Pricing Strategies

Kishore Kumar Gangwani

 Agenda for this session
General Guidelines throughout the teaching sessions:
• Matching the expectations
• Use of Mobile devices
• Recording any part of the session
• Participation in Class Discussion

Approach towards mandatory project work

(Plagiarism, Cheating, acceptable and unacceptable
collaboration)

What this course is all about?

What will not be covered in this course?
(Not a class for core marketing or quantitative pricing)
Slide 2 of 52
 Why Study Pricing?
• Slight improvements in pricing can yield significant results.
✓ For a firm with 8% profit margin is it better to improve price by 1 % or
reduce the costs by 1 % ?
➢ 1% improvement in price realization, assuming a steady unit sales
volume, would boost the company’s profits by 12.5%. Decreasing fixed
costs by 1% would lead to an increase in profits of 4%. (Dolan 1992)
✓ Continental Airlines had 44 million passengers in 2001, at an average
ticket price of $193. Charging $2, or 1.04%, more per ticket would have
transformed a loss into a profit.

• Managers don’t know customers’ WTP

✓ 80% of managers know how much it costs to produce their product.
23% say they know their customers’ willingness to pay for the product.
• Firms are unable to recruit employees with right pricing skills
✓ 41% of firms have identified their inability to recruit employees with
the right pricing tool sets as their major barrier to implementing
pricing practice overhauls.
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 Importance of Pricing
Pricing for telecom products: from past to present
• What are different pricing options?
✓ Past to present

Apple’s market leadership in music sales.

• Role of internet
• Song vs. album
• Subscription model

Pricing strategies used by Governments

• Taxes vs. user fees

Slide 4 of 52
 Technology and Pricing
Technological advancements and its effects on pricing
• Transparency
• Downward pressure on prices
• Informed customers (information asymmetry is gone)
• Data driven pricing
• Price differentiation
✓ Online vs. offline segment
✓ Segmenting for devices

Can type of device signal a difference in willingness to pay?

https://www.washingtonpost.com/posteverything/wp/2014/11/
03/if-you-use-a-mac-or-an-android-e-commerce-sites-may-be-
charging-you-more/?noredirect=on
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Chapter Overview
• Strategic Pricing and differentiation from tactical
approaches such as
✓ cost-driven, customer-driven or competitor-driven pricing

• Characteristics of strategic pricing

✓ Proactive
✓ Profit-driven
✓ Value-based
• Define the six elements of a pricing strategy and how they
work to maximize profitability?
✓ Value creation
✓ Value communication
✓ Price structure
✓ Price policy
✓ Price setting
✓ Price competition
Slide 6 of 52
 Cost-plus pricing
Price = (1+ percent markup)(Unit Variable Cost + Average Fixed
Cost)

• Historically, most common procedure

• Pricing every product/service yield fair Return Over Cost

Problems with cost driven Pricing:

• Determining a unit cost before price
✓ Estimate the costs of everything
• Costs are a function of sales and sales are a function of price
• Significant portion of costs are “fixed”
✓ Low marginal costs for digital products
• Leads to over-pricing in weak markets
• Under-pricing in strong markets
Slide 7 of 52
 Cost-plus pricing
• Costs are a function of sales and sales are a function of price
✓ What if sales decline? Can we increase the price?
➢ Wang Lab vs. Personal Computers (1976)
✓ What if sales improve? Can we reduce the price?
➢ pricing at average cost for small-scale capacity means
that the firm may never discover this.
❖ This is an issue for firms that face large economies of scale or
unknown experience curves.
❖ For example, an airplane manufacturer found that every time
they managed to double their sales, they reduced labor time
per plane produced by 10 percent.

