Pricing Strategies

1. Pricing Strategies Week 6 EWMBA 206

2. Analysis Framework Perceptual mapping First mover advantages Company Analysis Marketing Myopia Customer Analysis Competitor Analysis Positioning Segmentation Marketing Orientation Marketing Strategy Branding Product Pricing process Pricing and innovation Price Promotion Place Market

3. Economics of PricingTwo Problems with Single Price Strategy • Leave money on the table • Some customers are willing to pay more • Pass-up Profit • Some potential customers were not served even though the firm could have served them at prices above the marginal cost

4. Price DiscriminationCustomization by Observable Characteristics • Based on observable characteristics that signal buyers’ price sensitivity • http://www.chessclub.com/ : Students: $29.95/year; Adults: $59.95 • AMC theaters can observe the consumer-type using his student ID, seniors • Customer 1 No student ID $6.75 • Customer 2 Haas student ID $4.75 • Customer 3 Haas student ID $4.75 • etc.

5. Price DiscriminationPurchase Location • Consumers at different purchase locations have different price sensitivity • Cure for anthrax: $450 in the U.S. $190 in Canada http://www.canadadrugs.com • Staples website asks for zip code http://www.staples.com/ • Select segmentation variables that ensure • different segments purchase at different locations • high enough shipping cost to prevent arbitrage

6. Customize By Time of Purchase • Peak-load pricing: designed to re-distribute usage from peak time to off-peak time • Redeye flight. • Electronic road pricing.

7. Electronic Road Pricing

8. Price DiscriminationPalm Pilot: Product-line in Action Palm Vx $299 Palm VIIx $399 Palm IIIxe $179 Palmm505 Color $449 Palmm500 $399 Palm m100 $129

9. Microsoft Office:Product Line (Versioning) in Action Office 2000 Premium Office 2000 Developer Office 2000 Professional Office 2000 Standard Office 2000 Small Business

10. How to Price Discriminate Using through Product Line Design? • Key to Successful Versioning • Identify the best waysto distinguish the different versions of the product/service • Need to determine which features will be highly valuable to some customers but of little value to others. • Goal: Create the “right” # of versions -- targeted at the “right” customer segments by setting the “right” prices. • Strategic Issue -- Cannibalization: Will the high-end customers buy the higher priced version? How to dissuade them from buying the lower priced version?

11. Product Line (Versioning) Segmentation, Targeting & Cannibalization • Example 1: Pricing Dell Laptops • Table: Perceived Economic Value • Personal Users Business Users • Segment Size 60 40 • Dell 350 MHz $ 500 $ 750 • Dell 550 MHz $ 750 $ 2500

12. Product Line (Versioning) Segmentation, Targeting & Cannibalization • Example 1: Pricing Dell Laptops • Option I: Dell 350 MHz only: • Targeting: Business Users • Price $ 750 • Total Revenue $ 30,000 • Targeting: Business Users & Personal Users • Price $ 500 • Total Revenue $ 50,000 • Optimal targeting if introducing 350 MHz: Business Users + Personal Users

13. Product Line (Versioning) Segmentation, Targeting & Cannibalization • Example 1: Pricing Dell Laptops • Option II: Dell 550 MHz only: • Targeting: Business Users • Price $ 2500 • Total Revenue $ 100,000 • Targeting: Business Users & Personal Users • Price $ 750 • Total Revenue $ 75,000 • Optimal targeting if targeting 550 MHz: Business Users

14. Product Line (Versioning) Segmentation, Targeting & Cannibalization • Option III: Both 350 MHz & 550 MHz : • What will be the price of 350 Mhz = 500 • What are the options available to Business Users? • Buy 350 MHz at $ 500 or 550 MHz at $ X? • Surplus from 350 MHz = $ 750 - $ 500 = $ 250 • Thus, price of 550 MHz must satisfy $ 2500 - $ X = • $ 250 • Price $ 2250 (at most) • Segment Revenue $ 90,000 • Total Revenue $ 120,000

15. Product Line (Versioning) Segmentation, Targeting & Cannibalization • Example 1 (Revised): Pricing Dell Laptops • _______________________________________________ • Product Line Optimal Total • Targeting Revenues • _______________________________________________ • Dell 350 MHz only Business & Personal $ 50,000 • Dell 550 MHz only Business $100,000 • Both 350 MHz 350 MHz at Personal • & 550 MHz 550 MHz at Business $120,000 • _______________________________________________

16. Key Principles • Consumers are heterogeneous in their willingness to pay • Charge according to consumer price sensitivity. Make sure that people with inelastic demand pay more and people with elastic demand pay less. Key Problem • Cannibalization: Ensuring self-selection. • Make sure that prices directed at one segment cannot be taken advantage of by the other. • How did you achieve this for Dell?

