Marketing Mix — PricingMarketing Mix — Pricing

4 P’s:

PromotionProductPlace (channel)Pricing

IE 371IE 371 Marketing Management Marketing Management

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Overview: Pricing

Importance of pricing

Choosing a pricing strategy

Value pricing value equation assessing value

Communicating price & psychological aspects/biases

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The Importance of Pricing

A company has annual sales of 100,000 units for one its products. The selling price for this product is $100, variable cost is $60, and the allocation of fixed overheads is $3 million. The analysis of the market suggests that you have the following two options for the next year: Increase sales by 1% by keeping the current price, or Increase price by 1% and have the same sales as this year.

Which option would you choose? (you will make an extra $100,000 in revenue by either method)

Keep price same, increase sales:Sell 101,000 units, $40 profit per unit: total profit of $404,000

Increase price, sales levels stays the same:Sell 100,000 units, $41 profit per unit: total profit of $410,000

In this scenario, increasing price has a bigger impact on profit than increasing sales

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Comparison of Profit Levers

1% improvement in ... creates operating profit improvement of…

Source: McKinsey & Co., based on average economics of 2,463 companies

Fixed Cost

Var. Cost

Volume

Price

2.3

3.3

7.8

11.1

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Choosing a pricing strategy

ECONOMICS APPROACH Maximizes short-run profits

subject to assumptions about demand and costs

Is determined after product design & quality are fixed

Assumes a "rational" consumer that can assess true quality

MARKETING APPROACH Maximizes long-run profits

based on a scenario for market evolution and the firm's strategic advantages

Is part of evaluating alternative approaches to positioning

Recognizes consumers' need for & use of heuristics in processing information

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Cost and Demand-oriented pricing

Cost-oriented approaches Average cost pricing Experience curve pricing Target return pricing Break-even analysis to evaluate

possible prices (covering costs)

Demand-oriented approaches Marginal analysis (microeconomics)

find the price range that will maximize profits profit is largest when marginal revenue = marginal cost

$

revenue

profit area

Break-Even Point

cost

Units Produced

fixed cost

*

Units Produced

$*

AVC

MC

P=MR

q*

Units Produced

$ MC

MRD

*

q*

P

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Price discrimination

Pricing depending on who the customer is Differences due to willingness to pay in different segments Differences due to channel strategy (e.g., direct vs. indirect) Differences due to volume purchased (bulk discounts)

Pricing depending on product lifecycle Skimming vs. penetration pricing

Quantity

Skim Price

Final Price

Quantity

penetration price

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Value to Customer

Beyond physical good/product, value encompasses perceptions/feelings, service, convenience/availability, repairs, packaging, credit, warranty, etc.

Value pricing better matches price to customer value

Value Equation in its simple form:

Perceived Value = Perceived Quality - Price With added components:

Perceived Value =

Perceived Quality - Price - Time +/- Psychic Factors

Ways to determine value: Direct rating methods Perceived value method Value-in-Use (aka Economic Value Analysis)

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Value Pricing: Direct Rating Methods

Direct Price-Rating Method:

"Indicate price that reflects the total quality of offer”

E.g., How much will you pay for: Häagen Dazs? Breyer’s? Borden?

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Value Pricing: Direct Rating Methods

Direct Perceived-Value-Rating Method:

"Allocate 100 points to reflect total quality of the offer" Häagen Dazs (A) : 42 Breyer’s (B): 33 Borden (C): 25

Price = (rating / (100 / # of products)) * average price Price A = (42 / (100 / 3)) * $2.00 = $2.55 Price B = (33 / (100 / 3)) * $2.00 = $2.00 Price C = (25 / (100 / 3)) * $2.00 = $1.52

Average rating

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Value Equation revisited

Weighted version:

Perceived Value =

WqPerceived quality - WpPrice - WtTime +/- WsPsych Factors

(where each Wi represents the “importance” of that attribute to the customer)

