Transcript introduction to financial statement analysis

INTRODUCTION TO
STRATEGIC PRICING
BBE 3503
Dr. Tim Smith
Assistant Professor
Department of Bio-Based Products
BP 3503-5503: MARKETING BIO-BASED PRODUCTS
IMPORTANCE OF PRICING
• Andersen Consulting (Accenture) Study of Forest Products Companies in 1998
suggests that:
– over 40% of the differences in forest products company financial performance is driven by
marketing.
– “strategic pricing management” emerged as the most important skill in driving bottom line
performance (to the tune of $2 - $18 million dollars annually).
• But…Pricing is not a strong basis on which to compete!!!
• It doesn’t create value
• It doesn’t create loyalty
• It is easiest to copy
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
COEQUAL ELEMENTS OF MARKETING
1.
Product
2.
Promotion
3.
Place - Distribution
4.
Price
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Create Value
Captures Value
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
INEFFECTIVE PRICING QUESTION
“What prices do we need to cover
our costs?”
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
STRATEGIC PRICING QUESTION
“What costs can we afford to incur, given
the prices achievable in the market?”
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
INEFFECTIVE PRICING QUESTION
“What price is the customer willing
to pay?”
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
STRATEGIC PRICING QUESTION
“What is our product worth to this customer
and how can we communicate that value,
thus justifying the price?”
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
INEFFECTIVE PRICING QUESTION
“What prices do we need to meet our
sales or market-share objectives?”
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
STRATEGIC PRICING QUESTION
“What level of sales, or market share,
can we most profitably achieve?”
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
A FRAMEWORK FOR PRICING
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
A FRAMEWORK FOR PRICING: DATA COLLECTION
1. Cost Measurement: Incremental/Avoidable Costs Only
–
What are the incremental costs?
–
What are the avoidable fixed costs?
–
At what levels of output will additional semi-fixed costs be required?
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
COST MEASUREMENT
Example: Softwood Lumber Producer
Production Capacity
Price
Fixed Overhead
Personnel
Variable Costs
1.5
Units
Current Scenario
2000
$8.00
$4,500
$3,000
$1.50/unit
1200
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Option #1
New E-Channel
Option #2
New Trad. Channel
$6.00
$250
$150
$1.50/unit
400 (100)
$7.75
$1,500
$2,000
$1.50/unit
800 (150)
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
AVERAGE COST MEASUREMENT
Example: Softwood Lumber Producer
Capacity
Units
Revenue
Total Cost
Avg. Cost
Price
Current
2000
1200
$9,600
$9,300
$7.75
$8.00
+ E-Channel
+ New Trad.
Channel
1500
$11,200
$10,150
$6.77
$6.00
1850
$14,600
$13,775
$7.45
$7.75
Decision: If we do anything, we add the new traditional channel and make $.30 per unit.
(Don’t select the E-Channel because @ $6.00 we don’t cover our cost.)
WRONG!!!
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
INCREMENTAL COST MEASUREMENT
Example: Softwood Lumber Producer
Price
Unit Sales
Revenue
Other Foregone Sales
Revenue Gain
Personnel
Incremental Fixed Costs
Variable Material Costs
Total Inc. Costs
Net Contribution
New E-Channel
$6.00
400
$2,400
($800)
New Trad.
Channel
$7.75
800
$6,200
($1,200)
$1,600.00
$5,000.00
$150.00
$250.00
$600.00
$1,500.00
$2,000.00
$975.00
$1,000.00
$5,100.00
$600.00
($100.00)
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
A FRAMEWORK FOR PRICING: DATA COLLECTION
2. Customer Identification: Who are the potential customers, and why would
they buy your product?
–
What is the economic value to customers?
–
What other factors influence price sensitivity?
–
How can customers be segmented by price?
–
Can effective marketing and positioning influence a customer’s willingness to
pay?
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
A FRAMEWORK FOR PRICING: DATA COLLECTION
3. Competitor Identification: Current or potential competitors affecting your
profitability
–
Who are they?
–
What are their transactional prices versus list prices?
–
What are competitors’ pricing objectives – profitability or share?
–
What are their strengths/weaknesses – margins, reputation, products, product
lines, etc…
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
A FRAMEWORK FOR PRICING: STRATEGIC ANALYSIS
4. Financial Analysis: What volume trade-offs are needed for potential price
changes to increase profits?
–
What is the CM at the baseline price?
–
What volume is needed to allow a lower price to generate more contribution?
–
What volume can be forfeited at a higher price before contribution declines?
–
What volume is needed to cover incremental fixed costs (advertising, regulatory
approval, inc. capital equip., etc.)
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
BREAKEVEN SALES CURVE REQUIRED FOR CONSTANT
PROFITABILITY
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
A FRAMEWORK FOR PRICING:
STRATEGIC ANALYSIS
5. Segmentation/Implementation: How can a company price differently to
different segments to reflect differences in price sensitivity or the costs to
serve them?
–
Can segments be identified prior to purchase?
–
Can “fences” between segments be established?
–
Are there legal constraints to be addressed?
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
PRICE SEGMENTATION MODEL
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
A FRAMEWORK FOR PRICING:
STRATEGIC ANALYSIS
6. Competitive Analysis: How will competitors actions and reactions affect
profitability and long-term viability?
–
What can you realistically achieve, given competitor capabilities and intentions?
–
Can you influence competitors’ behavior?
–
Can profitability be insulated by targeting segments where you have competitive
advantage?
–
Should you withdraw resources from certain markets when confronted by fierce
competition?
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
A FRAMEWORK FOR PRICING:
STRATEGIC FORMULATION
7. Strategic Formulation: The price-value proposition for conducting future
business.
–
No right solution.
–
Can’t superimpose from one situation to another with different cost, customer,
and competitive conditions.
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
GENERIC PRICING STRATEGIES
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
PRICE SKIMMING
• Customers: Focus on a small segment of price insensitive buyers.
– Usually driven by exceptional value created by product differentiation.
– Also seen in impulse buying situations, when costs can be passed along to others, and
emotionally charged situations.
• Costs: Favors situations where incremental costs represent a LARGE share of the
product’s price.
– If variable costs are 80% of a product’s price, a 10% price hike would increase profits so
long as sales volume decreases by less than 30%.
– Therefore, a small niche of price insensitive buyers could allow for profitability even in the
most capital intensive industries.
• Competition: Must have some source of competitive protection to maintain this
strategy long-term.
– Patents/Copyrights, brand, access to scarce resource, access to exclusive distribution,
etc…
– Doesn’t mean you can’t skim while you can, then re-position when required by competition
(sequential skimming)
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
PENETRATION PRICING
• Customers: Price must be low enough to attract a large share of the
market.
– Need a large portion of customers to be at least somewhat price sensitive.
• Costs: Favors situations where incremental costs represent a SMALL
share of the product’s price.
– In this case each additional unit of sales provides a large contribution to profit.
– Can also work if increased volume leads to sufficient variable cost economies.
• Competition: Beware of the price war.
– Only if you have a significant cost advantage, or are so small your gain in sales
won’t prompt a response.
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
EFFECT OF CONTRIBUTION MARGIN
ON BREAK-EVEN VOLUME
125
120

