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Mar 171
Teck-Hua HoPricing Policy
I. Economic and Behavioral Foundations of Pricing
II. Innovative Pricing Concepts and Tools
III. Internet Pricing Models
SummarySummary
Mar 172
Teck-Hua HoPricing Policy
Punch-linePunch-line
Factors affect pricing strategy
Costs, customer, competition, constraints
Flawed pricing strategies
Cost-plus pricing
Customer-based pricing
Competition-driven pricing
What are the steps for profitable pricing?
Set your strategic objective and consider costs, customer, competition, and constraints simultaneously
Mar 173
Teck-Hua HoPricing Policy
EVC AnalysisEVC Analysis
PositiveDifferentiation
Value
ReferenceValue
Negative Differentiation value
EVC
Differentiation Value
Superior performance
Better reliability
Additional features
Lower maintenance cost
Faster serviceReference Values
Mar 174
Teck-Hua HoPricing Policy
Punch-linePunch-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
Mar 175
Teck-Hua HoPricing Policy
Factors Affecting Actual Factors Affecting Actual Willingness to Pay (1)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)
Mar 176
Teck-Hua HoPricing Policy
Factors Affecting Actual Factors Affecting Actual Willingness to Pay (2)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
Mar 177
Teck-Hua HoPricing Policy
Factors Affecting Actual Factors Affecting Actual Willingness to Pay (3)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
Mar 178
Teck-Hua HoPricing Policy
Course OutlineCourse Outline
22-Jan Overview and Introduction27-Jan Customers: Understanding and influencing purchase decision29-Jan Costs: How should they affect prices?3-Feb Competition: Price Simulation I5-Feb Competition-Driven Pricing10-Feb Cumberland Industries / Foundations for More Profitable Pricing12-Feb Federated Industries / Psychological Aspects of Pricing19-Feb Measuring Price Response Function
24-Feb Price Customization: Segmented Pricing26-Feb Price Customization: Nonlinear Pricing and Imedia Corporation5-Mar Price Line Pricing10-Mar Biopure12-Mar Cambridge Software / Price Bundling17-Mar Time Customization of Prices
Mar 179
Teck-Hua HoPricing Policy
Incremental Break-even Incremental Break-even Analysis (Analysis (when fixed & variable costs when fixed & variable costs
are unchangedare unchanged))
Contribution(a)
ContributionBefore Price Change
Variable costs(b)
Sales Volume
ContributionAfter Price Change
Sales Volume
Sales Volume ??
Variable costs(b)
Unaffected Contribution
(a)
AdditionalVariable Costs (e)
Contribution LostDue to Price (c)
ContributionGained Due toVolume (f)
CM1
P1
VC
P2
S
S1 S1
Mar 1710
Teck-Hua HoPricing Policy
Punch-linePunch-line
Only relevant costs (i.e., incremental & avoidable costs) are relevant to pricing decision.
General incremental break-even formula
Break-even curve Actual sales sensitivity analysis Break-even curve and actual sales sensitivity
analysis are the tools for evaluating pricing decision taking into account Costs, Customers, and Competitors
22
1*)]21()21[()12(
VCP
SVCVCPPTFCTFCS
Mar 1711
Teck-Hua HoPricing Policy
Lessons LearnedLessons Learned
Firms that recognize the sensitivity of the overall market do perform better
Even better: if you realize your competitors are using mechanical pricing rules, you can optimize the market for yourself
Explanations offered by managers after the 1989 beer price war:We think “they started it”We don’t know the market’s price elasticityDoing well means doing better than the competitor
Mar 1712
Teck-Hua HoPricing Policy
Punch-linePunch-line
Effective pricing depends on an accurate understanding of the relative importance of
Your decisions
Your competitors
The market
The importance of “knowing your competitors”
Mar 1713
Teck-Hua HoPricing Policy
Punch-linePunch-line
Price war is often a “negative-sum” game, it hurts the industry in the long-run
Three competitive principles: 1) know your opponents and yourselves, 2) use strategic foresight, 3) differentiate between one-time and repeated strategic interactions
