Pricing Strategies
Week 6
EWMBA 206
Ganesh Iyer
1
Analysis Framework
Perceptual mapping
Company Analysis
Marketing Myopia
First mover advantages
Customer Analysis
Competitor
Analysis
Positioning
Segmentation
Marketing Strategy
Pricing process
Pricing and innovation
Product
Marketing Orientation
Branding
Price
Promotion
Place
Market
Ganesh Iyer
2
Economics of Pricing
Two Problems with Single Price Strategy
 Leave money on the table
 Some customers are willing to pay more

Pass-up Profit
 Some potential customers were not served even though the firm could
have served them at prices above the marginal cost
Ganesh Iyer
3
Price Discrimination
Customization by Observable Characteristics
•
Based on observable characteristics that signal buyers’
price sensitivity
http://www.chessclub.com/ : Students: $29.95/year; Adults: $59.95

AMC theaters can observe the consumer-type using his student ID, seniors
» Customer 1
No student ID
$6.75
» Customer 2
Haas student ID
$4.75
» Customer 3
Haas student ID
$4.75
» etc.
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4
Price Discrimination
Purchase Location
 Consumers at different purchase locations have different
price sensitivity
 Cure for anthrax: $450 in the U.S. $190 in Canada
http://www.canadadrugs.com
 Staples website asks for zip code http://www.staples.com/
 Select segmentation variables that ensure
 different segments purchase at different locations
 high enough shipping cost to prevent arbitrage
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Customize By Time of Purchase

Peak-load pricing: designed to re-distribute usage from peak
time to off-peak time
 Redeye flight.
 Electronic road pricing.
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6
Electronic Road Pricing
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7
Price Discrimination
Palm Pilot: Product-line in Action
Palmm505 Palmm500 Palm VIIx
$399
Color
$399
$449
Palm Vx
$299
Palm IIIxe
$179
Palm m100
$129
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8
Microsoft Office:
Product Line (Versioning) in Action
Office 2000
Developer
Office 2000
Premium
Office 2000
Small Business
Office 2000
Professional
Office 2000
Standard
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How to Price Discriminate Using through Product
Line Design?

Key to Successful Versioning


Identify the best ways to distinguish the different versions of the
product/service

Need to determine which features will be highly valuable to
some customers but of little value to others.

Goal: Create the “right” # of versions -- targeted at the “right”
customer segments by setting the “right” prices.
Strategic Issue -- Cannibalization: Will the high-end customers
buy the higher priced version? How to dissuade them from buying
the lower priced version?
Ganesh Iyer
10
Product Line (Versioning)
Segmentation, Targeting & Cannibalization
Example 1: Pricing Dell Laptops
Table: Perceived Economic Value
Personal Users
Business Users
Segment Size
60
40
Dell 350 MHz
$ 500
$ 750
Dell 550 MHz
$ 750
$ 2500
Ganesh Iyer
11
Product Line (Versioning)
Segmentation, Targeting & Cannibalization

Example 1: Pricing Dell Laptops

Option I: Dell 350 MHz only:



Targeting: Business Users
– Price
– Total Revenue
$ 750
$ 30,000
Targeting: Business Users & Personal Users
– Price
$ 500
– Total Revenue
$ 50,000
Optimal targeting if introducing 350 MHz: Business Users + Personal
Users
Ganesh Iyer
12
Product Line (Versioning)
Segmentation, Targeting & Cannibalization

Example 1: Pricing Dell Laptops

Option II: Dell 550 MHz only:



Targeting: Business Users
– Price
– Total Revenue
$ 2500
$ 100,000
Targeting: Business Users & Personal Users
– Price
$ 750
– Total Revenue
$ 75,000
Optimal targeting if targeting 550 MHz: Business Users
Ganesh Iyer
13
Product Line (Versioning)
Segmentation, Targeting & Cannibalization

Option III: Both 350 MHz & 550 MHz :

What will be the price of 350 Mhz = 500

What are the options available to Business Users?

Buy 350 MHz at $ 500 or 550 MHz at $ X?

Surplus from 350 MHz = $ 750 - $ 500 = $ 250
Thus, price of 550 MHz must satisfy $ 2500 - $ X =
$ 250
– Price
– Segment Revenue
– Total Revenue
$ 2250 (at most)
$ 90,000
$ 120,000
Ganesh Iyer
14
Product Line (Versioning)
Segmentation, Targeting & Cannibalization

Example 1 (Revised): Pricing Dell Laptops
_______________________________________________
Product Line
Optimal
Total
Targeting
Revenues
_______________________________________________
Dell 350 MHz only
Business & Personal
$ 50,000
Dell 550 MHz only
Business
$100,000
Both 350 MHz
350 MHz at Personal
& 550 MHz
550 MHz at Business
$120,000
_______________________________________________
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Key Principles

Consumers are heterogeneous in their willingness to pay
» Charge according to consumer price sensitivity. Make sure that people
with inelastic demand pay more and people with elastic demand pay
less.
Key Problem
 Cannibalization: Ensuring self-selection.
» Make sure that prices directed at one segment cannot be taken
advantage of by the other.

