#4 Pricing Strategy & Tactics

8/6/2019 #4 Pricing Strategy & Tactics

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Pricing: Strategy and Tactics


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Dimensions of Price

Seller Buyer

Product

Promotion

Distribution

Price

VALUEPROFIT

+

+

-

-

Perceived

Quality

Competitive

Advantage

+/- +/-

Perceived

Quality

Competitive

Advantage +/- +/-

+/-+/-


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Planning for effective Pricing

Nagle & Holden (1995)

Strategic Objectives

Goals

Tactics

Price & Price Policy

Costs Customers Competition


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Strategic Pricing involves changing your mindset

What price will we need to cover our costs and earn a profit?

What costs can we afford to incur (given the prices that are achievable

in the market) and still make a profit?

What price is this customer willing to pay?

What is the product worth to the customer and how can we capture andcommunicate that value?

What prices do we need to meet our sale or share objectives?

What level of sales or share can we most profitably achieve?


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Pricing Strategy:Integrating the elements for profitable pricing

CostMeasurement

CustomerIdentification

CompetitorIdentification

FinancialAnalysis

SegmentAnalysis

CompetitorAnalysis

FinalStrategy

Datacollection

Strategicanalysis

Strategyformulation

Nagle & Holden (1995)


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Accounting convention can often misleadSales Revenue

- Cost of goods sold= Gross Profit

- Selling expenses- Depreciation- Administrative o/h= Operating Profit

- Interest paid= Pre-tax profit- Taxes

= Net Profit

Points to remember:

-Pricing decision is not about linear thinking

-May need to sacrifice gross profit to be able toreduce expenses further down the line

-Do not focus too much on the sunk cost ofproduction

-Historical production costs may be irrelevant to acurrent pricing decision

-Focus on the avoidable cost of holdinginventory


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The Perils of LINEAR thinking

(Case in point) ABC Publishing

Publishes books on special interest topics

First run = 2000 copies of each title

Customary price of each book = $20

Contribution to o/h and profit = $4

Was generally able to sell about 50% in first year

Rest was held in inventory

Problem:

One year, due to a substantial increase in interest rates, the $4contribution per book did not fully cover the interest cost of workingcapital

Most common solution? Raise price of books to increase revenues to cover additional cost

to preserve Gross Profit to preserve Net Profit


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Welcome to Non-linear thinking

Problem: The sunk cost of production is being used to guide pricing decision

Concern:

Increasing price may cover your costs, but does the higher price delivermore value to your customers?

Better solution: Shift the focus to the avoidable cost of holding inventory Note: the cost of production is no longer avoidable

Better Strategy Have a 50%-off sale on slower moving titles being held in inventory (Need to understand cumulative inventory holding costs over years)

Logic: Selling today at lower price will help avoid the interest cost of holding until

you can get the higher price will lead to better net contribution


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Moral

FINANCIAL REPORTING must be kept

separate from MANAGERIAL COSTANALYSIS for pricing (marketing)decisions


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Change your mindset

Sales Revenue- Incremental (avoidable) variable cost

= Total contribution in $- Incremental (avoidable) fixed costs= Net Contribution- Other fixed/sunk costs

= Pre-tax profit- Income Taxes

= Net Profit


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Moving away from Cost-Based Pricing &

Embracing the idea of Value Based Pricing

Pricing cannot be the result (solely) of financial

analysis

(Internal) numbers can be misleading

Optimal pricing calls for understanding anappreciating managerial uncertainty aboutconsumers decisions and about competitorsreactions


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Value based pricing (contd.)

Pricing decisions must be based onunderstanding of the components of value

USE VALUE Benefits/satisfaction offered by the product

ECONOMIC or EXCHANGE VALUE Perceived alternatives +differentiation value


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Economic Value Analysis

STEP #1: Identify the Reference Value i.e., the cost of the customers best alternative

STEP #2: Identify al the factors thatdifferentiate your product (note: somemay be positive and some may be negative) e.g., performance, reliability, features, maintenance cost, etc.

STEP #3: Determine the value to customersof these differentiating factors i.e., differentiation value


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Cost of bestalternative

Positivedifferentiation

value

Total Economic ValueReference

Value

Economic Value Analysis (contd.)

Negativedifferentiation

value

Price

Partly related topoints ofDifference (POD)

Partly related topoints of parity (POP)and competitorspoints of difference


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Pricing & Distribution

The way a product is distributed distinctly affectsthe way it is:

Compared with other products

The image consumers have of it

Cost of distribution

Therefore, pricing and distribution need to becoordinated.


