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Pricing Strategies

Week 6

EWMBA 206

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Analysis Framework

Market

Customer AnalysisCompetitor Analysis

Company AnalysisMarketing Myopia

Marketing Strategy

Product

Price

Promotion

Place

Marketing Orientation

Perceptual mapping

Segmentation Positioning

First mover advantages

Branding

Pricing processPricing and innovation

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Economics of PricingTwo 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

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Price DiscriminationCustomization by Observable Characteristics

• Based on observable characteristics that signal buyers’ price sensitivityhttp://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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Price DiscriminationPurchase 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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Electronic Road Pricing

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Price DiscriminationPalm Pilot: Product-line in Action

Palmm505Color$449

Palmm500$399

Palm VIIx$399

Palm IIIxe$179

Palm m100$129

Palm Vx$299

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Microsoft Office:Product Line (Versioning) in Action

Office 2000Developer

Office 2000Premium

Office 2000Professional

Office 2000Small Business

Office 2000Standard

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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?

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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

Product Line (Versioning) Segmentation, Targeting & Cannibalization

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Example 1: Pricing Dell Laptops

Option I: Dell 350 MHz only:

Targeting: Business Users– Price $ 750– Total Revenue $ 30,000

Targeting: Business Users & Personal Users– Price $ 500– Total Revenue $ 50,000

Optimal targeting if introducing 350 MHz: Business Users + Personal Users

Product Line (Versioning) Segmentation, Targeting & Cannibalization

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Example 1: Pricing Dell Laptops

Option II: Dell 550 MHz only:

Targeting: Business Users– Price $ 2500– Total Revenue $ 100,000

Targeting: Business Users & Personal Users– Price $ 750– Total Revenue $ 75,000

Optimal targeting if targeting 550 MHz: Business Users

Product Line (Versioning) Segmentation, Targeting & Cannibalization

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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 $ 2250 (at most)– Segment Revenue $ 90,000– Total Revenue $ 120,000

Product Line (Versioning) Segmentation, Targeting & Cannibalization

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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 _______________________________________________

Product Line (Versioning) Segmentation, Targeting & Cannibalization

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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?

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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?

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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 Buyer Revenues

$1000 E $1000

$800 E & G $1600

What should Intel price the 486?

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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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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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Controlling CannibalizationTwo 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.

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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

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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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Prospect TheoryApplications

Unbundle gains: Sports Illustrated, offer additional benefits rather than a discountBundle 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.

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Pricing StrategiesHomework

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?