Pricing Chapter 1. Strategic Pricing Stephan Sorger © Stephan Sorger 2015: ; Pricing: Ch 1: Strategic Pricing;

Pricing

Chapter 1. Strategic Pricing

Stephan Sorgerwww.stephansorger.com

© Stephan Sorger 2015: www.stephansorger.com; Pricing: Ch 1: Strategic Pricing; 1

Disclaimer:• All images such as logos, photos, etc. used in this presentation are the property of their respective copyright owners and are used here for educational purposes only• Some material adapted from: Nagle et al, “The Strategy and Tactics of Pricing,” 5 th Edition

http://www.stephansorger.com/




Chapter Overview


•Define Strategic Pricing and differentiate it from more tactical approaches such as cost-driven, market-driven or competitor-driven pricing

•Introduce the identifying characteristics of strategic pricing•Proactive•Profit-driven•Value-based

•Define the five elements of a pricing strategy and illustrate how they work in concert to maximize profitability:

•Value creation•Price and offer structure•Value communication•Pricing Policy•Price setting


Strategic Pricing Pyramid: 1-1



Strategic Pricing Pyramid: 1-1


Questions:-Why might customers say your prices are high?(Hint: Work from top to bottom on the pyramid)-33% of companies use cost-plus pricing even though managers know it is not effective. Why?-What is a problem with pricing for market share?


Alternative Approaches to Value Creation: 1-2


Product LedProduct Cost Price Value Customers

Customer LedCustomers Value Prices Costs Products


Alternative Approaches to Value Creation: 1-2


Product LedProduct Cost Price Value Customers

Customer LedCustomers Value Prices Costs Products

Questions: -Name some recent product failures; Why did they fail? Google Glass; RIM Blackberry Q10; HP Chromebook 11; “The Lone Ranger”-How does this relate to customer-led pricing?-How does this relate to the feature-driven approach done by tech firms?


Tactical Pricing Orientations


Cost-Driven Pricing (based on product cost)

Customer-Driven Pricing (arriving at final price via negotiation)

Competition-Driven Pricing(based on what competitors charge)

Instead of strategic, value-based pricing, some managers choose tactical techniques:

Result: Lower profitability in almost all cases


Cost-Driven Pricing


Target PriceTarget PriceUnit CostUnit CostTotal CostTotal Cost

VolumeVolume

“ “Price every product to yield a fair return over full cost”


Cost-Driven Pricing


Target PriceTarget PriceUnit CostUnit CostTotal CostTotal Cost

VolumeVolume

Unit cost:Variable cost: Material and labor to make one unit of productionAllocated fixed cost: Spread out fixed cost over many units

Cost-based Pricing: Example


Projected Costs and Revenues at Projected Costs and Revenues at Expected Sales = 1,000,000 unitsExpected Sales = 1,000,000 units

TotalTotal Per UnitPer UnitDirect Variable CostsDirect Variable Costs $3,000,000$3,000,000 $3.00$3.00Direct Fixed CostsDirect Fixed Costs $3,000,000$3,000,000 $3.00$3.00Administrative OverheadAdministrative Overhead $1,500,000$1,500,000 $1.50$1.50 Full CostFull Cost $7,500,000$7,500,000 $7.50$7.50RevenueRevenue $9,000,000$9,000,000 $9.00$9.00

Profit $1,500,000 $1.50

Example: Acme plans to launch its new product, the X-1000.The sales department expects to sell 1 million unitsThe finance department requires a minimum price of $9 to cover costs

Result: Make profit of $1.50

Cost-Based Pricing: Example


Actual Costs and Revenue at Actual Costs and Revenue at Actual Sales = 750,000 unitsActual Sales = 750,000 units TotalTotal Per UnitPer Unit

Direct Variable CostsDirect Variable Costs $2,250,000$2,250,000 $3.00$3.00

Direct Fixed CostsDirect Fixed Costs $3,000,000$3,000,000 $4.00$4.00

Administrative OverheadAdministrative Overhead $1,500,000$1,500,000 $2.00$2.00

Full Cost Full Cost $6,750,000$6,750,000 $9.00$9.00

RevenueRevenue $6,750,000$6,750,000 $9.00$9.00

Profit $0 $0

But the X-1000 sells only 750,000 units, not 1 millionCost-based pricing says increase price to $10.50 ($9 + $1.50 “profit”)

What happens when we increase price to $10.50?

Cost-Based Pricing: Example


5% Decline 33% DeclineCurrent in Unit Sales in Unit Sales

PricePrice $9.00$9.00 $10.50$10.50 $10.50$10.50

Unit SalesUnit Sales 750,000750,000 712,500712,500 500,000500,000

Variable CostsVariable Costs $3.00$3.00 $3.00$3.00 $3.00$3.00

Fixed CostsFixed Costs $4.00$4.00 $4.21$4.21 $6.00$6.00

Admin. OverheadAdmin. Overhead $2.00$2.00 $2.11$2.11 $3.00$3.00

Unit CostUnit Cost $9.00$9.00 $9.32$9.32 $12.00$12.00

Unit ProfitUnit Profit $0$0 +$1.18+$1.18 -$1.50-$1.50

Total ProfitTotal Profit $0$0 $843,750$843,750 -$750,000-$750,000

But raising price will decrease the number of units sold, impacting profit. Higher prices do not necessarily result in higher profits

No competition Competitive market

Cost-based Pricing


Financial Implications of a 10% Price CutFinancial Implications of a 10% Price Cut 5% Increase 33% IncreaseCurrent in Unit Sales in Unit Sales

Price $9.00 $8.10 $8.10

Unit Sales 750,000 787,500 1,000,000

Variable Costs $3.00 $3.00 $3.00

Fixed Costs $4.00 $3.81 $3.00

Admin. Overhead $2.00 $1.90 $1.50

Unit Cost $9.00 $8.71 $7.50

Unit Profit $0 -$0.61 +$0.60

Total Profit $0 -$480,375 $600,000

Instead, Acme should decrease its price to boost sales volume. Lower prices do not necessarily result in lower profits

Cost-based Pricing


Instead, Acme should decrease its price to boost sales volume. Lower prices do not necessarily result in lower profits

Questions: -Would cost-based pricing have suggested us to cut price?-Think of examples of profitable companies who emphasize low price: -Walmart; Southwest Airlines-Who else makes profits with low prices?

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Pricing Chapter 1. Strategic Pricing Stephan Sorger © Stephan Sorger 2015: ; Pricing: Ch 1: Strategic Pricing;