Transcript A Framework for Setting the Optimal Price

We Lose Money on Every Sale,
But We Make It Up on Volume:
Generating Association Profits
With Effective Pricing
AICPA Interchange 2000: July 21
Kevin Whorton
Director of Retail Programs
National Association of Chain Drug Stores, Inc.
General Manager, NACDS Services Corporation
1
Program Outline
I.
Overview of Pricing Techniques/Tactics
II.
Framework for Setting Optimal Price
III. Vignettes and Cautionary Tales
2
I: Overview of Pricing
Techniques and Tactics
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Pricing Objectives
Will drive strategies and techniques:
Maximize profit/financial surplus
Cost recovery
Maximize market size
Social equity
4
Pricing Strategies
Cost-oriented: based on markup/target
return on investment
Market penetration: low introductory price
Build acceptance, forestall competition
Market skimming: where market will bear
No foreseeable competition
Competitive price: defensive, matching, or
maintaining guaranteed low price
Prestige price: intentional high/establish
value
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Common Pricing Techniques
Cost-plus pricing: adding markup to achieve
defined margin
Demand-oriented pricing: consumer need
sets price; price level varies with demand
Line pricing: price set for individual items,
relative to other items within the line/brand
Price discrimination: offer multiple prices
within distinct markets/distribution channels
Other: price points, loss leader, promo
pricing
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Price Setting
Existing services
Qualitative research
Quantitative methods--contingent
valuation
Tradeoff (conjoint) modeling
Overall review of practices
New services
Price testing
Bundled/unbundled products
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Pricing By Service Category
Services Under Development
Marketing involvement during product
development process:
Define ideal product
Determine its attributes
Forecast success of product with a variety
of price points/strategies (measure
opportunity cost)
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Which Problems Apply to You
Too much/too little price variety in product line
Over-consistent pricing across categories with
different costs: associates, students, international
Internal resistance to hikes: “not business
decision”
Not bundled well with discounts for other services
Price level inconsistent with perceived value
Constant dues level over time, despite changes in
services/components of membership
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Potential Solutions
Varying solutions and potential returns
Direct changes in base dues
Bundling with products/premium membership
New categories (e.g. inst./multiple
memberships)
Multiple-year and discounted memberships
Changing price for categories with higher/lower
fulfillment costs (international, students)
Each change needs systematic review/evaluation
similar to new product development model 10
Communication
Make case for direct price changes…
Marshal evidence of over/underpricing
Address underlying issues (e.g., cost allocations)
Build internal/external understanding/acceptance
... or indirect price changes
Increase benefits, member discounts, premium
giveaways, member-only services (if overpriced)
Unbundle benefits, lower member discounts, create
premium level (if underpriced)
Continue to pursue a long-term strategy to change
direct prices
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Implementation
To succeed, maximize return on price changes
Communicate findings internally
Forecast results, re-evaluate effectiveness
Communicate to external audiences
The sales force — chapters, recruiters
Current customers — catalog, renewals
Prospects — promotional materials
Position change as increased market responsiveness
Establish precedent: ensure pricing is a marketing
decision
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Applications: Membership
Typical scheme:
Annual charge, no installments
Primary membership: often political/by-laws
Line pricing for other categories
No volume discounts
Strategy for changes: budget-balancing
Technique is cost-based
Full, not incremental cost
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Application: Member Dues
Identify pricing strategy/technique used
Determine if strategy is sub-optimal
Retention (by category) vs. benchmarks
Exit surveys: frequency of value/cost as a reason
Satisfaction ratings based on “value for price
paid”
Qualitative research, current members
Competitive scan/market penetration
Use file analysis: total members by company, site
Positioning: “primary” or “secondary” affiliation
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Application: Exhibit Fees
Far greater latitude: multiple attendees
Split registrant fees from space rental
History rules: working within budgets
Competitor intelligence
Potential for value-added: pre-show lists, travel
costs, all factored into budgets
Annual packages: ads + exhibitor fees
Willingness to trade certainty for higher price tag
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Application: Sponsorships
Typical scheme:
Full, not incremental cost
Based on perceived WTP or need for specific
program
Often linked to giving/donor relations
Altruistic motives vs. market access
Pricing the sponsor “ask”
• Identify market’s value to potential sponsor
• Extensive use of add-ons
• Specific deadlines for offers/auction to drive prices build-in
exclusivity for high profile
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• Avoid frequent use of tiers
Application: Certifications
Cost-plus pricing: Full cost vs variable cost:
packaging and recordkeeping
Externalities: ‘lift’ for all education
Product line: spinoffs, distance learning
Perceived value--new clients/higher income
Adjustments if problem signs (attrition rates)
Importance of lifetime value
Pricing for first and subsequent years
Pricing and penetration: elite/prestige (low) or
democratic/requisite credential (high)
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II: A Framework for Setting
the Optimal Price
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Assumptions
You price to generate a profit
There is a direct relationship between
price and demand
Cost is only one element used to establish
the final price
Price is used as a basis for determining a
product’s value
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Pricing Floor and Ceiling
Your costs set the
floor
The marketplace sets
the ceiling
There is a range of
acceptable prices:
in theory, only one is
optimal
1
1
1
0
0
Ceiling
Price
Range
Cost
0
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Components of Pricing Process
Pricing constraints and objectives
Demand, revenue, and elasticity
Cost, volume, and profit relationships
Pricing strategies
Factors in setting the specific price
Special adjustments
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Pricing Objectives
Specify pricing goals that reflect your
organization’s strategic goals
Profit: long-run, current, ROI
Sales: total revenue, unit sales
Market share
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Constraints
Determine the demand
Associations occupy niches/defined market
Look at competition: assns and commercial
Is product/service truly unique?
