Importance of Pricing

 “Number one problem facing marketing.” Marketing News

 “Pricing is the only element in the marketing mix that produces

revenue; the other elements produce costs.” Kotler

 “Many companies don’t understand and capture the value they

create for individual customers. “ Business Week

 “Most vandalized component of the marketing mix.” WA

1
The Strategy and Tactics of Pricing
 Importance of price in the 4 P’s
• Extracting value – and integrating with
--other elements creating value

• Consistent with the company strategy:

– positioning decision for segment(s)
– product portfolio decisions
– place decision – collaborators product line

• Signals & Embodies the Strategy:

– In positioning product (customers, competition)
– Relative to competition (e.g., hotels, airlines, retail)
– Defines play called: (margins or volume)
– Identifies Place/Role in Product line

The Strategy and Tactics of Pricing

 Strategic Pricing 5Cs

The goal of pricing strategy should be to match

objectives and fit in the overall plan (5Cs)

CONTEXT

Competition Customers

Pricing
Strategy

Company Collaborators

3
The Strategy and Tactics of Pricing
 Nagle’s Strategic Pricing Pyramid (Nagle:P7)

Price
Level Set price levels to
Price setting match objectives
Pricing
Policy
Negotiation Tactics &
Price Setting Procedures

Value Communication
Communication, Value Selling Tactics
Create good values
that you can sell
profitably. Price Structure
Metrics, Fences, Controls

Value Creation
Economic Value, Offering Design, Segmentation

Price is just the “tip of the iceberg” of a profitable pricing strategy.

The Strategy and Tactics of Pricing 4

 Some possible price policy objectives

– Begin to align price with value received

– Increase integrity of pricing structure to increase customer trust
– Capitalize on more sophisticated bundling and fencing techniques
– Minimize business at risk to competition
– Increase profitability
– Gain market share
– Increase customer loyalty
– Increase customer base
– Increase Share-of-Wallet from key customers
– Pre-emptive strikes
– Create fences between segments
– ----

Develop Price Strategies and Tactics to Meet Objectives

The Strategy and Tactics of Pricing 5

Review of Some Math Techniques for Pricing

• Review of Calculus of Optimization

– Motivation for the work

– How to calculate the first derivative

– Complete examples

• Regression Review

- Examples

The Strategy and Tactics of Pricing

 Contribution
The price where profits
will be maximized

The Strategy and Tactics of Pricing

 Gradient / Slope

• Gradient = Slope = Change in Y

Change in X

- Slope is a measure of how “Y” changes w.r.t a change in ”X”

- When will Slope =0?

-When increasing X does not increase “Y” any more

- Slope =0 at last point before an increment in “X” actually results in

a decrease in ”Y”

The Strategy and Tactics of Pricing

 Max Profit where?
Find the point where
the slope=0

The Strategy and Tactics of Pricing

 First Derivative - Review

The Integer Rule:

The function:

The 1st derivative w.r.t “a”:

The Strategy and Tactics of Pricing

 Derivatives Examples

• 3x4  12x3

• 4x2  8x

• 10x10

• 3x4 + 4x2 + 10x + 17  12x3 + 8x + 10

The Strategy and Tactics of Pricing

 Stepwise Solution for example

• The Profit Contribution Function was:

Profit = p x q – c x q = (p-c) x q = UCM x Quantity sold

• The demand (q) depends on the price

q = 10-p

• Replace q in the Profit Function

Profit= (p-c) x (10-p) = 10p - p2 -10c + pc

The Strategy and Tactics of Pricing

 Stepwise Solution continued

• The Profit Function

Profit = (p-c) x (10-p) = 10p-p2-10c+pc

• The slope is the first derivative w.r.t p

d(Profit)/dp = 10-2p+c

• The slope=0 when d(Profit)/dp=0

10- 2p + c = 0 i.e when p*=(10+c)/2
Suppose c = 3 => p*= 6.5
Max or Min?

