Pricing Management

Pricing Management

Managing Price, Gaining Profit

• Pricing is the fastest and most effective way for a company to realize its maximum profits. The wrong price can shrink it just as quickly. The leverage and payoff of improved pricing are high.[pic 1]
• Improvements in price typically have 3x-4x effect on profitability as proportionate increases in volume. Many managers overlook a key aspect of pricing management issues – transaction price management. Transaction level is the point where the product meets the consumer. Most companies use invoice price as a reporting measure instead of using actual transaction price.
• Pocket Price Waterfall, Pocket Price Band → Concepts that show companies where their products’ prices erode between invoice price and actual transaction price.

The Three Levels of Price Management

• Industry supply and demand - Changes in industry supply, demand and costs have very real effects on industry price levels. Managers should understand the pricing tone of their markets i.e. overall direction of price pressure and the variables fueling that pressure. This knowledge will allow them to predict and exploit broad price trends.
• Product market strategy – Trick is to understand what factors of the product and service package customers perceive as important and how a company and its competitors stack up against those factors to extract maximum WTP. Conjoint analysis and focus groups help in product’s price positioning and fine tuning of product and service offerings.
• Transactions – Decisions involved are what base price to use and what terms, discounts, allowances, rebates, incentives, and bonuses to apply. Focus here is microscopic. Transaction to transaction, deal to deal. The three discrete levels of price management are clearly related.

The Transaction Pricing Opportunity

• Top management neglect, high transaction volume and complexity, and management reporting shortfalls contribute to missed transaction pricing opportunities. MIS usually reports only on average prices and not transaction level prices.
• The Pocket Price Waterfall – Companies normally use invoice price as a measure to monitor price performance. This does not reflect the true transaction amount in many cases due to a host of pricing factors like prompt payment discounts, volume buying incentives, and cooperative advertising allowances. Pocket Price = Invoice Price – Income lost through transaction specific elements. Pocket price is the right measure of the pricing attractiveness of a transaction. The average decline from invoice down to pocket price was 16.7% (FMCG), 21.9% (Auto), 28.9% (Lighting)

[pic 2]

• The Pocket Price Band – Items sell over a range of prices. This range given a set unit volume of a specific product, is called the pocket price band. Understanding the variations in pocket price bands is critical to realizing a company’s best transaction pricing opportunities. Managers are surprised by the width of the price band and the customers at the end of it. Insights → What percentage of volume sells at deep discounts, whether there exists groups of customers who are willing to pay higher prices and now appropriately field discounting authority is being exercised.
• Castle Case Corrective Actions

• Aggressive corrective actions to bring the over discounted “Old favorite” accounts back in line
• Program to stimulate volume in larger accounts that had higher than average pocket prices. Increased volume not by lower prices but by identifying value add for each customer and delivering them.
• New MIS, clear decision rules for each discretionary item in the waterfall, pocket price as the universal measure of price performance.

• Tech Craft Corrective Actions

• Shifted their largest off-invoice discount – the annual volume bonus to on-invoice
• Used insights regarding dealers’ unequal sensitivity to different pieces of the waterfall to alter their pricing approach in several areas.

Capturing Untapped Transaction Pricing Opportunity

• Manage the pocket price band
• Engineer the pocket price waterfall
• Get organizational involvement and incentives right

Lecture 1

Marketing → Any activity in the firm that is to do with directly influencing the choice of the customer is marketing. Positioning statement is created to guide an organization what it must do and what it must not.

• Pricing Approaches

• Cost plus pricing approach – Widely used. Simple, fair, prudent.
• Competitors based pricing orientation
• Sales or customer based pricing orientation

• Say if you decrease price, volume might increase as expected but the increased volume might increase the SGA
• Info needed to make pricing change decisions → What is my CM? & What Is the price sensitivity?
• CM is high, delta S required is very small and hence such companies will be more aggressive.

Mapping Your Competitive Position

Most companies have to build fresh competitive advantages and destroy others’ advantages faster than they used to. The process is disorderly and unstable. Most customers can’t determine the features that determine their WTP, and 50% of salespeople don’t know what attributes justify the prices of the products they sell.

Price-Benefit Positioning Maps

• Price-benefit positioning maps shows the relationship between the primary benefit that a product provides to customers and the prices of all the products in a given market.
• Step 1: Define the market.

• Identify consumer needs → Cast a wide net include everything that can satisfy those needs then → Country or region to be studied. Other choices could be segment vs market, product vs brand etc.

• Step 2: Choose the price and determine the primary benefit.

