Pricing Strategy Module 2 PDF

PAMANTASAN NG CABUYAO |PRICING STRATEGY 1 MODULE 2 Pricing Policy There can never—and I mean never —be a discount on a new car coming out of the factory in pristine condition....

PAMANTASAN NG CABUYAO |PRICING STRATEGY 1 MODULE 2 Pricing Policy There can never—and I mean never —be a discount on a new car coming out of the factory in pristine condition. Elon Musk Policy is a course or principle of action adopted or proposed by a government, party, business, or individual (Oxford Dictionary) In a business language, a pricing policy is a company’s approach to setting the prices for its products or services. It includes the strategies, guidelines, and factors that influence pricing decisions. Legally, pricing policies are subject to legal regulations to prevent unfair competition, price discrimination, and monopolistic practices. According to Nagel et al, pricing policy is defined as the rules and conditions for price discounts or surcharges that could be applied to a transaction within a segment. is Here are some examples of pricing policies: Apple Inc.: Apple uses value-based pricing for its products like the iPhone, MacBook, and other devices. The company charges premium prices based on the brand’s strong reputation, high- nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 2 MODULE 2 quality design, and innovative features. Customers are willing to pay more for the perceived value and status associated with Apple products. Pharmaceutical Industry: Many pharmaceutical companies use value-based pricing for new medications, particularly for innovative treatments with few or no alternatives. The price is often based on the drug’s effectiveness, the value it brings to patients (such as life-saving potential), and the overall impact on healthcare costs. Luxury Goods: Brands like Louis Vuitton, Rolex, and others in the luxury segment use value- based pricing to reflect the exclusivity, craftsmanship, and prestige associated with their products. The perceived value of owning a luxury item allows these companies to maintain high prices. Pricing policies involve things like an upcharge for rush orders or a discount for must-take orders which the customer commits far in advance of shipment, can and usually should be transparent because their goal is to influence customer behavior. PRICING POLICIES AND PRICE EXPECTATIONS “A pricing policy is a rule or habit, consistently applied, that defines the criteria under which a company will change a price for an individual customer, for a limited period or particular transactions.” nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 3 MODULE 2 The pricing policies and price expectations highlight how consumer expectations and behaviors are influenced by pricing strategies, particularly when businesses use regular, predictable discounts. Here’s a breakdown of the key points: 1. Consumer Willingness to Pay : - Beyond Fairness: A customer’s willingness to pay is not just about whether the price is fair or reasonable compared to the product's economic value. Other factors, especially expectations shaped by past pricing strategies, also play a crucial role. - Expectations Matter: Buyer behavior is heavily influenced by what they expect prices to be in the future. If customers believe that a product will be discounted soon, they may delay their purchase to wait for the lower price. 2. Impact of Predictable Discounting : - Trained Behavior: Regular, predictable discounts have conditioned consumers, especially in retail, to expect lower prices if they wait. This reduces the effectiveness of regular pricing because customers become accustomed to waiting for sales. - Inventory and Revenue Impact: This expectation leads to fewer sales at regular prices and increases the amount of inventory that needs to be sold at the discounted price, potentially reducing overall profitability. 3. Undermining Pricing Power : - Short-Term vs. Long-Term: Companies often use discounts to achieve short-term sales goals. However, this can undermine their pricing power in the long term by reinforcing customer expectations for discounts, thereby reducing their willingness to pay full price. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 4 MODULE 2 - Erosion of Value Perception: When customers consistently buy at a discount, they may start to perceive the discounted price as the true value of the product, eroding the perceived value of the product at its regular price. 4. Pricing Policy Goals : - Change Customer Behavior: The goal of a well-designed pricing policy should be to stop encouraging customer behaviors that erode the perceived value of the product. This includes avoiding practices like predictable discounting that lead customers to expect lower prices and undermine long-term profitability. - Maintain Value Perception: The pricing policy should aim to preserve the perceived value of the product, ensuring that the difference between the price paid and the value received remains favorable to the company. Summary : The passage emphasizes the importance of managing customer expectations through strategic pricing policies. By avoiding predictable discounting and other short-term tactics, businesses can maintain their pricing power and the perceived value of their products, ultimately leading to more sustainable profitability. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 5 MODULE 2 THE EMERGENCE OF STRATEGIC SOURCING Strategic sourcing suggests that while buyers have become increasingly sophisticated in their purchasing strategies, focusing on minimizing costs through strategic sourcing, sellers often make pricing decisions with a short-term mindset. This approach can undermine their long-term pricing power and encourage more aggressive tactics from buyers. Sellers need to understand the broader impact of their pricing decisions and consider the long-term implications on buyer behavior and profitability. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 6 MODULE 2 1. Short-Term Focus on Pricing Decisions : - Quarterly Sales Focus: Companies often evaluate their pricing decisions, including whether to offer discounts or make price exceptions, based primarily on short-term goals, such as the impact on sales in the current quarter or the chances of winning the next deal. - Short-Term vs. Long-Term Impact: This short-term focus may lead to decisions that boost immediate sales but potentially harm the company's pricing power and profitability in the long run. 2. Strategic Sourcing by Buyers : - Buyers' Sophistication: Buyers, under the concept of "strategic sourcing," have developed advanced processes and policies aimed at securing the lowest prices possible from sellers. Strategic sourcing involves analyzing spending patterns, supplier markets, and negotiating tactics to optimize procurement costs. - Impact on Sellers: Buyers' sophisticated approaches often put pressure on sellers to lower prices or offer discounts, sometimes without the sellers fully realizing how these concessions affect buyers' future expectations. 3. Lack of Awareness Among Sellers : - Seller Behavior: Sellers often lack a deep understanding of how their pricing decisions and behaviors influence buyers' expectations. For example, frequently offering discounts or making price exceptions can train buyers to expect such concessions regularly. - Rewarding Aggressive Tactics: By not fully grasping the long-term implications, sellers may inadvertently encourage buyers to use more aggressive purchasing tactics, knowing that the seller is likely to yield to price pressures. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 7 MODULE 2 POLICIES FOR NEGOTIATION COMMODITIZING THE OFFERS: Particularly in B-to-B markets, customers often refuse to discuss what differentiates the offers of various competitors. Instead, they distribute “specs,” short for specifications, of exactly what they require. They then solicit bids to meet or exceed that specification. In some cases, the bids are “closed,” meaning that no one knows what anyone else is bidding until they are opened. You must have a menu of very profitably priced products and service “upgrades” that the customer can buy as needed. This refers to the process by which products or services that were once seen as unique or differentiated become perceived by consumers as interchangeable with those of other competitors. When an offer becomes commoditized, it loses its distinct value in the eyes of the customer, and purchasing decisions are driven primarily by price rather than by the unique features, benefits, or brand associated with the offer. How Commoditization Happens : a. Increased Competition : As more competitors enter the market offering similar products or services, it becomes harder for any single company to stand out. Over time, customers may begin to view all the available options as essentially the same, leading to a focus on price rather than other differentiating factors. b. Lack of Differentiation : When companies fail to innovate or effectively communicate the unique value of their products, customers may see little difference between their offerings and those of competitors. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 8 MODULE 2 Without clear differentiation, the offer is seen as a commodity. c. Price Sensitivity : Commoditized markets tend to be highly price-sensitive because customers don't perceive significant differences between competing products. Companies may find themselves in price wars, constantly lowering prices to attract or retain customers. d. Standardization of Features : As products or services become more standardized—meaning they offer the same features and benefits across different providers—the perceived uniqueness diminishes. For example, in technology markets, once-innovative features can quickly become standard, leading to commoditization. Implications of Commoditization : - Reduced Profit Margins: As price becomes the primary competitive factor, profit margins often shrink. - Brand Loyalty Erosion: Customers may switch between brands more easily because they see little difference in value, reducing brand loyalty. - Pressure on Innovation: Companies must innovate continually to differentiate their offers and avoid commoditization. - Focus on Cost Efficiency: In commoditized markets, companies may focus more on operational efficiency and cost-cutting to maintain profitability in the face of declining prices. