Pricing Strategies
• Pricing strategies & tactics (terminology).• The concept of value and the price-setting process.• Deciding how much of the strategic pricing gap to
capture.• Linking elasticity to value and estimating the
effect of a price change
According to McKinsey, “80 to 90 percent of all poorly chosen prices are too low… Companies habitually charge less than they could for new offerings. It’s a terrible habit.”
Key Learning Points
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Pricing Strategies• Customer Value Pricing (Demand-focused pricing)
Sets price based on the relative sharing of differentiation value); Company Objectives determine how much value to share or capture:
• Penetration or Market Share Pricing– Gives most value to customers, builds share & goodwill & erects entry
barriers; elastic demand, no sustainable advantage, market share objective…• Skimming or Prestige Pricing
– Majority of value goes to firm to maximize profits – invites competitive entry; inelastic demand, multiple price segments, sustainable advantage…
• Intermediate or Neutral Pricing– Equal sharing of value
• Technical, Cost-focused Pricing• Full-Cost Pricing – Markup, Breakeven, Rate-of-return
– Ignores competition and customer; most useful in stable supply & demand situations or unique, bidding situations with high uncertainty
• Variable-Cost Pricing– Ignores fixed costs; useful to stimulate or shift demand for perishable
offerings with seasonal demand. 2
Customer -- Psychological Aspects of Price• Value Is the Ratio of Perceived Benefits to Price
– Evaluated by comparing focal offering to a reference value
– Creates a price window for competitive offerings
3
The Price Setting ProcessDefine Price
Window
Set initial price range based on differential
value & relevant costs
Key Questions:•What is the role of costs in setting my initial price range?
•What is appropriate price ceiling for this product?
•How should I incorporate reference prices into my price window?
Set Initial Price
Determine amount of differential value to be
captured
Key Questions:• Is price consistent with my business strategy & objectives (skimming vs. penetration)?
•What are the non-value related determinants of price sensitivity?
•What are the price-volume tradeoffs & impact on profitability?
Communicate Prices to Market
Develop communication plan to
ensure prices are perceived to be fair
Key Questions:•What is the best way to communicate price (changes) to customers?
•What are the considerations for implementing significantly higher prices?
Brand Product of NotesPrice per
Ounce ($)
Price per
Gallon ($)
Acqua Panna – Natural Spring
Italy (Florence)
1 liter glass bottle
0.13162
16.85
Arrowhead – Mountain Spring
California Plastic 28-pack
0.02367
3.03
Dasani – Purified Drinking Water
USA Plastic 0.08876
11.36
Evian (Nomad) – Natural Spring
France (Alps)
Plastic 6-pack 0.12318
15.77
Menehune – Purified Drinking Water
Aiea, HI Plastic 0.07813
10.01
Perrier – Sparkling Natural Mineral
France Green Glass 0.08333
10.67
Rosauer’s Finest – Spring Water
Canada Plastic/Pop Top
0.02307
2.95
San Pellegrino – Sparkling Mineral
Italy (S.P.) Green Glass 0.08844
11.32
Talking Rain – Mountain Spring
Preston, WA
Plastic/Flavored
0.06760
8.65
Voss – Virgin aquifer Norway Clear glass cylinder
0.181746
23.26
City of Dallas– Residential Pipes/Lake Water
0.000012
0.00156
Using Competitive Information to Define Price Window
The relevant question is:Why are consumers willing to pay relatively steep prices for a commodity product?
0-$2.5 $2.5-$7.5 $7.5-$12.5 $12.5-$17.5 >$17.50
1
2
3
4
5
6
Neutral or Intermediate Prices
Skimming PricesPenetration Prices
Num
ber
of c
ompe
titiv
e of
ferin
gsCompetitive Water Prices & the Price Window
$s per Gallon
Conceptualizing the Price Window and Market Segments with a Normal Bell Curve
Price InsensitivePrice Sensitive
Low Price
Penetration Pricing Intermediate Pricing Price SkimmingHi Price
Value Buyers
Non-normal Distributions with Kinks Suggest Different Segments
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5.00 7.00 9.00 11.00 13.00 15.00 17.00 19.00 21.00 23.00 25.000
20
40
60
80
100
120
140
160
Observed Prices for Milwaukee’s Best, Miller, Budweiser & Michelob
$s per Gallon
Fre
quen
cy o
f O
bser
ved
Pric
e P
oint
s
$5 $10 $15 $20 $250
10
20
30
40
50
60
70
80
$5 $10 $15 $20 $250
20
40
60
80
$5 $10 $15 $20 $250
20
40
60
80
Price Windows for Milwaukee’s Best, Bud & Miller, and Michelob
$s per Gallon
Price Driven
Value Driven
BrandDrivenF
requ
ency
of
Obs
erve
d P
rice
Poi
nts
The Price Setting ProcessDefine Price
Window
Set initial price range based on differential
value & relevant costs
Key Questions:•What is the role of costs in setting my initial price range?
