Вы находитесь на странице: 1из 64

Pricing Strategy

SY2016-2017

Marketing Department College of Business Administration and Accountancy De La Salle University - Dasmarinas

PRICING STRATEGY SY 2016-2017

1

I. Course Title: PRICING STRATEGY

II. Course Description: This course explains the role of marketing in generating income for the business by explaining to the students the basic tools used and psychological influences considered when setting the right price. The students are expected to develop the computational and analytical skills needed to place the numerical value of a product in the marketing mix.

III. Learning Objectives:

LO1: Discuss the concept of pricing using the Standard Profit Equation and the role of consumer preference using the Conjoint Analysis for part-worth and customer utility. LO1a: Compute and compare profits using Standard Profit Equation. LO1b: Compute for Part-Worth and Customer Utility using Conjoint Analysis

LO2: Discuss the psychological influences on consumer price perception, Relevant Costs, Exchange Value Model and Price-to-Benefit Map LO2a: Identify incremental and avoidable costs LO2b: Compute the price range using the Exchange Value Model LO2c: Construct price comparison using Price-to-Benefit Map

LO3: Explain Price Positioning and revisit Product Life Cycle and Ansoff Product and Market Growth Matrix. LO3a: Identify the appropriate price positioning technique for each stage in the Product Life Cycle Model and for each quadrant of the Ansoff Product and Market Growth Matrix

LO4: Discuss the price structures and explain Profit Sensitivity Analysis and Price Elasticity. LO4a: Compute for the acceptable price adjustments. LO4b: Compute for the price elasticity.

IV. Course Expectations: Students are expected to be knowledgeable of the product models, namely: Product Life Cycle and Ansoff Product and Market Growth Matrix. Equally, they are expected to understand economic variables, namely: profit, sales volume or quantity sold, income, variable cost, fixed cost, marginal cost, break-even, demand elasticity.

V. Course Outline and Timetable: This course is following the topic sequence and timing shown below:

A. Preliminary Period 1. Topics 1.1.Introduction to Price and Pricing 1.2.Standard Profit Equation 1.3.Part-Worth and Customer Utility using Conjoint Analysis

PRICING STRATEGY SY 2016-2017

2

Note: May need to review economic concepts: profit, sales volume or quantity sold, income, variable cost, fixed cost, break-even, demand elasticity.

2.Learning Activities 2.1.Classroom and Online Discussions 2.2.Graded Group Output (30%) 2.3.Graded Online Assessments (40%) 2.4.Major Examination (30%)

B. Midterm Period

1.

Topics

1.1

Psychological influences on consumer price perception

1.2

Exchange Value Model

1.3

Price-to-Benefit Map

1.4

Pricing Positioning Techniques

Note: May need to review the economic concept marginal cost and product models namely: Product Life Cycle and Ansoff Price and Market Growth Matrix.

2.Learning Activities 2.1.Classroom and Online Discussions 2.2.Graded Group Output (30%) 2.3.Graded Online Assessments (40%) 2.4.Major Examination (30%)

C. Final Period

1.

Topics

1.1

Price Structures

1.2

Profit Sensitivity Analysis

1.3

Price Elasticity

Note: May need to review the economic concept of demand elasticity.

2.Learning Activities 2.1.Classroom and Online Discussions 2.2.Graded Group Output (30%) 2.3.Graded Online Assessments (40%) 2.4.Major Examination (30%)

Important: You are required to bring in class the following: pencil, eraser, white intermediate pad, calculator, and a copy of this module. Failure to do so, you will be asked to leave the room, marked absent and will only be allowed in class with complete materials.

PRICING STRATEGY SY 2016-2017

3

INTRODUCTION TO PRICE AND PRICING

Learning Objective 1: Discuss the concept of pricing using the Standard Profit Equation and Conjoint Analysis for part-worth and customer utility.

Learning Output: Students can compute and compare profits using Standard Profit Equation and quantitatively determine part-worth and customer utility using Conjoint Analysis.

Price is the only element in the marketing mix that directly affects profits. This is the value firms assign to the product and the amount paid by the consumers during the exchange process. Smith (2012) teaches us that it is crucial to set the price correctly because if the price is too high, we lose customers, while if we price too low, we lose profit potential. One of the crucial responsibilities of a marketer that is most important to a business is the setting of the right price.

Setting the right price is both a science and an art. It is a science because it uses quantitative tools and can be tested. It is an art because it anticipates customers’ perception on various elements surrounding the purchase of a product and predicts the value given to a product.

Several of the marketing books teach us break-even analysis and cost plus pricing as tools for setting a price. Although these are necessary economic variables that a business student needs to understand, they are insufficient tools in setting the right price. First, break-even analysis tells us that an incremental price increase or a unit of product sold on top of the break-even point generates profit. Second, cost plus pricing teaches us that setting a mark-up from the cost incurred in developing the product generates profit. Although there is a mathematical truth in break-even analysis and cost plus pricing, these tools however fail to consider customer utility or the total value customers give to a product. There is always the question “how much is the acceptable mark- up?”

Customer utility has an equivalent willingness to pay. The idea of pricing too high or too low is based on customer utility or the perceived value of the product and not the cost of producing a product. Let us always remember that consumers are unaware of the actual costs of producing the products they buy, their willingness to pay a price is based on the value they give to a product.

The willingness to pay by the consumers is influenced by many psychological factors creating an idea of acceptable price. Marketers perform several tasks in framing the consumers’ perceived price range such as: First, Marketers communicate well the value of the product through its promotion and adept about the product value. Second, at any point during a negotiation, sellers price aggressively and give discounts reluctantly because the price first mentioned or the price of the immediate previous purchase serves as a reference for the consumers’ transaction price.

To appreciate the importance of price on profitability, let us look at the standard profit equation. The standard profit equation has four variables, fixed cost, variable cost, quantity sold (sales volume) and price.

PRICING STRATEGY SY 2016-2017

4

Standard Profit Equation

Concept to Learn: Revenue

Let us assume that company ABC is selling an alphabet book for $12 and was able to sell 500 copies for one month. The revenue generated from the sale of the books in a month is $6,000, we calculated our revenue by multiplying the quantity of books sold and the selling price (also referred to as list price), Q x P = Revenue.

Concept to Learn: Income

Revenue is different from income. The amount left after deducting variable costs from the revenue is called income. In the standard profit equation it is the first half of the equation π = Q (P - V) - F, where the variable costs are deducted from the price. Costs are deducted from revenue because in principle, costs are supposed to be recovered from the exchange.

Notice that in the standard profit equation variable cost is immediately deducted from price, π = Q (P - V) F prior to multiplying the price to quantity sold. This tells us that variable cost is relevant to price and it is actually a component of price. Fixed cost is excluded from the price for the following reasons: 1.) Fixed cost is incurred whether there is a sale or none, it is not a relevant cost and must not be passed on to the consumers. 2.) If fixed cost is factored in the cost when setting the price, we will end up with higher prices and may lose price competitiveness.

In the alphabet book, variable cost is $0.75, performing the equation, (P - V) we do this $12 - $0.75 = $11.25. Multiplying $11.25 to 500 copies sold in a month Q (P - V) will give us an income of $5,625 for that particular month.

Concept to Learn: Profit

Profit is important because it drives business growth. In principle, profit is the amount that goes back to the business. Some parts of the profit earned may be declared as dividends or known as the earnings stockholders get from investing their resources to the business or declared as retained earnings which is cash re-invested to any activity intended to grow the business, e.g. expansion of the manufacturing plant, research and development for new products or product innovation, etc.

Completing the standard profit equation π = Q (P - V) - F, we now deduct the fixed cost from the income $5,625 - $5,000 leaving us with $625 profit. Positive profit means that the revenue is greater than all the costs incurred in producing the good. Negative profit means financial losses that the exchange failed to recover the costs and leave the business with nothing to invest for product innovation, new products or expanded distribution.

This is the most relevant role of marketing in business. Marketing contributes d irectly to the profits of the business by way of setting the right price.

Using the alphabet book example above, let us see how price affects profit when we adjust any of the item in the equation (see Table 1.) Notice the percent change in profit when we improve the

PRICING STRATEGY SY 2016-2017

5

items in the standard profit equation one-at-a-time. For quantity and price an improvement means increasing the existing number, while for variable and fixed costs an improvement means decreasing the costs.

Table 1. Comparative Values of the Standard Profit Equation Variables: Increasing Quantity Sold and Price, Decreasing Variable Cost and Fixed Cost

   

5% Increase

 

5% Decrease

5% Decrease

Items

Base Rate

on Quantity

Sold)

5% Increase

on Price

on Variable

Cost

on Fixed

Cost

Quantity Sold

500

525

500

500

500

Price

12.00

12.00

12.60

12.00

12.00

Variable Cost

0.75

0.75

0.75

0.71

0.75

Fixed Cost

5,000.00

5,000.00

5,000.00

5,000.00

4,750.00

Profit

625.00

906.25

925.00

645.00

875.00

% Increase

 

45%

48%

3%

40%

on Profit

Adjusting each of the item in the standard profit equation one-at-a-time will each improve the profit. If we increase our sales from 500 units to 525 profit grows by as much as 45%. If we increase price from $12.00 to $12.60 profit improves by as much as 48%. If we cut our variable cost from $0.75 to $0.71 profit rises by as much as 3%. If we reduce our fixed cost from $5,000 to $4,750 profit expands by as much as 40%. Improvements on the variables contribute to the profit growth, but it is the improvement in price that generated the highest percent increase on profit.

Solution to Table 1:

Each time you are given a problem that uses the standard profit equation always compute for the base profit (π1) or the computed profit using the given variables. Always remember that pricing decisions are based on the impact of price adjustment on profit.

When you are tasked to solve any pricing problem, use the following steps, otherwise 5 points will be deducted for each missing step.

Step 1, write the given variables and formula because this will guide you when setting up your equation or substituting values in the formula.

Given:

500 units

= Q or quantity sold

$12.00

= P or price

$0.75

= V or variable cost

$5,000

= F or fixed cost

Formula: π = Q (P - V) - F

PRICING STRATEGY SY 2016-2017

6

Step 2, substitute the values for each variables in the formula and show your solution.

π = 500 (12.00 – 0.75) 5,000

π = 500 (11.25) – 5,000

π = 5,625 – 5,000

π = $625

Note: Final answers must have its unit of measure or currency symbol. In case of answers with decimal values, round your final answer to two decimal places. In the case of Q or quantity sold, always round-up the number to a whole number if the number after the decimal point is 5 and above, if the number after the decimal point is below 5 disregard the decimal numbers.

Step 3, proceed with the computation by responding to the conditions required by the case.

Condition#1, Increase Q or quantity sold by 5%. Note: Show your solution for the adjusted value of the variables. All other variables will take on their original values.

500 x 1.05 = 525 units

π = 525 (12.00 – 0.75) 5,000

π = 525 (11.25) – 5,000

π = 5,906.25 – 5,000

π = $906.25

Note: Final answers must have its unit of measure or currency symbol. In case of answers with decimal values, round your final answer to two decimal places. In the case of Q or quantity sold, always round-up the number to a whole number if the number after the decimal point is 5 and above, if the number after the decimal point is below 5 disregard the decimal numbers.

