MKTG 4300 - Pricing & Channels - Midterm 1 Review

Financial Analysis Step 2: Calculate BE Sales change

Price Change = Price * Desired Change % % BE Sales Change = -(Price Change) / (CM + Price Change) Unit BE Sales Change = % BE Sales Change * Original Volume

Price Sensitivity is High if...

Product - Low differentiation - Easy comparability - Performs as expected - Not mission critical Buyer - Sophisticated, deliberative - Bears little / none of cost - Able to switch out easily - Not motivated by prestige

Perceived Value & Positioning

The way one sets their: 1) Target 2) Frame of Reference 3) Key Benefit Will affect the way that consumers see one's brand and how it's positioned.

Break-Even Analysis

To determine break-even quantity: Fixed Costs / (Unit Price - Unit Variable Cost) A.K.A Fixed Costs / Contribution Margin To determine break-even sales: Fixed Costs / Unit CM% OR BE Quantity * Unit Price

Understanding Costs

Total Cost (TC) = (Fixed Cost + Variable Cost) Fixed Cost (FC) = constant regardless of volume. Variable Cost (VC) = varies according to volume.

Financial Analysis Step 1: Determine Original Contribution

Unit Contribution Margin (UCM) = Unit Price - Unit Variable Cost Contribution margin goes toward covering fixed costs -and eventually to profit.

Cost and Margin Equations

Unit Variable Cost (UVC) = Variable Cost / Quantity Unit Contribution Margin (UCM) = Price - Unit Variable Cost Total Contribution Margin (TCM) = Revenue - Variable Cost Unit Contribution Margin % (UCM%) = (Price - Unit Variable Cost) / Price UCM % of each sale goes toward covering fixed costs, and eventually to profit. Contribution Margin % (CM%) = (Revenue - Variable Cost) / Revenue At aggregate level, CM % of revenue goes towards covering fixed costs, and eventually to profit.

1) Segment the Market

Use appropriate segmentation method to divide potential market, e.g. demographics, geography, behavioral, psychographic

VALUE EQUATION

Value = Perceived Benefits / Price - If price increases, value decreases. - If benefit increases, value increases.

Cost-Plus Pricing

Adding a standard markup to the cost of the product. Price = Cost + Markup (%) - Sellers factor in what they determine to be "fair profit" for themselves. - Commonly used by retailers, wholesalers, professional services, B2B companies, contractors.

Advantages and Disadvantages of Cost-Plus

Advantages: - Fair returns over costs. - Simple and easy. Disadvantages: - If costs change as volume changes. - Passive, rather than proactive. - Can lead to "death spiral"

Calculating Price, Markup, Margin

Price = Cost * (1 + Markup %) Markup % = (Price - Cost) / Cost Margin % = (Price - Cost) / Price

3) Align target segment to key benefit

Select the combination of target segment and key benefit that you can deliver in a meaningful and differentiated way.

ARTICLE: Is a $2000 puffer jacket worth it? The truth about expensive down coats

- The reason these puffer coats are so expensive is not due to how warm they keep you. Rather, it's about the nuances of style. - Designer brands emphasize styling elements. While the jacket will keep you warm, it's more about the look than the warmth.

ARTICLE: Why concert tickets are so expensive

- Ticket prices have soared to above $100 on average - Artists relying on touring for income. Fills a gap which money from streaming doesn't. - The shift from physical to digital has been one of the primary causes of price hikes.

Non-Linear Pricing

- A menu in which the price at different quantities is not proportional to the amount that's purchased. - A menu in which the price at different quantities is not proportional to the amount that's purchased.

ARTICLE: At priceless U.K eatery, diners prove generous

- A restaurant in the U.K known as "Just Around the Corner" was described as crazy for letting customers decide how much they'd like to pay for their meal. - By providing great atmosphere, service, and food, customers generally overpay by more then 20% the average price of the same meal at other establishments. - "If you please people, they leave more money" - High level of involvement compared to other restaurants. If quality slips, the customer will pay less.

ARTICLE: How retailers use personalized prices to test what you're willing to pay

- Author tested and noticed that prices were different depending on the device he used. - Author noticed prices differed from one consumer to another. They knew what a given consumer was willing to pay. - Demand curve: some customers are willing to pay more than others. - Web retailers profile their customers using a bunch of metrics to determine how much they'd be willing to pay.

