Copyright © 2000, Strategic Pricing Group, Boston, MA Gerald E. Smith, D.B.A. Carroll School of Management Boston College Strategic Management of Pricing

Copyright © 2000, Strategic Pricing Group, Boston, MA THE MARKETING MIX Product Promotion Distribution Price

Copyright © 2000, Strategic Pricing Group, Boston, MA TACTICAL PRICING PHILOSOPHIES 1. Cost-Driven Pricing Financial prudence requires pricing every product or service to yield a fair return over its "full cost."

Copyright © 2000, Strategic Pricing Group, Boston, MA TACTICAL PRICING EXAMPLE How would you solve this problem? PROJECTED ACTUAL Unit Sales 1,000,000 units 750,000 units Total Per Unit Total Per Unit Revenue$9,000,000$9.00 $6,750,000$9.00 Variable Costs$3,000,000$3.00$2,250,000$3.00 Fixed Costs$3,000,000$3.00$3,000,000$4.00 Admin Overhead$1,500,000$1.50$1,500,000$2.00 Total Costs$7,500,000$7.50$6,750,000$9.00 Profit$1,500,000$1.50$ $

Copyright © 2000, Strategic Pricing Group, Boston, MA TACTICAL PRICING EXAMPLE How will the market respond? SCENARIO 1 SCENARIO 2 New Price 1: $10.00 New Price 2: $8.00 Unit Sales 550,000 units 950,000 units Total Per Unit Total Per Unit Revenue$5,500,000$10.00$7,600,000$8.00 Variable Costs$1,650,000$ 3.00$2,850,000$3.00 Fixed Costs$3,000,000$ 5.45$3,000,000$3.16 Admin Overhead$1,500,000$ 2.73$1,500,000$1.58 Total Costs$6,150,000$11.18$7,350,000$7.74 Profit-$ 650,000-$ 1.18$ 250,000$0.26

Copyright © 2000, Strategic Pricing Group, Boston, MA Cost-Plus Pricing Death Spiral Annual Fixed Costs $1 Million Last year’s unit sales volume = 400,000 Copyright © 2000, Gerald Smith

Copyright © 2000, Strategic Pricing Group, Boston, MA Cost-Plus Pricing Death Spiral Last year’s unit sales volume = 400,000 VC = $2.00 FC/Unit = $2.50 Margin (50%) = $2.25 This Year’s Price = $6.25 Copyright © 2000, Gerald Smith Annual Fixed Costs $1 Million

Cost-Plus Pricing Death Spiral Annual Fixed Costs $1 Million Last year’s unit sales volume = 400,000 This year’s unit sales volume = 250,000 VC = $2.00 FC/Unit = $2.50 Margin (50%) = $2.25 This Year’s Price = $6.25 Copyright © 2000, Gerald Smith

Cost-Plus Pricing Death Spiral Annual Fixed Costs $1 Million Last year’s unit sales volume = 400,000 This year’s unit sales volume = 250,000 VC = $2.00 FC/Unit = $2.50 Margin (50%) = $2.25 This Year’s Price = $6.25 VC = $2.00 FC/Unit = $4.00 Margin (50%) = $3.00 Next Year’s Price = $9.00 Copyright © 2000, Gerald Smith

Cost-Plus Pricing Death Spiral Last year’s unit sales volume = 400,000 This year’s unit sales volume = 250,000 VC = $2.00 FC/Unit = $2.50 Margin (50%) = $2.25 This Year’s Price = $6.25 VC = $2.00 FC/Unit = $4.00 Margin (50%) = $3.00 Next Year’s Price = $9.00 Next year’s unit sales volume = ?? Copyright © 2000, Gerald Smith Annual Fixed Costs $1 Million

Cost-Plus Pricing Death Spiral Last year’s unit sales volume = 400,000 This year’s unit sales volume = 250,000 VC = $2.00 FC/Unit = $2.50 Margin (50%) = $2.25 This Year’s Price = $6.25 VC = $2.00 FC/Unit = $4.00 Margin (50%) = $3.00 Next Year’s Price = $9.00 VC = $2.00 FC/Unit = ?? Margin (50%) = ?? Year t+2 Price = ?? Next year’s unit sales volume = ?? Copyright © 2000, Gerald Smith Annual Fixed Costs $1 Million

Copyright © 2000, Strategic Pricing Group, Boston, MA LESSONS FROM TACTICAL PRICING FAILURES Lesson 1 There is no direct relationship between levels of price and profit. Lesson 2 Cost-based target prices tend to become price caps.