17. Product Line Design: Disabling Attributes TRUE STORY • Intel sells 486DX chip for $1000. • Intel disables the math coprocessor of the DX chip and makes the SX chip (thus incurring a cost of $50). • Intel sells the 486SX chip for $800! • So Intel sells a damaged product that actually costs more to make for a lower price. • What is going on here?

18. Product Line Design: Disabling Attributes Problem facing Intel when it introduced 486 chip (two types of early adopters): E, G (50% of each type), E is willing to pay more and performs lots of math calculations Res. Price Buyer Revenues $1000 E $1000 $800 E & G $1600 What should Intel price the 486?

19. Disabling Attributes If Intel can charge different prices to different users • $800 to G • $1000 to E • Total: $1800 • Price discrimination can earn the seller an extra 200! • But there is a caveat……..

20. Disabling Attributes • The seller wants to charge G less than E for the same 486 chip. • At the same time, the seller has to prevent E from buying the product meant for G. What does the seller do? • The seller disables the math coprocessor for G! • Actually incurs a cost of doing so (say $10) • But makes $200 extra from E.

22. Controlling CannibalizationTwo Methods • Potential Cannibalization: If the low-end version is “too attractive”, it may attract some customers who would other wise pay a premium for the high-end version • Method #1: Cut the price of your high-end version to ensure that your high-value customers buy the high end version. • Method #2: Damage your low-end version “enough” to make it unattractive to the high-end segment

23. Learning: Optimal Product Line Design Selecting the Defining feature(s) of the Product-Line • Point #1: Identify the attributes/features that are highly valued by some high willingness to pay customer segments yet of little importance to other customer segments • Point #2: Greater the differences among the customers in their willingness to pay for the differentiating attribute, the wider is the product line. • Point # 3: Find the best way to reduce cannibalization. This is where product strategy, pricing and segmentation all come together.

24. Psychology in Pricing Strategy • Jeans: $42…$32; http://www1.macys.com/catalog/product/index.ognc?ID=204004&CategoryID=11221&LinkType=EverGreen • Rolex watch: $10,000 http://www.rolex.com/en/ • 9,990 • 9,975 • Relative price difference matters not the absolute. • Weber-Fechner law: Relative price difference and not the absolute matters. • Weber gradually increased the weight that a blindfolded man was holding and asked him to respond when he first felt the increase. • Response was proportional to a relative increase in the weight. • If the weight is 1 kg, an increase of 10 grams will not be perceived. • If weight is 20 grams, an increase in 10 grams is perceived • Applies to sound, vision etc.

25. Psychology in Pricing Strategy • I will show you two numerical differences. Look at them quickly!

26. Psychology in Pricing • Which difference do you think is greater? • Top or Bottom • Odd number pricing ($0.99 vs. $1.00). • This is why Nike shoes are priced at $49.99, not $50! • Theoretical underpinning: Mental categorization. • Pricing and social networks • Pricing Trump towers • Price quality perceptions

27. Prospect Theory (Kahnemann and Tversky) • One additional dollar gives a lesser increase in satisfaction or value than the dissatisfaction caused by a one dollar decrease • Giving or taking a dollar • People feel the pain of losses much more than they feel the happiness of equivalent gains.

28. Prospect TheoryApplications Unbundle gains: Sports Illustrated, offer additional benefits rather than a discount Bundle Losses: Sellers of consumer durables and warranties. Example, a $50 warranty for $700 appliance.

29. Key Messages • Developing profitable pricing strategies is a critical and creative exercise. • Pricing is the only element of the marketing mix whose cost is getting it wrong. • Pricing’s impact on profitability is often more significant and more immediate than the impact of other elements of the marketing mix.

30. Pricing StrategiesHomework Crazy Eddie • In the New York city stereo wars of the 90’s Crazy Eddie had made his trademark “We cannot be undersold. We will not be undersold. Our prices are the lowest….guaranteed. Our prices are insane.” His main competitor Newmark & Lewis is no less ambitious. With any purchase you get the store’s “Lifetime low-price guarantee”. It promises to rebate double the difference if you can find a lower price elsewhere. If after your purchase from Newmark you find the same item at a lower price (proof of purchase required), in this marketing area, during the lifetime of your purchase, Newmark will give you a 200% gift certificate refund (100% of the price difference plus an additional 100%). These strategies on the face of it seem so crazy. They could lead to superheated competition and could run both Crazy Eddie and Newmark out of business. What do think happened? Think of the following questions: • Would these price guarantees claims increase competition between the two retailers and reduce their profits or would it do the opposite? • What could be the reasons why these retailers adopted these policies in the first place? • Can you think of some advantages of these policies?