Pricing Strategy over the Life Cycle – Chs. 7-8

• Review Fire Safety Homework• Understand how price sensitivity, costs, and

competition influence pricing strategy over the product life cycle.

• Introduce organizational tools and diagnostic analytics that can be used to identify and overcome implementation challenges

Incremental Quantity Breakeven % 2010-11:(5% Price Increase; ~62% CM)

Breakeven Sales as a % of 2010 Sales (1+/- Incremental Breakeven %)

Expected 2011 Sales as a % of 2010 Sales (No price change; Market Growth = 29%)

Breakeven 2011 Sales as a % of 2010 Sales (5% Price Increase; Growth = 29%)

Actual 2011 Sales as a % of 2010 Sales

Quantity % Above/Below Breakeven (2010 basis)

Quantity % Above/Below Breakeven (2011 basis)

Fire Safety: 1. Given overall market growth rate = 29%, Fire Safety’s 5% price increase in FY 2011, & 2010 CM≈62%, what was Fire Safety’s incremental % breakeven point for unit quantity and $ sales change in FY 2011? How does that compare with actual 2011 unit quantity and $ sales changes.

-P%CM% + P%

-5%62%+5%

= = -7.5%

92.5%

129%

107.8%

119.4%

-11.6%

-9.7%

Incremental Quantity Breakeven % 2011-12:(5% Price Increase; ~64% CM)

Breakeven Sales as a % of Sales (1+/- Incremental Breakeven %)

Expected 2012 Sales as a % of 2011 Sales (No price change; Growth = 44%)

Breakeven 2012 Sales as a % of 2011 Sales (5% Price Increase; Growth = 44%)

Would you recommend the 5% price increase to FSI management for FY 2012? Why (not)? What would you recommend?

Fire Safety: 2. Given the expected market growth rate of 44%, Fire Safety’s proposed 5% price increase in FY 2012, & 2011 CM ≈ 64%, what is Fire Safety’s incremental percentage breakeven point for unit quantity and $ sales change in FY 2012?

-7.2%

92.8%

144%

133.6%

-5%64%+5%

Breakeven Elasticity = -1.45

Observed Elasticity = %Q (107.8-129) -16.44% -3.29

%P 129 5.00%The Final Requires Calculating Breakeven Volumes &

Expected Volumes based on Elasticities

Elasticity Required to Breakeven

Price increase: |Elasticity| < the breakeven amount leads to contribution increase.Price decrease: |Elasticity| > the breakeven amount leads to contribution increase.

The Final Requires Calculating Breakeven Volumes & Expected Volumes based on Elasticities

Sales and Profits Over the PLC

Product Adoption CurveInnovators

3-5%Early

Adopters10-15%

EarlyMajority

34%

LateMajority

34%

Laggards orNonadopters

5-16%

90

50

20

5

0Time

Pe

rce

nt

Ad

op

tio

n

CUSTOMERS Growing customer baseEarly adoptersLittle product knowledgeModerate knowledge buyersIncreasing brand loyalty

Large segmented marketLate adopters/LaggardsHigh knowledge buyersRepeat purchasersComparison shopping

Declining customer baseHigh knowledge buyersFamiliar with all suppliers and options

COMPETITION Shakeout to stable # of competitorsHomogeneous dominant brandsMarket share defenseGains from competitors

Increased competitive entryBrand proliferation & confusionDifferentiation vs. Cost leadership

Increased price competition to fill capacityExiting of weak competitors

Declining unit variable costs through volume;Increasing contribution margins

Low variable costsHigh contribution marginsCost controlsAsset utilization

Excess capacityHigh average costs, due to low capacity utilization

Reference value effectPrice quality effectDifficult comparison effect

MORE SENSITIVITY

Switching cost effectExpenditure effectEnd benefit effectLower riskHIGH SENSITIVITY

Switching cost effectExpenditure effectEnd benefit effect

HIGH SENSITIVITY

COSTS

PRICE SENSITIVITY

Brand positioningDifferentiationBrand loyaltyDefensible competitive position

Market share defenseMarketing and production efficiencyProfitable market segmentation

Retrench, & defend strongest product linesHarvest the businessConsolidation to small # of competitors

MARKETING OBJECTIVES

Bundled pricing to simplify segmented pricing according to buyer knowledge (Hi-Mod-Lo)

Expansion of product line and price pointsMultiple pricing channelsSegmentation pricing

Price to maintain margins, but signal intent to defendPrice for max. cash flowPredatory pricing

PRICING STRATEGIES

High incremental costs of production and promotionLow contribution marginExternal sourcing

Reference value effectPrice quality effectDifficult comparison &Fairness effectLOW SENSITIVITY

Generate primary demandCustomer awarenessMarket educationBuyer frames of referenceInformation diffusion

Establish value and worth

Small customer baseInnovatorsLittle product knowledgeLow knowledge buyers

Few competitorsLow threat of competitive rivalryGains from market development are high

