Pricing and Channel
Marketing is the process of
planning and executing the conception, pricing, promotion and distribution of ideas, goods, and services to create exchanges that satisfy individual and organizational goals.
revenue
price x unit-sales
pricing strategy
proactive, planned, focusing on long-term effect
cost-based pricing
product > cost > price > value > customer
Value is the
ratio = (perceived benefit/ Price)
discounts & allowance vs. loss-leader pricing
really about the strategy or whatever you are doing - loss leader: short-term sacrifice to build business later - discount can be a standard policy
profit
revenue - cost
Manufacturers' loss leader pricing
(= captive product pricing) - manufacturers have loss leaders and make profit from other supplementary products
Why Value Matters?
- "Frugalnomics" and the economic buyer - Multi-channel competition - Global competitors - Less emphasis on relationships
Profitability Analysis - elements of profitability
- (P) Price Per Unit - (Q) Volume - units - sold per period - Costs - - Variable per unit (or activity) (VC) - - Fixed per period (FC)
What distributors say about value
- 90% of respondents believe that they deliver more value than their competitors - This response is nearly identical to the response from two years ago. - Two issues: 1) Price Pressure 2) Unclear understanding of value
The Lake Wobegon Effect
- A natural tendency to overestimates one's capabilities, is named after the town. The characterization of the fictional location, where "all the women are strong, all the men are good looking, and all the children are above average," has been used to describe a real and pervasive human tendency to overestimate one's achievements and capabilities in relation to others
Customer Value-Based Pricing
- Value-based pricing: firms set selling prices on the perceived value to the customer, rather than the actual cost of the product, the market price, competitor prices, or the historical price goal of value-based pricing: to align price with value delivered - marketing: creating value for consumers - pricing: capturing the value created fro consumers
Value and Price Positions
- We offer - much more value - than our competitors for a - higher price - than our competitors We offer - more value - than our competitors for roughly the - same price - as our competitors - We offer - comparable value - to our competitors for a - lower price - than our competitors - we offer - less value - than our competitors for a - much lower price - than our competitors - we offer - more value - than our competitors for a - lower price - we offer - comparable value - to our competitors for roughly the - same price
Fixed cost
- a cost that does not vary with sales or production levels - Ex. rens, administrative salaries
Variable Cost
- a cost that is directly related to production volume - Ex. parts, labor
#3 Medical Products - Asthma Management
- Exercise - series of products that were aimed at management... § What was done and how it was used to solve a business problem § So the actual business thing that was going on is that the company was trying to buy a technology company that made a new enhancement technology § There was a established market leader in the market place § And a fairly expensive product that cost -> 10s of thousands of dollars to buy § That was what we called market leader -> $42K for the product § Average cost per test was $12 § Product lasted a long time (30K views) before you had to refer to get something new § Harder to maintain because it was older technology - and the maintenance cost was higher § It took longer to do the test > 12 minutes rather than 6 or 5 minutes § So there was higher labor cost -> high end nurses... § Maybe the assumption that the revenue per test was the same § So there wasn't a real big difference there § Also discovered that for certain test and technologies - there was something called the retention referral that patient came back and they came back monthly, quaterly, or every three or six months to see if they were giving the patient were working or not - how well they were working and if use the test to measure the effectiveness § So two of the technologies actually had benefit there § There were three different kinds of physicians that were evaluated § Allergies - typical allergy office might have dozen physicians § Couple nurses § And do couple thousand visits primary care doct
The cost questions in pricing are:
- How much sales gain would be required to profit from a price cut? - How much sales loss would be tolerable to profit from a price increase? - What costs can we afford to incur and still earn a profit?
