Customers
I. Economic and Behavioral
Foundations of Pricing
II. Innovative Pricing
Concepts and Tools
III. Internet Pricing
Models
January 19, 2006
Teck H. Ho
1
Class Outline
The economic value to the customer (EVC):
EVC analysis
How to determine EVC?
How to communicate EVC?
Use of EVC
The willingness to pay (WTP):
Price elasticity
Ten factors affecting price elasticity
How to change price sensitivity
January 19, 2006
Teck H. Ho
2
Dell XPS M140 Notebook
http://www1.us.dell.com/content/default.aspx?c=us&cs=19&l=en&s=dhs
XPS M140
Packs a Punch
Small and potent.
At about 1.5" thin, 5.5 lbs light and with a Genuine
Windows® XP Media Center Edition 2005 Operating
System, the M140 is a true expression of multimedia
power in a package that gets heads turning.
True "instant on" functionality provides quick access to
DVDs, video, music and photos and the 14.1" WXGA
screen with optional TrueLifeTM helps make all this
come alive.
How much is your willingness to pay?
January 19, 2006
Teck H. Ho
3
Motivation Questions
 As a buyer, what information do you use to
determine how much you are willing to pay
for a Dell XPS Laptop?
 Are you sure about the accuracy of your
information? How will a conversation with
computer expert or sales person affect your
decision?
 What can a company do to influence
consumer’s willingness to pay?
January 19, 2006
Teck H. Ho
4
EVC Analysis
 Economic value to the customer (EVC): the maximum
amount a customer should be willing to pay, assuming
that s/he is fully informed about the benefits of the
product and the offerings of competitors
EVC = Reference Value + Differentiation Value
 Reference value: the price of perceived closest substitute
adjusted by difference in quantity used
 Differentiation value: value of a product’s attribute
difference between your offering and the closest
substitute (+ or -)
January 19, 2006
Teck H. Ho
5
EVC Analysis
Negative
Differentiation value
Positive
Differentiation
Value
Differentiation Value
Superior performance
Better reliability
Additional features
Lower maintenance
cost
Faster service
EVC
Reference
Value
Reference Value
January 19, 2006
Teck H. Ho
6
Dryel (released in June 1999)
http://www.dryel.com/usa/index.shtml
Welcome to Dryel® — the safe, easy way to care for dry clean only
and special care clothes in your home in about 30 minutes.
At about $0.60 per garment (based on average national retail price),
Dryel is the affordable alternative to dry cleaning your clothes. Discover
how Dryel can give you the freedom to purchase and wear the kind of clothes
you want, whenever you want.
January 19, 2006
Teck H. Ho
7
EVC in 1999
Negative
Differentiation value
Positive
Differentiation
Value
EVC
Reference
Value
January 19, 2006
Teck H. Ho
8
EVC in 2003
Negative
Differentiation value
Positive
Differentiation
Value
EVC
Reference
Value
January 19, 2006
Teck H. Ho
9
An example: Alathon 25
 In 1995, Du Pont introduced Alathon 25, a polyethylene resin designed
to compete with other resins in the manufacture of flexible pipe. Tests
indicated that Alathon 25 pipe had failure rates of 3% compared with
8% for the competition. Farmers purchased Alathon pipe as part of
below-ground irrigation system. The common substitute for Alathon
pipe was a pipe made of an off-grade resin selling for $6.5 per hundred
feet. Labor cost of replacing a failed pipe is about $60. Pipe failures, if
not detected quickly, can also damage crops. The damage could range
from 0 (if the plants were mature) to $40 when vulnerable seedlings
were washed out. Young, poorly rooted crops are in place
approximately 20% of the time that the irrigation system is in use.
 What was the product’s economic value for the farmers?
 What if the failure rate is reduced from 7% to 1% (instead of 8% to
3%)?
January 19, 2006
Teck H. Ho
10
Differentiation Value
An example: Alathon 25
Crop – Less Reduction
= $0.40
$40 x 0.20 x 5% = $0.40
Labor Savings
= $3.00
$60 x 5% = $3.00
Replacement Savings
= $0.31
$6.5 x 5% = $0.31
EVC = $10.21
Reference
Value = $6.50
January 19, 2006
Teck H. Ho
11
Using EVC to Segment Market
EVC Profile: Different segments have different EVCs. You
need to determine the EVC of each segment and its size
for formulating an effective pricing strategy.
64.1
Indoor Plumbing Do-it-Yourself
58.3
44.5
Sewage
In-Ground Irrigation
39.8
Indoor-Plumbing
28.0
Commodity Value
10.2
Farmers
Market potential
January 19, 2006
Teck H. Ho
12
Communicating EVC to
Your Customers
Do not assume customers know EVC
Educate customers is important when
The product delivers a stream of benefits over time
The purchase price represents only a small portion of
the product’s overall costs
The fact that consumers are not buying your
product is not by itself a reason to cut price. It
may be a reason to change your marketing
program to justify the price
January 19, 2006
Teck H. Ho
13
Steps in EVC Analysis
1.