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 9 MODULE 2 Examples : - Smartphones: While premium brands like Apple or Samsung differentiate themselves through design, ecosystem, and brand prestige, many smartphones on the market offer similar features at lower prices, leading to commoditization in some segments. - Airline Industry: Many airline routes have become commoditized, with consumers primarily choosing flights based on price rather than the specific airline, leading to fierce price competition. - Basic Consumer Goods: Products like bottled water, coffee beans, and basic clothing items often become commoditized as many brands offer similar quality and features, making price the main differentiator. Avoiding Commoditization : To avoid commoditizing their offers, companies should focus on: - Innovation: Continuously improving and adding unique features or services. - Branding: Building a strong brand identity that resonates emotionally with customers. - Customer Experience: Providing exceptional customer service and experiences that go beyond the product itself. - Customization: Offering personalized or tailored solutions that set them apart from standardized options. By doing so, companies can maintain the perception of value and prevent their offerings from being reduced to mere commodities in the marketplace. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 10 MODULE 2 DOUBLE DISCOUNTING OF PRICE INCREASES: Some companies’ pricing strategies have suffered for years from the effects of poorly negotiated price increases. The seller in these cases establishes an across-the-board price increase that is presented to buyers. Buyers without power are forced to take it or leave it. When increasing prices, there must be no exceptions. If more powerful buyers must have a concession, give it without undermining the integrity of the price increase. Double discounting of price increases refers to a situation where the effect of a price increase is offset or diminished twice, reducing its intended financial impact. This can happen in several ways, typically through customer behavior or internal company practices. Here's a closer look: a. Customer Behavior : - Anticipated Discounting: When customers expect regular discounts or promotions, they may resist paying higher prices and wait for a sale or negotiate for a discount. If a company raises its prices but then frequently offers discounts to encourage sales, the net effect of the price increase is diminished. - Sales Promotions: Suppose a company increases the price of a product but continues to offer the same percentage of discounts during sales or promotions. In that case, the actual price the customer pays might not significantly change, leading to an effective "double discount" where the price increase is largely negated. b. Internal Company Practices : - Salesforce Discounting: If a company's salesforce has the authority to offer discounts to close deals, they may continue to offer the same or even higher discounts after a price increase. This practice can reduce the impact of the price increase because the additional revenue nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 11 MODULE 2 generated from higher prices is offset by the larger or more frequent discounts given to customers. - Contractual Agreements: In some industries, companies have long-term contracts with customers that include clauses allowing for discounts based on volume, early payment, or other factors. After a price increase, if these discounts are still applied at the same rate, the intended effect of the price increase may be diluted, effectively discounting the price increase twice. Impact of Double Discounting : - Erosion of Profit Margins: The primary impact of double discounting is that it can erode the profit margins a company hoped to gain from the price increase. Instead of improving profitability, the company might find that its revenue growth is flat or less than expected. - Customer Expectations: Frequent discounting, especially after a price increase, can lead customers to expect that any future price increases will also be offset by discounts. This expectation can make it harder for the company to realize the full benefit of any future price adjustments. - Reduced Pricing Power: Over time, the practice of double discounting can weaken a company's pricing power, making it difficult to enforce or maintain higher prices in the market. Example : - Retail: A retail store increases the price of a product by 10%, hoping to boost revenue. However, during frequent sales, it offers a 20% discount on the new price, effectively reducing the price back to or even below the original level before the increase. As a result, the intended benefit of the price increase is lost. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 12 MODULE 2 - B2B Sales: A software company raises the price of its subscription service by 15%, but the sales team continues to offer a 10% discount to clients during negotiations. This practice means the actual revenue gain from the price increase is much lower than expected. Strategies to Avoid Double Discounting : - Reduce Discount Frequency: Companies can reduce the frequency of discounts and promotions, making price increases more effective. - Train Sales Teams: Educating sales teams on the importance of maintaining price discipline and minimizing discounts can help preserve the intended benefits of price increases. - Adjust Discount Policies: Re-evaluating discount policies to ensure they are aligned with pricing strategies can prevent