Goal of Pricing and Financial Analysis
- Managerial Question: Should we increase - decrease - our price next year? - A useful financial analysis involves an accurate identification of the true cost of sales, and determination of the effects of sales changes on profitability - the goal of financial analysis is to identify the trade offs between the levels of price and sales volume that will increase profits
Why study pricing strategy and tactics? - Importance of Price
- Price is the only marketing mix element that produces revenue and profit. - can effect the bottom line through pricing
Marketers today
- Segmentation - need to figure out some way to identify characteristics - Pricing - product improvement for price to increase - Communication - - Product Development
#2 Promotion - Email Archiving
- So that was something that they were able to expand the product § Email archiving - big business that had email systems - spending lot of money and free of email storage § They don't need much storage and managed the email better § It turned out that it did same a lot of money in managing mailboxes to the users § But the real cost savings for businesses for this set of products was that it made them able to respond to lawsuits § Because they was selling into things like law firms and businesses that have lots of high liability § So the real cost savings or real financial benefit was that they didn't have to drop everything and go through gigabytes of documents in order to respond to a lawsuit § But the other thing was that when they did financial analysis - with the value model - the annual TCO for what they were doing currently was over a million of dollars but the actual cost to IT was only $50 per user The other new solutions were different § They though that their initial sales were IT sales that made the IT guys life easier - but it turned out that - their really feed out other time for all the other people in the office - otherwise had to go through their own archives... So totally change the productivity profile of all the employees
Limitations of Break-Even Analysis
- The assumption that variable cost remain proportional to volume at all output levels - the assumption that price is constant over relevant volume levels - costs used in the analysis may be relevant over a limited range of volume
Key Learning from Alpha Case
- The key success often resides in gaining a clear understanding of the real attributes driving customer choice and their relative importance - Softer nontechnical attributes - perceived reliability, quality of vendor support, ease of doing business - are often as important as or more important than precisely measurable technical features - trusting internal perceptions of which attributes drive customer choice can be a fatal mistake: rely on customers for the critical information
The loss leader pricing is effective when
- The manufacturing cost of the loss leader is minimal - consumers purchase other item(s) in addition to the loss leader
USPS: cost based pricing
- USPS change their pricing they kept increasing their costs of stamps because they were trying to cover more and more costs - but everytime they did their pricing piece - their extra volume wend down - people starting to look for alternatives such as DHL, FedEx - so its not always a simple formula that can simply change the dynamics of the margin
La Grand Alliance (LGA) - Summary
- Use complex allocation schemes only when they are appropriate - think about how cost information will be used when designing a cost information system - think of ways to control costs other than allocation - consider the behavioral implication of any system you design
Pricing Strategy?
- a strategy is a long term plan of action designed to achieve a particular goal, most often "winning" - strategy is differentiated from tactics or immediate actions with resources at hand - originally confined to military matters, the word has become commonly used in many fields: - business strategy, economic strategy, marketing strategy, treading strategy, technology strategy, game theoretical strategy.
Break-even analysis
- break-even point is the quantity of output at which total revenue = total cost - sales exceeding break-even point result in a profit - sales below it results in loss
Brands Can Move On the Matrix
- by developing the right messaging, a company can differentiate - if you can persuade customers that buying from the company matters a lot, you can grow market share rapidly - there is a structured approach called - laddering - that is used by leading marketing companies to develop such messages
pricing orientations
- cost-driven pricing; most basic, ability to produce high quality at low cost - Customer-driven pricing; something that meets value - Costco going after segment that cares about getting a good deal - competition-driven pricing;
cost plus pricing advantages
- fair returns over costs for each item sold. - simple
cost-driven pricing Strategic - the cost questions relevant to pricing are:
- how much sales volume would we need to profit from a price cut? - how much sales volume could we afford to lose and still profit from a price increase? - What costs can we afford to incur and still earn a profit on the resulting sales?
steps of value oriented pricing
- identify potential economic value - build economic value model - validate economic value with voice of customer - develop price model
Customer Driven Pricing
- is figuring out what is the customer willing to pay but its not customer WTP but what price is justifiable - the customer question relevant to pricing is not: What price is the customer willing to pay? the customer questions relevant to pricing are: - what price can we convince customers is justified by the value of our product - or service - to them? - How can we better segment customers to reflect the differences in value to different types of customers?