• Specify the scope of your analysis of prices. Retail Vs wholesale prices, prices with transaction costs or without them, bundled or unbundled etc. and maintain uniformity.
• Identify the primary benefit – the benefit that explains the largest amount of variance in prices. Success depends on the value the customer places on the benefits.
• Gather unbiased data about the price and benefits of all the competitors. Regression analysis to find out which benefit explains most of the variance in products’ prices. If many benefits are correlated they can be combined into a single benefit by creating an index or a scale.

• Step 3: Plot positions and draw the expected price line.

• Price-benefit positioning maps may be an oversimplification, but they show the relative positions of competitors on a common scale.
• Draw the expected-price line that best fits the points on the map. The line shows how much customers expect to pay on average to get different levels of the primary benefit. The line’s slope tells us how much more a customer is likely to pay for a higher level of the primary benefit. Normally a straight line that rises to the right fits the data best.
• Deviations in price above or below the line are caused by the added or reduced value associated with secondary benefits or pricing strategies designed to milk or build market share.

Interpreting Positioning Maps

• Valuing Intangible benefits - (Harley Davidson – Premium was paid not for the engine but the HOG and the experience)[pic 3]
• Anticipating shifts in the value of benefits – (Restaurants in NYC décor, food, service 73%, cuisine and location only 7%)
• Finding paths of least resistance – Sub segments where competitive intensity is low, BMW low-end pricey segment
• Preempting rivals – Draw maps based on projections of market trends

Lecture 2

• Do not ignore the effect of Ad-spend, competitors’ pricing etc. on your demand.
• Any optimal pricing → Marginal Revenue = Marginal Cost
• Pricing is just the ‘tip’ of the iceberg. It is supported by all the elements in the pricing framework. Create → Calibrate → Communicate → Capture value
• Differentiation/Pricing Premium

• Bottled water sales in USD 14B, a commodity product that is readily available. Fortified water for pets as well
• Kopi Luwak – Coffee beans defecated by Asian Palm Civet, USD 700/ kilogram

• Consumers simply buy products that maximizes their consumer surplus. E.g. PA < UA – UB + PB
• Value: Monetary gain/savings from a product + Psychological benefits. Economic Value: Maximum price that a fully-informed customer would be willing to pay. EVC = Reference Value + Positive Diff Value – Negative Diff Value
• Value Based Pricing: EVC (from customer’s perspective) & price the product below EVC to entice customers. Relatively easy in B2B but complex in B2C. And if EVC is less for a particular customer/segment, then that is not your target.
• Value Triad: Revenue gains, cost reduction, psychological benefits
• EVC Examples: O-rings → Value due to maintenance/downtime/material savings. Magazine Advertisement → Customer acquisition cost savings (Circulation, readers per copy, % seen, % motivated, %sold, sales per customer)
• EVC as a tool to calculate demand curve/segmentation and to calculate how many segments to encompass

Why Consumers Don’t Buy: The Psychology of New Product Adoption

A lot of innovative products fail because consumers overvalue existing products and undervalue new alternatives. This is because of the psychological switching costs in terms of giving up some of the benefits of the existing option.

The Prospect Theory Value Function

• Individuals are sensitive to gains and losses
• Reference point matters: The gains or losses are usually measured to a reference point, usually the status quo.
• Decreasing marginal sensitivity: The curve for gains is concave and the curve for losses is convex.
• Aversion to losses: Consumers don’t treat losses and gains of comparable sizes the same.

The Endowment effect

• People value items in their possession more than they value items not in their possession
• It is not enough for an innovation to be objectively better than the product it seeks to replace; it must be significantly better to overcome the biases consumers bring to their analysis.
• Because of innovation the losses (expenses, behavior change, foregone benefits) are immediate and the gains are delayed. Benefits accrue over the life of the product or don’t manifest themselves until some later point of time.

The Psychology of the Innovator- The “Developer’s curse”

• Problem 1- Self Selection: “Believers” are the people who work in towards innovating a new product even though they know that there are losses involved in moving away from an existing product. Innovators are the only people who would adapt to a new product and they lie on an extreme. For these people, the importance of the feature is extremely high.  [pic 4]
• Problem 2- A clash in perspectives: There is a 9X problem—a mismatch of 9 to 1 between what innovators think consumers want and what consumers actually want
• Problem 3- A curse of knowledge: People find it difficult to remember what they knew prior to knowing what they know now. In other words, once we learn some information, we find it difficult to appreciate what a person who does not know that information might be thinking.

The bottom line: How much change are you asking of consumers?