© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Part Two: Chapter 12 Pricing in an Online World “It is only an auctioneer who can equally and impartially admire all schools or art.” Oscar Wilde, The Critic as Artist

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Power of Pricing The most active and dynamic of marketing’s fundamental tools The most digital of marketing actions Pricing = information Informational aspect means that all pricing actions are affected by the Net

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation The Power of Pricing 1.The Worship of Premium Pricing – companies try too hard to hold onto high profit margins with small sales 2.Skim Pricing of New Products – companies serve the most desirable segment first and forget to adapt to the main stream 3.Cost-Driven Pricing – Cost is internal to the firm, but value is the only thing the customer cares about Drucker’s Pricing Sins

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation The Power of Pricing Pricing is Tightly Linked to Profitability Proper pricing must reflect changes brought about by the Internet The High Leverage of Proper Pricing

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Power of Pricing For Internet marketers, evaluating price sensitivity online –How does the presence of the Internet change price sensitivity of products? –How can online content influence price sensitivity of customers? –What new pricing tools work better online than through traditional methods?

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Power of Pricing The Internet tends to increase price sensitivity, but prices online are not automatically lower or less dispersed Value uncertainty contributes in predictable ways to price sensitivity

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Price Sensitivity & the Net Common perception is that the Net will always raise consumer price sensitivity –This will be true for many companies But, some companies will be able to get higher prices So, we need to understand why the Internet brings about changes in price sensitivity Price Sensitivity and Online Information

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Price Sensitivity & the Net The most important determinant of price sensitivity Unique features and benefits lower price sensitivity and raise willingness to pay To prove uniqueness –Provide hard facts, solid testimonials, and hands-on trial use The Internet is effective at doing this The Unique Value Effect

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Power of Pricing Reference price effect: Competitive alternatives and how they are presented online

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Price Sensitivity & the Net Connects price sensitivity with the presence and awareness of alternatives –Price elasticity depends on whether there are alternatives available in the marketplace The Net enables instantaneous side-by-side price comparisons of available alternatives –Increasing information may lead to less willingness to pay This may be the Net’s biggest impact The Substitute Awareness Effect

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Power of Pricing Reference price effect: Competitive alternatives and how they are presented online Difficult comparison effect: Not every consumer is motivated to comparison shop or trusts alternate sites

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Price Sensitivity & the Net Price elasticity is much higher on items that are nonperishable and can be stored easily –Example: A discount on books may prompt purchase even though the consumer may not read the book for several months It’s harder to stimulate demand by lowering the prices of perishable items –There has to be a closer match between time of purchase and consumption Inventory Effect

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Power of Pricing Reference price effect: Competitive alternatives and how they are presented online Difficult comparison effect: Not every consumer is motivated to comparison shop or trusts alternate sites Switching cost effect: Battle for customers coming and going

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Creating customer switching barriers Collect details on customers to raise switching costs Knowing preferences is necessary for better service The Web site should learn about the customer’s preferences

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Power of Pricing Reference price effect: Competitive alternatives and how they are presented online Difficult comparison effect: Not every consumer is motivated to comparison shop or trusts alternate sites Switching cost effect: Battle for customers coming and going Price-quality effect: Advantage goes to well- established brands

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Price Sensitivity & the Net Well-known brands with a high quality reputation can charge higher prices because price sensitivity is lessened –Example – Charles Schwab vs. Ameritrade Unknown online low-price outlets need to build confidence and trust if they want customers to respond to low price –One solution is to partner with trusted and well- known firms While well-known firms may eventually have to lower their prices to match the competition, the price-quality effect delays the need for this response Price-Quality Effect

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Power of Pricing Information about product alternatives influences price sensitivity SOURCE: PRNewsFoto/Nokia, PRNewsFoto/Handspring Inc, Market Wire Global Locate

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Pricing and Purchase Importance Total expenditure effect: Consumers are most price sensitive to items that consume largest part of their budget End benefit effect: Supply chain inputs (lower costs of inputs) are more sensitive for companies with price-sensitive customers

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Pricing and Purchase Importance Consumers are more price sensitive when shopping for items that comprise a larger percentage of their budget They naturally pay more attention to shopping for the best price –Examples include cars & healthcare Total Expenditure Effect

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Pricing and Purchase Importance Consumers who spend major portion of budget on pharmaceuticals are more likely to look for savings online

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Pricing and Purchase Importance Total expenditure effect: Consumers are most price sensitive to items that consume largest part of their budget End benefit effect: Supply chain inputs are more sensitive for companies with price-sensitive customers Shared cost effect: Different approaches for cost deciders and cost payers

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Price Sensitivity & the Net Price sensitivity decreases if the person choosing the product isn’t the person paying for the product –Example: Business travelers are less price sensitive because their employers are footing the bill Companies have to decide whether they’re targeting their sites at the decider or the payer If the target is the payer, emphasize cost effectiveness Shared Cost Effect

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Real-Time Pricing Alternatives Auctions Rental Markets Yield Management

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Time-based Pricing Borrowing a lesson from financial markets: “The only valid price is the one quoted right now.”

