Pricing Management

“The single most important decision in evaluating a business is Pricing Power”

-- Warren Buffett
Product Creates value
Promotion Place

Pricing Harvests value

WHAT IS PRICE ????? The Many Dimensions of Prices

o Base price
o Discounts, bonuses, rebates, conditions, special offers
o Differentiated prices by package size or product variant
o Differentiated prices based on customer segment (e.g. child,
senior), time of day, location, or phase of the product cycle
o Prices for complementary products (razors and blades;
smartphones and data plans)
o Prices for special or additional services
o Prices with two or more dimensions (e.g. upfront charge and a
usage fee)
o Bundles
o Prices based on personal negotiations
o Wholesale, retail, and manufacturers‘ suggested retail prices
(MSRP)
 Price ….The strongest profit driver????

Company sells 1 million

units of a product priced
old
at $ 100 per unit.
Price $100
Variable unit cost $ 60
Sales volume 1 million
Fixed cost $ 30 million
What effect would an isolated change of 5% in one of the profit drivers
have on profit???
 Price ….The strongest profit driver????

An improvement of five percent leads to

profit
profit increases by….
old new old new
Price 100 105 10 million 15 million 50 %
Variable unit cost 60 57 10 million 13 million 30 %

Sales volume 1 million 1.05 million 10 million 12 million 20 %

Fixed cost 30 million 28.5 million 10 million 11.5 million 15 %

Profit = (Price * Volume) - Costs

 Alternative 1: Accept a price cut of 5 % and volume remains constant.

Alternative 2: Accept a volume reduction of 5 % and price remains constant.

Why Study Pricing?

 Even slight improvements in pricing can yield significant results.

 Fast applicability.

 Only marketing instrument which does not require upfront expenditures or

investments.
 How prices are set??
What information serve as basis for price decisions????
 Three Cs and Pricing

 Costs

 Customer

 Competition
Cost-Based Pricing

Cost-Based Pricing involves setting a price such that

Price = (1+ percent markup)(Unit Variable Cost + Average Fixed Cost)

• You have to know costs.

• Costs are a function of sales which are in turn a function of prices.

• Distributing fixed costs is hard.

• Ignoring the value you create leads to underpricing.

Competition-Based Pricing

• It encourages firms to ignore their unique value proposition

• It can lead to price wars

• Lot of price dispersion exists

Customer-Based Pricing

• Customers do not reveal how much they value the product

• Customers need to be educated about the value of the product

• When customers are used to being in control of a firm’s pricing, they revolt at
price changes
Value
Economic Value to the Customer (EVC)

Value that a fully informed customer would or should ascribe to the product.

EVC = Reference value + Differential value

• Maximum price
• Customers’ needs and preferences are relevant
• Next best alternative
 Economic Value to the Customer (EVC)

Forms of EVC:

Monetary value Psychological value

Total cost savings or Innate satisfaction

income enhancements
 Steps of EVC calculation:

- Identify the price of the competing product that the customer views as the best substitute. (this is
Reference value)
o Consider a similar quantity of the best substitute
o Should not include the prices of items that may be used along with the alternative product but
that are actually separate products

- Identify all factors that differentiate your product from this competing product. These are the
differentiating factors.
o Product-need framework
 Product-Need Framework

Core-quality Feature-styling Reputation-support

characteristics characteristics services characteristics

Objective performance
needs

Hedonic performance needs

Social performance needs

Performance reliability
needs

Product convenience needs

 Steps of EVC calculation:

- Determine the monetary value to the customer of each of these differentiating factors. These are
the positive and negative differentiation value.
o Translate the factors into monetary terms by identifying additional expenditures/or savings
o Estimate how customers weigh money against their preferences and feelings for the factor

- Sum the reference value and the differentiation values to determine the total economic value to the
customer, i.e., the maximum that someone fully informed of the product’s benefits would be willing to
pay for the product.
 EVC example

ABC Computer has developed software that allows their servers to host twice as much webspace as its
rivals. How should they price this new software-server combination?