Is there an expected price?
Anticipate the competitive reaction
Who are your competitors?
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Constraints (cont.)
Establish universe size market share
Is the market large enough to generate
adequate sales?
Is the universe stable? Growing or shrinking?
Determine the cost of producing and
marketing the product or service
Production, marketing, fulfillment, overhead
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Other Pricing Constraints
Newness of product: stage in the product life
cycle
Single product vs. product line
Cost of changing prices and the time period
they apply
The competitive marketplace (monopoly vs.
competitive)
Competitor’s prices
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Demand Curve Factors
Consumer tastes
Price and availability of other products
(preference set)
Consumer income
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Typical Demand Curve
3,000
Quantity
2,500
2,000
1,500
1,000
500
0
$0
$50
$100
$125
$150
$200
$250
Price
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Revenue Curve
Total Revenue
$200,000
$150,000
$100,000
$50,000
$0
0
500
1,000 1,250 1,500 2,000 2,500
Quantity
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Price Elasticity and Demand
There is a relationship between the
quantity demanded and price.
Elasticity is the % change in quantity
demanded relative to the % change in price.
Price elasticity of demand (E) is:
(Initial quantity demanded / New quantity demanded) /
Initial quantity demanded
(E) = _________________________________________
(Initial price - New price) / Initial price
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What does this mean?
 Demand is elastic when a small price increase
produces a larger percentage decrease in
quantity demanded. (Price elasticity > 1)
 Demand is inelastic when a small price increase
produces a smaller percentage decrease in
quantity demanded. (Price elasticity < 1)
 Unit demand elasticity- percentage change in
price produces an identical change in quantity
demanded
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Factors Affecting Elasticity
The greater the number of substitutes, the
greater the elasticity
Products and services considered to be
necessities are price inelastic
Items that require large cash outlays compared
to disposable income are price elastic
One way to measure elasticity is through yearto-year purchasing
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Cost, Volume, and
Profit Relationships
Pricing Terms
Marginal Analysis
Break-even Analysis
Estimating Demand
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Terms
 Profit = Total revenue -Total cost
 Total cost (TC) = total production, marketing,
and sales expense.
Fixed costs (FC) do not change with the quantity sold
(rent, salaries)
Variable costs (VC) vary directly with the quantity sold
 Variable cost expressed on a per unit basis it
called unit variable cost.
 Marginal cost (MC) is change in unit cost for
producing and marketing one additional unit.
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Marginal Analysis for
Profit Maximization
To maximize profit
sell and promote your products/services as
long as the revenue received from the sale of
an additional product is greater than the cost
to produce and market that product.
In theory, you want to operate up to the
point where MR = MC
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Break-even Analysis
Analyze the relationship between total
revenue and total cost to determine
profitability at various levels of output.
The break-even point (BEP) is the point
where total revenue = total cost.
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Calculating Break-even Point
Fixed Cost_______
BEPq = Unit price - Unit variable cost
Answers question: How many units do I need
to sell to break even?
$55,000___
BEPq = $35 - ($10 + $ 8) = 3235.3
Question: # units can we realistically sell?