Connection to segmentation: Quality sensitive customers: Wq > Wp

Price sensitive customers: Wq < Wp

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Value Pricing: Perceived Value Method

Perceived value rating method making additional use of

attribute value and importance ratings (weights) "Allocate 100 points to reflect importance of each attribute to

total quality" "Allocate 100 points to reflect quality of each product for

each attribute"

Product

Attribute ImportanceA B C

Creaminess 25 40 40 20

Availability 30 33 33 33

Flavors 30 50 25 25

“Reward” value 15 45 3520

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Now convert the attribute ratings and importance measures into an index score per attribute for each product:

Scores for product A attributes:

Attribute 1 (creaminess):

40 / (100/3) multiplied by weight of .25 = .300

Attribute 2 (avail.): 33/33.33 x .30 = .297

Attribute 3 (flavors): 50/33.33 x .30 = .450

Attribute 4 (reward): 45 / 33.33 x .15 = .203

Add these scores to determine the overall index score (1.25).

Multiply this by the average price in the category.

1.25 X average price of $2.00= Perceived value of $2.50

Value Pricing: Perceived Value Method

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Value Pricing: Value-In-Use Analysis

Value-in-use components: Value-in-use = Reference Value + Differentiation Value Reference Value:

Price of perceived “best substitute” for the product being evaluated Adjust price of competing product for any diff. in quantity used

Differentiation Value: Value of product attributes that are different from those of the best

substitute Positive if customer likes differentiating attribute, negative otherwise

Product X Product YPrice $300 Same basic benefits as X

Better safety $100Start-up cost $200 Start-up costs $100Post-purch. cost $500 Post-purch. costs $400

Reference value: $1000Differentiation value: $100 (safety)

Example: Calculate value-in-use of new product Y, for which best existing competitor is product X

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Communicating Price

Tools like “Value-in-Use Analysis” only help you determine the POTENTIAL economic value to customer. Doesn’t consider whether the customer will/can PERCEIVE this benefit.

Customer perception/cognition shapes behavior. Customers are not always “rational”

Psychological considerations & Implications for pricing, examples: Sunk cost fallacy Framing effects

Reference points Bias in perception of absolute vs % change in price Mental accounting

Transaction utility Fairness

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Sunk Costs

Example:

Joe spent $1000 to join an exclusive tennis club. Two weeks after joining Joe develops tennis elbow, making it very painful to play. He continues to play, however, arguing that he hates to waste the money he paid to join.

Sunk costs are not supposed to matter; each decision should depend on the tradeoff between future costs and benefits

Other places we see sunk costs having an influence: All-you-can eat buffets Gym memberships Season tickets to theaters, concerts, sports events

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You love a good basketball game and have a ticket for a game at 7pm tonight. The game is being played near Ft. Worth, at least 40 minutes from where you live. It is 5pm. It is raining very hard, the road conditions are awful. You got the ticket free from a friend, who had bought the ticket but couldn't go [you paid $100 for the ticket]. Will you go?

Yes No

Paid $100 53% 47%

Free Ticket 39% 61%

Sunk Costs

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Sunk Costs, Part 2: Which costs matter?

Imagine that you have decided to see a play downtown. You paid $100 for a box seat ticket. As you enter the theater, you discover that you have lost the ticket. Would you pay $100 for another ticket?

Imagine that you have decided to see a play downtown. You planned to buy a box seat ticket for $100. As you enter the theater, you discover that you have lost $100 in cash. Assuming that they accept credit cards, would you buy the $100 play ticket as you originally planned?

Yes No

Lost ticket 42% 58%

Lost cash 90% 10%

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Communicating Price: Reference points

Example:Alternative positions for a New York hotel

a. Positioned against a European vacation

It's a sad tale but many couples who go to Europe hoping for the honeymoon they never had end up contemplating divorce. Jet-lag, ill-marked streets, language barriers, wildly inflated prices make for stress and confusion more than for charm and romance. That intimate dinner for two you both dreamed of may dissolve in a silly but unavoidable fight over how best to read the map.

