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Marketing Final Study Guide Chapter 7: Pricing- Understanding & Capturing Customer Value Price: The amount of money charged for a product or service, or the sum of all the values that customers give up in order to gain the benefits of having or using a product or service

- If Price= or < PV and > Price Floor- then exchange- price is established when currency for the exchange changes hands

- Price is the only element in the marketing mix that produces revenue; all other elements represent costs, also only flexible element as it can be changed quickly

- Pricing is the number one problem facing many marketing executives- smart managers treat pricing as a key strategic tool for creating and capturing customer value

- A small percentage improvement in price can generate large profit increases What price is right?

- In a world of perfect information, that price which maximizes profit - Market research, Elasticity testing, Alternative fulfillment mechanisms, Competitors, Channel choice

- Cost should be part of price determination- consumer decides what the value of it is- can be a key differentiation factor

- Past performance is not indicative of future return - Factors that effect price: industry, economy, influences (government and social), elasticity, economy and demand

The Power of Price

- Very powerful influence on consumer behavior - Flexible, easy to change - Easy to communicate differences relative to competitors 3 Major Pricing Strategies

- If customers perceive that a product’s price exceeds its value, they won’t but it- if the company prices the product below its costs, profits will suffer- right strategy delivers both value to the customer and profits to the company

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Customer Value Based Pricing Strategies: uses buyer’s perceptions of value as the key to pricing- price is set before the marketing program is set

- Assess customer needs and value perceptions —> Set target price to match customer perceived value —> Determine costs that can be incurred —> Design product to deliver value at target price

- Good value is not the same as low price - Good Value Pricing: offering the right combination of quality and good service at a fair price • After recession, less expensive versions of established brand-name products or resigning existing brands to offer more quality for less

• “Everyday Low Prices”- Walmart - Value Added Pricing: attaching value-added features and services to differentiate a company’s offers while charging higher prices (rather than cutting prices)

• Panera: focuses on offering good food/environment, not low prices Cost Based Pricing: setting prices based on the costs for producing, distributing, and selling the product plus a fair rate of return for effort and risk

- Design a good product —> Determine product costs —> Set price based on cost —> Convince buyers of product’s value

- Can be based on low cost producers (Southwest, Costco) or high costs (BMW) Competition Based Pricing: setting prices based on competitors’ strategies, prices, costs and market offerings

- Have to ask how market offerings compare with competitors’ offerings in terms of value, and how strong are the currency competitors and what are their current pricing strategies

- Ex: Tesco in Europe announces automatic rebates at checkout Price Elasticity of Demand

- A measure of the sensitivity of demand to changes in price

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- Inelastic: if demand hardly changes with a small price change • A price decrease will increase sales slightly (if E is negative) and decrease revenues • A price increase will decrease sales slightly (if E is negative) and increase revenues - Elastic: if demand changes greatly with a price change • A price decrease will increase sales and increase revenues • A price increase will decrease sales and decrease revenues - Absolute values of elastic- always greater than one, inelastic- always less than one New Product Pricing Strategy

- Skimming: set high initial prices to skim revenues layer by layer- set high, end lower • Do this in an inelastic market- don’t price too low • Product benefits that customers want at any cost, little chance that competitors can enter the market quickly, several customers segments with different levels of price sensitivity

• Product’s quality and image must support higher price and enough buyers must want the product at the price, costs of producing a smaller volume cannot be so high they cancel the advantage of charging more, competitors shouldn't be able to easily enter market and undercut high prices

• Ex: Apple Watch, usually technology - Market Penetration: setting a low initial price for a new product to attract a large number of buyers and a large market share- start lower and maintain price

• Do this in elastic market- no barriers, don’t price too high • Lower price encourages demand and sales in the early stages of the product life cycle, discourages competitors from entering the market- pioneering brand

• Market must be highly price sensitive so that a low price produces market growth, production and distribution must decrease as sales volume increases, low price must help keep out competition and must be able to maintain price position

• Ex: Food brands usually do this Managing Product Lines

- Most firms have multiple products in a given category - This requires strategic thinking about the relationship of the products - Price is a key factor in conveying differences to consumers

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Product Mix Pricing Strategies

- Set prices that maximize profits of total product mix Product Line Pricing: setting prices across an entire product line

- Goal: optimize (maximize) profits on the product line, not individual products - Pricing must have consistency across the line to avoid negative consumer sentiment - Typical approach: products with variable features at incremental price points - Price jumps based on features, consider competition, requires review of product costs Optional Product Pricing: pricing optional or accessory products sold with the main product

- Start with one product and add options - Ex: leather seats, upgraded audio, custom wheels Captive Product Pricing: pricing products that must be used with the main product

- Two or more products that work only when used together- buy the 1st, need the 2nd - Low entry price, margin on repeat purchase - Ex: razor and razor blades Product Bundle Pricing: pricing bundles of products sold together, 2+ products for one price

