Pricing Practices That Endanger Profits

Pricing Practices That Endanger Profits

Surej P JohnJuly 7th, 2011

Chapter 6

Chapter Objectives

• To understand how consumers perceive prices, price changes, and price differences

• To develop the concept of reference price and further develop the concept of price thresholds

• Key pricing principle– Prices should be set so as to reflect

customers’ perceptions of value

Reference PriceReference Price

• The price that buyers use to compare the offered price of a product or service.

• The reference price may be a price in a buyer's memory, or it may be the price of an alternative product.

Order of Presenting Prices

• The order in which buyers are exposed to alternative prices affect their perceptions.– Ascending Prices– Descending Prices

Ascending Series

Descending Series

Order of Presenting Prices

• Buyers who initially see high prices will perceive subsequent lower prices as less expensive than would if they initially see low prices.

• Buyers are more sensitive to price increase rather than price decrease.

Introductory Pricing Strategies and Tactics

• Sellers introduce new products with short-term “introductory low-price promotions”

– Facilitates market penetration

– Produces lower long-run sales volume than if the product is introduced at its regular price

– The introductory low price serves as a reference price for evaluating a perceived price increase when the price is raised to its normal price

– Refer Table 6.1

Singapore Sheraton• Market situation, Singapore,

1986-1990:– Five-star and four-star hotel

construction to double supply of beds

– Ministry of tourism predicts the number of visitors to remain steady at two million annually for the next few years.

• What do you expect will be the effect on hotel prices by 1988 - 1990?

Singapore Sheraton Towers

• Purchased major credit card mailing list on world-wide basis

• Mailed brochure and five one-night free stay coupons– Brochure described the new hotel– Room rates included in the

brochure

• The results:– Gave away 20,000 room-nights– By 1990, 80% of business was

repeat visits– Maintained five-star room rates

Absolute Price ThresholdsAbsolute Price Thresholds• Acceptable price rangeAcceptable price range

– Upper price threshold (price tolerance or reservation price)

– Lower price threshold

– How wide is the range of acceptable prices and what is the price level around which this range is centered?

• Based on alternative offerings, customer satisfaction and loyalty, knowledge about other prices and quality

Disneyland Paris ( Box 6.2)• Opened in 19921992 - admission 250

francs– By 19941994, losses averaged $1 million

per day; hotels half empty

• Market research survey - 19941994– Price of 200 francs was

psychological threshold

• 19951995 - Set admission price for one adult at 195 francs ($39)– Operated at a profit for first time

• 19961996 - 11.7 million people visited– 33% increase over 1994; 9%

increase over 1995; 40% of visitors were French

Differential Price Threshold• Minimum difference in price for a buyer

to perceive a product different from the next best alternative.

• Also known as relative price• Two concepts are relevant when

considering the issue of price differences.– Price elasticity– Cross price elasticity

Price Elasticity of demand

• Price elasticity of demand is the percentage change in quantity sold relative to (divided by) the percentage change in price.

• If the value of elasticity is < -1, (i.e., -2 or -3), then price elastic.

• If the value of elasticity is , 0, but > -1 (e.g., -0.5), then price inelastic.

Cross-price Elasticity

• Cross-price elasticity refers to the % change in demand for one product relative to (divided by) the % change in price of another product.

• If the value is > 0, then the two products are substitutessubstitutes.

• If the value is < 0, then the two products are complementscomplements.

Cross-price Elasticity

• How the price of one product is perceived to differ from the price of another offering that buyers believe is an alternative choice to consider

• Differential price thresholds– The degree to which buyers are sensitive

to relative price differences

Decomposing Price Elasticity Prices increases vs. price decreases

Difference in relative price elasticity between price increases and price decreases means it is easier to lose sales from current buyers by increasing price than it is to gain sales from new buyers by reducing price

Decomposing Price Elasticity

Competitive effects Price elasticity of demand

varies over brands within the same product category.

Price elasticity also varies Price elasticity also varies across market segments.across market segments.

Extreme prices will become more price elastic as the prices are changed toward the market average or as competitor’s pricing moves the brand’s price toward the market average


Asymmetric competition Price elasticity of demand affected

mostly by the substitutionsubstitution effect. The degree that demand for a

product or brand is price elastic or inelastic depends on its cross-price elasticity relative to competing products.

Price promotions of a higher priced brand affect the market share of a lower priced brand than the reverse.


The effect of price thresholds Demand is very price elastic at upper

and lower absolute price threshold Buyers have different price thresholds for

different products, while different buyers have different price thresholds for a given product

Price Elasticity Price elasticities are not constant

and they can be managed over products, brands and time to a greater extent than previously recognized

END OF CHAPTER VIEND OF CHAPTER VI

Have a BreakHave a Break…….…….

Chapter 8

Customer Customer Value AnalysisValue Analysis

Customer Value Analysis• A cynic is a man who knows the price of

everything, and the value of nothing.-Oscar Wilde

• What we obtain too cheaply we esteem too lightly; it is dearness only that gives everything its value.