Why bother when all the charms and romance you want are available at a fraction of the cost in New York? America's grandest city rivals any in Europe--museums, restaurants, theater, and shopping set the world standard. So do the city's quaint, historical neighborhoods--Little Italy, Greenwich Village, Chelsea--full of shops and cafes just waiting for you to explore.

Let us be your host. We are located in the heart of midtown, offering well-appointed, spacious, comfortable rooms.

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Communicating Price: Reference points

Example:Alternative positions for a New York hotel

b. Positioned against an American vacationIt's a sad tale but many trips to explore the history and charm of America end up a blurred series of pecan rolls and cheese burgers along lifeless stretches of highway. Shopping malls, chain stores, super highways, and suburban sprawl make more for disappointing repetition in America's heartland than for insight into the country's roots. That idle afternoon you dreamed of poking around dusty old stores, soaking up small town warmth may dissolve instead into price comparison between Gap stores in different states.

The alternative may be to head east to New York, a wonderful old city chock full of history and charm. From its colonial roots, New York grew bigger bit by bit, neighborhood by neighborhood, each reflecting the people who came and the hopes they brought with them. Each neighborhood--Little Italy, Greenwich Village, Chelsea--is a small town with a warmth and a feel all its own. Come explore the shops and cafes. Come and see America without the chain stores.

Let us be your host. We are located in the heart of midtown, offering well-appointed, spacious, comfortable rooms.

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Reference points

Why can Digiorno’s pizza charge around $8 for a frozen pizza?

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Communicating Price: Framing Effects

Example: Average price of other items purchased at the same time

a. Low average price--drug store

Imagine you are in the drug store when you notice a plastic drinking cup with the logo of your favorite team. The price of $7.99 is a little higher than usual for these plastic products but the logo is especially appealing. How likely are you to purchase the cup?

b. High average price--Amazon

Imagine you are shopping online at Amazon.com when you notice a plastic drinking cup with the logo of your favorite team. The price of $7.99 is a little higher than usual for these plastic products but the logo is especially appealing. How likely are you to purchase the cup?

Willingness to purchase item

Low average priceHigh average price

3.19

4.13

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Communicating Price: Framing Effects

Loss aversion and reference point effects example:

a. Cash discount

Imagine you are about to purchase a desk from an antique dealer. You are trying to decide whether to use a credit card or pay cash. The dealer tells you that the price of the desk is $550 if you use a credit card but that there is a $15 discount for cash. Will you use a credit card or pay cash?

b. Credit card surcharge

Imagine you are about to purchase a desk from an antique dealer. You are trying to decide whether to use a credit card or pay cash. The dealer tells you that the price of the desk is $535 if you pay cash but that there is a $15 surcharge if you use your credit card. Will you use a credit card or pay cash?

Payment methodcash credit card

Cash discountCredit surcharge

60%

82%

40%

18%

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Communicating Price: Framing Effects

Imagine that you are in the market for a new car. You've decided to purchase the car from either of two dealers who have offered slightly different deals.

One has offered to sell the car for $22,700 but will provide a rebate of $1500. The other will also sell the car for $22,700 but instead of a rebate has offered to pay your insurance for the year, which, as it turns out, is expected to cost about $1500. Which option seems more attractive to you, the rebate or the insurance?

Percent choosing

RebateInsurance

66%

34%

25

Imagine that you are about to purchase a calculator for $225. The calculator salesman informs you that the calculator you wish to buy is on sale for $215 at the other branch of the store, located a 20 minute drive away.  Would you make the trip to the other store?

Communicating Price: Perceptions of price changes

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Why is driving across town to save $10 more attractive in the case of the small purchase than the large one?

Imagine that you are about to purchase a calculator for $25. The calculator salesman informs you that the calculator you wish to buy is on sale for $15 at the other branch of the store, located a 20 minute drive away.  Would you make the trip to the other store?

