The Pricing Strategy Pyramid

1. The Pricing Strategy Pyramid Price Level Price setting Pricing Policy Negotiation Tactics & Pricing Setting Procedures Value Communication Communication, Value Selling Tools Price Structure Metrics, Fences, Controls Value Creation Economic Value, Offering Design, Segmentation

2. Price Setting Process Optimization Preliminary Segment Pricing Implementation Refine preliminary prices with iterative process balancing tradeoffs between price, cost, and market response Set baseline prices based on type of value assessment and initial differential value capture rate Set final prices and ensure acceptance among customers and organization through effective change management approach Key Questions: What tradeoffs should I make between long-term strategic objectives and short-term market responses to price changes? What types of analytical techniques are best suited to my product and market conditions? How can I estimate customer response to potential price changes? Key Questions: How much of the differential value should be captured for each segment? How much time and effort should I invest in assessing the value of my products? How should I adjust segment prices to account for different price sensitivities? Key Questions: What tradeoffs should I make between long-term strategic objectives and short-term market responses to price changes? What types of analytical techniques are best suited to my product and market conditions? How can I estimate customer response to potential price changes?

3. Economic Value Estimation® Framework Positive Differentiation Value Negative Differentiation Value Your UniqueValueDelivery Value Capture Total Economic Value Competitive Reference Value Price of Next Best Competitive Alternative

4. Sample Differential Value Capture Rates Market Differential Value Capture Rate Enterprise Software 20 - 50% Heavy Manufacturing 10 - 30% Process Manufacturing 10 - 20% Computers 20 - 40% High Technology 5 - 50% Professional Services 10 - 40% Distribution 5 - 20% Pharmaceuticals 30 - 50%

5. Preliminary Price Worksheet First, start with the value calculated from either the EVE or the WTP assessment. Second, determine the baseline value capture rate based on similar products in the market to set a starting point for price. Third, adjust the starting price up or down depending on the relevant price sensitivity factors. Finally, set the preliminary price by determining determine the percentage of the economic value you will attempt to capture. This preliminary price will be the starting point for considering strategic factors and conducting breakeven analysis. Economic Value $ XXX Baseline Value Split YY% Starting Price $ Z Z Price Sensitivity Factors + / = / - Product performance risk + Expenditure Effect -- Fairness affect - Total adjustments (- 10% ) Preliminary Price $ NNN

6. The Goal of Strategic Pricing: Align Price with Value A high Missed Opportunities B Price - Value medium Price Paid Unharvested Value low low medium high Value Received

7. Pricing Strategies • SKIM • SEQUENTIAL SKIM • PENETRATION • NEUTRAL

8. Pricing Strategy SKIM PENETRATION NEUTRAL COSTS CUSTOMERS COMPETITION

9. Pricing Strategy SKIM PENETRATION NEUTRAL Low CMs Low Volumes Changes in Unit Price Drive Profit Large BE Sales Changes At or near capacity High CMs High volumes Changes in volume drive profitability Small BE Sales Changes Excess capacity Costs similar to competitors Sufficient CM to finance adv, etc. Little excess capacity Incremental capacity is expensive COSTS High price sensitivity -Total Expend Effect -Large Part of End-Benefit Little differentiation Low Price Sensitivity -Reference Price Effect -Price Quality Effect -Difficult Comparison Effect Customers are more sensitive to other elements of the marketing mix CUSTOMERS Limited threat of opportunism Limited opportunity for scale economies Sustainable differentiation Low threat brands Sustainable cost & resource advantage Competitors not willing to retaliate Financial strength Aggressive small share brands Avoid threat of retaliation Large share brands with a lot to lose Sustainable mktg mix advantages Oligopolies COMPETITION

10. Categorize These Pricing Strategies • How would you categorize the pricing strategies for the following products and retailers? (S=skim, N=neutral, P=penetration) Pepperidge Farm Cookies _______ Almost Home Cookies _______ Suave Shampoo _______ ARCO Gasoline _______ Land O' Lakes Butter _______ T.J. Maxx (Clothing) _______ L'Oreal Hair Coloring _______ Bloomingdales _______ Sears _______

