1. The Strategy and Tactics of Pricing
Brandon Township Library
June 6, 2011
The Strategy and Tactics of Pricing-WJSchroer Co.

2. Pricing is Marketing Marketing is comprised of 4 Co-Equal Parts
(The 4Ps)
Product
Place st 3 elements add value
Promotion
Price Firm’s attempt to capture value in profit
The Strategy and Tactics of Pricing-WJSchroer Co.

3. Pricing Principles Creating exceptional value in products/
Pricing is the amount of money exchanged…….
for items/services of perceived value
Creating exceptional value in products/
services reduces importance of pricing
in the buying decision.
But…..while organizations do have full control over product, place and promotion…..
They have no control over the competitive marketplace and
the appearance of competitive pricing…which may render
their offering not competitive….
The Strategy and Tactics of Pricing-WJSchroer Co.

4. Pricing Principles Customer goal is to obtain the
most value for the money
For commodities…that means paying the least amount possible
For differentiated products…consumer will pay more…for perceived added value.
Bargain!
The Strategy and Tactics of Pricing-WJSchroer Co.

5. Pricing Principles Customers are not concerned with the
firm’s needs to cover production costs
Firms which set prices to meet
internal needs (only)are leaving
money on the table
Pricing is a function of
Uniqueness
Demand/Supply
Substitutes
Brand Preference
Perceived value
Promotion (i.e. popularity)
Culture
Utility
Not…. cost or desired profit margin
The Strategy and Tactics of Pricing-WJSchroer Co.

6. Pricing based on cost
Unit cost = Variable Cost + Fixed Cost Unit Sales Sales of 100,000 20% return Variable cost of $5.50/unit Fixed overhead of $150,000 Fixed expense/maintenance $100,000 Invested capital $1,000,000 Unit cost= $ $150,000+$100,000 = $ ,000 units
The Strategy and Tactics of Pricing-WJSchroer Co.

7. Price based on cost Markup price = _____Unit Cost____________
(1-desired return on sales)
______ $8____
(1-.2) or $10/unit
Is $10 the right price?
Too high?
Too low?
The Strategy and Tactics of Pricing-WJSchroer Co.

8. Pricing Assumptions
In the former example….the target price is based on
(cost) and a set of assumptions…
Sales volume
Variable cost
What if the assumptions are wrong?
If sales are greater than the estimate….unit costs go down
Should you reduce the price to not exceed the margin goal ?
Hold the price and put the surplus margin into advertising?
If sales are lesser than the estimate…unit costs go up
Should you increase price to hold margin (in the face of declining volume?
Hold the price and absorb the margin decline?
The Strategy and Tactics of Pricing-WJSchroer Co.

9. How to Price a New Car Ford Mustang Market Driven Approach
What does the market demand?
Affordable Sports Car
What does the average car cost?
$2,200-$3,200
What is the competition for this entry?
None
Concept:
Take an existing car/mechanicals…add in the elements of sportiness (bucket seats, styling, racing trim, wheel covers, console with manual shift, etc.)
Ford Mustang
The Strategy and Tactics of Pricing-WJSchroer Co.

10. Ford Mustang Results Price= $2,500
More Mustangs sold in 1964 than any car Ford ever built
After 2 years, net profits of $1.1 Billion
Lesson learned: Market-based pricing is more effective
Market Based pricing
What does the customer want?
Is there a market?
What are they (consumers) willing (able) to pay?
What is the competition?
The Strategy and Tactics of Pricing-WJSchroer Co.

11. Pricing-Two Models Product Driven Focus
Product------Price Customer
Customer Driven Focus
Customer Price Product
The Strategy and Tactics of Pricing-WJSchroer Co.

12. Effective Pricing Costs Price Sensitivity Competition
Strategic Objectives
Goals
Tactics
The Strategy and Tactics of Pricing-WJSchroer Co.

13. Definition of Terms
Strategic Objectives- General aspirations or macro strategies of the firm at large
(i.e. Texas Instruments strategy of a substantial cost advantage via market share dominance)
Strategic Goals- Concrete outcomes desired by the firm (i.e. Have the Apple iBook seen as affordable and a good value for college students)
Tactics- Specific actions taken by a firm to achieve Goals
(i.e. offer special pricing of the iBook to college students to insure acceptance and market dominance by that important segment.)
The Strategy and Tactics of Pricing-WJSchroer Co.

