Pricing Strategy & Tactics – Chs. 4-6 – Understand the role of pricing policies in developing a strategic approach to pricing – Establish the link between.
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Pricing Strategy & Tactics – Chs. 4-6– Understand the role of pricing policies in developing a strategic
approach to pricing– Establish the link between a firm’s pricing actions and customer
expectations & future purchase behaviors– Provide frameworks for understanding customer behaviors and
establishing policies to ensure profitable pricing outcomes– Understand the major stages of the price setting process and the
role of value and cost at each stage– Demonstrate the three factors shaping the choice of a price point
• Strategic alignment, Price-volume tradeoffs, & Customer response
– Introduce dynamic pricing (Rick Lester, TRG, September 27)– Examine how to develop value-based communication messages to
reflect key product characteristics
• Most managers have difficulty communicating their firms pricing policies… because they don’t have any….
• Lack of proactive (not reactive) pricing policies reduces firm negotiating power with potential buyers who devise purchase strategies to gain discounts. This has led to a large number of firms that have created “strategic sourcing” programs.
• One problem is that purchasers tend to research and understand the competitive landscape better than the firm’s sales representatives.
• Compounding the competitive landscape issue is the fact that many firms provide incentives based on units sold and not on margin gained off each sale.
Chapter 5 – Pricing PolicyChapter 5 – Pricing Policy(Management of customer expectations and behaviors…)
The Interaction of Expectations and Behaviors
Benefits Of Policy Driven Pricing
• Provides greater consistency across customer base
• Mitigates costs associated with ad-hoc discounting
• Forces “give-get” trade-offs & value recognition
• Increases perceptions of price integrity
• Creates more efficient selling process
How Pricing Policy Leads to Certain Behaviors
Policy:Your firm only offers discounts to customers when they have a betterprice from your competitor(s).
Behavioral Implication:Your loyal customers get nothing in return, while non-loyal customers are rewarded for searching for better deals from your competitors.
Loyal and non-loyal customers begin to develop strategic relationships with your competitor(s) to keep your firm “honest” (i.e., press for the lowest price from your firm).
Policy:Your firm offers greater than normal discounts only to achieve sales goals (usually sales quotas).
Behavioral Implication:Discounts tend to pile up at the end of a reporting period since achievement of sales goals are not clear at the beginning of the reporting period. Customers figure the timing issue out and migrate their purchases toward the end of your firm’s reporting period to secure discounts.
Inventories tend to be greater than normal since sales tend to become cyclical with the reporting period.
How Pricing Policy Leads to Certain Behaviors
Policy:Your firm provides discounts for annual volume, regardless of order volume or the share your buyer’s total need your sales represent.
Behavioral Implication:This policy tends to lead to buyers centralizing their purchases with your firm. Centralization takes the value proposition away from those who understand it and places it with those who do not (i.e., order makers).
This policy also benefits buyers by allowing them to assemble into buying groups in order to secure the discount or to hunt for better prices from your competitor(s).
How Pricing Policy Leads to Certain Behaviors
Policy:Your firm publishes list prices, but your firm’s discounting patterns are inconsistent so as to keep your competitor(s) guessing as to yoursales price(s).
Behavioral Implication:Competitors cannot benchmark prices. Instead, competitors use information from purchasing agents to determine your prices, which leaves your firm with little to no power to influence your competitors’ pricing. Consequently, your customers take advantage of the situation by manipulating information between your firm and your competitors for their own benefit.
How Pricing Policy Leads to Certain Behaviors
Structuring Your Firm’s Pricing Policies
Remove Inconsistency in PoliciesCentralize the pricing policy development and monitoring so that allsales representatives operate under the same policy and use the same metrics.
Provide IncentivesReconsider commission compensation since it tends to focus salesrepresentatives on short-term goals. Sales representatives should beinformed as to what is good/bad for the company. In general, focus on higher margin sales should be one goal for sales representatives.
Provide Analytical Performance DataData should be provided to management and sales representatives.
