Pricing Strategy over the Life Cycle – Chs. 7-8 Review Fire Safety Homework Understand how price sensitivity, costs, and competition influence pricing strategy over the product life cycle. Introduce organizational tools and diagnostic analytics that can be used to identify and overcome implementation challenges

Fire Safety: 1. Given overall market growth rate = 29%, Fire Safety’s 5% price increase in FY 2011, & 2010 CM≈62%, what was Fire Safety’s incremental % breakeven point for unit quantity and $ sales change in FY 2011? How does that compare with actual 2011 unit quantity and $ sales changes. Incremental Quantity Breakeven % 2010-11: (5% Price Increase; ~62% CM) Breakeven Sales as a % of 2010 Sales (1+/- Incremental Breakeven %) Expected 2011 Sales as a % of 2010 Sales (No price change; Market Growth = 29%) Breakeven 2011 Sales as a % of 2010 Sales (5% Price Increase; Growth = 29%) Actual 2011 Sales as a % of 2010 Sales Quantity % Above/Below Breakeven (2010 basis) Quantity % Above/Below Breakeven (2011 basis) -DP% -5% = = -7.5% CM% + DP% 62%+5% 92.5% 129% 119.4% 107.8% -11.6% -9.7%

The Final Requires Calculating Breakeven Volumes & Fire Safety: 2. Given the expected market growth rate of 44%, Fire Safety’s proposed 5% price increase in FY 2012, & 2011 CM ≈ 64%, what is Fire Safety’s incremental percentage breakeven point for unit quantity and $ sales change in FY 2012? Incremental Quantity Breakeven % 2011-12: (5% Price Increase; ~64% CM) Breakeven Sales as a % of Sales (1+/- Incremental Breakeven %) Expected 2012 Sales as a % of 2011 Sales (No price change; Growth = 44%) Breakeven 2012 Sales as a % of 2011 Sales (5% Price Increase; Growth = 44%) -5% -7.2% 64%+5% 92.8% 144% 133.6% Breakeven Elasticity = -1.45 Would you recommend the 5% price increase to FSI management for FY 2012? Why (not)? What would you recommend? Observed Elasticity = %DQ (107.8-129) -16.44% -3.29 %DP 129 5.00% The Final Requires Calculating Breakeven Volumes & Expected Volumes based on Elasticities

Elasticity Required to Breakeven The Final Requires Calculating Breakeven Volumes & Expected Volumes based on Elasticities Current Contribution Margin 5% 10% 20% 30% 40% 50% 60% 70% 80% 90% % Change in Price -4.00 -3.33 -2.50 -2.00 -1.67 -1.43 -1.25 -1.11 -1.00 -0.91 15% -5.00 -2.86 -2.22 -1.82 -1.54 -1.33 -1.18 -1.05 -0.95 -6.67 -10.00 0% -5% -20.00 -10% -15% -20% Price increase: |Elasticity| < the breakeven amount leads to contribution increase. Price decrease: |Elasticity| > the breakeven amount leads to contribution increase.

Sales and Profits Over the PLC The purpose of this slide is to ensure that all students know the dynamics of the product life cycle. Ask: What is the product life cycle and how is it relevant to pricing? Answer: The life cycle represents how markets for products evolve over time, and therefore how marketing should also change, depending on the stage of the life cycle. The horizontal dimension is time; the vertical dimension is cumulative market penetration. As a product moves through the four life cycle phases (introduction, growth, maturity, and decline) so do changes to relevant costs, price sensitivity and behavior of competitors. Accordingly, pricing strategy and tactics must vary if they are to remain competitive.

Product Adoption Curve Innovators 3-5% Early Adopters 10-15% Majority 34% Late Laggards or Nonadopters 5-16% 90 50 20 5 Time Percent Adoption The purpose of this slide is to ensure that all students know the dynamics of the product life cycle. Ask: What is the product life cycle and how is it relevant to pricing? Answer: The life cycle represents how markets for products evolve over time, and therefore how marketing should also change, depending on the stage of the life cycle. The horizontal dimension is time; the vertical dimension is cumulative market penetration. As a product moves through the four life cycle phases (introduction, growth, maturity, and decline) so do changes to relevant costs, price sensitivity and behavior of competitors. Accordingly, pricing strategy and tactics must vary if they are to remain competitive.