2.
3.
4.
5.
6.
Identify the price of the closest competitive product to
determine reference value
Identify all factors that differentiate your product from
the competitive product
Determine the differentiation value
Sum up the reference value and differentiation value to
determine EVC
Develop EVC profile for each segment
Develop marketing programs to educate consumers
about EVC
January 19, 2006
Teck H. Ho
14
Use of EVC
Advantages
Describe decision process of sophisticated purchasers
Enables firm to distinguish between under-promoted vs.
overpriced product
Can indicate attribute improvements which give largest
gain in EVC (i.e., channel your improvement effort)
Can be a great aid to sales force
Limitations:
Actual willingness to pay depends perceived
differentiation value and perceived value of the
competitive product
January 19, 2006
Teck H. Ho
15
EVC Analysis
Line Extension Opportunities
Rating on Attribute
L
H
Improve
L
Ignore
H
Maintain
EVC of
Attribute
January 19, 2006
Overkill
Teck H. Ho
16
Factors Affecting Actual
Willingness to Pay (1)
 Substitutes awareness effect: Buyers are more price
sensitive the higher the price difference between this product
and the perceived substitute
 Difficult comparison effect: buyers are less price sensitive
the more difficult to evaluate competing offers
 Switching cost effect: Buyers are less price sensitive the
greater the sunk investment they have made in anticipation
of its continued use.
 Price-quality effect: Buyers are less price sensitive to the
extent that higher price signals higher quality. (Image and
exclusive products or products without quality cues)
January 19, 2006
Teck H. Ho
17
Baby Oil
(Rite Aid versus Johnson & Johnson)
January 19, 2006
Teck H. Ho
18
UC Medical Plans
HMO
POS
Health Maintenance
Point-of-Service Plan
Organization (Health Net, (Blue Cross Plus)
Kaiser, PacifiCare,
WHA)
Reasons People
Least Costly Overall
Greater Choice of Medical
Choose This Type
Providers than an HMO;
of Plan
ability to go outside the
network for care (at a higher
cost)
Choice of Providers You choose a PCP or a Tier 1 works like an HMO.
primary care group from Tier 2--you may choose any
the network. Both your
provider, but you pay more of
primary and speciality
the cots (see "Cost Sharing
care is through your
for Services" below)
chosen PCP/medical
group.
Definition
Provider
Relationships
Primary Care
Speciality Care
Networks
January 19, 2006
Providers and medical
Providers and medical groups
groups contracted
contracted through the HMO
through the HMO network network for Tier 1; no network
for Tier 2
Care is coordinated by
In Tier 1, care is coordinated
a PCP.
by a PCP; Tier 2 does not
require a PCP.
Your PCP authorizes
Your PCP authorizes referrals
referrals to specialists.
in Tier 1. You may self-refer
in Tier 2.
Plan networks are
Tier 1 is similar to an HMO
limited. Fewer HMO
network. Tier 2 has no
networks are available
network
outside urban areas and
providers are becoming
less willing to contract
with HMOs.
Teck H. Ho
PPO
Preferred Provider
Organization (Blue
Cross PPO)
Indemnity Plan
Traditional Fee-for-Service Plan
(Core)
Broader network of
providers than HMO or
POS; preferred doctor
only participates in this
kind of plan
You do not choose a
PCP; you pay less if
you use a network
provider. If you use a
non-network provider,
your costs will be higher
(see "Cost Sharing for
Services" below)
Providers and medical
groups contracted
through the PPO
network
No PCP required
No limits on access to providers;
desire to self-insure a larger
part of front-end costs (high
deductible)
Unrestricted access to any
provider (see "Cost Sharing for
Services" below)
No network
No PCP required
You may self-refer in or You may self-refer.
out of network.
Networks tend to be
wider than HMO
networks. Plans often
have nationwide
networks.
No network.
19
UC Medical Plans
In-Area Coverage
Out-of-Network
Coverage
US Premiums
Cost Sharing for
Services
(copayment=flat
dollar cost;
coinsurance=%of
total cost
Out-of-Pocket
Maximum
Claims
You must receive
services from a network
provider
You must receive services
from a network provider to
have coverage at the Tier 1
benefit level; Tier 2 has no
requirement.
For srvices outside the
network, you pay a deductible
and share more of the costs.
You must receive
No restriction.
services from a network
provider to have
coverage at the highest
level in the plan
You are only covered
For services outside the No restriction.
for emergency services
network, you pay a
deductible and share
more of the costs.
Lowest premiums (except More expensive than an HMO; Most expensive
Lowest premium due to plan
for Core)
less expensive than PPO
design (high deductible,
catastrophic coverage)
Copayments for
Tier 1--Higher copayments for Annual deductibles;
Coinsurance coverage lower
services; no deductibles services than HMO; Tier 2-coinsurance payments than most PPOs after high
or co-insurance
deductibles & coinsurance
lower for network
annual deductible is satisfied.
providers; higher for
non-network providers
Yes
Yes
Yes
Yes
Tier 1--like an HMO.