Slide 8 of 52
 Cost-plus pricing
• Costs are a function of sales and sales are a function of price
✓ What if sales decline? Can we increase the price?
➢ Wang Lab vs. Personal Computers (1976)
❑ Growth till 1980’s
❑ Mid 1980’s Personal Computers>potential competitor
❑ Competition increased, and growth slowed
❑ Price increased to reflect rising overhead allocation
❑ Result, sales decreased further
❑ Loyal customers began switching to alternative
✓ What if sales improve? Can we reduce the price?
➢ pricing at average cost for small-scale capacity means
that the firm may never discover this. This is an issue
for firms that face large economies of scale or
unknown experience curves.
➢ For example, an aeroplane manufacturer found that
every time they managed to double their sales, they
reduced labor time per plane produced by 10 percent. Slide 9 of 52
 Cost-plus pricing
Blame culture
• Finance blame marketing for cutting the price
• Marketing blame finance for excessive costs

Slide 10 of 52
 Customer-Based Pricing
Companies realized the fallacy of cost-based pricing.
• Result?
✓ Pricing authority taken away from financial managers and
given to sales or product managers.

• Seems to be consistent in trend with value-based pricing

✓ In practice : misuse of pricing
✓ Short term sales and targets

Slide 11 of 52
 Customer-Based Pricing
Fundamental problems with customer driven Pricing:
• Customers do not reveal how much they value the product
✓ Radiohead ‘pay what you want’
• Customers need to be educated about the value of the
product and increase their WTP
✓ Volvo in India
✓ Customers may underprice the products and give less WTP
bcoz they have no prior experience.
• When customers are used to being in control of a firm’s
pricing, they revolt at price changes
✓ Turbotax starting charging users $9.95 for each additional
return they filed. Users revolted and gave them a 1.5-star
rating. The company retreated, reverted to charging
nothing and refunded the money.
✓ Magic band by Disney Slide 12 of 52
 Competition- based pricing
• Pricing policy dictated by the competition.
• Pricing is a tool to achieve market share or sales objective.
• For some managers, this method is ‘pricing strategically.’

Problems with competition-based Pricing:

• Firms ignore their unique value proposition
✓ A radiology software firm with a unique 3D capability lost
millions because they priced at the same price as the
marketing leader.
• Price wars
✓ Fixed or declining market size
• Higher market share may not result in maximum profits
✓ Some segments of the population are more profitable to
serve
Slide 13 of 52
Optimization in strategic pricing

Hyundai Venue Commands Longest Waiting Period Among

Subcompact SUVs This August.
• Minimum waiting period on the Venue is 1 month.
• Waiting period for the Maruti Vitara Brezza goes up to 45
days.
• Ford EcoSport attracts a waiting period of up to 5 weeks.
• Waiting period on the Nexon range from 10 to 45 days.

https://www.cardekho.com/india-car-news/hyundai-venue-
commands-longest-waiting-period-among-subcompact-suvs-
this-august-24111.htm

Why few firms ask customers to wait for their products?

Slide 14 of 52
Optimization in strategic pricing

Pricing based on estimating the demand curve

• Impractical because of the assumption of stable demand
curve.
• Economists argue that demand is rarely stable because of
price sensitivity.

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Price Sensitivity: An example

How important is the price of the stent to the cardiologist in

choosing which one to insert?

Not very much important, Why?

✓ Life-or-death situation for the patient, product performance is the key.

✓ Doctor is a very knowledgeable, sophisticated decision maker, aware of
stent features and the advantages/disadvantages of each for various
types of blockages.
✓ Doctor may have more experience inserting one type of stent or
another and would prefer not to shift away from the “usual brand” if it
is appropriate for the situation.
✓ Doctor is not the one paying for the stent
Seems intuitive or common sense, but a systematic approach
can be useful in judging price sensitivity
Slide 16 of 52
Price Sensitivity: An example

What are the key factors for Price Sensitivity?

• Product Category Factors

• Who Pays? (Cardiologist, Airfare)
• Competitive Factors
• Reference Prices
• Price/Quality Relationships

Slide 17 of 52
Factors for price sensitivity

Product Category Factors

• Low-cost vs. high cost product categories
✓ 10% price difference in cab fare vs. a car
• Important factors
✓ Absolute Dollar Cost.
✓ Purchase frequency
➢ Regular user or infrequent user
✓ Dollar Cost of item as a percentage of total cost.
➢ Using a chemical for producing heat insulators
(50%) or polyesters (5%) (Dolan and Simon)

Slide 18 of 52
Factors for price sensitivity

Who Pays?

https://me.me/i/iphone-moda-ipod-ipad-ipaid-d-6985067
Slide 19 of 52
Factors for price sensitivity

Who Pays?