the erosion of price increases. - Customer Communication: Communicating the reasons for price increases to customers and emphasizing the value provided can reduce the pressure to offer discounts. By managing discounts carefully and ensuring they don’t undermine price increases, companies can maintain their pricing power and achieve the desired financial outcomes. DISCOUNTING FOR VOLUME. Sometimes buyers will offer a seller incremental volume in return for a price concession. There is nothing in principle wrong with accepting or, even better, proactively proposing such a deal. Making the discount into an end-of-year rebate instead of an upfront discount has the added advantage of protecting you from duplicitous buyers who promise more business to get the discount, but never order the promised incremental volume. With the discount focused entirely nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 13 MODULE 2 on the increment, they don’t get the savings until they have bought the required volume, and the lower price doesn’t get incorporated into the buyers’ expected price level. If you’re going to give a discount for volume, focus the discount on the incremental volume and give it as a rebate. Discounting for volume is a pricing strategy where a seller offers a lower price per unit to customers who purchase larger quantities of a product or service. This practice is common in both B2B (business-to-business) and B2C (business-to-consumer) markets and serves various strategic purposes, including driving higher sales volumes, encouraging customer loyalty, and optimizing production efficiency. Key Aspects of Volume Discounting : a. Tiered Pricing : - Structured Discounts: Volume discounts are often structured in tiers. For example, a company might offer a 5% discount for orders over 100 units, a 10% discount for orders over 500 units, and a 15% discount for orders over 1,000 units. The more a customer buys, the greater the discount they receive. - Incentive for Larger Purchases: This tiered approach incentivizes customers to purchase more to achieve the next level of discount, thereby increasing the seller's overall sales volume. b. Rationale Behind Volume Discounts : - Economies of Scale: As production or sales volumes increase, the cost per unit for the seller often decreases due to economies of scale. For example, bulk manufacturing or shipping can lower the cost per item, allowing the seller to pass some of these savings on to the customer through volume discounts. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 14 MODULE 2 - Increased Cash Flow: By encouraging larger purchases, companies can improve their cash flow and reduce inventory holding costs. Customers buying in bulk also help sellers move inventory more quickly, which can be particularly important for products with expiration dates or changing market demands. - Customer Loyalty: Offering volume discounts can build customer loyalty, as buyers may prefer to continue purchasing from a seller that offers financial benefits for bulk orders. - Competitive Advantage: Volume discounts can be a competitive differentiator in crowded markets. By offering better deals for larger orders, companies can attract cost-conscious customers and gain a competitive edge over rivals who do not offer similar discounts. c. Types of Volume Discounts : - Cumulative Volume Discounts: These are based on the total volume purchased over a specific period, such as a year. For example, a customer might receive a discount on all future purchases once their total spending reaches a certain threshold within a year. This encourages repeat purchases and long-term relationships. - Non-Cumulative Volume Discounts: These discounts apply to single orders rather than the cumulative total. A customer receives a discount based solely on the size of their current order. This type is common in one-time or infrequent purchasing scenarios. - Bundling Discounts: In some cases, companies offer discounts when customers purchase a bundle of products or services together, effectively giving a volume discount for buying in bulk or as part of a package deal. d. Potential Challenges of Volume Discounts : nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 15 MODULE 2 - Margin Erosion: If not managed carefully, volume discounts can erode profit margins. The seller must ensure that the discount offered does not undercut profitability, especially if the customer consistently purchases at high volumes. - Customer Expectations: Offering volume discounts can set a precedent where customers expect discounts for larger orders, potentially making it difficult to return to standard pricing or maintain pricing power in the future. - Inventory Management: Encouraging large orders through volume discounts can lead to inventory management challenges, such as stockouts or overproduction. The seller needs to balance the demand generated by discounts with their ability to supply products efficiently. - Complexity in Pricing: Implementing tiered or cumulative discounts adds complexity to pricing structures, requiring careful management to ensure that customers receive the correct discounts and that sales teams understand the discount policies. e. Strategic Considerations : - Targeting Key Customers: Volume discounts are often used strategically to win or retain large customers who might otherwise take their business to competitors. These discounts can be a powerful tool in securing contracts with major clients who require large quantities. - Encouraging New Customers: For new customers, volume discounts can be a compelling incentive to place larger initial orders, helping the seller establish a strong relationship from the outset. - Clear Communication: It's crucial to communicate the terms of volume discounts to customers. Transparency ensures that customers understand the benefits of purchasing in larger quantities and prevents misunderstandings about pricing. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 16 MODULE 2 Example of Volume Discounting : Wholesale Business: A wholesaler sells electronic components to manufacturers. The standard price for 100 units is $10 each. However, the wholesaler offers a 10% discount for orders over 500 units and a 15% discount for orders over 1,000 units. A customer purchasing 600 units would pay $9 per unit, while a customer purchasing 1,200 units would pay $8.50 per unit. The wholesaler benefits from moving more inventory, while the customer enjoys cost savings. Retail Scenario: A grocery store offers a discount on cases of bottled water. The regular price is $12 per case, but customers who buy 5 or more cases receive a 10% discount, reducing the price to $10.80 per case. This encourages customers to buy in bulk, increasing the store's overall sales volume. Discounting for volume is a common and effective pricing strategy that encourages customers to purchase larger quantities by offering them a lower price per unit. While it can boost sales and customer loyalty, it must be managed carefully to avoid margin erosion and maintain profitability. By understanding the dynamics of volume discounts and strategically applying them, companies can optimize their sales processes and strengthen customer relationships. DISCOUNTING TO COMPENSATE FOR PAST FAILURE. There is no situation in which sellers are more vulnerable than when their firm has failed to meet its commitments. Failure to deliver on time or to deliver the promised quality undermines the case that your firm deserves either a higher price or a higher share of a customer’s business. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 17 MODULE 2 Two things make this a powerful weapon for the purchaser. First, the seller does owe the customer something for having failed to meet its obligations. Second, by making that “something” a price concession, the seller exploits a common psychological bias that makes forgoing revenue less psychologically painful than making an equal-sized expenditure, even though each would affect bottom-line profit equally. Make it a policy to negotiate with the customer a fair compensation for the cost of any legitimate failure, but pay that compensation as a lump-sum payment, rather than letting it reduce your established price point. Discounting to compensate for past failure refers to a pricing strategy where a company offers a discount or price reduction to a customer as a form of compensation for a previous mistake, service failure, or product defect. This approach is often used as part of customer service recovery efforts to rebuild trust, retain the customer, and demonstrate accountability. - Purpose: The discount is offered to make amends for an error, such as a delayed delivery, defective product, or poor service experience. It serves as a goodwill gesture to show that the company values the customer and acknowledges the inconvenience caused. - Customer Retention: By offering a discount, the company aims to retain the customers and prevent them from taking their business elsewhere. It's a way to turn a negative experience into a positive one, potentially restoring the customer’s faith in the brand. - Building Loyalty: A well-handled discount or compensation can enhance customer loyalty, as it shows that the company is willing to take responsibility and make things right. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 18 MODULE 2 POLICIES FOR RESPONDING TO PRICE OBJECTIONS The Benefits of Proactive, The Problem with Reactive, Ad Policy-Based Price Negotiation Hoc Price Negotiation Reactive, ad hoc price negotiation refers to the practice of responding to pricing demands from customers on a case-by-case basis without a consistent or strategic approach. This method can lead to several problems for a business, ultimately undermining its pricing strategy and profitability. Key Problems with Reactive, Ad Hoc Price Negotiation : 1. Inconsistent Pricing : - Lack of Standardization: When pricing decisions are made reactively, different customers may end up paying different prices for the same product or service, depending on how aggressive they are in negotiating or the circumstances of the deal. This inconsistency can create confusion, resentment, and a perception of unfairness among customers. - Erosion of Trust: Customers who discover they received a worse deal than others might feel cheated, leading to a loss of trust in the company. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 19 MODULE 2 2. Margin Erosion : - Discount Pressure: Reactive negotiations often result in discounts being granted to close deals quickly, which can erode profit margins. Over time, frequent concessions can significantly reduce the company's overall profitability. - Race to the Bottom: If a company consistently lowers prices to meet customer demands without a clear pricing strategy, it may find itself in a downward spiral of decreasing prices, which can be difficult to reverse. 