•What is appropriate price ceiling for this product?
•How should I incorporate reference prices into my price window?
Set Initial Price
Determine amount of differential value to be
captured
Key Questions:• Is price consistent with my business strategy & objectives (skimming vs. penetration)?
•What are the non-value related determinants of price sensitivity?
•What are the price-volume tradeoffs & impact on profitability?
Communicate Prices to Market
Develop communication plan to
ensure prices are perceived to be fair
Key Questions:•What is the best way to communicate price (changes) to customers?
•What are the considerations for implementing significantly higher prices?
Economic Value Estimation Framework
PositiveDifferentiati
on Value
PositiveDifferentiati
on Value
Your uniquevalue
delivery
Competitive Reference
Value
Competitive Reference
Value
Price of Next Best
CompetitiveAlternative
Negative Differentiatio
n Value
Negative Differentiatio
n Value
Costs unique to doing business with you
Price to capture a share of this value
Total Economic
Value
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Defining the Price Window (& Objectives)Positively Differentiated Offering Negatively Differentiated Offering
Penetration pricing sets price far enough below economic value (not below cost!) to attract and hold a large base of consumers. Generates sales volume (& lower marginal costs) at the expense of higher margins.
Price skimming captures high margins at the expense of sales volume. Prices are high relative to what the “middle market” is willing to pay. Viable when the profit from the price-insensitive segment exceeds profit from sales to larger market at lower price.
Neutral or Intermediate Pricing
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Customer -- Psychological Aspects of Price• Value Is the Ratio of Perceived Benefits to Price
– Evaluated by comparing focal offering to a reference value
– Creates a price window for competitive offerings• Linking Elasticity and Value Estimates
– As differential value increases, elasticity decreases– Marketers can effectively use price to signal quality
when:• Consumers lack information• Product quality is difficult to assess before
(experience goods) or even after (credence goods) purchase
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Estimating Customer ValueMKTG 6223: Understanding What Customers Value
MKTG 6214: Advanced Pricing Management
• Economic Value Method
• Survey-Based Methods
• Direct Purchase Observation
• Quantify the objective value of attributes
• Self-report willingness-to-pay • Conjoint studies
• Estimate price elasticity based on purchase data, perhaps in conjunction with an experiment
Estimating Customer Value
• Marketing Pro Formas • Breakeven Analysis• Customer Lifetime Value (CLV)• Sales Forecasts• Demand Elasticity• Channel Margin Calculus
Financial Analysis in MarketingK&P Chapter 2
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Price Experiment for Mobile Phone
Elastic demand-2.83
Inelastic demand-.50
Demand Elasticity wrt PriceNecessary to Evaluate Price-Volume Trade-offs
E =% change in price
% change in demand
If the absolute value of E is < 1.0, demand is inelasticIf the absolute value of E is > 1.0, demand is elastic
Ecar phone=(41% - 45%)/41%
(900-600)/900= -.50
Price D from 600 900
Ecar phone=(24% - 41%)/24%(1200-900)/1200
= -2.83
Price D from 1200 900
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Quantity Demanded
Pri
ce
Elasticity – a visual representation . . . .
Inelastic: customers are not very sensitive to price changes when there is strong differential advantage and few substitutes – gemstones, transplant organs
unit elastic (i.e., e = -1)
Elastic: customers are very sensitive to price changes when there is no differential advantage between substitutes – grains, fruits and vegetables, paper clips, rubber bands
Q1Q2
P1
P2
P1
P2
Q2Q1
Price elasticities on average ≈ -2.5
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Break-even (B/E) Sales Analysis FormulaPrice Change (No change in costs):
% B/E unit sales D = — %DP %CM’ + %DP
— $DP$CM’ + $DP
or
For example, your current contribution margin is 50%; that is, unit variable costs are 50% of price
What % unit sales increase is necessary for a 10% price decrease to breakeven?