14. A discussion of costs…. Must know labor, raw materials, overhead But…
…must know how costs change with changes in sales….
Costs should never determine price….but costs play a role in pricing
The Strategy and Tactics of Pricing-WJSchroer Co.

15. “Cost Pricers” vs. “Effective Pricers”
Cost pricers….select quantities sold and buyers to serve before setting price..then
Try to impose cost-based prices irrespective of what buyers will pay or what competition is doing.
Effective pricers evaluate price sensitivity of buyers then decide what to produce and to whom to sell by comparing the prices they can charge with the costs they will incur….
The Strategy and Tactics of Pricing-WJSchroer Co.

16. Airline Pricing Example
When fuel prices go up dramatically over a short period of time…
Some airlines passed on the cost in a fuel surcharge….
However, other airlines strategically reduced number of flights…reducing seat availability…which led to more full fare passengers…and resulting higher margins which covered the higher fuel costs….
The Strategy and Tactics of Pricing-WJSchroer Co.

17. Costs…Fixed and Variable
Fixed costs are any cost which does not change based on volume sold
Advertising
Some overhead
Product design
Administration
Variable Costs are those which change directly with sales….
Raw materials
Energy to produce
Labor to produce/distribute/package
The Strategy and Tactics of Pricing-WJSchroer Co.

18. Break-Even Sales
How much would sales have to decline in order to make a price increase unprofitable?
%breakeven sales change = -% price change x 100
(basic calculation) %CM + % price change
Example:
Sales = 4,000 units
X wholesale price $10/unit
= Revenue $40,000
Variable cost = $5.50/unit
Fixed costs = $15,000
If price is reduced 5%
$CM=$10-$5.50= $4.50
CM= x = 45%
The Strategy and Tactics of Pricing-WJSchroer Co.%

19. Break Even Sales Cont’d
Example:
Sales = 4,000 units
X wholesale price $10/unit
= Revenue $40,000
Variable cost = $5.50/unit
Fixed costs = $15,000
If price is reduced 5%
$CM=$10-$5.50= $4.50
CM= x = 45%
$10.00
%break-even sales change = -(-5.0) = = .125 x 100= 12.5%
(-5.0) 40
Unit break-even sales change = .125 x 4,000 units = 500 units
The Strategy and Tactics of Pricing-WJSchroer Co.

20. The Strategy and Tactics of Pricing-WJSchroer Co.

21. Relevant Costs in Pricing
Not all costs are relevant in Pricing Strategy
Relevant Costs are….
Forward Looking
Incremental
Avoidable
The Strategy and Tactics of Pricing-WJSchroer Co.

22. Pricing Sensitivity- 9 Effects
Unique Value Effect
Does the product have any unique attributes that distinguish it?
How much do buyers value those unique effects?
Substitute Awareness Effect
What alternatives do buyers have??
Are buyers aware of the alternative suppliers or substitute products??
The Strategy and Tactics of Pricing-WJSchroer Co.

23. Pricing Sensitivity- 9 Effects cont’d
Difficult Comparison Effect
How difficult is it for buyers to compare offers of different suppliers?
Is the product highly complex?
Are prices of different suppliers easily comparable?
Total Expenditure Effect
How significant are buyer’s expenditures on the product in dollar terms and as a portion of total income?
The Strategy and Tactics of Pricing-WJSchroer Co.

24. Pricing Sensitivity- 9 Effects cont’d
End Benefit Effect
What benefit do buyers seek from the product
How price sensitive are buyers to the cost of the end benefit
What portion of the benefit does price of the product account for?
Shared Cost Effect
Do buyers pay the full cost of the product?
If not, what portion do they pay?
The Strategy and Tactics of Pricing-WJSchroer Co.

25. Pricing Sensitivity- 9 Effects cont’d
Sunk Investment Effect
Must buyers of the product make complementary expenditures in anticipation of continued use?
For how long are buyers locked in?
Price Quality Effect
Is a prestige image an important attribute?
Is the product enhanced in value when its price excludes some customers?
Is the product of unknown quality and are there few cues for determining quality before use?
The Strategy and Tactics of Pricing-WJSchroer Co.

26. Pricing Sensitivity- 9 Effects cont’d
Do buyers hold inventory of this product?
Do they expect the current price to be temporary?
The Strategy and Tactics of Pricing-WJSchroer Co.