ARTICLE / VIDEO: Why real champagne is so expensive.

- Champagne is synonymous with wealth and luxury. A good bottle costs $500+ - Expensive, real champagne is made in Champagne, France. Expensive for: 1) Region - grown in cooler part of France 2) Manual labor for picking the best grapes 3) Controlled fermentation laws. 4) History & affiliation with wealth & celebrities

Avoiding a Price War

- Develop strong brand positioning (eg. differentiated) and communicate it clearly and consistently. - Improve proposition via innovations, upgrades, warranties, guarantees. - Build strong customer relationships & brand loyalty. - If necessary, execute a limited price response.

ARTICLE: About 150 U.S. Cadillac Dealers to Exit Brand, Rather Than Sell Electric Cars

- GM gave dealers a choice: accept a buyout offer to exit the brand, OR spend 200k on dealership upgrades to accommodate for the sale of electric vehicles. - Electric vehicles will reshape the way a dealership is run. Fewer maintenances will affect a key part of dealerships' businesses. - Pandemic has led to a drop-off in demand for electric cars. This makes dealers skeptical.

Why do Financial Analysis?

- Goal is to identify the tradeoffs between price level and sales volume that will result in greater profits. Managerial questions: Should we change our price due to certain circumstances? And if we do change our price, how will that affect profit? - Financial analysis involves clearly identifying costs, and then determining how the change in sales will affect profitability.

Why are Theater Popcorn Prices so high?

- High fixed costs - High clean-up costs - Limited selling time - Captive audience - Little competition - Vital aspect of the movie experience

5) Set price and optimal pricing structure

- Metrics: methods for charging the consumer. - Fences: policies, rules or programs that must be followed to qualify for the price.

Why Perceived Values Differ

- Personal Tastes - Nature of Use - Intensity of Use - Category Knowledge

Price Elasticity

- Price elasticity of demand refers to consumers' responsiveness or sensitivity to changes in price.

Pricing on Perceived Value

- Product value may be perceived differently by different individuals and / or segments. - The potential buyer has other options. - Price is often considered by the potential buyer as a measure of the product's value. Therefore, value tends to be a function of: - The benefit delivered by features / attributes. - Options that the buyer has and is aware of. - The extent to which the buyer sees price as a measure of the product's value.

Consumer Value-Based Pricing

- Setting price based on the perceived value to the consumer: aligning price with the benefit the consumer receives. - The idea that everyone should pay the same price is suboptimal. Therefore, customization of price is becoming more commonplace. Advantage: - Helps maximize company profits Disadvantage: - Difficult to do; uses conjecture

Market Structure: Pure Monopoly

- Single seller: company and industry are the same. - Truly unique product, with no close substitutes. - Entry / exit is largely blocked. - Company is price leader.

True Economic Value vs Perceived Value Gap

- TEV represents what a fully informed, rational buyer should be willing to pay. - In reality, someone's willingness to pay is governed by PV - perception of value. The gap exists because...: - They aren't aware of all benefits - They're aware of all benefits, but are skeptical of the claims - They're aware and accept the claims, but don't see the relevance of the benefits

ARTICLE: Why the world's cheapest car flopped.

- The Tata Nano was introduced in India in 2009 at a retail price of $2,000. - The car failed because Indian consumers climbing to the middle class wanted cheap cars that didn't seem cheap. - The Nano is being re-released into the "cool people's car." It will release with stereo, hubcaps, and a chrome trim. PREFACE: - Engineers designed original Nano to keep costs in check. LEAST EXPENSIVE MASS-PRODUCED CAR IN THE WORLD. - Customers didn't like it for it's sound / performance, among other issues. - Public image hurt by a series of 2010 cases where the car caught fire.

BE Analysis Limitations

- The assumption that variable costs remain proportional to volume at all output levels - Costs used in the analysis might be relevant only over a limited range of volume. - The assumption that price is constant over the relevant volume levels.

ARTICLE: How companies raise prices without raising prices

- The demand curve affects every businesses - raise prices and sales decrease, cut prices and sales increase. Either higher sales, or higher profit. 1) Unbundling services, lowering product quality and de-valuing reward programs Unbundled services so that rather than paying for everything all-in-one, consumers have to pay multiple fees. (eg: airplane seat ticket costs, luggage fee, early boarding fee, etc.) 2) Shrinkflation - Reducing weight, quantity, volume of a package while maintaining price. 3) Disappearing deals / coupons - Raise prices by providing less opportunities to get a discount. 4) The sunk costs of memberships - While Costco offers cheap products, these low prices are offset by the cost of the membership. 5) From good to better to best - Introduce higher-quality versions of products at higher prices.