11. Illustrating Setting Price Ajax Manufacturing has developed a new type of seat belt that is easier to install and more comfortable to wear than the seat belts now in use. Standard seat belts sell to automobile manufacturers for $5.00 each. The labor cost to install the belts is $3.00 each. The new belts take 10% less time to install with a resulting labor cost of $2.70 per belt. Marketing research performed by Ajax has determined that car buyers would be willing to pay $50.00 more for a car equipped with the new belts. Since car manufacturers normally earn a 50% mark-up, this equals an added profit of $25.00 per car. The cost to Ajax of the new belt is $10.00 per car and the current strategy calls for a price of $15.00 each. A typical car requires five seat belts. (a) What is the economic value of the new seat belt to automobile manufacturers? (b) What type of pricing strategy does Ajax appear to be following? What other options are available?

12. Analytical Approaches to Profitability Analysis Volume of Transactions

13. Analyzing Profitability Using theBreakeven Sales Change Approach

14. Risk Analytic Approach to Profitability Analysis

15. Determinants of Price Sensitivity • The Reference Price Effect • The Difficult Comparison Effect • The Switching Cost Effect • The Price-Quality Effect • The Expenditure Effect • The End-Benefit Effect • The Fairness Effect • The Framing Effect • The Shared-Cost Effect

16. Price Sensitivity Illustration You are considering purchasing a personal computer. What factors would affect your price sensitivity in making that decision? How would those same factors affect the price sensitivity of some personal computer buyers differently?

17. Price Sensitivity Illustration For each of the following purchase decisions, what factors are likely to affect the consumer's price sensitivity? A diamond engagement ring Automobile repairs Food for meals at home Which university to attend A company car Draperies for your new home Text books Health insurance plan Souvenirs Vacation resort

18. Price Sensitivity Discussion Questions What can a company do to decrease its customer's price sensitivity? Would all of the company's customers be likely to react in the same way?

19. Price Sensitivity Discussion Questions Would a company ever want to do anything to increase its customers' price sensitivity? Why? What steps might it take?

20. Price Sensitivity Discussion Questions Which of the following statements are always true, sometimes true, never true? Why? (a) Price elasticity is generally the same for all brands in a product category. (b) Advertising increases price sensitivity. (c) As a product category matures, the consumers become more price sensitive. (d) Each consumer has different price sensitivities for different products.

21. Price Sensitivity Discussion Questions The gasoline service stations in Rochester, New York convinced the City Council to ban signs displaying gasoline prices. Why would they want to do this? What effect do you think this law had on gasoline prices? Why?

22. Price Sensitivity Discussion Questions Despite the fact that rental rates for commercial space and labor costs are generally higher in big cities than in small towns, the prices of many products--such as stereo equipment and clothing--are higher in small towns than in large cities. Can you explain this?

23. Price Sensitivity Discussion Questions Many local rental car agencies rent late model cars at substantially lower prices than national companies such as Hertz and Avis. Despite their higher prices, the national companies still retain most of the market. Explain why most renters patronize the national car rental companies despite their higher prices. How have the national companies encouraged this price insensitivity? (a) If you were a small, local company, what factors would you look for to identify the price-sensitive segment of renters likely to be attracted to your lower price? (b) If you were a small company trying to become national, how might you overcome the low price sensitivity of customers to induce them to try your cars and evaluate the quality of your service?

24. Positive Differentiation Negative Differentiation Competitive Reference Total Economic Value The Elements of the Price Setting Process Price Sensitivity Factors 1. The Fairness Effect 2. The Perceived Risk Effect 3. The Switching Cost Effect 4. The Difficult Comparison Effect 5. The Price-Quality Effect 6. The Expenditure Effect 7. The End-Benefit Effect 8. The Shared-Cost Effect 9. The Reference Effect 10. The Framing Effect Value Estimation Price Levels Breakeven Sales Analysis Risk Analysis 1mm Contribution Dollars ($) 0 Unit Sales Gain