Copyright © 2000, Strategic Pricing Group, Boston, MA LESSONS FROM TACTICAL PRICING FAILURES The cost question in pricing is not: How should we price to cover all our costs and achieve our profit objectives? The cost questions in pricing are: How much sales volume would we need to profit from a price cut? How much sales volume could we afford to lose and still profit from a price increase?

Copyright © 2000, Strategic Pricing Group, Boston, MA TACTICAL PRICING PHILOSOPHIES 2. Customer-Driven Pricing The demands of the market require pricing every product to reflect the customer's "willingness-to- pay."

Copyright © 2000, Strategic Pricing Group, Boston, MA LESSONS FROM TACTICAL PRICING FAILURES Lesson 3 Customer resistance to a price is not by itself a good reason to cut it. Lesson 4 If you must discount to reflect value, do so selectively with segmented pricing.

Copyright © 2000, Strategic Pricing Group, Boston, MA LESSONS FROM TACTICAL PRICING FAILURES The sales question is not: What level of price are buyers currently willing-to- pay? The sales questions in pricing are: What level of price can we convince buyers is justified by the value of our product (or service) to them? How can we better segment the market for pricing to reflect differences in value to different types of customers?

Copyright © 2000, Strategic Pricing Group, Boston, MA TACTICAL PRICING PHILOSOPHIES 3. Competition-Driven Pricing Price is a competitive weapon that we manipulate to achieve our market share objectives, and to repel competitive threats.

Copyright © 2000, Strategic Pricing Group, Boston, MA LESSON FROM TACTICAL PRICING FAILURES Lesson 5 "Winning" a game of price competition is often not worth the fight. Lesson 6 Price is usually not the best competitive weapon, especially for competitors with large market shares.

Copyright © 2000, Strategic Pricing Group, Boston, MA ASK STRATEGIC PRICING QUESTIONS Don't be constrained by Tactical Thinking Do Not Ask: What price do we need to cover our costs and achieve our profit objectives? Ask: What changes in our prices or product mix would increase the contribution available to cover our costs and increase our profits?

Copyright © 2000, Strategic Pricing Group, Boston, MA Do Not Ask: What prices are buyers willing-to-pay? Ask: What prices can we convince buyers are justified by the value of our product (or service) to them? How can we better segment the market for pricing to reflect differences in value to different types of customers? ASK STRATEGIC PRICING QUESTIONS Don't be constrained by Tactical Thinking

Copyright © 2000, Strategic Pricing Group, Boston, MA Do Not Ask: What level of price will enable us to achieve our market share objectives? Ask: What level of market share can we most profitably achieve? With which weapon s can we most effectively compete? "How can we minimize the adverse effects?” ASK STRATEGIC PRICING QUESTIONS Don't be constrained by Tactical Thinking

Copyright © 2000, Strategic Pricing Group, Boston, MA PROFIT DRIVEN PRICING Costs CompetitionCustomers Pricing Strategy

Copyright © 2000, Strategic Pricing Group, Boston, MA PROFIT-DRIVEN PRICING lThe goal of pricing is to capture the value of a company's products or services to maximize long- run profitability. lYou cannot achieve superior long-run profitability by following short-run, tactical pricing rules. lLong-run profitability requires a pricing strategy (1)That takes into account Costs, Customers, and Competition (2)That specifies how the company will balance the inherent tradeoffs among them.