Pricing Strategies for Business

Market
 Introduction
• Objective of the firm is to create value for the
customers – better than competitors.

• How firm can create value?

• Through marketing mix – product, price distribution,

and promotion.

• Effective pricing can not compensate for the poor

execution of the 3Ps.

• Ineffective pricing can preclude the firm from getting

financial success.
 Factors affecting Pricing

Competition
Competition Costs
Costs

Pricing
Strategy

Demand
Demand Objectives
Objectives

CUSTOMER VALUE PRICE COST PRODUCT

 Factors affecting Pricing
• Pricing objectives:
• 1. Return on Investment
• 2. Market share
• 3. Meeting competition
• 4. Profit
• e.g. Dow Chemical set low price to build market share.
• DuPont charge high price initially and then reduce it.
• Demand: Elasticity of demand and impact of price on
sales.
• Competitive Reactions: increase spending on
advertisement, reduce price etc.

• Costs: Fixed costs and Variable costs

 Microsoft Xbox v/s PlayStation 2
Microsoft gaming console in 2001 (USA)
Fixed costs: $500 Million
Cost per unit: $375 per unit
Objective: sell 5 million X-Box

Sony PlayStation II: $299 per unit

Nintendo GameCube: $199 per unit (expected)

If price is set at $ 375: Cost recovered

If price is set at $299: Loss per unit : $76
If price is set at $199: Loss per unit: $176

What price do you suggest to Microsoft?

 Microsoft Xbox v/s PlayStation 2
Microsoft priced at $299 per unit

Sony reduced the price of play station ii to $199 in

2002.

What to do?

How to sustain?
 Traditional Pricing Approach
Cost –Plus Pricing Approach

Cost per unit + Mark-up = Price of the product

Disadvantages:
1. Customer’s value of perception
2. Competition

Competitive Pricing Approach: Match the close

competitors’ price
 Pricing Approaches for New Product
• Penetration Pricing:
• Product is introduced at a low price in the market
• Objective: capture market share quickly
• It is appropriate when:
• Targeted customers are price sensitive
• Opportunity for a substantial cost reduction as volume
expand (e.g. iron ore, medical synergies)
• Skimming Pricing
• Product is introduced at a high price.
• Objective: to capture early profit
• It is appropriate when:
• Targeted customers are not price sensitive
• Product is innovative or having substantial
differentiation e.g. customized products, G.E. Medical
equipment.
 Value based Pricing: Defining Value
Economic Value
• Value placed by customer on product.
• Calculated using reference value and differentiation
value
Reference Value
Refers to the price of the consumer’s next “best”
alternative.
Differentiation Value
Refers to the value of whatever (benefits, service
etc.) differentiates the offering from the
alternative(s).
Can be positive or negative.
Economic Value Estimation Framework

Negative
Negative Costs unique to doing
Differentiation
Differentiation
Your unique Positive Value
Value business with you
Positive
value Differentiation
Differentiation Price to
delivery Value
Value capture a
share of
this value

Price of Total
Customer’s Economic
Reference
Reference Value
Value Value
Next Best
Alternative
 Economic Value Analysis
• Step 1: Identify Reference Value

• Reference value is calculated as the price of the best

perceived alternative.
 Economic Value Analysis
Step 2: Estimate Differentiation Value
• Determine the value drivers – those attributes that
impact customer perceptions and purchase choice.
Are they monetary gains or cost savings?
Are they psychological benefits or costs?
• Identify attributes that differentiate between your
product and the competitive reference product.
• What benefits or costs are associated with your
product?
• E.g. warranty, product specification, technology,
Brand.
 Economic Value Analysis
• How can you quantify each benefit and cost?

• Gather data that can be used to assign the monetary

amount to each value driver (e.g., in-depth customer
interviews, surveys, focus groups).

• Cost Drivers: Create value by economic savings

• Example: Machine can process more material/hr. with less
electricity, training and maintenance and labor costs.