Peak-Load Pricing

- The highest price is charged in periods when demand is at its highest. - Goal is to shift consumption to attain balance between supply and demand. - Widely used for non-storable products, e.g. electricity, ski resorts, hotel rooms.

ARTICLE: General Mills says prices to climb next year

- The maker of Cheerios and Betty Crocker cake mix says it is facing escalating costs across the entire business. - Example: Raw materials such as meat / grains, transportation & labor. - Start to end of 2021 saw the largest 12-month price increase for all food consumed at home at 6.4%. - Labor shortages among suppliers has also affected delivery of key ingredients to General Mills factories. - Had to work to find alternative suppliers.

Loss-Leader Pricing

- The practice of setting the price for only minimal profit - or even a loss - to attract customers who might then buy additional products with higher margins. Pros: can result in incremental sales; can encourage customers to try a product. Con: customers don't always buy more.

ARTICLE: A Quick Guide to Value-Based Pricing

- 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 competitor. 1) Focus on a single element (Brand A focusing on big-screen TV buyers, not all TV buyers.) 2) Compare with next best alternative 3) Understand differentiated worth (What differentiating factors increase / decrease price) 4) Place a dollar amount on the differentiation (How much will big-screen TV buyers pay for an extra 5 inches of screen size?)

ARTICLE: What does inflation mean for some American businesses? For some, bigger profits.

- While inflation rises, so do wages & material costs. However, this gives manufacturers the opportunity to raise price (and sometimes outpace the expense of said products). - Widespread inflation allows prices to rise, sometimes permanently. - Some of the highest profits companies have seen in awhile. - Demand for products has increased as well (computers, automobiles, luxury goods, etc.)

Financial Analysis in 3 Steps

1) Determine original contribution 2) Calculate BE sales change for planned price change.* 3) Calculate the profit implications of the actual change in sales: more or less than BE sales change? * = "Break even" relative to what our profit situation is now.

Three Simple Thought Starters

1) Of the 4 Ps, none makes a greater or more immediate impact on our profits than Price. 2) If a potential buyer can't find, purchase or obtain our product, the sale never happens. 3) Product and Promotion usually get more attention, but Price and Place have a huge influence on value and differentiation

Determining Value-Based Price STEPS ONLY

1) Segment the market. 2) Identify value drivers. 3) Align target segment to key benefit. 4) Compare to next best alternative. 5) Set price & optimal pricing structure.

Price Leadership

A price leader acts as the dominant influence on prices within a category / industry; usually has large market share and holds technical superiority. - Ultimately, price leaders can impact prices only to a limited extent - price levels tend to strongly reflect supply & demand.

Achieving Inelastic Demand

A product / service can achieve low price elasticity via strong positioning and brand equity: 1) Differentiated 2) Believable 3) Relevant

ARTICLE: How inflation has changed prices (and the menu) at one small business

After nearly 20 years in business, restaurant owner Judy Henry began charging $1.50 for loafs which used to be complementary. - The pandemic caused the restaurants' profit to cut more than 1/2, from $1.4million in 2019 to $350k in 2020. Fixed Costs (FC): - Rent / Mortgage - Yearly Salaries - Insurance - Loans & License Fees Variable Costs (VC): - Ingredients - Kitchen Supplies - Hourly Wages - Utilities

Break-Even Point

Break-even point is the quantity at which Total Revenue = Total Cost. - Sales > BEP = profit - Sales < BEP = loss

4) Compare to next best alternative

Compare your offering with the next best option to identify the worth of your point of difference. - Can use market research or "educated guess" - a step involving trial-and-error.

Pricing & Competitors

Competitors' prices usually impose a tight discipline on company's pricing, applying a downward pressure. - Competition provides buyers with more choices, increasing price sensitivity. - Competitive price levels serve as a helpful reference point for consumers. - How much a company is constrained by competitor pricing depends largely on its point-of-difference. - Matching competitor price, or going above / below, is a function of brand positioning.

