Setting the Price Level

Lesson 6

Pricing for Value

Jishnu Changkakoti

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The Strategic Pricing Pyramid

Price Level
Price setting

Pricing Policy
Negotiating tactics,
price selling procedures

Price & Value Communication

Communication, value selling tools

Price Structure
Metrics, fences, controls

Value Creation
Economic value, offering design, segmentation

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 Factors in price setting
• Three key inputs for setting the price level:

• Cost of product or service

• Customer requirements

• Competitive offerings

• Firms may overestimate the value of a differentiated product

• Prices may be too low and disregard the possible premium

customers may be willing to pay

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The Price Setting Process

Communicate Prices
Define Price Window Set Initial Price
to market

Develop
Set initial price range Determine amount of
communication plan to
based on differential differential value to be
ensure prices are
value & costs captured with price
perceived to be fair

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1. Defining the price window
• We have invented a unique new product - a Price ceiling
toothbrush has a container in which toothpaste is
inserted. So there’s no need to buy a toothpaste
separately any more!
Negative
• For a customer to buy this, what would be a differentiation value
reference price?

• Assuming Rs. 60 as price of a premium Positive

toothbrush, reference price = Rs.60 differentiation value Price
Window
• What is the positive differentiation value? Total
Economic
• Assuming price of a 50g toothpaste tube is Rs. Value
50, differentiation value is Rs. 50 since you don’t Reference value
need to buy the paste

• Therefore total economic value of the product = Rs. Price floor

60 + Rs.50 = Rs.110

• Here the price window is between Rs. 60 & Rs.110

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2. Setting the initial price point
• The price point will be set within the price window
(between Rs.60 & Rs.110) based on the following:

A. Alignment with overall business objectives

B. Price-volume trade-offs

C. Customer response

• The ideal is to set a price point that yields long-

term, sustainable profitability
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A. Alignment with business objectives

• How much of the economic value do we capture by price, and

how much do we leave on the table

• Amazon’s pricing strategy at launch

• The goal was to grow market share quickly before any

competitor could enter & copy its model

• Therefore, its pricing undercut traditional retailers so much

that customer would be willing to switch to this new channel

• So technically, Amazon captured only a small portion of the

economic value added

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How much value to capture in price?
• Judgement should be driven by what will deliver long-term sustainable profitability

• Advantages of launching at a lower price

• Leaving more value on the table will help customers adopt the new product/
service faster

• Seller saves cost of customer education because she is using price to get
people in

• Quick adoption & market share gain can discourage competitive entry

• However:

• If the product is has sustainable long term differentiation, then launching with a
lower price will forgo a lot of potential margin in the long term

• Unless value is initially established and paid for by early adopters, very difficult
to raise prices later on

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 Alignment with business objectives
• Three possible strategies:

1. Skim Pricing

• normal skim, sequential skim

• Assumption - profit from selling to price-insensitive customers will exceed that

from selling to a larger market at a lower price

2. Penetration Pricing - low enough price to attract a large base of consumers

• Not necessarily cheap, but low relative to perceived value in the segment

• Can have a negative impact if brand imagery is premium

3. Neutral Pricing

• For our toothbrush, what could be the price for each of these strategies?

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 B. Define the Price-Volume trade-off
(profitability analysis)
1. Incremental breakeven analysis

• Understand relationship between changes in price and volume

• If I increase price, how much volume can I afford to lose before the price increase becomes
unprofitable

• If I reduce price, how much volume would I have to gain to improve my profitability

• Advantage of doing this - we know the payoffs for price changes without needing to figure out how
competitors will react

• For our toothbrush, if

• Let’s say we price at Rs.100

• Variable cost = Rs.30, so contribution margin = Price -VC= Rs.70

• If fixed costs = Rs.10 lakhs, then breakeven vol = fixed costs/contribution margin = 14,286 pieces

• If we take a price increase of 10% to Rs.110, then breakeven volume =12,500 i.e. my volumes can
go down by 13% without any loss of profits
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 Profitability analysis (contd.)
2. Simulations

• In situations where more precise estimation of customer response to prices is needed to

better manage risk

• Powerful way to estimate distribution of potential outcomes of each strategy by

performing thousands of simulations

• Simulation softwares are available off-the-shelf

3. Automated price optimisation

• Best approach in markets with high transaction volumes, standardised products and
non-negotiable pricing

• Used by retailers like Walmart etc. to calculate and reprice on an almost real-time basis

• Even small price improvements can give huge gains due to the very high number of
transactions involved - American Airlines 15% increase

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c. Determine customer response
• Depends on sensitivity to the price-value trade-off

• Price sensitivity drivers:

• Size of expenditure

• Shared costs

• Switching cost

• Perceived risk

• Importance of end-benefit

• Price-quality perceptions

• Perceived fairness

• Price framing - gain or loss

• Good communication on price and value can decrease price sensitivity

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Estimating customer response
• Price experimentation - test out the changes in a controlled sample of
customers first

• Purchase intention surveys

• Structured inference - use results the managers have seen in the past to
estimate results

• can range from purely judgemental to statistical

• if there is no internal company data, use surrogate data on similar price

changes in other markets, or similar products in the same market

• Incremental implementation - take a series of small steps, checking results

after each step

• Simulations

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 C. Communicating price/ price increases to customers

• Most important:

• Customers should understand the rationale for the price increase

• They should believe it is fair. Perceived fairness is one of the most powerful factors
driving price sensitivity

• This needs regular communication and alignment with customers

• Sometimes giving customers options on how to adjust to the new prices is also
necessary

• Example - a medical device manufacturer was taking a 40% price increase in a key product

1. They communicated the planned increase 3 months in advance

2. A letter was sent to customers saying that no price increases had been taken for 8
years, and the new price would still be lower than if they had taken increases

3. Personal meetings were held with key customers to explain that the product was not
generating sufficient returns, which would affect its ability to invest in R&D, & a
significant proportion of the price increase gains would be invested back in R&D
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Selling it to the sales force
1. Marketing should make sure each sales representative understands the big picture so that they buy
into the need for the change

• Present the business case showing the problem, and how the pricing change will help address it

• Make each person understand his/her role in making the strategy work through more effective
communication and negotiation tactics

2. Remove barriers that discourage behavioural change

• e.g. incentives only based on top line revenue will not make them negotiate hard for higher prices

• encourage right behaviour through other means - competition, peer pressure

3. Empower the team to ensure that they succeed

• Training - formal training sessions, mock calls with objection handling, videos showing right and
wrong way to make the call etc.

• What Jowers was planning to do in Atlantic Computers

• Selling tools

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Thank You

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