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This document is one of the 36 authorized copies to be used in the MBA, Marketing, Uchenna Uzo, , 2017-11-24

Steps in Value Pricing

Pricing is one of the most complex decisions in marketing. The price
decision is the one where you can reinforce or tear down all that you have
built up with other marketing decisions. In this note, we list the different
points that have to be considered when making a price decision.

We believe that there are three steps in value pricing: Data collection,
analysis, and the decision on the pricing strategy. The first two encompass
three dimensions:

− Cost and financial. You need to be aware of the cost variables of

your product. Even though making decisions based exclusively on
cost is a sure road to failure, it is just as bad to make price decisions
without taking cost into account.

− Customer identification and segmentation. The customer is the one

who is going to decide whether the pricing decisions that you made
are right or wrong. You need to analyze which are the specific
customers that you expect will agree with your pricing decision.

− Competitor information. Finally, when you are out in the market, you will
be competing with firms trying to serve similar customer needs. Pricing is
going to put you in a map with those competitors. Furthermore,
competitors are going to interpret your pricing and react to it.

In the following section we will ask the relevant questions for each of the
boxes in this diagram.

This technical note was prepared by Professors Carlos García Pont and Francisco Iniesta. October
2002.

Copyright © 2002, IESE. To order copies or request permission to reproduce materials, call IESE PUBLISHING
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Data Cost Customer Competitor

Collection measurement identification identification
This document is one of the 36 authorized copies to be used in the MBA, Marketing, Uchenna Uzo, , 2017-11-24

Strategic Financial Segment Competitive

Analysis Analysis Analysis analysis

Strategy
formulation Final Strategy

Data collection
Frequently, pricing strategies fail because they do not reflect all the key elements.
Marketers who ignore cost make pricing decisions that maximize market share rather
than profitability. Financial managers who ignore customer value and purchase
motivations make pricing decisions that undermine opportunities to spread fixed costs.
Marketers and financial managers who fail to collect enough information about the
personalities and capabilities of competitors make short-run decisions that look good
until competitors react to them in anticipated ways. Good pricing decisions require
information about all three of the factors –cost, customers, and competitors– that
determine the success of a pricing strategy. Consequently, pricing decisions should
begin with the following:

1. Cost measurement: What are the incremental, avoidable costs that are relevant to
this particular pricing decision?

a) What is the incremental (not average) variable cost of sales, including

manufacturing, customer service, and technical support?

b) At what levels of output will additional expenditures on semi fixed costs be

required and how much will they be?

c) What are the avoidable (not yet sunk) fixed costs involved in offering this
product at the proposed price?

2. Customer identification: Who are the potential customers, and why would they
buy this product?

a) What is the economic value of this product or service to customers?

b) What other factors (such as difficulty in comparing alternatives, prestige

associated with the purchase, budget constraints, the ability to shift all or
part of the cost to someone else) influence customers’ sensitivity to price?

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c) How do differences in perceived value and nonvalue factors influencing

price sensitivity divide customers into market segments?

d) How could an effective marketing and positioning strategy influence the

customers’ willingness to pay?
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3. Competitor identification: Who are the current and potential competitors whose
behavior may constrain the profitability of this market?

a) Who are the current and potential competitors?

b) If competitors are currently in this market, what actual transaction prices (as
opposed to list prices) do they charge?

c) In view of competitors’ past behavior, personalities and organizational

structures, what is their goal in pricing? Do they seek to maximize
profitability or sales?

d) What are competitors’ strengths and weaknesses compared with the firm? Do
they have higher or lower contribution margins, better or poorer reputations,
superior or inferior products, more or less diversified product lines?

It is important that the three steps in data collection are done independently of one
another, so that we get as much objective data as possible.

Strategic Analysis
The analysis stage, like the data collection process, involves costs, customers and
competition. At this point, however, the information becomes interrelated. Financial
analysis is driven by price, product and market selection proposals intended to better
meet the customer needs or to gain competitive advantage. The firm chooses to target
customer segments based, in part, on an analysis of the incremental costs of serving
them or of the firm’s ability to serve them more efficiently than competitors can.
Competitor analysis is driven partly by the desire to anticipate competitive reactions
to specific proposed price changes designed to penetrate customer segments.

4. Financial analysis: What volume trade-offs are necessary for potential price,
product, or promotional changes to increase profits? For new products or new
markets what sales volume is required to justify the incremental fixed
expenditures?

a) What is the contribution margin for the product at the initial baseline price?

b) How much additional sales volume is required to make a lower price

generate more contribution?

c) What is the maximum tolerable loss of sales before a higher price fails to
generate more contribution?

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 MN-340-E Steps in Value Pricing

d) How much additional sales volume is necessary to cover any incremental fixed
costs (such as advertising, regulatory approval) associated with the decision?

e) What sales level is necessary to justify selling a new product or moving an

established product into a new market, given the incremental fixed costs
associated with that sales level.
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5. Segmentation analysis and implementation: How can the firm price differently to
customer segments to reflect differences a) in price sensitivity and b) in the
incremental cost of serving them? How can the firm most effectively communicate
value to these customer segments, given their different purchase motivations?

a) How can members of different segments be identified prior to purchase?

b) How can “fences” between segments be established so that low-price sales

do not undermine value in high-price markets?

c) How can the firm avoid violating legal constraints on price segmentations?

6. Competitive analysis: How might competitors react to the firm’s proposed pricing moves
and what moves are they likely to initiate? How will competitors’ actions and reactions
affect the profitability and long-term viability of the firm’s proposed strategy?

a) What goals can the firm profitably achieve, given its capabilities and
intentions?

b) How might the firm use the information to influence its competitors’
behavior in ways that would make its goals more achievable or profitable?

c) How can the firm insulate its profitability from competitive threats by
targeting segments where it can achieve a competitive advantage?

d) From what markets would the firm strategically withdraw resources when it
cannot profit from the inevitable competitive confrontations?

7. Strategy formulation. The end result of the financial analysis phase is a price-
value strategy, a plan for conducting future business. No one right strategy exists
for every situation. Some of the worst strategic mistakes have been made by
managers who tried to superimpose strategies that worked in one industry onto
another with different conditions.

To be effective, the process of price strategy formulation should begin with these three
elements. In large companies it is useful to formalize the process, so that all the
relevant information is taken into account. In smaller companies, usually all these
issues are taken into account informally.

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