3 Pricing Strategies

Cost-driven: - Company focuses on reaching profit margin with little regard to a consumers' perceived value. Consumer-driven: - Setting price based on consumers' perceived value of the product/service(s). Competitor-driven: - Setting price based on competitors' prices and strategies. It is up to a business to decide how they want to weigh cost, consumers, and competition into their pricing strategy.

The Downside of Cost-Plus Pricing

Cost-plus pricing can ensure profitability, but it also can leave money on the table.

Price & Demand + Movements

Depending on what price we set + market conditions, demand changes. Cause of movement: - Product goes on sale - Price increase driven by higher (production) costs. Causes of complete shift: - Consumer tastes - Price or availability of similar products - Consumer income

Financial Analysis Step 3: Calculate profit implications

Determine the true profit impact of the price change, based on actual sales results. Change in Profit = (Change in Actual Unit Sales - Change in Unit BE Sales) * New Cont. Margin OR Change in Profit = (Change in Actual % Sales - Change in % BE Sales) * Base Sales & New Cont. Margin

Market Structure: Oligopoly

Few large companies: must carefully consider rivals' reactions to all pricing decisions. - Standardized or differentiated products - High barriers of entry due to sunk cost

Why Contribution Margin Matters

For every dollar of revenue, (100 - CM%) goes to cover variable costs. The other CM % contributes to fixed costs - once covered, goes to profit.

Pricing Objectives

Goals a company hopes to accomplish through its pricing strategies. Main idea is to maximize profit: - Current profit - Long-run profit - Target return (ROI) Depending on the company, a certain metric would be emphasized. - Nordstrom: Sales volume in $$$ - Walmart: Sales volume in UNITS - Pampers vs Huggies: Market share - JCPenney: Survival - Patagonia, TOMs: Social responsibility A company that fails to grow profit year over year risks being uncompetitive and eventually going out of business.

Price, Promo Work Together

High/High Strategy - Strong marketing => higher PV => higher price => higher margins => more marketing investment...

Closing the TEV-PV Gap (+ Example)

Ideally, marketing efforts should turn an uninformed, skeptical consumer (one with low PV) into a fully informed, rational buyer (whose PV approaches TEV). Closing the gap between TEV and PV can be achieved via various marketing levers: advertising, personal selling, getting the consumer to try the product.

2) Identify the value drivers

Identify the most important benefit(s) consumers truly seek from their purchase. - Remember: Consumers seek solutions, not things.

Cost-Plus Death Spiral

If sales decrease, you will have to continuously increase price, leading to even less sales.

Cost-Plus Pricing in Grocery Stores

In grocery stores, higher markups are typically applied to products with: - lower volume - lower turnover - higher perishability - more handling.

Market Structure: Monopolistic Competition

Large # of companies, with no single seller controlling the market. - Differentiated products or services - Easy entry and exit

High Price vs Low Price

Lower price implies: - Higher sales - Lower profit margin - Lower quality - Undifferentiated brand - Weak brand equity (Typically appropriate in later stages of product life cycle) Higher price implies: - Lower sales - Higher profit margin - Higher quality - Differentiated brand - Strong brand equity (Typically appropriate in earlier stages of product lifecycle)

Markup vs Margin

Markup: % by which we increase cost to get price. Margin: % of price that represents our gross profit.

Finding BE Point & Sales with an included One-Time Fee (annual endorsement, etc.)

One-time Fee = X BE Point = (Fixed Costs + X) / (Unit Price - Unit VC) BE Sales = BEP * Unit Price

Profit Equations

P = Total Revenue - Total Cost OR P = (Unit Price - Unit Cost) * Unit Sales Total Revenue = (Price * Quantity) Total Cost = (Fixed Cost + Variable Cost)

Private Label

Products made by a contract manufacturer, sold exclusively under a retailer's brand name. - Quality of Private Label is obviously lesser than national brands. But consumers were OKAY with that. - Typical Private Label price is 8-10% below national brand price. - Private Label has become the share leader in many grocery categories. - The extent of Private Label is driven largely by the size of the price gap between it and the national brand.

Finding BE Point & Sales with Sale Royalties included

Royalty = X BE Point = Fixed Costs / (P - (Unit VC + X)) BE Sales = BEP * Unit Price

Finding TARGET Quantity & Sales based on Desired Profit

Target = (Fixed Costs + Desired Profit) / (Unit Price - Unit VC)