Transcript Kids Building Bricks

Chapter 6
Pricing Practices That Endanger
Profits
Surej P John
July 7th, 2011
Chapter Objectives
• To understand how consumers perceive
prices, price changes, and price differences
• To develop the concept of reference price
and further develop the concept of price
thresholds
• Key pricing principle
– Prices should be set so as to reflect customers’
perceptions of value
Reference Price
• The price that buyers use to compare
the offered price of a product or
service.
• The reference price may be a price in
a buyer's memory, or it may be the
price of an alternative product.
Order of Presenting Prices
• The order in which buyers are exposed to
alternative prices affect their perceptions.
– Ascending Prices
– Descending Prices
Ascending Series
Descending Series
Order of Presenting Prices
• Buyers who initially see high prices will
perceive subsequent lower prices as
less expensive than would if they
initially see low prices.
• Buyers are more sensitive to price
increase rather than price decrease.
Introductory Pricing Strategies
and Tactics
• Sellers introduce new products with short-term
“introductory low-price promotions”
– Facilitates market penetration
– Produces lower long-run sales volume than if
the product is introduced at its regular price
– The introductory low price serves as a
reference price for evaluating a perceived
price increase when the price is raised to its
normal price
– Refer Table 6.1
Singapore Sheraton
• Market situation, Singapore,
1986-1990:
– Five-star and four-star hotel
construction to double supply of
beds
– Ministry of tourism predicts the
number of visitors to remain steady
at two million annually for the next
few years.
• What do you expect will be the
effect on hotel prices by 1988 1990?
Singapore Sheraton Towers
• Purchased major credit card
mailing list on world-wide basis
• Mailed brochure and five onenight free stay coupons
– Brochure described the new hotel
– Room rates included in the
brochure
• The results:
– Gave away 20,000 room-nights
– By 1990, 80% of business was
repeat visits
– Maintained five-star room rates
Absolute Price Thresholds
• Acceptable price range
– Upper price threshold (price tolerance or
reservation price)
– Lower price threshold
– How wide is the range of acceptable prices
and what is the price level around which this
range is centered?
• Based on alternative offerings, customer
satisfaction and loyalty, knowledge about
other prices and quality
Disneyland Paris ( Box 6.2)
• Opened in 1992 - admission 250
francs
– By 1994, losses averaged $1 million per
day; hotels half empty
• Market research survey - 1994
– Price of 200 francs was psychological
threshold
• 1995 - Set admission price for one
adult at 195 francs ($39)
– Operated at a profit for first time
• 1996 - 11.7 million people visited
– 33% increase over 1994; 9% increase
over 1995; 40% of visitors were French
Differential Price Threshold
• Minimum difference in price for a buyer
to perceive a product different from the
next best alternative.
• Also known as relative price
• Two concepts are relevant when
considering the issue of price
differences.
– Price elasticity
– Cross price elasticity
Price Elasticity of demand
• Price elasticity of demand is the
percentage change in quantity sold
relative to (divided by) the percentage
change in price.
• If the value of elasticity is < -1, (i.e., -2
or -3), then price elastic.
• If the value of elasticity is , 0, but > -1
(e.g., -0.5), then price inelastic.
Cross-price Elasticity
• Cross-price elasticity refers to the %
change in demand for one product
relative to (divided by) the % change in
price of another product.
• If the value is > 0, then the two products
are substitutes.
• If the value is < 0, then the two products
are complements.
Cross-price Elasticity
• How the price of one product is
perceived to differ from the price of
another offering that buyers believe is
an alternative choice to consider
• Differential price thresholds
– The degree to which buyers are sensitive
to relative price differences
Decomposing Price Elasticity

Prices increases vs. price decreases
 Difference
in relative price elasticity between price
increases and price decreases means it is easier to lose
sales from current buyers by increasing price than it is
to gain sales from new buyers by reducing price
Decomposing Price Elasticity

Competitive effects
Price elasticity of demand varies over
brands within the same product
category.
 Price elasticity also varies across
market segments.
 Extreme prices will become more price
elastic as the prices are changed
toward the market average or as
competitor’s pricing moves the brand’s
price toward the market average

Decomposing Price Elasticity

Asymmetric competition
Price elasticity of demand affected mostly
by the substitution effect.
 The degree that demand for a product or
brand is price elastic or inelastic depends on
its cross-price elasticity relative to competing
products.
 Price promotions of a higher priced brand
affect the market share of a lower priced
brand than the reverse.

Decomposing Price Elasticity

The effect of price thresholds
 Demand
is very price elastic at upper and lower
absolute price threshold
 Buyers have different price thresholds for different
products, while different buyers have different price
thresholds for a given product
Decomposing Price Elasticity
Other influences on price elasticity
Does the product
have unique
attributes?
What benefit do
buyers seek from the
product?
Improved perceptions of product
and service quality makes the
product less price sensitive.
How the product is going
to be used or what
context the product is
used?
The relative dollar
magnitude of purchase
influence buyers sensitivity.
Price Elasticity

