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What is Pricing?
“The single most important decision in evaluating a business is pricing power. If you’ve got the
power to raise prices without losing business to a competitor, you’ve got a very good business. And
if you have to have a prayer session before raising the price by 10 percent, then you’ve got a terrible
business.” – Warren Buffet.
Pricing means different to different people. For the sake for simplification categorise into two groups
of people – Brand conscious and Price Sensitive. The value received from pricing means different to
each group. Pricing is also looked at from the company perspective – here the cost + profit is added
into the price of the product.
When companies reduce price of product, the product’s value increases and vice-verse. In this case
the company is either reducing the profit margin or increasing the profit margin. Therefore, the price
of the product directly impacts the value a customer gets from the product – whether that be
functional, hedonic, symbolic or cost-saving.
E.g. the actual price for Tim-tams in coles is $2.50 and if a consumer is on a diet the value Tim-tams
have on the customer is low, however if the price drops by 50% the consumer is more likely to
purchase it either for immediate consumption or future use.
Customer Perspective Pricing:
Benefits for Functional Product: Core product + augmented product. E.g. Flight tickets: Core
product – travel, Augmented Product – meal, entertainment. Prices will vary based on the
augmented product – more leg room will cost more.
Benefits for Symbolic product: Core product + recognition, confidence, and reliability.
Companies needs to understand to be able to price their products better.
Company Perspective Pricing:
Cost + Profit
Pros and Cons
Discounting price pros – increased value, can make consumer try your product, and can
convert consumer to your product.
Discounting price cons – might affect the evaluation of the product – close to expiry, defect.
High price pros – companies make more profit, more margin, change the image of the brand
– more reputable.
High price cons – may reduce market share, might lead to substitution, customer may perceive
low value.
Economics of Pricing
Price elasticity: the responsiveness of the quantity demand and supply in relation to price.
Low price elasticity a.k.a Inelastic Demand – when price changes make a small difference in the
demand. E.g. daily consumer goods – milk, eggs, bread, seasonal products – mangoes.
High price elasticity – small changes in price will result in large changes in the quanty demanded. E.g.
real estate, clothing, luxury goods.
Pricing objectives
Internal orientation
Profit maximization
Sales volume/market share
Product quality attributes
Competitive orientation
Create barriers to entry
Avoid competitive attacks
Maintain current market position
Political/External orientation
Avoid political problems
4. Value-based Pricing
- Definition: “Value-based pricing is the method of setting a price by which a company
calculates and tries to earn the differentiated worth of its product for a particular customer
segment when compared to its competitors”. Key to value-based pricing is to understand the
customer and competitor and price accordingly.
- Value-based pricing requires a careful understanding of the value a customer gets. Here the
value is the benefit you get in exchange for something you give up. When consumers are
forced to make tradeoffs in their purchase, brands can learn what they truly value.
o HRB Example: To understand how value-based pricing works, let’s take the example
of Brand A that is about to launch a new LED television. It wants to figure out the price
for its new 65-inch LED TV, the biggest screen size in the marketplace at the time. The
company’s closest competitor, Brand B, recently introduced a 60-inch TV for $799.
Both TVs have other features that are similar – both have built-in WiFi, the same level
of definition, same number of HDMI inputs, same refresh rate, and so on.
Focus on a single segment: Value-based pricing always references one
specific segment (For B2B products, it can be a single customer). Brand A’s
focus is only big-screen TV buyers, not all TV buyers. Marketers can’t use
value-based pricing unless they have a specific segment. If they have multiple
segments, they must determine a suitable value-based price for each one.
Compare with next best alternative: Value-based pricing only works when
the target segment has a specific competitor’s product they can buy instead.
Always asks the question: “What would this segment buy if my product wasn’t
available?” This “next best alternative” for the target is the essential point of
comparison for calculating the value-based price. For products that are truly
new, without peers, the value-based pricing methodology won’t work well.
Understand differentiated worth: Next step is to identify product features
that are unique, that is, differentiated, from the competitor’s offering. In the
example only the larger screen size is a differentiated feature.
Place a dollar amount on the differentiation: Last and most difficult step is
estimating the dollar value of the differentiated features. Example: how much
will big-screen TV shoppers pay for an extra 5 inches of screen size? And then
add that amount to Brand B’s price. To accomplish this step, marketers
typically use research methods like conjoint analysis or qualitative customer
interviewing.
o Just because the differentiated worth is $150 doesn’t mean the company will get it all
(negotiation process → marketer may have to share the differentiated worth with the
customer.