Profit Zone:
Skimming More
easily accomplished
115
110

Price
105
80% CM
 20% CM


100
95

90

Profit Zone:
Penetration More
easily accomplished
85
80

75
45
55
65
75
85
95
105 115 125 135 145 155 165 175 185 195 205 215
Volume
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
EXAMPLE: PENETRATION PRICING & MARKET SHARE
The Introduction
Price:
Unit Variable Costs:
Market Share:
Voume:
Revenue:
Fixed Costs:
Variable Costs:
Profit Margin
Incumbent
Challenger
$3.50
$1.00
85%
850,000,000
2,975,000,000
1,500,000,000
850,000,000
0.21
$3.25
$1.35
15%
150,000,000
487,500,000
500,000,000
202,500,000
(0.44)
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
EXAMPLE: PENETRATION PRICING & MARKET SHARE
X years (months) later
Price:
Unit Variable Costs:
Market Share:
Voume:
Revenue:
Fixed Costs:
Variable Costs:
Profit Margin
Incumbent
Challenger
$3.50
$1.05
70%
700,000,000
2,450,000,000
1,500,000,000
735,000,000
0.09
$3.25
$1.15
30%
300,000,000
975,000,000
500,000,000
345,000,000
0.13
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
NEUTRAL PRICING
• A strategic decision not to use price as a significant marketing tool.
– Usually a default strategy, because conditions are not favorable for either of the
other two strategies.
– Also used to maintain a coherent product line pricing strategy.
– DOES NOT IMPLY A LOW PRICE IN THE MARKET.
– A high price is a neutral price when the product value seems to justify the price to
most potential buyers.
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
Pricing in Mature/Commodity Markets
• Pricing latitude reduced by severe price competition:
– Accumulated purchase experience of repeat buyers  improves their ability to
evaluate competing products  reduces loyalty.
– Increased imitation of successful products (i.e. product/performance/ grading
standards)  reduced differentiation.
– Increased price sensitivity attract competitors whose distinct competence is efficient
production/distribution  further price erosion.
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BP 3503-5503: MARKETING BIO-BASED PRODUCTS
SOME SUGGESTIONS…
– Improve control and utilization of costs – identify unprofitable products or
customers.
– Improve estimation of price sensitivity – when demand is primarily from repeat
buyers and competition is relatively stable, a little fine tuning can significantly
improve profits.
– Unbundle related products/services – Dominate what you are best at and own that
business (high volume in one area, rather than seller everything to an ever fewer
number of customers).
– Expand the product line – accessorize, accessorize, accessorize.
– Reevaluate distribution – less need to pay channel to promote to new buyers, less
need to restrict distribution.
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