• Revenue Drivers: Add incremental value by facilitating

revenue or margin requirements
• Example: Packaging is more attractive thus increasing sales

• Assign the estimated value to each driver

 Economic Value Estimation
Example – Heavy equipment manufacturer
Higher residual Add’l warranty
value = $1200 cost = -$1050
Parts inventory Total offering
savings = $1250 economic value
Invoice processing $79,950
consistency savings
= $1500
Differentiation How much of the
Fuel economy Value = $7,450 Differentiation
savings = $2200 Value do you
Increased revenue Capture versus
from higher Share with your
uptime = $2350 Customers

Competitive
Reference price
alternative for
Reference = $72,500
this customer
= $72,500
Economic Value Estimation Framework

Negative
Negative Costs unique to doing
Differentiation
Differentiation
Your unique Positive Value
Value business with you
Positive
value Differentiation
Differentiation Price to
delivery Value
Value capture a
share of
this value

Price of Total
Customer’s Economic
Reference
Reference Value
Value Value
Next Best
Alternative
 Value based Pricing for different segments
A one-size fits all approach to pricing reduces
profitability and intensifies customer pricing pressure

2 ….leaves money on the table for these customers and

communicates that value does not have to be paid for…
High

1 Setting price here

Value
A B C D
Low
Segment Size

3 ….and misses growth opportunities by

pricing these customers out of the market
 Benefits of Value Price for 5 Segments (A, B, C, D, E)
A B C D E Total
Percent of Market 5 15 35 25 20 100%

Segment Size 50 150 350 250 200 1000

Reservation Price = $20 $15 $10 $8 $6

Maxim. contribution w/:

1 Price ($10) $10 $10 $10 $10 $10
VC equal to $5 $5 $5 $5 $5
Contribution equals
$250 $750 $1750 $0 $0 $2750
2 Prices ($15, $8)
$15 $15 $8 $8 $8
VC equal to
$5 $5 $5 $5 $5
Contribution equals
$500 $1500 $1050 $750 $0 $3800
5 Prices ($20  $6)
VC equal to $20 $15 $10 $8 $6
Contribution equals $5 $5 $5 $5 $5
$750 $1500 $1750 $750 $200 $4950
Value-based Pricing Metrics

Market Traditional Metrics Value-based Metrics

Real Estate Want Ads $ / column inch $ / property value

Light bulb $ / unit $ / hours of use

Internet service $ / minute $ / download

 iTunes’ New Price Metric Re-Aligned Price and Value
iTunes

Old New
Metric Metric
$ / CD $ / Song

Overpayment
Value
Inducement
Value Price Value Price
of of of of
CD CD Song Song
Price Fences
◦ Price Fences are a means to charge different
customers different prices.
◦ Types include
 Buyer identification fences (e.g., airlines)
 Purchase location fences (e.g., real estate)
 Time purchase fences (e.g., fashion, yield management - hotels,
airlines…)
 Purchase quantity fences
 Volume discount
 Order discount
 Two-part pricing (e.g., printer and cartridges)
 Competitive Bidding
◦ Significant business is done through competitive
bidding, especially in government purchase.
◦ In bidding, firm has to develop a price rather than
relying on list price.
◦ Mostly suitable for commodity type of products e.g.
MRO materials.
◦ It can be done online or offline.
◦ Types of competitive bidding
◦ Closed bidding
◦ Open bidding
 Competitive Bidding
◦ Closed bidding
◦ It involves the formal invitation to suppliers to submit a
written bid on a specific contract.
◦ All bids are opened simultaneously and often job goes to
lowest bidder who meet desired specifications.
◦ On-line sealed bids: on-line auctions e.g. AMC invites
online closed bids from real estate firms to sell land.
◦ Open bidding
◦ It is more informal and allow suppliers to make offer up
to a certain date.
◦ It is appropriate when specific requirements are hard to
determine or competitors offering vary significantly.
◦ First suppliers capabilities are evaluated then prices are
negotiated. E.g. customized production system.
 Competitive Bidding
◦ Online open bidding (reverse auction)
◦ All qualified suppliers are invited online for live
bidding.
◦ All participants can see the bids of other suppliers.
◦ Goal: push price down.
◦ Can damage supplier-customer relationships.
◦ E.g. Zydus use it for by medical products
(standard/commodity type)
Thank You

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