- Can promote sales of products consumers wouldn’t usually buy- increase margin - Ex: “Would you like fries with that Big Mac?”, value meals- beverages are very profitable, season tickets

By-Product Pricing: pricing low value by-products to get rid of or make money on them

Reference Pricing: Adjacencies in stores, pricing well known profits very low to create perception that all prices are low

Price Adjustments

- Why do we change price? Competition, Liquidity, End of season, Broken assortments, Change in macroeconomic conditions

- Consumers interpret price in their own way- remember price sends quality signals 4

- Price reductions can lead consumers to believe quality is reduced- continuous discounting creates a tolerance on the part of consumers

- Competing on price is a slippery slope Discounting and Allowance Pricing: reducing prices to reward customers responses such as paying early or promoting the product

- Biggest reason to mark down is to make customers feel like they are getting a better deal while also creating liquidity

Segmented Pricing: adjusting prices to allow for differences in customers, products or locations

Psychological Pricing: adjusting prices for psychological effect

- Quality is associated with price- high prices creates a quality signal (ex: Smirnoff) - Reference Pricing: aspect of psychological pricing, prices that buyers carry in their minds and refer to when they look at a given product, adjacencies in stores, pricing well known products very low to create perception that all prices are low

• You likely know the current price of gasoline, you may not know price of oven Promotional Pricing: temporarily reducing prices to spur short run sales

- Loss Leaders (does it work? $$) - Many types: Special Event Pricing, Limited Time Offer, Flash Sales, Cash Rebates, Low interest financing, Longer warranties/Free Maintenance

- Alternatives (can be a slippery slope): BOGO, GWP, PWP, service, location Geographic Pricing: pricing based on location

- Ex: Applies prices their phones by region, Target makes markdowns based on performance of product by geographic cluster

Dynamic Pricing: adjusting prices continually to see the characteristics and needs of individual customers and satisfactions (adjust prices to demand)

- Trying to match individual price preference with the price- asses your perception of value and adjust the price accordingly

- Ex: stocks, airlines, hotels, football tickets

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International Pricing: adjusting prices for international markets

The Effect of Price Changes

- Price and location are still the primary drivers of switching behaviors - Price does not act as a long term retainer- service and assortment are more important - In a tough environment it’s tough to get noticed- 50% off is the new 30% off - Small changes in price can have a large effect on profitability Appendix 1: Marketing by the Numbers (pages 355-360) Elements of Costs

- Fixed Costs: rent, plant and equipment, corporate payroll - Variable Costs: payroll, materials, marketing costs - Variable Payroll costs are the driver of movement of production to developing countries - Costs plus profit requirement establish the floor for pricing - Target costing focuses on establishing the price then driving cost to achieve desired levels of profit

Breakeven

- Not used to set price- uses to see if we can make $$ at a set price and the unit quantity demanded at the price

- Have to price and achieve quantities at sufficient levels to attain profit targets - Pricing is important to profitability Pricing through a channel example:

- Happy Jean Company sells jeans for $22 that cost $16 to make- they sell those jeans to True Religion for $40 and Nordstrom sells for $120

- Happy Markup: $6, 27% (6/22), True Religion: 18/40=45%, Nordstrom: 80/120=67% - If true religion opens their own stores or Nordstrom has their own brand- capture more margin Setting Price Based On Costs

- Markup Pricing: adds a standard markup to the cost of the product

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Setting Price Based On External Factors

- Markup: the difference between a company’s selling price for a product and its costs to manufacture or purchase it

- Markup Chain: the sequence of markups used by firms at each level in channel

Reading 5: If Brands Are Built Over Years, Why Are They Managed By Quarters?

- Consumers are 50% more price sensitive than they were 25 years ago- recent survey of consumer goods managers showed 7 out of 10 cited pricing pressure and shopper’s declining loyalty as their primary concerns

- Shows how some brands are managed for promotions while a longterm view allows a better pricing strategy

- Allure of brand is fading- customers buying generic products, brands are resorting to price promotion which leads to a vicious cycle- start protecting brand equity

Short Term Focus Weakens Brand

- Abundant Short Term Data: through store scanners, managers can immediately tie a spike in sales to a price promotion- this makes promotion look profitable but eventually most of a product is sold at a discount and profits are eroded

• Scanner data reveals immediate effect of price promotions - Difficulty Measuring Long Term Marketing Focus: instantaneous spikes do not have as strong of an effect on long term sales as ads, new products, etc

• Ex: TV ad campaign that spurs sales increased during the first year will continue over years to come even if ads are no longer aired

- Wall Street Pressures: analysts uses quarterly sales to value firms and advise clients so managers are often rewards for short term results

Construct a Long View Dashboard

- Monitor changes in baseline sales: your estimate of what the product’s sales would be at a constant, non discounted price over months, quarters and years

- Customers responses to regular prices and price promotions: a jump in buyers’ price and promotion sensitivity reflects a decrease in the price premium your brand could command

Focus Marketing Strategy on Brand Equity: make marketing decisions that protect your brand

