Types of BEP BEP Analysis Type I: BEP of a price change Type II: BEP of a fixed-cost investment BEP Analysis Type III: BEP of the change in variable cost Type IV: BEP of Cannibalization

Example: Type III BEP Sun Manufacturing sells bookcases at a price of $100 a piece. Variable costs per unit are $50. Suppose that the unit variable costs have changed to $60, what will be the percentage increase in sales volume in order to make the profit remains the same?

Unit Contribution_oldVC Unit Contribution_newVC Formula for Type III BEP Analysis Break-Even Point = ( Unit Contribution_oldVC Unit Contribution_newVC ) -1

Solution Margin at the old unit variable cost is $50 Margin at the new unit variable cost is $40 -1 = 25% 50 40 BEP = To make sure the profit remains the same, the sales volume has to go up by 25%.

Types of BEP BEP Analysis Type I: BEP of a price change Type II: BEP of a fixed-cost investment BEP Analysis Type III: BEP of the change in variable cost Type IV: BEP of Cannibalization

Example: Type IV BEP Sun Manufacturing sells bookcases at a price of $100 a piece. Variable costs per unit are $50. Suppose that the company is considering introduce a new brand that sells $120 and costs $60 each, what will be the percentage of sales for the new brand that is coming from the existing brand, so that the profit remains the same?

Unit Contribution_old offering Unit Contribution_new offering Formula for Type IV BEP Analysis Break-Even Rate = ( Unit Contribution_old offering Unit Contribution_new offering )

Solution BEP = = 83.3% 50 60 Margin of the existing product is $50 Margin of the new product is $60 50 60 BEP = = 83.3% To make sure the profit remains the same, the new product can take up to 83.3% of the market share from the existing product.

Chapter 7 Price Levels 9

The Pricing Strategy Pyramid Price Level Price setting Pricing Policy Negotiation Tactics & Pricing Setting Procedures Value Creation Economic Value, Offering Design, Segmentation Price Structure Metrics, Fences, Controls Value Communication Communication, Value Selling Tools This class session is about setting prices. After building the foundation for pricing -- value creation, price structure, value communication, and pricing policy -- now the final step is to set and adjust prices.

Preliminary Segment Pricing Price Setting Process Implementation Set final prices and ensure acceptance among customers and organization through effective change management approach Key Questions: What tradeoffs should I make between long-term strategic objectives and short-term market responses to price changes? What types of analytical techniques are best suited to my product and market conditions? How can I estimate customer response to potential price changes? Preliminary Segment Pricing Set baseline prices based on type of value assessment and initial differential value capture rate Key Questions: How much of the differential value should be captured for each segment? How much time and effort should I invest in assessing the value of my products? How should I adjust segment prices to account for different price sensitivities? Optimization Refine preliminary prices with iterative process balancing tradeoffs between price, cost, and market response Key Questions: What tradeoffs should I make between long-term strategic objectives and short-term market responses to price changes? What types of analytical techniques are best suited to my product and market conditions? How can I estimate customer response to potential price changes?

Preliminary Segment Pricing Positive Differentiation Negative Differentiation Key question: How much differential value should be captured in each segment? Competitive Reference The answer to this question can differ substantially across segments based on strategic considerations and differences in price sensitivity

Price Setting Illustration

Three Generic Pricing Strategies Skim Penetration Neutral

Conditions for Different Pricing Strategies SKIM PENETRATION NEUTRAL COSTS CUSTOMERS COMPETITION

Pricing Strategy SKIM PENETRATION NEUTRAL COSTS CUSTOMERS COMPETITION Low CMs Low Volumes Changes in Unit Price Drive Profit Large BE Sales Changes At or near capacity High CMs High volumes Changes in volume drive profitability Small BE Sales Changes Excess capacity Costs similar to competitors Sufficient CM to finance adv, etc. Little excess capacity Incremental capacity is expensive COSTS High price sensitivity -Total Expend Effect -Large Part of End-Benefit Little differentiation Low Price Sensitivity -Reference Price Effect -Price Quality Effect -Difficult Comparison Effect Customers are more sensitive to other elements of the marketing mix CUSTOMERS Limited threat of opportunism Limited opportunity for scale economies Sustainable differentiation Low threat brands Sustainable cost & resource advantage Competitors not willing to retaliate Financial strength Aggressive small share brands Avoid threat of retaliation Large share brands with a lot to lose Sustainable mktg mix advantages Oligopolies COMPETITION