Travel? $25 $225

Yes 68% 29%

No 32% 71%

Communicating Price: Perceptions of price changes

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Communicating Price: Transaction Utility

Example:

You are traveling in Thailand and you notice a very nice leather bag that you would like to buy. You figure that a bag of similar style and workmanship would cost about $150 in the U.S. Further, it's exactly what you want.

You bargain with the merchant and settle on a price of 1450 baht (about $35).

a. Poor deal relative to a friend

You later show your purchase to a friend, who reveals a similar bag purchased from the same merchant for about 830 baht (about $20).

b. Good deal relative to a friend

You later show your purchase to a friend, who reveals a similar bag purchased from the same merchant for about 2070 baht (about $50).

Satisfaction Loyaltypoor dealgood deal

5.26

6.42

5.17

7.31

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Communicating Price: Efficiency & Fairness

Example: Supply and demand versus community norms

A football team normally sells some tickets on the day of their games. Recently, interest in the next game has increased greatly, and tickets are in great demand. The team owners can distribute the tickets in one of three ways. (1) By auction: the tickets are sold to the highest bidders. (2) By lottery: the tickets are sold to the people whose names are drawn. (3) By queue: the tickets are sold on a first-come first-served basis. Rank these three in terms of which you feel is most fair and which is the least fair--the auction, the lottery, and the queue.

auctionlotteryqueue

Most fair (%) Least fair (%)

49%

7%

25%

44%20%

55%

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Communicating Price: Expectations & Fairness

Example: Reasonable profits

You are lying on the beach on a hot day. All you have to drink is ice water. For the past hour you have been thinking about how much you would enjoy a nice cold bottle of your favorite brand of beer. A companion gets up to go make a phone call and offers to bring back a beer from the only nearby place where beer is sold, a fancy resort hotel. He says that the beer might be expensive so he asks how much you would be willing to pay for the beer. He says he will buy it if it costs as much or less than the price you state, but if it costs more than the price you state he will not buy it. You trust your friend and there is no chance of bargaining with the bartender. What price do you tell him?

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Communicating Price: Expectations & Fairness

Example: Reasonable profits

You are lying on the beach on a hot day. All you have to drink is ice water. For the past hour you have been thinking about how much you would enjoy a nice cold bottle of your favorite brand of beer. A companion gets up to go make a phone call and offers to bring back a beer from the only nearby place where beer is sold, a run-down grocery store. He says that the beer might be expensive so he asks how much you would be willing to pay for the beer. He says he will buy it if it costs as much or less than the price you state, but if it costs more than the price you state he will not buy it. You trust your friend and there is no chance of bargaining with the bartender. What price do you tell him?

Stated price

ResortGrocery

$6.85

$5.44

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What actions do people think are fair?

• A hardware store has been selling snow shovels for $15. The morning after a large snowstorm, the store raises the price to $20.

Rate the fairness of this action.

General public:

  N=107 Fair or acceptable 18% Unfair 82%

MBA students:

  N = 89 Fair or acceptable 73% Unfair 27%

Lots of training in business and economics can make you have too “rational” of an approach to price increases!

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Fairness: Increase Price or Remove a Discount?

Removing a discount seems more fair than increasing price.

A shortage has developed for a popular model of automobile, and customers must now wait two months for delivery. A dealer has been selling these cars at list price. Now the dealer prices this model at $200 above list price.

N=130 Acceptable 29% Unfair 71%

A shortage has developed for a popular model of automobile, and customers must now wait two months for delivery. A dealer has been selling these cars at a discount of $200 below list price. Now the dealer sells this model only at list price.

N=123 Acceptable 58% Unfair 42%

What does this tell us about using penetration pricing for new products?

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Price: Summary

Of all marketing mix variables, price easiest to alter. Further, it is the only component of the marketing mix that brings in revenue. It has a significant impact on profitability.

Key requirements of pricing policy It should complement your strategic goals It should be based on perceived value to customer, i.e., in the

end it should be based on how much better product is expected to provide benefits relative to the competition

Customers do not always respond rationally to prices; pricing is subject to perceptual biases and heuristics