Step 4, compute for the ∆π or change in profit using this formula:

∆π = π 2 – π 1

π 1

∆π=906.25 – 625

∆π=

625

281.25

625

∆π= 0.45 ≈ 45% Note: Always round to two decimal places.

Interpretation: Increasing Q or quantity sold will generate $906.25 profit or 45% increase in profit.

PRICING STRATEGY SY 2016-2017

7

Condition#2, Increase P or price by 5%. Note: Show your solution for the adjusted value of the variables. All other variables will take on their original values.

$12.00 x 1.05 = $12.60

π = 500 (12.60 – 0.75) 5,000

π = 500 (11.85) 5,000

π = 5,925 – 5,000

π = $925

Why use 1.05 when increasing by 5%? Increasing is adding from to the whole (100%
Why use 1.05 when increasing by 5%?
Increasing is adding from to the whole (100% or 1.00).
100% (1.00) + 5% (.05)
= 1.05

Step 4, compute for the ∆π or change in profit using this formula:

∆π = π 2 – π 1

π 1

∆π=925 – 625

∆π=

625

300

625

∆π= 0.48 ≈ 48% Note: Always round to two decimal places.

Interpretation: Increasing P or price will generate $925 profit or 48% increase in profit.

Condition#3, Decrease V or variable cost by 5%. Note: Show your solution for the adjusted value of the variables. All other variables will take on their original values.

$0.75 x 0.95 = $71

π = 500 (12.60 – 0.71) 5,000

π = 500 (11.29) 5,000

π = 5,645 5,000

π = $645

Why use 0.95 when decreasing by 5%? Decreasing is subtracting from the whole (100% or
Why use 0.95 when decreasing by 5%?
Decreasing is subtracting from the whole (100% or
1.00).
100% (1.00) - 5% (.05)
= 0.95

Step 4, compute for the ∆π or change in profit using this formula:

∆π = π 2 – π 1

π 1

∆π=645 625

∆π=

625

20

625

∆π= 0.03 3% Note: Always round to two decimal places.

Interpretation: Decreasing V or variable cost will generate $645 profit or 3% increase in profit.

PRICING STRATEGY SY 2016-2017

8

Condition#3, Decrease F or fixed cost by 5%. Note: Show your solution for the adjusted value of the variables. All other variables will take on their original values.

$5,000 x 0.95 = $4,750

π = 500 (12.60 – 0.75) 4,750

π = 500 (11.25) – 4,750

π = 5,625 – 4,750

π = $875

Note: Final answers must have its unit of measure or currency symbol. In case of answers with decimal values, round your final answer to two

decimal places.

Step 4, compute for the ∆π or change in profit using this formula:

∆π = π 2 – π 1

π 1

∆π=875– 625

∆π=

625

250

625

∆π= 0.40 ≈ 40% Note: Always round to two decimal places.

Interpretation: Decreasing F or fixed cost will generate $875 profit or 40% increase in profit.

PRICING STRATEGY SY 2016-2017

9

Exercise #1: Standard Profit Equation

Name:

Score:

Instructions:

1.

Print this page and using a pencil, write your name and class schedule.

2.

Read the short case on Frosting Café.

3.

Write down the given and formula (equation).

4.

Compute for the profits.

5.

KEEP a clean paper.

Frosting Café is a popular snack place serving cupcakes made from all-organic ingredients. It prides itself as a healthy alternative to more popular international brands like Starbucks yet the product and service experience is comparable.

Jane Doe the owner of Frosting Café is presently enjoying weekly sales of 250 cupcakes at P75 a piece. Frosting Café operates on a variable cost of P5.50 and fixed cost of P10,000.

Compute for the following:

1. Generated weekly profit with the present weekly sales

2. Generated weekly profit should Jane Doe improves her price by 5%.

3. Generated weekly profit should Jane Doe improves her quantity sold (volume sales) by

5%.

4. Which option makes Jane Doe better off: improving price or increasing sales volume?

PRICING STRATEGY SY 2016-2017

10

Exercise #1: Standard Profit Equation

Name:

Score:

Instructions:

1.

Print this page and using a pencil, write your name and class schedule.

2.

Read the short case on Frosting Café.

3.

Write down the given and formula (equation).

4.

Compute for the profits.

5.

KEEP a clean paper.

Jane Doe decided to increase her price to P79 per cupcake while operating on the same variable cost P5.50 and fixed cost P10,000. She is surprised to find out that her sales volume is unaffected by the price adjustment and still sells 250 pieces of cupcakes weekly.

Jane Doe wants to improve her profits by cutting on variable costs and fixed costs.

Compute for the following:

1. Generated weekly profit with the present weekly sales

2. Generated weekly profit should Jane Doe reduces her variable cost by 2.5%.

3. Generated weekly profit should Jane Doe reduces her fixed cost by 2.5%.

4. Which option makes Jane Doe better off: improving price or increasing sales volume?

PRICING STRATEGY SY 2016-2017

11

Conjoint Analysis: Customer Utility and Part-Worth Utility

Pricing as a scientific exercise requires marketers to gather information and conduct quantitative analysis to identify the range of profit-yielding price. However, even with empirical data, pricing uncertainties are always present. These uncertainties occur because pricing structure, price point and price discount varies depending on geography and customer situation and the heterogeneity of the consumers. These uncertainty-causing variables demand for an understanding of how consumers value a product.

Consistent with the purpose of creating value demands that we know our customers well. Value is created when we are able to satisfy consumer preferences. One simple way of understanding the value customers place on a product is by determining the part-worth utility or the value customer place on each product feature, attribute and benefit. The collective part-worth utilities is called customer utility.

Assume that we are marketing fresh fruit blends cold beverage using only the finest fruit of the season and milk. We are deciding whether to use fresh milk or vanilla ice cream for extra sweetness and creaminess. We also considered the existing price range in the market, P95 to P60. We know that marketing decisions are based on consumer preferences so we decided to conduct a survey.

1. Setting-Up the Table for Product Features and Attributes

The first step is to set-up your table of product features and attributes. We are choosing between fresh milk and vanilla ice cream and based on the market prices of fresh fruit blends range from P95 to P60. Other marketing decisions are affected by the kind of brand that we intend to build for the product. Given these variables we are able to create eight possible combinations, see Table 2.

Table 2. Product Features and Attributes

Fresh Fruit Blends Fresh Milk Premium Brand

Fresh Fruit Blends Fresh Milk Premium Brand

Fresh Fruit Blends Vanilla Ice Cream Premium Brand

Fresh Fruit Blends Vanilla Ice Cream Premium Brand

P95

P60

P95

P60

Fresh Fruit Blends Fresh Milk Niche Brand

Fresh Fruit Blends Fresh Milk Niche Brand

Fresh Fruit Blends Vanilla Ice Cream Niche Brand

Fresh Fruit Blends Vanilla Ice Cream Niche Brand

P95

P60

P95

P60

2. Preparing the questionnaire

In marketing we commonly use the Likert Scale and assign a numerical interpretation that excludes “Neutral” as a choice because “Neutral” may mean “No Choice” or “No Response”. Response choices must be written using simple sentences to avoid confusion.

PRICING STRATEGY SY 2016-2017

12

The questionnaire may appear like our example below:

Encircle the score that best represents your choice. (5 most likely and 1 least likely)

Numerical Interpretation:

5- I will choose this 5 out of 5 times. 4- I will choose this 4 out of 5 times. 3- I will choose this 3 out of 5 times. 2- I will choose this 2 out of 5 times. 1- I will choose this 1 out of 5 times.

1. I prefer fresh milk over other creamer for my fruit blends.

5

4

3

2

1

2. I enjoy my fruit blends if I am certain that all ingredients are fresh.

5

4

3

2

1

3. I want my fruit blends to be made of natural ingredients.

5

4

3

2

1

4. I want a creamy texture to my fruit blends.

5

4

3

2

1

5. I prefer fruit blends that are sweet.

5

4

3

2

1

6. I think a fruit blend that is similar to a milkshake can be equally satisfying.

5

4

3

2

1

7. I prefer my fruit blends while hanging out with friends and enjoying conversation with them.

5

4

3

2

1

8. I am confident with my fruit blend if it is sold by a known brands.

5

4

3

2

1

9. I certainly prefer y fruit blend served in a nice looking cup.

5

4

3

2

1

10. I normally take my fruit blend while walking.

5

4

3

2

1

11. As soon as available, I take my cup of fruit blend and leave.

5

4

3

2

1

12. It doesn’t really matter if my fruit blend is served in a clear cup as long as it is clean.

5

4

3

2

1

13. I am willing to spend P95 for a 16oz cup of fruit blend.

5

4

3

2

1

14. I am willing to spend P60 for a 16oz cup of fruit blend.

5

4

3

2

1

Note that we prepared three questions for each of the product attribute, they are as follows:

Questions 1 to 3, Fresh Milk Questions 4 to 6, Vanilla Ice Cream Questions 7 to 9, Premium Brand Questions 10 to 12, Niche Brand Question 13, willingness to pay P95 Question 14, willingness to pay P60

It is important that we know which item measures the preference on a product feature, attribute or benefit because we are going to group the items when getting a single mean or part-worth utility.

PRICING STRATEGY SY 2016-2017

13

3. Computing the Part-Worth Utilities and Customer Utility

After retrieving the accomplished questionnaires, tally the scores for each number. Get the mean of the score for each number by adding all tallied scores and dividing the total scores to the number of respondents. We have 14 items, we should have 14 mean scores. Since we have three questions for each product attribute, we will add up all the means of the items pertaining to the product attribute and divide each sum of means to three. The quotient of the sum of means is the part-worth utility, see Table 3.

Table 3. Tallied Responses and Computed Scores (hypothetical)

       

Sum

Part-

Total

of

Worth

 

Respondents

 

Score

Mean

Means

Utilities

Questions

1

2

3

4

5

6

7

8

9

10

       

Q1.

4

5

3

3

4

5

3

5

3

3

38

3.8

 

4.2

Q2.

5

5

4

4

5

5

4

5

4

4

45

4.5

Fresh

Q3.

4

5

4

3

4

5

4

5

4

4

42

4.2

12.5

Milk

Q4.

3

3

5

4

3

4

5

3

4

5

39

3.9

 

3.6

Q5.

3

3

5

4

3

4

5

3

4

5

39

3.9

Vanilla

Q6.

2

2

5

2

2

2

5

2

2

5

29

2.9

10.7

Ice Cream

Q7.

4

2

4

5

4

4

4

2

2

4

35

3.5

 

3.7

Q8.

5

4

4

5

5

5

4

4

4

4

44

4.4

Premium

Q9.

4

3

2

4

4

4

2

3

3

2

31

3.1

11.0

Brand

Q10.

3

3

4

4

3

3

4

3

3

4

34

3.4

 

3.2

Q11.

