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Key Strategic and Tactical Considerations in Pricing

The Strategic Role of Pricing

There are two fools in every market one charges too much, the other too little.
Old Russian proverb

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Whats the Right Price?

Low Price

High Price

No possible profit at this price

No possible demand at this price

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Price in the Marketing Mix

The only marketing mix element of the 4Ps that directly affects revenues Links to other marketing mix strategies: Brand strategy Distribution Strategy Marketing Communications Strategies Service Level and Quality

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Business Goals and Strategies

Profitability, Return on Investment, Shareholder Value etc

Marketing Goals and Strategies

Positioning the Brand, Market Share, Sales, Profitability etc

Product Strategy

Pricing Strategy

Distribution Strategy
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Promotion Strategy

Designing a Revenue and Pricing Model

Some key considerations:

How does the business or product make its money? Who are its customers? What are its sources of revenues and cashflow? What are its pricing objectives? Is its revenue model sustainable? Revenue and pricing models will probably change over time
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Digital jukebox Spotify on track to report modest first profit, August 2011
The digital jukebox reported a profit for the first time in 2011 in the biggest indication yet that a business model is emerging that could stem the millions lost to music piracy. Already ahead of iTunes as the biggest digital music retailer in Sweden and Norway, Spotify now has 1.9 million paying subscribers in the US and Europe, although most of its 6 million active users still use its song library for nothing. Spotify makes three-quarters of its money from subscriptions and a quarter from advertising. In 2010 an average of 450,000 customers paid 8 a month, generating 45m, to which can be added just over 13m in advertising revenues.

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Pricing objectives can be long term or short term and can include

Create and support the brands positioning and image Long term market share maximization Short term sales growth Maintain the status quo Long term profit maximization

What is Profit?

Profit = Total Revenues Total Costs = (Price x Quantity Sold) Total Costs

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Selling Price per Unit - Variable Cost per Unit = Gross Profit per Unit x no of units sold = Total Gross Profit or Contribution

- Fixed Cost per Unit

= Net Profit per Unit x no of units sold = Total Net Profit

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Example
You run a small business. The production cost of one item is 65p. You find that selling at the prices below results in the following sales volumes. Price Quantity Sold Total Sales Revenue GP/Item Total GP

70p 80p 90p 100p

120 110 90 60

What is the best price to charge?

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Example
You run a small business. The production cost of one item is 65p. You find that selling at the prices below results in the following sales volumes. Price Quantity Sold Total Sales Revenue GP/Item Total GP

70p 80p 90p 100p

120 110 90 60

84 88 81 60

5p 15p 25p 35p

6.00 16.50 22.50 21.00

What is the best price to charge?

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Example
You run a small business. The production cost of one item is 65p. You find that selling at the prices below results in the following sales volumes. Price Quantity Sold Total Sales Revenue GP/Item Total GP

70p 80p 90p 100p

120 110 90 60 88

84 88 81 60

5p 15p 25p 35p

6.00 16.50 22.50 21.00

What is the best price to charge?

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Designing a Pricing Model

Setting the pricing objective(s)

Estimating costs
Determining demand Analyzing competitor offers Selecting a pricing method Selecting the final price

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Main Strategic Approaches to Pricing

1. Positioning the brand 2. Cost -based pricing 3. Demand - based pricing 4. Competitor and substitute - based pricing

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1. Positioning the Brand: Price / Quality Strategies

Price
Low Medium High

High

Superb value strategy

High value strategy

Premium strategy

Quality Medium

Good value strategy

Medium value strategy

Overcharging strategy

Low

Economy strategy

False economy strategy

Rip-off strategy

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2. Cost-Based Pricing
Cost Plus or Markup Pricing

Aims to cover costs Based on a calculation of fixed and variable costs plus a margin for profit

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Variable cost per unit

Fixed costs Expected unit sales

10
300,000 a year 50,000 a year

Unit cost = variable cost per unit + fixed costs unit sales = 10 + 300,000 50,000 = 16

If 25%profit mark up is required: Selling price is 16 + (16 x 25%) = 16 + 4

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Cost-Based Pricing

Simple approach Sometimes used for pricing professional services, industrial products and capital goods Does not take into account customers perceived value or competitor offers

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3. Demand-Based Pricing

Usually aims to maximize total gross profit (contribution) by charging what the market will bear.

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Some Key Considerations

How the brand is positioned in the market Buyers perceptions of value Buyers sensitivity to price

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To find the optimum price to maximize profit we need to know the Price Elasticity of Demand for the product

change in quantity demanded %

=
change in price %

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A Simple Demand Curve

Price

Quantity demanded

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Elastic Demand

Price

Quantity demanded

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Inelastic Demand

Price

Quantity demanded

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Demand Curve for a Luxury Product

Price

Quantity demanded

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Demand elasticity is affected by various factors including

Awareness and sensitivity of buyers to price and price changes

Readiness of buyers to seek a lower price

Availability of competitors or substitutes

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Demand-Based Pricing

Not often possible in practice to determine an accurate demand curve to calculate the optimum price

Price is often determined by estimating what the market will bear to maximize profit

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3. Competitors and Substitutes-Based Pricing

Pricing relative to competitor and substitute product offerings in the market

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Key considerations in competitor / substitutes pricing

What is the competitive structure of the industry how many rival sellers? Which brand is the market or price leader? Competitive power - what is the power of sellers relative to buyers in the market?

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Other Strategic and Tactical Pricing Considerations

1. Differential pricing

2. New product pricing strategies

3. Tactical pricing

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1. Differential Pricing

Different prices for different market segments with different needs and demand elasticities Market must be segmentable Cost of segmentation should not exceed extra revenues generated Should not cause customer discontent Should be legal
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2. Two Possible New Product Pricing Strategies

1. Market Skimming Strategy Price initially high and then gradually lowers

Usually only applicable for a new, unique high tech product

Needs a segment of innovators and early adopters who are prepared to pay a high price Initial high price can generate cashflow and contribute towards early payback

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2. Two Possible New Product Pricing Strategies

2. Penetration Pricing Strategy

Aims to gain rapid market share at low price so that long run economies of scale will lead to long term profits and market leadership

Suitable when demand is highly elastic

Main product may be priced low extras, consumables etc may be priced high Bait and Hook strategy

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3. Tactical Pricing
Distinguish from the strategic, long term pricing strategy for a brand Aims to manage and maintain sales volumes and margins with short term fluctuations in demand Short term promotional pricing can take many forms sales, special offers, discounts, free gifts, BOGOFFs etc

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