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Kevin Whorton Director of Retail Programs National Association of Chain Drug Stores, Inc. General Manager, NACDS Services Corporation

We Lose Money on Every Sale, But We Make It Up on Volume:

Growing Association Profits With Effective Pricing

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Program Outline

I. Overview of Pricing Techniques/Tactics

II. Framework for Setting Optimal Price

III. Vignettes and Cautionary Tales

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I: Overview of Pricing Techniques and Tactics

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Pricing Objectives

Will drive strategies and techniques: Maximize profit/financial surplus Cost recovery Maximize market size Social equity

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Pricing Strategies

Cost-oriented: based on markup/target return on investment

Market penetration: low introductory priceBuild acceptance, forestall competition

Market skimming: where market will bear No foreseeable competition

Competitive price: defensive, matching, or maintaining guaranteed low price

Prestige price: intentional high/establish value

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Common Pricing Techniques

Cost-plus pricing: adding markup to achieve defined margin

Demand-oriented pricing: consumer need sets price; price level varies with demand

Line pricing: price set for individual items, relative to other items within the line/brand

Price discrimination: offer multiple prices within distinct markets/distribution channels

Other: price points, loss leader, promo pricing

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Price Setting

Existing servicesQualitative researchQuantitative methods--contingent valuation Tradeoff (conjoint) modelingOverall review of practices

New servicesPrice testingBundled/unbundled products

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Pricing By Service Category

Services Under Development Marketing involvement during product

development process:Define ideal productDetermine its attributesForecast success of product with a variety

of price points/strategies (measure opportunity cost)

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Which Problems Apply to You

Too much/too little price variety in product line Over-consistent pricing across categories with

different costs: associates, students, international Internal resistance to hikes: “not business decision” Not bundled well with discounts for other services Price level inconsistent with perceived value Constant dues level over time, despite changes in

services/components of membership

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Potential Solutions

Varying solutions and potential returns Direct changes in base dues Bundling with products/premium membership New categories (e.g. inst./multiple memberships) Multiple-year and discounted memberships Changing price for categories with higher/lower

fulfillment costs (international, students) Each change needs systematic review/evaluation similar to new product development model

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Communication

Make case for direct price changes…Marshal evidence of over/underpricingAddress underlying issues (e.g., cost allocations)Build internal/external understanding/acceptance

... or indirect price changes Increase benefits, member discounts, premium

giveaways, member-only services (if overpriced)Unbundle benefits, lower member discounts, create

premium level (if underpriced)Continue to pursue a long-term strategy to change

direct prices

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Implementation

To succeed, maximize return on price changes Communicate findings internally

Forecast results, re-evaluate effectiveness

Communicate to external audiencesThe sales force — chapters, recruitersCurrent customers — catalog, renewalsProspects — promotional materialsPosition change as increased market responsivenessEstablish precedent: ensure pricing is a marketing

decision

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Applications: Membership

Typical scheme: Annual charge, no installments

Primary membership: often political/by-laws

Line pricing for other categoriesNo volume discountsStrategy for changes: budget-balancing

Technique is cost-basedFull, not incremental cost

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Application: Member Dues

Identify pricing strategy/technique used Determine if strategy is sub-optimal

Retention (by category) vs. benchmarksExit surveys: frequency of value/cost as a reason Satisfaction ratings based on “value for price paid”Qualitative research, current membersCompetitive scan/market penetrationUse file analysis: total members by company, sitePositioning: “primary” or “secondary” affiliation

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Application: Exhibit Fees

Far greater latitude: multiple attendeesSplit registrant fees from space rentalHistory rules: working within budgetsCompetitor intelligencePotential for value-added: pre-show lists,

travel costs, all factored into budgetsAnnual packages: ads + exhibitor feesWillingness to trade certainty for higher

price tag

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Application: Sponsorships

Typical scheme: Full, not incremental costBased on perceived WTP or need for specific programOften linked to giving/donor relationsAltruistic motives vs. market access Pricing the sponsor “ask”

• Identify market’s value to potential sponsor• Extensive use of add-ons• Specific deadlines for offers/auction to drive prices build-in

exclusivity for high profile• Avoid frequent use of tiers

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Application: Certifications

Cost-plus pricing: FC vs. VC: packaging and recordkeeping Externalities: ‘lift’ for all educationProduct line: spinoffs, distance learningPerceived value--new clients/higher incomeAdjustments if problem signs (attrition rates)Importance of lifetime value

Pricing for first and subsequent yearsPricing and penetration: elite/prestige (low) or

democratic/requisite credential (high)

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II: A Framework for Setting the Optimal Price

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"No margin, no mission."

Henri Manasse, Ph.D, Sc.D.ASHP Executive Vice President and Chief Executive Officer

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Assumptions

You price to generate a profit.There is a direct relationship

between price and demand.Cost is only one element used to

establish the final price.Price is used as a basis for

determining a product’s value.