2

3

4

3

2

2

4

3

3

4

30

3.0

Niche

Q12.

3

3

4

2

3

3

4

3

3

4

32

3.2

9.6

Brand

                           

3.2

Q13.

5

3

2

2

5

5

2

3

3

2

32

3.2

P95

                           

4.0

Q14.

3

4

5

4

3

3

5

4

4

5

40

4.0

P60

Now we get back to our first table and distribute the part-worth utilities. Adding up all part-worth utilities will give you customer utility. The highest customer utility 11.9 will be ranked 1 and the lowest will be ranked 8. See Table 4.

PRICING STRATEGY SY 2016-2017

14

Table 4. Product Features and Attributes with Part-Worth Utilities and Customer Utility

Fresh Fruit Blends Fresh Milk Premium Brand

Fresh Fruit Blends Fresh Milk Premium Brand

Fresh Fruit Blends Vanilla Ice Cream Premium Brand

Fresh Fruit Blends Vanilla Ice Cream Premium Brand

 

P95

 

P60

 

P95

 

P60

4.2

+ 3.7 + 3.2 = 11.1 Rank 4

4.2

+ 3.7 + 4.0 = 11.9 Rank 1

3.6

+ 3.7 + 3.2 = 10.5 Rank 7

3.6

+ 3.7 + 4.0 = 11.3 Rank 3

Fresh Fruit Blends Fresh Milk Niche Brand

Fresh Fruit Blends Fresh Milk Niche Brand

Fresh Fruit Blends Vanilla Ice Cream Niche Brand

Fresh Fruit Blends Vanilla Ice Cream Niche Brand

 

P95

 

P60

 

P95

 

P60

4.2

+ 3.2 + 3.2 = 10.6 Rank 6

4.2

+ 3.2 + 4.0 = 11.4 Rank 2

3.6

+ 3.2 + 3.2 = 10.0 Rank 8

3.6

+ 3.2 + 4.0 = 10.8 Rank 5

This information guides us when determining the direction to take when marketing our fresh fruit blends. We identified the preference for fresh milk, premium brand, priced at P60 for a 16oz cup (see Rank=1). This means that it will be valuable for both the customers and the firm to use fresh milk, invest in the branding efforts for the product, and set the price at P60 per 16oz.

Now let us explore the monetary value of each of the part-worth measured using the economic unit util.

Price is always one of the attributes measured in conjoint analysis. According to Smith (2012), “the ratio of price disparity in the study design to util disparity between the two price points found from the customer preferences reveals the dollar value per util.” (p.51)

Step 1: Get the given:

Price ranging from P60 - P95 Part-worth utilities are 4.0 utils and 3.2 utils

Step 2: Set up the equation, always subtract the smaller number from the bigger number:

P43.75/util =

P95 - P60

4.0 utils 3.2 utils

Using P43.75/util as our valuation, we can now determine the value of other attributes. For instance, the difference in the part-worth of premium brand (3.7) and niche brand (3.2) is 0.5 util, or P21.88. In the case of fresh milk (4.2) and vanilla ice cream (3.6) is 0.6 util, or P26.25. This means that both premium brand and fresh milk add value to the product.

PRICING STRATEGY SY 2016-2017

15

Computations:

Premium brand 3.7 utils Niche brand 3.2 utils = 0.5 utils 0.5 utils x P43.75/util = P21.88

Interpretation: Premium brand adds value to the product.

Fresh milk 4.2 utils Vanilla ice cream 3.6 utils = 0.6 utils 0.6 utils x P43.75/util = P26.25

Interpretation: Fresh milk adds value to the product.

Table 5. Fresh Fruit Blends Part-Worth Utility

Attribute

Level

Part-Worth (utils)

Difference

Brand

Premium Brand

3.7

0.5

Niche Brand

3.2

Ingredient

Fresh Milk Vanilla Ice Cream

4.2

0.6

3.6

Price

P95

3.2

n/a

P60

4.0

With our available information, we can say that our fresh fruit blends is best marketed as a premium brand using fresh milk and priced at P60 (see Table 6).

Table 6. Product Features and Attributes with Part-Worth Utilities and Customer Utility

Fresh Fruit Blends Fresh Milk Premium Brand

Fresh Fruit Blends Fresh Milk Premium Brand

Fresh Fruit Blends Vanilla Ice Cream Premium Brand

Fresh Fruit Blends Vanilla Ice Cream Premium Brand

 

P95

P60

 

P95

 

P60

4.2

+ 3.7 + 3.2 = 11.1 Rank 4

4.2 + 3.7 + 4.0 = 11.9 Rank 1

3.6

+ 3.7 + 3.2 = 10.5 Rank 7

3.6

+ 3.7 + 4.0 = 11.3 Rank 3

Fresh Fruit Blends Fresh Milk Niche Brand

Fresh Fruit Blends Fresh Milk Niche Brand

Fresh Fruit Blends Vanilla Ice Cream Niche Brand

Fresh Fruit Blends Vanilla Ice Cream Niche Brand

 

P95

P60

 

P95

 

P60

4.2

+ 3.2 + 3.2 = 10.6 Rank 6

4.2 + 3.2 + 4.0 = 11.4 Rank 2

3.6

+ 3.2 + 3.2 = 10.0 Rank 8

3.6

+ 3.2 + 4.0 = 10.8 Rank 5

Let us say, we decide to offer a choice of premium brand with vanilla ice cream, what will be the price consideration? We get the product valuation by adding the difference of the part-worth utilities premium brand and niche brand (0.5utils), fresh milk and vanilla ice cream (0.6utils), giving you 1.1utils or in monetary value P48.13 (1.1 x P43.75). Add the price with the higher part- worth utlity P60 and product valuation P48.13 and you will get P108.13. Interpretation: This new

PRICING STRATEGY SY 2016-2017

16

variant can attract the customers away from P60 if the new variant is priced at or lower than P108.13 (Smith, 2012). Application: If you want to price your new fresh fruit blend with vanilla ice cream and remain within customer preference you can price it at > P60 or ≤ P108.13.

Completing the Conjoint Analysis with Statistics

Although the computed part-worth (util) and customer utility are useful bases for predicting consumer preferences it is still worth the while to use statistical tools for better interpretation. To aid us in our conjoint analysis, we will use the conjoint analysis calculator of Klaus Goepel, screen shots are shown below. Follow the next series of instructions.

Step 1, Download from our SchoolBook and open the Goepel Conjoint Analysis calculator.

SchoolBook and open the Goepel Conjoint Analysis calculator. Picture 1 . Goepel Conjoint Analysis Calculator Step

Picture 1. Goepel Conjoint Analysis Calculator

Step 2, Enter the product attributes that we used in our example. We only have three attributes so we leave the column for Factor 4 empty. Goepel calculator will generate combination of attributes, which is the same combination of attributes we generated manually. Input our computed rank on the fields for each combination.

PRICING STRATEGY SY 2016-2017

17

PRICING STRATEGY SY 2016-2017 17 Picture 2 . Goepel Conjoint Analysis Calculator with Encoded Product Attributes

Picture 2. Goepel Conjoint Analysis Calculator with Encoded Product Attributes and Ranking

Step 3, Goepel calculator will do the regression analysis for us. Scroll down and you will find -1 and 1 values which tells us which attribute that when added or removed either adds (1) or reduces the value of the product.

removed either adds (1) or reduces the value of the product. Picture 3 . Goepel Conjoint

Picture 3. Goepel Conjoint Analysis Calculator with Linear Regression Correlation

Step 4, the last table shows the results of the conjoint analysis. The table says that the price of the fresh fruit blends is the most valued product attribute; -1.75 tells us that consumers may move

PRICING STRATEGY SY 2016-2017

18

away from the fresh fruits blends 1.75% of the time if the price is perceived to be a mismatch. The choice between fresh milk and vanilla ice cream adds value to the product.

fresh milk and vanilla ice cream adds value to the product. Picture 4 . Goepel Conjoint

Picture 4. Goepel Conjoint Analysis Calculator Table of Results

Definition of Terms:

Customer Utility is the sum of all part-worth utilities given to a product by the costumers.

Income is the revenue generated less the costs incurred when producing the product.

Fixed Costs are costs on rent, advertising, insurance, office supplies, utilities (electricity, water, phone and internet), etc., which tend to remain the same regardless of production output.

Part-worth utility is the value given to each product feature, attribute and benefit.

Price is the value firms assign to the product and the amount paid by the consumers during the exchange process.

Profit is the financial benefit that is realized when the amount of revenue gained from a business activity exceeds the expenses, costs, taxes needed to sustain the activity. Any profit that is gained goes to business owners who may or may not decide to spend it on the business.

Revenue is the amount generated by multiplying the quantity sold to the price of the product. This is the sales generated expressed in monetary terms.

Util is the unit of measure to part-worth utility

PRICING STRATEGY SY 2016-2017

19

Variable Costs are those costs that vary depending on a company’s production volume; they rise as production increases as in peak months and fall as production decreases as in lean months.

Concept Review:

Learning Objective 1: Discuss the concept of pricing using the Standard Profit Equation and Conjoint Analysis for part-worth and customer utility.

1.1.What are the risks in wrong pricing? 1.2.What is the drawback of break-even analysis and cost plus pricing? 1.3.What is the appropriate basis for setting the right price? 1.4.Is it possible to set the price correctly without consumer research? Why? 1.5.How is value created in pricing?

PRICING STRATEGY SY 2016-2017

20

Exercise #3 Part-Worth Utility and Customer Utility

Name:

Score:

Instructions:

1. Using this questionnaire, conduct a consumer response survey online.

2. Subscribe to an online survey site and upload our questions.

3. Run the survey for one week.

4. Compute for the part-worth utility and customer utility.

5. Do a conjoint analysis. Submit a research report.

a. Contents of the Consumer Response Survey using Conjoint Analysis

i. 1 st Paragraph (page 1): Describe of the project.

ii. 2 nd Paragraph (page 1): Describe the research methodology

iii. 3 rd Paragraph (page 1): Describe the data gathering

iv. 1 st Paragraph with table (page 2): Part-worth Utility and Customer Utility

v. 1 st Paragraph with table (page 3): Conjoint Analysis Result and Data Interpretation

Project Description:

The consumer response survey is measuring consumer preference on online shopping. We are using the following product attributes: Price (uniform and discounted), Product Variety (extensive and selective), Delivery Days (5-10 days and 3 weeks), Payment (cash-on-delivery and credit/debit cards).

Project Title: A Consumer Response Survey on Online Shopping Preferences using Four-Factor Conjoint Analysis

Research Report Format:

The research report takes on the article format with the research title and a by-line. Using Arial or Times New Roman 12, double-space, narrative with tables. First page will look like the one below:

A Consumer Response Survey on Online Shopping Preferences using Four-Factor Conjoint Analysis By: Juana Dela Cruz, MKA3-0

The consumer response survey is measuring the consumer preference for online shopping.

