#4 pricing strategy & tactics
TRANSCRIPT
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Pricing: Strategy and Tactics
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Dimensions of Price
Seller Buyer
Product
Promotion
Distribution
Price
VALUEPROFIT
+
+
-
-
Perceived
Quality
Competitive
Advantage
+/- +/-
Perceived
Quality
Competitive
Advantage +/- +/-
+/-+/-
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Planning for effective Pricing
Nagle & Holden (1995)
Strategic Objectives
Goals
Tactics
Price & Price Policy
Costs Customers Competition
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Strategic Pricing involves changing your mindset
What price will we need to cover our costs and earn a profit?
What costs can we afford to incur (given the prices that are achievable
in the market) and still make a profit?
What price is this customer willing to pay?
What is the product worth to the customer and how can we capture andcommunicate that value?
What prices do we need to meet our sale or share objectives?
What level of sales or share can we most profitably achieve?
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Pricing Strategy:Integrating the elements for profitable pricing
CostMeasurement
CustomerIdentification
CompetitorIdentification
FinancialAnalysis
SegmentAnalysis
CompetitorAnalysis
FinalStrategy
Datacollection
Strategicanalysis
Strategyformulation
Nagle & Holden (1995)
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Accounting convention can often misleadSales Revenue
- Cost of goods sold= Gross Profit
- Selling expenses- Depreciation- Administrative o/h= Operating Profit
- Interest paid= Pre-tax profit- Taxes
= Net Profit
Points to remember:
-Pricing decision is not about linear thinking
-May need to sacrifice gross profit to be able toreduce expenses further down the line
-Do not focus too much on the sunk cost ofproduction
-Historical production costs may be irrelevant to acurrent pricing decision
-Focus on the avoidable cost of holdinginventory
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The Perils of LINEAR thinking
(Case in point) ABC Publishing
Publishes books on special interest topics
First run = 2000 copies of each title
Customary price of each book = $20
Contribution to o/h and profit = $4
Was generally able to sell about 50% in first year
Rest was held in inventory
Problem:
One year, due to a substantial increase in interest rates, the $4contribution per book did not fully cover the interest cost of workingcapital
Most common solution? Raise price of books to increase revenues to cover additional cost
to preserve Gross Profit to preserve Net Profit
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Welcome to Non-linear thinking
Problem: The sunk cost of production is being used to guide pricing decision
Concern:
Increasing price may cover your costs, but does the higher price delivermore value to your customers?
Better solution: Shift the focus to the avoidable cost of holding inventory Note: the cost of production is no longer avoidable
Better Strategy Have a 50%-off sale on slower moving titles being held in inventory (Need to understand cumulative inventory holding costs over years)
Logic: Selling today at lower price will help avoid the interest cost of holding until
you can get the higher price will lead to better net contribution
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Moral
FINANCIAL REPORTING must be kept
separate from MANAGERIAL COSTANALYSIS for pricing (marketing)decisions
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Change your mindset
Sales Revenue- Incremental (avoidable) variable cost
= Total contribution in $- Incremental (avoidable) fixed costs= Net Contribution- Other fixed/sunk costs
= Pre-tax profit- Income Taxes
= Net Profit
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Moving away from Cost-Based Pricing &
Embracing the idea of Value Based Pricing
Pricing cannot be the result (solely) of financial
analysis
(Internal) numbers can be misleading
Optimal pricing calls for understanding anappreciating managerial uncertainty aboutconsumers decisions and about competitorsreactions
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Value based pricing (contd.)
Pricing decisions must be based onunderstanding of the components of value
USE VALUE Benefits/satisfaction offered by the product
ECONOMIC or EXCHANGE VALUE Perceived alternatives +differentiation value
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Economic Value Analysis
STEP #1: Identify the Reference Value i.e., the cost of the customers best alternative
STEP #2: Identify al the factors thatdifferentiate your product (note: somemay be positive and some may be negative) e.g., performance, reliability, features, maintenance cost, etc.
STEP #3: Determine the value to customersof these differentiating factors i.e., differentiation value
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Cost of bestalternative
Positivedifferentiation
value
Total Economic ValueReference
Value
Economic Value Analysis (contd.)
Negativedifferentiation
value
Price
Partly related topoints ofDifference (POD)
Partly related topoints of parity (POP)and competitorspoints of difference
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Pricing & Distribution
The way a product is distributed distinctly affectsthe way it is:
Compared with other products
The image consumers have of it
Cost of distribution
Therefore, pricing and distribution need to becoordinated.