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Developing the
Break-even Chart
Where P = $35
UVC = $18 (printing, distribution, storage)
FC = $55,000 (development,
marketing, salaries, OH)
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Break-even Chart
 Q

TR
TVC
TC
(P X Q)
(UVC X Q)
(FC X TVC)
 1,000
 2,000
 3,000
 4,000
 5,000
 6,000
$35,000
$70,000
$105,000
$140,000
$175,000
$210,000
$18,000
$36,000
$54,000
$72,000
$90,000
$108,000
$73,000
$91,000
$109,000
$127,000
$145,000
$163,000
Profit
ROI
($38,000)
($21,000)
($4,000)
$13,000 10.2%
$30,000 20.7%
$47,000 28.8%
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Break-even Graph
$250
$200
TR
$150
TC
$100
FC
$50
$0
1000
2000
3000
4000
5000
6000
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Estimating Demand
Universe/market share
Example: Membership category (N=250)
31,000 certified technicians
15,000 take exam in 1999 (12,000 pass)
Approximately 1/3 are in the health-system
market niche
Min. universe = .33 x 43,000 = 14,190
Mkt share estimate = 10% or 1,419
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Estimating Demand (cont.)
Previous sales/similar products
Review sales of earlier editions
What external factors are affecting demand?
Examine sales of similar products
External research: sales of competitive
products
Internal research: ask customers if they’d
buy
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Summary
Establish a pricing policy
Set your parameters and goals
Make assumptions
Use the tools
Draw on your experience
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III: Vignettes and
Cautionary Tales
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Sponsorship: Effect On
Pricing the Subsidized Item
Grant in hand to subsidize program
development
“Net cost” of development is zero
Developer wants to price low
What do you do?
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Sponsorship’s Effect (2)
If net cost=0, should you give it away?
Social objective of pricing strategies
Publicize your role as good guys
OR…Price where the market will bear
If you can make money, price based on gross
cost
Product is a sponsorship magnet
Yet pricing should reflect perceived value
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“The Fait Accompli”
What do you do when the price is
established and the “go/no go” is GO
Illustrated: Spinoff of an established product
Power resides with the product developer
Your own analysis yields profit = 0
Probable outcome: profit < 0
What do you do?
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“The Fait Accompli” (2)
De-emphasize the product
May be self fulfilling prophecy
Free/low-cost marketing options
Wait until the next round
Work on fixing problem for the next edition
Price-test the release: forecast results
Prepare for markdowns in promotion plan
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New Product Release
Product rollout begins in six months
Your charge: develop pre-pub and rollout
communications and pricing strategies
Marketing has autonomy over discounts,
some control over rollout price
How do you determine pricing?
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New Product Release (2)
Pre-pub allows some flexibility in price
testing (validate your research)
Know your doubling day from product
history: drive your forecast
Don’t pick at random, test price points
Pre-pub to price-sensitive segments
Consumer expectations/rollout price turnoff
Commit to using the pre-pub learning to
adjust actual rollout price
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Rapid Price Escalation
Underpriced good, with some uncertainty
Decision-maker sees product far underpriced
Sound basis on market data
Objective: raise to market price, turn cash
calf into a cash cow
What do you do?
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Rapid Price Escalation (2)
One fell swoop
Understand elasticity
Avoid disrupting established buying patterns:
will people stay in the habit of buying?
Budget-based decisions: don’t outrun
real willingness to pay
Communicate: one adjustment year
Incremental multi-year: gradual, less pain
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Product Line Extension
Successful product needs milking
Decision: expand product line
May be segmenting content for a niche
May be compiling discrete products or issues
into a single volume
What do you consider in pricing?
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Product Line Extension (2)
Considerations?
How much do components or single
attributes contribute to value/how many are
in product
Perceived value affected by media or content
What is the niche-specific demand
Are you being a cannibal?
“Fit” with long-term pricing strategy
Other approaches: bundling, repackaging
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Desperation Marketing
Got a dog to unload
May be low-pickup conference,
underperforming book or product
“Fire sale,” on-site discounts are options
 Must sunset the product/no questions asked
No current pricing process in place
What do you do?
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Desperation Marketing (2)
Time to ignore cost data
How to exhaust inventory gracefully
Avoid “aging” your catalog’s perception
Avoid hurting image: product and other lines
Avoid future expectations of a white sale
Giveaways: perform the social function
People perceive value from pricing
Understand why it tanked!!!
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Membership = Bundle
Association membership is under review
Each represents a bundle of goods
Board wants to re-evaluate what members
get for their dues, and/or dues level
Service mix and membership categories last
changed in the Truman Administration
What input do you provide?
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Membership = Bundle (2)
Evaluate value of components in bundle
Use a “time-neutral” perspective
Ignore history and competition for now
Integrate with an overall financial model
Loss leader, competition, or primary revenue
source
Attribute all indirect member-caused
revenue:
journal ads, exhibit revenue, sales
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