How did you achieve this for Dell?
Ganesh Iyer
16
Product Line Design:
Disabling Attributes
TRUE STORY
 Intel sells 486DX chip for $1000.

Intel disables the math coprocessor of the DX chip and makes
the SX chip (thus incurring a cost of $50).

Intel sells the 486SX chip for $800!

So Intel sells a damaged product that actually costs more to
make for a lower price.

What is going on here?
Ganesh Iyer
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Product Line Design:
Disabling Attributes
Problem facing Intel when it introduced 486 chip (two types of early
adopters):
E, G (50% of each type), E is willing to pay more and performs lots
of math calculations
Res. Price
$1000
$800
Buyer
E
E&G
Revenues
$1000
$1600
What should Intel price the 486?
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18
Disabling Attributes
If Intel can charge different prices to different users
» $800 to G
» $1000 to E
» Total:
$1800

Price discrimination can earn the seller an extra 200!

But there is a caveat……..
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19
Disabling Attributes

The seller wants to charge G less than E for the same 486 chip.

At the same time, the seller has to prevent E from buying the
product meant for G. What does the seller do?

The seller disables the math coprocessor for G!
» Actually incurs a cost of doing so (say $10)
» But makes $200 extra from E.
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Ganesh Iyer
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Controlling Cannibalization
Two Methods

Potential Cannibalization: If the low-end version is “too
attractive”, it may attract some customers who would other wise
pay a premium for the high-end version

Method #1: Cut the price of your high-end version to ensure
that your high-value customers buy the high end version.

Method #2: Damage your low-end version “enough” to make
it unattractive to the high-end segment
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Learning: Optimal Product Line Design
Selecting the Defining feature(s) of the Product-Line

Point #1: Identify the attributes/features that are highly valued
by some high willingness to pay customer segments yet of little
importance to other customer segments

Point #2: Greater the differences among the customers in their
willingness to pay for the differentiating attribute, the wider is the
product line.

Point # 3: Find the best way to reduce cannibalization.
This is where product strategy, pricing and segmentation all come
together.
Ganesh Iyer
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Psychology in Pricing Strategy

Jeans: $42…$32;
http://www1.macys.com/catalog/product/index.ognc?ID=204004&CategoryID=
11221&LinkType=EverGreen

Rolex watch: $10,000 http://www.rolex.com/en/
» 9,990
» 9,975

Relative price difference matters not the absolute.

Weber-Fechner law: Relative price difference and not the absolute
matters.
» Weber gradually increased the weight that a blindfolded man was holding
and asked him to respond when he first felt the increase.
» Response was proportional to a relative increase in the weight.
» If the weight is 1 kg, an increase of 10 grams will not be perceived.
» If weight is 20 grams, an increase in 10 grams is perceived
» Applies to sound, vision etc.
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Psychology in Pricing Strategy

I will show you two numerical differences. Look at them quickly!
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Psychology in Pricing

Which difference do you think is greater?
» Top or Bottom

Odd number pricing ($0.99 vs. $1.00).
» This is why Nike shoes are priced at $49.99, not $50!
» Theoretical underpinning: Mental categorization.

Pricing and social networks
» Pricing Trump towers

Price quality perceptions
Ganesh Iyer
26
Prospect Theory (Kahnemann and Tversky)

One additional dollar gives a lesser increase in
satisfaction or value than the dissatisfaction caused
by a one dollar decrease

Giving or taking a dollar

People feel the pain of losses much more than they
feel the happiness of equivalent gains.
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27
Prospect Theory
Applications
Unbundle gains: Sports Illustrated, offer additional benefits rather than a discount
Bundle Losses: Sellers of consumer durables and warranties. Example, a $50 warranty for
$700 appliance.
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Key Messages

Developing profitable pricing strategies is a critical and creative
exercise.

Pricing is the only element of the marketing mix whose cost is
getting it wrong.

Pricing’s impact on profitability is often more significant and
more immediate than the impact of other elements of the
marketing mix.
Ganesh Iyer
29
Pricing Strategies
Homework
Crazy Eddie

In the New York city stereo wars of the 90’s Crazy Eddie had made his
trademark “We cannot be undersold. We will not be undersold. Our prices are
the lowest….guaranteed. Our prices are insane.” His main competitor
Newmark & Lewis is no less ambitious. With any purchase you get the store’s
“Lifetime low-price guarantee”. It promises to rebate double the difference if you
can find a lower price elsewhere. If after your purchase from Newmark you find
the same item at a lower price (proof of purchase required), in this marketing
area, during the lifetime of your purchase, Newmark will give you a 200% gift
certificate refund (100% of the price difference plus an additional 100%). These
strategies on the face of it seem so crazy. They could lead to superheated
competition and could run both Crazy Eddie and Newmark out of business.
What do think happened? Think of the following questions:

Would these price guarantees claims increase competition between the two
retailers and reduce their profits or would it do the opposite?
 What could be the reasons why these retailers adopted these policies in the first
place?

Can you think of some advantages of these policies?
Ganesh Iyer
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