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Price Setting Methods:Cost Based Pricing
Markup pricing / cost-plus pricing
Breakeven (target profit/return) pricing
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Change your Mindset:
Target Cost v/s Target Price
Manufacturer Retailer Consumer
Product is worth
$100
Max SP= $100
Expected Margin(10%)
Buys for $90
Must Sell for $90
Expected Margin(20%)
TARGET COST
$72
Need
Differential Value ofproduct
The TakeawayPut the Horse before the Cart
Demand & Price determine Cost.Cost should not determine PRICE!!!
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Price Setting Methods:Value-Based Pricing
Starts with consumers perceptions of VALUE
and works backwards to set target cost ratherthan target return
Therefore,
Price is Based on Value Cost is based on Price
(contrast with cost-based approaches)
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Steps in Price Setting
SetPricing
Objective
EstimateDemand
EstimateCost
AnalyzeCompetition
DeterminePrice
MakeNecessary
Adjustments
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Effect of Price on Demand
Q- Q Q+
Price
Quantity
P
P-
P+
Law ofDemand: Inverse Relationship Other things remaining the same, more isdemanded at a lower price
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Price Elasticity ofDemand
Q- Q Q+
Price
Quantity
P
P-
P+
Elastic Demand(small change in price produces
large change in demand)
(lowering price will lead to highertotal revenue)
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Price Elasticity ofDemand
Q- Q Q+
Price
Quantity
P
P-
P+
Inelastic Demand
(large change in price produces
small change in demand)
(raising price will lead to greatertotal revenue)
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Price Elasticity ofDemand
Q-QQ+
Price
Quantity
P
P-
P+
Demand in Monopoly
(large change in price produces
NO CHANGE in demand)
(can raise price as much as desired)
Regulation
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(Elasticity of) Demand and Price!(A Case Study)
Technology
What the TrafficWill BearVictoria Murphy Barret 07.03.06
DemandTec is teaching retailers that much of what they knew about pricing was wrong. An iPod at 10 a.m. maysoon sell for less than one at 7 p.m.
Duane Reade had a diaper dilemma three years ago. The pharmacy chain that blankets New York
City was struggling to boost sales of one of its most basic products. Competitors were outselling it,
and discounts and coupons failed to move the diapers faster. Duane Reade went looking for help.
It dumped its historical sales data into a new software program that would suggest how to price
diapers so they'd fly out of the stores.
After a few minutes of calculations the computer suggested Duane Reade do what it had never
done before: make the markup on the diapers a function of the child's age. For example, make the
newborn sizes more expensive, and the big-kid pull-ups cheaper. After a year an increase in diaper
sales helped boost baby care revenue by 27% even as the category's gross margin rose 2
percentage points.
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Psychology & Pricing
Reference Prices Internal v/s External
Role of Advertised Regular prices
Pricing for Quality
Price Endings
e.g., 9-ending, 99-ending prices e.g., 0-ending, 5-ending prices
Odd versus Even ending prices
Mind your Pricing Hues! Impact of Color
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Sale Price
Even EndingOdd Ending
Percent
100
80
60
40
20
0
Store
Walmart
K-Mart
26
74
66
34
Use ofOdd vs. Even Sale Prices
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Di Di it * i Di it r t l ti
% f t l
. % . %
6. % .6% 1.8% .6% 9. %
1. % 1. %
1. % 1. %
.6% 1.8% 1. % 4. % .6% 8.6%
3.1% 1.8% 1.8% 1. % 2 % 28.2%
1.8% 1.8% 4.9% 1.8% 22% 8% .6% 50.9%
1.2% 1.8% 6. % 14. % 1.8% 25.8% 25.8% 22.1% 100%
1.0% 1.0%
1.0% 1.0%2.0% 2.0%
1.0% 2.0% 2.9%
1.0% 1.0%
1.0% 1.0% 1.0% 1.0% 3.9%
1.0% 1.0% 1.0% 6.9% 2.9% 12. %
1.0% 2.0% 10.8% 10.8% 2.9% 48% 75.5%
1.0% 1.0% 2.9% 3.9% 11.8% 11.8% 9.8% 57.8% 100%
3
4
5
6
7
8
9
DiDi it
t l
1
34
5
6
7
8
9
Di
Di it
t l
t rl rt
K- rt
0 1 2 3 4 5 6 7 8 9
PenniesDi it
t l
AnalyzingPrice Endings
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Priceinformation
located here
is
processed
here
Priceinformation
located here
is
processed
here
Differences in left v/s right brain activity may influence how a price is perceived!
Neuro-biology & price communication