1. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter 13 Experience Curve Pricing

2. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. The Experience Curve  The experience curve shows that unit costs of a product decline predictably over time as volume increases.  The experience curve considers a broad array of costs: acquisition, manufacturing, distribution, marketing.

3. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Cost/price Experience

4. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Experience Curve

5. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Stable Experience Curve

6. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. The Implications of Price-Cost Relationships  The experience curve relates costs, prices, volume, and profit margins over time  The ability to predict prices better than one’s competition is a major strategic advantage over the long term  The experience curve suggests the need to develop marketing plans over the product life cycle

7. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Sources Of Experience Effect LearningLearning –Developing skills that allow people to be more efficient Technological improvementsTechnological improvements – Changing the production process, changing distribution methods Economies of scaleEconomies of scale –Efficiencies due to size in most value-added activities

8. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Types of Experience Curves Firm’s cost experience curve- relates changes in the firm’s costs to changes in cumulative volume Competitive cost experience curves- show the current costs of all direct competitors relative to their cumulative volume experience Industry cost and price experience curves- relate industry average costs and prices to cumulative volume

9. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Price Reductions The use of price reductions to increase profits requires not only market growth but accelerating and large increments of growth When selling in mature markets, using price reductions to increase market share should not be considered if current profits margins are low or negative, competitors will likely follow price reductions, and there are no significant secondary advantages

10. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter 14 Pricing Over the Product Life Cycle

11. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Product Life Cycles- The Conceptual Model Development Stage- the product concept is engineered from idea to actual design –The accumulated cash investment grows to a substantial amount before the product is introduced for sale Introduction- the period of initial success or failure for new products –The firm’s marketing efforts are geared towards stimulating primary demand (demand for the product itself)

12. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Product Life Cycles- The Conceptual Model Growth- the product begins to make rapid sales gains as the rate of market acceptance accelerates –Competitor’s marketing strategies focus on stimulating secondary demand with emphasis on product differentiation Maturity- the rate of the market acceptance decreases as the number of new potential customers diminishes –Marketing strategies are designed to create customer preference and loyalty, and continued growth requires an increase in market share

13. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Product Life Cycles- The Conceptual Model Saturation- products and production methods have become standardized, and buyers are generally well aware of similarities and differences in products –Competition for market share intensifies Shakeout- prices tend to decline faster than do costs –High-cost sellers tend to be forced out of the market

14. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Product Life Cycles- The Conceptual Model Decline- Sales begin to diminish as customers turn to new or better products

15. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. New-product Pricing Throughout the cycle, changes occur in promotional and price elasticity and in costs of production and distribution Pricing over the cycle depends on: –Technical maturity –Market maturity –Competitive maturity

16. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. New-product Pricing Value analysis- increasing perceived value by increasing performance relative to customer needs and willingness to pay for that performance Rate-of-Return Pricing- reveals a price for a given product that makes it an irresistibly good investment to customers in view of their alternatives and at the same time extracts from the customers all that can safely be demanded

17. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. New-product Pricing Pricing the Superiority Differential- Determine the price premium that the new product’s superiority will most profitably warrant –Depends on uncertainties for buyer, future costs, and the dynamic demand schedule Estimating Costs- A value-oriented approach to pricing begins with determining what the target market would be willing to pay, and then design a product using this target cost

18. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Whose Cost? Competitor’s costs- –can be determined for products in the market by estimating: Their staying power The floor of retaliation pricing –can be determined for unborn competitive products by: Forecasting the relationship between unit direct costs and cumulative experience

19. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Whose Cost? Seller’s costs- –1. A new product must be pre-priced in the R&D stage and then periodically as it progresses toward market –2. Establish a price floor –3. Estimate total costs with and without the new product

20. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Skimming vs. Penetration The speed with which a new product loses its uniqueness and sinks to the level of just another competitive product depends on: –1. Its total sales potential –2. The investment required for rivals to manufacture and distribute the product –3. The strength of the patent and know-how protection –4. The alertness and power of competitors

21. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Pricing During Growth Objective is to select a price that will help generate a sales volume that enables the firm to realize its target contribution –3 essential points for pricing during growth: 1. Range of feasible prices has narrowed 2. Unit variable costs have decreased due to experience factor 3. Fixed expenses have increased due to increased capitalization and period marketing costs

22. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Pricing During Growth Responding to Lower-Priced Competitive Offerings- The firm should introduce a lower-priced version of the product before competitors enter Prolonging the Growth Stage- The firm can revitalize the product with “new and improved” versions Pricing Next Generation Products

23. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Pricing During Maturity Pricing objective is to choose the price alternative leading to maximum contribution –Follow competition’s reduced prices –Try to reduce costs by using cheaper materials, eliminating several labor operations, or reducing period marketing costs

24. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Pricing A Declining Product Pricing objective is to maximize contributions per sales dollar generated –Most firms eliminate all period marketing costs and remain in the market as long as price exceeds direct variable costs

25. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Dynamic Pricing Models Diffusion effect refers to the increased likelihood of purchase as market penetration increases Saturation effect refers to the reduction in the unfulfilled demand as market penetration increases

26. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Focused Price Reductions  Pricing according to customers’ perceived values  Offering similar services to customers at different prices shifts demand and enhances volume from price sensitive segments  Price bundling  Offering two or more products or services at a price that usually is lower than the sum of the individual prices

27. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Focused Price Reductions  Product redesign  Unbundling the base product from the options by changing it in some way (fewer features, lower grade material, different brand name) and then selling it as a separate, lower-priced product  The objective is to appeal to price sensitive customers who would normally not buy the original product at its regular price

28. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter 15 Product-line Pricing

29. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Nature of Decision Problem Demand interrelationships –Complementarity –Substitute relationships Cost interrelationships –Common resources –Common support structure Nature of marketing strategy –Segmentation issues

30. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Behavioral Issues Acceptable price range(s) –Low-price product (low absolute threshold) –High-price product (high absolute threshold) Differential prices and positioning –Segmentation strategy and tactics Consumer surplus –Price bundling

31. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Types of Pricing Decisions low-end product  Determining the lowest priced product and its price (low-end product) high-end product  Determining the highest price product and its price (high-end product)  Setting the price differentials for all intermediate products

32. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Guidelines Segmented pricing strategySegmented pricing strategy: –Noticeable differences should be equivalent to perceived value differences. –Highest and lowest prices in line have a special complementary relationship to other offerings – priced to encourage desired buyer perceptions. –Price differentials should get wider as price increases over product line.

33. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Guidelines Trading-up pricing strategyTrading-up pricing strategy: –Decide which products are to be designed and priced similar to each other. –Higher-priced product should have a feature or observable benefit perceived to be of value, but the incremental price is less than its perceived value (a smaller price differential).

34. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Price Bundling Price bundling is the tactic of marketing two or more products and/or services for a price below the sum of the individual prices It creates an incentive for purchasers of one product to also buy other(s). Examples: –Weekend hotel packages –Vacation packages –Cable TV plans –Season ticket plans

35. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Principle Of Price Bundling  Different buyers value each product offering differently.  At any specific price, some buyers would be willing to pay more, and some buyers would be willing to spend less.  By packaging products at special prices, the goal is to shift some of the consumers’ surplus for products they would be willing to pay more for to products they would be willing to pay less for.

36. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Developing A Price Bundling Strategy Four basic steps –1. Define customer segment targets –2. Determine bundling objectives –3. Determine demand conditions for each objective –4. Determine profitability of alternative strategies

37. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Price Bundling Decisions Pure bundle or mixed bundle?Pure bundle or mixed bundle? –Mixed bundles generally more profitable unless bundle purchase is “normal” or logical (e.g., Car options; Furniture suites). Magnitude of price discounts?Magnitude of price discounts? –Sufficient to enhance transaction value (20% or more). –For mixed joint bundles, provide some discount on individual items and additional discounts for the bundle (provides greater perceived transaction value).

38. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Yield Management Yield management operates on the principle that different segments of the market have different degrees of price sensitivity. On airline flights, seats are priced differently depending on the time of day, day of the week, length of stay at destination, when purchased and other restrictions.

39. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Conditions for Using Yield Management Feasible ConditionRequirement Segmentable markets Price sensitive customers can be identified and separated Arbitrage preventable Customers who buy at low price cannot resell to less price-sensitive customers Early purchase feasible Customers are willing and able to purchase in advance of use

40. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Conditions for Using Yield Management Necessary Condition Requirement Historical sales data Existing IT facilitates developing data base to monitor sales response to price and marketing Accurate sales forecast Segment by segment demand forecasts facilitate selective discounting to improve revenues Information systems Need sophisticated systems to utilize yield management

41. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Benefits of Yield Management Continuous monitoring of demand. Facilitates use of proactive dynamic pricing. Focused price reductions offer leverage for increasing profits. Focusing on revenue management shifts performance measures from averages to contributions per unit of resource.