 Relative to buying two servers from ABC’s competitor, by buying one doubly efficient server from
ABC, a firm would save $4,000 in labor costs, $500 in electricity and $1,500 in software licenses.

 The price of competitor is $6,800.

EVC of a server with the software??????

 Exercise
Air filtration alternatives for toy factory
New Product Next best alternative
Probability of system crash 1 % over one year 20 % over one year
Cost of system crash 100000 100000
Hours of operation 2500 2500
Operating system cost per hour 15 10
Price To be determined 75000

A firm trying to sell a new product to the owner of a toy factory that requires an air filtration system. Assume the
factory owner faces two choices- this seller’s new product and a well-established, next best alternative offered by
another firm.
 Perceived value

Suppose the claim of Probability of system crash of 1 % is perceived to optimistic and instead it is
believed to be 5 %.
What would be the Perceived value??
Value-Pricing Framework

Marketing Efforts EVC 81500

Price of Substitutes Perceived value Consumer incentives to

77500 purchase
(PV – Price)
Product Price

Firm’s incentive to sell

(Price- COGS)

Cost
50000
Economic Value to the Customer (EVC)

 Price estimation of new product or service.

 Who should you target?

 Analyzing Competitor and their economic power.

 Whether or not new product/ idea is economically viable?

 Re-thinking about pricing of the existing products or services.

 Illustration of Monetary value

Situation:
SprayCo, an $800MM surface treatment and coating
manufacturer, primarily serves the automotive industry.

Recently, they unveiled a coating product that is superior to

anything else on the market: it can be applied quickly, has
better durability, and binds more effectively to curved
surfaces.

However, SprayCo’s new product would be impossible to

produce without patented materials they obtain from their
chemical supplier.
 Value
Value Driver Feature Benefit Value Formula

Auto Other

Decreased materials Strong bonding (Percent reduction in materials used)

Only one coat necessary
costs coat X (Current cost of materials)

(Total #Applications per year) X

Effectively
Reduced likelihood that (Percent reduction in projects
Reduction in product adheres over
coating process will fail on requiring reapplication) X (Total # of
failure costs other coatings on
initial application hours per reapplication) X (Avg $ cost
first attempt
of FTE per hour)

Storage takes up less (Percentage reduction in standing

Reduction in
Non-toxic space, as protective inventory) X (Current Cost of
inventory costs
casing is not required Maintaining Inventory)

Increased revenue
Binds to sharply Effectively coats headlight (Margin of product) X (# of new units
due to expanded
curved surfaces fixtures sold to coat headlight fixtures)
product use

(Percentage increase in price

Increased revenue Longer time allowable
Durable, weather premium due to improved product
due to better product between the application of
resistant durability) X (Current price of product)
durability new coats
X (# of units sold)

Decreased processing
Increased revenue (Number of new orders that require
time for non-toxic
due to rapid Non-toxic same day fulfillment) X (Premium paid
materials allows for same
fulfillment times for same day fulfillment)
day fulfillment
Measuring Customer Responses to Prices
 Methods to measure customer responses

Surveys Observations

Expert Customer Experiments Market

Judgements Surveys Observations

Direct Indirect
Expert Judgements

• Specialists or experts with deep knowledge

• Company employees, management consultants, Specialists from market research institutes, experts
from dealer/distribution or customer advisory panels

• Structured/Unstructured

• Experts should represent a range of functions and positions in the hierarchy

Customer Surveys

Direct Surveys

• Direct questioning

• Focused, targeted way

• Overestimation of price effects  Direct questioning

 Buy-response surveys
• Social desirability bias and prestige effect  Attribute rating
 In-depth Interviews
 Van Westendorp’s Price Sensitivity Meter

Customers are asked 4 questions:

A) At what price would the product be too expensive, so that you would not
buy it?
B) At what price would you consider the product to be expensive, but you
would still be inclined to buy it?
C) At what price would you consider to be acceptable or a bargain, so that
the product is good value for money?
D) At what price would be too cheap, so that you would doubt the quality of
the product and would not buy it?
Customer Surveys

Indirect surveys

• Goal is to come as close as possible to replicating a real buying situation.

