MKTG 6214Glenn Voss

Pricing Strategy & Tactics – Chs. 1-3• Define Strategic Pricing & 5 elements of a pricing strategy:

(1) Value creation, (2) Price and offer structure (3) Value communication, (4) Pricing policy, & (5) Price setting;

• Define Value and explain its role in pricing strategy;

• Show how value-based segmentation enables companies to more profitably align its offerings with differences in what consumers are willing to pay; and

• Examine mechanisms to maintain segmented structures: (1) Price-offer configuration, (2) Price metrics, & (3) Price fences.

MKTG6214 Course Materials

Textbook:• The Strategy and Tactics of Pricing, 5th edition,

2011, Nagle, Hogan, and Zale Cases:• 2 Cases in course packet at Study.net

Password: MKTG6214

• Springfield Nor’easters case available onlineUser Name:Password:

Lectures and Discussions:• In conjunction with cases & handouts of slides

• 2 Written Case Analyses 20(completed in groups of 1-6)

• Final Examination 10• Total 30

Assessment & Grade Distribution

Cox Recommended Grade DistributionA/A- 40%B/B+ 50%B-… 10%

Date Topics Text Readings Class Discussion

8/23 Strategic Pricing & Value Creation Chapters 1-3 Russian Technology

8/30 Price Setting & Value Communication

Chapters 4-6

9/6 Pricing Strategy over the Life Cycle Chapters 7-8 Akash RathodB2B Pricing

9/13 Case Analysis Atlantic Computers Case

9/20 Financial Analysis & Costs Chapters 9-10 Springfield Case

9/27 Competition Chapter 11 Rick LesterTRG Arts

10/4 Final Review Virgin Mobile Case

10/11 Final exam

Modeling the Marketing Process

Product/Service Offering

Promotion/ Communication

Place/ Channel

Company Customers Competitors Collaborators Context

Market Segmentation

Selection & Targeting

Product/Service Offering Positioning

SWOT Analysis

CustomerAcquisition

Customer Retention

Customer Relationship Management

Revenue & Profits

Create Value

Sustain Value

Communicate, Capture & Share Value

Pricing

The Strategic Pricing Pyramid

PriceLevel

Price setting

Pricing Policy

Negotiation Tactics &Criteria for Discounting

Value CreationEconomic Value, Offering Design, Segmentation

Price/Value CommunicationCommunication, Value Selling Tools

Price StructureMetrics, Fences, Controls

Price setting is just the “tip of the iceberg” of a profitable pricing strategy.Price setting is just the “tip of the iceberg” of a profitable pricing strategy.

Create Value

Communicate, Capture, &

Share Value

Value-Based Pricing

Objective: Maximize the difference between the value created for the customer and the company’s costs to provide that value.

Effective pricing strategies should be based on three factors:

The Value-based Pricing Process

CUSTOMER VALUE PRICE COST PRODUCT

CostsCosts

CustomersCustomers

Pricing Strategy

CompetitionCompetition

Value Creation

Defining VALUE

Use Value (Utility)•Monetary gain (or savings) from using a product/service offering•Psychological benefits (or costs) associated with using a product/service offering

Economic Value•Calculated using reference value and differentiation valueReference ValueRefers to the price of the consumer’s “best” alternative.Differentiation ValueRefers to the value of whatever differentiates the offering from the alternative(s). Can be positive or negative.Total economic value represents the maximum price that a fully-informed consumer would be willing to pay for a product/service offering.

Economic Value Estimation Framework

PositiveDifferentiati

on Value

PositiveDifferentiati

on Value

Your uniquevalue

delivery

Reference Value

Reference Value

Price of Customer’s Next Best

Alternative

Negative Differentiatio

n Value

Negative Differentiatio

n Value

Costs unique to doing business with you

Price to capture a share of this value

Total Economic

Value

Economic Value Estimation

Example – Heavy equipment manufacturerExample – Heavy equipment manufacturer

Reference

Competitive alternative for this customer

= $72,500

Add’l warranty cost = -$1050

Increased revenue from higher

uptime = $2350

Invoice processing consistency savings

= $1500

Parts inventory program savings =

$1250

Total offering economic value

$79,950

Differentiation Value = $7,450

Reference price= $72,500

Higher residual value = $1200

Fuel economy savings = $2200

How much of the Differentiation Value do you Capture versus Share with your Customers

Economic Value Analysis

Step 1: Identify Reference Value• Reference value is calculated as the price of the best perceived alternative, not necessarily the next best competitive alternative, with regard to form, function, effectiveness, and/or efficacy.

Step 2: Estimate Differentiation Value•Determine the value drivers – those attributes that impact customer perceptions and purchase choice

Are they monetary gains or cost savings?Are they psychological benefits or costs?

In most cases, the components making up differentiationvalue can be quantified to some extent. Some consumers,however, will pay more for a product simply because of thebrand name – despite the fact that the tangible valueof the product may be substantially lower than alternativesavailable to them. Therefore, the brand name can often bea component of the differentiation value (brand equity).

Comment regarding differentiation value . . . .

What type of differentiation value does a brand name provide?