3. Undermining of Value Proposition : - Perception of Lower Value: Constantly negotiating prices on an ad hoc basis can signal to customers that the initial price is not reflective of the true value of the product or service. This can diminish the perceived value of the offering, making it harder to maintain price levels in the future. - Weakening of Brand: A brand that is seen as easily negotiable might lose its premium status and become associated with lower value, which can impact its market positioning. 4. Encouragement of Opportunistic Behavior : - Customer Expectation of Discounts: When customers realize that they can negotiate prices, they may begin to expect discounts as the norm. This behavior can lead to more frequent and aggressive demands for lower prices in the future. - Increased Negotiation Frequency: Reactive pricing can encourage customers to negotiate every purchase, turning what should be a straightforward transaction into a time-consuming negotiation process. 5. Inefficiency in Sales Processes : nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 20 MODULE 2 - Time-Consuming Negotiations: Sales teams may spend excessive time negotiating prices on a case-by-case basis, which can be inefficient and detract from other important sales activities. This can also lead to delays in closing deals. - Lack of Focus on Value: Instead of focusing on the value the product or service provides, the conversation becomes centered around price, which can detract from the sales process's effectiveness. 6. Difficulty in Long-Term Planning : - Unpredictable Revenue: With prices constantly fluctuating due to reactive negotiations, it becomes difficult for the company to predict revenue accurately. This unpredictability can complicate budgeting, forecasting, and long-term financial planning. - Challenges in Strategy Implementation: Reactive pricing makes it hard to implement a coherent pricing strategy across the organization, leading to misalignment between sales teams and overall business goals. Example : - B2B Sales Scenario: In a B2B context, a company selling industrial equipment might face pressure from large clients to lower prices. If the sales team frequently offers ad hoc discounts to secure deals, other clients may expect similar treatment. Over time, the company's average selling price (ASP) could decline, eroding margins and making it difficult to sustain profitability. Solution: Implementing a Proactive Pricing Strategy : To avoid the pitfalls of reactive, ad hoc price negotiation, companies should develop a clear, consistent pricing strategy that: nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 21 MODULE 2 Establishes Firm Pricing Guidelines: Setting clear rules on when discounts can be offered and ensuring that all salespeople adhere to them. Focuses on Value: Training sales teams to emphasize the value and benefits of the product or service rather than immediately resorting to price concessions. Segmented Pricing: Implementing differentiated pricing based on customer segments, purchase volumes, or other relevant criteria to provide a structured approach to pricing. Long-Term Relationship Building: Encouraging long-term relationships with customers based on trust and value rather than short-term gains through price cuts. In summary, reactive, ad hoc price negotiation can lead to inconsistent pricing, margin erosion, and weakened customer relationships. A proactive, well-structured pricing strategy is essential to maintain profitability, brand value, and customer trust. POLICIES FOR RESPONDING TO PRICE OBJECTIONS nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 22 MODULE 2 Value-driven buyers purchase a disproportionate share of sales volume in most business- to-business markets. Brand-driven buyers are those for whom differentiation, particularly of the type that is difficult to determine before purchase, is valuable but the cost to evaluate all suppliers to determine the best possible deal is just too high. Price-driven buyers are the polar opposite of brand buyers. They genuinely are not looking for a feature or service that exceeds some level that they specify in advance. Convenience-driven buyers don’t compare prices; they just buy from the easiest source of supply. POLICIES FOR DEALING WITH POWER BUYERS A subset of value buyers is what we call power buyers, who control so much volume that they have the power to deliver or deny huge amounts of market share. They expect to get better prices than any other buyer because of that power. Dealing with power buyers reactively is risky; a seller is almost certain to suffer a decline in profitability as a result. Make power buyers compete. ❖ Many companies with strong brand preferences miss a big opportunity by framing the strategic issue poorly. ❖ To win the business of a power buyer, without making a price concession, is to offer one of them a way to drive store traffic. This generally involves giving the power buyer something that they can sell exclusively. