This Pricing Strategies document provides extensive information for a company to develop an optimal pricing strategy. A well-devised pricing structure will earn the company profit and reflect the realities of the marketplace. Some of the topics covered in this document include: how to improve performance, what pricing should do, questions associated with pricing, and The 9 Laws of Pricing Sensitivity. This document is a useful tool for any company that provides services or sells products, and wants information for devising a pricing strategy.
This Pricing Strategies document provides extensive information for a company to develop an optimal pricing strategy. A well-devised pricing structure will earn the company profit and reflect the realities of the marketplace. Some of the topics covered in this document include: how to improve performance, what pricing should do, questions associated with pricing, and The 9 Laws of Pricing Sensitivity. This document is a useful tool for any company that provides services or sells products, and wants information for devising a pricing strategy. Pricing Strategies for Marketing Pricing Strategies For Marketing 2010 Table of Contents Executive Summary......................................................................................................................... 4 Learn How to Improve Performance .............................................................................................. 5 The Breakeven Analysis ............................................................................................................... 6 What Pricing Should Do .................................................................................................................. 8 Pricing Strategies ............................................................................................................................ 9 Questions Associated with Pricing ................................................................................................ 13 The 9 Laws of Pricing Sensitivity ................................................................................................... 16 Pricing Definitions ......................................................................................................................... 18 Common Pricing Mistakes ......................................................................................................... 21 Pricing Tactics ............................................................................................................................ 21 © Copyright 2010 Docstoc Inc. 3 Executive Summary P ricing is one of the most important ingredients of the marketing blend. It is the only ingredient that produces a turnover for the company. Many companies do not view their pricing strategies as a part of their overall marketing strategy. Because pricing strategies have a profound impact on a company’s overall profit margin, they should be given the same consideration as the promotion and advertising strategies. A price that is higher or lower can dramatically alter gross margins and sales volumes, which indirectly affects other expenses like reducing storage costs, or establishing opportunities for volume discounts with suppliers. The four “P’s” of marketing are: 1. Pricing 2. Product 3. Promotion 4. Place Setting prices is very hard. There are costs associated with producing, designing and promoting a product line. The product’s pricing has to incorporate the expenditures for all of those components into its overall price. It needs to support the relationship between supply and demand. If a product is priced too high or too low, it could wind up being a loss of sales for the company. The company that prices by instinct is more likely to fall behind their competitors irregardless of how good their products and services are. This is particularly true for the agencies that are viewed as strong performers. They do extremely well at conceiving, building and distributing products; but because they haven't gotten their pricing structured properly, they are not adequately compensated in their markets, either in profits or in share price performance. The companies that master their effective pricing efforts do so because they quickly adopt modeling tools that are data-driven, and they use those tools to monitor, assess and modify their prices. They examine the impact of the many variables so as to optimize the product’s price. These companies are using cutting edge technology-enabled strategies to © Copyright 2010 Docstoc Inc. 4 manage and optimize their pricing structures, which enable them to adjust and fine-tune their prices much faster. The companies that take a scientific approach to defining their pricing structures usually out perform the agencies that don’t. The top performing agencies will include advanced pricing strategies, and the supportive technologies in their pricing strategy. Learn How to Improve Performance By putting together a pricing strategy that is powerful and structured. The main question that businesses will have about their pricing strategy is, "How am I supposed to know what price I should charge?" Prices are set by: Calculating your costs Estimating the benefits to consumers Comparing your products, services, and prices to others that are similar. Establish pricing by looking at how much it costs to produce the product or service and then adding a fair price for the benefits that the customer will enjoy. Taking a look at what others are charging for similar products or services will help to guide you when you are deciding what a "fair" price would be for these benefits. Developing a pricing strategy that is adequate entails finding out just how much to charge for your product or service. The pricing must be competitive enough to allow for a reasonable profit. The important word here is “reasonable”, keeping in mind that there is a limit to how much consumers are willing to pay. There are other factors