Pricing
Chapter 1. Strategic Pricing
Stephan Sorger
www.stephansorger.com
Disclaimer:
• All images such as logos, photos, etc. used in this presentation are the property of their respective copyright
owners and are used here for educational purposes only
• Some material adapted from: Nagle et al, “The Strategy and Tactics of Pricing,” 5th Edition
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Ch 1: Strategic Pricing; 1
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Ch 1: Strategic Pricing; 2
Chapter Overview
•Define Strategic Pricing and differentiate it from more tactical approaches such as
cost-driven, market-driven or competitor-driven pricing
•Introduce the identifying characteristics of strategic pricing
•Proactive
•Profit-driven
•Value-based
•Define the five elements of a pricing strategy and illustrate how they work in concert
to maximize profitability:
•Value creation
•Price and offer structure
•Value communication
•Pricing Policy
•Price setting
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Ch 1: Strategic Pricing; 3
Strategic Pricing Pyramid: 1-1
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Ch 1: Strategic Pricing; 4
Strategic Pricing Pyramid: 1-1
Questions:
-Why might customers say your prices are high?
(Hint: Work from top to bottom on the pyramid)
-33% of companies use cost-plus pricing even
though managers know it is not effective. Why?
-What is a problem with pricing for market share?
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Ch 1: Strategic Pricing; 5
Alternative Approaches to Value Creation: 1-2
Product Led
Product  Cost  Price  Value  Customers
Customer Led
Customers  Value  Prices  Costs  Products
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Ch 1: Strategic Pricing; 6
Alternative Approaches to Value Creation: 1-2
Product Led
Product  Cost  Price  Value  Customers
Customer Led
Customers  Value  Prices  Costs  Products
Questions:
-Name some recent product failures; Why did they fail?
Google Glass; RIM Blackberry Q10; HP Chromebook 11; “The Lone Ranger”
-How does this relate to customer-led pricing?
-How does this relate to the feature-driven approach done by tech firms?
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Ch 1: Strategic Pricing; 7
Tactical Pricing Orientations
Instead of strategic, value-based pricing, some
managers choose tactical techniques:
Cost-Driven Pricing
(based on product cost)
Customer-Driven Pricing
(arriving at final price via negotiation)
Competition-Driven Pricing(based on what competitors charge)
Result: Lower profitability in almost all cases
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Ch 1: Strategic Pricing; 8
Cost-Driven Pricing
“Price every product to yield a fair return over full cost”
Total Cost
Unit Cost
Target Price
Volume
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Ch 1: Strategic Pricing; 9
Cost-Driven Pricing
Unit cost:
Variable cost: Material and labor to make one unit of production
Allocated fixed cost: Spread out fixed cost over many units
Total Cost
Unit Cost
Target Price
Volume
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Ch 1: Strategic Pricing; 10
Cost-based Pricing: Example
Example: Acme plans to launch its new product, the X-1000.
The sales department expects to sell 1 million units
The finance department requires a minimum price of $9 to cover costs
Projected Costs and Revenues at
Expected Sales = 1,000,000 units
Direct Variable Costs
Direct Fixed Costs
Administrative Overhead
Full Cost
Revenue
Profit
Total
$3,000,000
$3,000,000
$1,500,000
$7,500,000
$9,000,000
$1,500,000
Per Unit
$3.00
$3.00
$1.50
$7.50
$9.00
$1.50
Result: Make profit of $1.50
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Ch 1: Strategic Pricing; 11
Cost-Based Pricing: Example
But the X-1000 sells only 750,000 units, not 1 million
Cost-based pricing says increase price to $10.50 ($9 + $1.50 “profit”)
Actual Costs and Revenue at
Actual Sales = 750,000 units
Total
Per Unit
Direct Variable Costs
$2,250,000
$3.00
Direct Fixed Costs
$3,000,000
$4.00
Administrative Overhead
$1,500,000
$2.00
Full Cost
$6,750,000
$9.00
Revenue
$6,750,000
$9.00
Profit
$0
$0
What happens when we increase price to $10.50?
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Ch 1: Strategic Pricing; 12
Cost-Based Pricing: Example
But raising price will decrease the number of units sold, impacting profit.
 Higher prices do not necessarily result in higher profits
Current
Price
5% Decline
in Unit Sales
33% Decline
in Unit Sales
$9.00
$10.50
$10.50
750,000
712,500
500,000
Variable Costs
$3.00
$3.00
$3.00
Fixed Costs
$4.00
$4.21
$6.00
Admin. Overhead
$2.00
$2.11
$3.00
Unit Cost
$9.00
$9.32
$12.00
Unit Profit
$0
+$1.18
-$1.50
Unit Sales
Total Profit
$0
$843,750
No competition
-$750,000
Competitive market
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Ch 1: Strategic Pricing; 13
Cost-based Pricing
Instead, Acme should decrease its price to boost sales volume.
 Lower prices do not necessarily result in lower profits
Financial Implications of a 10% Price Cut
Current
Price
5% Increase
in Unit Sales
33% Increase
in Unit Sales
$9.00
$8.10
750,000
787,500
Variable Costs
$3.00
$3.00
$3.00
Fixed Costs
$4.00
$3.81
$3.00
Admin. Overhead
$2.00
$1.90
$1.50
Unit Cost
$9.00
$8.71
$7.50
Unit Profit
$0
-$0.61
+$0.60
Total Profit
$0
-$480,375
$600,000
Unit Sales
$8.10
1,000,000
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Ch 1: Strategic Pricing; 14
Cost-based Pricing
Instead, Acme should decrease its price to boost sales volume.
 Lower prices do not necessarily result in lower profits
Questions:
-Would cost-based pricing have suggested us to cut price?
-Think of examples of profitable companies who emphasize low price:
-Walmart; Southwest Airlines
-Who else makes profits with low prices?
© Stephan Sorger 2015: www.stephansorger.com; Pricing: Ch 1: Strategic Pricing; 15