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 23 MODULE 2 Quantify the value to the power buyer. ❖ There are many ways that a brand can bring differential value to a big-box retailer. Even if the retailer already has someone as a customer, the brand can drive store visit frequency. Eliminate unnecessary costs. ❖ The most difficult challenge to manage is trying to serve both high-volume power buyers who are unwilling to pay for your pull marketing efforts and non-power buyers who value your brand because you support its marketing. ❖ One option is to specialize in serving only power buyers, enabling the company to eliminate the costs of marketing and distribution. Segment the product offering. ❖ There is no need to offer the same product through a power buyer and through traditional channels where there is a conflict. Resist “divide and conquer” tactics. ❖ Power buyers get their power from their ability to deny a brand or product line any volume through their stores or buying group. ❖ The key to their success is to structure the discussion as being about the pricing of each of the manufacturer’s products individually. nrfawitan 2024  PAMANTASAN NG CABUYAO |PRICING STRATEGY 24 MODULE 2 POLICIES FOR SUCCESSFULLY MANAGING PRICE INCREASES One of the most difficult discussions to have with a customer involves telling them that you will increase their prices. Two very different occasions call for increases, and well-designed policies can help to make all of them more successful: Policies for Leading an Industry-Wide Increase Policies for Transitioning from Flexible to Policy-Based The most important increase to achieve quickly is the Pricing one that results from a large, sustained increase in In markets where volume comes mostly from repeat variable cost of production or a shortage of industry purchasers, it is difficult to transition from poor capacity. policies to good ones all at once. These should be the easiest price increases since all To minimize the risk of transition and create time to suppliers are facing the same problem. There is no test new policies for managing discounts real alternative for the customers, regardless of how consistently, one needs to begin with policies for difficult the increase may prove for them. managing the transition. 1. Before announcing an increase, let it be known publicly why the increase is necessary for the industry as a whole based upon costs that the industry is incurring or demands on capacity. 2. Announce the size and effective date of the increase, stating exactly which product lines are increasing by how much 3. Empower your most important customers a transition guarantee POLICIES FOR PRICING IN AN ECONOMIC DOWNTURN Pricing policies are most likely to be abandoned when the market enters a recession and sales turn down. Revenue then seems much more important than preserving profitability in the future. But unmanaged price-cutting in a recession not only undermines price levels that you will want to sustain in the later recovery, but it can also trigger a price war that makes all competitors worse off while still in the downturn. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 25 MODULE 2 In business markets, the value that some products can justify is tied to the health of their customer’s markets. POLICIES FOR PROMOTIONAL PRICING A discount to induce product trial is a legitimate means to gain sales, but if poorly managed it can have the effect of depressing margins, as regular customers learn how to qualify for them as well. For search goods, a promotional discount is the incentive for the customer to investigate the supplier’s offer. For experience goods, it is the incentive to take the risk of what could turn out to be a disappointing purchase. The size of the promotional discount necessary to induce a trial can be mitigated by the policy. A liberal returns policy if the customer is unsatisfied is one way to take away the risk of trying a product at full price. For consumer products, promotional pricing is one of the most important issues for which a company needs pricing policies and a process for reviewing their effectiveness. A policy of limiting the availability of promotional discounts and targeting them to prospective buyers is often advisable. One way to do this is with coupons. Pricing cannot be magically made by good policies. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 26 MODULE 2 Profitable, but unsatisfactory ones can hurt your chances of charging rates that are commensurate with the quality of what you provide. When you have good policies in place, people view buying your product as a trade- off between price and value rather than as a contest to win at your expense. They are therefore a crucial component of any pricing plan intended to maximize value and preserve long-term client relationships. Good Policies vs. Magic Solutions: - Pricing strategies are not about finding a magical formula or shortcut. Effective pricing requires thoughtful planning and understanding of market dynamics, customer needs, and business objectives. Impact of Poor Policies: - Even if a business is profitable, poor pricing policies can undermine your ability to charge prices that reflect the true value of your product or service. For example, inconsistent or unclear pricing can lead to customer dissatisfaction and damage to the brand's reputation. Customer Perspective: - When pricing policies are well-designed, customers perceive their purchase as a balanced trade-off between the price they pay and the value they receive. They are less likely to feel that they are simply trying to get the best deal at the business's expense. Long-term Value and Relationships : - Good pricing policies are integral to maintaining and building long- term client relationships. They help establish trust and ensure that customers feel they are receiving fair value. This, in turn, supports sustainable pricing that reflects the quality of the product or service while fostering ongoing customer loyalty. In summary, effective pricing policies are essential not just for maximizing immediate profits but for ensuring that your pricing reflects the value of your offering and maintains strong, long-term customer relationships. