considerations for
price sensitivity?
implementing
•What are the pricesignificantly higher
volume tradeoffs &
prices?
impact on profitability?
Determine amount of
differential value to be
captured
Economic Value Estimation Framework
Your unique
value
delivery
Price of Next
Best
Competitive
Alternative
Positive
Differentiation
Value
Competitive
Reference
Value
Negative
Differentiation
Value
Price to
capture a
share of
this value
Costs unique to
doing business
with you
Total
Economic
Value
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Defining the Price Window (& Objectives)
Positively Differentiated Offering
Negatively Differentiated Offering
Neutral or
Intermediate 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.
12
Customer -- Psychological Aspects of Price
• Value Is the Ratio of Perceived Benefits to Price
– Evaluated by comparing focal offering to a reference
value
– Creates a price window for competitive offerings
• Linking Elasticity and Value Estimates
– As differential value increases, elasticity decreases
– Marketers can effectively use price to signal quality
when:
• Consumers lack information
• Product quality is difficult to assess before
(experience goods) or even after (credence goods)
purchase
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Estimating Customer Value
MKTG 6223: Understanding What Customers Value
MKTG 6214: Advanced Pricing Management
Estimating Customer
Value
• Economic Value
Method
• Quantify the objective value of
attributes
• Survey-Based
Methods
• Self-report willingness-to-pay
• Conjoint studies
• Direct Purchase
Observation
• Estimate price elasticity based
on purchase data, perhaps in
conjunction with an experiment
Financial Analysis in Marketing
K&P Chapter 2
•
•
•
•
•
•
Marketing Pro Formas
Breakeven Analysis
Customer Lifetime Value (CLV)
Sales Forecasts
Demand Elasticity
Channel Margin Calculus
15
Price Experiment for
Mobile Phone
Inelastic demand
-.50
Elastic demand
-2.83
Demand Elasticity wrt Price
Necessary to Evaluate Price-Volume Trade-offs
% change in demand
E =
% change in price
Price D from 1200  900
Ecar phone= (24% - 41%)/24%
(1200-900)/1200
= -2.83
Price D from 600  900
Ecar phone= (41% - 45%)/41%
(900-600)/900
= -.50
If the absolute value of E is < 1.0, demand is inelastic
If the absolute value of E is > 1.0, demand is elastic
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Price
Elasticity – a visual representation . . . .
P2
P1
Elastic: customers are very sensitive to price
changes when there is no differential
advantage between substitutes – grains, fruits
and vegetables, paper clips, rubber bands
P2
Price elasticities on average ≈ -2.5
unit elastic (i.e., e = -1)
P1
Inelastic: customers are not very sensitive to price
changes when there is strong differential advantage
and few substitutes – gemstones, transplant organs
Q2 Q1Q2
Q1
Quantity Demanded
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Break-even (B/E) Sales Analysis Formula
Price Change (No change in costs):
% B/E unit sales D =
— %DP
or
%CM’ + %DP
— $DP
$CM’ + $DP
For example, your current contribution margin is 50%;
that is, unit variable costs are 50% of price
What % unit sales increase is necessary for a
10% price decrease to breakeven?
