1. Chapter 1. Strategic Pricing
Stephan Sorger
Disclaimer:
All images such as logos, photos, etc. used in this presentation are the property of their respective copyright owners and are used here for educational purposes only
Some material adapted from: Nagle et al, “The Strategy and Tactics of Pricing,” 5th Edition
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2. © Stephan Sorger 2015: www. stephansorger
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3. Chapter Overview
Define Strategic Pricing and differentiate it from more tactical approaches such as cost-driven, market-driven or competitor-driven pricing
Introduce the identifying characteristics of strategic pricing
Proactive
Profit-driven
Value-based
Define the five elements of a pricing strategy and illustrate how they work in concert to maximize profitability:
Value creation
Price and offer structure
Value communication
Pricing Policy
Price setting
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4. Strategic Pricing Pyramid: 1-1
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5. Strategic Pricing Pyramid: 1-1
Questions:
-Why might customers say your prices are high?
(Hint: Work from top to bottom on the pyramid)
-33% of companies use cost-plus pricing even
though managers know it is not effective. Why?
-What is a problem with pricing for market share?
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6. Alternative Approaches to Value Creation: 1-2
Product Led
Product  Cost  Price  Value  Customers
Customer Led
Customers  Value  Prices  Costs  Products
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7. Alternative Approaches to Value Creation: 1-2
Product Led
Product  Cost  Price  Value  Customers
Customer Led
Customers  Value  Prices  Costs  Products
Questions:
-Name some recent product failures; Why did they fail?
Google Glass; RIM Blackberry Q10; HP Chromebook 11; “The Lone Ranger”
-How does this relate to customer-led pricing?
-How does this relate to the feature-driven approach done by tech firms?
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8. Tactical Pricing Orientations
Instead of strategic, value-based pricing, some managers choose tactical techniques:
Cost-Driven Pricing (based on product cost)
Customer-Driven Pricing (arriving at final price via negotiation)
Competition-Driven Pricing (based on what competitors charge)
Result: Lower profitability in almost all cases
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9. Cost-Driven Pricing
“Price every product to yield a fair return over full cost”
Total Cost
Unit Cost
Target Price
Volume
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10. Cost-Driven Pricing Unit cost:
Variable cost: Material and labor to make one unit of production
Allocated fixed cost: Spread out fixed cost over many units
Total Cost
Unit Cost
Target Price
Volume
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11. Projected Costs and Revenues at Expected Sales = 1,000,000 units
Cost-based Pricing: Example
Example: Acme plans to launch its new product, the X-1000.
The sales department expects to sell 1 million units
The finance department requires a minimum price of $9 to cover costs
Projected Costs and Revenues at Expected Sales = 1,000,000 units
Total Per Unit
Direct Variable Costs $3,000,000 $3.00
Direct Fixed Costs $3,000,000 $3.00
Administrative Overhead $1,500,000 $1.50
Full Cost $7,500,000 $7.50
Revenue $9,000,000 $9.00
Profit
$1,500,000
$1.50
Result: Make profit of $1.50
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12. Cost-Based Pricing: Example
But the X-1000 sells only 750,000 units, not 1 million
Cost-based pricing says increase price to $10.50 ($9 + $1.50 “profit”)
Actual Costs and Revenue at Actual Sales = 750,000 units
Total Per Unit
Direct Variable Costs $2,250,000 $3.00
Direct Fixed Costs $3,000,000 $4.00
Administrative Overhead $1,500,000 $2.00
Full Cost $6,750,000 $9.00
Revenue $6,750,000 $9.00
Profit $0 $0
What happens when we increase price to $10.50?
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13. 5% Decline 33% Decline Current in Unit Sales in Unit Sales
Cost-Based Pricing: Example
But raising price will decrease the number of units sold, impacting profit.
 Higher prices do not necessarily result in higher profits
5% Decline 33% Decline Current in Unit Sales in Unit Sales
Price $9.00 $10.50 $10.50
Unit Sales 750, , ,000
Variable Costs $3.00 $3.00 $3.00
Fixed Costs $4.00 $4.21 $6.00
Admin. Overhead $2.00 $2.11 $3.00
Unit Cost $9.00 $9.32 $12.00
Unit Profit $0 +$1.18 -$1.50
Total Profit $0 $843,750 -$750,000
No competition
Competitive market
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14. Cost-based Pricing
Instead, Acme should decrease its price to boost sales volume.
 Lower prices do not necessarily result in lower profits
Financial Implications of a 10% Price Cut
5% Increase 33% Increase Current in Unit Sales in Unit Sales
Price $9.00 $8.10 $8.10
Unit Sales 750, ,500 1,000,000
Variable Costs $3.00 $3.00 $3.00
Fixed Costs $4.00 $3.81 $3.00
Admin. Overhead $2.00 $1.90 $1.50
Unit Cost $9.00 $8.71 $7.50
Unit Profit $0 -$0.61 +$0.60
Total Profit $0 -$480,375 $600,000
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15. Cost-based Pricing
Instead, Acme should decrease its price to boost sales volume.
 Lower prices do not necessarily result in lower profits
Questions:
-Would cost-based pricing have suggested us to cut price?
-Think of examples of profitable companies who emphasize low price:
-Walmart; Southwest Airlines
-Who else makes profits with low prices?
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