• Conjoint measurement : Central objective is to answer what utility and as result what willingness to
pay does a customer associate with a given product???
 Conjoint Analysis

• Determine the attributes to Attribute Level

include Brand Maruti; Hyundai; Honda
• Determine the levels for each Price 800,000; 850,000; 900,000
attribute Colour White; silver; black
• Design the questionnaire and Mileage 22, 20, 18
administer it (km/ltr)

• Analyze the collected data

 Which car would you buy?
Please indicate your choice using the scale below

Car A Car B
Maruti Hyundai
Rs. 800,000 Rs. 850,000
White Silver
22 km/ltr 20 km/ltr

Clear preference Clear preference

Indifferent
for Car A for Car B

1----------2-----------3---------4----------5----------6----------7---------8----------9
 Observations

Experiments

Field price experiments:

 real purchase conditions
 Product under study not removed from its purchase environment
 Test subjects are unaware

Classic test markets Store test Simulated test market

Observations

Experiments

Lab experiments:

• Control maximum, secrecy, lower

costs, less time commitment
• Sample representativeness
questionable
• External validity - ??

• Neuro-pricing
Observations

Experiments

Field experiments Lab experiments

- natural purchase environment - Mimic the realism of purchase

- Actual purchase data situation
- Buyers unaware about - Researcher can control who,
experiment when and where one participates
- Risk of being discovered by - Quick price manipulations
competitors - Can eliminate external factors’
- Can become too costly and influence
potential goodwill loss
Illustration of stimulus used in experiments
Market Observations

• Historical sales data

• Panel data
• Store scanner data
Price Structures
 Price Segmentation

The practice of charging different customers different prices for the same item.

Factors causing pricing differences

across market segments

• Product’s value to the customer (VTC)

• Cost to the seller
• Customer’s price sensitivity or
responsiveness to price changes
To accomplish price segmentation with fixed prices, it is necessary to have more than one price for a
single product.

The pattern of an organization’s prices is known as its Price Structure.

 Two main difficulties in accomplishing price segmentation

• Customers may not voluntarily identify themselves as willing to pay higher

prices than others.

• Possibility of arbitrage
 How to create a segmented price structure?????

Individual Price differentiation (First-degree)

- Auctions
- Negotiations
 Price differentiation through self-selection (second degree)

- Performance-based

- Volume-based
 Order-size discount,
 Cumulative discount,
 Fixed charge pricing,
 Two-part pricing,
 Step discounts
 Price Number of Supported Type of
Netflix Plan
(monthly) screens resolution device

Mobiles,
Mobile Rs 149 1 SD
tablets
Mobiles,
Basic Rs 199 1 SD tablets,
laptops, TVs
Mobiles,
Standard Rs 499 2 HD tablets,
laptops, TVs
Mobiles,
Premium Rs 649 4 4K + HDR tablets,
laptops, TVs
 Price differentiation based on Customer Criteria (third degree)

- Person-based differentiation (sociodemographic factors)

- Time-based differentiation
- Peak-load pricing
- Priority pricing
- Time-of-purchase basis

- Place-based differentiation
- Delivered pricing
- Zone pricing
 Offer
Configurations/Price
bundling A B
Segment 1 50 130
Segment 2 75 100
Advantages:

 Minimal enforcement of price differences because consumers self-select offers

 Reduced transaction cost for both sellers and customers

 Customers less price sensitive to cost of bundles when bundled as a single expenditure
 Special forms of Price Bundling

• Tie-in sales – primary product (tying good) + supplemental (tied good)

• Add-on price bundling – may purchase secondary product only if they have
already purchased the primary product
• Cross-couponing – receive a coupon on product B after purchase of product A
Thanks
Psychology of Price
 The Economic Perspective:

Consumers Buy When Perceived Value Exceeds Price

➢ Consumers should purchase an item whenever the perceived value of

that item exceeds its actual price
[i.e., whenever (Perceived Value – Actual Price) > 0]
 S-O-R model

Stimulus Organism Response

Explains why a
customer responds
to a price in a
particular way
 What is your
Perceived Value..??

