Pricing Strategy & Tactics – Chs. 4-6

1. Pricing Strategy & Tactics – Chs. 4-6 • Understand the role of pricing policies in developing a strategic approach to pricing • Establish the link between a firm’s pricing actions and customer expectations & future purchase behaviors • Provide frameworks for understanding customer behaviors and establishing policies to ensure profitable pricing outcomes • Understand the major stages of the price setting process and the role of value and cost at each stage • Demonstrate the three factors shaping the choice of a price point • Strategic alignment, Price-volume tradeoffs, & Customer response • Introduce dynamic pricing (Rick Lester, TRG, September 27) • Examine how to develop value-based communication messages to reflect key product characteristics

2. Chapter 5 – Pricing Policy (Management of customer expectations and behaviors…) • Most managers have difficulty communicating their firms pricing policies… because they don’t have any…. • Lack of proactive (not reactive) pricing policies reduces firm negotiating power with potential buyers who devise purchase strategies to gain discounts. This has led to a large number of firms that have created “strategic sourcing” programs. • One problem is that purchasers tend to research and understand the competitive landscape better than the firm’s sales representatives. • Compounding the competitive landscape issue is the fact that many firms provide incentives based on units sold and not on margin gained off each sale.

3. The Interaction of Expectations and Behaviors

4. Benefits Of Policy Driven Pricing • Provides greater consistency across customer base • Mitigates costs associated with ad-hoc discounting • Forces “give-get” trade-offs & value recognition • Increases perceptions of price integrity • Creates more efficient selling process

5. How Pricing Policy Leads to Certain Behaviors Policy: Your firm only offers discounts to customers when they have a betterprice from your competitor(s). Behavioral Implication: Your loyal customers get nothing in return, while non-loyal customers are rewarded for searching for better deals from your competitors. Loyal and non-loyal customers begin to develop strategic relationships with your competitor(s) to keep your firm “honest” (i.e., press for the lowest price from your firm).

6. How Pricing Policy Leads to Certain Behaviors Policy: Your firm offers greater than normal discounts only to achieve sales goals (usually sales quotas). Behavioral Implication: Discounts tend to pile up at the end of a reporting period since achievement of sales goals are not clear at the beginning of the reporting period. Customers figure the timing issue out and migrate their purchases toward the end of your firm’s reporting period to secure discounts. Inventories tend to be greater than normal since sales tend to become cyclical with the reporting period.

7. How Pricing Policy Leads to Certain Behaviors Policy: Your firm provides discounts for annual volume, regardless of order volume or the share your buyer’s total need your sales represent. Behavioral Implication: This policy tends to lead to buyers centralizing their purchases with your firm. Centralization takes the value proposition away from those who understand it and places it with those who do not (i.e., order makers). This policy also benefits buyers by allowing them to assemble into buying groups in order to secure the discount or to hunt for better prices from your competitor(s).

8. How Pricing Policy Leads to Certain Behaviors Policy: Your firm publishes list prices, but your firm’s discounting patterns are inconsistent so as to keep your competitor(s) guessing as to yoursales price(s). Behavioral Implication: Competitors cannot benchmark prices. Instead, competitors use information from purchasing agents to determine your prices, which leaves your firm with little to no power to influence your competitors’ pricing. Consequently, your customers take advantage of the situation by manipulating information between your firm and your competitors for their own benefit.

9. Structuring Your Firm’s Pricing Policies Remove Inconsistency in Policies Centralize the pricing policy development and monitoring so that allsales representatives operate under the same policy and use the same metrics. Provide Incentives Reconsider commission compensation since it tends to focus salesrepresentatives on short-term goals. Sales representatives should beinformed as to what is good/bad for the company. In general, focus on higher margin sales should be one goal for sales representatives. Provide Analytical Performance Data Data should be provided to management and sales representatives.

