Economic Value

Pricing Strategy & Tactics – Chs. 1-3 • Define Strategic Pricing & 5 elements of a pricing strategy: (1) Value creation, (2) Price and offer structure (3) Value communication, (4) Pricing policy, & (5) Price setting; • Define Value and explain its role in pricing strategy; • Show how value-based segmentation enables companies to more profitably align its offerings with differences in what consumers are willing to pay; and • Examine mechanisms to maintain segmented structures: (1) Price-offer configuration, (2) Price metrics, & (3) Price fences.

MKTG 6214 Glenn Voss

MKTG6214 Course Materials Textbook: • The Strategy and Tactics of Pricing, 5th edition, 2011, Nagle, Hogan, and Zale Cases: • 2 Cases in course packet at Study.net Password:

MKTG6214

• Springfield Nor’easters case available online User Name: Password:

Lectures and Discussions: • In conjunction with cases & handouts of slides

Assessment & Grade Distribution • 2 Written Case Analyses

20

(completed in groups of 1-6)

• Final Examination • Total Cox Recommended Grade Distribution A/AB/B+ B-…

10 30

40% 50% 10%

Date

Topics

Text Readings

8/23

Strategic Pricing & Value Creation

Chapters 1-3

8/30 9/6

Price Setting & Value Chapters 4-6 Communication Pricing Strategy over the Life Cycle Chapters 7-8

9/13

Case Analysis

9/20

Financial Analysis & Costs

Chapters 9-10

9/27

Competition

Chapter 11

10/4

Final Review

10/11

Final exam

Class Discussion Russian Technology

Akash Rathod B2B Pricing Atlantic Computers Case Springfield Case Rick Lester TRG Arts Virgin Mobile Case

Modeling the Marketing Process SWOT Analysis Company Customers Competitors Collaborators Context Market Segmentation Create

Value Communicate, Capture & Share Value

Selection & Targeting

Product/Service Offering

Product/Service Offering Positioning

Place/

Pricing

Channel Promotion/ Communication

Customer Acquisition

Customer Retention

Revenue & Profits

Customer Relationship Management Sustain

Value

The Strategic Pricing Pyramid Price Level Price setting

Pricing Policy Negotiation Tactics & Criteria for Discounting

Price/Value Communication Communication, Value Selling Tools

Communicate, Capture, & Share Value

Price Structure Metrics, Fences, Controls

Value Creation Economic Value, Offering Design, Segmentation

Create Value

Price setting is just the “tip of the iceberg” of a profitable pricing strategy.

Value-Based Pricing Effective pricing strategies should be based on three factors: Competition

Costs Pricing Strategy

Customers

Objective: Maximize the difference between the value created for the customer and the company’s costs to provide that value.

The Value-based Pricing Process CUSTOMER

VALUE

PRICE

COST

PRODUCT

Value Creation Defining VALUE Use Value (Utility) • Monetary gain (or savings) from using a product/service offering • Psychological benefits (or costs) associated with using a product/service offering Economic Value • Calculated using reference value and differentiation value Reference Value Refers to the price of the consumer’s “best” alternative.

Differentiation Value Refers to the value of whatever differentiates the offering from the alternative(s). Can be positive or negative. Total economic value represents the maximum price that a fully-informed consumer would be willing to pay for a product/service offering.

Economic Value Estimation Framework

Your unique value delivery

Price of Customer’s Next Best Alternative

Positive Differentiation Value

Reference Value

Negative Differentiation Value Price to capture a share of this value

Costs unique to doing business with you

Total Economic Value

Economic Value Estimation Example – Heavy equipment manufacturer Higher residual value = $1200 Parts inventory program savings = $1250 Invoice processing consistency savings = $1500

Fuel economy savings = $2200

Add’l warranty cost = -$1050

Differentiation Value = $7,450

Increased revenue from higher uptime = $2350

Competitive alternative for this customer = $72,500

Reference

Reference price = $72,500

Total offering economic value $79,950 How much of the Differentiation Value do you Capture versus Share with your Customers

Economic Value Analysis Step 1: Identify Reference Value • Reference value is calculated as the price of the best perceived alternative, not necessarily the next best competitive alternative, with regard to form, function, effectiveness, and/or efficacy.

Step 2: Estimate Differentiation Value • Determine the value drivers – those attributes that impact customer perceptions and purchase choice Are they monetary gains or cost savings? Are they psychological benefits or costs?

Comment regarding differentiation value . . . . In most cases, the components making up differentiation value can be quantified to some extent. Some consumers, however, will pay more for a product simply because of the brand name – despite the fact that the tangible value of the product may be substantially lower than alternatives available to them. Therefore, the brand name can often be a component of the differentiation value (brand equity).

What type of differentiation value does a brand name provide?

Economic Value Analysis Step 1: Identify Reference Value • Reference value is calculated as the price of the best perceived alternative, not necessarily the next best competitive alternative, with regard to form, function, effectiveness, and/or efficacy.