27. E = % change in unit price
Pricing Elasticity
Percentage change in product’s unit sales for each 1% change in its price
E = % change in unit price
% change in price
If a price elasticity is then a 10% price increase would lead to a 25% decrease in sales volume.
However, not all products are equally elastic…and some products not elastic at all different price levels…
The Strategy and Tactics of Pricing-WJSchroer Co.

28. Price Elasticity Elastic products Soda pop Potato chips
Breakfast cereal
Vacation travel (i.e. Europe)
Inelastic products
Gasoline
Cable TV service
The Strategy and Tactics of Pricing-WJSchroer Co.

29. Price Elasticity Principles of Price Elasticity…
Often related to a brand’s price…further from category average…the lower the demand elasticity..
Age of a brand tends to lower its elasticity
Elasticity is often related to market share (i.e. AT&T)
The Strategy and Tactics of Pricing-WJSchroer Co.

30. Pricing and Competition
Intense Price Competition….a factor of…
High interbrand price sensitivity- means volume gained as a result of price cutting comes at the expense of a competitor.
Low competitive barriers means new competitors can enter and other competitors can gain share at a cost close to established competitors must bear.
Questions:
What price changes is each of my competitors likely to make?
How will each competitor respond to my price changes?
The Strategy and Tactics of Pricing-WJSchroer Co.

31. Pricing and Competition
Cooperative Pricing-
When a price leader increases…other firms increase.
Prices change in parallel
-Used when competitors are at/near capacity and the cost for expansion is high
Adaptive Pricing-
Firms take prices set by larger firms and follow…
Rationale:
Adaptive firm believes…
sales share is so small any price changes it makes won’t affect market.
Contribution margin so small and demand so insensitive that price changes of its own via price-cutting won’t add to its market share
The Strategy and Tactics of Pricing-WJSchroer Co.

32. Pricing and Competition
Opportunistic Pricing-
Price used as a competitive weapon.
Price cuts
Premiums disguised as “free”
Coupons, rebates and “cents-off”
Goal is to capture market share.
Useful primarily for firms with lower costs than competitors
Useful for new firms..those with low market share.
Key questions…
Can competitors detect opportunistic pricing?
Can competitors match or retaliate against opportunistic pricing?
Are competitors willing to retaliate?
If competitive market intelligence is not collected competitors may not learn of opportunistic pricing…
The Strategy and Tactics of Pricing-WJSchroer Co.

33. Pricing and Competition
Predatory Pricing-
Prices set to financially harm another firm.
Educational Predation
Cutthroat Predation
Key questions for how competitors may price:
What are competitor future goals?
What is the competitor’s business strategy?
What assumptions does it have about itself and its industry?
What are its capabilities…both strengths and weaknesses?
The Strategy and Tactics of Pricing-WJSchroer Co.

34. Pricing Strategy Skim Pricing- Examples:
Price set to capture economic value-directed at price-insensitive customers
Price generates high margin
Price limits volume and market share
Examples:
Convenience store items
Kiosks selling candy/tobacco in office buildings
Lunch wagons
Health food
Luxury/prestige automobiles
Generator sales after a tornado
CDs after a rock concert
New products with competitive advantage
(Even with competitive imitation…lowering price won’t necessarily help volume or share –get what you can when you can.
The Strategy and Tactics of Pricing-WJSchroer Co.

35. Pricing Strategy Sequential Skimming-
Moving to the next most profitable segment of buyers after skimming price is exhausted.
Tactical Execution-
Price cuts must be infrequent
Modified models/reduced features used to make a apples-to-apples comparison difficult
Examples:
Polaroid cameras
Broadway shows (iterative return shows)
Clothing End of season merchandise sales
The Strategy and Tactics of Pricing-WJSchroer Co.

36. Pricing Strategy Penetration Pricing-
Setting a price far enough below product’s economic value to attract/hold a large base
Not all products work with penetration pricing
-Where the price is trivial…(chewing gum)
-Where others pay a large portion of cost (i.e. medical care)
-Where price is a signal of quality (Cartier watches)
Products where penetration pricing works-
-Commodities (used as loss leaders)
Sam’s Club/Costco
Products with competitive disadvantage (People’s Express)
The Strategy and Tactics of Pricing-WJSchroer Co.

37. Pricing Strategy Neutral Pricing-
Pricing most buyers would consider reasonable.
Strategy mimizes price as a marketing tool.
Neutral strategy employed to…
Keep competitors from gaining volume/share
Maintain consistency in pricing (Chevy Camaro)
When competitors use other tools to build volume (Amex)
Using advertising to build demand and prevent competitors from using penetration pricing (Miller Beer)
The Strategy and Tactics of Pricing-WJSchroer Co.