— %DP%CM’ + %DP
10%50% - 10%=
10%40%= 25%=
25%-10%
B/Ee = = -2.5
Estimating the Effect of a Price ChangeSee Kerin & Peterson, Ex. 8.2
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Cost, Volume, and Profit Data
Unit sales volume 1,000 1,000
Unit selling price $10 $10
Unit variable cost $5 $2
Unit contribution (margin) $5 50% $8 80%
Fixed costs $3,000 $6,000
Net profit $2,000 $2,000
Break-even Sales Change PD% QD% e QD% eFor a price reduction of -20% 66.7% -3.3 33.3% -1.7
For a price reduction of -10% 25.0% -2.5 14.3% -1.4
For a price reduction of -5% 11.1% -2.2 6.7% -1.3
For a price increase of 5% -9.1% -1.8 -5.9% -1.2
For a price increase of 10% -16.7% -1.7 -11.1% -1.1
For a price increase of 20% -28.6% -1.4 -20.0% -1.0
Collaborators -- Channel Margin AnalysisCases May Require Price-Setting to Intermediaries
GM50%
COGS50%
WM 20%
RM40%
$120
$240
$300
$500
Cost of Goods Sold
Manufacturer Price
Wholesale Price
Retail Price
Planned Prices and Margins for a Software Product
What if you wanted a $400 MSRP?
$400
Cost of Goods Sold
Manufacturer Price
Wholesale Price
Retail Price
$120
$192
$240
GM goes to 72/192 = 37.5%
Or reduce COGS 20% to $96
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Unit Profit Margin Analysis
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Altius Weighted Average Victor TX Victor Elevate
Current Share of Sales 70% 30%
Retail price $48.00 $39.00 $27.00
Retailer gross profit
Retailer gross margin % 15.0% 15.0% 15.0% 20.0%
Manufacturer price
Manufacturer variable cost
Manufacturer unit contribution
Manufacturer gross margin % 70% 70% 70%
$7.20 $5.85 $5.40
$33.15
70% $23.21
$7.75
64%
30% $9.95
Value of market share point ($M) ? ? ? ?
$45.30
$6.80
70% x 48 + 30% x 39 =
Current Market Share and Gross Profit for Altius's Product Line
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Altius Victor TX Victor
Market share, retail dollar sales (%) 55.2%
Unit volume (M)
Retail sales ($M) - 55.2% of $483M $266.6 $0.00 $0.00
Retailer gross margin (%) 15.0% 15.0% 15.0%
Manufacturer sales ($M)
Manufacturer gross margin (%) 70.0% 70.0% 70.0%
Gross profit ($M)
Victor TX 70% of unit volume 70.0% 30.0%
Market share, unit sales (%) 45.2%
Victor Price Cut Analysis
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Current price $2 Retail Price Cut $4 Retail Price Cut
Retail price $39 $37 $35 Retailer margin 15% 15% 15%Altius price $31.45Altius variable costAltius unit contributionAltius gross margin 70%
Altius Manufacturer Price Change %
Unit sales increase to maintain profit
% Retail price change
Elasticity required to break even
Victor Market Share increase required to break even
Victor Market Share required to break even
Altius Market Share required to break even
$33.15 $9.95
$23.21 — $DP$CM’ + $DPBE= =
- -1.70 23.21-1.70
— %DP%CM’ + %DPBE= =
- -5.1% 70%-5.1%
-5.1%
7.9%
The Price Setting ProcessDefine Price
Window
Set initial price range based on differential
value & relevant costs
Key Questions:•What is the role of costs in setting my initial price range?
•What is appropriate price ceiling for this product?
•How should I incorporate reference prices into my price window?
Set Initial Price
Determine amount of differential value to be
captured
Key Questions:• Is price consistent with my business strategy & objectives (skimming vs. penetration)?
•What are the non-value related determinants of price sensitivity?
•What are the price-volume tradeoffs & impact on profitability?
Communicate Prices to Market
Develop communication plan to
ensure prices are perceived to be fair
Key Questions:•What is the best way to communicate price (changes) to customers?
•What are the considerations for implementing significantly higher prices?
Happy Pricing!
Review Questions
• What are 2 Customer Value Pricing (i.e., Demand-focused Pricing) strategies?
• What are 2 Cost-focused Pricing strategies?• How do we define value?• What are the three steps in the Price-Setting
process?• What is the link between pricing strategy and
competitive advantage?
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