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Time-based Pricing Borrowing a lesson from financial markets: “The only valid price is the one quoted right now.” Auctions, a primary time-based price strategy, let marketplace determine pricing

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Time-based Pricing Borrowing a lesson from financial markets: “The only valid price is the one quoted right now.” Auctions, a primary time-based price strategy, let marketplace determine pricing –Internet resolves problem of assembling enough bidders and enough information –Lessons from EBay

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Real-Time Pricing Setting prices is difficult if –Companies don’t know their demand curves –Different customers pay different prices for the product or service –Customers buy multiple products that are linked to each other Under rapidly changing conditions –It’s impossible for companies to calculate demand curves accurately, so they can’t figure out price elasticity Instead of setting prices themselves, many companies are using real-time pricing –The power of the Internet to provide real-time information to the marketplace makes real-time pricing possible Why Simple Pricing Approaches Fail

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Real-Time Pricing Alternatives Auctions work well on the Internet –In-depth information is available to bidders –Confused bidders can call or for more information –Participants can join in from anywhere on the planet Online auction sites improve the power and efficiency of auctions –The Internet makes it easier to gather buyers and sellers together in the same place at the same time –The Internet enables sellers to provide in-depth information, so buyers can evaluate the item being sold –The Internet expands the number of bidders, which raises the price paid and the profitability of the auction Auctions as Real-Time Pricing

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Real-Time Pricing Alternatives Online Auction Types English Auction –An auctioneer calls out bids until no one is willing to top the last bid –The high bidder gets the item –Examples: FirstAuction.com, Onsale.com and E-bay.com Dutch Auction –The price starts high and falls at regular time intervals –The first customer willing to bid gets as many of the items as he/she wants at that price –Remaining items continue to have their prices cut Auctions as Real-Time Pricing

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Time-based Pricing

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Real-Time Pricing Alternatives The rental market serves customers’ immediate needs More efficient because the buyer pays a fee for each use rather than paying a large lump sum for unlimited use –Example – software rentals Barriers to further online adoption include credibility and the lack of willingness of sellers to use micro-transactions Online Rental Markets

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Real-Time Pricing Alternatives Yield management is the matching of price and available capacity Price Available Capacity Yield Management

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Real-Time Pricing Alternatives Requirements for successful yield mgt: –Fixed and perishable capacity – the good must lose 100% of its value at a specific point in time. In addition, the industry should face high fixed costs so the cost of an additional customer is relatively low –Customer base with identifiable segments – give price sensitive customers a break without causing a loss of customers willing to pay full price –Demand uncertainty + information technology – tracking is necessary to ensure proper yield management (made easier by using company web sites) Yield Management

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Time-based Pricing Yield management, used regularly in travel industry, links price to availability –Importance of fixed, perishable capacity –Low incremental cost vs. average cost –Cost-sensitive vs. most loyal customers –Analyzing and predicting demand uncertainty

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Time-based Pricing Yield management, used regularly in travel industry, links price to availability –Importance of fixed, perishable capacity –Low incremental cost vs. average cost –Cost-sensitive vs. most loyal customers –Analyzing and predicting demand uncertainty Other approaches: rentals, trials and sales

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Personalized Pricing Price differences based on willingness to pay, servicing costs or other individual-level distinctions Higher profits, but potential obstacles –Could be illegal or unethical –Difficult to identify high-value buyers –Consumer resale risks

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Personalized Pricing Emerging approaches –Coupons and loyalty discounts –Price pegged to credit scores –Personal-level pricing contracts –Personalized bundling

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Bundling Bundling works particularly well online Bundling is the combination of products into larger packages –A single fee gives users access to entire product offering Example: AOL

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Bundle Pricing Bundling to reduce costs –Production efficiency bundling promotes combined products when production or shipping has steep set-up costs— manufacturing of automobiles –Margin spread bundling combines items with high contribution margins—online support and technical assistance (live support more expensive)

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Bundle Pricing Bundling to expand markets –Aggregation bundling stimulates volume, offers higher priced individual items to unusual customer segments—songs such as Napster –Trade-up bundling encourages customers to increase purchases in price-sensitive markets— price of single song versus album –Loyalty bundling used to cement loyalty, discourage switching—financial services, combining credit cards, mortgages, and check accounts

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Bundle Pricing Bundling to improve performance –Joint performance bundling recognizes that certain components perform better together than separately—Quicken bill pay, data files, and turbo tax software –Product definition bundling helps consumers understand full range of product and service benefits—type of product versioning, where enhanced product include items sold separately (Quicken)

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Conclusion The Internet is having a fundamental impact on pricing strategy –At worst, it will flatten the customer base –At best, it will increase the ability to differentiate Customers will move along the exchange spectrum more rapidly –Move to electronic commodity markets or seduced to mutually valuable long-term relationships? Creative pricing strategies are critical

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Study Question 1 Studies have shown that price can have a greater impact on profits than lowered costs or expanded what? A.Bundling B.Marketing C.sales D.volume

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Study Question 2 Business writer Peter Drucker has criticized some pricing strategies for not recognizing that cost is internal and customers care most about which of the following? A.Value B.Efficiency C.Features D.personalization

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Study Question 3 To maximize profit, firms must decide price based on consumer demand, cost and which of the following? A.purchase importance B.material supply C.competition D.availability

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Study Question 4 The more price-sensitive a market is, the profit-maximizing margin for a firm generally is __________. A.Higher B.lower C.unchanged D.variable

© Copyright 2006, Thomson South-Western, a division of the Thomson Corporation Study Question 5 Switching costs that penalize consumers can lead to greater customer _________. A.Loyalty B.Sensitivity C.inaction D.resentment