Market Dynamics over the PLCGROWTH MATURITY DECLINEINTRODUCTION

CUSTOMERS Moderate knowledge buyersIncreasing brand loyalty

High knowledge buyersRepeat purchasersComparison shopping

COMPETITION Homogeneous dominant brands Market share defenseGains from competitors

Brand proliferation & confusionDifferentiation vs. Cost leadership

Declining unit variable costs through volume

High contribution marginsAsset utilization

Difficult comparison &Price quality effect

MORE SENSITIVITY

Switching cost effectExpenditure effect

HIGH SENSITIVITY

COSTS

PRICE SENSITIVITY

Brand positioning & loyalty Brand differentiationDefensible competitive position

Market share defenseMarketing & production efficiencyProfitable market segmentation

MARKETING OBJECTIVES

Simplify segmented pricing according to buyer knowledge (Hi-Mod-Lo)

Expansion of product line and price pointsSegmentation pricing

PRICING STRATEGIES

High incremental costs of production and promotion

Difficult comparison & Fairness effect

LOW SENSITIVITY

Generate primary demandCustomer awarenessMarket education

Establish value and worth

Little product knowledgeLow knowledge buyers

Few competitorsGains from market development are high

Market Dynamics over the PLCGROWTH MATURITYINTRODUCTION

PLC & Brand Strategies

Brand StageLaunch

Maintenance

Retirement

Product Category Life CycleIntroduction

Price to establish, communicate & promote value of the product

N/A

N/A

GrowthBased on LT strategy, identify appropriate segment(s) before commercialization

Segment & target for LT advantage. Lower price as necessary to maintain market growth. Price compete only to gain cost advantage.

Price to clear inventory quickly while launching new models

MaturityUse aggressive pricing to dominate based on cost advantage or target underserved niches w/a service advantage.

Unbundle. Price products & services separately. Rationalize product line & distribution strategy. Price to maximize profit, not market share or growth.

Slowly price yourself out of business.

DeclineNot recommended.

Only with strong advantage. Consolidate to solidify cost or service leadership.

Withdraw cash w/incrementally higher prices.

Product differentiation strategy

Cost leadership strategy

Marketing differentiation (& product proliferation) strategy

PLC & Brand Strategies

Brand StageLaunch

Maintenance

Retirement

Product Category Life CycleIntroduction

Price to establish, communicate & promote value of the product

N/A

N/A

GrowthBased on LT strategy, identify appropriate segment(s) before commercialization

Segment & target for LT advantage. Lower price as necessary to maintain market growth. Price compete only to gain cost advantage.

Price to clear inventory quickly while launching new models

MaturityUse aggressive pricing to dominate based on cost advantage or target underserved niches w/a service advantage.

Unbundle. Price products & services separately. Rationalize product line & distribution strategy. Price to maximize profit, not market share or growth.

Slowly price yourself out of business.

Product differentiation Cost leadershipMarketing differentiation (& product proliferation)

Illustrative Customer Profitability Map

Price

High

Low

Cost to Serve

“Gold”

“Silver” “Lead”

“Platinum”

Low High

Price Banding OutputA

ctu

al P

rice

Fair Price

At Risk

Fair Price

Outlaws

Customer Lifetime Value (CLV)Useful Analysis at the Individual Customer & Segment

CLVinfinite lifetime = CM/(i* + 1 – r) – ACwhereCM = average annual contribution for the customer (segment)

i* = i (=the risk-free discount rate) × risk factorr = retention rate for the customer (segment)AC = acquisition costs

How valuable/profitable is each customer (segment) given prices & variable costs (i.e., contribution), retention rates, discount rate, risk level & acquisition costs?

How valuable/profitable is an acquisition or retention campaign given prices & variable costs (i.e., contribution), retention rates, discount rate, risk level & acquisition costs?

Customer EquityFacebook April/May 2012

At Facebook• April 2012 Unique Users: 900,000,000 • Revenue ≈ 3.7 B; CM (90%) ≈ $4; i* = .05; r = .95• CLV ≈ $40

• Customer Equity = #Users × CLV = $36 B

= # Customers × CLVCustomer Equity

External Valuation May 2012: ~$100 B

Customer EquityFacebook July/August 2012

At Facebook• July 2012 Unique Users: 955,000,000• Revenue ≈ 4.7 B; CM (90%) ≈ $4.4• CLV ≈ $44

• Customer Equity = $42 B

= # Customers × CLVCustomer Equity

External Valuation August 2012: ~$50 B

Price Waterfall Example

Price ($)

Major Opportunity

620 45

1 67

507 15 251 5 6 455

0

200

400

600

800

TransactionPrice

OrdersizeDiscount

Upcharges MCP / BidDiscounts

and WaivedUpcharges

InvoicePrice

Credits Discount /Terms

Misc.Charges /

Allowances

Rebates DebitBacks

PocketPrice

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