cost plus pricing - disadvantages:
- it may not be able to determine the costs before the price. Why? - may not know cost for a year - volume changes with the price - passive pricing, not proactive - may lead to a death spiral
Common pricing strategy and tactics
- loss leader pricing - discount/ allowance - segmented pricing - psychological pricing - geographic pricing
the goal of pricing strategy should be to
- maximize long run profitability Pricing Strategy: costs, competition and customers -> strategic objectives > goals > tactics
Demand
- price and demand are inversely related - price elasticity of demand - the: Change of Demand / Change of Price
psychological pricing
- prices as a quality cue - Ex. Starbucks - Prestige pricing; raising price above competitive level - Ex. Tag Heuer raised average price from $250 to $1,000 - Odd pricing - setting the prices at uneven amounts such as $1.99 rather than $2.00
cost-plus pricing
- pricing based on costs and markup - percentage of selling price that is added to the cost to get the selling price - selling price = cost + markup - most retailer and wholesalers use cost-plus pricing
other marketing mix elements
- product; product life cycle, product quality and benefits - distribution; types of distribution outlets - promotion; sales promotion
La Grand Alliance (LGA) - Cost Information
- raw materials are a normalized estimate of the target cost of an individual dish - in practice, cost would be increased by waste in preparation, imperfections in measurement, "fix-ups", staff meals, spoilage, and shrinkage - prep time for an individual dish did not take into account time spent on prior preparation, e.g. stocks, sauces, dough, etc. - prior prep could be as much as 30% of staff time
Pricing Tactics
- reacting to marketing conditions; offensive or defensive; focusing on short-term effect
Loss-Leader Pricing
- sell a product at a loss to get a bunch of customer in the door - Example: Sell turkey at a loss on thanksgiving and people buy other things - deliberately selling a product below its customary price to attract attention to it (not always loss)
price elasticity
- soft drink, coffee, snack: 1.5 to 2.5 - fruit, vegetable, wine: 0.8 - watches: 0.4 - Gasoline: 0.2
rational vs emotional buying behavior
- some purchases are inherently more emotional than others - large purchases are inherently less subjective than small purchases - buyers often use analytical tools to evaluate large purchase options - there are often multiple decision markers, which "washes out" biases
Demand is less elastic when
- there are no or few substitutes - buyers have strong preferences towards products or brands - buyers think that higher prices are justified by quality improvement: high price signals high quality
Value Analysis
- to know who we should charge to, and how much to charge, we need customer value analysis - customer value analysis is to understand all the experiences that customers have with the products and services the firm provides them
La Grand Alliance (LGA) - Background
- week before restaurant opening in Boston in 1976, US bi-centennial - la Grand Alliance is in the Lafayette Hotel and owned by L'unions des Grand Hotels (UGH) - capacity of 100 people at a time, 700 dinners per week, 750 lunches, 4.3 weeks per month - Aim for "average check" of $15 per dinner and $7.50 for lunch - cost handled elsewhere; wine cellar; shared services such as laundry and cleaning
Why Plastic Mousetrap failed?
Although plastic mousetrap were more efficient but more expensive - it failed in the market because people were used to the idea of throwing stuff away
overview of Credit Policy and Loans
Approved (rules) Denied
Three steps for financial analysis for pricing
1) Determine the contribution margin 2) Calculate the break-even sales change for the price change - or difference - 3) Calculate the profit implications of the actual sales change: is it greater or less than the break-even sales change
Performance and condition ratio - subjective assessment of Trends. Includes:
15) Loss Provision as % of Net Charge-Offs 17) Efficiency Ratio (overhead exps/revenue) 18) Assets per Employee 20) Earnings Assets / Assets 22) Loss Allowance / Non-Current Loans 25) Net Loans and Leases / Assets 26) Net Loans and Leases / Deposits 27) Net Loans and Leases Core Deposits 28) Domestic Deposits / Total Assets
Performance and Condition Ratio: Objective Assessment of Trends How to objectively assess trends:
1st consider the observable trend from the perspective of bank-management's focus on positive on financial results 2nd compare the ratio at the beginning of comparison period to the ratio at the end of the comparison period
Performance and Condition Ratio: Objective Assessment of Trends Yield of Earning Assets: A) Trend = 2016 ratio - 2012 ratio = 4.64% - 4.80% = - .16% B) Trend = 2016 ratio - 2013 ratio = 4.64% - 4.59% = .05%
A) deterioration and stable b) improvement and stable
Performance and Condition Ratio: Objective Assessment of Trends Non-Interest Expense A) Trend = 2016 ratio - 2012 ratio = 3.71% - 2.42% = 1.29% B) Trend = 2016 ratio - 2013 ratio = 3.71% - 2.54% = 1.17% improvement
A) deterioration, very negative B) deterioration, very negative
Performance and condition ratio - subjective assessment of Trends. Includes: Net Loans and Leases / Deposits (increasing trend) :
Bankers: if viewed from the perspective of the bank's positive financial performance, Trend is Positive, because: - greater leveraging of deposits increases ROE - Positive impact on positive financial results Regulators: Alternative analysis: - if viewed from the perspective of bank's over-reliance on deposits as funding source (the regulatory perspective), - Trend is Negative
#1 Product - Building Access Control
Belief: - Simple installation: IP Technology over LAN solution self-configuration tools - Lower Cost: Lower price per reader than other vendors - Low Power Consumption: IP Technology requires less power - Reduced Administration: Better software solution Reality: simple installation - IP Technology over LAN solution - self-configuration tools lower cost - lower cost per reader than other vendors - low power consumption: IP technology requires less power - Reduced Administration - better software solution
- Price determines the demand and supply of products in the economic system: Why?