• Some things the user of the product pays for; sometimes

not.
• Decision maker may pay no portion of the cost, may share
some costs, or pay full costs
✓ Out of the pocket vs Mediclaim expenses
• More the decision maker pays, the greater is the price
sensitivity.

Slide 20 of 52
Factors for price sensitivity

Competitive Factors

• Price sensitivity is higher if

✓ Perceived differences in alternatives are insignificant
✓ It is easy to compare products and prices(Life insurance
policies)
✓ Similar price schedules
➢ Fixed only or fixed plus variable
✓ It is easy for decision maker to switch products.
➢ Switch your cell numbers

Slide 21 of 52
Factors for price sensitivity

Reference Prices

• Reference Price = f (Fair price, competitor price, price last

paid, price paid by others)
• Reference prices are subjective.

• Price sensitivity is higher if

✓ Prices are above reference prices

Slide 22 of 52
Factors for price sensitivity

Price/Quality Relationships

Slide 23 of 52
Strategic Pricing

Kishore Kumar Gangwani

Strategic Pricing

• Optimal price is limited by the demand curve

✓ Customers WTP to buy various quantities

• Is demand always available upfront?

✓ It is created
✓ Demand is a function of sellers’ decisions about
➢ Offer, communication, managing price expectations.

• Objective of strategic pricing

✓ sustainable profitability.
• Characteristics of strategic pricing
✓ Proactive
✓ Profit-driven
✓ Value-based
Slide 25 of 52
 Characteristics of Strategic Pricing
• Value-based
✓ Differences in pricing across customers or applications
reflect differences in the value to customers.
✓ How about price reduction in response to reduced demand
during recession?

• Proactive
✓ Anticipate disruptive events and strategy to deal with it
✓ Low priced products during recession

• Profit-driven
✓ Market share or profit driven
✓ First iPhone at $499, and overpricing
✓ Price reduced to $399
✓ Should Apple be worried in present situation? Slide 26 of 52
 Characteristics of Strategic Pricing
• Define the six elements of a pricing strategy and how they
work to maximize profitability?
✓ Value creation
✓ Value communication
✓ Price structure
✓ Price policy
✓ Price setting
✓ Price competition

Slide 27 of 52
 Value Creation
• Value vs. WTP. Are they same?
• how to create value cost-effectively and convince people to
pay prices commensurate with that value.
✓ Blackberry failed to create great value

✓ The fast furniture

✓ https://www.curbed.com/2019/7/24/20707586/cheap-
furniture-amazon-target-ikea-wayfair

Slide 28 of 52
 Value Communication
• Prices should be justified
✓ A random act of listening the price of Ghee.
• Price and value communications is quite a challenging task.
✓ Economic benefits, psychological benefits.

• Price presentations
• Are consumers price decisions irrational?

• Value communication depends on

✓ the type of product , the purchase context, stage in
decision making
➢ Laundry vs. vacations
➢ Pay as you go vs. flat fee

Slide 29 of 52
 Price Structure
• How to monetize the value into revenue?
✓ Price per unit

• Why multiple price structures?

✓ Differences in value creation and ability to pay
✓ Business vs. pleasure traveler
✓ Air Arabia vs. Emirates

Slide 30 of 52
 Pricing Policy
Why price resistance?
• Product is not delivering the value
• Customers do not understand the value
• Price is high relative to the value.
• Exploiting the sellers’ reactive pricing process.
✓ Customer acquisition policies

Slide 31 of 52
 Price Setting
• Price setting from economics point of view
✓ (MR=MC)

• Reality of price setting?