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Pricing Floor and Ceiling

Your costs set the floor.

The marketplace sets the ceiling.

There is a range of acceptable prices (in theory on one is optimal).

0

0

0

1

1

1Ceiling

PriceRange

Cost

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Components of Pricing Process

Pricing constraints and objectivesDemand, revenue, and elasticityCost, volume, and profit relationshipsPricing strategiesFactors in setting the specific priceSpecial adjustments

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Pricing Objectives

Specify pricing goals that reflect your organization’s strategic goals

Profit Manage for long-run profits Maximize current profits (current

quarter, current year) Target return on investment

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Pricing Objectives (cont.)

Sales Given adequate profit, increase in sales

revenue will lead to increases in market share and profit.

Market share (ratio of your sales to industry sales) Declining market Long-term strategy for entry into new

markets

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Pricing Objectives (cont.)

Unit sales Good for products that increase in price

each year Can be deceptive with price cutting

(revenue can be down while unit sales are up

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Constraints

Determine the demand Associations are niche oriented w/ a

defined marketplace. Look at both competitive association

products and competitive commercial products.

Is your product/service truly unique? Is there an expected price?

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Constraints (cont.)

Anticipate the competitive reaction Who are your competitors? How crowded is the marketplace? What are your competitor's charging? How will you price position your

product?

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Constraints (cont.)

Establish universe size market share Is the market large enough to generate

adequate sales? Is the universe stable? Is the universe growing or shrinking? At

what rate?

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Constraints (cont.)

Determine the cost of producing and marketing the product or service Production costs Marketing costs Fulfillment costs Assigned overhead or other fixed costs

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Other Pricing Constraints

Newness of product: stage in the product life cycle

Single product vs. product line Cost of changing prices and the time

period they apply The competitive marketplace (monopoly

vs. competitive) Competitor’s prices

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Pricing Objectives (cont.)

SurvivalSocial responsibility

True for many associations Look at total product line for profitability

(gains offset losses)

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Demand, Revenue, Elasticity

Demand Curve FactorsPrice Elasticity and Demand

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Demand Curve Factors

Consumer tastes Price and availability of other

products (preference set)Consumer income

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Typical Demand Curve

0

500

1,000

1,500

2,000

2,500

3,000

$0 $50 $100 $125 $150 $200 $250

Price

Qu

an

tity

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Revenue Curve

$0

$50,000

$100,000

$150,000

$200,000

0 500 1,000 1,250 1,500 2,000 2,500

Quantity

To

tal

Re

ve

nu

e

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Price Elasticity and Demand

There is a relationship between the quantity demanded and price. Elasticity is the % change in quantity

demanded relative to the % change in price.

Price elasticity of demand (E) is: (Initial quantity demanded / New quantity demanded) /

Initial quantity demanded

(E) = _________________________________________

(Initial price - New price) / Initial price

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What does this mean?

Demand is elastic when a small price increase produces a larger percentage decrease in quantity demanded. Price elasticity is > 1.

Demand is inelastic when a small price increase produces a smaller percentage decrease in quantity demanded. Price elasticity is < 1.

(The above also works in reverse.) Unit demand elasticity- when the percentage of

change in price produces an identical change in

quantity demanded.

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Factors Affecting Elasticity

The greater the number of substitutes, the greater the elasticity.

Products and services considered to be necessities are price inelastic.

Items that require large cash outlays compared to disposable income are price elastic.

One way to measure elasticity is through year-to-year purchasing.

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Cost, Volume, and Profit Relationships

Pricing TermsMarginal AnalysisBreak-even AnalysisEstimating Demand

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Terms

Profit = Total revenue -Total cost Total cost (TC) = total production, marketing, and

sales expense. Fixed costs (FC) do not change with the quantity sold

(rent, salaries) Variable costs (VC) vary directly with the quantity sold

Variable cost expressed on a per unit basis it called unit variable cost.

Marginal cost (MC) is change in unit cost for producing and marketing one additional unit.

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Marginal Analysis for Profit Maximization

To maximize profit sell and promote your products/services

as long as the revenue received from the sale of an additional product is greater than the cost to produce and market that product.

In theory, you want to operate up to the point where MR = MC

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Break-even Analysis

Analyze the relationship between total revenue and total cost to determine profitability at various levels of output.

The break-even point (BEP) is the point where total revenue = total cost.

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Calculating the Break-even Point

Fixed Cost_______ BEPq = Unit price - Unit variable cost

Answers the question: How many units do I need to sell to break even?

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Practical Example of Break-even

$55,000___ BEPq = $35 - ($10 + $ 8) = 3235.3

Question: How may units can we realistically sell?