-John Jakes, The Rebel• The quality is remembered long after the

price is forgotten.-James E. Brill, ABA Journal

Value Analysis Management

Perceived Acquisition Value

• Perceived acquisition value = perceived benefits or quality perceived total sacrifice

• Perceived total sacrifice to the buyer is equal to purchase price + start-up costs + post-purchase costs

• Perceived benefits or quality is equal to some combination of physical attributes, service attributes, and technical support available, as well as the purchase price and other indicators of quality

Components of Perceived Acquisition Value

1. Sacrifice

2. Equity

3. Aesthetics

4. Relative use

5. Perceived transaction value

The Concept of BenefitsThe Concept of Benefits• To provide benefits a product or service

must be able to:– 1. Perform certain tasks or functions

– 2. Solve identified problems

– 3. Provide specific pleasures

The Concept of Benefits

• It is necessary to:– Identify the benefits that customers will

perceive the product or service to offer

– Determine the relative importance of those benefits that customers place on the product of service

The Five Steps Of Value-oriented Pricing

• 1. Conceptualize customer value1. Conceptualize customer value– Translate features and attributes into

perceived benefits.– Consider relative benefits delivered by

the product itself.

The Five Steps Of Value-oriented Pricing

• 2. 2. Understand The Key Value Drivers Understand The Key Value Drivers for Customersfor Customers

• 33. Calculate customer value. Calculate customer value– Determine sources of differentiation value– Determine customer value segments– Perform customer value assessments– Estimate economic value to customer

value segments

Value-in-use analysis

• Value in Use = Total willingness to pay for a product across all consumers

• Consumer Surplus = Difference between the maximum amount customers are willing to pay for a product and the amount they actually pay.

• Consumer Surplus = Value in Use – Value in Exchange


• To use the concept of Value in Use:– Determine the customer's reference reference

productproduct– Customer’s life cycle costCustomer’s life cycle cost using the

reference product– Improvement value of the productImprovement value of the product

relative to the reference product

• Reference Product: – Customers next best alternative for meeting the same need as

current or proposed new product– Existing model about to be replaced– Competing product

• Life Cycle Costs:– All costs that a customer will incur over the product’s useful life.– These costs include Actual purchase price, Startup costs, post

purchase costs• Improvement value of the product:

– The improvement value of the product represents the potential incremental satisfaction or profits the customer can expect from this product over those of the reference product.


• P max y = LCCx +Ivy –(PPCY+SUCy)

P max y = maximum acceptable price of Product Y

LCCx = Life cycle costs of the reference product X

Ivy = Improvement value for the new product Y

PPCY = Post purchase cost for the new product Y

SUCy = Start up costs for the New Product Y

Example• Old reference product, Current Purchase price = $400• Post purchase cost = $300• Start up cost = $300• Hence Life cycle cost for product X,

• LCC x = Px + PPCx + SUC x = $1000• Assume “NEW “ product is highly efficient and has an

Improvement Value, Ivy = $200 PPC y = $200 SUC y = $200

• Therefore Max. Accpetable Price, • P max y = LCCx +Ivy –(PPCY+SUCy)

Pmax y = $800

Consumer Surplus• Max. Accpetable price ( Value in Use)= $800• If the current Selling price (Value in Exchange) = $500Consumer surplus = Value in use- value in exchange = $300

Limitations of Value in Use• Sometimes the product offering is so new

that its difficult to accurately estimate its relative value to customers

• Value of the product may depend on the Value of the product may depend on the nature of the buyer, how the buyer uses nature of the buyer, how the buyer uses the product, variations in perceived the product, variations in perceived benefits of the product by different buyers.benefits of the product by different buyers.

The Five steps of Value-oriented Pricing

3. Value mapping- illustrates the way customers in a value segment trade off perceived benefits against perceived sacrifice

Value disadvantage area

Value advantage area

Value equivalence line

A

B

C

Perceived Price

Perceived Benefits

Value-oriented Pricing 41


4. Communicating value.4. Communicating value.– Keep price structures understandable, flexible, and

relatively easy to administer.– Consistently and clearly communicate price structure.

Discounts, allowances, rebates, rewards for loyalty should be above-board and clearly defined.

– Provide complete and concrete information about the offer.

– Provide appropriate reference price and actual selling price.


4. Communicating 4. Communicating value.value.

– For temporary price For temporary price reductions, provide the reductions, provide the specific ending date of the specific ending date of the offer and the price in effect offer and the price in effect after the ending date.after the ending date.

– For price increases, provide the beginning date of the new higher prices.


• 5. Develop Ways to Capture Customer 5. Develop Ways to Capture Customer ValueValue– The seller becomes externally-focused when

managing prices– Establish pricing rules or structure that force

customers to acknowledge value received

Contingency Value PricingContingency Value Pricing• Occurs when the value of the Occurs when the value of the

service cannot be calculated service cannot be calculated before its deliverybefore its delivery

• Forms of contingency pricing includeForms of contingency pricing include– Money-back guarantees– Real estate agents’ commissions based

on a percentage of the selling price– Lawyers’ or professional sports agents’

fees based on a percentage of the damage award or contract negotiated

Class Assignment-5

• Question No: 4 on Page 217

Pricing Practices That Endanger Profits

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