Lecture 7
Pricing Policies and Levels
Dr. Yacheng Sun, UC Boulder
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Pricing Policies
Dr. Yacheng Sun, UC Boulder
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Learning Objectives

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

Illustrate common pricing policies and their impact on
profitability
Dr. Yacheng Sun, UC Boulder
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Benefits Of Policy Driven Pricing

Provides greater consistency across customer
base

Mitigates cost associated with ad-hoc
discounting

Forces trade-offs & value recognition

Increases perceptions of price integrity

Creates more efficient selling process
Dr. Yacheng Sun, UC Boulder
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The Interaction of Expectations and Behaviors
Dr. Yacheng Sun, UC Boulder
Strategic Capabilities of Procurement versus Sales - Exhibit 5-2
Dr. Yacheng Sun, UC Boulder
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Buyer Types
Dr. Yacheng Sun, UC Boulder
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Cues for Identifying Customer Type
Relationship








Value
Price
Convenience
Desire for interaction
Emotional Involvement
Loyalty
Number/type of considered vendors
People involved in decision
Fast decisions
Switching Costs
Operational importance of differentiation
Dr. Yacheng Sun, UC Boulder
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Price Levels
Dr. Yacheng Sun, UC Boulder
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Overview

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 new pricing approaches such as dynamic pricing

Show how to communicate new prices to maximize perceived fairness and
minimize adverse customer response
Dr. Yacheng Sun, UC Boulder
The Price Setting Process
Define Price
Window
Set
Initial Price
Communicate Prices
to Market
Set initial price range
based on differential
value and relevant
costs
Determine amount of
differential value to be
captured with price
Develop communication
plan to ensure prices are
perceived to be fair
Key Questions:
Key Questions:
•What is the appropriate
price ceiling for this
product?
•Is the price point
consistent with my
overall business
objectives?
•How should I
incorporate reference
prices into my price
window?
• What are the non-value
related determinants of
price sensitivity?
•What is the role of
costs in setting my
initial price range?
•What are the pricevolume tradeoffs and
what is their impact on
profitability?
Dr. Yacheng Sun, UC Boulder
Key Questions:
• What is the best
approach to communicate
price changes to
customers?
•What are the
considerations for
implementing significantly
higher prices?
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Defining Price Windows
Exhibit 6-2a:
Positively Differentiated Offering
Exhibit 6-2b:
Negatively Differentiated Offering
Dr. Yacheng Sun, UC Boulder
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Three Generic Pricing Strategies
Skim
Penetration
Neutral
Dr. Yacheng Sun, UC Boulder
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Price Strategy Options
Price Skimming
Price skimming attempts to capture high margins at the expense of high
sales volume.
Prices are high relative to what the “middle market” would be typically
willing to pay.
A price skimming strategy is only viable when the profit from selling to the
price-insensitive segment exceeds the sales foregone from selling to a
larger market at a lower price.
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Price Strategy Options
Price Skimming
Consumers – Consumers purchasing products that are priced using a
skimming strategy are generally __________ due to some ___________
feature of the product or the context in which the product will be consumed.
Costs – When incremental cost represent a large share of a product’s price,
then a small increase in price will result in a large percentage increase in the
contribution margin. If variable costs are 90% of a product’s price, increasing
price by 15% would make a product more profitable as long as unit sales do
not decrease by more than 60%.
Competition – Skimming usually requires certain _____________________
Protection includes copyrights, patents, brand reputation (trademarks), access
to scarce resources, preemption of the best distribution channel, and image.
Dr. Yacheng Sun, UC Boulder
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Price Strategy Options
Sequential Price Skimming
Sequential price skimming begins with a price that attracts the __________
consumers first. After the company has “skimmed” the
top level of consumers, the company will then reduce the price just low
enough to sell to the next most lucrative segment. The company
continues this process until all skimming opportunities have been
exhausted.
Sequential price skimming is often used for introducing durable and
nondurable products to the market. Companies may use the strategy to
ramp up capacity or build selective markets in a strategic order (most
lucrative first). For example, personal computer chips produced by Intel
are priced using a sequential price skimming strategy.
Dr. Yacheng Sun, UC Boulder
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Price Strategy Options
Penetration Pricing
Penetration pricing involves setting price far enough below economic value
(not necessarily below economic cost!) to attract and hold a large base
of consumers.
Penetration pricing is designed to ______________ at the expense of
higher margins.
Penetration pricing does not necessarily mean the product is “cheap.” The
price is low relative to the economic value that consumers attach to
the product.
Dr. Yacheng Sun, UC Boulder
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Penetration Pricing with Loss Leaders
A loss leader is a product that is priced and sold below its variable as an
incentive to attract customers to increase sales of other goods/services
in the product line.
Loss leaders only are effective when products in a product line are
_____________.
Loss leaders can be priced so low that they have a negative unadjusted
contribution margin. However, sales in complementary products can
more than off-set the negative contribution margin of the loss leader.
Usually, the best loss leaders are goods/services that are purchased
_____________ by ___________buyers.
Dr. Yacheng Sun, UC Boulder
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Price Strategy Options
Penetration Pricing
Consumers – Consumers must be willing to _____________. Lowering
price may erode consumers’ perceptions of a product’s image or prestige.
Penetration pricing is usually not successful for trivial expenditure products
or products whose value is difficult to determine (e.g., service products).
Costs – Penetration pricing is more likely to succeed if sufficient variable
cost economies are created. The danger of penetration pricing is that costs
for the industry tend to converge over time; making it difficult to maintain
cost economies and consumers relative to competitors.
Competition – Competitors will undercut price if they _______________.
Small firms (firms with a relatively smaller market share than competitors)
can exploit penetration pricing more than larger firms.
Dr. Yacheng Sun, UC Boulder
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Price Strategy Options
Neutral Pricing
Neutral pricing involves strategically deciding not to use price as a tool to
gain market share or to restrict it.
Neutral pricing is often a default strategy since a company may not be able
to exploit a skimming or penetration strategy.
Neutral pricing is common in product markets that are perceived to be
commodities.
Dr. Yacheng Sun, UC Boulder
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Conditions for Alternative Pricing Objectives
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
Dr. Yacheng Sun, UC Boulder
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Analytical Approaches to Profitability Analysis
High
Number of
Transactions
Automated Price
Automated Price
Optimization
Optimization
System
System
Spreadsheet
Spreadsheet- based
basedBreak
Break- even
Analysis
even Analysis
Simulation
Simulation
Modeling
Modeling/ /Risk
Risk
Analysis
Analysis
Low
High
Low
Frequency of
Price Changes
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Incremental Percent Breakeven Sales Changes
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%
Dr. Yacheng Sun, UC Boulder
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Price Sensitivity Drivers
Dr. Yacheng Sun, UC Boulder
Risk Analytic Output from 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
25