Pricing for Profit

Small Business September 2010

Supported by

Capital Region Business Enterprise Centre

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“Nothing contributes so much to the prosperity and happiness of a country

as high profits.’ David Ricardo

‘Mr Forbes, the ledger shows a slight profit this month!..

Young man, I don’t give a damn what your books show. Do we have any money in the

Bank?’ Malcolm Forbes

Pricing for Profit

Pricing for ProfitTopic Duration

The Importance of Pricing for Profit

Approx.3 Hours

Reaching for the Ceiling (Price)

Feeling the Floor (Price)

Setting the Price

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McKinsey 1992 study found...

“One percent improvement in price created

an 11% improvement in profit.

By contrast, one percent improvement in

variable cost, volume and fixed costs

produced profit improvements of

only 7.8%, 3.3% and 2.3% respectively.”

Source: Marketing Management 12e, Kotler & Keller

Importance of Pricing for Profit

What is Profitable Pricing

Reaching for the ceiling

Market Value Based Pricing

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Like beauty, value is in the eyes of the beholder

Versace$2776.9

775g$5.76 (0.74/100g)

800g$4.36 (0.55/100g)

Woolworths Qb Sheet set $31.99

Sheridan Qb Sheet set $149.00

Wittner$204

Understanding Current & Forecasting Future Price

Past Prices are usually

easy to identify from retail scan

data, market sales reports

etc.

Future Price is harder to determine.

Identify External Price Influences

P.E.S.T.E.• Political

• e.g. Housing grant changes, home insulation fund cancellation, change of government, Tax changes, etc.

• Economic• e.g. GFC, investor and consumer sentiment.

• Social• e.g. Gen Y, Baby Boomers, etc.

• Technology• e.g. Decrease in cost of storage in computer market

• Environment• e.g. Free range, organic, Icelandic eruption, disease outbreak, etc.

Internal Market Shifts

• New technology

• iPhone, iPAD, etc.

• New entrants

• Brands- Nudi Juice

• Supply Chain Dominance

• Integration - Vertical /Horizontal

• Market Consolidation

• Takeovers, Mergers, etc.

• Etc.

* “...A key question is whether price is largely defined by cost. The answer is not simple as both grocery and petrol industries are distinguished by many variable costs that affect retail prices. In the grocery market for example, applying costs across products is not guided by standard economic theory as costs are not just based on product but include services around product supply such as item display, parking and customer services. Also, relationships resulting from alliances with key dominant players will allow some businesses to determine prices or offer lower prices while others cannot.

* Retail petroleum price discounts; impact on grocery prices - VACC research paper June 2007

Consumer Reference Price

What a customer expects to pay is influenced by…

• Actual shopping experience (price memory) –

• how often they buy, how often they buy at discount, etc.

• Price / quality inferences (threshold and trade off) –

• ‘you have to pay at least $200 for a good wallet’.

• Brand perceptions (equity) –

• Expect to pay more for BMW than a Ford.

• Where they buy it (channel) –

• Expect to pay less on e-bay, more for wine at a restaurant than a club or pub, etc.

• Other choices (substitution) –

• Other categories that deliver similar benefits e.g. Drinks choice = soft-drinks, milk, water, alcoholic, etc.)

Internal Market Price Factors

A number of reference price points operate in each

category.

1. Usual listed / shelf / recommended price

2. Average discounted price

3. Expected future price

What is the maximum price you could charge?

Price Elasticity of Demand =

Proportionate change in Demand Proportionate change in Price

Explore how you create value for your customer?

Functional Benefits (e.g. what it is used for )

e.g. BMW – ‘efficient, safe and comfortable transport’.

Emotional Benefits (e.g. how it should makes them feel)

e.g. BMW - ‘the exhilaration of superior engineering.’