38. Pricing Strategy Segmented Pricing-
Most products are bought by customers who have different price sensitivities
Airlines—both skim and penetration price (for business/vacation buyers)
Sporting events-Penetration and skim pricing
Boxing championships…Skim and sequential skim, then penetration pricing
The Strategy and Tactics of Pricing-WJSchroer Co.

39. Pricing Strategy
Any of the three strategies may be appropriate… the dollar amounts aren’t important…it’s the relative values the prices represent…
Sporting events—
-Football-Average income customers-skim pricing of low quality food at moderate prices
-Tennis-High income customers-skim pricing of moderate quality food at high prices
Moderate income customers-sale of high economic value-Service merchandise
Price insensitive on what to buy…price sensitive on where to buy it!
The Strategy and Tactics of Pricing-WJSchroer Co.

40. Pricing Procedure
Identify incremental, avoidable costs applicable to a change in sales
Calculate contribution margin and break-even sales level
Evaluate buyer sensitivity to determine change in purchases
Identify competitors and assess their likely responses
Identify buyers for whom costs, price sensitivity or competition are different and segment pricing accordingly
Calculate profit implications for various sales changes
Accept or reject proposed price changes by weighing likely outcomes (pro and con)
The Strategy and Tactics of Pricing-WJSchroer Co.

41. Marketing Tools Using Pricing
Sampling-
Use for…frequently purchased, low production cost, benefits obvious after one use…
Can go through or around distribution channels
Expensive on a per-person basis…but often effective
In store demonstrations are similar….can be used where sampling isn’t cost effective or affordable
(Normally used in conjunction with a coupon, rebate or both)
“Test drives” of products can be effective/efficient (hot tubs)
The Strategy and Tactics of Pricing-WJSchroer Co.

42. Marketing Tools Using Pricing
Direct Sales
Traditional door-to-door not effective…however,
Direct selling “parties” where sampling is combined with social networking is popular and effective (i.e. Purse Party)
Classes-teaching a skill or “how-to” aspect of a product or service is popular and efficient. Requires competent trainer and the ability to transfer interest in the service/product to the store.
Special events (Invited customers only) provide sense of exclusiveness with selected sales activities designed for the invited customer demographics (normally coupon/rebate/special offer is attached)
The Strategy and Tactics of Pricing-WJSchroer Co.

43. Bundling
Combining one or more products/services to offer a more competitive price while hiding individual unit price
-Appeals to a more basic user
-Must appeal to a significant segment of the purchasing audience
-Items which are normally used together or in sequence
-Price incentive but still allows margin return, eliminates competitive category purchase, bigger total dollar purchase
Examples:
Computer software
Cable TV
Telephone
Fast Food
Tools
Almost anything can be bundled
The Strategy and Tactics of Pricing-WJSchroer Co.

44. Segmented Pricing
Market segmentation divides buyers into different groups allowing more tailored marketing/pricing for each segment
Key is to get buyers to reveal price sensitivity.
Tactic is to set prices high..then discount for information.
Examples:
College students offer student ID to get discounted tickets to movies
Seniors offer ID to receive discounts to car insurance
Rebates and coupons bring in all but only price sensitive redeem…allowing no discount for majority of sales.
The Strategy and Tactics of Pricing-WJSchroer Co.

45. Segmented Pricing Segmenting by location
Grocery stores have different pricing by store based on competition
Gas stations price by neighborhood
Stores with nearby box store competition price differently
Pricing can vary by neighborhood/region/state/country
Segmentation by Time
Theaters price mid-day matinees lower
Restaurants charge more for dinner…even with similar menu
Periodic sales (if not overdone )can stimulate non-seasonal purchases (i.e. furniture sales)
New model introductions offer similar opportunity to “close out” old models stimulating price sensitive buyers
The Strategy and Tactics of Pricing-WJSchroer Co.

46. Segmented Pricing Peak-Load Pricing
Pricing based on demand when product is not storable (or when competition is lesser)
Examples:
Airlines
Electric Power
Potential for…
Gasoline Service Stations
Late night restaurants
Concerts (last minute demand)
Service personnel (weekend rates for plumbers)
The Strategy and Tactics of Pricing-WJSchroer Co.