10. Buyer Types - Exhibit 5-3

11. Cues for Identifying Customer TypeConsider these Characteristics in Each Case Relationship Value Price Convenience • Desire for interaction • Emotional Involvement • Loyalty • Number/type of considered vendors • Involved decision-making • Fast decisions • Switching Costs • Operational importance of differentiation

12. See Reading on Price Positioning Convenience Driven Price Driven Brand (Relationship) Driven Value Driven

13. Pricing Strategy & Tactics – Chs. 5-6 • Understand the role of pricing policies in developing a strategic approach to pricing • Establish the link between a firm’s pricing actions and customer expectations & future purchase behaviors • Provide frameworks for understanding customer behaviors and establishing policies to ensure profitable pricing outcomes • Understand the major stages of the price setting process and the role of value and cost at each stage • Demonstrate the three factors shaping the choice of a price point • Strategic alignment, Price-volume tradeoffs, & Customer response • Introduce dynamic pricing • Show how to communicate new prices to maximize perceived fairness and minimize adverse customer response

14. The Price Setting Process - Exhibit 6-1 Define Price Window Set Initial Price Communicate Prices to Market Determine amount of differential value to be captured Develop communication plan to ensure prices are perceived to be fair Set initial price range based on differential value & relevant costs • Key Questions: • What is the best approach to communicate price changes to customers? • What are the considerations for implementing significantly higher prices? • Key Questions: • What is the appropriate price ceiling for this product? • How should I incorporate reference prices into my price window? • What is the role of costs in setting my initial price range? • Key Questions: • Is price point consistent with my business strategy & objectives? • What are the price-volume tradeoffs and what is their impact on profitability? • What are the non-value related determinants of price sensitivity?

15. Defining Price WindowsSpringfield Case: Weighted Average Economic Value Exhibit 6-2b: Negatively Differentiated Offering Exhibit 6-2a: Positively Differentiated Offering Neutral Pricing Price skimming captures high margins at the expense of sales volume. Prices are high relative to what the “middle market” is willing to pay. Viable when the profit from the price-insensitive segment exceeds profit from sales to larger market at lower price. Penetration pricing sets price far enough below economic value (not below cost!) to attract and hold a large base of consumers. Generates sales volume (& lower marginal costs) at the expense of higher margins.

16. Consistent with Business Strategy? Competitive Advantage The unique position a firm develops through resource & capability deployments that leads customers to choose the firm’s products over competitors. Advantage can be based on: • Cost Leadership (Low cost & price); • Product Differentiation – offering superior economic value by creating superior product/service features & quality through innovation & product development capabilities; • Marketing Differentiation – offering superior perceived value by developing • Unique image (brand-centric differentiation) achieved through targeting, positioning & communication capabilities • Close relationships with customers (customer-centric differentiation) achieved through CRM capabilities & customization For each case, ask “What is the focal firm’s competitive advantage?”

17. Conditions for Alternative Pricing Objectives Product Differentiation Skim Cost Leadership Penetration Marketing Differentiation Neutral CUSTOMERS • Difficult Comparison Effect • Price Quality Effect • Low Price Sensitivity • Reference Price Effect • Little differentiation • High price sensitivity • Total Expend Effect • Large Part of End-Benefit • Customers are sensitive to other elements of the marketing mix COMPETITION • Sustainable differentiation • Limited threat of opportunism • Limited opportunity for scale economies • Low threat brands • Sustainable cost & resource advantage • Financial strength • Competitors not willing to retaliate • Aggressive small share brands • Large share brands w/ a lot to lose (Oligopolies) • Sustainable mktg mix advantages • Avoid threat of retaliation COSTS • Changes in Unit Price Drive Profit • Low CMs • Low Volumes • Large BE Sales Changes • At or near capacity • Changes in volume drive profitability • High CMs • High volumes • Small BE Sales Changes • Excess capacity • Sufficient CM to finance advertising... • Costs similar to competitors • Little excess capacity • Incremental capacity is expensive