Decision on initiating or matching price cut should be made based on long-term consequence (i.e., the final outcome in the new world)
Mar 1714
Teck-Hua HoPricing Policy
Course OutlineCourse Outline
22-Jan Overview and Introduction27-Jan Customers: Understanding and influencing purchase decision29-Jan Costs: How should they affect prices?3-Feb Competition: Price Simulation I5-Feb Competition-Driven Pricing10-Feb Cumberland Industries / Foundations for More Profitable Pricing12-Feb Federated Industries / Psychological Aspects of Pricing19-Feb Measuring Price Response Function
24-Feb Price Customization: Segmented Pricing26-Feb Price Customization: Nonlinear Pricing and Imedia Corporation5-Mar Price Line Pricing10-Mar Biopure12-Mar Cambridge Software / Price Bundling17-Mar Time Customization of Prices
Mar 1715
Teck-Hua HoPricing Policy
Value/Cost Inputs to Pricing Value/Cost Inputs to Pricing (11 ½-Inch Pads)(11 ½-Inch Pads)
Total Variable Cost: $27.28
Value from Fazio Data: $1,272
Value from Colerick Data: $894
Price to Yield 100% Contribution Margin: $54.56
Mar 1716
Teck-Hua HoPricing Policy
Pricing Scorecard QuestionnairePricing Scorecard QuestionnaireImportance Performance
1-5 Rating from Poor 1 2 3 4 5 ExcellentLow to High
Pricing MindsetExtent to which our process1a. Is connected to corporate and marketing Strategy1b. Is understood by people in our organization1c. Provides meaningful guidance2. Rests on fact foundation that is:a. Relevantb. Accuratec. Appropriately disaggregatedd. Timely
Scope of UnderstandingExtent to which our understanding covers1a. Value customers place on product1b. Variation in value across customers2. Likely competitive reactions and means for influencing3. Product's role in company portfolio
ProcessExtent to which our pricing process formally analyzes:1. Customization strategies2. Managing pocket price and account specific costs3. Today's pricing influence on future opportunities4. Communicating/implementing pricing in the marketplace5. Legal boundaries
Mar 1717
Teck-Hua HoPricing Policy
Punch-linePunch-line
Skimming versus penetration pricing
Pricing scorecard
The role of pricing structure
Product and cost advantages (both internal and external)
Mar 1718
Teck-Hua HoPricing Policy
PROCUREMENT POLICY
Capacitor Market – Incentives Capacitor Market – Incentives to Price Cutto Price Cut
COMMODITY PRODUCT OVERCAPACITY
PRICE KEY BUYING DETERMINANT
ANY BUSINESS PRICED ABOVE DIRECT COST WORTHWHILE
INCENTIVE TO CUT PRICE
LARGE INDIVIDUAL TRANSACTIONS
BUYER CONCENTRATION
LARGE GAINS TO SINGLE PRICE CUT
Mar 1719
Teck-Hua HoPricing Policy
Punch-linePunch-line
Manage reference price over time
Apply Weber-Fechner Law to announce price increase or decrease accordingly
Segregate gains and integrate losses
Publicize your high fixed cost or cost increase
Use odd pricing to signal low price
Mar 1720
Teck-Hua HoPricing Policy
Why is Conjoint Analysis Why is Conjoint Analysis so so Sexy Sexy as a Consulting as a Consulting Tool?Tool? 3Cs
Customer
Competitor
Company
2 Ps
Product (EVC Analysis)
Price (demand estimation)
Data-driven
Decision-driven
Mar 1721
Teck-Hua HoPricing Policy
Course OutlineCourse Outline
22-Jan Overview and Introduction27-Jan Customers: Understanding and influencing purchase decision29-Jan Costs: How should they affect prices?3-Feb Competition: Price Simulation I5-Feb Competition-Driven Pricing10-Feb Cumberland Industries / Foundations for More Profitable Pricing12-Feb Federated Industries / Psychological Aspects of Pricing19-Feb Measuring Price Response Function
24-Feb Price Customization: Segmented Pricing26-Feb Price Customization: Nonlinear Pricing and Imedia Corporation5-Mar Price Line Pricing10-Mar Biopure12-Mar Cambridge Software / Price Bundling17-Mar Time Customization of Prices
Mar 1722
Teck-Hua HoPricing Policy
Two Problems with Single Two Problems with Single Price StrategyPrice 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 variable cost
Mar 1723
Teck-Hua HoPricing Policy
Single PriceSingle Price
$
SalesVolume
$2000
Money Left on Table
Profit
