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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 Key Learning Points 1

Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

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Page 1: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

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

1

Page 2: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

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

Page 3: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

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

Page 4: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

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?

Page 5: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

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?

Page 6: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

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

Page 7: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

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

Page 8: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

Non-normal Distributions with Kinks Suggest Different Segments

8

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

Page 9: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

$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

Page 10: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

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?

Page 11: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

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

11

Page 12: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

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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Page 13: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

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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Page 14: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

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

Page 15: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

• 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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Page 16: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

Price Experiment for Mobile Phone

Elastic demand-2.83

Inelastic demand-.50

Page 17: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

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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Page 18: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

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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Page 19: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

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

Page 20: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

Estimating the Effect of a Price ChangeSee Kerin & Peterson, Ex. 8.2

20

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

Page 21: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

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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Page 22: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

Unit Profit Margin Analysis

22

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 =

Page 23: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

Current Market Share and Gross Profit for Altius's Product Line

23

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%

Page 24: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

Victor Price Cut Analysis

24

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%

Page 25: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

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?

Page 26: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic pricing

Happy Pricing!

Page 27: Pricing Strategies Pricing strategies & tactics (terminology). The concept of value and the price-setting process. Deciding how much of the strategic 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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