Market Dynamics over the PLC INTRODUCTION GROWTH MATURITY DECLINE CUSTOMERS Small customer base Innovators Little product knowledge Low knowledge buyers Growing customer base Early adopters Little product knowledge Moderate knowledge buyers Increasing brand loyalty Large segmented market Late adopters/Laggards High knowledge buyers Repeat purchasers Comparison shopping Declining customer base High knowledge buyers Familiar with all suppliers and options COMPETITION Few competitors Low threat of competitive rivalry Gains from market development are high Increased competitive entry Brand proliferation & confusion Differentiation vs. Cost leadership Shakeout to stable # of competitors Homogeneous dominant brands Market share defense Gains from competitors Increased price competition to fill capacity Exiting of weak competitors COSTS High incremental costs of production and promotion Low contribution margin External sourcing Declining unit variable costs through volume; Increasing contribution margins Low variable costs High contribution margins Cost controls Asset utilization Excess capacity High average costs, due to low capacity utilization PRICE SENSITIVITY Reference value effect Price quality effect Difficult comparison & Fairness effect LOW SENSITIVITY Reference value effect Price quality effect Difficult comparison effect MORE SENSITIVITY Switching cost effect Expenditure effect End benefit effect Lower risk HIGH SENSITIVITY Switching cost effect Expenditure effect End benefit effect HIGH SENSITIVITY MARKETING OBJECTIVES Generate primary demand Customer awareness Market education Buyer frames of reference Information diffusion Brand positioning Differentiation Brand loyalty Defensible competitive position Market share defense Marketing and production efficiency Profitable market segmentation Retrench, & defend strongest product lines Harvest the business Consolidation to small # of competitors PRICING STRATEGIES Establish value and worth Bundled pricing to simplify segmented pricing according to buyer knowledge (Hi-Mod-Lo) Expansion of product line and price points Multiple pricing channels Segmentation pricing Price to maintain margins, but signal intent to defend Price for max. cash flow Predatory pricing

Market Dynamics over the PLC INTRODUCTION GROWTH MATURITY CUSTOMERS Little product knowledge Low knowledge buyers Moderate knowledge buyers Increasing brand loyalty High knowledge buyers Repeat purchasers Comparison shopping COMPETITION Few competitors Gains from market development are high Brand proliferation & confusion Differentiation vs. Cost leadership Homogeneous dominant brands Market share defense Gains from competitors COSTS High incremental costs of production and promotion Declining unit variable costs through volume High contribution margins Asset utilization PRICE SENSITIVITY Difficult comparison & Fairness effect LOW SENSITIVITY Difficult comparison & Price quality effect MORE SENSITIVITY Switching cost effect Expenditure effect HIGH SENSITIVITY MARKETING OBJECTIVES Generate primary demand Customer awareness Market education Brand positioning & loyalty Brand differentiation Defensible competitive position Market share defense Marketing & production efficiency Profitable market segmentation PRICING STRATEGIES Establish value and worth Simplify segmented pricing according to buyer knowledge (Hi-Mod-Lo) Expansion of product line and price points Segmentation pricing

PLC & Brand Strategies Product Category Life Cycle Brand Stage Launch Maintenance Retirement Introduction Price to establish, communicate & promote value of the product N/A Growth Based on LT strategy, identify appropriate segment(s) before commercialization Segment & target for LT advantage. Lower price as necessary to maintain market growth. Price compete only to gain cost advantage. Price to clear inventory quickly while launching new models Maturity Use aggressive pricing to dominate based on cost advantage or target underserved niches w/a service advantage. Unbundle. Price products & services separately. Rationalize product line & distribution strategy. Price to maximize profit, not market share or growth. Slowly price yourself out of business. Decline Not recommended. Only with strong advantage. Consolidate to solidify cost or service leadership. Withdraw cash w/incrementally higher prices. Product differentiation strategy Cost leadership strategy Marketing differentiation (& product proliferation) strategy