We are using the following product attributes: Price (uniform and discounted), Product Variety

(extensive and selective), Delivery Days (5-10 days and 3 weeks), Payment (cash-on-delivery and

credit/debit cards).

PRICING STRATEGY SY 2016-2017

21

6. Title, by-line and tables are centered, narratives are full justified. First line of each paragraph are indented.

7. Make sure to follow the instructions. Failure to comply with the instruction, 5 points will be deducted for each missed instruction.

Numerical Interpretation:

5- I will choose this 5 out of 5 times. 4- I will choose this 4 out of 5 times. 3- I will choose this 3 out of 5 times. 2- I will choose this 2 out of 5 times. 1- I will choose this 1 out of 5 times.

1.

am buying online if the price of the products is less than the price set by the leading retailers.

I

5

4

3

2

1

2.

I am shopping online if the price is discounted.

5

4

3

2

1

3.

I prefer online shopping because the prices are reasonably

affordable than the prices set by the leading retailers.

5

4

3

2

1

4.

I

am shopping online and paying the same price set by the

leading retailers.

5

4

3

2

1

5.

Products sold for both online and offline must have the same price.

5

4

3

2

1

6.

Prices of the product must be uniform at all times.

5

4

3

2

1

7.

I

enjoy shopping if there are variety of products to choose from.

5

4

3

2

1

8.

Shopping is like browsing the web, I search for many different things.

5

4

3

2

1

9.

My eyes feast on the number of different products displayed.

5

4

3

2

1

10.

prefer specialty stores because the variety of products are minimal.

I

5

4

3

2

1

11.

find it fun to shop for products in stores that carries only the specific product line that I am searching for.

I

5

4

3

2

1

12.

I

like stores that focus on a specific product line.

5

4

3

2

1

13.

When shopping online I expect the items within 5 to 10 days.

5

4

3

2

1

14.

find it reasonable to receive the item I purchased online 3 weeks upon placing the order.

I

5

4

3

2

1

15.

Online shopping is preferable if cash-on-delivery is available as

a

payment option.

5

4

3

2

1

16.

feel comfortable ordering online if I am allowed to pay in cash- on-delivery.

I

5

4

3

2

1

17.

I

only buy products online if the site accepts cash-on-delivery

payment.

5

4

3

2

1

18.

When I shop online I prefer PayPal and direct credit or debit card transactions.

5

4

3

2

1

19.

Shopping online is convenient because I get to pay using my

credit or debit card.

5

4

3

2

1

20.

I

use my credit or debit card every time I shop online.

5

4

3

2

1

PRICING STRATEGY SY 2016-2017

22

PSYCHOLOGICAL INFLUENCES ON PRICING

Learning Objective 2: Discuss the psychological influences on consumer price perception, Relevant Costs, Exchange Value Model and Price-to-Benefit Map.

Learning Output: Compute the price range using the Exchange Value Model and construct price comparison using Price-to-Benefit Map

Consumers’ perceived value is dependent on their perception about the product and the alternatives. Marketers do branding to reduce consumer price sensitivity. The human brain responds to heuristics or symbols produced by memory and consumers’ perception of value are influenced by heuristics produced by true economic costs, perceptual challenges, prospect theory and effects of prospect theory.

True Economic Costs. Our premise on consumer behavior is that consumers are rational beings with a tendency toward problem-solution approach in their purchasing decisions and the likely attention on the implicit economic cost associated with the trade-offs as they buy. Interestingly, perceived value varies due to the shared cost effect.

o

Shared cost effect implies that consumers’ price sensitivity eases when other people’s money is used to pay for a product. There are four classifications of buying behavior distinguished according to whose money is spent (Smith,

2012).

People spending their own money for themselves. There is high attention on gaining utility from the product and the money paid. Consumers choose well and ensure the value of their money.

People spending their own money on someone else. Consumers seek utility for the receiver and the utility of giving for themselves. Just like buying a birthday cake to a friend, consumer will most likely more than willing to trade-off cake flavors and variants.

People spending someone else’s money for themselves. Consumers are more benefit oriented, but less price sensitive. An example is when a company buys an employee a car, employee will most likely maximize the utility by choosing the best car brand that is viable with the allocated budget.

People spending someone else’s money on someone else. Consumers are neither price sensitive nor benefit sensitive.

o

Switching Costs is a psychological cost associated when changing brands commonly occurring with products that require user-knowledge. Switching cost arise from product-specific investment like learning how to operate a new product. The adjustments on the new technology requires from the consumers makes them price sensitive. The greater the product-specific investment on a product the higher the price sensitivity of the consumers (Micu & Micu, 2007).

PRICING STRATEGY SY 2016-2017

23

o

Expenditure Effect refers to the tendency of consumers to be more price sensitive at higher prices and so they are more than willing to invest on evaluating the alternatives. Other factors that comprise the idea of economic incentives are time and effort in acquiring a product. For instance, high-income segment may have the income to spend but lacks the time to evaluate the alternatives and so opt to pay a higher price. Low income households prefers to buy in smaller volume like the sachet packed alternative because they are more price sensitive with large-expenditure items. Business markets purchase in volume orders because of the savings incentives from volume discounts (Micu & Micu, 2007).

o

Difficult Comparison Effect is when consumers encounter difficulty comparing prices and benefits which may be caused by limited information, limited knowledge on the points of comparison just as in branded and generic drugs. Even size changes cause difficult comparison effect like a slice of an S&R priced at P99 and whole box containing 8 huge slices at P599, consumers most likely have a relaxed price sensitivity on a box of pizza because it appears cheaper than buying on a per slice basis.

Perceptual Challenges, social norms, cultural beliefs and traditions have psychological influences on price sensitivity.

o Prices Ending in 9. Have you ever wondered why there are prices that end in 9? According to Smith (2012), studies have shown that digits as 5 and 0 are easily stored and retrieved from memory due to familiarity. Between P595 and P600, it is easier for the consumers to choose between two prices because both last digits are easily retrieved from memory when comparing alternatives. The ability to compare prices increases the likelihood of price sensitivity. Using the difficult comparison effect, we choose an odd number like 9 and priced the product at P599 because consumers will likely have a hard time recalling the price, thus reduces price sensitivity.

Have you ever wondered why the last digit? Societies using the Arabic numeral system (1,2,3,4…) numbers are encoded from left to right. The most important number is the one on the left (Smith, 2012). Customers will remember that the product is priced somewhere at P500+ and most likely forget the other two digits. Pricing set at P599 will maximize profit potential than with another odd number as P597.

Some cultures have number belief, Western is 9, Asian is 8 (for good luck), Poland is 5.

o The Fairness Effect is the consumers’ idea of a “fair price” and use this as the basis for acceptable price. When evaluating the fairness of a price, consumers include the motive of the seller. If the motive is perceived to be good, consumers are less price sensitive. Companies with good reputation works well for this purpose. In the case

PRICING STRATEGY SY 2016-2017

24

of individual consumers, they expect a uniform price and the same choices made available for all. Marketers must exercise caution when giving away discount to some customers. Apart from the potential loss in profit, too much variation in price discount may result of price credibility problem (Smith, 2012) and customers may feel bad about the difference in price offerings.

o

Overconfidence of Control over Future Behavior refers to the tendency to over- estimate the ability to modify ones behavior such as the case of availing a one-year magazine subscription. Those who buy magazines on a per-copy basis do so because of the magazine’s editorial content. Subscribing to the magazine for a period is purely a purchase decision motivated by the discounted price. This is the same with membership to fitness club instead of paying its services on a per-visit basis, some choose to avail a year of membership. Studies show that those who pay on a per-visit basis went frequently than those with paid membership (Smith, 2012).

o

Small-Pie Bias occurs when sellers and buyers negotiate a price. Both parties tend to underestimate the size of the bargaining zone and agree on a transaction price that fails to maximize value/profit potential of the agreed price. To avoid small-pie bias do the following:

Formulate buyer’s reservation price. During a conversation with the buyer uncover buyer’s reservation price (the price a buyers are willing to buy the product given the set of benefits revealed to them.)

Make the initial offer. Offer the product at a price higher than the buyers’ reservation price and allow the price to be negotiated down to the transaction price.

Price aggressively. Discount reluctantly. (Smith, 2012)

o

Promotional Influences refer to the ability of marketing communications to reduce price sensitivity by communicating aggressively the product attributes, benefits and value.

Prospect Theory of Tversky (1979) The premise of prospect theory is that people’s choices are based on the perception of losses and gains. The three value functions of losses and gains are reference dependency, diminishing sensitivity and loss aversion.

o Reference dependency. It is customary for customers to compare choices using their point of reference like the current satisfaction level, most recent prices seen in the market or the need for replacement arises. The point of reference is the point when customers will choose to remain with the current product (status quo) or replace with replicas the last item purchased. The theory states that “Losses away from point of references will be avoided. Gains above the point of references will be discounted.” Example: Existing Product A is selling at P279. New Product B is launched promising better product attributes and more benefits, priced at P389. The promise of gain through better product attributes and additional benefits may be

PRICING STRATEGY SY 2016-2017

25

discounted or may not be viewed as additional value because the current customers are satisfied with Product A, while the P110 price difference will be considered unnecessary loss by the customers. Most likely, customers will remain with Product A and may find switching to Product B as risky (Smith, 2012; Micu & Micu, 2007; Kuhberger, 2002).

o

Diminishing Sensitivity occurs when the gains and losses increase away from the point of reference, e.g. increasing number of choices or absolute magnitude of gains and losses expressed in price differences. Example: When P5 is increased to P10 customers may resist the 50 percent increase of price as opposed to P490 to P495 customers may be forgiving even if both prices increased by P5.

o

Loss Aversion. Customers are more conscious about the potential loss during transaction than the potential gain. Paying for a product is always considered by customers as a loss. To manage the perceived loss, promotion should consistently communicate product attributes and benefits to create the value positioning in the minds of our customers thereby reducing price sensitivity.

Addressing the psychological influences, Prospect Theory suggests that when promoting products, marketing communications should unbundle the perceived gains (product features, attributes and benefits) and bundle losses (avoiding surcharges instead give discounts) or shift the pain from the direct price paid to indirect opportunity costs (e.g., From P279, now faster access, larger data capacity, real time activation for only P389).