Categorize These Pricing Strategies How would you categorize the pricing strategies for the following products and retailers? (S=skim, N=neutral, P=penetration) Pepperidge Farm Cookies _______ Suave Shampoo _______ Land O' Lakes Butter _______ T.J. Maxx (Clothing) _______ L'Oreal Hair Coloring _______ Bloomingdales _______ Sears _______

Analytical Approaches to Profitability Analysis

Analyzing Profitability Using the Breakeven Sales Change Approach

Risk Analytic Approach to Profitability Analysis

Determinants of Price Sensitivity The Reference Price Effect The Difficult Comparison Effect The Switching Cost Effect The Price-Quality Effect The Expenditure Effect The End-Benefit Effect The Fairness Effect The Framing Effect The Shared-Cost Effect

Price Sensitivity Illustration For each of the following purchase decisions, what factors are likely to affect the consumer's price sensitivity? A diamond engagement ring Automobile repairs Food for meals at home Which university to attend A company car Draperies for your new home Text books Health insurance plan Souvenirs Vacation resort Answer: Diamond ring: Reference price (of discount jewelers), difficult comparison (or quality across stores), price-quality, end-benefit. Food: Expenditure, end-benefit (guests or just family), reference price effects. Company Car: Shared cost, price-quality (image). Text Books: Shared cost (Is educational expense tax deductible and does company or scholarship reimburse?), End-Benefit (small part of total cost of course), reference price (substitutes are few and poor). Souvenirs: End-benefit (cost as share of total vacation), expenditure, reference price effects. Automobile repairs: Difficult comparison, price quality, end-benefit (How expensive are repairs as a share of total cost of owning the car?), framing (fear of a potential loss if taken to an "unauthorized dealer" using "aftermarket" parts installed by "non-factory-trained" mechanics?). University to attend: Shared cost, expenditure (as percent of family income), difficult comparison. Draperies for new home: End-benefit (share of total cost of decorating room), price-quality (for living room where expense has prestige value or in other rooms), reference price (Can buyer make own draperies as an option?). Health insurance plan: Shared cost (employer payment), price-quality, expenditure. Vacation resort: Reference price, end-benefit (cost as a percent of total including travel), expenditure, price quality (The premium priced hotel is assumed to have better accommodations).

Price Sensitivity Discussion Questions What can a company do to decrease its customer's price sensitivity? Would all of the company's customers be likely to react in the same way?

Price Sensitivity Discussion Questions Would a company ever want to do anything to increase its customers' price sensitivity? Why? What steps might it take? Answer: Yes, a company selling a relatively low-priced product would want to increase price sensitivity. It might advertise to convince customers that there really is no difference among brands except the price (e.g., Motel 6 ads). It might also use promotional prices to induce trial, thus reducing the difficult comparison effect.

Price Sensitivity Discussion Questions Which of the following statements are always true, sometimes true, never true? Why? (a) Price elasticity is generally the same for all brands in a product category. (b) Advertising increases price sensitivity. (c) As a product category matures, the consumers become more price sensitive. (d) Each consumer has different price sensitivities for different products.

Price Sensitivity Questions The gasoline service stations in Rochester, New York convinced the City Council to ban signs displaying gasoline prices Why would they want to do this? What effect do you think this law had on gasoline prices? Why?

Price Sensitivity Questions Despite the fact that rental rates for commercial space and labor costs are generally higher in big cities than in small towns, the prices of many products--such as stereo equipment and clothing--are higher in small towns than in large cities.

Price Sensitivity Discussion Questions Many local rental car agencies rent late model cars at substantially lower prices than national companies such as Hertz and Avis. Despite their higher prices, the national companies still retain most of the market (a) Explain why most renters patronize the national car rental companies despite their higher prices. How have the national companies encouraged this price insensitivity? (b) If you were a small, local company, what factors would you look for to identify the price-sensitive segment of renters likely to be attracted to your lower price? (c) If you were a small company trying to become national, how might you overcome the low price sensitivity of customers to induce them to try your cars and evaluate the quality of your service?

Next Lecture Price and Promotion 29