Economic Value Analysis

Step 1: Identify Reference Value• Reference value is calculated as the price of the best perceived alternative, not necessarily the next best competitive alternative, with regard to form, function, effectiveness, and/or efficacy.

Step 2: Estimate Differentiation Value•Determine the value drivers – those attributes that impact customer perceptions and purchase choice

Are they monetary gains or cost savings?Are they psychological benefits or costs?

•Identify attributes that differentiate between your product and the competitive reference product. What benefits or costs are associated with your product? How can you quantify each benefit and cost?–Gather data that can be used to assign the monetary amount to each value driver (e.g., in-depth customer interviews, surveys, focus groups)–Focus on the underlying customer business model (what drives the business model will typically drive the value perceptions of the customer)–Value drivers can vary across customers & across time•Determine the value derived from a bundle of features

-$1

$0

$1

$2

$3

$4

$5

$6

$0 $100 $200 $300 $400 $500 $600

-$1

$0

$1

$2

$3

$4

$0 $100 $200 $300 $400 $500 $600

$2,020,788(~ 5,800 units)

RevenueContribution

Segment B — Innovators

$ (M)

Segment E — Budget ShoppersPrice ($)

$4,041,864(~ 10,100 units)

$626,904

Price ($)

$261,496$ (M)

Estimating Psychological ValueImpact of Warranty Length on Willingness to Pay

MKTG 6223    Understanding What Customers Value

Pricing Russian TechnologyQuiz

Cost of a Surge (minor)Labor $ 9,000Incremental materials, fuel $ 6,000Lost Production (8 hours to restart.) $80,000

$95,000Frequency of minor surge per compressor .4 per yearCost of a Surge (major)Labor $ 24,000Incremental materials, fuel $ 11,000Equipment (new compressor)$180,000Lost Production (24 hr. To restart) $240,000

$455,000Frequency of major surge per compressor = .004 per year

Pricing Russian TechnologyQuiz

1. What is the economic value of this product? 2. How close to this value would customers be willing to pay? 3. Why might customers object to paying the full economic value? 4. What would you do to overcome those objections? What price do you think Compressor Controls should charge for this product & why?

Brand Product of NotesPrice per

Ounce ($)

Price per

Gallon ($)

Acqua Panna – Natural Spring

Italy (Florence)

1 liter glass bottle

0.13162

16.85

Arrowhead – Mountain Spring

California Plastic 28-pack

0.02367

3.03

Dasani – Purified Drinking Water

USA Plastic 0.08876

11.36

Evian (Nomad) – Natural Spring

France (Alps)

Plastic 6-pack 0.12318

15.77

Menehune – Purified Drinking Water

Aiea, HI Plastic 0.07813

10.01

Perrier – Sparkling Natural Mineral

France Green Glass 0.08333

10.67

Rosauer’s Finest – Spring Water

Canada Plastic/Pop Top

0.02307

2.95

San Pellegrino – Sparkling Mineral

Italy (S.P.) Green Glass 0.08844

11.32

Talking Rain – Mountain Spring

Preston, WA

Plastic/Flavored

0.06760

8.65

Voss – Virgin aquifer Norway Clear glass cylinder

0.181746

23.26

City of Dallas– Residential Pipes/Lake Water

0.000012

0.00156

The price of the most basic of commodity products . . . .

The relevant question is:Why are consumers willing to pay relatively steep prices for a commodity product?

Price StructureTactics for Pricing Differently Across Segments

Market Segmentation – organizing the market into homogeneous groups (or segments) that the firm can effectively & efficiently target.

Market Segmentation

Selection & Targeting

Product/Service Offering Positioning

Product/Service Offering

Promotion/ CommunicationPricing

Place/ Channel

CustomerAcquisition

Customer Retention

Revenue & Profits

Create Value

Communicate,

Sustain Value

Capture & Share Value

Customer Relationship Management

The Reason for Segmented PricingA one-size fits all approach to pricing reduces

profitability and intensifies customer pricing pressure

High

Low

Val

ue

Segment Size

A B C D

Setting price here

….leaves money on the table for these customers and communicates that value does not have to be paid for…

11

22

….and misses growth opportunities by pricing these customers out of the market

33

Benefits of Price Segmentationwith 5 Segments (A, B, C, D, E)

Percent of Market

Segment Size

Reservation Price =

A5

50

$20

B15

150

$15

C35

350

$10

D25

250

$ 8

E20

200

$ 6

Total100%

1000

$10$5

$250 $2750

$10$5

$750

$10$5

$1750

$10$5$0

$10$5$0

$20$5

$750

$15$5

$1500

$10$5

$1750

$8$5

$750

$6$5

$200 $4950

0%

20%

40%

60%

80%

100%

0 2000 4000 6000 8000 10000

Cumulative number of SKUs

Cumulative percent of total sales

0%

20%

40%

60%

80%

100%

0 2000 4000 6000 8000 10000

Cumulative number of SKUs

Cumulative percent of total sales

Careful Analysis is Required to Avoid Nonprofitable Segmentation & Proliferation

Focus price improvement efforts on the top moving SKUs

Identify opportunities for SKU rationalization

SKU Velocity Analysis focuses on SKUs that drive a majority of revenue & volume

Benefits of Price Segmentation Can Change with Ambiguous Reservation Prices

Percent of Market

Segment Size

Reservation Price ≈30% buy next higher-priced option if target price not available

A5

50

$20

B15

150

$15

C35

350

$10

D25

250

$ 8

E20

200

$ 6

Total100

1000

Examples: You stop at a gas station, get out, and discover that there is only premium gas available. Do you buy or leave?

