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Pricing Strategies

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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.

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									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



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           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?




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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).




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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;




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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



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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.




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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


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            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




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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


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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


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       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


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               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



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combinations at the store or consumer level.




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