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
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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.
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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 terrible habit.”
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
• 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