Business takes time and it sets up a plan
Growth (or decline) rates
Check Lecture #3
Consumer Value-Based Pricing
Costs, Customers, and Competitors -> Strategic Objectives -> Goals -> Tactics
geographic pricing strategies
F.O.B. (free on board) point-of-purchase pricing - seller pays cost of loading goods on carrier; the customer pays entire transportation cost (A to B: paid by buyer - fuel cost) Uniform delivered pricing - same delivered price for all customers, Zone-delivered pricing - customer within the same zone pay the same total price
Producer Cost = $21.60 Markup = $2.40 Margin? Markup?
Markup 2.40/21.60 = 11% Margin 2.40/(2.40+21.60) = 10%
Price as a product differentiation and a positioning tool: Why?
Same products - different labels - have different price - due to: Status, - its really about what they can get for - and is called value
Performance and Condition Ratio - Objective Assessment of Trends
Performance ratios (3-14, 16, and 19): 3) Yield on Earnings; 4) Cost of Funding Earning Assets; 5) Net Interest Margin; 6) Non-interest income/ Earning Assets; 7) Non-interest Expense / Earnings Assets; 8) Loan/lease loss provision/Assets; 9) Net Operating Income/Assets; 10) ROA; 11) pre-tax ROA; 12) ROE; 13) RE/Avg. Assets; 14) Net Charge-offs / Loans; 16) Earnings Coverage (X) Net Charge-Offs; and 19) Cash Dividends / Net Income Condition Ratios (21, 23, 24, and 29-33): 21) loss allowance / loans; 23) non-current assets and ORE / Loans; 24) non-current loans / loans; 29) equity capital / assets; 30) Core Capital - leverage - ratio; 31) Tier 1 Risk-Based Capital; 32) Total Risk-Based Capital Ratio; and 33) Common Equity Tier 1 Cap Ratio
Performance and condition ratio - subjective assessment of Trends. Includes: Loss Provision / Net Charge Offs: Increasing Trend (vice-versa)
Regulators: If viewed form the prespective of the bank's positive financial performance, Trend is very negative because: - changes in loss provision compared to changes in net charge-offs - if change in loss provision is greater than change in charge-offs, more money is going into loss reserves than is being charged-off Bank: Alternate analysis - if viewed from the perspective of the bank's cushion against loan losses, Trend is Positive
Performance and condition ratio - subjective assessment of Trends. Includes: Efficiency Ratio (overhead Exp / Revenues): Increasing Trend (vice-versa)
Regulators: If viewed from the perspective of the bank's positive financial performance, Trend is very negative, because: - Changes in overhead expense compared to change in Revenues - If change in overhead expense is greater than change in revenues, growth in overhead expense is out-pacing growth in revenues - negative impact on positive financial results Alternative analysis: - If viewed from the perspective of bank's successful expansion of market area, facilities and employees - Trend in Positive
Performance and Condition Ratio: Objective Assessment of Trends How to objectively assess trends:
Stable is change of +/- .25% Positive is improvement of greater than .25% Negative is deterioration of .26% to .75% Very negative is deterioration of greater than .76%
The Break-even Sales Change
The change that would sustain the same level of profit contribution at the new price as was achieved at the original price. A higher level of sales will produce higher profitability; a lower level of sales, lower profitability.