— %DP
10%
=
%CM’ + %DP
50% - 10%
B/Ee =
25%
-10%
=
= -2.5
10%
40%
= 25%
Estimating the Effect of a Price Change
See Kerin & Peterson, Ex. 8.2
Cost, Volume, and Profit Data
Unit sales volume
1,000
1,000
Unit selling price
$10
$10
Unit variable cost
$5
$2
Unit contribution (margin)
$5
50%
$8
Fixed costs
$3,000
$6,000
Net profit
$2,000
$2,000
80%
Break-even Sales Change
PD%
QD%
e
QD%
e
For a price reduction of
-20%
66.7%
-3.3
33.3%
-1.7
For a price reduction of
-10%
25.0%
-2.5
14.3%
-1.4
For a price reduction of
-5%
11.1%
-2.2
6.7%
-1.3
For a price increase of
5%
-9.1%
-1.8
-5.9%
-1.2
For a price increase of
10%
-16.7%
-1.7
-11.1%
-1.1
For a price increase of
20%
-28.6%
-1.4
-20.0%
-1.0
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Collaborators -- Channel Margin Analysis
Cases May Require Price-Setting to Intermediaries
Planned Prices and Margins for
a Software Product
Retail Price $400
Retail Price $500
RM
40%
Wholesale Price $240
Wholesale Price $300
Manufacturer Price $240
WM 20%
GM
50%
Manufacturer Price $192
GM goes to 72/192 = 37.5%
Cost of Goods Sold $120
Cost of Goods Sold $120
COGS
50%
Or reduce COGS 20% to $96
What if you wanted a $400 MSRP?
21
Unit Profit Margin Analysis
Altius Weighted Average
Victor TX
Victor
70%
30%
$45.30
$48.00
$39.00
$27.00
Retailer gross profit
$6.80
$7.20
$5.85
$5.40
Retailer gross margin %
15.0%
15.0%
15.0%
20.0%
Current Share of Sales
Retail price
70% x 48 + 30% x 39 =
Manufacturer price
$33.15
Manufacturer variable cost
30%  $9.95
Manufacturer unit contribution
70% $23.21
Manufacturer gross margin %
Value of market share point ($M)
Elevate
70%
70%
?
?
70%
?
$7.75
64%
?
22
Current Market Share and Gross Profit
for Altius's Product Line
Altius
Market share, retail dollar sales (%)
Victor TX
Victor
$266.6
$0.00
$0.00
15.0%
15.0%
15.0%
70.0%
70.0%
70.0%
70.0%
30.0%
55.2%
Unit volume (M)
Retail sales ($M) - 55.2% of $483M
Retailer gross margin (%)
Manufacturer sales ($M)
Manufacturer gross margin (%)
Gross profit ($M)
Victor TX 70% of unit volume
Market share, unit sales (%)
45.2%
23
Victor Price Cut Analysis
Current price
Retail price
Retailer margin
Altius price
Altius variable cost
Altius unit contribution
Altius gross margin
$39
15%
$33.15
$9.95
$23.21
70%
$2 Retail Price Cut $4 Retail Price Cut
$37
15%
$31.45
$35
15%
— $DP
BE= $CM’ + $DP
=
— %DP
BE= %CM’ + %DP
=
Altius Manufacturer Price Change %
-5.1%
Unit sales increase to maintain profit
7.9%
- -1.70
23.21-1.70
- -5.1%
70%-5.1%
% Retail price change
Elasticity required to break even
Victor Market Share increase required to break even
Victor Market Share required to break even
Altius Market Share required to break even
24
The Price Setting Process
Define Price
Window
Set initial price range
based on differential
value & relevant costs
Key Questions:
•What is the role of costs
in setting my initial price
range?
•What is appropriate price
ceiling for this product?
•How should I incorporate
reference prices into my
price window?
Set
Initial Price
Communicate Prices
to Market
Develop
communication plan to
ensure prices are
perceived to be fair
Key Questions:
Key Questions:
•Is price consistent with my •What is the best way
business strategy &
to communicate price
objectives (skimming vs.
(changes) to
penetration)?
customers?
•What are the non-value
•What are the
related determinants of
considerations for
price sensitivity?
implementing
•What are the pricesignificantly higher
volume tradeoffs &
prices?
impact on profitability?
Determine amount of
differential value to be
captured
Happy Pricing!
Review Questions
• What are 2 Customer Value Pricing (i.e., Demandfocused Pricing) strategies?
• What are 2 Cost-focused Pricing strategies?
• How do we define value?
• What are the three steps in the Price-Setting
process?
• What is the link between pricing strategy and
competitive advantage?
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