• Uncertainties in MR and MC
✓ Changes in revenue due to price change
✓ Customer and competitive reactions

• Pricing tools
✓ conjoint analysis
✓ optimization models
✓ May create a sense of false precision about the right price.
• Price setting requires
✓ managerial experience and judgment , iterations, cross
functional collaborations Slide 32 of 52
 Price Competition
• Competitive pricing
• The potential market value is a function of Reference Value
Differentiating Value
✓ Dinner in the Sky
• How to influence the reference?
✓ Price decisions by JIO from launch to the date

Slide 33 of 52
Questions?
Comments?
Concerns?
Economic Value

Kishore Kumar Gangwani

 Economic Value
• What do marketers mean when they propose pricing to reflect
value?
• Economic value
• How to determine economic value?
✓ Availability of customers’ alternatives.
➢ Value may not reflect in real payments.
• The value of home delivery
• Economic value
✓ Monetary and psychological value impacts WTP
✓ Which one is more?

• How to estimate monetary and psychological value?

Slide 36 of 52
Economic Value

Slide 37 of 52
 Economic Value

• https://www.buyatoyota.com/home/vehicles/priusprime/calc
ulator/

Slide 38 of 52
 How to estimate economic value?

• How to collect and analyze competitive reference prices?

• Estimating monetary value
• Estimating psychological value

Slide 39 of 52
 Competitive reference prices
• If the seller do not exist, what would his customer do?
• The real market share
• One competing product vs. basket of products

• How to establish the competitive reference price?

✓ Collect accurate price data which is comparable to the
pricing for your product.
➢ Collect at point of sale, customers, sales agents etc.
➢ Customer service executive can collect the data.
✓ Challenge is the unpublished price data

Slide 40 of 52
Competitive Reference Prices

Slide 41 of 52
Competitive Reference Prices

Slide 42 of 52
 Estimating Monetary Value
Value drivers for an equipment manufacturer

Slide 43 of 52
Monetary Value Estimation for Dyna-Test
Industrial Buyers

Slide 44 of 52
Monetary Value Estimation for Dyna-Test
Academic and Government Buyers

Slide 45 of 52
Monetary Value Profile for Dyna-Test

Slide 46 of 52
 How to estimate economic value?
• Economic value derived from monetary value estimation may
not necessarily be the perceived value
✓ Unawareness about a reference product
✓ not influenced by the reference product’s price.
✓ Unsure about differentiating attributes, not willing to learn
about the product
✓ Impulse purchase
✓ brand image
• Product’s market value is determined not only by the product’s
economic value, but also by the accuracy with which buyers
perceive that value

Slide 47 of 52
 Estimating Psychological value
• Quantitative techniques
✓ Conjoint analysis
• How to describe a flat screen TV?

Slide 48 of 52
 Estimating Psychological Value
• How to set prices given that there were many different types
of golfers who would be potential customer?
• Beginning players
✓ Club was appealing because it was much more forgiving of
poorly hit balls compared to traditional clubs.
✓ Management perceived that beginners would be relatively
price sensitive, unwilling to pay a premium for the tech.
• Advanced players
✓ added distance was appealing, qualitative research
indicated they would be willing to pay a substantial
premium.

• How should they set prices to maximize profits?

Slide 49 of 52
 Estimating Psychological Value
How should they set prices to maximize profits?
• Identify different segments
✓ Innovators
➢ Frequent golfers, higher incomes, do a detailed research
✓ Value Seekers
➢ Casual players (five to ten times), moderate income, purchase
from major sporting goods retailers. Value seekers are thrifty, but
they will pay a premium for added performance.
✓ Lost Players
➢ Large segment, occasional players, do not purchase significantly,
can be drawn back to playing if a new innovation creates enough
buzz to capture their attention.
✓ Budget Shoppers
➢ Players range widely in ability and frequency of play, budget
constraints, buy from discount stores, online outlets.

Slide 50 of 52
 Estimating Psychological Value
How should they set prices to maximize profits?
• Identify the attributes for each segment
✓ Most common attribute by all segments
➢ Distance, straightness, and consistency.

• Warranty was not a key driver in the purchase decision;

potential purchasers were more focused on the performance
attributes of the club.
✓ Initial hypothesis was not correct, because consumers across all
segments were willing to pay a premium for a one-year warranty.
✓ Extending the warranty from one to two years did not lead to a similar
increase in willingness-to-pay.

Slide 51 of 52
Questions?
Comments?
Concerns?