- Common misconceptions about value-based pricing:
o MC1: Value-based pricing requires the company to evaluate consumers’ willingness-
to-pay for each and every product feature
i.Features shared with competitor’s product are already captured in their
product price. Only calculate value of differentiated features.
o MC2: Even if competitors are not smart with pricing, using value-based pricing will
lead to success
i.Success of value-based pricing depends on how smartly competitors have
priced their products. If they have set untenably low prices, value-based pricing
can’t save you -> still only able to add the value of the differentiated feature
values.
o MC3: The brand’s value is part of the value-based pricing calculation
i.Much harder to deal with brand value in v-b pricing. This is why brand value is
left out of the equation with v-b pricing. And it is one reason why the method
is more popular in B2B settings that give less weight to the brand value.
- Reasons value-based pricing isn’t more widespread: difficulty in assessing value,
communicating value, market segmentation, sales force management, and senior
management support.
o Problems:
Lack of data, processes and tools to measure customer value reliably
i.Value, as perceived by customers, is seldom found in what the firm thinks it is
selling.
ii.Empirical tools: conjoint analysis, expert interviews and customer expert
interviews and customer value-in-use assessment.
iii.Deep understanding of customer value & using the language of the customer
→ allows seller to quantify willingness to pay with greater degree of
confidence.
Communicating the value offered, two challenges:
i.Companies are aware of the value of their product but unsure what this
performance actually means to a customer using the product.
ii.Buyers are reluctant to buy into “sales pitch” (interesting and compelling ways
to get the ear of the customer and earn their trust is necessary)
Overcome market segmentation → companies use multiple variables to
segment their markets (age, disposable income, gender, account size,
industry type)
i.Customer segmentation starts with mapping customer needs
ii.Allows the differentiation between groups of people with varying willingness to
pay and prepare tailored offerings (typically reduces the perception that most
customers are quality-insensitive, price-conscious buyers)
Sales force management (poor salesforce management leads to discount
waves to reach quotas) → long-term consequences is lack of confidence in
value added of one’s which further fuels price discounts.
i.Steps to be taken in salesforce management: establishing clear guidelines
for price promotions, staggering levels of approval for granting concessions,
restricting discounting latitude at the level of sales representatives,
continuously monitoring the gap between list
Lack of senior management support
i.Many senior managers still believe that market share translates into high
profitability → sales force encouraged to seek top line growth by focusing on
volume and have no incentive to sell value.
ii.Important to establish that quality (profitability) of market share is more
important than sheer amount.
o Implementation of value-based pricing, five distinct types of capabilities needed to
understand and communicate value:
a. Capabilities in value assessment
b. Capabilities in value communication
c. Capabilities in market segmentation
d. Capabilities in sales force management
e. Capabilities in leadership
- Pricing for Value:
a. Value-based pricing implies basing pricing on the product benefits perceived by the
customer instead of on the exact cost of developing the product.
b. Difference Feature/Benefit: Feature → Legroom in airplane / Benefit → ability to
sleep
c. It is a method of pricing products in which companies first try to determine how much
the products are worth to their customers. The goal is to avoid setting prices that are
either too high for customers or lower than they would be willing to pay if they knew what
kind of benefit they could get by using a product. Most products are still priced according
to what they cost to produce. But some manufacturers and IT vendors employ an
alternative approach, using information technology to help estimate how much value a
product would provide to the buyer, then basing its price on that value.
d. For example, one pharmaceutical maker priced a new antiulcer drug, but not by
adding up the costs of developing and manufacturing the medication and tacking on the
amount of profit it wanted to make. Instead, the company used value-based pricing
techniques to justify a higher price than it might otherwise have been able to get from
medical insurers. Its weapon: studies that showed the new drug could help patients avoid
expensive surgery, which in turn would lower costs for the insurance companies.
e. Long term, by definition, prices based on value-based pricing are always higher or
equal to the prices derived from cost-based pricing (if they were lower, it would mean
that the actual value perceived by the customer is lower than the costs of producing the
good plus a profit margin, meaning that companies would not be interested to produce
and sell at that price in the long term).
