1 teck-hua ho pricing policy mar 17 i. economic and behavioral foundations of pricing ii. innovative...

Mar 171

Teck-Hua HoPricing Policy

I. Economic and Behavioral Foundations of Pricing

II. Innovative Pricing Concepts and Tools

III. Internet Pricing Models

SummarySummary

Mar 172


Punch-linePunch-line

Factors affect pricing strategy

Costs, customer, competition, constraints

Flawed pricing strategies

Cost-plus pricing

Customer-based pricing

Competition-driven pricing

What are the steps for profitable pricing?

Set your strategic objective and consider costs, customer, competition, and constraints simultaneously

Mar 173


EVC AnalysisEVC Analysis

PositiveDifferentiation

Value

ReferenceValue

Negative Differentiation value

EVC

Differentiation Value

Superior performance

Better reliability

Additional features

Lower maintenance cost

Faster serviceReference Values

Mar 174



EVC = Reference value + Differentiation value

EVC is the maximum willingness-to-pay, not actual willingness-to-pay

Always examine and enhance your product, place, and promotion strategies to attain EVC

Pay attention to factors that influence actual willingness to pay

Mar 175


Factors Affecting Actual Factors Affecting Actual Willingness to Pay (1)Willingness to Pay (1) Substitutes awareness effect: Buyers are more price sensitive

the higher the price difference between this product and the perceived substitute

Difficult comparison effect: buyers are less price sensitive the more difficult to evaluate competing offers

Switching cost effect: Buyers are less price sensitive the greater the sunk investment they have made in anticipation of its continued use.

Price-quality effect: Buyers are less price sensitive to the extent that higher price signals higher quality. (Image and exclusive products or products without quality cues)

Mar 176


Factors Affecting Actual Factors Affecting Actual Willingness to Pay (2)Willingness to Pay (2) Unique Value effect: Buyers are less price sensitive the more

they value any unique attributes

End-benefit effect: When purchasing supplies, buyers are more price sensitive (1) the more price sensitive the demand for the end product; (2) the larger share of the total cost of the end product

Expenditure effect: Buyers are more price sensitive the higher the total expenditure, both in dollar terms and as a percentage of income

Shared-cost effect: Buyers are less price sensitive the smaller the portion of the price they actually pay

Mar 177


Factors Affecting Actual Factors Affecting Actual Willingness to Pay (3)Willingness to Pay (3)

Fairness effect: Buyers are more price sensitive when it is outside the range that they perceive as “fair”

Inventory effect: Buyers are more price sensitive in the short run when they can hold inventories and believe that the current price is temporarily lower or higher than it will be in the future

Mar 178


Course OutlineCourse Outline

22-Jan Overview and Introduction27-Jan Customers: Understanding and influencing purchase decision29-Jan Costs: How should they affect prices?3-Feb Competition: Price Simulation I5-Feb Competition-Driven Pricing10-Feb Cumberland Industries / Foundations for More Profitable Pricing12-Feb Federated Industries / Psychological Aspects of Pricing19-Feb Measuring Price Response Function

24-Feb Price Customization: Segmented Pricing26-Feb Price Customization: Nonlinear Pricing and Imedia Corporation5-Mar Price Line Pricing10-Mar Biopure12-Mar Cambridge Software / Price Bundling17-Mar Time Customization of Prices

Mar 179


Incremental Break-even Incremental Break-even Analysis (Analysis (when fixed & variable costs when fixed & variable costs

are unchangedare unchanged))

Contribution(a)

ContributionBefore Price Change

Variable costs(b)

Sales Volume

ContributionAfter Price Change

Sales Volume

Sales Volume ??

Variable costs(b)

Unaffected Contribution

(a)

AdditionalVariable Costs (e)

Contribution LostDue to Price (c)

ContributionGained Due toVolume (f)

CM1

P1

VC

P2

S

S1 S1

Mar 1710



Only relevant costs (i.e., incremental & avoidable costs) are relevant to pricing decision.

General incremental break-even formula

Break-even curve Actual sales sensitivity analysis Break-even curve and actual sales sensitivity

analysis are the tools for evaluating pricing decision taking into account Costs, Customers, and Competitors

22

1*)]21()21[()12(

VCP

SVCVCPPTFCTFCS

Mar 1711


Lessons LearnedLessons Learned

Firms that recognize the sensitivity of the overall market do perform better

Even better: if you realize your competitors are using mechanical pricing rules, you can optimize the market for yourself

Explanations offered by managers after the 1989 beer price war:We think “they started it”We don’t know the market’s price elasticityDoing well means doing better than the competitor

Mar 1712



Effective pricing depends on an accurate understanding of the relative importance of

Your decisions

Your competitors

The market

The importance of “knowing your competitors”

Mar 1713



Price war is often a “negative-sum” game, it hurts the industry in the long-run

Three competitive principles: 1) know your opponents and yourselves, 2) use strategic foresight, 3) differentiate between one-time and repeated strategic interactions