Step 2: Estimate Differentiation Value • Determine the value drivers – those attributes that impact customer perceptions and purchase choice Are they monetary gains or cost savings? Are they psychological benefits or costs? • Identify attributes that differentiate between your product and the competitive reference product. What benefits or costs are associated with your product? How can you quantify each benefit and cost? – Gather data that can be used to assign the monetary amount to each value driver (e.g., in-depth customer interviews, surveys, focus groups) – Focus on the underlying customer business model (what drives the business model will typically drive the value perceptions of the customer) – Value drivers can vary across customers & across time

• Determine the value derived from a bundle of features

Estimating Psychological Value Impact of Warranty Length on Willingness to Pay MKTG 6223

Understanding What Customers Value Segment B — Innovators

$6

Revenue Contribution

$5 $4

$ (M)

$3

$4,041,864 (~ 10,100 units)

$2 $1

$626,904

$0 $0

$100

$200

-$1

$300

$400

$500

$600

Price ($)

Segment E — Budget Shoppers

$4

$3

$ (M)

$2

$261,496

$2,020,788 (~ 5,800 units)

$1

$0 $0 -$1

$100

$200

$300

Price ($)

$400

$500

$600

Pricing Russian Technology Quiz Cost of a Surge (minor) Labor Incremental materials, fuel Lost Production (8 hours to restart.)

$ 9,000 $ 6,000 $80,000 $95,000 Frequency of minor surge per compressor .4 per year Cost of a Surge (major) Labor Incremental materials, fuel Equipment (new compressor) Lost Production (24 hr. To restart)

$ 24,000 $ 11,000 $180,000 $240,000 $455,000

Frequency of major surge per compressor = .004 per year

Pricing Russian Technology Quiz 1. What is the economic value of this product? 2. How close to this value would customers be willing to pay? 3. Why might customers object to paying the full economic value? 4. What would you do to overcome those objections?

The price of the most basic of commodity products . . . . Brand

Product of

Notes

Price per Ounce ($)

Price per Gallon ($)

Acqua Panna – Natural Spring

Italy (Florence)

1 liter glass bottle

0.13162

16.85

Arrowhead – Mountain Spring

California

Plastic 28-pack

0.02367

3.03

Dasani – Purified Drinking Water

USA

Plastic

0.08876

11.36

Evian (Nomad) – Natural Spring

France (Alps)

Plastic 6-pack

0.12318

15.77

Menehune – Purified Drinking Water

Aiea, HI

Plastic

0.07813

10.01

Perrier – Sparkling Natural Mineral

France

Green Glass

0.08333

10.67

Rosauer’s Finest – Spring Water

Canada

Plastic/Pop Top

0.02307

2.95

San Pellegrino – Sparkling Mineral

Italy (S.P.)

Green Glass

0.08844

11.32

Talking Rain – Mountain Spring

Preston, WA

Plastic/Flavored

0.06760

8.65

Voss – Virgin aquifer

Norway

Clear glass cylinder

0.181746

23.26

Pipes/Lake Water

0.000012

0.00156

City of Dallas– Residential

The relevant question is: Why are consumers willing to pay relatively steep prices for a commodity product?

Price Structure Tactics for Pricing Differently Across Segments Market Segmentation – organizing the market into homogeneous groups (or segments) that the firm can effectively & efficiently target.

Market Segmentation Create Value Communicate, Capture & Share Value

Selection & Targeting

Product/Service Offering

Product/Service Offering Positioning

Place/

Pricing

Channel Promotion/ Communication

Customer Acquisition

Customer Retention

Revenue & Profits

Customer Relationship Management Sustain Value

The Reason for Segmented Pricing A one-size fits all approach to pricing reduces profitability and intensifies customer pricing pressure 2 ….leaves money on the table for these customers and

communicates that value does not have to be paid for… High

Value

1 Setting price here

A

B

C

D Low

Segment Size

3 ….and misses growth opportunities by pricing these customers out of the market

Benefits of Price Segmentation with 5 Segments (A, B, C, D, E) Percent of Market

A 5

B 15

C 35

D 25

E 20

Total 100%

Segment Size

50

150

350

250

200

1000

$20

$15

$10

$8

$6

$10 $5 $250 $15 $5 $500 $20 $5 $750

$10 $5 $750 $15 $5 $1500 $15 $5 $1500

$10 $5 $1750 $8 $5 $1050 $10 $5 $1750

$10 $5 $0 $8 $5 $750 $8 $5 $750

$10 $5 $0 $8 $5 $0 $6 $5 $200

Reservation Price =

Maxim. contribution w/: 1 Price ($10) VC equal to Contribution equals 2 Prices ($15, $8) VC equal to Contribution equals 5 Prices ($20  $6) VC equal to Contribution equals

$2750

$3800

$4950

Careful Analysis is Required to Avoid Nonprofitable Segmentation & Proliferation SKU Velocity Analysis focuses on SKUs that drive a majority of revenue & volume Identify opportunities for SKU rationalization

100%

80%

60% Cumulative percent of total sales 40%

Focus price improvement efforts on the top moving SKUs

20%

0% 0

2000

4000

6000

8000

Cumulative number of SKUs

10000

Benefits of Price Segmentation Can Change with Ambiguous Reservation Prices Percent of Market

A 5

B 15

C 35

D 25

E 20

Total 100

Segment Size

50

150

350

250

200

1000

$20

$15

$10

$8

$6

Reservation Price ≈

30% buy next higher-priced option if target price not available

Examples: You stop at a gas station, get out, and discover that there is only premium gas available. Do you buy or leave? You go to the ballpark and discover that there are only premium seats available. Do you buy or leave?