Rational to 1.1 A
The president's current thinking is flawed. Without knowing the price sensitivity of the market, he can't assume he'll sell 80K units at $9.25. In fact a price increase is likely to decrease sales further. What's needed is to first determine the likely impact of the price change on sales volume.
Performance and condition ratio - subjective assessment of Trends
Trends of certain other ratios must be assessed subjectively, considering the dynamics of the ratio components.
The cost question in pricing is not
What prices do we need to cover costs and achieve our profit objectives?
cost-driven pricing Tactical - the cost question relevant to pricing is NOT:
What prices do we need to cover the costs and achieve our profit objectives?
Marketing is a function of
a business, distinct from finance and operations
discount/allowance
people don't expect to pay list price - promotion
Cost-driven pricing
advantages: - most common pricing method - pricing to yield a fair return over all costs. simple. Disadvantages: - it may be impossible to determine the cost before determining the price. Why? - problem - costs change with volume. - price proactively rather than re-actively - may lead to a death spiral
Price is the
amount of money needed to acquire a product or service: - Buyers: cost - Sellers: Income
Segmented Pricing
anytime you can define a piece of your target market based on some characteristics
why can certain industries have higher margins (cosmetics) and why other industries have lower margins?
because its a case where its purely a perception of the brand vs someone who is actually a bargin shopper, who is trying to buy the same thing - and you have brands that is considered to be price effective that you buty them specifically because you can afford them
discount and allowance
cash discounts - deduction granted for paying bill within a specific time quantity discounts - deduction for large quantity purchases - encourage large volume purchase seasonal discount - deduction granted fro orders during off-season
segmented Pricing
consumer-segment pricing - discount for children and students product-form pricing - different versions of products with different prices - software: student version; standard version; premium version location pricing - seat prices in a concert (front seats are more expensive relative to the back) time pricing - call phone service's off-pick discounts
pricing orientations
cost-driven pricing customer-driven pricing competitive-driven pricing
perceived acquisition value
customer value = perceived benefits/ total sacrifice - what are the sacrifices to consumers in the purchasing process? costs to customers: - price; purchasing cost; time; - search cost: risk of non-performance; - service and maintenance, and any other life-cycle cost involved; - psychological costs involved in shopping and searching - opportunity cost of forgoing alternatives What are the benefits to consumers in the purchasing process? Benefits to customers: - products and their functions - reputation and image of products - additional services to provide reliable parts or service - a product's ability to reduce costs or improve gains through its use
value-based pricing
customers > value > price > cost > product
geographic pricing
delivery - further you live - the higher the cost
elastic demand
demand changes greatly with a small change in price
inelastic demand
demand hardly changes with a small change in price
strategy or tactics; a price cut at the selling season?
discounts - people want to know that they are beating someone through discounts
pricing strategy
does affect the survival of firms
Price
is a noun and a verb - that WTP and giving up something
retailers' loss leader pricing
loss leaders: temporary price cut to attract customers
price should depend on
marketing environment; consumers, competitors, distribution channel members
Competition-driven pricing
match the competition: - pricing to meet competition - pricing below competition - pricing above competition - short-term gains in market shares - long-term consequences of price wars - erosion in profits - price wars The competitor question relevant to pricing is not: What level of price will enable us to achieve our sales and market share objectives? The competitive question relevant to pricing are: what level of market share can we most profitably achieve, and how can we most profitable achieve it?
Psychological Pricing
not a rational buying decision - getting into your head
Performance and Condition Ratio - Objective Assessment of Trends
some ratios are assessed objectively by comparing the changes in the ratios from one period to another
Total Cost
sum of total fixed cost and total variable cost
Xbox demand is price iPhone Demand is price
xbox...elastic -> low price inelastic -> high price
disadvantage of cost-based pricing
you don't always know what the cost is all the time
Setting Value, Not Price
you should be trying to figure out - instead of coming up with price - it should be the last thing that you should come up with in your arithmetic - focus on value