that will establish your pricing strategy and that will make it the best possible. Think about the five forces that influence the other business decisions, and realize that pricing needs to take into account these same factors: 1. Company objectives © Copyright 2010 Docstoc Inc. 5 2. Competition 3. Fixed and variable costs 4. Proposed positioning strategies 5. Target group and willingness to pay If a premium item is priced too low, customers will not believe the quality is good enough. On the other hand, if the selling price is too high customers will purchase the competitors' goods that are priced lower. The Breakeven Analysis The pricing strategy that you outlined in your marketing plan is a very useful way of collecting the information that you will need, and should answer the following questions: What is the cost of your product or service? Be sure to include all of the fixed and variable costs when calculating these figures, for example: ─ the cost of labor ─ the cost of materials ─ freight costs ─ administrative costs ─ costs associated with marketing the product How does the pricing of your product or service compare to the market price of similar products or services? Explain how the pricing of your product or service is competitive. ─ If the price you plan to charge is lower, why are you able to do this? ─ If it were higher, why would your customer be willing to pay more? This is where the "strategy" part of the pricing strategy comes into play; will your business be more competitive if you charge more, less, or the same as your competitors and why? What return on your investment (ROI) are you expecting to have using this pricing strategy, and within what time frame? © Copyright 2010 Docstoc Inc. 6 © Copyright 2010 Docstoc Inc. 7 What Pricing Should Do Pricing structures that have been well devised should accomplish three things: 1. Accomplish the company’s financial aspiration which is to earn a profit. 2. Match the realities of the market place by ensuring that the consumers will pay the price. 3. Support the product’s positioning and be consistent with the other variables in the marketing composition a. Pricing is influenced by the kind of distribution channel utilized, the type of promotions used, and the quality of the product. i. Pricing will be high if manufacturing costs are and distribution is exclusive, and if the product is supported by in depth advertising and marketing campaigns. ii. A lower price can be an acceptable alternative for product quality, effective promotions, or an energetic selling effort by distributors. An efficient price is one that is closely aligned with what consumers are willing to pay. It is a price that shifts most of the consumer surplus to the producer. A good pricing strategy would be the one that can balance between the pricing below which the company winds up with losses (the price floor) and the pricing beyond which the company has a no demand situation (the price ceiling). © Copyright 2010 Docstoc Inc. 8 Pricing Strategies A company can adopt a number of pricing strategies all of which are based predominately on the company’s overall objectives. A company that makes use of these pricing strategies will see their bottom line rise! Bundling and Quantity Discounts Another method of rewarding customers for making larger purchases is through quantity discounts, or bundling. Examples: Make the per-unit price lower when a customer purchases a quantity of five instead of just one. Charge less when a customer purchases several related items at the same time. Bundle overstocks with popular items to avoid having to have a closeout. Bundle established items with a new product to help build awareness. Closeout This technique is useful when you have a surplus of inventory. Offer the inventory at a huge discount to get around having to sore it or even throw it away. The objective is to minimize your losses instead of making a profit. Competitive Pricing Using the competitor’s retail or wholesale pricing as a benchmark, establish a pricing structure that is comparable to theirs. Depending on your positioning strategy, your price may be slightly below, above or exactly the same as your competitors. You must collect your competitors pricing information using methods that are legally sanctioned. Cost plus Markup The opposite of competitive pricing, it requires you to look at your own cost structure instead of looking at the market. You decide the profit that you want to make, add that to your costs, and then decide on a selling price. This method will assure a certain per-unit margin; © Copyright 2010 Docstoc Inc. 9 however, it may leave you with prices that are out-of-sync with customer expectations, which can hurt your profit overall. Loss Leader This is a viable short-term promotional technique. The practice involves selling items at or below cost to attract customers, who will also purchase high-profit items. This concept is a useful if you have customers who typically purchase several items at one time. Membership or Trade Discounting This is one manner of segmenting customers in that you attract business from profitable customer segments by giving them special prices. It could be by means of: Charging less for certain items. Offering a blanket discount. Offering free product rewards. Optional Pricing The company sells optional extras along with the product to maximize its turnover. This strategy is most commonly used in the auto industry. Penetration Pricing The company establishes a low price to increase sales and their market share. Premium Pricing The price set is high as an indication of the product’s exclusiveness. Examples would be: Bentley etc. Chanel First class transport services Gucci Harrods Mercedes Rolex © Copyright 2010 Docstoc Inc. 10 Product Line Pricing This concept began back with the five and dime stores. Everything in those stores would cost either 5 or ten cents. The underlying rationale is that consumers viewed those amounts as suitable