Mobile Customer Prices Paid per Minute (Virgin Ex 9b) 70

Price per Minute Paid

60

50 100

40

300 500

30

700

20 10 0 0

100

200

300

400

500

Contract Minutes

600

700

800

Benefits of Price Segmentation Given Ambiguous Reservation Prices Percent of Market

A 5

B 15

C 35

D 25

E 20

Total 100

Segment Size

50

150

350

250

200

1000

$20

$15

$10

$8

$6

$10 $5 $750 $15 $5 $1500 $15 $5 $1500

$10 $5 $1750 $8-15 $5 $1785 $10 $5 $1750

$10 $5 $375 $8 $5 $750 $8 $5 $750

$10 $5 $0 $8 $5 $180 $6 $5 $200

Reservation Price ≈

30% buy next higher-priced option if target price not available

Maxim. contribution w/: 1 Price ($10) VC equal to Contribution equals 2 Prices ($15, $8) VC equal to Contribution equals 5 Prices ($20  $6) VC equal to Contribution equals

$10 $5 $250 $15 $5 $500 $20 $5 $750

$3125

$4715

$4950

Benefits of Price Segmentation Given Ambiguous Reservation Prices & Incremental VC & FC A 5

B 15

C 35

D 25

E 20

Total 100

50

150

350

250

200

1000

$20

$15

$10

$8

$6

$10 $5.30 $720 $15 $5.40 $1440 $15 $5.70 $1395

$10 $5.20 $1680 $8-15 $5.30 $1694 $10 $5.60 $1540

$10 $5.10 $365 $8 $5.20 $700 $8 $5.50 $625

$10 $5.00 $0 $8 $5.10 $168 $6 $5.40 $120

Percent of Market

Segment Size Reservation Price ≈

30% buy next higher-priced option if target price not available

Maxim. contribution w/: 1 Price ($10) VC equal to Contribution equals 2 Prices ($15, $8) VC equal to Contribution equals 5 Prices ($20  $6) VC equal to Contribution equals

$10 $5.40 $240 $15 $5.50 $480 $20 $5.80 $710

$3000

$4482

$4390

Add $.10 in VC for each incremental price point above $6 (higher VC for higher-priced products) & $.10 additional FC per product/price offering greater than 1.

Value Based Market Segmentation – pp. 40-45 6 Steps for Value Based Segmentation

Determine basic segmentation criteria

Identify discriminating value drivers

Determine operational advantages and constraints with regard to those value drivers

Create primary and secondary segments

Create detailed segment descriptions

Develop metrics and fences

Three Mechanisms to Maintain Segmented Structures

Price-offer configuration Price metrics Price fences

Pricing Menus Map Price Structure Help Customers Trade Up or Trade Down A “Fixed Price, Flexible Offer” Menu

Examples of Tiered Offers in Software

Standard SRP $219.99

Basic SRP $199.95

Professional SRP $299.99 All in Standard + MS Access

Pro SRP $279.95 All in Basic + Create Customized forms, Tools to Track add’l items

Developer SRP $529.99 Development Tools to Build Own Applications

Premier SRP $399.99 All in Pro + Daily Sales Summary, Retail Specific Reports

Price Offer Configuration Principles For Offer Creation

Toilet on the plane

First to Board Premium Seats

On-Board Entertainment

Beverages

WiFi Access

Bag Check

Price Metrics Criteria For Evaluating Price Metrics - Exhibit 3.4 Potential Metrics

1 2

Tracks with Differences in Cost-to-Serve

3

Easy to Measure and Enforce

4 5

Tracks with Differences in Value Across Segments

Facilitates Favorable Positioning against Competition Aligns with How Buyers Experience Value in Use

Optimal Metric

Value-based Pricing Metrics Market

Traditional Metrics

Value-based Metrics

Real Estate Want Ads

$ / column inch

$ / property value

Aircraft Engines

$ / engine

$ / hour of use

Information service

$ / minute

$ / download

Example: Innovative Price Metrics Can Unlock Value and Ignite Growth iTunes

Why did this new pricing model have such an impact on sales?

iTunes’ New Price Metric Re-Aligned Price and Value iTunes

Old Metric $ / CD

New Metric $ / Song

Overpayment Value Inducement Value of CD

Price of CD

Value of Song

Price of Song

Price Fences – Price Fences are a means to charge different customers different prices. – Types include • • • •

Buyer identification fences (e.g., airlines, student/senior, membership) Purchase location fences (e.g., grocery chains, real estate) Time purchase fences (e.g., fashion, yield management - hotels, airlines…) Purchase quantity fences – Volume discount – Order discount – Step discount – Two-part pricing (e.g., printer and cartridges)

Next Week: Price Setting and Value Communications or How to price bottled air to morons…