Passed-up Profit
$100
380
190
$3900
50%
25%
25%
Mar 1724
Teck-Hua HoPricing Policy
Customized PricingCustomized Pricing
$
SalesVolume
$2633
Money Left on Table
Profit (first-class)
Passed-up Profit
$100
380
127
$3900$1367
254
Profit (Economy)
(Need to build segmentation fences)
Mar 1725
Teck-Hua HoPricing Policy
Punch-linePunch-line
Price customization significantly increases profit. It aims to reduce money left on the table passed-up profit
Ways of price customization By consumer: get buyers to act voluntarily By location: prevent arbitrage By time of purchase: manage yield and redistribute
usage By product: understand consumers By volume: do not hinder competition
Mar 1726
Teck-Hua HoPricing Policy 11
An Example: Cellular An Example: Cellular Phone ServicePhone Service
HV USERS(Professional Use)
LV USERS(Personal Use)
Mar 1727
Teck-Hua HoPricing Policy
LessonsLessons
Nonlinear pricing can work whether customers are the same or different. It is more efficient when customers are the same.
The more complex forms of nonlinear pricing extract higher value but are more difficult to implement
Non-linear pricing has the great advantage of self-selection by the customers
Mar 1728
Teck-Hua HoPricing Policy
If consumers are similar in their usage intensity in a single segment, the optimal pricing strategy involves setting a usage based fee equaling marginal cost (in this case it is zero).
The fixed fee equals to the consumer surplus of the segment served.
Note that here the two-part tariff enables the firm to extract all consumer surplus.
Key Lessons: Serving Single Segment Only
Mar 1729
Teck-Hua HoPricing Policy
If we are serving multiple segments with different usage intensities, the optimal pricing strategy involves setting a usage based fee higher than marginal cost.
The fixed fee in this case equals the consumer surplus of the personal (low-valuation) user.
Key Learning Points
Mar 1730
Teck-Hua HoPricing Policy
HV Users (Professional Users)
Monthly Fixed Fee $ 54Airtime Charges $ 0 per hourDemand 12
LV Users (Personal Users)
Monthly Access Fee $ 32Airtime Charges $ 2 per hourDemand 8
Note that Professional Users is indifferent between the two payment plans
Total Profits = 100 x $54 + 100 x ($32 + $2 x 8) = $10.2 K
Optimal Menu of PlansOptimal Menu of Plans
Mar 1731
Teck-Hua HoPricing Policy
Product Line Product Line InterdependenciesInterdependencies
Image of Brand/Company
Image of Product Line
Price of Product A
Traffic at Outlet
Demand forProduct A
Demand forProduct B
Complements
+-
Substitutes
+/-
+/-
Mar 1732
Teck-Hua HoPricing Policy
Punch-linePunch-line When making pricing decisions, we should take into account the
inter-relationships among products.
Complementary relations lead to product-line prices that are lower than optimal isolated prices.
Substitutive relations lead to product-line prices that are higher than the optimal isolated prices at the upper end of the price scale.
In evaluating the profitability of a price change (with demand interdependencies), we simply need to modify the new contribution margin in the break-even formula in order to obtain the revised break-even sales volume
Mar 1733
Teck-Hua HoPricing Policy
Course OutlineCourse Outline
22-Jan Overview and Introduction27-Jan Customers: Understanding and influencing purchase decision29-Jan Costs: How should they affect prices?3-Feb Competition: Price Simulation I5-Feb Competition-Driven Pricing10-Feb Cumberland Industries / Foundations for More Profitable Pricing12-Feb Federated Industries / Psychological Aspects of Pricing19-Feb Measuring Price Response Function
24-Feb Price Customization: Segmented Pricing26-Feb Price Customization: Nonlinear Pricing and Imedia Corporation5-Mar Price Line Pricing10-Mar Biopure12-Mar Cambridge Software / Price Bundling17-Mar Time Customization of Prices
Mar 1734
Teck-Hua HoPricing Policy
Biopure: Punch-lineBiopure: Punch-lineA case on product line pricing: questioning the ability of
a firm to effectively price similar products at different prices to different consumers.