Decision on initiating or matching price cut should be made based on long-term consequence (i.e., the final outcome in the new world)

Mar 1714





Mar 1715


Value/Cost Inputs to Pricing Value/Cost Inputs to Pricing (11 ½-Inch Pads)(11 ½-Inch Pads)

Total Variable Cost: $27.28

Value from Fazio Data: $1,272

Value from Colerick Data: $894

Price to Yield 100% Contribution Margin: $54.56

Mar 1716


Pricing Scorecard QuestionnairePricing Scorecard QuestionnaireImportance Performance

1-5 Rating from Poor 1 2 3 4 5 ExcellentLow to High

Pricing MindsetExtent to which our process1a. Is connected to corporate and marketing Strategy1b. Is understood by people in our organization1c. Provides meaningful guidance2. Rests on fact foundation that is:a. Relevantb. Accuratec. Appropriately disaggregatedd. Timely

Scope of UnderstandingExtent to which our understanding covers1a. Value customers place on product1b. Variation in value across customers2. Likely competitive reactions and means for influencing3. Product's role in company portfolio

ProcessExtent to which our pricing process formally analyzes:1. Customization strategies2. Managing pocket price and account specific costs3. Today's pricing influence on future opportunities4. Communicating/implementing pricing in the marketplace5. Legal boundaries

Mar 1717



Skimming versus penetration pricing

Pricing scorecard

The role of pricing structure

Product and cost advantages (both internal and external)

Mar 1718


PROCUREMENT POLICY

Capacitor Market – Incentives Capacitor Market – Incentives to Price Cutto Price Cut

COMMODITY PRODUCT OVERCAPACITY

PRICE KEY BUYING DETERMINANT

ANY BUSINESS PRICED ABOVE DIRECT COST WORTHWHILE

INCENTIVE TO CUT PRICE

LARGE INDIVIDUAL TRANSACTIONS

BUYER CONCENTRATION

LARGE GAINS TO SINGLE PRICE CUT

Mar 1719



Manage reference price over time

Apply Weber-Fechner Law to announce price increase or decrease accordingly

Segregate gains and integrate losses

Publicize your high fixed cost or cost increase

Use odd pricing to signal low price

Mar 1720


Why is Conjoint Analysis Why is Conjoint Analysis so so Sexy Sexy as a Consulting as a Consulting Tool?Tool? 3Cs

Customer

Competitor

Company

2 Ps

Product (EVC Analysis)

Price (demand estimation)

Data-driven

Decision-driven

Mar 1721





Mar 1722


Two Problems with Single Two Problems with Single Price StrategyPrice Strategy Leave money on the table

Some customers are willing to pay more

Pass-up Profit

Some potential customers were not served even though the firm could have served them at prices above the variable cost

Mar 1723


Single PriceSingle Price

$

SalesVolume

$2000

Money Left on Table

Profit

Passed-up Profit

$100

380

190

$3900

50%

25%

25%

Mar 1724


Customized PricingCustomized Pricing

$

SalesVolume

$2633

Money Left on Table

Profit (first-class)

Passed-up Profit

$100

380

127

$3900$1367

254

Profit (Economy)

(Need to build segmentation fences)

Mar 1725



Price customization significantly increases profit. It aims to reduce money left on the table passed-up profit

Ways of price customization By consumer: get buyers to act voluntarily By location: prevent arbitrage By time of purchase: manage yield and redistribute

usage By product: understand consumers By volume: do not hinder competition

Mar 1726

Teck-Hua HoPricing Policy 11

An Example: Cellular An Example: Cellular Phone ServicePhone Service

HV USERS(Professional Use)

LV USERS(Personal Use)

Mar 1727


LessonsLessons

Nonlinear pricing can work whether customers are the same or different. It is more efficient when customers are the same.

The more complex forms of nonlinear pricing extract higher value but are more difficult to implement

Non-linear pricing has the great advantage of self-selection by the customers

Mar 1728


If consumers are similar in their usage intensity in a single segment, the optimal pricing strategy involves setting a usage based fee equaling marginal cost (in this case it is zero).

The fixed fee equals to the consumer surplus of the segment served.

Note that here the two-part tariff enables the firm to extract all consumer surplus.

Key Lessons: Serving Single Segment Only

Mar 1729


If we are serving multiple segments with different usage intensities, the optimal pricing strategy involves setting a usage based fee higher than marginal cost.

The fixed fee in this case equals the consumer surplus of the personal (low-valuation) user.

Key Learning Points

Mar 1730


HV Users (Professional Users)

Monthly Fixed Fee $ 54Airtime Charges $ 0 per hourDemand 12

LV Users (Personal Users)

Monthly Access Fee $ 32Airtime Charges $ 2 per hourDemand 8

Note that Professional Users is indifferent between the two payment plans

Total Profits = 100 x $54 + 100 x ($32 + $2 x 8) = $10.2 K

Optimal Menu of PlansOptimal Menu of Plans

Mar 1731


Product Line Product Line InterdependenciesInterdependencies

Image of Brand/Company

Image of Product Line

Price of Product A

Traffic at Outlet

Demand forProduct A

Demand forProduct B

Complements

+-

Substitutes

+/-

+/-

Mar 1732


Punch-linePunch-line When making pricing decisions, we should take into account the

inter-relationships among products.