47. Segmented Pricing Variant of Peak Load Pricing- Priority Pricing
“Loyalty club” customers get priority treatment
“Platinum card” holders get automatic upgrades
“Preferred service” contract holders go to the head of the line
Shoppers with most points qualify for special discounts/preferences
Purchasers of appliances from the store receive priority service treatment
Priority pricing/service can also be part of a “bundle”
The Strategy and Tactics of Pricing-WJSchroer Co.

48. Segmented Pricing Volume Discounts
Volume Discounts-Most common when dealing with business customers…but not always…
Loyalty purchasers
Membership organizations
Telephone minute consumption
Frequent buyer clubs/Frequent flier clubs
Order Discounts
Amount purchases per order is subject to discount
“Free shipping”
Discount of x%
“Buy 3 get 1 Free”
The Strategy and Tactics of Pricing-WJSchroer Co.

49. Segmented Pricing Step Discounts
Encourages use of volume purchases for different purposes
Example: Electricity
Two Part Pricing
Membership or Entry fee plus usage fee
Amusement parks
Car rental companies
Country/Racket clubs
Nightclubs
Can be combined with “Step pricing”
The Strategy and Tactics of Pricing-WJSchroer Co.

50. Loss Leaders
Pricing an item below its variable cost in order to attract buyers to the entire line of products.
Pricing of some items has a strong psychological impact on the customer’s choice of which store to patronize.
Rationale:
-Its impossible for shoppers to remember more than a few item’s prices.
-Certain segments of shoppers are higher volume shoppers. Placing loss leaders among the high volume shopper market basket insures their participation while not giving discounts to low volume shoppers.
The Strategy and Tactics of Pricing-WJSchroer Co.

51. Anchor Pricing
Shoppers use an anchor price to determine where they should fall on the spectrum of offerings.
By introducing a “super-premium” line of copiers or orange juice or other product, manufacturers built higher levels of volume on the original “premium” line because it was now seen as a “good sense” purchase.
This can be used to reverse effect…introducing “generic” label lowest priced grocery products which increase sales of “store brand” products
The Strategy and Tactics of Pricing-WJSchroer Co.

52. Pricing and Psychology
-Perception of % Differences
You have ordered a new computer. You find that alternatively you could…
Save $400 on a new computer that cost $1,000
You have ordered a new car. You find that alternatively you could…
Save $400 on a new car that cost $20,000
The work to cancel the original order for both is identical. Which would you buy?
The Strategy and Tactics of Pricing-WJSchroer Co.

53. Pricing and Psychology
Weber-Fechner Law- Evaluation of price differences relative to the level of the base price.
Test of gas prices….given a constant differential between brand names and independent gas stations……as gas prices rise, consumers move to purchase more gas at the independent gas stations (counter to Weber-Fechner)…even though the differential stays the same.
The Strategy and Tactics of Pricing-WJSchroer Co.

54. Pricing and Psychology
Perception of Odd and Even Endings
First Pair _____________$.89__________$.75
Second Pair $ $.79
Effect of advertised odd-price endings on sales of margarine
Parkay brand Sales
Regular Price $ ,817
Discount Price $ ,283
Odd Discount Price $ ,567
The Strategy and Tactics of Pricing-WJSchroer Co.

55. Pricing and Psychology
Current price/Recalled price/Context
Current Price- Influence current price by adding a higher priced product at top of the line (increases reference or anchor price)
Also…. Was $1.75…….Now $1.69
Their Price $1.75………..Our Price $1.69
Shoppers establish a higher reference price when prices are shown in descending order…..
Conclusion…place higher priced brand names at eye level….lower priced store brands at lower levels….
The Strategy and Tactics of Pricing-WJSchroer Co.

56. Pricing and Psychology
Past Prices
New Products introduced at regular vs. discount prices
Unit Sales
Product Store Type Introductor y Post Introductory
Mouthwash Experimental
Control
Toothpaste Experimental , ,010
Control ,050
Alum. Foil Experimental , ,275
Control , ,395
Light bulbs Experimental , ,250
Control , ,285
The Strategy and Tactics of Pricing-WJSchroer Co.

57. Pricing and Psychology
Past Price
Price increases better often and small to increase reference price
Large, episodic price increases create sticker shock
Reference prices may also be influenced by substitutes or similar items
Purchase Context
“Its less than you probably spend at ______________”
The cost is less than 1/6 the price you would pay at ______________”
Price to be paid for beer on a hot day at the beach…coming from a
………run down convenience store……………$1.50
………resort hotel……………………………………..$2.65
The Strategy and Tactics of Pricing-WJSchroer Co.