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Developing the Break-even Chart

Where P = $35UVC = $18 (printing, distribution,

storage)FC = $55,000 (development,

marketing, salaries, OH)

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Break-even Chart

Q TR TVC TC Profit ROI (P X Q) (UVC X Q) (FC X TVC)

1,000 $35,000 $18,000 $73,000 ($38,000) 2,000 $70,000 $36,000 $91,000 ($21,000) 3,000 $105,000 $54,000 $109,000 ($4,000) 4,000 $140,000 $72,000 $127,000 $13,000 10.2% 5,000 $175,000 $90,000 $145,000 $30,000 20.7% 6,000 $210,000 $108,000 $163,000 $47,000 28.8%

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Break-even Graph

$0

$50

$100

$150

$200

$250

1000 2000 3000 4000 5000 6000

TR

TC

FC

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Estimating Demand

Universe/market shareExample: Membership category

(N=250) 31,000 certified technicians 15,000 take exam in 1999 (12,000 pass) Approximately 1/3 are in the health-system

market niche Min. universe = .33 x 43,000 = 14,190 Mkt share estimate = 10% or 1,419

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Estimating Demand (cont.)

Average Sales Method1,000 units x .3 = 3332,000 units x .4 = 8003,000 units x .2 = 6004,000 units x .1 = 400Total estimate = 2,133

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Estimating Demand (cont.)

Previous sales/similar products Review sales of earlier editions What external factors are affecting

demand? Examine sales of similar products External research: sales of competitive

products Internal research: ask customers if they’d

buy

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Summary

Establish a pricing policySet your parameters and goalsMake assumptionsUse the toolsDraw on your experience

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III: Vignettes and Cautionary Tales

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Sponsorship: Effect On Pricing the Subsidized Item

Grant in hand to subsidize program development “Net cost” of development is zero Developer wants to price low

What do you do?

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Sponsorship’s Effect (2)

If net cost=0, should you give it away? Social objective of pricing strategies Publicize your role as good guys

OR…Price where the market will bear If you can make money, price based on

gross cost Product is a sponsorship magnet Yet pricing should reflect perceived value

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“The Fait Accompli”

What do you do when the price is established and the “go/no go” is GO Illustrated: Spinoff of an established product Power resides with the product developer Your own analysis yields profit = 0 Probable outcome: profit < 0

What do you do?

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“The Fait Accompli” (2)

De-emphasize the product May be self fulfilling prophecy

Free/low-cost marketing optionsWait until the next round

Work on fixing problem for the next edition

Price-test the release: forecast results Prepare for markdowns in promotion plan

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New Product Release

Product rollout begins in six months Your charge: develop pre-pub and rollout

communications and pricing strategies Marketing has autonomy over discounts,

some control over rollout price

How do you determine pricing?

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New Product Release (2)

Pre-pub allows some flexibility in price testing (validate your research)

Know your doubling day from product history: drive your forecast

Don’t pick at random, test price points Pre-pub to price-sensitive segments Consumer expectations/rollout price turnoff Commit to using the pre-pub learning to

adjust actual rollout price

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Rapid Price Escalation

Underpriced good, with some uncertainty Decision-maker sees product far

underpriced Sound basis on market data Objective: raise to market price, turn cash

calf into a cash cow

What do you do?

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Rapid Price Escalation (2)

One fell swoop Understand elasticity Avoid disrupting established buying patterns:

will people stay in the habit of buying? Budget-based decisions: don’t outrun

real willingness to pay Communicate: one adjustment year

Incremental multi-year: gradual, less pain

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Product Line Extension

Successful product needs milking Decision: expand product line May be segmenting content for a niche May be compiling discrete products or

issues into a single volume

What do you consider in pricing?

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Product Line Extension (2)

Considerations? How much do components or single

attributes contribute to value/how many are in product

Perceived value affected by media or content What is the niche-specific demand Are you being a cannibal? “Fit” with long-term pricing strategy Other approaches: bundling, repackaging

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Desperation Marketing

Got a dog to unload May be low-pickup conference,

underperforming book or product “Fire sale,” on-site discounts are options Must sunset the product/no questions

asked No current pricing process in place

What do you do?

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Desperation Marketing (2)

Time to ignore cost data How to exhaust inventory gracefully Avoid “aging” your catalog’s perception Avoid hurting image: product and other

lines Avoid future expectations of a white sale Giveaways: perform the social function People perceive value from pricing Understand why it tanked!!!

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Membership = Bundle

Association membership is under review Each represents a bundle of goods Board wants to re-evaluate what members

get for their dues, and/or dues level Service mix and membership categories

last changed in the Truman Administration

What input do you provide?

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Membership = Bundle (2)

Evaluate value of components in bundle Use a “time-neutral” perspective Ignore history and competition for now

Integrate with an overall financial model Loss leader, competition, or primary

revenue source Attribute all indirect member-caused

revenue:journal ads, exhibit revenue, sales