Effects of Prospect Theory These psychological influences have been codified long before Prospect Theory but only with the theory were these influences found its practical applications. These psychological influences are also the reasons why setting prices are more than a quantitative exercise (Smith, 2012).

o

Reference Price Effect. Consumers experience reference price effect whenever their price expectation is affected by their exposure to the current price or the last price they saw. Moving away from the reference price increases the likelihood of price sensitivity. If the consumers are coming from a recent sales promotion either the product or its alternative, their reference price is the discounted price.

o

Endowment Effect. Endowment effect takes place when we allow our consumers to experience the products prior to actual buying like giving away sampling or trial products. Endowment effect is the value people place on an object once they possess it than they otherwise would.

o

Anchoring. The premise of anchoring is that consumer expectations are created with their exposure to early information becoming the reference points. Once consumers are exposed to a particular information it is hard to change their expectations in relation to the same information. In pricing, when a seller makes an

PRICING STRATEGY SY 2016-2017

26

initial offer to a buyer, it becomes the reference price of the buyer. Previous purchases are also strong price points to anchor on. Anchoring may be used for the expected high or low price and benefits and product attributes of a product.

o

Comparison Set Effect. The prices of the comparable alternatives are also reference prices. When the products of competing alternatives are priced low, consumers expect similar products within the same price range.

o

Framing Effect. Consumers become increasingly sensitive to price when they perceive price as a loss rather than gain. According to Kuhberger (2002) “…framing effect does not exist with complete information… but expected in the case of asymmetrical violation of complementarity, that is if the sure option is described partially and the risky option is described completely.”

o

Order Bias. Consumers’ price sensitivity is also affected by the order prices are presented. This psychological effect takes on anchoring and loss aversion as such that if consumers are presented prices from highest to lowest, consumers are less price sensitive and perceive the succeeding lower prices as discounted prices thereby increasing the gain and reducing loss. If we reverse the order, consumers’ reference point will come from the lower priced good. Moving up the price range will cause the consumers to view the prices as increasing losses resulting to heightened price sensitivity.

o

End-Benefit Effect is the price sensitivity of the consumers in relation to the purpose or end benefit derived from the purchased good. Example: The price sensitivity over chocolates between a consumer who is on a weight loss program and someone who just buys regularly. The consumer who is on a weight loss program might be less price sensitive if the purchase of a chocolate is a reward for a disciplined eating behavior for a week of treatment or otherwise if the consumer considers weight loss as a significant investment of money and commitment to the program.

Concept Review

Learning Objective 2: Discuss the psychological influences on consumer price perception, Relevant Costs, Exchange Value Model and Price-to-Benefit Map

2.1.Consumers are inherently price sensitive, how can we reduce consumers’ sensitivity to price? 2.2.How are prices ending in 9 able to generate economic value? 2.3.Why are consumers more price sensitive on premium prices than discounted prices? Which psychological influence support your position?

PRICING STRATEGY SY 2016-2017

27

Relevant Costs

Moving forward with pricing, let us be reminded that when setting the price include only the relevant costs or costs with direct impact on the pricing decisions (Hou, 1997). From the previous topics we learned that the price on the tag psychologically influences costumer preferences and buying decisions. When setting the price, we do not limit the considerations to the demand-side. In this section, we will emphasize the pricing considerations from the supply-side.

According to Hou (1997), we set a price based on our anticipated sales for the the future. This future-orientated sales makes us rely on historical data as basis for pricing, such as previous sales at a previous price or the use of naïve sales forecasting. Historical data, although readily available, may only be used if the competitive environment is static. Hou (1997) reminds us that in a very dynamic business environment, historical data is unreliable.

There are two aspects of relevant costs: 1.) incremental costs, and 2.) avoidable costs. Incremental costs are types of costs that may increase as a result of taking a particular course of action to expand one’s business or increase sales, e.g. direct labor and sales commissions(Hou, 1997). Avoidable costs or costs that may be avoided or need not be incurred are relevant(Hou, 1997).

An example is our food vendor Aling Maria, selling arroz caldo for P15 per bowl. During school days, Aling Maria is able to sell 150 bowls daily, variable cost is P5.50 (rice grains, chicken parts, garlic, onion, ginger, disposable bowls and spoons, LPG, utilities), fixed cost is P700 (monthly rent for the kiosk). Aling Maria decided to make her kiosk more attractive to the teen consumers who are her frequent customers during school days. She hired the local painter who also does murals and Jeepney arts commissioned to re-paint her kiosk for P500 labor fee and additional P500 for the materials. Positive about her newly designed kiosk, Aling Maria hired a helper to assist her with the additional customers and agreed to pay the helper P5 per bowl sold. Excited to show off her newly designed kiosk, Aling Maria requested her daughter to design a colored flier and paid P1,500 for printing.

Questions: If we are to consider the costs when pricing Aling Maria’s arroz caldo, which are considered relevant costs?

When setting the price remember that we are asking the customers to pay an amount that will recover the costs of producing the good that they buy plus the value they attached to the product.

Variable cost is a relevant cost. Aling Maria’s arroz caldo has a variable cost of P5.50 consisting of the rice grains, chicken parts, garlic, onion, ginger, disposable bowls and spoons, LPG, utilities. Technically, we are putting a price for each of the item comprising the variable cost because work is done to convert each of the raw materials into a final good, (i.e. each of the item is washed, cut, diced, boiled, seasoned, etc.) and each of the item creates value to the final product (i.e. rice grain is a combined fine malagkit and bigas, chicken parts are from the reputable poultry farm of the province, etc.) Variable cost is relevant because without its composition, there is no product.

PRICING STRATEGY SY 2016-2017

28

Incremental cost is relevant. When Aling Maria anticipated an increase sales volume or quantity sold as a result of the more attractive kiosk, she is adding labor cost with additional helper assisting her and increasing the volume of her supplies to produce more arroz caldo.

Avoidable cost is relevant. The promotional fliers which is avoidable, meaning it is added to generate more sales yet Aling Maria can also do away without it, will also comprise the additional costs in generating increased sales volume.

The incremental and avoidable costs will now be considered marginal cost or the cost of producing the additional unit of sale or product.

Fixed cost is not relevant. Fixed costs such as the monthly rent for the kiosk is not relevant to pricing because whether Aling Maria sells her arroz caldo or not, she will be paying the rent and so we take it out of the pricing equation. Also remember, fixed costs are the responsibility of the business and not the customers, so we do not pass fixed cost to the customers. If we do, we will end up using the total cost as a basis for our pricing which will result to a high price that is no longer competitive in the market.

Capital expenditure (CAPEX) is not relevant. Our simple example of CAPEX is the cost associated to the repainting of the kiosk which are the labor cost of the local painter and the painting supplies. These are not relevant because whether or not Aling Maria sells her product, if the circumstances require that she re-paints her kiosk she will have to do it.

Exchange Value Model

Recognizing that consumers’ willingness to pay or price preference is framed by the psychological influences and the price of the competitor are crucial when setting the price. Exchange Value Model is a simple tool used most appropriate for new product or new product variant when there are two products being compared. This tool is used when computing for the acceptable price range for the new product.

There are two ways of using the exchange value model: 1.) extreme boundaries, and 2.) narrow boundaries.

Extreme Boundaries

Using the extreme boundaries, the price range for a product includes the customer utility and marginal cost. As a general rule, the highest possible price we can sell a product should be equal to customer utility and the lowest possible price is the marginal cost. Setting the price higher than the customer utility will result to customers refusing to purchase the product; while setting the price lower than the marginal cost will result to losses for the firm.

PRICING STRATEGY SY 2016-2017

29

Let us get back to our alphabet book sold at $12 per copy, selling 500 copies a month. If we decide to sell additional one unit making our monthly sales 501 the cost that will be incurred in producing and selling additional one unit is called marginal cost. Supposed that there is a marginal cost of $0.35 when we increase our sales by one unit, extreme boundaries is telling us that we cannot price the book lower than $0.35.

Assume that we conducted a consumer response survey using conjoint analysis and found out that customers are willing to pay $15 for our book, using extreme boundaries the price range of our alphabet book is $15 highest price possible and $0.35 lowest price possible. This range indicates that we can price the book anywhere between $15 and $0.35 and remain mutually beneficial for the firm and the customers.

Notice the range is too wide. This is the challenge under extreme boundaries. We can end up pricing the book at the point where customers are happy with the price yet the firm is unable to capture the most of the value. Ensuring that we capture both value to customers and value to the firm, we narrow the price range using narrow boundaries.

Narrow Boundaries

When narrowing the boundaries we can determine the exchange value of the new product by calculating the expected cost and differential value.

Step 1: Calculate the Expected Cost

When calculating the expected cost the following are needed:

1. Selling price for the comparable alternative, in this case the alphabet book selling at $12 per copy.

2. Frequency of sales for the comparable alternative, hypothetically let us peg the re-order rate of the alphabet book at 78%.

We can use a decision tree when calculating the expected cost.

a. Expected Cost

Expected Cost = $21.36 $12 x 1 + $12 x .78 + 0

Repeat Buy Alphabet Book $12 x 78% Will not re-buy $12 x 100% $0 x
Repeat Buy
Alphabet Book
$12 x 78%
Will not re-buy
$12 x 100%
$0 x 22%

Figure 1. Decision Tree for Expected Cost

PRICING STRATEGY SY 2016-2017

30

Our decision tree shows that the alphabet book is sold at $12 for all 500 copies sold ($12 x 100%) and that this book has a 78% repeat buy or 78% of the time this book will be re-purchased by its existing customers, e.g. school endorsing the book for use the next school year ($12 x 78%), while 22% will choose another book ($0 x 22%).

The expected cost is used to compute for the price of the new book, and this is done using algebra.

It is important at this point that we understand that a selling price is not only the cost plus mark- up. The selling price includes the value-adding features of a product. In the case of the alphabet book we the price of the core product which is the contents of the book, is $8.50 referred to as the Reference Price, the rest are prices for the value adding features, i.e. publisher, the book is published by a reputable and leading publisher; author, written by an expert on the subject area; international accreditations, packaging, etc. These value-adding features are also given a price and they comprise 29% of the selling price. To get the reference price, we take-out the other parts of the price, in our example the prices of the value adding features or the 29%.

Since the new book is comparable to the first edition, we assume that the new book contains the value-added features of the first book. So we take out the 29% of the price or $3.50 as the same value-added feature of the second book. Since we do not have the price of the core product, we denote X for the price of the core product. Using algebra we know that the price of the new book is $3.50 + X.

The new book will be the latest edition once it is distributed and promises a much higher repeat buy at 95%. We now substitute the given numbers to our decision tree.

Step 2: Calculate the Exchange Value

b. Exchange Value

Expected Cost = $21.36 $3.50 + X (100%) + $3.50 + X (95%) + $0 (5%)

Repeat Buy Alphabet Book 2 nd Edition $3.50 + X (95%) Will not re-buy $3.50
Repeat Buy
Alphabet Book 2 nd
Edition
$3.50 + X (95%)
Will not re-buy
$3.50 + X (100%)

$0 (5%)

Figure 2. Decision Tree for Exchange Value

PRICING STRATEGY SY 2016-2017

31

Solution:

$21.36 = $3.50 + X (100%) + $3.50 + X (95%) + $0 (5%)

Simplify:

$21.36 = $3.50 + X (1) + $3.50 + X (0.95) + 0

Distribute:

$21.36 = $3.50 (1) + X (1) + $3.50 (0.95) + X (0.95) $21.36 = $3.50 + 1X+ $3.33 + 0.95X

Combine Similar Terms $21.36 = $3.50 + 1X+ $3.33 + 0.95X $21.36 = $3.50 + $3.33 + 1X + 0.95X $21.36 = $6.83 + 1.95X

Transpose $21.36 = $6.83 + 1.95X $21.36 - $6.83 = 1.95X $14.53 = 1.95X

Cancel the Coefficient of X $14.53 = 1.95X $14.53 = 1.95X 1.95 1.95
Cancel the Coefficient of X
$14.53 = 1.95X
$14.53 = 1.95X
1.95
1.95

Perform the Operation $14.53 = X

1.95

$7.45 = Exchange Value

Finally, compute for the differential value using this formula:

Price of the Comparable Alternative + Differential Value = Exchange Value

Substitute our Values $8.50 + DV = $7.45

Transpose

DV = $7.45 - $8.50

-1.04 = Differential Value

The differential value is the change in customer utility in comparison to the alternative. If the product is superior, the differential value is positive, if inferior (less in product attribute) the differential value is negative (Smith, 2012, p.13).