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Price Setting Methods:Cost Based Pricing

Markup pricing / cost-plus pricing

Breakeven (target profit/return) pricing


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Change your Mindset:

Target Cost v/s Target Price

Manufacturer Retailer Consumer

Product is worth

$100

Max SP= $100

Expected Margin(10%)

Buys for $90

Must Sell for $90

Expected Margin(20%)

TARGET COST

$72

Need

Differential Value ofproduct

The TakeawayPut the Horse before the Cart

Demand & Price determine Cost.Cost should not determine PRICE!!!


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Price Setting Methods:Value-Based Pricing

Starts with consumers perceptions of VALUE

and works backwards to set target cost ratherthan target return

Therefore,

Price is Based on Value Cost is based on Price

(contrast with cost-based approaches)


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Steps in Price Setting

SetPricing

Objective

EstimateDemand

EstimateCost

AnalyzeCompetition

DeterminePrice

MakeNecessary

Adjustments


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Effect of Price on Demand

Q- Q Q+

Price

Quantity

P

P-

P+

Law ofDemand: Inverse Relationship Other things remaining the same, more isdemanded at a lower price


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Price Elasticity ofDemand

Q- Q Q+

Price

Quantity

P

P-

P+

Elastic Demand(small change in price produces

large change in demand)

(lowering price will lead to highertotal revenue)


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Q- Q Q+

Price

Quantity

P

P-

P+

Inelastic Demand

(large change in price produces

small change in demand)

(raising price will lead to greatertotal revenue)


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Q-QQ+

Price

Quantity

P

P-

P+

Demand in Monopoly

(large change in price produces

NO CHANGE in demand)

(can raise price as much as desired)

Regulation


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(Elasticity of) Demand and Price!(A Case Study)

Technology

What the TrafficWill BearVictoria Murphy Barret 07.03.06

DemandTec is teaching retailers that much of what they knew about pricing was wrong. An iPod at 10 a.m. maysoon sell for less than one at 7 p.m.

Duane Reade had a diaper dilemma three years ago. The pharmacy chain that blankets New York

City was struggling to boost sales of one of its most basic products. Competitors were outselling it,

and discounts and coupons failed to move the diapers faster. Duane Reade went looking for help.

It dumped its historical sales data into a new software program that would suggest how to price

diapers so they'd fly out of the stores.

After a few minutes of calculations the computer suggested Duane Reade do what it had never

done before: make the markup on the diapers a function of the child's age. For example, make the

newborn sizes more expensive, and the big-kid pull-ups cheaper. After a year an increase in diaper

sales helped boost baby care revenue by 27% even as the category's gross margin rose 2

percentage points.


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Psychology & Pricing

Reference Prices Internal v/s External

Role of Advertised Regular prices

Pricing for Quality

Price Endings

e.g., 9-ending, 99-ending prices e.g., 0-ending, 5-ending prices

Odd versus Even ending prices

Mind your Pricing Hues! Impact of Color


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Sale Price

Even EndingOdd Ending

Percent

100

80

60

40

20

0

Store

Walmart

K-Mart

26

74

66

34

Use ofOdd vs. Even Sale Prices


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Di Di it * i Di it r t l ti

% f t l

. % . %

6. % .6% 1.8% .6% 9. %

1. % 1. %

1. % 1. %

.6% 1.8% 1. % 4. % .6% 8.6%

3.1% 1.8% 1.8% 1. % 2 % 28.2%

1.8% 1.8% 4.9% 1.8% 22% 8% .6% 50.9%

1.2% 1.8% 6. % 14. % 1.8% 25.8% 25.8% 22.1% 100%

1.0% 1.0%

1.0% 1.0%2.0% 2.0%

1.0% 2.0% 2.9%

1.0% 1.0%

1.0% 1.0% 1.0% 1.0% 3.9%

1.0% 1.0% 1.0% 6.9% 2.9% 12. %

1.0% 2.0% 10.8% 10.8% 2.9% 48% 75.5%

1.0% 1.0% 2.9% 3.9% 11.8% 11.8% 9.8% 57.8% 100%

3

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5

6

7

8

9

DiDi it

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1

34

5

6

7

8

9

Di

Di it

t l

t rl rt

K- rt

0 1 2 3 4 5 6 7 8 9

PenniesDi it

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AnalyzingPrice Endings


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Priceinformation

located here

is

processed

here

Priceinformation

located here

is

processed

here

Differences in left v/s right brain activity may influence how a price is perceived!

Neuro-biology & price communication

#4 Pricing Strategy & Tactics

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