Timing of Price Promotion

Suppose that you are running a local mountain bike store
and knows that you are looking at two types of customers.



10% are casual shoppers, who are willing to pay $3,000
for the bike. Yet they are happy to pay a discount price.
Casual shopper only shops on Saturday & Sunday.
90% are deal seekers, who are only willing to pay $300
for the bike. Deal seekers check out the stores for prices
7 days a week.
Your goal is to maximize the overall profit.
Dr. Yacheng Sun, UC Boulder
1
When to Price Promote?
Mon
Tue
Wed
Thur
Fri
Sat
Sun
Sale?
Deal
seekers
Casual
shoppers
Dr. Yacheng Sun, UC Boulder
2

Suppose that you are running an online mountain bike store
and knows that you are looking at two types of customers.



10% are casual shoppers, who are willing to pay $3,000
for the bike. Yet they are happy to see a discount price.
Casual shopper shop online with equal probability in
either of the 7 days.
90% are deal seekers, who are only willing to pay $300
for the bike. Deal seekers are online looking for deals 7
days a week.
Your goal is to maximize the overall profit.
Dr. Yacheng Sun, UC Boulder
3
When to Price Promote?
Mon
Tue
Wed
Thur
Fri
Sat
Sun
Sale?
Deal
seekers
Casual
shoppers
Dr. Yacheng Sun, UC Boulder
4
Exam 1 Review
Dr. Yacheng Sun, UC Boulder
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Price & Profit
Profit = Total Revenue – Total Costs
= (Unit Price x Quantity Sold) – Total Costs
= (Unit Price x Quantity Sold) – Fixed Costs
– Variable Costs
= (Unit Price x Quantity Sold) – Fixed Costs –
(Unit Cost x Quantity Sold)
Dr. Yacheng Sun, UC Boulder
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Example
Projected Costs and Revenues at
Expected Sales = 1,000,000 units
Total
Direct Variable Costs
$3,000,000
Direct Fixed Costs
$4,000,000
Administrative Overhead
$1,500,000
Full Cost
$7,500,000
Revenue
$10,000,000
Profit
$1,500,000
Dr. Yacheng Sun, UC Boulder
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Unit contribution, Margin and Markup
Unit contribution is the difference between the price
and the variable cost
Margin: (Unit contribution)/(Unite Price)
Markup: (Unit contribution)/(Unite Cost)
Dr. Yacheng Sun, UC Boulder
8
Margin
Manufacturer’s margin
 Retailer’s margin

$1.50
Manufacturer
$2.00
Retailer
Cost of sales: $1
Selling price: $1.50
Unit contribution: $.50
Margin: 33%
Consumer
Cost of sales: $1.50
Selling price: $2.00
Unit contribution: $.50
Margin: 25%
Dr. Yacheng Sun, UC Boulder
9
Markup
Manufacturer’s markup
 Retailer’s markup

$1.50
Manufacturer
$2.00
Retailer
Cost of sales: $1
Unit contribution: $.50
Markup: 50%
Consumer
Cost of sales: $1.50
Unit contribution: $.50
Markup: 33%
Dr. Yacheng Sun, UC Boulder
10
Relationship between Markup and Margin
1/Markup = (1/Margin) -1
Practice
A 25% markup =
% margin
A 20% markup =
% margin
A 25% margin =
% markup
A 50% margin =
% markup
Dr. Yacheng Sun, UC Boulder
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Psychological Aspects of Pricing
Perception Bias
Weber-Fechner Law
Status Quo Bias
Prospect Theory
Dr. Yacheng Sun, UC Boulder
12
Shape of the Value Function (Prospect Theory)
#1 V(w) <V(x)<V(y)
#2 V(y)-V(x) <V(x)-V(w)
Reference point
Utility(+)
Value function
#3 V(x) <-V(-x)
V(x)
-x
losses
0 w x
y
gains
V(-x)
Disutility(-)
Dr. Yacheng Sun, UC Boulder
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A Numerical Example
Gain
Utility
Change
in Utils
Loss
Utility
Change
in Utils
$200
40
40
-$200
-80
-80
$400
70
30
-$400
-140
-60
$600
90
20
-$600
-180
-40
$800
100
10
-$800
-200
-20
$1,000
105
5
-$1,000
-210
-10
Option B: Straight
$799.99
Option A: $999.99
and $200 mail-in
rebate
What is the Utility
for Option A?
What is the Utility
for Option B?
Dr. Yacheng Sun, UC Boulder
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Implications of PT
Aggregate multiple losses
Separate multiple gains
Separate small gain and big loss
Aggregate small loss and big gain
Dr. Yacheng Sun, UC Boulder
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Transaction Utility
Reference price
Transaction
Utility
Price
$0
Economic Value
For the consumer
Dr. Yacheng Sun, UC Boulder
Price consumer
is willing to pay
16
Formation of Reference Price
Purchase context
Cost
Current price
Past price
Reference Price
Advertised price
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Flanking Brands/Products
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Alternative Approaches to Price
Product Led
Product
Cost
Price
Value
Customers
Customer Led
Customers
Values
Prices
Dr. Yacheng Sun, UC Boulder
Costs
Products
19
Defining VALUE
Use Value (Utility)