The Strategy and Tactics of Pricing

 Calculating Max or Min…

• To maximize or minimize a function, you take the

derivative (w.r.t. to the variable of interest) and set it
equal to 0

• Check 2nd derivative

– For a Max 2nd derivative<0
– For a Min  2nd derivative>0

So for Example since second derivative is -2 i.e

negative, the point is a maximum.

The Strategy and Tactics of Pricing

 Another example

• Say demand is q=100-p,

where q = Quantity, p = Price
– If price is 20, 80 units demand
– If price is raised to 30, demand decreases to 70
– If price is lowered to 15, demand increases to 85

• For c = 10, what to charge to maximize profits?

The Strategy and Tactics of Pricing

Write down profit and maximize
• Profit = q (p-c) =
(100 – p)(p – 10) = 100p + 10p -1000-p2

• 1st Derivative: 100+10-2p

• 110-2p=0

• p=55

• Max or Min?

The Strategy and Tactics of Pricing

 Regression

Dependent Explanatory
Variable Variable

The Strategy and Tactics of Pricing

 Regression
• An approach for modeling the relationship
between a scalar
dependent variable ”y” and
one or more explanatory variables

Dependent Explanatory
Variable Variable

The Strategy and Tactics of Pricing

 Interpreting Regression
• Say we were interested in predicting salary
based on number of years in school

hs ba mba

The Strategy and Tactics of Pricing

 Regression Coefficients

• A= - 60,000; B=10,000

• Salary = - 60,000 + (10,000) (years in school)

– This means that the average MBA salary would be
- 60,000+10,000*18 = $120,000
( assuming total 18 years schooling to get an MBA)

• A key inference is that each year in school

adds 10k to the predicted (average) salary

The Strategy and Tactics of Pricing

Las Vegas Hotel Example 1 –
Do Prices Affect Occupancy? What is weird here?

Occupancy Rate

Price

The Strategy and Tactics of Pricing

Las Vegas Hotel – Example 2
- Why does this graph make more sense?

• Do prices affect occupancy?

The Strategy and Tactics of Pricing

 Per the Las Vegas Hotel #2

• y = -1.9219x + 964.12
R² = 0.9477
• We asked what the trend line is and what
the confidence level (R2) are
• We find that:
– β = -1.92
o Which means – with each $10 increase, there will be
a decrease of about 19 guests
– R² = 0.95
o Which means – the confidence level is very high and
the correlation is almost perfect

The Strategy and Tactics of Pricing

 Keurig At-Home

X Y
Price Customers Purchasers at Price

55 43.8 100

90

50 53.5 80

70

Percent Purchase
45 60 60

50 Series1

40 69.5 40

30

35 79.3 20

10
30 87.3 0
0 10 20 30 40 50 60

25 97.8 Price

% Customers =
The Strategy and Tactics of Pricing
Profitable Pricing Requires Understanding Costs (Nagle Ch 9)

The Strategy and Tactics of Pricing 25

Profitable Pricing Requires Understanding Costs (Nagle Ch 9)

• UNDERSTANDING RELEVANT/DIFFERENTIAL COSTS

– A relevant cost is a cost incurred if a sale is made, or a cost not incurred if a sale is not made.
• 无论sale发生没发生，都要支付的一笔成本
• IDENTIFYING RELEVANT/DIFFERENTIAL COSTS
– Incremental (not the “full cost”)是指单位产量的变动所引起成本变动额（一般为1unit）。是用来判断企业最佳生
产量的因素
– Avoidable (not the “sunk cost”)是指企业可以通过决策行动改变其数额的成本，或是成本发生与否直接同某项
备选方案是否选用相关联的成本 。
 Relevant costs: They include incremental and avoidable costs

 Incremental costs: costs incurred associated with changes in pricing and sales (not the “full costs”)
 边际成本
– All variables costs指生产多少，消耗多少的cost
– Incremental fixed costs (e.g. ads informing of price change)指不管你生产不生产，都要消耗的费用，比如
场地租金之类

– Semi-fixed costs: fixed over a range of sales but vary outside the range “半固定费用”、“阶梯式成
本”、“步增变动成本”。指在某一时期内只有当业务量(产量或销售量等) 超过一定范围时才会变动的成本。

 Avoidable costs: costs not yet been incurred or can be reversed (not the “sunk cost”)

– future costs are usually avoidable, past costs are “sunk”

– future replacement cost, not historical replacement cost
The Strategy and Tactics of Pricing 26
 Identify Incremental Variable Costs
•
• VARIABLE COSTS ARE ALWAYS INCREMENTAL
• But be careful of averages! The incremental variable cost for a
change in sales is often not equal to the average variable cost

• Examples:
– Overtime vs. average cost production;
– Costs from multiple sources using different technologies
(joint product vs. prime sourcing);
– Average over different types of customers.

