Pricing Practices That Endanger Profits Chapter 6 Pricing Practices That Endanger Profits Surej P John July 7th, 2011

Chapter Objectives To understand how consumers perceive prices, price changes, and price differences To develop the concept of reference price and further develop the concept of price thresholds Key pricing principle Prices should be set so as to reflect customers’ perceptions of value

Reference Price The price that buyers use to compare the offered price of a product or service. The reference price may be a price in a buyer's memory, or it may be the price of an alternative product.

Order of Presenting Prices The order in which buyers are exposed to alternative prices affect their perceptions. Ascending Prices Descending Prices

Ascending Series

Descending Series

Order of Presenting Prices Buyers who initially see high prices will perceive subsequent lower prices as less expensive than would if they initially see low prices. Buyers are more sensitive to price increase rather than price decrease.

Introductory Pricing Strategies and Tactics Sellers introduce new products with short-term “introductory low-price promotions” Facilitates market penetration Produces lower long-run sales volume than if the product is introduced at its regular price The introductory low price serves as a reference price for evaluating a perceived price increase when the price is raised to its normal price Refer Table 6.1

Singapore Sheraton Market situation, Singapore, 1986-1990: Five-star and four-star hotel construction to double supply of beds Ministry of tourism predicts the number of visitors to remain steady at two million annually for the next few years. What do you expect will be the effect on hotel prices by 1988 - 1990?

Singapore Sheraton Towers Purchased major credit card mailing list on world-wide basis Mailed brochure and five one-night free stay coupons Brochure described the new hotel Room rates included in the brochure The results: Gave away 20,000 room-nights By 1990, 80% of business was repeat visits Maintained five-star room rates

Absolute Price Thresholds Acceptable price range Upper price threshold (price tolerance or reservation price) Lower price threshold How wide is the range of acceptable prices and what is the price level around which this range is centered? Based on alternative offerings, customer satisfaction and loyalty, knowledge about other prices and quality

Disneyland Paris ( Box 6.2) Opened in 1992 - admission 250 francs By 1994, losses averaged $1 million per day; hotels half empty Market research survey - 1994 Price of 200 francs was psychological threshold 1995 - Set admission price for one adult at 195 francs ($39) Operated at a profit for first time 1996 - 11.7 million people visited 33% increase over 1994; 9% increase over 1995; 40% of visitors were French

Differential Price Threshold Minimum difference in price for a buyer to perceive a product different from the next best alternative. Also known as relative price Two concepts are relevant when considering the issue of price differences. Price elasticity Cross price elasticity

Price Elasticity of demand Price elasticity of demand is the percentage change in quantity sold relative to (divided by) the percentage change in price. If the value of elasticity is < -1, (i.e., -2 or -3), then price elastic. If the value of elasticity is , 0, but > -1 (e.g., -0.5), then price inelastic.

Cross-price Elasticity Cross-price elasticity refers to the % change in demand for one product relative to (divided by) the % change in price of another product. If the value is > 0, then the two products are substitutes. If the value is < 0, then the two products are complements.

Cross-price Elasticity How the price of one product is perceived to differ from the price of another offering that buyers believe is an alternative choice to consider Differential price thresholds The degree to which buyers are sensitive to relative price differences

Decomposing Price Elasticity Prices increases vs. price decreases Difference in relative price elasticity between price increases and price decreases means it is easier to lose sales from current buyers by increasing price than it is to gain sales from new buyers by reducing price

Decomposing Price Elasticity Competitive effects Price elasticity of demand varies over brands within the same product category. Price elasticity also varies across market segments. Extreme prices will become more price elastic as the prices are changed toward the market average or as competitor’s pricing moves the brand’s price toward the market average

Decomposing Price Elasticity Asymmetric competition Price elasticity of demand affected mostly by the substitution effect. The degree that demand for a product or brand is price elastic or inelastic depends on its cross-price elasticity relative to competing products. Price promotions of a higher priced brand affect the market share of a lower priced brand than the reverse.

Decomposing Price Elasticity The effect of price thresholds Demand is very price elastic at upper and lower absolute price threshold Buyers have different price thresholds for different products, while different buyers have different price thresholds for a given product

Decomposing Price Elasticity Other influences on price elasticity Does the product have unique attributes? What benefit do buyers seek from the product? Improved perceptions of product and service quality makes the product less price sensitive. How the product is going to be used or what context the product is used? The relative dollar magnitude of purchase influence buyers sensitivity.

Price Elasticity Price elasticities are not constant and they can be managed over products, brands and time to a greater extent than previously recognized END OF CHAPTER VI

Have a Break…….