pricing points for a whole range of products. The advantage was the ease of administration. The disadvantage was that the pricing was inflexible during inflationary times; or when prices were unstable. Another way to look at product line pricing is when different products are priced within the same product range at different price points. For example, a DVR manufacturer offers different DVR recorders with different features at different prices. The greater the features and benefits derived, the more the consumer is willing to pay. This form of price discrimination helps companies to maximize their turnover and profits. Promotional Pricing This is where the pricing plays a major role in the marketing composition. Price Skimming At first, the company establishes a high price and then slowly lowers it to make the product available to a wider market. The objective is to skim market profits layer by layer. Psychological Pricing The seller reflects on the psychology of price and the positioning of price within the market place. Instead of charging $1000 for an item, their price will be $999. Versioning Versioning is commonly used with services or technical products. Vendors sell the same general product in two or three configurations. A very basic version may be offered on a ‘trial’ basis. For example, during the trial period, the item may be offered for free, or for a nominal cost. Upgrades or additional services are made available to the consumer at a higher price. © Copyright 2010 Docstoc Inc. 11 © Copyright 2010 Docstoc Inc. 12 Questions Associated with Pricing The following are the typical kinds of questions that need to be asked when developing pricing structures: How much should be charged for a product or service? This is the general starting point for discussing pricing; however, a better question to ask is “How much to consumers value the product, services or other intangibles that the vendor offers”. What are the pricing objectives? Should profit maximizing pricing be used? How should the pricing be set? ─ Cost plus pricing ─ Value based pricing ─ Rate of return pricing ─ Competitor indexing Should there be single pricing or multiple pricing? Should prices be modified for certain geographical areas (zone pricing)? Should there be discounts for quantity purchases? What are the competitors charging? Should one of the following strategies be used? ─ Price skimming ─ Penetration pricing What image should the pricing convey? Should psychological pricing be utilized? How important are consumer issues relating to pricing sensitivities? ─ Sticker shock ─ Elasticity © Copyright 2010 Docstoc Inc. 13 Should real time pricing be used? Is price discrimination or yield management suitable? Are there any legal restrictions on: ─ Retail price maintenance ─ Price collusion ─ Price discrimination Have price points already been established for the product category? Keeping in mind that the more competitive the industry is, the less flexibility there will be, how flexible can the pricing be? ─ The price floor is determined by certain production factors like: Costs (many times only variable costs are considered) Economies of scale Marginal costs Degree of operating leverage ─ The price ceiling is determined by: Price elasticity Price points Are there any transfer pricing considerations? What is the likelihood of getting involved in pricing wars? How visible should the price be? ─ Neutral (not important) ─ Highly visible (to aid in promoting a low priced economical product or to reinforce the prestigious image of a quality product) ─ Hidden (to allow vendors to generate an interest in the product without pricing considerations) © Copyright 2010 Docstoc Inc. 14 Are there any joint product pricing factors to consider? What are the non-price costs of purchasing the products, for example: ─ Travel time to the store ─ Store wait time ─ Disagreeable elements associated with the purchase of the product for example: Going to the Dentist equates with some kind of pain Being near a fish market equates with odors What kind of payment processes will be utilized? ─ Cash ─ Check ─ Credit card ─ Price bartering © Copyright 2010 Docstoc Inc. 15 The 9 Laws of Pricing Sensitivity 1 In their book, "The Strategy and Tactics of Pricing", Thomas Nagle and Reed Holden outline 9 laws or factors that influence a buyer's price sensitivity with respect to a given purchase: Law Number One: Reference Price Effect Buyer’s price sensitivity for a given product increases the higher the product’s price relative to perceived alternatives. Perceived alternatives can vary by buyer segment, by occasion, and other factors. Law Number Two: Difficult comparison Effect Buyers are less sensitive to the price of a known / more reputable product when they have difficulty comparing it to potential alternatives. Law Number Three: Switching Costs Effect The higher the product-specific investment a buyer must make to switch suppliers, the less price sensitive that buyer is when choosing between alternatives. Law Number Four: Price - Quality Effect Buyers are less sensitive to price the more that higher prices signal higher quality. Products for which this effect is particularly relevant include: image products, exclusive products, and products with minimal cues for quality. Law Number Five: Expenditure Effect Buyers are more price sensitive when the expense accounts for a large percentage of buyers’ available income or budget. 