Buyer Types - Exhibit 5-3
• Desire for interaction• Emotional Involvement• Loyalty• Number/type of considered vendors• Involved decision-making• Fast decisions• Switching Costs• Operational importance of
differentiation
Cues for Identifying Customer TypeConsider these Characteristics in Each Case
PriceRelationship Value Convenience
See Reading on Price Positioning
Brand (Relationship) Driven
Convenience Driven
Value Driven
Price Driven
Pricing Strategy & Tactics – Chs. 5-6– Understand the role of pricing policies in developing a strategic
approach to pricing– Establish the link between a firm’s pricing actions and customer
expectations & future purchase behaviors– Provide frameworks for understanding customer behaviors and
establishing policies to ensure profitable pricing outcomes– Understand the major stages of the price setting process and the
role of value and cost at each stage– Demonstrate the three factors shaping the choice of a price point
• Strategic alignment, Price-volume tradeoffs, & Customer response
– Introduce dynamic pricing– Show how to communicate new prices to maximize perceived
fairness and minimize adverse customer response
The Price Setting Process - Exhibit 6-1
Define Price Window
Set initial price range based on differential
value & relevant costs
Key Questions:
•What is the appropriate price ceiling for this product?•How should I incorporate reference prices into my price window?•What is the role of costs in setting my initial price range?
Set Initial Price
Determine amount of differential value to be
captured
Key Questions:
•Is price point consistent with my business strategy & objectives?•What are the price-volume tradeoffs and what is their impact on profitability?•What are the non-value related determinants of price sensitivity?
Communicate Prices to MarketDevelop
communication plan to ensure prices are
perceived to be fairKey Questions:
•What is the best approach to communicate price changes to customers?•What are the considerations for implementing significantly higher prices?
Defining Price WindowsSpringfield Case: Weighted Average Economic Value
Exhibit 6-2a:Positively Differentiated Offering
Exhibit 6-2b: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 Pricing
Consistent with Business Strategy? Competitive Advantage
The unique position a firm develops through resource & capability deployments that leads customers to choose the firm’s products over competitors. Advantage can be based on:•Cost Leadership (Low cost & price);•Product Differentiation – offering superior economic value by creating superior product/service features & quality through innovation & product development capabilities;•Marketing Differentiation – offering superior perceived value by developing
– Unique image (brand-centric differentiation) achieved through targeting, positioning & communication capabilities
– Close relationships with customers (customer-centric differentiation) achieved through CRM capabilities & customization
For each case, ask “What is the focal firm’s competitive advantage?”
Conditions for Alternative Pricing ObjectivesProduct Differentiation
SkimCost Leadership
PenetrationMarketing Differentiation
Neutral
COSTS
CUSTOMERS
COMPETITION
•Sufficient CM to finance advertising...
•Costs similar to competitors
•Little excess capacity•Incremental capacity is expensive
•Customers are sensitive to other elements of the marketing mix
•Large share brands w/ a lot to lose (Oligopolies)
•Sustainable mktg mix advantages
•Avoid threat of retaliation
•Changes in volume drive profitability
•High CMs•High volumes•Small BE Sales Changes•Excess capacity
•Little differentiation•High price sensitivity•Total Expend Effect•Large Part of End-Benefit
•Sustainable cost & resource advantage
•Financial strength•Competitors not willing to retaliate
•Aggressive small share brands
•Changes in Unit Price Drive Profit
•Low CMs•Low Volumes•Large BE Sales Changes•At or near capacity
•Difficult Comparison Effect
•Price Quality Effect•Low Price Sensitivity•Reference Price Effect
•Sustainable differentiation
•Limited threat of opportunism
•Limited opportunity for scale economies
•Low threat brands
SKIM•Difficult Comparison Effect•Price Quality Effect•Sustainable differentiation•Changes in Unit Price Drive Profit
PENETRATION•Little differentiation•Sustainable cost & resource advantage•Changes in volume drive profitability
NEUTRAL
•Customers are sensitive to other elements of
the marketing mix
•Large share brands w/a lot to lose (Oligopolies)
•Sufficient CM to finance advertising...
