Smart Pricing

• "invisible hand" that sets the market price, is almost always visible. “the market does not set prices. Marketers do.”

• “ four most common methods of price setting: 1) pretty much like selecting a lottery number: Pick what comes to mind, say a prayer, and hope for the best. 2) cost-plus pricing 3) competition-based pricing, 4) consumer-based pricing. Each of these approaches requires human intervention, and each is overly simplistic.” They are not necessarily the best ways to price a product or service. In many cases, they are nothing but shortcuts managers use to cope with the weight of their decision-making responsibility.”

• cost-plus pricing

  • “To use cost-plus pricing, a firm first determines its sales target and then figures out the average cost it will incur based on the sales target. The price for the product is set by taking the average cost plus a markup. For example, if the sales of Apple’s iPod are 2 million units, the average cost at that output level might be 100 dollars per iPod. Assuming that the normal markup at the company is 70%, Apple’s selling price for an iPod would be $170. The size of the markup is determined either by the company’s targeted internal rate of return on investment or by some vaguely defined “industry convention.”
  • biggest problem: it is an inward-looking approach that tends to distract a company from its customer orientation and obscure the importance of detailed market research

• competition-based pricing (strategic pricing)

  • “When taking this approach, a firm simply checks out its competition’s price and then sets the price of its own product at about the same level, plus or minus a few percent. ”

• consumer-based pricing

  • “the firm first sizes up its customers to determine how much each customer is willing to pay for its product or service and then charges the price each customer is willing to bear.”

• 4 levers to increase profitability

  • sales
  • variable costs
  • fixed costs
  • price

• learn about how, why and when the different pricing strategy works

• 1. Pay as you wish pricing
  • why? eliminates many of the disadvantages of set pricing. The seller gets the best offer from every possible buyer, with no chance that the buyer will leave feeling that he overpaid.
  • important feature: “structure multiple tiers of demand for the same product ”. e.g. music industry, book selling, charity and nonprofit group, food industry. also build a stronger sense of community
  • 5 key qualities for successful program with this strategy:
  • A product with a low marginal cost
  • A fair-minded customer
  • A product that can be sold credibly at a wide range of prices. “A Wide Distribution in the Amount Customers Are Willing to Pay for a Product”
  • A strong relationship between buyer and seller
  • A very competitive marketplace
• 2. Free
  • e.g. Google services
• 3. The art of price wars
  • why? “a price war can be a great way to shake out competition and build a commanding market share in a short period of time”

  • framework: “incremental break-even analysis (IBEA)”. “A price war always starts with a firm initiating a deep price cut in an industry. When a firm initiates such a price cut, it expects to benefit from higher volume, either right away or at some point in the future. In the short term, the firm can benefit only if its sales go up sufficiently to offset the lost profit per unit. That’s where IBEA comes in handy—it identifies how much sales need to increase to make up for the contribution margin sacrificed by the price cut.”
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    “ it is more tempting for a company to initiate a price war, a deep price cut, if it faces a small Δq, the threshold increase in sales required for a firm to profit from the price cut.”

  • “IBEA is most effective when the most efficient competitor in a high-margin industry executes it. If the initial profit margin is high, only a small increase in sales is needed for a firm to benefit from a price cut. ” e.g. consumer electronics, home appliances, personal computers, mobile phones, cable tv, automobile
  • “The formula also clarifies the role scale plays in price wars. As the reduction in marginal costs (Δc in the formula) gets bigger, the percentage in added sales required to break even (Δq) declines. This means that price wars are more likely to break out in industries with significant scale economies. ”
  • “IBEA suggests two broad principles for fighting a price war. First, companies should do two things that discourage a competitor from starting and benefiting from a price war: increase the hurdle (Δq) competitors face to discourage them from thinking about price cutting in the first place, and differentiate the product enough to make substitution difficult.”
  • “Second, if a price war must be fought, don’t just take a defensive posture. a company should always strive to position itself to profit from rising consumer demand (Δq) or any possible redistribution of market share.”
• 4. Thinking Small
  • “simply repackaging goods in different sizes or reimagining a service in such a way that the cost is somehow within reach of the lowest strata of income can uncover a huge underserved market.” “ the greatest challenge of business today is how to charge the least and serve the most. ”
• 5. The Automatic Markdown
  • Clothing
  • “frame a high perceived value for a product, encourage customers to buy right away, and give price-sensitive shoppers a reason to come back next week. It even does a terrific job with price discovery, making it easy to see the exact price point at which a buyer will buy.”
• 6. Name your own price
  • “Disguising the brand and other characteristics of the product, which the pay-as-you-wish pricing mechanism does not do, made it difficult for customers to do head-to-head comparison shopping, helping to preserve the premium the seller could charge for its branded product”
  • “In financial services, some banks have succeeded in gaining new clients without damaging their profitability by shaping offers around careful data mining. Instead of simply offering a lower interest rate to every potential new client, the bank offers lower rates only to clients that it sees as the most desirable new customers. This encourages the lower-risk client to sign up, while avoiding the trap of growing by taking on new higher-risk clients, which would reduce the bank’s overall risk-adjusted return. At the same time, by mining the data of their existing customers, banks can also rank-order their customers based on their profit contributions and mete out services and fees accordingly.”
  • “matching the right offer with the right customer at the right profit-maximizing moment. Companies will continue to improve the way they segment customers efficiently and even identify the habits of individual customers on the fly”
• 7. Subscribe and save: pricing for marketing profitability
  • customer-centric view. view every transaction horizontally
  • Accounting losses are simple to understand. When you don’t sell enough of Product X to cover the cost of the product and the overhead, the store loses money on the product.
  • marketing profitability loss mean: Negative marketing profitability occurs when customers who are attracted to the store for a particular product spend little on anything outside of that product or spend a lot on items that are not profitable to the retailer but for which the carrying costs are very high. Essentially, marketing profitability shows how strong—or weak—the coattails of a given category are. At the same time, marketing profitability can reveal if a particular product is attracting the wrong kind of customer to a store.
  • “After examining the retailer’s business through the two lenses of accounting profitability and marketing profitability, we can divide the store’s entire stock into four basic divisions. Some products have a high accounting profit (a large difference between revenues and costs for the product) but a low marketing profit. A lucky few have a high accounting profit as well as a high marketing profit. Others have a low accounting profit but a high marketing profit. Finally, some have both low (or even negative) accounting and marketing profits. This new perspective gives the retailer an important tool to clarify not just the right price and product mix, but any number of supportive business practices.”
  • growing opportunity: “but getting more people to spend more time (increase frequency by attracting kid meal with toy + parents + playground) and money (increase price gradually)”

Conclusion:

• Customer Focus
  • what kind of customers you're dealing with
  • what customers value about your product or service and how to price to capture that value
  • pay close attention to consumer buying behavior
• Differentiate pricing
  • keep 3 price points: low/medium/high -> ensure customers with different price sensitivity pay different prices
• Smart pricing metrics