- Conjoint Analysis Study is concerned with understanding how people make choices between
products or services or a combination of product and service, so that businesses can design
new products or services that better meet customers underlying needs. The fulfillment of
customers, wishes in a profitable way requires that companies understand which aspects of
their product and service are most valued by the customer. Conjoint analysis is considered to
be one of the best methods for achieving this purpose. It consists of generating and
conducting specific experiments among customers with the purpose of modeling their
purchasing decision. E.g. surveys/questionnaires asking client multiple questions to
understand their position in case of a new telecommunication service to be launched. These
questions would cover topics of price, features, brand, and network connectivity to get a well-
rounded response.
5. Reference Pricing
- Is also known as competitive pricing. because here the product is sold just below the price of
a competitor's product. Reference price is the cost at which a manufacturer or a store owner
sells a particular product, giving a hefty discount compared to its previously advertised price.
Marketers generally induce buying behaviour in customers by putting goods and services at a
huge discount compared to its original price. Human beings tend to compare the price of the
product with the reference price, and if the new price is heavily discounted compared to the
original price, it could trigger buying, thereby increasing value. Under r-p product choices
looks more attract next to a costly alternative than it does in isolation – Isolation Effect.
- Internal reference pricing: This is when the companies sets a price lesser than the previously
advertised price.
- External reference pricing: using the price of the competitors as a highest benchmark and
setting a price on par or lower.
- Brands use phrases like best price guaranteed to lure consumers. Brands are either price
matching or price beating. E.g. Bunnings in Australia, Life Pharmacy in Dubai, UAE.
6. Personalised Pricing
- Means selling the product for different prices – Airline, Hotel, Travel.
- It means moving the moving consumer surplus over to the manufacturer. The more there are
different forms of personalised pricing the more of the consumer surplus can be moved.
- Consumer can self select – selecting the ticket for a flight or be selected – pricing because you
are member or a loyal customer.
- Does different pricing work? To an extent they do work, depending on the context in which
the product is sold. If in a flight food is not included in the fare price of the ticket and it is a
long flight, travelers of the economy class may pay a different price for food than the business
or first class.
- Not every buyer is the same and the prevailing “one price fits all” model is becoming obsolete.
The promise is that machines will find valuable trends in consumer behaviour – what people
buy, when they buy and how they want to buy – and help retailers create specific offers and
prices that could encourage more spending. The online retailer only asks for your name when
you register on the website, but it carefully tracks what you have purchased and collect
personal information about your buying habits. Personalization helps them identify your
interest and your willingness to pay. Once you make a purchase, you are presented with
recommendations based on your previous purchases.
o E.g when purchasing a cookbook on amazon.com, you are presented with options of
cooking utensils that can go well with the cook book, or when you are shopping for
clothing on Asos.com suggested items pop up to enhance the appearance of the item
you purchased.
- Some forms of personalised pricing:
o Auction
o Promotional pricing
Sales, coupons, rebates.
Only worthwhile if these segment markets and fit with
product/service. E.g. ½ off chocolates, discount on dips when you buy
chips.
For business markets consider the pass-through ratios. E.g. high-low pricing.
Charging high on a regular basis but running frequent promotions to lower
prices temporarily on selected items, Everyday low pricing (EDLP): charging
constant low prices with few or no temporary price discount – ALDI, CostCo.
o Group pricing (based on group membership/identity)
Price sensitivity issues.
Two versions:
Supplier decision
o Product pricing varying for individual and/or business or
group. E.g. SPSS - company = $41,800, students = $59.
Buyer decision
o Discounts when you take a credit card from a specific bank.
E.g. Emirates NBD offers Emirates lounge access at the
Emirates Airport.
International Pricing
o Different versions in the same market for the same product –
electronic vs. paper books.
o International pricing: US edition textbook: $70, Indian edition
textbook: $25.
o Problems raised by internet: localisation is a partial solution,
grey markets cause parallel imports, and sometimes natural
barriers exist to deter grey markets, e.g. language,
keyboards, warranties etc.
7. Pricing Dynamics
- Pricing strategies do not only relate to the level at which you set a price but also the dynamics
of the price level. Few products have constant prices in most cases prices drop towards the
end of the product cycle. E.g. the value of a brand new car depreciates the moment it is out
of the showroom.