The

economic exchange value is the price customer will pay for its nearest comparable offer plus

the

value of the increased (or decreased) benefits of the improved (or degraded) new product,

PRICING STRATEGY SY 2016-2017

32

meaning the exchange value is the upper narrow boundary or the highest possible price of the new product (Smith, 2012, p.13).

Concept Review

Learning Objective 2: Discuss the psychological influences on consumer price perception, Relevant Costs, Exchange Value Model and Price-to-Benefit Map

2.1.Why is it important to learn and distinguish relevant costs? 2.2.Why are fixed costs and capex excluded from pricing? 2.3.Which of the following are relevant costs?

a. Advertising cost

b. Cost of raw materials

c. Cost of retail store renovation

d. Monthly retail store rent fees

e. Sales commission

f. Overtime pay for labor incurred during peak season

2.4. A grande size Frappuccino in Starbucks is priced roughly at P175. Determine the reference price for each of the possible data combination:

a. 65% is branding, 35% is coffee. Reference price is

b. 10% is packaging, 25% is ambiance and store service, 5% is coffee, 60% brand.

?

Reference price is

?

2.5.Compute for the price range for a new XYZ shirt using the following data:

a. Customer utility is P325 and marginal cost is P75

b. Comparable alternative ABC shirt is selling at P289, 85% of ABC customers are re-buying

c. 40% of the selling price of ABC shirt is purely distribution and promotion.

d. XYZ shirt has a promising 50% customers re-buying rate.

2.6.Compute for the price range for a new Happy Pets dog food variant using the following data:

a.

Customer utility is P220 and marginal cost is P65

b.

Comparable alternative Healthy Dog is selling at P160, 95% of their customers are re-buying

c.

70% of the selling price of Healthy Dog is purely distribution and promotion.

d.

Happy Pets has a promising 90% customers re-buying rate.

PRICING STRATEGY SY 2016-2017

33

Price-to-Benefit Map

Price-to-Benefit map is a graph showing the relationship of price and perceived product value. The graph indicates that perceived benefits delivered by the product increase in proportion to the price. Another way of saying it is products of perceived greater benefits are priced higher. The graph plots the perceived prices on the vertical axis (x) and the perceived benefit on the horizontal axis (y). (See Graph 1.)

perceived benefit on the horizontal axis (y). (See Graph 1.) Graph 1. Price-to-Benefit Map (Smith, 2012)

Graph 1. Price-to-Benefit Map (Smith, 2012)

The graph has four parts (Smith, 2012):

Value equivalence line is the points where price is in proportion with the product benefits.

Zone of indifference are the broken lines parallel the value equivalence line. They indicate the differences in the perceived value or benefits that has negligible effect on the price sensitivity of the consumers and maximizing the price points along this area can improve profitability. The zone of indifference arises because products are unable to maximize the price-benefit proportion on the value equivalence line and the challenges in customer purchase decision.

Aside from the heterogeneity of the consumers, purchase decision is tiered according to perceived benefit and perceived price. This somehow controls immediate product switching when alternatives are far from each indicative of clear difference on benefits offered and price charged. Benefit brackets consisting of: Benefit floor which arises from the minimum requirement of a consumer from a product to merit a purchase, e.g. a mobile phone benefit floor may include features for calling, texting, and camera and internet

PRICING STRATEGY SY 2016-2017

34

access. Meanwhile, benefit ceiling are additional features that customers do not really take advantage of but expect to be included just the same, e.g. viewing movies, may be synced to other mobile communication devices. These variation on benefits and their prices if unexplored remain as point in the zone of indifference.

Value advantaged or the unharvested value is the space on the left side of the value equivalence line. It is also called unharvested value because points lying on this side of the value equivalence line indicate that there are more benefits than the price of the product. This happens when the company decide to prices aggressively to capture market share by adding additional features while selling at the same price. The problem with value advantaged pricing is its tendency to launch a price war which inadvertently result to profit loss for the industry.

Value disadvantaged is the space on the right side of the value equivalence line. Price and benefit points on this space indicate that a product is charged higher relative to the benefits it offers. This occurs when companies packed a product with features and priced it at a premium but consumers place little value on the product attributes. This may also happen when the competitive landscape changed, very much like the high technology products, misaligning the products in terms of price and benefits.

misaligning the products in terms of price and benefits. Graph 2. Value Advantage and Value Disadvantage

Graph 2. Value Advantage and Value Disadvantage (Smith, 2012)

The natural tendency of consumers to differ in expectations and preferences results to varying perceived benefits and prices. Differences in the perceived price of the product result to dispersion in perceived price, shown in Graph 3. This is due to the failure to promote the price accurately. Extensive distribution can also cause dispersion in the perceived price because different distribution channels offer different prices for the same product, e.g. a bottle of cola may be priced

PRICING STRATEGY SY 2016-2017

35

P12 in a Sari-Sari store and P75 in a restaurant. Price discounts also results to dispersion of the perceived price.

discounts also results to dispersion of the perceived price. Graph 3. Dispersion on the Perceived Price

Graph 3. Dispersion on the Perceived Price (Smith, 2012)

Although dispersion in prices can enhance profits, too much price variations can result to positioning challenges.

Dispersion in perceived benefits occurs when promotions fail to communicate the benefits of a product.

promotions fail to communicate the benefits of a product. Graph 4. Dispersion on the Perceived Benefits

Graph 4. Dispersion on the Perceived Benefits (Smith, 2012)

PRICING STRATEGY SY 2016-2017

36

Dispersion in both perceived price and perceived benefits indicates that consumers are confused about the benefits and price of the product and large dispersion denotes overlapping perceptions.

and large dispersion denotes overlapping perceptions. Graph 5. Dispersion of Perceived Benefits and Price (Smith,

Graph 5. Dispersion of Perceived Benefits and Price (Smith, 2012)

Tactical approaches to the marketing mix cause differences in perception. There are customer who are expecting high benefits and willing to pay a high price but end up paying a low price resulting to lost profit opportunity. There are instances where products are willingly purchased at the actual price but fail to deliver the expected benefits, causing the customers to shy away favoring the alternative products resulting to lost sales and profits. The key is sustaining a marketing mix strategy that consistently communicates and delivers the value expected by the customers.

PRICING STRATEGY SY 2016-2017

37

Appendix 1: Creating a Price-Benefit Map Using MS Excel and Word

Using the consumer response survey we can represent the price and benefit relationship using our MS Excel and MS Word.

Step 1: After computing the mean for the perceived benefits, encode the scores on column A of your MS Excel worksheet. Place the scores for the perceived benefits on column A and perceived price on column B. This way your entries on perceived benefit will appear on the horizontal axis of the graph and those on column B will appear on the vertical axis of the graph (see below). Each row shows the scores given by each of the respondent of the consumer response survey.

by each of the respondent of the consumer response survey. Picture 5 . Encoding the Values

Picture 5. Encoding the Values for Perceived Benefit and Perceived Price in Excel Worksheet- Product A

Continue encoding all the entries in the same columns for the comparable alternative (see below). For both products, indicate product A and product B so you can easily recognize the scores of each product.

PRICING STRATEGY SY 2016-2017

38

PRICING STRATEGY SY 2016-2017 38 Picture 6 . Encoding the Values for Perceived Benefit and Perceived

Picture 6. Encoding the Values for Perceived Benefit and Perceived Price in Excel Worksheet- Product B

Step 2: Highlight all the scores in columns A and B. Click Insert tab, go to Graph and click Scatter (see below).

Click Insert tab, go to Graph and click Scatter (see below). Picture 7 . Creating a

Picture 7. Creating a Scatter Graph for Products A and B in Excel Worksheet

PRICING STRATEGY SY 2016-2017

39

MS Excel will generate the scatter graph for you. You will notice that the scores represented in dots on the graph are clustered according to the product. In the case of our sample data, you will notice a clear clustering (see below).

sample data, you will notice a clear clustering (see below). Picture 8 . Generated Scatter Graph

Picture 8. Generated Scatter Graph for Products A and B in Excel Worksheet

Step 3: Now that you have your scatter graph, edit the graph and place the correct labels by clicking on this icon and choosing Axis Titles. On the vertical axis type Price and on the horizontal axis type Benefit.

axis type Price and on the horizontal axis type Benefit. Picture 9 . Editing the Axis
axis type Price and on the horizontal axis type Benefit. Picture 9 . Editing the Axis

Picture 9. Editing the Axis Labels for the Horizontal and Vertical Axis in Excel Worksheet

This instructional material is prepared by Mary Felidora Florinor M. Amparo, Ph.D., RME for use in the classroom and online classes. Use the required textbook cited (Smith, 2012) for a more detailed discussion on each topic.

PRICING STRATEGY SY 2016-2017

40

Your scatter graph should look like the one below.

40 Your scatter graph should look like the one below. Picture 10 . Sample Scatter Graph

Picture 10. Sample Scatter Graph with Axis Labels for the Horizontal and Vertical Axis in Excel Worksheet

Do the same with the chart title and type Price-Benefit Map for the two brands you are comparing.

type Price-Benefit Map for the two brands you are comparing. Picture 11 . Editing the Scatter

Picture 11. Editing the Scatter Graph Title in Excel Worksheet

PRICING STRATEGY SY 2016-2017

41

Your scatter graph should look like the one below.

41 Your scatter graph should look like the one below. Picture 12 . Sample Scatter Graph

Picture 12. Sample Scatter Graph with Title in Excel Worksheet

Step 4: Transfer the scatter graph to MS Word, the document that you are required to submit. This is done by clicking on the graph, then right click on your mouse and choose copy.

the graph, then right click on your mouse and choose copy. Picture 13 . Copying the

Picture 13. Copying the Scatter Graph in Excel Worksheet

PRICING STRATEGY SY 2016-2017

42

Step 5: Go to MS Word and open a new document. On the blank page, click Paste. Your first page should look like the one below.

click Paste. Your first page should look like the one below. Picture 14 . Transferring the

Picture 14. Transferring the Scatter Graph to MSWord document

Step 6: Completing your price-benefit map requires you to draw a value equivalence line. This is done by clicking Insert, choose Shapes, and then choose Line.

by clicking Insert, choose Shapes, and then choose Line. Picture 15 . Completing the Scatter Graph

Picture 15. Completing the Scatter Graph with Value Equivalence Line in MSWord

PRICING STRATEGY SY 2016-2017

43

Place the cursor on the lower left corner of the scatter graph then drag to the upper right corner of the same graph. Your scatter graph should look like the one below.

graph. Your scatter graph should look like the one below. Picture 16 . Sample Scatter Graph

Picture 16. Sample Scatter Graph with Value Equivalence Line in MSWord

Step 7: Showing the scores for each product requires that you draw a circle showing the two clusters of scores. You can do this by clicking on Insert, choosing Shapes and then clicking Oval (see below).