PLC & Brand Strategies Product Category Life Cycle Brand Stage Launch Maintenance Retirement Introduction Price to establish, communicate & promote value of the product N/A Growth Based on LT strategy, identify appropriate segment(s) before commercialization Segment & target for LT advantage. Lower price as necessary to maintain market growth. Price compete only to gain cost advantage. Price to clear inventory quickly while launching new models Maturity Use aggressive pricing to dominate based on cost advantage or target underserved niches w/a service advantage. Unbundle. Price products & services separately. Rationalize product line & distribution strategy. Price to maximize profit, not market share or growth. Slowly price yourself out of business. Product differentiation Cost leadership Marketing differentiation (& product proliferation)

Illustrative Customer Profitability Map High “Platinum” “Gold”            Price                        Topic: Customer Profitabiity Key Learning Points for Students Illustrate how customer profitability can be useful tool to guide pricing strategies Teaching Recommendations Break the students in to four groups and assign each group a quadrant. Ask the students to develop a pricing strategy for their quadrant. Do a readout of the groups and compare the different approaches Discussion Question(s) Understanding customer profitability is an important tool for pricing strategists, yet it is used in only a small percentage of firms. What might the barriers to more widespread adoption? Low “Silver” “Lead” Low High Cost to Serve

Price Banding Output Actual Price Fair Price At Risk Fair Price Outlaws Actual Price Topic: Price Banding Key Learning Points for Students Understand the process for developing regression-based models of pricing performance Be able to use the tool to diagnose potential pricing problems in support of a revised pricing policies Teaching Recommendations The key to successfully teaching these concepts is to ensure the students understand the concept of “fair” price. Fair is defined as a price that is consistent with the average price paid for other transactions with similar characteristics (e.g., volume, region, time of year, etc.) It is important to note that “fair” does not mean optimal. It is a measure of current pricing practices and should not be the only consideration when enforcing price levels. Discussion Question(s) What do we mean by “fair” prices? Is fairness a valid metric for pricing analytics? Fair Price

Customer Lifetime Value (CLV) Useful Analysis at the Individual Customer & Segment CLVinfinite lifetime = CM/(i* + 1 – r) – AC where CM = average annual contribution for the customer (segment) i* = i (=the risk-free discount rate) × risk factor r = retention rate for the customer (segment) AC = acquisition costs How valuable/profitable is each customer (segment) given prices & variable costs (i.e., contribution), retention rates, discount rate, risk level & acquisition costs? How valuable/profitable is an acquisition or retention campaign given prices & variable costs (i.e., contribution), retention rates, discount rate, risk level & acquisition costs?

Customer Equity Facebook April/May 2012 = # Customers × CLV At Facebook April 2012 Unique Users: 900,000,000 Revenue ≈ 3.7 B; CM (90%) ≈ $4; i* = .05; r = .95 CLV ≈ $40 Customer Equity = #Users × CLV = $36 B External Valuation May 2012: ~$100 B

Customer Equity Facebook July/August 2012 = # Customers × CLV At Facebook July 2012 Unique Users: 955,000,000 Revenue ≈ 4.7 B; CM (90%) ≈ $4.4 CLV ≈ $44 Customer Equity = $42 B External Valuation August 2012: ~$50 B

Price Waterfall Example 800 620 45 600 1 67 Price ($) 507 15 25 1 5 6 455 400 Major Opportunity 200 Topic: Price Waterfall Key Learning Points for Students Understand the concept of the pocket price waterfall and how it can be used to identify and track discount leaks Teaching Recommendations Have the students go through various elements of the waterfall and suggest various ways that “leaks” might occur Discussion Question(s) Does the fact that one or more of the discount “buckets” is very large in this example mean that it represents a big opportunity for improvement? Why or why not? Transaction Ordersize Upcharges MCP / Bid Invoice Credits Discount / Misc. Rebates Debit Pocket Price Discount Discounts Price Terms Charges / Backs Price and Waived Allowances Upcharges

Next Week Atlantic Computers Case Analysis & Toilet Paper Priced Like Airline Tickets