Price elasticities are not constant and they can
be managed over products, brands and time to
a greater extent than previously recognized
END OF CHAPTER VI
Have a Break…….
Chapter 8
Customer Value Analysis
Customer Value Analysis
• A cynic is a man who knows the price of
everything, and the value of nothing.
-Oscar Wilde
• What we obtain too cheaply we esteem too
lightly; it is dearness only that gives
everything its value.
-John Jakes, The Rebel
• The quality is remembered long after the
price is forgotten.
-James E. Brill, ABA Journal
Value Analysis Management
Customer value management is
understanding all the experiences that
customers have with the products and
services the firm provides them
The firm’s pricing is driven by
measurable value provided to
customers and not by customer’s
expressed willingness to pay
Perceived Acquisition Value
• Perceived acquisition value =
perceived benefits or quality
perceived total sacrifice
• Perceived total sacrifice to the buyer is equal to
purchase price + start-up costs + post-purchase costs
• Perceived benefits or quality is equal to some
combination of physical attributes, service attributes,
and technical support available, as well as the purchase
price and other indicators of quality
Components of Perceived
Acquisition Value
 1. Sacrifice
 2. Equity
 3. Aesthetics
 4. Relative use
 5. Perceived transaction value
The Concept of Benefits
• To provide benefits a product or service
must be able to:
– 1. Perform certain tasks or functions
– 2. Solve identified problems
– 3. Provide specific pleasures
The Concept of Benefits
• It is necessary to:
– Identify the benefits that customers will
perceive the product or service to offer
– Determine the relative importance of those
benefits that customers place on the
product of service
The Five Steps Of Valueoriented Pricing
• 1. Conceptualize customer value
– Translate features and attributes into
perceived benefits.
– Consider relative benefits delivered by
the product itself.
The Five Steps Of Valueoriented Pricing
• 2. Understand The Key Value Drivers
for Customers
• 3. Calculate customer value
– Determine sources of differentiation
value
– Determine customer value segments
– Perform customer value assessments
– Estimate economic value to customer
value segments
Value-in-use analysis
• Value in Use = Total willingness to pay for a
product across all consumers
• Consumer Surplus = Difference between
the maximum amount customers are willing
to pay for a product and the amount they
actually pay.
• Consumer Surplus = Value in Use – Value
in Exchange
Value-in-use analysis
• To use the concept of Value in Use:
– Determine the customer's reference
product
– Customer’s life cycle cost using the
reference product
– Improvement value of the product
relative to the reference product
• Reference Product:
– Customers next best alternative for meeting the
same need as current or proposed new product
– Existing model about to be replaced
– Competing product
• Life Cycle Costs:
– All costs that a customer will incur over the
product’s useful life.
– These costs include Actual purchase price, Startup
costs, post purchase costs
• Improvement value of the product:
– The improvement value of the product represents the
potential incremental satisfaction or profits the
customer can expect from this product over those of
the reference product.
Value-in-use analysis
• P max y = LCCx +Ivy –(PPCY+SUCy)
P max y = maximum acceptable price of Product Y
LCCx = Life cycle costs of the reference product X
Ivy
= Improvement value for the new product Y
PPCY = Post purchase cost for the new product Y
SUCy = Start up costs for the New Product Y
Example
• Old reference product, Current Purchase price = $400
•
Post purchase cost
= $300
•
Start up cost
= $300
• Hence Life cycle cost for product X,
• LCC x = Px + PPCx + SUC x = $1000
• Assume “NEW “ product is highly efficient and has an
Improvement Value, Ivy = $200
PPC y = $200
SUC y = $200
• Therefore Max. Accpetable Price,
• P max y = LCCx +Ivy –(PPCY+SUCy)
Pmax y = $800
Consumer Surplus
• Max. Accpetable price ( Value in Use)= $800
• If the current Selling price (Value in Exchange) = $500
Consumer surplus = Value in use- value in exchange = $300
Limitations of Value in Use
• Sometimes the product offering is so new
that its difficult to accurately estimate its
relative value to customers
• Value of the product may depend on the
nature of the buyer, how the buyer uses
the product, variations in perceived
benefits of the product by different buyers.
The Five steps of Valueoriented Pricing
3. Value mapping- illustrates the way
customers in a value segment trade off
perceived benefits against perceived
sacrifice
Perceived
Value equivalence line
Price
Value disadvantage area
C
B
A
Value advantage area
Perceived Benefits
The Five steps of Valueoriented Pricing
4. Communicating value.
– Keep price structures understandable, flexible, and
relatively easy to administer.
– Consistently and clearly communicate price structure.
Discounts, allowances, rebates, rewards for loyalty
should be above-board and clearly defined.
– Provide complete and concrete information about the
offer.
– Provide appropriate reference price and actual selling
price.
Value-oriented Pricing
41
The Five steps of Valueoriented Pricing
4. Communicating
value.
– For temporary price
reductions, provide the
specific ending date of the
offer and the price in effect
after the ending date.
– For price increases,
provide the beginning date
of the new higher prices.
The Five steps of Valueoriented Pricing
• 5. Develop Ways to Capture Customer
Value
– The seller becomes externally-focused when
managing prices
– Establish pricing rules or structure that force
customers to acknowledge value received
Contingency Value Pricing
• Occurs when the value of the service cannot be
calculated before its delivery
• Forms of contingency pricing include
– Money-back guarantees
– Real estate agents’ commissions based on a percentage
of the selling price
– Lawyers’ or professional sports agents’ fees based on a
percentage of the damage award or contract negotiated
Class Assignment-5
• Question No: 4 on Page 217