Setting Price: The Price-Volume Trade-offPrice optimization is a complex process that involves 2 distinct components: (a) the firm’s current price and cost structure, and (b) customer response to price offerings and changes. Estimating customer response requires deep understanding of customers and competitors, a difficult and imprecise problem at best. Instead, start with 2 relatively easy questions to answer:
1.How much volume could I afford to lose before a price increase would decrease my profitability?
2.How much volume would I have to gain for a price decrease to improve my profitability?
In effect, you change the customer response estimation problem from a two-tailed estimate to a one-tailed estimate.
Q ≤ QBE?
Q ≥ QBE?
Incremental Percent Breakeven Sales Change
P × CM% × Q = P (1 + P%) Q (1 + Q%) P (CM% + P%)
P (1 + P%)× ×
Current contribution New CM%× New Quantity×New Price=
CM% = ×(CM% + P%) (1 + Q%)
Q% = CM%(CM% + P%)
(CM% + P%) (CM% + P%)
–
(CM% + P%) – P%
Q% =
Incremental Percent Breakeven Sales Change
(P – C) Q = (P + P - C) (Q + Q) ×
Current contribution New Quantity×New Contribution Margin=
PQ – CQ = PQ +PQ + PQ + PQ – CQ - CQ
0 = PQ + PQ + PQ - CQ
0 = Q(P + P – C) + PQ
Q(P + P – C) = PQ
Q = P (P + P – C)Q
P (CM + P)
=BE
Incremental Percent Breakeven Sales Changes
Price increase: % decrease < the breakeven decrease leads to contribution increase.Price decrease: % increase > the breakeven increase leads to contribution increase.
Price Sensitivity Drivers
• Size of expenditure • Shared costs• Switching costs• Importance of end-benefits• Perceived risk• Price-Quality perceptions• Perceived fairness• Price framing• Reference prices
Relative to income
Paid by employer, parents…
Monetary & non-monetary
Economic & psychological
Receive expected benefits?
Higher price=higher quality?
Fair price range
Gains vs. losses
Gains vs. losses
Prospect TheoryPerceived Value
GainsLosses
Reference point
Objective Value
Small Gains Overvalued
Large Gains Undervalued
Small Losses Strongly Overvalued
InternalRemember their favorite brand(s) & the last price they paid.Wow! I paid $15.00 for that Franciscan yesterday and it’s on sale here for $12.99. Better get a case.
Reference Price Shoppers:
External Reference Price Shoppers: Remember their favorite brand(s) but not the last price paid.OK. The Voss brand is $16.00. Just out of curiosity, how much is the Rombauer – oh, $32. Voss it is.
Price Range Shoppers: Don’t have a favorite brand or remember prices.
Let’s see. Clos du Bois $9.99, Voss $16.00, Franciscan $12.99 & Rombauer $35...
Quantity Demanded
Pri
ce
Elasticity – a visual representation . . . .
inelasticunit elastic
elastic
(few substitutes – gemstones, transplant organs)
(many substitutes – grains,fruits and vegetables, bagged soil,paper clips, rubber bands)
Q1Q2
P1
P2
P1
P2
Q2 Q1
Elasticity – Measurement of PriceSensitivity at the Market Segment Level
We can measure or estimate price sensitivity at the market segment level by assessing the price elasticity for a particular product or service.
Elasticity = Percent Change in Unit Sales (over relevant range)
Percent Change in Price (over relevant range)
E =% in Unit Sales
% in Price
E =(22%-49%)/Average(22%,49%)
(14-12)/Average(14,12)
Single Ticket Demand in Springfield Nor’easters
How to Estimate Volume Along the Demand Curve
Use the Polynomial Trendline Function in Excel
y = -0.0225x2 + 0.34x - 0.35R² = 1
Elasticity – Measurement of PriceSensitivity at the Market Segment Level
Measure of Price Elasticity
|Price Elasticity| < 1 An increase in price within the range evaluated results in lower unit sales but higher revenue (profit?).
|Price Elasticity| > 1 An increase in price within the range evaluated results in lower unit sales and lower revenue (profit?).
|Price Elasticity| = 1 An increase in price within the range evaluated results in an identical change in unit sales and the same revenue (profit?).