Complementary relations lead to product-line prices that are lower than optimal isolated prices.

Substitutive relations lead to product-line prices that are higher than the optimal isolated prices at the upper end of the price scale.

In evaluating the profitability of a price change (with demand interdependencies), we simply need to modify the new contribution margin in the break-even formula in order to obtain the revised break-even sales volume

Mar 1733





Mar 1734


Biopure: Punch-lineBiopure: Punch-lineA case on product line pricing: questioning the ability of

a firm to effectively price similar products at different prices to different consumers.

Market potential: animal market is larger and human market is smaller than expected.

Reference price: the prices of many other products other than Oxyglobin can serve as reference prices.

Mar 1735


Multi-version Case: “Student” Multi-version Case: “Student” and “Industrial”and “Industrial”

Unit Larrge, Corporate R&D Consultants and Small Students TOTAL NETContribution Multidivisional and University Professional Businesses CONTRIBUTION

Corporations Laboratories CompaniesSegment Size 5,000 2,000 20,000 15,000 500,000

Segment Dev. Cost $150,000 $100,000 $200,000 $200,000 $300,000

Individual WTP "Industrial" $2,500 $2,000 $600 $300 $100 "Student" $150 $100 $200 $175 $50

"Student" $100,000; $15

$50 $35 ($30,000) $500,000 $325,000 $7,200,000 $7,895,000$50 $35 $500,000 $325,000 $7,200,000 $7,925,000$50 $35 $325,000 $7,200,000 $7,425,000$50 $35 $7,200,000 $7,100,000

"Industrial" $500,000; $35

$2,400 $2,365 $11,675,000 $11,175,000$1,950 $1,915 $9,425,000 $3,730,000 $12,655,000$450 $415 $1,925,000 $730,000 $8,100,000 $10,255,000$175 $140 $550,000 $180,000 $2,600,000 $1,900,000 $4,730,000

"Student" at; Industrial" at:

$50 $2400 $11,675,000 ($30,000) $500,000 $325,000 $7,200,000 $19,070,000$50 $1950 $9,425,000 $3,730,000 $500,000 $325,000 $7,200,000 $20,580,000$50 $450 $1,925,000 $730,000 $8,100,000 $325,000 $7,200,000 $17,680,000$50 $175 $550,000 $180,000 $2,600,000 $1,900,000 $7,200,000 $11,830,000

Mar 1736



“Versioning” strategy can be highly profitable for the firm.

Price the premium version low enough to make sure that high-end customers willingly choose it.

Beware of lumpiness in demand curve they can lead to local optima in profit function.

Mar 1737


Punch-linePunch-line Price bundling can work when willingness to pays for

component products are negatively correlated.

Bundling can improve profit because unexploited customer surplus (“money left on the table”) from one product is transferred to a second product.

Price bundling can appear in the form of pure and mixed bundling. The distribution of WTPs determines which form is superior.

Mar 1738


Basic MotivationsBasic Motivations

InformationAbout Demand

Known

InitiallyLimited

Not Timedriven

Timedriven

1. Trial

2. PurchaseAcceleration

3. Potential Build-up

4. Peak Load

5. Peak Load withDemand Shift

6. Demand probing

7. Yield Management

Mar 1739


3. Potential Buildup of Low-3. Potential Buildup of Low-

WTP CustomersWTP Customers Mr. Coffee coffee maker (unit variable cost = $32)

The goal is to charge maximum WTP of a growing proportion of the market that would buy at regular price

Suppose customers for a coffee maker are of two types, one valuing the product at $60 and the other at $40.

Each group has a “birth” rate of 100 per month

1 2 3 4 5 6 Time

Price

$60

$40

Mar 1740


3. Potential Buildup of Low-3. Potential Buildup of Low-

WTP CustomersWTP Customers

Month N($60) N($40) Contribution if P=$60

Contribution

If P=$40

1 100 100 $2800 $1600

2 100 200 $2800 $2400

3 100 300 $2800 $3200

4 100 100 $2800 $1600

5 100 200 $2800 $2400

6 100 300 $2800 $3200

Unit Variable Cost = $32

Mar 1741


Punch-linePunch-lineClearly understand the underlying motivation

Design the time-customization plan based on the motivation

Consider the potential negative consequences and long-term dynamic effects

1 teck-hua ho pricing policy mar 17 i. economic and behavioral foundations of pricing ii. innovative...

Documents

price sensitive

teckhua ho pricing policy

pricequality effect

profitable pricing

price difference

current price

pricing strategy costs

cost effect