What price do you

tell your friend.???
 Price Anchor Effects

Customers feel uncertain about their price judgement – they search for
a reference point – so-called ANCHORS
 The Magic of the Middle

Tendency of customers to pick a middle option

If customers do not know how much a product costs and have no clear
special needs, they will gravitate towards a price in the middle.

$4 and $12

1. Reduces the risk of poor quality product

2. Reduces the risk of overspending
3. Customer avoid excessive search costs
 Assortment Effect
OFFER A OFFER B

Online $59 68 % Online $59 16 %

Print + Online $125 32% Print $125 0%

Print + Online $125 84%

 Which would you buy?

A small (350
ml) $6.10
Medium (450
Large (610 ml)
ml) $7.10
$7.50
 Price Threshold Effect

A price point which triggers a pronounced change in sales volume

whenever it is crossed.

1. Read digits in a price from left to right

2. Perceive them with decreasing intensity

9.95
 Price as a Quality Indicator
Price allows immediate objective comparisons among products.
Price signal of high credibility which the seller transmits.

▪ Brands and manufacturer names do ▪ Consumer’s self-confidence is low

not play a major role ▪ The greater the desire for a quick and
▪ First-hand experience is lacking or easy purchase, avoid cognitive
difficult dissonance
▪ Last purchase is in the distant past ▪ The greater the buyer’s purchasing
▪ Technical complexity power
▪ Absolute price is not too high ▪ The less knowledgeable the buyer is
▪ Time pressure increases
 Price Figure Effect

$ 4.32 ▪ Occur when customers perceive the ordering of the

price digits in a certain way.

$ 2.34 ▪ Do not perceive prices as whole, singular things, but

instead have a perception for each individual digit.

$ 4.44
▪ Example: Left to right comparison
 Price Shading Effect

• Reflect the translation or generalization of learned relationships which influence the way
the customer interprets how the price is presented.
• Visual presentation and communication of prices important.

Lowest price Rock Bottom Price

Crazy Low Price

• Signals scarcity
 OLYMPIC GAMES 2012

• Lowest (standard) price was £ 20.12 and the most expensive

ticket was £ 2012.
• Motto “PAY YOUR AGE” for children and young adults.
• No discounts available
• No ticket bundles
• The ingenious price structure and communication campaign
ultimately generated ticket revenues of £ 660 million (75 %
more than planned and preceding three Olympic games).
Thanks
Handling Price Competition
 Role of competitors in price-change response

Responses of competitors are important because they determine how the price change will affect
the price differentials between the company that initiates the price change and its competitors

A – 360
B - 375
C- 388
 Pricing game: Negative sum game

Sports Competition Price Competition

⚫ The more intense, the ⚫ The more intense, the
better the game worse the game

⚫ Play as hard as you can ⚫ Weigh the cost of each

confrontation
⚫ Goal is to win, regardless
of cost ⚫ Goal is to profit
considering all costs
 Basic competitive stances

• Cooperative stance: satisfied with current situation and prefers things to remain the same

• Aggressive stance: want to improve position at the expense of price-change initiator; would like to
see things change with respect to initiator

• Dismissive stance: competitor who feels that whatever the initiator does will not substantially
affect him or her; ignore price-change initiator
 Competitor’s likely response to Initiator’s
Competitor’s stance Price increase Price decrease
Cooperative matching increase matching decrease
Aggressive No change or smaller Matching or larger
increase decrease
Dismissive No change No change
How to determine the stance of your competitors??????
 Four competitive dimensions

• Relative size

• Degree of brand differentiation

• Difference in unit costs

• Goals
Competitor characteristics associated with competitive stance

Competitive dimension
Competitor’s Relative size Differentiated Unit costs Goals
stance brand
Cooperative Equal No Equal maintain

Aggressive Smaller or No Lower Expand

larger
Dismissive larger yes lower Unrelated
 Communication of Competitive Information

Price signaling:
When the publicly available price-related information is intentionally managed to
have an effect on competitors

News releases,
Press conferences,
Media access to company executives,
Planting articles in major newspapers,
Blogs, Material posted on the Internet
 Categories of Price Signaling