Insert, choosing Shapes and then clicking Oval (see below). Picture 17 . Clustering the Values of

Picture 17. Clustering the Values of Perceived Benefits and Price of the Scatter Graph Line in MSWord

PRICING STRATEGY SY 2016-2017

44

Proceed to drawing your first circle making sure that the scores for one product are all inside the circle. Then click on the circle, edit the shape by removing the color filling-up the shape (see below).

by removing the color filling-up the shape (see below). Picture 18 . Clustering the Values of

Picture 18. Clustering the Values of Perceived Benefits and Price of the Scatter Graph Line in MSWord Product A

Click on the shape again, on your mouse do a right click, choose Copy then Paste (see below).

mouse do a right click, choose Copy then Paste (see below). Picture 19 . Clustering the

Picture 19. Clustering the Values of Perceived Benefits and Price of the Scatter Graph Line in MSWord Product B

PRICING STRATEGY SY 2016-2017

45

Now you have two identical shapes. Click on the second circle and drag to the next cluster of scores. Your scatter graph should look like the one below.

scores. Your scatter graph should look like the one below. Picture 20 . Price-Benefit Map in

Picture 20. Price-Benefit Map in MSWord

Step 8: The final step is to write your data interpretation. You are only expected to indicate the type of price-benefit relationship that you generated for the products you surveyed.

that you generated for the products you surveyed. Picture 21 . Completing the Price-Benefit Map with

Picture 21. Completing the Price-Benefit Map with Verbal Interpretation in MSWord

PRICING STRATEGY SY 2016-2017

46

Possible deviations like overlapping dots may be due to dispersed perceived price and benefit. Should that be the case, you should be able to show the dispersal by adjusting your circles or ovals in such a way that you are able to capture the data deviations.

Concept Review

Learning Objective 2: Discuss the psychological influences on consumer price perception, Relevant Costs, Exchange Value Model and Price-to-Benefit Map

2.1.Using the consumer response survey you completed, create a price-to-benefit map. Include your interpretation by indicating which brand is priced at value advantage and/or value disadvantage.

PRICING STRATEGY SY 2016-2017

47

PRICE POSITIONING AND PRICE STRUCTURE

Learning Objective 3: Explain Price Positioning.

Learning Output 3a: Identify the appropriate price positioning technique for each of the stage in the Product Life Cycle Model and for each quadrant of the Ansoff Product and Market Growth Matrix

Learning Objective 4: Discuss the price structures and Explain Profit Sensitivity Analysis and Price Elasticity.

Learning Output 4a: Compute for the acceptable price adjustments. Learning Output 4b: Compute for the price elasticity.

Types of Pricing Positioning

The price-to-benefit map enables the marketers to identify opportunities referred to as the customer addressable horizon. It can be used to identify new products, estimate market size and sales volume and even anticipate competitor reactions and visually capture the three pricing positioning, namely: price neutral positioning, price penetration positioning and price skimming positioning.

Price Neutral Positioning is when products are priced within the zone of indifference denoting that price is not used to capture market share, instead pressure is placed on the distribution and promotion strategies. In this case, existing competitors will most likely drop the price for the premium product and increase the benefit for the low priced product. Shown in Graph 6 are existing competitors responding to the new product.

6 are existing competitors responding to the new product. Graph 6. Neutral Pricing Positioning (Smith, 2012)

Graph 6. Neutral Pricing Positioning (Smith, 2012)

PRICING STRATEGY SY 2016-2017

48

Price Penetration Positioning is when price is used to capture market share by offering a low price in comparison to the benefits the product is offering. This is commonly used by high-technology industry which has gained cost advantages brought about by the benefit of improvements from new technologies. Penetration pricing enables the product to capture market interest while trading-off contribution margin and initiate competitive reactions that may be unfavorable to the industry. Notice that existing competitors will most likely reduce their prices in response to the low priced new product.

their prices in response to the low priced new product. Graph 7. Price Penetration Positioning (Smith,

Graph 7. Price Penetration Positioning (Smith, 2012)

Price Skimming Positioning is when a new product sets a high reference price in comparison to the benefits it delivers. This pricing positioning is expected to gradually reduce its price in the future time. This type of pricing positioning does not result to competitor responses and will fail to motivate early purchase given that existing alternatives are priced lower.

PRICING STRATEGY SY 2016-2017

49

PRICING STRATEGY SY 2016-2017 49 Graph 8. Price Skimming Positioning (Smith, 2012) This instructional material is

Graph 8. Price Skimming Positioning (Smith, 2012)

PRICING STRATEGY SY 2016-2017

50

Appendix 2: Revisiting the Product Life Cycle and the Ansoff Product and Market Growth Matrix

Product Life Cycle

The most recognized model used when formulating product strategies is Everett Roger’s Product Life Cycle or PLC. It is a model that describes the stages in the product life cycle from its development and launch in the market to its withdrawal or decline. The tool enables us to have a guided decision pertaining to allocating resources and targeting the suitable market segments at each product life cycle stage. For instance, you found out in your market research that there is a significant market size who are still resistant to the product that you are about to launch. With our knowledge on STP (segmenting-targeting-positioning) we know that it is important to consider market size when targeting a segment. Validating the decision to target the resistant segment using the PLC model will reveal that innovators or opinion leaders are the more suitable segment to introduce a new product to stir promotion, while early adopters are the most suitable segment that guarantees sales and profit growth potential. Both segments are characterized as “very much willing to try new things”. Given that there is a substancial market size for the resistant segment, we instead focus on those who are willing to try new things.

Just as in any life cycle, products have the following stages: birth, growth, maturity and decline.

Introduction is the stage of product research and development until it is launched or made available in the market. At this stage, the product generates very small sales and negative profits.

Growth is the phase of fast sales increase and the most profitable.

Maturity is the point when the product reaches stability. Growth and profit starts to decline.

Decline is the final stage, sales starts to decline, and withdrawal from the market may be the suitable strategy otherwise reinvent, reposition and relaunch and start all over again.

Depending on the product and marketing mix strategy, products may not follow the stages sequentially. We gathered some brand failures and turnarounds from Market Watch (2015) and got the following:

Hewlett-Packard’s Touchpad is a story of a sweeping product decline. Touchpad was introduced in July 2011 promising a powerful video capacity and impressive processing speeds. The market anticipated it to be the strongest competitor of Apple’s IPad. Despite aggressive promotional efforts, Hewlett-Packard had to cut-short Touchpad’s product life due to the failed operating system. Attempts to correct the operating systems were put on hold and the product was withdrawn from the market.

Emirates is successful revival story. Emirates Airline has been flying our skies since 1985 but only recently has it become an iconic brand and recognized as “the world’s best airline”. Emirates Airline is a product story that is able to recover from the decline stage and resurface as today’s finest airline. The reinvention success of Emirates is attributed to the

PRICING STRATEGY SY 2016-2017

51

reinvigorated superior customer service, investment in technology and US$58 billion investment on 170 new aircrafts.

and US$58 billion investment on 170 new aircrafts. Graph 9. Product Life Cycle At each stage

Graph 9. Product Life Cycle

At each stage in the product life cycle are types of consumers whose buying behavior cause the shift from one stage to the next which teaches us that companies need not target the entire market during the initial stages but focus on the early adopters and opinion leaders to drive sales growth and a market-wide acceptance of the new product. Below are the different segments:

Innovators are consumers during the introduction stage of a product. They are individuals of higher net worth than average which enables them to take risks. They are most likely the first to be exposed to new products and give valuable feedback. They are considered opinion leaders of the society and provide valuable promotion to a product during the introduction stage.

Early Adopters are characterized as independent-minded and highly educated individuals. Similar to innovators, early adopters are the first to try a new product and serve as opinion leaders. They give a market credibility and lead the product to the next stages of product life cycle.

Early Majority are characterized as well educated and financially stable individuals who follow early adopters after a varying degree of time and sustain the growth of the market.

Late Majority comes at the time when sales and profit growth slows down. They are characterized as individuals of lower social status and lesser financial means and tend to be highly price sensitive. Due to their social and economic status they are usually skeptical about innovation and change.

PRICING STRATEGY SY 2016-2017

52

Laggards are the last to adopt to a new product. They are usually the senior segment of the society who have become resistant to change and prefer the traditional values and products.

The Ansoff Product and Market Growth Matrix

After identifying the target market, product positioning and launching the product, marketers think of ways to grow the market because the growth in sales volume is dependent on the market size. If the market cease to grow, so do products.

Another tool used when formulating marketing strategy aiming for market growth is the Ansoff Product and Market Growth Matrix that was published in the Harvard Business Review in 1957. This tool is useful for new and existing products and markets comprising of four stages.

and existing products and markets comprising of four stages. Figure 3. Ansoff Product and Market Growth

Figure 3. Ansoff Product and Market Growth Matrix

Market Penetration is a growth strategy focused selling existing products in existing markets. Growth in market share is achieved by repelling competitors and gaining brand loyalty from existing market.

Market Development is a growth strategy using existing products and new markets. This can be done by distributing the existing products to new geographic segments, demographic segments or new channel of distribution.

Product Development is a growth strategy that involves developing new products or modifying the existing products to address the changing needs of an existing market.

PRICING STRATEGY SY 2016-2017

53

Diversification is considered when all other growth strategies fail. This is a growth strategy involving new products in new markets. Unlike the other three strategies that makes use of the company’s existing resources and experiences, diversification is venturing into new grounds requiring new competencies thus presents the highest degree of risk.

new competencies thus presents the highest degree of risk. Graph 10. Product Life Cycle and Ansoff

Graph 10. Product Life Cycle and Ansoff Strategies

At each stage in the product life cycle is a product and market growth strategy. On the launch stage where the product is very young the suitable strategy is to penetrate the market categorized as the innovators/opinion leaders and early adopters. Growth is the highest from introduction stage to growth stage as the product reaches its early majority segment. As the product reaches maturity stage characterized by slowing of growth because the product has saturated the market, it is about time to develop new markets for existing products or the riskier product development to address the needs of the new segment, the late majority. When market and product development fail and the product continuously loses its growth potential and starts to decline, diversification is considered.

Learning Objective 3: Discuss the different price structure techniques.

Price Variances and Price Structures

Enabling price to deliver value to both the firm and consumers require that we manage price variances and utilize price structures.

