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Maximizing Profit Through Strategic Pricing
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Maximizing Profit Through Strategic Pricing
Robert A. McKinney
Pricing Strategist with The McKinney Group, LLC
Copyright 2009
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The McKinney Group, LLC
Effect of price on profit
What is traditional pricing
•Cost-plus pricing
•Customer-driven pricing
•Competition-driven pricing
What is strategic pricing
•Keys to strategic pricing
•Differentiated-Value Pricing(sm)
•Copier example
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• Growth-oriented startup to $50MM
• Competitive Strategy
• Strategic Pricing
•
• Certified Managerial Accountant (CMA)
• MBA, Strategic Management, Purdue University
• Member:
• Experience:
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The McKinney Group, LLC
Effect of price on profit
What is traditional pricing
•Cost-plus pricing
•Customer-driven pricing
•Competition-driven pricing
What is strategic pricing
•Keys to strategic pricing
•Differentiated-Value Pricing(sm)
•Copier example
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Pricing affects the bottom line in many ways
• Influences perceived value in marketplace
• Influences how well a product will sell
•Determines profit
•Each 1% Δ in price = 8% Δ in profit
Original Price
Price $114
Costs $100
Net Profit $14
Discounted price
Price $103
Costs $100
Net Profit $3
10% price cut
80% profit cut!
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While lower prices sometimes lead to more sales,
more sales are required just to break even
$100,000 overhead (fixed) costs
/ $14 profit per piece
7,143 pieces must be sold to break even
$100,000 overhead (fixed) costs
/ $3 profit per piece
33,333 pieces must be sold to break even
Lower price would require >4x the
sales just to break even
Total Profit = Profit per piece x Quantity sold
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The McKinney Group, LLC
Effect of price on profit
What is traditional pricing
•Cost-plus pricing
•Customer-driven pricing
•Competition-driven pricing
What is strategic pricing
•Keys to strategic pricing
•Differentiated-Value Pricing(sm)
•Copier example
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What is traditional pricing
Reacts to market conditions rather than proactively
managing them
Focused on:
•Closing deals
•Growth
•Maximizing market share
Players:
•Finance:
•Marketing:
•Sales:
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Cost-plus pricing
“Fair” profit after all costs
Leads to overpricing and underpricing
• Most companies don’t know their total costs
• Costs change
• Competitor’s costs are different than yours
• Customers don’t care about your costs
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Customer-driven pricing
(“Willingness-to-pay” pricing)
Goal: Maximum number of happy customers
Leads to discounting and underpricing
• Teaches customers that you are not serious about getting paid for the value you create
• Rewards aggressive behavior by procurement departments
• Price disparities can damage relationships with existing customers
• Encourages competitors to discount also (“Race to the bottom”)
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Customer-driven pricing
(“Willingness-to-pay” pricing)
Price History, Division
$-
$50
$100
$150
$200
$250
$300
$350
$400
2000 2001 2002 2003 2004 2005 2006 2007
$/u
nit
Fredonia bulk
Paulding bulk
-11%
-10%
5-year CAGR
( 2002-2007)
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Customer-driven pricing
(“Willingness-to-pay” pricing)
Pricing vs. volume, Division
$-
$200
$400
$600
$800
$1,000
$1,200
$1,400
$1,600
$1,800
- 1,000
2,000 3,000
4,000 5,000
6,000 7,000
8,000 9,000
10,000
Units per year
$/ u
nit
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Competition-driven pricing
Driven by market share and growth goals
Leads to price wars and commoditization
•Easiest way to make a sale, cut the price
Generic business strategies
1. Low Cost
2. Differentiation
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The McKinney Group, LLC
Effect of price on profit
What is traditional pricing
•Cost-plus pricing
•Customer-driven pricing
•Competition-driven pricing
What is strategic pricing
•Keys to strategic pricing
•Differentiated-Value Pricing(sm)
•Copier example
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What is strategic pricing
Focused on value creation
Proactively manages market conditions
Driven to maximize net profit
Controlled
Players:
•Finance
•Marketing
•Sales
•Management
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Differentiated-Value Pricing(sm) ensures that you
profit from the value that you create
DVP(sm) is a framework to quantify value
• Basis of your value proposition
DVP(sm) is the foundation of strategic pricing
• Allows you to determine prices that maximize net profits
• Minimizes risk of commoditization
• Minimizes risk of price wars & “races to the bottom”
DVP(sm) helps the marketing team with all aspects of developing a
marketing mix
DVP(sm) improves the effectiveness of Sales
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Example: Determining price for new copier from
Alpha Copier Company
Finance
•Manufacturing costs: $1,250
•Alpha’s standard gross margin: 50%
•Price should be $1,875
Sales
•“Market is very competitive”
•Beta company has a $1,200 copier.
•Beta has also been very aggressive regarding price, and has been
marketing themselves heavily in an attempt to grow market share
•Price can be no more than 15% higher than Beta ($1,400)
Finance and Sales agree on $1,750
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The first step is to understand the value created by
your company and its competition
Attributes Alpha Beta
Pages per minute 30 15
Resolution 600 x 600 300 x 300
Paper capacity 500 sheets 1,000 sheets
Duplex capacity Yes No
USB input Yes No
Internet capability Yes No
Brand image Reliable Low cost
Cost ?? $1,200
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The next step is to quantify the value
Secondary research
•Historical company sales data
•Scanner data
Primary research
•Market research panels or focus groups
•Surveys
• Buy-response surveys
• Conjoint (“tradeoff”) analysis
• In-store or laboratory purchase experiments
• In depth customer interviews
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Secondary research
•Historical company sales data
•Scanner data
Primary research
•Market research panels or focus groups
•Surveys
• Buy-response surveys
• Conjoint (“tradeoff”) analysis
• In-store or laboratory purchase experiments
• In depth customer interviews
The next step is to quantify the value
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Translating value creation to dollars and cents
Attributes Alpha Beta Avg ∆ in value (Alpha vs. Beta)
Pages per minute 30 15 $75
Resolution 600 x 600 300 x 300 $200
Paper capacity 500 sheets 1,000 sheets -$50
Duplex capacity Yes No $75
USB input Yes No 25
Internet capability Yes No 50
Brand image Reliable Low cost $300
Cost ?? $1,200 $725
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Using Differentiated-Value Pricing (sm) to calculate price showed
Alpha that their new copier created more value than they thought
$1,200 Beta copier
$725 Additional value created by Alpha’s new model
$1,925 Value of Alpha’s new copier
$1,875 Cost-plus price determined by Finance
$1,400 Competition-driven price determined by Sales
3% difference in price
7% difference in net profit38% difference in price
450% Δ in net profit
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Differentiated-Value Pricing (sm) also allows Alpha to support
their value proposition when communicating with internal
players, distributors, and customers
$1,200 Beta copier
Additional value created by
$725 Alpha’s new (differentiated) model
$1,925 Value of Alpha’s new copier
Attributes Alpha Beta
Pages /minute 30 15
Resolution 600 x 600 300 x 300
Duplex Yes No
USB input Yes No
Internet Yes No
Brand image Reliable Low cost
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DVP(sm) is a foundation for strategic pricing
Skim pricing
Differentiated-Value Pricing(sm)
Bundling
Bundling
Bundling
Seg mentation
Rebates /
Coupons
Price fences
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For more information, including many free resources about
pricing and business strategy, go to: www.TMG-SMC.com