Savings gained from using a product/service offering
Monetary gain from using a product/service offering
Satisfaction received from using a product/service offering
Economic Value/Exchange Value


Value based on substitutes/alternatives in marketplace
Calculated using reference value and differentiation value
Dr. Yacheng Sun, UC Boulder
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Illustrating Value: Pricing of Market Research
market research helps to provide information and reduce uncertainty in decision making
Dr. Yacheng Sun, UC Boulder
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Calculation
1.
Identify the status quo course of action when no
market research is available, by calculating expected
revenue and/or expected cost.
2.
Identify the scenario in which market research can
change the course of action and the associated odds.
3.
Determine the gain conditional on that scenario.
4.
Multiply the conditional gain and the probability for the
occurrence of the scenario.
Dr. Yacheng Sun, UC Boulder
22
Value of
MR
0.8
0.6
0.4
0.2
0
0.2
0.4
0.6
Dr. Yacheng Sun, UC Boulder
0.8
1.0
Prob. of
Success
23
Techniques for Measuring Price Sensitivity
Variable Measured
Actual Purchases
Preferences and
Intentions
Uncontrolled
Experimentally
Controlled
• Historical Sales
• In-store Experiments
Data
• Laboratory purchase
• Panel Data
experiments
• Store Scanner Data
• Direct Questioning
• Buy-response
Survey
• Depth Interview
Dr. Yacheng Sun, UC Boulder
• Simulate Purchase
Experiments
• Trade-off (Conjoint)
Analysis
24
Methods of Obtaining Data from
respondents
 Pair-wise
evaluation
 Rank-ordering product bundles
 Evaluating products on a rating scale
Dr. Yacheng Sun, UC Boulder
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Conjoint Study Process
Stage 1
—Designing the conjoint study:
Step 1.1:
Select attributes relevant to the product or
service category,
Step 1.2:
Select levels for each attribute, and
Step 1.3:
Develop the product bundles to be evaluated.
Stage 2
—Obtaining data from a sample of respondents:
Step 2.1:
Design a data-collection procedure, and
Step 2.2:
Select a computation method for obtaining
part-worth functions.
Stage 3
—Evaluating product design options:
Step 3.1:
Segment customers based on their partworth functions,
Step 3.2:
Design market simulations, and
Step 3.3:
Select choice rule.
Dr. Yacheng Sun, UC Boulder
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Conjoint Utility Computations
kj m
U(P) = S S aijxij
j=1
i=1
P:
A particular product/concept of interest
U(P):
The utility associated with product P
aij:
Utility associated with the jth level (j = 1, 2, 3...kj) on the
ith attribute
kj:
Number of levels of attribute i
m:
Number of attributes
xij:
1 if the jth level of the ith attribute is present in product
P, 0 otherwise
Dr. Yacheng Sun, UC Boulder
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Market Share and Revenue Share Forecasts
Define the competitive set – this is the set of
products from which customers in the target
segment make their choices. Some of them
may be existing products and, others concepts
being evaluated. We denote this set of
products as P1, P2,...PN.
Select Choice rule
 Maximum utility rule
 Share of preference rule
 Logit choice rule
Dr. Yacheng Sun, UC Boulder
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Market Share Computation (Frozen Pizza)
Utility (Value) of each product for each customer.
Customer 1
Customer 2
Customer 3
Aloha Special
40
45
30
Meat-Lover’s Treat
58
50
10
Veggie DeLite
55
35
100
Maximum Utility Rule: If we assume customers will only buy the
product with the highest utility, the market share for Meat Lover’s treat
is 2/3 and for Veggie Delite is 1/3.
Share of preference rule: If we assume that each customer will buy
each product in proportion to its utility relative to the other products,
then market shares for the three products are: Aloha Special (27.2%),
Meat Lover’s Treat (27.9%) and Veggie Delite (44.9%).
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
31
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
32
Analytical Approaches to Profitability Analysis
High
Number of
Transactions
Automated Price
Automated Price
Optimization
Optimization
System
System
Spreadsheet Spreadsheet based Break based Break even Analysis
even Analysis
Simulation
Simulation
Modeling / Risk
Modeling / Risk
Analysis
Analysis
Low
High
Low
Frequency of
Price Changes
33
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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