1 Information source: http://en.wikipedia.org/wiki/Pricing © Copyright 2010 Docstoc Inc. 16 Law Number Six: End Benefit Effect The effect refers to the relationship a given purchase has to a larger overall benefit, and is divided into two parts: Derived demand: The more sensitive buyers are to the price of the end benefit, the more sensitive they will be to the prices of those products that contribute to that benefit. Price proportion cost: The price proportion cost refers to the percent of the total cost of the end benefit accounted for by a given component that helps to produce the end benefit (e.g., think CPU and PCs). The smaller the given components share of the total cost of the end benefit, the less sensitive buyers will be to the component's price. Law Number Seven: Shared - Cost Effect The smaller the portion of the purchase price buyers must pay for themselves, the sensitive to pricing they will be. Law Number Eight: Fairness Effect Buyers are more receptive to the price of a product when the price is outside the range they view as “fair” or “reasonable” given the purchase context. Law Number Nine: The Framing Effect Buyers are more sensitive to pricing when they perceive the price as a loss rather than a forgone gain, and they have greater price sensitivity when the price is paid separately rather than as part of a bundle. © Copyright 2010 Docstoc Inc. 17 Pricing Definitions Pricing The method of deciding what a company will receive in exchange for its products. Pricing factors are: Manufacturing cost Market place competition Market condition Quality of product Effective Price The price the company receives after accounting for: Discounts Promotions Other incentives The Price/Quality Relationship The perception by most consumers who believe that something with a high price tag is the sign of high quality. The belief in this relationship is most important with complex products that are hard to test, and with experiential products that cannot be tested until used (like most services). The greater the uncertainty involving a product, the more consumers rely on the price/quality hypothesis; and the more of a premium they are prepared to pay. The classic example of this is the pricing of the snack cake Twinkies, which were perceived as low quality when the price was lowered. Note, however, that excessive reliance on the price/quantity relationship by consumers may lead to the raising of prices on all products and services, even those of low quality, which in turn causes the price/quality relationship to no longer apply. © Copyright 2010 Docstoc Inc. 18 Premium Pricing Also referred to as prestige pricing, it is the strategy of consistently pricing at, or near, the high end of the possible price range to help attract status-conscious consumers. A few examples of companies that utilize premium pricing in the marketplace include Rolex and Bentley. Consumers will buy a premium priced product because: 1. They believe the high price is an indication of good quality; 2. They believe it to be a sign of self worth - "They are worth it" - It authenticates their success and status - It is a signal to others that they are a member of an exclusive group; 3. They require flawless performance in this application - The cost of product malfunction is too high to buy anything but the best as in the example of purchasing a heart pacemaker. Goldilocks Pricing2 This term commonly describes the practice of giving a “gold plated” version of a product at a premium price to make the next-lower priced option appear to be more reasonably priced as in the example of encouraging consumers to see business-class airline seats as a good value for their money by offering an even higher priced first-class option. Another example would be a third-class railway carriage in Victorian England are said to have been built without windows, not so much to punish third-class customers (for which there was not economic incentive) as to motivate those who could afford it to purchase second-class seats to pay for them instead of taking the cheaper option. This is also known as a potential result of price discrimination. 2 Information source: http://en.wikipedia.org/wiki/Pricing © Copyright 2010 Docstoc Inc. 19 The name comes from the story of Goldilocks. Goldilocks chose neither the hottest nor the coldest porridge; she chose the porridge that was "just right". More technically, this kind of pricing exploits the general cognitive bias of aversion to extremes. This practice is known academically as "framing". By providing three options (i.e. small, medium, and large; first, business, and coach classes) you can manipulate the consumer into choosing the middle choice and thus, the middle choice should yield the most profit to the seller, since it is the most chosen option. Demand Based Pricing Any pricing structure that uses consumer demand based on perceived value as the central element. These include: Bundle pricing Geo Penetration pricing Premium pricing Price discrimination Price lining Price points, Price skimming Psychological pricing Value based pricing Yield management Pricing factors are: manufacturing cost market place competition market condition © Copyright 2010 Docstoc Inc. 20 quality of product Multidimensional Pricing When a product or service is priced using multiple numbers. In this practice, price no longer is a single monetary amount such as in the sticker price of a car. Instead it consists of various dimensions: down payment monthly payments number of payments Research shows that this method can significantly influence a consumers' ability to understand and process pricing information. Common Pricing Mistakes Many companies make regular pricing mistakes. Bernstein's article "Supplier Pricing Mistakes" outlines several which include: Cost-Up pricing Inadequate systems for tracking competitor selling prices and market share Paying sales reps on dollar volume vs. addition of profitability measures Price increases poorly executed Weak controls on discounting Worldwide price inconsistencies Pricing Tactics Micromarketing is the practice of tailoring small, specialized products and brands also known as micro brands. Their promotions are designed to suite the needs and wants of much smaller segments within a market. It is a kind of market customization that involves pricing customer or product © Copyright 2010 Docstoc Inc. 21 combinations at the store or consumer level. © Copyright 2010 Docstoc Inc. 22
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