Customer Value Analysis Chapter 8 Customer Value Analysis

Customer Value Analysis A cynic is a man who knows the price of everything, and the value of nothing. -Oscar Wilde What we obtain too cheaply we esteem too lightly; it is dearness only that gives everything its value. -John Jakes, The Rebel The quality is remembered long after the price is forgotten. -James E. Brill, ABA Journal

Value Analysis Management Customer value management is understanding all the experiences that customers have with the products and services the firm provides them The firm’s pricing is driven by measurable value provided to customers and not by customer’s expressed willingness to pay

Perceived Acquisition Value Perceived acquisition value = perceived benefits or quality perceived total sacrifice Perceived total sacrifice to the buyer is equal to purchase price + start-up costs + post-purchase costs Perceived benefits or quality is equal to some combination of physical attributes, service attributes, and technical support available, as well as the purchase price and other indicators of quality

Components of Perceived Acquisition Value 1. Sacrifice 2. Equity 3. Aesthetics 4. Relative use 5. Perceived transaction value

The Concept of Benefits To provide benefits a product or service must be able to: 1. Perform certain tasks or functions 2. Solve identified problems 3. Provide specific pleasures

The Concept of Benefits It is necessary to: Identify the benefits that customers will perceive the product or service to offer Determine the relative importance of those benefits that customers place on the product of service

The Five Steps Of Value-oriented Pricing 1. Conceptualize customer value Translate features and attributes into perceived benefits. Consider relative benefits delivered by the product itself.

The Five Steps Of Value-oriented Pricing 2. Understand The Key Value Drivers for Customers 3. Calculate customer value Determine sources of differentiation value Determine customer value segments Perform customer value assessments Estimate economic value to customer value segments

Value-in-use analysis Value in Use = Total willingness to pay for a product across all consumers Consumer Surplus = Difference between the maximum amount customers are willing to pay for a product and the amount they actually pay. Consumer Surplus = Value in Use – Value in Exchange

Value-in-use analysis To use the concept of Value in Use: Determine the customer's reference product Customer’s life cycle cost using the reference product Improvement value of the product relative to the reference product

Reference Product: Customers next best alternative for meeting the same need as current or proposed new product Existing model about to be replaced Competing product Life Cycle Costs: All costs that a customer will incur over the product’s useful life. These costs include Actual purchase price, Startup costs, post purchase costs Improvement value of the product: The improvement value of the product represents the potential incremental satisfaction or profits the customer can expect from this product over those of the reference product.

Value-in-use analysis P max y = LCCx +Ivy –(PPCY+SUCy) P max y = maximum acceptable price of Product Y LCCx = Life cycle costs of the reference product X Ivy = Improvement value for the new product Y PPCY = Post purchase cost for the new product Y SUCy = Start up costs for the New Product Y

Example Old reference product, Current Purchase price = $400 Post purchase cost = $300 Start up cost = $300 Hence Life cycle cost for product X, LCC x = Px + PPCx + SUC x = $1000 Assume “NEW “ product is highly efficient and has an Improvement Value, Ivy = $200 PPC y = $200 SUC y = $200 Therefore Max. Accpetable Price, P max y = LCCx +Ivy –(PPCY+SUCy) Pmax y = $800

Consumer Surplus Max. Accpetable price ( Value in Use)= $800 If the current Selling price (Value in Exchange) = $500 Consumer surplus = Value in use- value in exchange = $300

Limitations of Value in Use Sometimes the product offering is so new that its difficult to accurately estimate its relative value to customers Value of the product may depend on the nature of the buyer, how the buyer uses the product, variations in perceived benefits of the product by different buyers.

The Five steps of Value-oriented Pricing 3. Value mapping- illustrates the way customers in a value segment trade off perceived benefits against perceived sacrifice

The Five steps of Value-oriented Pricing 4. Communicating value. Keep price structures understandable, flexible, and relatively easy to administer. Consistently and clearly communicate price structure. Discounts, allowances, rebates, rewards for loyalty should be above-board and clearly defined. Provide complete and concrete information about the offer. Provide appropriate reference price and actual selling price. Value-oriented Pricing

The Five steps of Value-oriented Pricing 4. Communicating value. For temporary price reductions, provide the specific ending date of the offer and the price in effect after the ending date. For price increases, provide the beginning date of the new higher prices.

The Five steps of Value-oriented Pricing 5. Develop Ways to Capture Customer Value The seller becomes externally-focused when managing prices Establish pricing rules or structure that force customers to acknowledge value received

Contingency Value Pricing Occurs when the value of the service cannot be calculated before its delivery Forms of contingency pricing include Money-back guarantees Real estate agents’ commissions based on a percentage of the selling price Lawyers’ or professional sports agents’ fees based on a percentage of the damage award or contract negotiated

Class Assignment-5 Question No: 4 on Page 217