Aspirational Benefits (e.g. Why others will think its a smart choice)

e.g. BMW – ‘Reward and recognition for personal success

POINTS OF PARITY POINTS OF DIFFERENCE

How do you match competitors How are you better or Worse than competitors

Ways to influence consumer reference price

Price Reference Strategies

Examples

Distribution

Channel choice - Online, department store, discount store, etc. In store location – discount v.s. designer items. Availability – ‘managed scarcity’ can increase price premium.

Recommended retail price

Pricing just above or below a competitor creates a point of reference re price –quality comparison

If a manufacturer’s price is shown that is high than the shelf price it creates an additional buyer incentive

Price Band Cues – 99c, under $50, etc.

Discount promotion patterns

Regular discounting lowers expectation for future price. VIP program – rewards repeat buyers to drive loyalty but also

lowers price reference over time.

Product bundling

Splitting expensive items into smaller units or breaking up payments over a period of time to lower price barrier.

Grouping items to increase perceived value may also bring forward future purchase or increase trial.

Branding and marketing

Create the right meaning around your product through name, design, merchandising, packaging, advertising, etc.

Feeling for the Floor

Cost Based Pricing

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Calculating the Floor Price

Sustainable Gross Margin

Breakeven Analysis

FIXED COSTSCONTRIBUTION MARGIN

Contribution Margin

Total Sales- Variable costsTotal Sales

Calculating the Breakeven Point

Practical Demonstration

www.cabenet.com.au

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powering better business online

Importance of Accurate Business Information

Clive Peeter’s

• Greg Smith, Managing Director, said “we provided an earlier business update on 11 February 2010, stating that we considered the half year result to be very creditable, having regard to the misappropriation events and the material impact that these had on trading over the months of July 2009 to October 2009.”

• Smith added “some erosion of gross margin occurred during H1 2010 due to a more competitive retail environment. However Clive Peeters margins were impacted negatively as a result of the misappropriation events and the associated impact this had on our supply channel and rebate revenue”.

• The Company announced that its efforts to reduce costs over FY 2009 had been sustained over H1 2010, with underlying costs coming in within expectations. Smith added “our cost to sales ratio for the half fell to 20.7% despite the decline in sales. We are aiming to reduce the ratio further as we consolidate our business operations and resume new store rollout”.

• The Company noted the improvement in its Sydney operations, assisted by reductions in advertising and store remuneration costs, and by the closure of the central warehouse. The H1 2010 result for Sydney was a $0.8 million net operating loss after tax (H1 2009 $1.6 million)

The Clive Peeter’s Story...

Announcement 4 May 2010....

Operating loss $4,500,000.00

The Clive Peeter’s Story continued...

Revenue, Gross Margin Relationship

Woolworths

Sustainable Gross Margin

David Jones

Setting the Price

Pricing for Profit

Adds up to better business

powering better business online

Optimum Pricing Approach

Floor Price = Fixed costs+ Variable Costs + Minimum Gross Margin

Ceiling Price = Maximum Price /Quality Reference Point for the customer

Your Business Strategy

Your business

strategy should

drive all your key

decisions –

especially

pricing

Be clear about your intentions?

Business Strategy questions… NOW FUTURE

What do you want to achieve?

What do you want to stand for in the market?

Why does it matter – to you and others?

What capability do you need to be successful?

What do you need to overcome?

How do you plan to achieve your goals?

What plans / actions to you need to resource?

Strategic Pricing Tips

Know your marketplace – external price Influences (macro / micro economic)

Estimate the ceiling price – customer price-quality relationship, consumer / buyer reference points, elasticity of demand in your category

Be clear about your business costs – fixed / variable / working capital / sustainable gross margin

Cost your business plan – Why, what, when and how, know cost to serve each customer group, to mitigate competitors, prioritise opportunities (market /customer segments), set minimum and stretch targets

Make the price you need – deliver maximum value to the customer for the price that fits with your business goals.

Chess player thinking – flexible price strategies supported by strategic marketing and business operational processes