Strategic Pricing

Lesson 1
Pricing for Value
Elkana Ezekiel

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HENRY FORD ON PRICE, VALUE, ETC.

DOES THIS MAKE GOOD BUSINESS SENSE?

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Learning Outcomes & Course
Objectives
Understand problems with existing pricing methods

Grasp the fundamental principles that guide strategic pricing

Understand the strategy and process of price-setting

Understand the impact of a firm’s pricing strategy on business

Issues and challenges associated with setting and holding price in a competitive
environment

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The importance of pricing
A customer/consumer buys your product or service only when it
delivers value to the customer
While there are many ways for money to flow out of a company,
price is the only way for the company to generate revenue by
capturing the value from what it creates
Compared to the other 3 Ps, price conveys the most important
signal to the customer - what the company believes the product is
actually worth.

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 Examples of value that was added through
pricing actions
The “Sabre” airline booking system developed by American Airlines
could reprice tickets every 6 minutes
◦ It added 15% revenue to American Airlines in the first year of
operation

Increase in net income due to a 1% change in different factors

McKinsey AT Kearney
Reducing fixed costs 2.7% 1.5%
Increasing volume 3.7% 2.5%
Reducing variable costs 7.3% 4.6%
Increasing price 11% 7.1%

Source: Pricing on Purpose, Ronald J.Baker

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Exercise
You are launching an MP3 player. Here are the per unit costs:
◦ Raw material cost = $30
◦ Packaging material cost = $15
◦ Labour cost = $10
◦ Total cost $ 55.
What will you price this product at? Why? What are the key considerations?

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The common pricing methods
Cost-Plus Pricing

Customer-Driven Pricing

Competition-Driven Pricing

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 Cost-Plus Pricing
Product Cost Price Value Customers

Pros:

Easiest to do

◦ Supposed to be financially prudent, since each product should yield a fair return over all costs
incurred

Cons:

◦ Does not take into consideration either the consumer’s value needs or the competitive scenario

◦ Unit cost is a moving target as it depends on volumes, and volumes depend on price

◦ Leads to over-pricing in weak markets and under-pricing in strong ones

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 Customer-driven Pricing
Pros:

◦ If priced at what consumers want to pay, the product should have reasonable sales
volumes

Cons:

◦ Making more sales volumes may not give more profitability - strategic pricing should price
more profitably by capturing more value

◦ Customers’ willingness to pay is not good enough if the price does not reflect the product’s
true value. It is the job of sales and marketing to raise customers’ willingness to pay to a
level that reflects the value of the product

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 Competition-driven Pricing
Pros:

◦ Makes it easier for the product to be part of the consideration set of customers when they compare against
competition

Cons:

◦ Achieving market share goals by pricing vs. competition may not be useful if it results in lowering of profitability.

◦ Important to find the combination of margin and market share that maximises profitability in the long term

◦ Oppo phones - low price, high share strategy

◦ Apple - high price, low share strategy

◦ Price reduction is easily matched by competition, eventually resulting in lower margins for the entire market

What if Starbucks had followed competitor-driven pricing?

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Moving from tactical to strategic pricing
Strategic pricing starts by looking at what creates value for customers
From
Product Cost Price Value Customers

Customers Value Price Cost Product

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 Example of value-driven pricing: Ford Mustang
Ford used to follow the standard cost-driven pricing

Lee Iocaca turned this on its head by first talking to customers who were interested in sports cars

◦ what features they would want

◦ what would be an attractive price

Corvette from Chevrolet was the benchmark

◦ but the price of $3490 was felt to be too high

Iocaca told his engineers that they had to deliver a car with specified features at a price of $2500.

Eventually, the Mustang was launched in a record 18 months & was a huge hit

Price?

◦ $2368

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Guiding principles of strategic pricing
Strategic pricing is about proactively managing customer behaviour
vs. simply adapting to it.
Strategic pricing incorporates three principles:
Value-based: It should reflect the value the customer gets from the product

Proactive: Reflect the changing business landscape

Profit-driven: Pricing that delivers greater return for the firm than other investment
opportunities

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Setting the right price
What are the reasons why the price of a product may not be
acceptable to customers?
The price is too high compared to competitors

The customer does not properly understand the differential value of

the product and therefore considers it too expensive

The product does not meet the customer’s needs effectively

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 The Strategic Pricing Pyramid

Price Level
Maps the five distinct sets Price setting
of choices involved in any Pricing Policy
pricing strategy Negotiating tactics,
price selling procedures

Price & Value Communication

Communication, value selling tools

Price Structure
Metrics, fences, controls

Value Creation
Economic value, offering design, segmentation

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Value creation
Economic value - estimating this to set the right price needs deep understanding
of the customer’s needs e.g. strategic sourcing

Designing the solution: Building product /service features that reflect benefits
most valued by the customer

Different customers may value the product differently. Hence the importance of
segmentation to align price and value, and drive higher profitability

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 Intel
The Pentium was the first chip with a built in math co-processor to increase computation speeds

But this technology was soon matched by AMD

Intel realised that any technological advantage would be short-lived

 decided to focus on features that drove customer revenues instead

Research showed that end customers preferred PCs with Intel chips and were willing to pay a premium
too

They converted this insight into the “Intel Inside” campaign

This enabled both Intel and their laptop manufacturing customers to capture higher price

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 Price structure
A price structure aligns price with the value delivered and the cost-to-serve

It is important to set a price for the customer segment vs. for the product

◦ Pricing uniformly high to maximize high-value customer business will make

the product too expensive for low-value customers

Price structures are created using 2 techniques:

◦ Price Metrics - the unit by which price is applied to the product/service

◦ Price Fences - conditions that the buyers have to meet to get preferential
terms – not necessarily lower prices
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 Price and value communication
A complete and effective pricing strategy requires justifying your prices by communicating the value
created for different customers

Customers may not understand the value of your product if:

◦ they are unaware of the features e.g. PUF in Godrej refrigerators

◦ lack knowledge of how to use the features e.g. Advanced calculations with Excel

◦ do not understand how a feature satisfies an unmet need e.g. iTunes reflects need for a single song
not the whole CD

When new categories like photocopiers or food processors were launched, initial customer response was
not too good. The companies did extensive marketing to demonstrate the value of these products to
grow the market

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 Pricing policy
Pricing policy is used to manage the expectations of customers and employees and to encourage
more profitable behaviours

A clear policy helps to prevent over-discounting a product in the face of customer pressure for
discounts to hit sales targets

Gillette example

◦ In the late 1990’s, to maintain its high stock price, Gillette needed to deliver revenue growth each
quarter

◦ They started giving quarter-end “one time” discounts to deliver targets

◦ Customers learned the game and extracted maximum discounts

◦ Eventually the stock declined by more than 50% over the decade

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Price level
The right price level should ideally be decided through a systematic
process that translates diverse inputs like customer value, costs,
competitor prices and broad strategic objectives.

The price level should be set to maximize profits, even if there is

a loss of volumes

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Embedding the strategy
In order to embed a price strategy in an organisation, the expectations of all
stakeholders - customers, sales, finance - have to be changed and managed

This can be done through:

1. Providing incentives for change

2. Setting appropriate and clear expectations

3. Providing the knowledge and skills to change

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Thank You

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