PRICING STRATEGY SY 2016-2017

54

Price variance is when we offer products in different price points to address the heterogeneity of consumers, those who are willing to pay high and those who demand lower price. Managing price variance requires that we do the price segmentation, price promotions, and discount management.

o

Price segmentation is setting prices based on customers’ willingness to pay. Different prices is set for different consumer segments. Price segmentation enables the firm to maximize profits by charging high prices to consumers who are willing to pay more and generate sales volume from consumers who are willing to pay less. Price segments are identified using segmentation hedges that are correlated with the perceived value and culturally accepted by the consumer segment. These segmentation hedges can be constructed using consumer demographics, time of purchase, purchase location and promotional sales e.g. coupons, rebates, and trial offers.

o

Price promotions involves the lowering of prices to capture the consumer segments who are willing to pay less. Price promotions generates a temporary increase in sales volume by encouraging product trials and brand switches permitting improved market share. Price promotion is not without a drawback, the economic inefficiency is primarily caused by customers who are willing to pay high opt to avail the price discount, missing the economic opportunity from the particular segment. There are three commonly used price promotions: coupons, rebates and trial offers.

Coupons come in different forms. They can be distributed directly to customers, included in the packaging, or sent along with direct mails. Regardless of the form, coupons is a mechanism for the customers to signal their willingness to pay low.

Rebates are discounts offered to encourage repeat purchase or brand loyalty, e.g. loyalty cards used by customers to earn points from purchases made with a retailer, points earned have equivalent monetary value and may be used to purchase items from the same retailer.

Trial offers like product sampling or products are offered at a discounted price to induce trial.

o

Discount management are transactions involving reduction of selling prices for various reasons like, volume discount (purchases in large amounts), or special client-supplier relationship, etc. Aside from economic efficiency of price discounting, customers may experience the fairness effect knowing that they are paying different prices from other customers. Difficulty may also arise from customers who may experience the anchoring effect, expecting a price based on the most recent price paid.

Price structure is another way of addressing customer heterogeneity. Price is set according to customer’s consumption volume or paying only the amount of products or services consumed.

PRICING STRATEGY SY 2016-2017

55

o

Multipart Price Structures has two types of pricing mechanism, Two-Part Tariffs and Tying Arrangements.

Two-Part Tariffs is when customers are asked to pay an “entrance fee” and a “metered fee”. “Entrance Fee” is a fixed sum charged to all customers regardless of their level of consumption. An example of an entrance fee is the connection fee paid to water services like Maynilad or Manila Waters. “Metered Fee” is the price paid on a per use level of consumption. An example of a metered fee is the amount billed to us monthly based on our water consumption.

Tying Arrangements is a price structure generating profits with the sale of consumable portion of tied-in products and not the sale of the durable portion. An example of a product using tying arrangement is a razor, the consumable portion is the blade and the durable part is the handle.

o

Add-Ons, Accessories, and Complementary Products are pair or group of products sold together. These products are distinct from one another and may be priced and sold individually providing separate benefits but the sale of one may increase the likelihood of purchase of another product. An example is a purchase of a laptop includes Windows and productivity tool MS Office Starter Pack (complementary products), plus flash drive, mouse or headset (add-on), USB cable and charger (accessories).

o

Versioning is offering different variations of the same product and sold simultaneously. Each version offers a specific benefit, lower versions have fewer product features. Following the price-to-benefit map, as features add up, so does the price. An example of product versioning is Windows 8, Windows 8.1 and Windows 10.

PRICING STRATEGY SY 2016-2017

56

PRICING STRATEGY SY 2016-2017 56 Graph 11. Versioning (Smith, 2012) o Bundling is selling a set

Graph 11. Versioning (Smith, 2012)

o

Bundling is selling a set of distinct products in one basket or package at a single price. There are two types of bundling: Pure bundling, products in a bundle are not sold individually, and Mixed bundling, both the bundle and the individual products are sold in the same retail space. Bundle is popular because the single price is less than the sum of prices when the products in a bundle are purchased individually. An example of a bundle is a Christmas basket sold in supermarkets as suggested gifts.

o

Subscription and Customer Lifetime Value is a pricing structure commonly used in magazines, fitness centers, etc., where customers pay a single payment for what could have been a series of individual purchases or paying in advance a period’s consumption. An example is a one-year subscription of Reader’s Digest, regardless of uncertainty in the editorial content, subscribers purchase copies ahead of time.

o

Yield Management or revenue management is the selling of a product or service with changing prices over a period of time like airline tickets, the closer the date of departure the higher the price, and failure to appear on the departure date forfeits the airline ticket and the seat is sold to the next customer at a higher price. This type of price structure requires the following (Smith, 2012):

Operational Requirements

Capacity is limited and perishable.

Customers will reserve units of capacity ahead of time.

The firm can sell that resource at a variety of prices, also known as fare classes, each of which has a fixed price.

PRICING STRATEGY SY 2016-2017

57

The firm can change the availability of the predefined fare classes over time.

Market Requirements

Large number of potential customers

Willingness to pay will change over time depending on the specific drivers of customer demand

Demand may be derived and contingent on specific factors external to the product being offered

Challenge Yourself.

Learning Objective 3: Discuss the different price structure techniques.

3.1. Think of a tie-in arrangement for your product, identify the durable and consumable products.

3.2. If you are to use bundling, what product will you bundle and how much will you price your bundle?

Learning Objective 4: Use the Product Life Cycle model in identifying appropriate pricing positioning.

PLC and Pricing Strategy

Using the PLC model we can predetermine the pricing directions to take.

Introduction. During this stage we can expect very minimal restrictions on pricing because price competition is still low. Pricing success is dependent on how much promotion is carried out to educate the market of the product attributes and benefits.

o Pricing strategies

Reference price effect argues against price penetration but since it is important for new products to be experienced by the consumers and it imperative that they understand the product’s full value. We use price neutral or price skimming and offer free-trials for a period of time.

Best if the price of the new product is derived using the Exchange Value Model.

Growth. During the growth stage the product experiences rapid growth both in terms of market segments and competitor size. Consumers have knowledge about the product benefits and firms have better pricing idea. At this point, we limit the latitude on setting prices and have an accurate idea of an acceptable price.

PRICING STRATEGY SY 2016-2017

58

o Pricing strategies

Armed with price accuracy and increasing competition driving the prices down, you may consider exploring the price structures that offer add-ons (Laptop + Windows) or versioning (Windows 8.0, Windows 8.1, Windows 10).

Maturity. Pricing becomes very rigid and the focus is shifted to price structures and managing price variances. This is also the stage where companies can explore new sources of profitability and maximize economies-of-scale, scope and learning.

Decline. During this stage the prices are volatile and companies may choose any of the strategies:

o Exit Strategies

Harvest Strategy is slowly exiting the market while generating the remaining profit from the customers. Companies will refrain from any capital investments like, new production plant or process improvement.

Consolidate Strategy is seeking to become the last product of its kind serving the industry. Companies will sustain a low-cost position through economies of scale and technology improvements.

Focus Strategy is focusing on the key strength and core competencies letting go of the weaknesses and allowing other companies to serve the needs of a niche market.

Challenge Yourself. Learning Objective 4: Use the Product Life Cycle model in identifying appropriate pricing positioning.

4.1. Using the product lifecycle model, discuss the appropriate pricing positioning technique for your product. 4.2. Using the consumer survey you conducted, set the price for your product. Note: Always be guided by the psychological influences of price on consumers.

Learning Objective 4: Discuss the price structures and explain Profit Sensitivity Analysis and Price Elasticity.

Learning Output 4a: Compute for the acceptable price adjustments. Learning Output 4b: Compute for the price elasticity.

Profit Sensitivity Analysis: Computing the Impact of Price Discounting on Profit

The other situation when we have to compute for the price is when we are considering price adjustments. There are instances when we want to offer a discounted price or sometimes we set

PRICING STRATEGY SY 2016-2017

59

the price wrongly and we have to correct it. In cases like these, we change the price but we do it with caution. Any price adjustment will have an immediate impact on profit and an equivalent reaction on quantity sold.

Pricing Myth: Lower prices generate higher sales leading to higher profits. (WRONG!) General Rule: Price and Quantity have an inverse relationship. Increase price leads to decrease in quantity. Decrease price expect increase in quantity.

Calculating the profit sensitivity to price changes requires that we know our volume hurdle. Volume hurdle acts as a safety net or the allowable percent change in quantity in relation to price change. The decision to adjust a price is dependent on whether or not the computed volume hurdle satisfies the condition %∆Q ≥ Volume Hurdle. Volume hurdle is computed using several formula depending on the given data and nature of price adjustment:

Case #1: Using the -%∆P and %CM when asked to compute for the volume hurdle

When the case problem gives you a negative percent change in price (-%∆P) which means that you are asked to do price discounting or price off, and variable cost, use this formula:

%∆Q ≥ -%∆P÷ %CM + %∆P

Case #2: Using P f , P i and variable cost when asked to compute for the volume hurdle

When the case problem gives you the following variables:

P f referring to new price or price final P i referring to the original price or price initial V referring to variable cost

Use this formula:

P i – P f P f – V
P i – P f
P f – V

Sample Case:

We are launching the 2 nd Edition of the alphabet book at a lower price, we consider offering a 50% off on the 1 st Edition, selling it at $6 per copy. The price seem acceptable considering that we cannot price the 2 nd Edition above its exchange value $7.45. To justify the new price, the general rule is that the %∆Q ≥ volume hurdle. This brings us to predicting our %∆Q.

PRICING STRATEGY SY 2016-2017

60

When calculating the %∆Q, we need to have our %∆P. The %∆P is the variance between the new or final price and the initial price.

P f – P i

P i

Substituting the values:

$6 – $12

$12

%∆P = -0.50

General Rule #3: Price decrease will generate a negative %∆P. Price increase will generate a positive %∆P.

Now that we have our %∆P we can now calculate for the predicted %∆Q. To get a %∆Q close to the volume hurdle Smith (2012) suggests that we multiply -1.67, (the elasticity of many products in many industries) to the %∆P. Let us multiply the %∆P to -1.67:

-.50 x -1.67 = 0.84 %∆Q = 0.84 ≈ 84%

Let us check if the price discount that will result to 84% change in quantity is acceptable, we calculate the volume hurdle:

Substitute the values:

$12 - $6 $6 - $0.75

= 6 ÷ 5.25

P i – P f P f – V
P i – P f
P f – V

Volume hurdle = 1.14 ≈ 114%, this means that if price is discounted from $12 to $6 (50% Price Off), the quantity adjustment (also known as the sales volume adjustment) must not be lower than 114% of the current sales volume.

Check the values against the general rule %∆Q ≥ Volume Hurdle:

0.84 < 1.14 Price discount is unacceptable. This means that the proposed 50% price off is unacceptable.

PRICING STRATEGY SY 2016-2017

61

This is validated further using the standard profit equation. The general rule that applies is that the π f ≥ π i; where π f is the new profit computed using the new price and quantity, π i is the orginal profit computed using the original price and quantity. Decisions pertaining to pricing is always in relation to potential profit that may be generated. Anything we do in Marketing should leave the firm and the customer better off. Marketing’s success is measured according to our contribution to profits.