Signal to indicate Signal to encourage

Signal competitive competitors to match a
company’s limited
strength goals planned price increase
Legal, ethical and Social Issues
Related to Pricing
 1. Pricing practices involves price-setting process that limits price
competition

Price Fixing – Interferes with the independence of the price-setting process

- Collusive or arbitrary agreements on prices

Price Fixing

Horizontal Price Fixing Vertical Price Fixing

Agreements among competing sellers on
Common minimum price, same Resale price maintenance
mandatory surcharges, establish uniform Explicit bilateral contracts
costs and markups, restrict product
supply
 2. Inappropriate price levels concerns the prices that end up actually
occurring
Excessively High Prices
• Price Controls (legally mandated maximum
prices)
• Enactment of laws against price gouging
(price gouging means opportunistic activity
aimed at profiteering or unfair and
exorbitant pricing)
Excessively Low Prices
• Lead to consumption of product that is
considered undesirable (unwholesome
demand)
• e.g., guns,
• Full costs of producing and/or disposing of
products are borne by general public
• Predatory pricing
3. Inappropriate price differentials concerns the differences in price
levels between different buyers

Price Segmentation

When a price segmentation practice is seen by consumers as unfair

If repeated often, impressions of unfairness could contribute to a demoralizing cynicism
Practice of giving favorable prices to only some customers may be subject
• Cost-justification
• Meeting competition
 4. Inadequate price communication

• Manipulation of price formats

• Inflated external reference prices
• Using low prices as baits (employing hedging words)
Pricing for Retailers
 Relevant?????

Price management environment for retailers is complex and

challenging

▪ Size of assortments: ten thousands of items; major retail

chains need to set almost half a million of prices

▪ Consumers often buy several items in one shopping trip or

visit

▪ Interconnections within assortment

 Price Image

• Price image of a retail store or online store plays an important role.

• Critical in overall assessment of the store/retailer.

“The general belief about the overall level of prices that consumers associate with a particular retailer”

• Customers use price image to generalize about the price of a specific item.
 Price Image

• Key value items or focus items: high influence on price perceptions

• Fixed-price items: Price decision taken by manufacturers

• Skimming items: Minimal influence on price perceptions; Difficult to compare

 Multi-channel Retailers: Pricing Challenges

• Selling through more than one medium

• Price differences across various channels

• Price differences across online and offline channels

should be handled carefully

• Need to strike a balance between customer’s

expectations of prices in different channels and cost
structure of each channel
 Multi-channel Retailers: Pricing Challenges

Important:
Understand what customers value in each channel and how that affects what they are
willing to pay.
 Decisions on Price Promotions

• Temporary, short-term price reductions for selected items.

• Come in many forms, including discounts, special package sizes, loyalty discounts, coupons or
refunds.
 Various forms of price promotions
PROS CONS
Contests Builds excitement and interest, stimulate - Can lead to sales drop following event and
short-terms legal/regulatory issues.
- May complicate promotion
Coupons - Provides incentive to price-sensitive - Can lead to price sensitivity
customers - Potential fraud issues
- Encourages brand switching
- Redemption can be easily measured
Loyalty/frequency - Encourages repeat purchases - Costs of administration and redemption may
programs be high
Sampling/trial - Reduces consumer risk of trying new - Program can be costly
offer product or brand
Rebates - Stimulates short-term sales - Delayed gratification can lead to price
sensitivity
- Low redemption rates if have to mail in proof
of purchase
 Various forms of price promotions

PROS CONS
Discounts - Provides incentive to price-conscious - Can create inventory problems
customers
- Encourages brand switching
Special package - Can offer several packages of same - Difficult to determine how much larger the
sizes product at a reduced total price special package has to be made
Short term and long term effects of price promotions
Short term effects
- Higher volumes
- Short term price elasticities of
discounts are typically higher
than elasticities based on
normal price changes
- stock up purchases/ pantry
filling by consumers
- Online auctions can address
individual customers directly
Long term effects
- Carryover or loyalty effects
- Ambivalent effects/ Split price
image
- May have negative effect on
future buying decisions when
consumers associate lower
prices with lower quality.