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Reading 6: How To Stop Customers From Fixating On Price

- Consumers often only care about price when making a buying decision- treat companies products as commodities- fixate on prices and lose interest in marketing communications

- The Commoditized Customer: a market when buyers display rampant skepticism, routine behaviors, minimal expectations, and a strong preference for quick and effortless transactions regardless of product differentiation- choose on basis of price

• Key to escape is not what you do to your product, but what you do to customer- take their focus (price) and alter it in a surprising or challenging way

- Perils of Price Discounting: counterproductive, promotions heighten price consciousness, if you want customers to deliberate about your offering’s selling points don’t offer a special price

Four Strategies: 1. Using Price Structure to Clarify Advantage: call attention to value of product or service it delivers and ideally to the one dimension that most meaningfully differentiates

- Must revise pricing structure to align with value- telling customers that they will be charged according to value delivered makes them reassess their preferences

• Pricing change compels customers to pay attention to a certain form of value- key to success is to vary pricing according to whats most distinctive about your offering rather than the make of the product itself (harder in a hyper-competitive market)

- Ex: Goodyear tire pricing to a mileage expectancy, GE “power by the hour” engine pricingCall attention to benefits (higher price, more mileage)

2. Willfully overprice to Stimulate Change: thought provoking effect of setting prices higher than what consumers normally intend to pay- both intuitive and counterintuitive

- Consumers don’t automatically dismiss the higher price model, motivated to take a closer look and see if there are added features to justify price

- Implication: for every purchase decision there is a price range above what potential customers say they are willing to pay that will provoke them to question the need

- Ex: Apple computers, Burt’s Bees Chapstick 3. Partitioning Prices to Highlight Overlooked Benefits: break a price into component charges which highlights dimensions of differentiation that might otherwise go unnoticed

- Presenting a cost as a set of smaller mandatory charges invites closer analysis and increases likelihood that a customer will revise a routine consumption behavior- must see real benefit

- People are unlikely to factor a benefit into their choice unless an explicit charge is macro for it (can produce resentment if highlighting standard feature)

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- Ex: Cable provides can charge one all inclusive price or offer an itemized bill 4. Equalizing Price Points to Crystallize Personal Relevance: applies when customers are asked to choose among several options designed to appeal to different tastes, in these cases all variants should be priced the same because it will compel customer to buy based on what best suits needs

- Will fully appreciate the range of options, not find wats to shed features for lower prices - Ex: iTunes charging .99 per song- fair pricing but also made customers think about the benefits of iTunes large library

Overall: price tags name terms of exchange, signals quality and can shape the value of the product or service by motivating customers to better understand offering

Reading 7: What Is A Free Customer Worth?

- Customers who pay littler or nothing and are subsidized by another set of customers are essential to a vast array of businesses, including shopping malls, real estate brokers, IT providers, auction houses, print and online media, employment and dating services

- According to one estimate- this business model accounts for a majority of the revenues of 60 of the world’s 100 largest companies

- With prevalence of so-called two markets is likely to grow: charging one set of customers litter or nothing (attract critical mass)

- Managers naturally focused more on customers who generate bulk revenue and they lack method of calculating lifetime value of free customers

Knowing Lifetime Value of Free Customer Determines:

- Optimal way to grow: how much should a company spend at various points in time to acquire and retain free or heavily subsidized customers?

- Real value of the enterprise: how much should investors or acquirers pay for all or part of a business with such customers?

- Best organizational design: how should the business and its incentive systems be structured to encourage the units responsible for the free and the paying customers to work together?

- Lifetime value of a free customer is their incremental effect on the net present value of cash flows from the population of fee customers

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Network Effects: Direct Network Effects: where a buyer attracts more buyers or a seller attracts more sellers

- Can be positive (ex: more players on Xbox Live) or negative (employment sites competition) - When strong and negative, a firm faces challenge of building a critical mass of players on the side in question Indirect Network Effects: how a greater number of buyers or users of a service or product attracts more sellers and vice versa

- Can be positive (ex: more people owning a video game console) or negative (increasing advertising relative to editorial content can drive away customers)

- Must find a balance between price and right number of ads - Uber: Direct effects-drivers protesting in SF because there are too many drivers and wages drop, indirect- ads driving riders away

Auctions Example

- Found that direct effects were positive- stronger around buyers than sellers - Indirect effects were positive- more buyers made the side more attractive to more sellers - The effect of buyers on sellers was greater than other way around- larger pool of buyers was more powerful magnet for sellers

- Buyers were worth more than anticipated and helped them decided how much to spend to acquire buyers at different stages

- Penetration pricing increased profits the most, a low price in the initial period attracts many more sellers, who in turn attract more buyers and become less price sensitive over time 1. Determine how much to spend on marketing to buyers: model revealed that additional buyers had powerful effect on attracting paying sellers- buyers worth more than thought so increased advertising to buyers 2. Test different pricing strategies: penetration strategy 3. Cater more to buyers: understand their behavior ...