18. PENETRATION • Little differentiation • Sustainable cost & resource advantage • Changes in volume drive profitability • NEUTRAL • Customers are sensitive to other elements of the marketing mix • Large share brands w/a lot to lose (Oligopolies) • Sufficient CM to finance advertising... • SKIM • Difficult Comparison Effect • Price Quality Effect • Sustainable differentiation • Changes in Unit Price Drive Profit

19. Setting Price: The Price-Volume Trade-off Price optimization is a complex process that involves 2 distinct components: (a) the firm’s current price and cost structure, and (b) customer response to price offerings and changes. Estimating customer response requires deep understanding of customers and competitors, a difficult and imprecise problem at best. • Instead, start with 2 relatively easy questions to answer: • How much volume could I afford to lose before a price increase would decrease my profitability? • How much volume would I have to gain for a price decrease to improve my profitability? DQ ≤ DQBE? DQ ≥DQBE? In effect, you change the customer response estimation problem from a two-tailed estimate to a one-tailed estimate.

20. Incremental Percent Breakeven Sales Change × × Current contribution New Price New CM% New Quantity = P (CM% + DP%) P × CM% × Q = P (1 + DP%) × × Q (1 + DQ%) P (1 + DP%) CM% = (CM% + DP%) × (1 + DQ%) CM% (CM% + DP%) BEDQ% = – (CM% + DP%) (CM% + DP%) – DP% BEDQ% = (CM% + DP%)

21. Incremental Percent Breakeven Sales Change = × Current contribution New Contribution Margin New Quantity (P – C) Q = (P + DP - C) × (Q + DQ) PQ – CQ = PQ +PDQ + DPQ + DPDQ – CQ - CDQ 0 = PDQ + DPQ + DPDQ - CDQ 0 = DQ(P + DP – C) + DPQ DQ(P + DP – C) = -DPQ DQ -DP -DP = = BE Q (P + DP – C) (CM + DP)

22. Incremental Percent Breakeven Sales Changes Price increase: % decrease < the breakeven decrease leads to contribution increase. Price decrease: % increase > the breakeven increase leads to contribution increase.

23. Price Sensitivity Drivers Relative to income Paid by employer, parents… Monetary & non-monetary Economic & psychological Receive expected benefits? Higher price=higher quality? Fair price range Gains vs. losses Gains vs. losses • Size of expenditure • Shared costs • Switching costs • Importance of end-benefits • Perceived risk • Price-Quality perceptions • Perceived fairness • Price framing • Reference prices

24. Prospect Theory Perceived Value Small Gains Overvalued Large Gains Undervalued Small Losses Strongly Overvalued Reference point Losses Gains Objective Value

25. Internal Remember their favorite brand(s) & the last price they paid. Reference Price Shoppers: Wow! I paid $15.00 for that Franciscan yesterday and it’s on sale here for $12.99. Better get a case.

26. External Reference Price Shoppers: Remember their favorite brand(s) but not the last price paid. OK. The Voss brand is $16.00. Just out of curiosity, how much is the Rombauer – oh, $32. Voss it is.

27. Price Range Shoppers: Don’t have a favorite brand or remember prices. Let’s see. Clos du Bois $9.99, Voss $16.00, Franciscan $12.99 & Rombauer $35...

28. Elasticity – a visual representation . . . . Price P2 elastic P1 (many substitutes – grains,fruits and vegetables, bagged soil,paper clips, rubber bands) P2 unit elastic P1 inelastic (few substitutes – gemstones, transplant organs) Quantity Demanded Q2 Q1 Q2 Q1

29. (22%-49%)/Average(22%,49%) (14-12)/Average(14,12) % D in Unit Sales % D in Price E = E = Elasticity – Measurement of Price Sensitivity at the Market Segment Level We can measure or estimate price sensitivity at the market segment level by assessing the price elasticity for a particular product or service. Percent Change in Unit Sales (over relevant range) Percent Change in Price (over relevant range) Elasticity = Single Ticket Demand in Springfield Nor’easters