You go to the ballpark and discover that there are only premium seats available. Do you buy or leave?

Mobile Customer Prices Paid per Minute (Virgin Ex 9b)

0

10

20

30

40

50

60

70

0 100 200 300 400 500 600 700 800

Pri

ce p

er

Min

ute

Pai

d

Contract Minutes

100

300

500

700

Benefits of Price Segmentation Given Ambiguous Reservation Prices

Percent of Market

Segment Size

Reservation Price ≈30% buy next higher-priced option if target price not available

A5

50

$20

B15

150

$15

C35

350

$10

D25

250

$ 8

E20

200

$ 6

Total100

1000

Maxim. contribution w/:1 Price ($10)VC equal toContribution equals2 Prices ($15, $8)VC equal toContribution equals5 Prices ($20 $6)VC equal toContribution equals

$10$5

$250 $3125$15

$5$500

$20$5

$750

$10$5

$750$15

$5$1500

$15$5

$1500

$10$5

$1750$8-15

$5$1785

$10$5

$1750

$10$5

$375$8$5

$750$8$5

$750

$10$5$0$8$5

$180$6$5

$200

$4715

$4950

Benefits of Price Segmentation Given Ambiguous Reservation Prices & Incremental VC & FC

Percent of Market

Segment Size

Reservation Price ≈30% buy next higher-priced option if target price not available

A5

50

$20

B15

150

$15

C35

350

$10

D25

250

$ 8

E20

200

$ 6

Total100

1000

Maxim. contribution w/:1 Price ($10)VC equal toContribution equals2 Prices ($15, $8)VC equal toContribution equals5 Prices ($20 $6)VC equal toContribution equals

$10$5.40$240 $3000

$15$5.50$480

$20$5.80$710

$10$5.30$720

$15$5.40

$1440$15

$5.70$1395

$10$5.20

$1680$8-15$5.30

$1694$10

$5.60$1540

$10$5.10$365

$8$5.20$700

$8$5.50$625

$10$5.00

$0$8

$5.10$168

$6$5.40$120

$4482

$4390Add $.10 in VC for each incremental price point above $6 (higher VC for higher-priced products) & $.10 additional FC per product/price offering greater than 1.

Value Based Market Segmentation – pp. 40-456 Steps for Value Based Segmentation

Three Mechanisms to Maintain Segmented Structures

Pricing Menus Map Price StructureHelp Customers Trade Up or Trade DownPricing Menus Map Price Structure

Help Customers Trade Up or Trade DownA “Fixed Price, Flexible Offer” Menu

Examples of Tiered Offers in Software

Basic SRP $199.95 Pro SRP $279.95All in Basic +

Create Customized forms,Tools to Track add’l items

Premier SRP $399.99All in Pro +

Daily Sales Summary,Retail Specific Reports

Standard SRP $219.99 Professional SRP $299.99All in Standard +

MS Access

Developer SRP $529.99Development Tools to Build

Own Applications

Price Offer ConfigurationPrinciples For Offer Creation

Toilet on the plane Beverages

First to BoardPremium Seats

WiFi Access

On-Board Entertainment Bag Check

Tracks with Differences in Value Across Segments

Tracks with Differences in Cost-to-Serve

Easy to Measure and Enforce

Aligns with How Buyers Experience Value in Use

Potential Metrics

Facilitates Favorable Positioning against Competition

11

2

3

44

55

Price Metrics Criteria For Evaluating Price Metrics - Exhibit 3.4

Optimal Metric

Value-based Pricing Metrics

Market Traditional Metrics Value-based Metrics

Real Estate Want Ads $ / column inch $ / property value

Aircraft Engines $ / engine $ / hour of use

Information service $ / minute $ / download

Example: Innovative Price Metrics Can Unlock Value and Ignite Growth

iTunes

Why did this new pricing model have such an impact on sales?

iTunes’ New Price Metric Re-Aligned Price and Value

Old Metric$ / CD

Value of CD

Price of

CD

Overpayment

New Metric

$ / Song

Value of

Song

Price of

Song

ValueInducement

iTunes

Price Fences

– Price Fences are a means to charge different customers different prices.

– Types include• Buyer identification fences (e.g., airlines, student/senior, membership)

• Purchase location fences (e.g., grocery chains, real estate)

• Time purchase fences (e.g., fashion, yield management - hotels, airlines…)

• Purchase quantity fences– Volume discount– Order discount– Step discount– Two-part pricing (e.g., printer and cartridges)

Next Week:Price Setting and Value Communications orHow to price bottled air to morons…