Market potential: animal market is larger and human market is smaller than expected.
Reference price: the prices of many other products other than Oxyglobin can serve as reference prices.
Mar 1735
Teck-Hua HoPricing Policy
Multi-version Case: “Student” Multi-version Case: “Student” and “Industrial”and “Industrial”
Unit Larrge, Corporate R&D Consultants and Small Students TOTAL NETContribution Multidivisional and University Professional Businesses CONTRIBUTION
Corporations Laboratories CompaniesSegment Size 5,000 2,000 20,000 15,000 500,000
Segment Dev. Cost $150,000 $100,000 $200,000 $200,000 $300,000
Individual WTP "Industrial" $2,500 $2,000 $600 $300 $100 "Student" $150 $100 $200 $175 $50
"Student" $100,000; $15
$50 $35 ($30,000) $500,000 $325,000 $7,200,000 $7,895,000$50 $35 $500,000 $325,000 $7,200,000 $7,925,000$50 $35 $325,000 $7,200,000 $7,425,000$50 $35 $7,200,000 $7,100,000
"Industrial" $500,000; $35
$2,400 $2,365 $11,675,000 $11,175,000$1,950 $1,915 $9,425,000 $3,730,000 $12,655,000$450 $415 $1,925,000 $730,000 $8,100,000 $10,255,000$175 $140 $550,000 $180,000 $2,600,000 $1,900,000 $4,730,000
"Student" at; Industrial" at:
$50 $2400 $11,675,000 ($30,000) $500,000 $325,000 $7,200,000 $19,070,000$50 $1950 $9,425,000 $3,730,000 $500,000 $325,000 $7,200,000 $20,580,000$50 $450 $1,925,000 $730,000 $8,100,000 $325,000 $7,200,000 $17,680,000$50 $175 $550,000 $180,000 $2,600,000 $1,900,000 $7,200,000 $11,830,000
Mar 1736
Teck-Hua HoPricing Policy
Punch-linePunch-line
“Versioning” strategy can be highly profitable for the firm.
Price the premium version low enough to make sure that high-end customers willingly choose it.
Beware of lumpiness in demand curve they can lead to local optima in profit function.
Mar 1737
Teck-Hua HoPricing Policy
Punch-linePunch-line Price bundling can work when willingness to pays for
component products are negatively correlated.
Bundling can improve profit because unexploited customer surplus (“money left on the table”) from one product is transferred to a second product.
Price bundling can appear in the form of pure and mixed bundling. The distribution of WTPs determines which form is superior.
Mar 1738
Teck-Hua HoPricing Policy
Basic MotivationsBasic Motivations
InformationAbout Demand
Known
InitiallyLimited
Not Timedriven
Timedriven
1. Trial
2. PurchaseAcceleration
3. Potential Build-up
4. Peak Load
5. Peak Load withDemand Shift
6. Demand probing
7. Yield Management
Mar 1739
Teck-Hua HoPricing Policy
3. Potential Buildup of Low-3. Potential Buildup of Low-
WTP CustomersWTP Customers Mr. Coffee coffee maker (unit variable cost = $32)
The goal is to charge maximum WTP of a growing proportion of the market that would buy at regular price
Suppose customers for a coffee maker are of two types, one valuing the product at $60 and the other at $40.
Each group has a “birth” rate of 100 per month
1 2 3 4 5 6 Time
Price
$60
$40
Mar 1740
Teck-Hua HoPricing Policy
3. Potential Buildup of Low-3. Potential Buildup of Low-
WTP CustomersWTP Customers
Month N($60) N($40) Contribution if P=$60
Contribution
If P=$40
1 100 100 $2800 $1600
2 100 200 $2800 $2400
3 100 300 $2800 $3200
4 100 100 $2800 $1600
5 100 200 $2800 $2400
6 100 300 $2800 $3200
Unit Variable Cost = $32
Mar 1741
Teck-Hua HoPricing Policy
Punch-linePunch-lineClearly understand the underlying motivation
Design the time-customization plan based on the motivation
Consider the potential negative consequences and long-term dynamic effects