30. How to Estimate Volume Along the Demand Curve Use the Polynomial Trendline Function in Excel y = -0.0225x2 + 0.34x - 0.35 R² = 1

31. Elasticity – Measurement of Price Sensitivity at the Market Segment Level Measure of Price Elasticity |Price Elasticity| < 1 An increase in price within the range evaluated results in lower unit sales but higher revenue (profit?). Inelastic |Price Elasticity| > 1 An increase in price within the range evaluated results in lower unit sales and lower revenue (profit?). Elastic |Price Elasticity| = 1 An increase in price within the range evaluated results in an identical change in unit sales and the same revenue (profit?). Unit Elastic

32. Elasticity Required to Breakeven Price increase: |Elasticity| < the breakeven amount leads to contribution increase. Price decrease: |Elasticity| > the breakeven amount leads to contribution increase.

33. Homework for Next WeekFire Safety – DP% BEDQ% = (CM% + DP%)

34. Price & Value Communication • The Problem: Customer generally does not know true value unless informed by seller. • Value communication is important when your product or service creates value that is not readily apparent to potential consumers. • Value communication is nothing more than information dissemination. • Develop value proposition (i.e., compellingly unique & distinctive economic or psychological benefits). • Communicate the value proposition, and • Deliver the value.

35. Adapting the Message for Product Characteristics Relative Cost of Search Low Simple “Search” Goods High Complex “Experience” Goods Management Consulting Greater Price Dispersion Commodity Chemicals Investment Advice Home Equity Loans Auto Repairs Hotels Economic Benefits Desktop Computers Life Insurance Type of Benefits SUV’s College Education Pain Medications Blood Pressure Drugs Sports Cars Fitness Equipment Unique work of Art Digital Cameras Psychological Benefits Cosmetics Exotic Vacations Designer Clothes

36. Framework of Value Communication Strategies Relative Cost of Search Low “Search” Goods High “Experience” Goods Strategy 1 Economic Value Communication Communicate Objective Information That Differential Economic Value Justifies Pricing (e.g., Computers) Strategy 2 Economic Value Assurance Communicate Assurances That Differential Economic Value Justifies Pricing (e.g., Investment Returns, Hotel Guarantee) Economic Benefits Type of Benefits Strategy 3 Psychological End-Benefit Framing Associate Differential Performance with Subjective Psychological Value That Justifies Pricing (e.g., Cosmetics) Strategy 4 Psychological End-Benefit Assurance Communicate Assurances That Total Psychological Value Justifies Pricing (e.g., Art, Exotic Vacations, Mattresses?) Psychological Benefits

37. Art Assignment • Choose a product & identify (15 minutes) • Your retail price position and the Value Proposition for the product; i.e., what is compellingly unique & distinctive. • The target customers (relational, value, convenience, or price), the relative size of the market, and their desired psychological benefits. • How you will communicate the value to customers given high experience characteristics & psychological benefits. For example, what assurances can you offer that the product will deliver the desired psychological benefits? • Price range, pricing objective (skimming, penetration, or neutral), price point & whether you will negotiate discounts. • Communicate value & price in 2 minutes

38. The Price Setting Process - Exhibit 6-1 Define Price Window Set Initial Price Communicate Prices to Market Determine amount of differential value to be captured Develop communication plan to ensure prices are perceived to be fair Set initial price range based on differential value & relevant costs • Key Questions: • What is the best approach to communicate price changes to customers? • What are the considerations for implementing significantly higher prices? • Key Questions: • What is the appropriate price ceiling for this product? • How should I incorporate reference prices into my price window? • What is the role of costs in setting my initial price range? • Key Questions: • Is price point consistent with my business strategy & objectives? • What are the price-volume tradeoffs and what is their impact on profitability? • What are the non-value related determinants of price sensitivity?

39. Next WeekAkash RathodB2B Pricing&Pricing Strategy Over the Life Cycle (Chs. 7-8)