Tier 2--members file claims for
partial payment of costs after
deductible is satisfied
Typically, a card
program with a formulary
and different copayments
for generic, brand name,
and non-for-mulary
drugs. Usually has a
mail-order program for
maintenance drugs.
May be used to cover
copayments in Tier 1,
deductibles and coinsurance
in Tier 2, expenses not
covered by plan or with limited
coverage (e.g, laser eye
surgery)
Members file claims for
partial payment of costs
after deductible is
satisfied
Coinsurance design-with a retail network and
a mail order program
Members file claims for
partial payment of costs
after deductible is
satisfied
No formulary; prescriptions
covered on straight percentage
reimbursement with no discounts.
May be used to cover
deductibles and
coinsurance, expenses
not covered by plan or
with limited coverage
(e.g, laser eye surgery)
May be used to cover
deductibles and
coinsurance, expenses
not covered by plan or
with limited coverage
(e.g, laser eye surgery)
No Claims, but preauthorization required for
some services (see plan
details)
Prescriptions
Typically, a card
program with a formulary
and different copayments
for generic, brand name,
and non-for-mulary
drugs. Usually has a
mail-order program for
maintenance drugs.
How It Works with a May be used to cover
FSA (flexible
copayments, expense not
spending account) covered by plan or with
limited coverage (e.g,
laser eye surgery).
January 19, 2006
Teck H. Ho
20
UC Medical Plans
Plan
Blue Cross Plus
Blue Cross PPO
BluePremier HMO NM
Core
Health Net
Kaiser Permanente- CA
PacificCare of CA
Western Health Advantage
January 19, 2006
Type
POS
PPO
HMO
Idemnity
HMO
HMO
HMO
HMO
Self
$
$
$
$
$
$
$
$
Teck H. Ho
64.23
86.78
75.51
17.64
10.00
18.12
10.50
Self+Family
$
186.26
$
251.66
$
218.18
$
$
51.15
$
29.00
$
52.55
$
30.45
21
Price-Quality Effect:
http://www.sephora.com
Romance
Ralph Lauren Romance. The women's fragrance that evokes
the timeless essence of falling in love. Discover the sensual
essence of velvety woods, extravagant florals, and seductive
musk.
For the man with no boundaries - a subtle, serene,
and aquatic scent.
January 19, 2006
Teck H. Ho
22
Factors Affecting Actual
Willingness to Pay (2)
 Unique Value effect: Buyers are less price sensitive the
more they value any unique attributes
 End-benefit effect: When purchasing supplies, buyers are
more price sensitive (1) the more price sensitive the
demand for the end product; (2) the larger share of the
total cost of the end product
 Expenditure effect: Buyers are more price sensitive the
higher the total expenditure, both in dollar terms and as a
percentage of income
 Shared-cost effect: Buyers are less price sensitive the
smaller the portion of the price they actually pay
January 19, 2006
Teck H. Ho
23
Unique Value Effect:
http://rnglounge.com/
Steamed clams
served with
beaten eggs.
Double Boiled
Sharks fin soup
Double boiled with
chicken and sliced
Virginia ham
January 19, 2006
Teck H. Ho
24
The Xootr Cruz
http://www.novacruz.com/novacruz/default.asp
wheels and bearings
20%
deck
12
curved steer support
8
lower handle
8
deck-support-frame
8
brakes(lever/pad/cables)
5
front fork
3
handle bar clamp
3
handlebar/grips
3
fasteners
2
packaging
2
locking pin
1
labor/overhead
January 19, 2006
Teck H. Ho
25
25
Factors Affecting Actual
Willingness to Pay (3)
Fairness effect: Buyers are more price sensitive
when it is outside the range that they perceive as
“fair”
Inventory effect: Buyers are more price sensitive
in the short run when they can hold inventories
and believe that the current price is temporarily
lower or higher than it will be in the future
January 19, 2006
Teck H. Ho
26
Seller’s Posted Price Game
Seller has a variable cost of $10 (assume there is
no fixed cost) and buyer is a distributor with an
offer for the product for $20
Both seller and buyer know the above information
and there are no other traders in the market
Seller posts the price at $X (i.e., makes a take-itor-leave-it offer) (earning = $X - $10)
If you are the buyer, would you buy the product if
the posted price is $X? (earning = $20 - $X)
If there is no trade, both parties earn nothing
January 19, 2006
Teck H. Ho
27
Discussion
What are these slogans trying to accomplish?
Gold Mastercard: “Some circles shall remain
exclusive.”
Woolite: “Woolite cleans this spring sensation for
pennies. So why dry clean it for dollars?”
Dysan (floppy disks): “You can buy a less
expensive diskette and not save a thing.”
January 19, 2006
Teck H. Ho
28
Punch-line
EVC = Reference value + Differentiation
value
EVC is the maximum willingness-to-pay,
not actual willingness-to-pay
Always examine and enhance your
product, place, and promotion strategies to
attain EVC
Pay attention to factors that influence
actual willingness to pay
January 19, 2006
Teck H. Ho
29