The Strategy and Tactics of Pricing 27

 • 固定成本和可变成本
• 根据成本费用与产量的关系可将总成本费用分为可变
成本、固定成本和半可变（或半固定）成本。固定成
本是指不随产品产量的变化的各项成本费用。可变成
本是指随着产品产量的增减而成正比例变化的各项费
用。有些成本费用属于半可变成本，如不能熄灭的工
业炉的燃料费等。工资、营业费用和流动资金利息等
也都可能既有可变因素，又有固定因素。必要时需将
半可变（或半固定）成进一步分解为可变成本和固定
成本，使产品成本费用最终划分为可变成本和固定成
本。长期借款利息应视为固定成本，流动资金借款和
短期借款利息可能部分与产品产量有关，其利息可视
为可变半固定成本，为简化计算，一般将其作为固定
成本。 [1]
The Strategy and Tactics of Pricing 28
 Identify Incremental Fixed Costs
• Some fixed costs are also incremental for pricing
– They are the fixed costs incurred to implement a
change in pricing.

• Most fixed costs are not incremental

– Since they do not change with a change in price or
sales, they are not incremental. They have no impact on
the relative profitability of alternative pricing strategies.
• Examples:
– Product Development Costs
– Advertising

The Strategy and Tactics of Pricing 29

 Identify Incremental Opportunity Costs

• Beware of overlooking or ignoring opportunity

costs.
– They are often incremental, even when associated with
otherwise “fixed” assets.

• Examples:
– Alternative uses of capacity, funds, or management
time.

The Strategy and Tactics of Pricing 30

 Determine The Contribution Margin

PER UNIT Price TOTAL Sales Revenue

- Incremental Variable Costs - Total Variable Costs

= Contribution Margin ($, %) = Total Contribution ($, %)

边际贡献是从销售收入中减去变动成本之后
的余额。边际贡献作为销售收入同变动成本
的差额，应是从一定数额的销售收入中扣除
与之相关联的全部变动成本(直接材料费、
直接人工费、变动性制造费用、变动性销售
费用和行政管理费) 的结果。

The Strategy and Tactics of Pricing 31

 Approximately Right, Or Precisely Wrong

•Determining the relevant cost of a product or service -- the incremental, avoidable,

differential cost—for decision making requires making adjustments to the full, average
costs as calculated for financial purposes.

-These adjustments often require making judgments about differential costs which are
uncertain, approximate and debatable.

• This is not, however, a reason to avoid making such judgments.

•It is better to make pricing decisions based on a

rough idea of the relevant unit cost of your product or service
than on a precise accounting of costs that are irrelevant
to its profitability!

The Strategy and Tactics of Pricing 32

 Costing for Effective Management

Incremental Costing Incremental Costing Total Costing

For simple pricing decision For pricing with incremental For measuring overall
investment business profitability

Unit Price Incremental revenue Sales revenue

Incremental VC per unit
= Contribution margin / unit
(UCM)
S.P – V.C = UCM
( SP, VC, UCM all per unit)
Incremental variable cost total variable costs
= Incremental contribution = total contribution
incremental fixed costs incremental fixed costs
= Net incremental contribution = net contribution
non-incremental fixed
(+ Rev)–(+V.C) –(+F.C) = (+Contrib) and sunk costs
= Net profit
Sales Rev- TVC = T. Contrib
T.Contrib- (+F.C) = N. Contrib
Net Contribution
- (Non Increm F.C+Sunk Costs)
= Net Profit

The Strategy and Tactics of Pricing 33