Unit Elastic
Elastic
Inelastic
Elasticity Required to Breakeven
Price increase: |Elasticity| < the breakeven amount leads to contribution increase.Price decrease: |Elasticity| > the breakeven amount leads to contribution increase.
Homework for Next WeekFire Safety
Q% =(CM% + P%)
– P%
The Problem: Customer generally does not know true value unless informed by seller.
Value communication is important when your product or service creates value that is not readily apparent to potential consumers.
Value communication is nothing more than information dissemination.
• Develop value proposition (i.e., compellingly unique & distinctive economic or psychological benefits).
•Communicate the value proposition, and
•Deliver the value.
Price & Value Communication
Relative Cost of SearchT
ype
of B
enef
its
Econ
omic
Ben
efits
Psyc
holo
gica
l Ben
efits
SportsCars
SUV’sCollege
Education
InvestmentAdvice
ExoticVacations
HomeEquityLoans
Pain Medications
DigitalCameras
DesktopComputers
CommodityChemicals
AutoRepairs
LifeInsurance
BloodPressureDrugs
ManagementConsulting
Cosmetics
Hotels
FitnessEquipment
High Complex “Experience” Goods
LowSimple “Search” Goods
Adapting the Message for Product Characteristics
DesignerClothes
Greater Price
Dispersion
Unique work of Art
Strategy 1Economic Value Communication
CommunicateObjective Information That Differential Economic Value
Justifies Pricing (e.g., Computers)
Strategy 2Economic Value
Assurance
Communicate Assurances ThatDifferential Economic Value
Justifies Pricing (e.g., Investment Returns, Hotel Guarantee)
Strategy 3Psychological End-Benefit
Framing
Associate Differential Performance with Subjective Psychological Value
That Justifies Pricing (e.g., Cosmetics)
Strategy 4Psychological End-Benefit
Assurance
CommunicateAssurances That Total
Psychological ValueJustifies Pricing (e.g., Art, Exotic
Vacations, Mattresses?)
Eco
nom
ic B
enef
its
Psy
chol
ogic
al B
enef
its
High“Experience” Goods
Low “Search” Goods
Relative Cost of SearchTy
pe o
f Ben
efits
Framework of Value Communication Strategies
Art Assignment• Choose a product & identify (15 minutes)
–Your retail price position and the Value Proposition for the product; i.e., what is compellingly unique & distinctive.
–The target customers (relational, value, convenience, or price), the relative size of the market, and their desired psychological benefits.
–How you will communicate the value to customers given high experience characteristics & psychological benefits. For example, what assurances can you offer that the product will deliver the desired psychological benefits?
–Price range, pricing objective (skimming, penetration, or neutral), price point & whether you will negotiate discounts.
• Communicate value & price in 2 minutes
The Price Setting Process - Exhibit 6-1
Define Price Window
Set initial price range based on differential
value & relevant costs
Key Questions:
•What is the appropriate price ceiling for this product?•How should I incorporate reference prices into my price window?•What is the role of costs in setting my initial price range?
Set Initial Price
Determine amount of differential value to be
captured
Key Questions:
•Is price point consistent with my business strategy & objectives?•What are the price-volume tradeoffs and what is their impact on profitability?•What are the non-value related determinants of price sensitivity?
Communicate Prices to Market
Develop communication plan to
ensure prices are perceived to be fair
Key Questions:
•What is the best approach to communicate price changes to customers?•What are the considerations for implementing significantly higher prices?
Next Week
Akash RathodB2B Pricing
&Pricing Strategy Over the Life
Cycle (Chs. 7-8)
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