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 27 MODULE 2 Price Level Pricing is the moment of truth—all of marketing comes to focus in the pricing decision. E. Raymond Corey, Harvard Business School Process to Select Value-Based Prices for Maximizing Profitability Selecting value-based prices involves a strategic process where the firm determines the optimal price point for its products and services, aiming to maximize profitability. This process is essential because the chosen price must reflect the perceived value of the offering to the customer while ensuring that the firm meets its financial objectives. Economic Theory and Optimal Price Levels Economic theory provides a framework for setting an "optimal" price level based on the demand curve, which illustrates the relationship between price and the quantity demanded. The theory suggests that by understanding this curve, a firm can identify the price point where its revenue is maximized. This optimal price is determined under the assumption that "all other things are equal," meaning that other variables like market conditions, costs, and competition remain constant. Complexity of Pricing in Real-World Business nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 28 MODULE 2 In practice, however, pricing is far more complex. Companies face a multitude of factors that influence their pricing decisions, making it a challenging task. Different departments within the organization often have conflicting objectives that complicate the process. Financial Managers: Focus on ensuring that prices are high enough to cover past investments, meet margin objectives, and contribute to the overall financial health of the company. They often use cost allocation methods to determine the minimum price required to achieve these goals. Marketing and Sales Teams: Aim to set prices low enough to attract customers, remain competitive, and achieve sales targets. They conduct analyses of customer behavior, competitive offerings, and market trends to find a price point that will maximize market penetration and sales volume. Blending Financial Constraints with Market Conditions An effective pricing strategy does not simply compromise between these conflicting objectives but rather blends them to create a balanced approach. This involves considering both the internal financial constraints (such as cost structures and profitability targets) and external market conditions (such as customer demand, competition, and market dynamics). The goal is to set a price that is sustainable for the company while being attractive to customers. This requires a deep understanding of the value that customers place on the product or service, as well as the factors that drive their price sensitivity. Designing an Efficient and Adaptable Pricing Process nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 29 MODULE 2 The pricing process should be designed to be both efficient and adaptable, capable of being applied across different products, services, and market contexts. It involves: 1. Value Estimation and Segmentation: Understanding the perceived value of the product or service to different customer segments. 2. Drivers of Price Sensitivity: Analyzing factors that influence how sensitive customers are to price changes, such as the availability of substitutes or the overall economic environment. 3. Cost Considerations: Incorporating data on production costs, past investments, and financial objectives. 4. Strategic Objectives: Aligning pricing with the company’s broader strategic goals, such as market positioning and long-term growth. 5. Market Response Analysis: Monitoring how the market reacts to different price points and adjusting the strategy accordingly. This comprehensive approach ensures that the pricing strategy is not only aligned with the company’s financial goals but also resonates with customers, leading to sustained profitability and market success. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 30 MODULE 2 THE PRICE-SETTING PROCESS Step 1: Define the Viable Price Range The range starts with defining the highest and lowest price points that a business might sustainably charge for the product or service. The feasible price floor for a product that is positively differentiated is the price of the next-best competitive alternative. Theoretically, the price floor is the variable cost of the product—after all, any price above the variable cost will allow the seller to earn a positive contribution margin on a sale. For a product that is negatively differentiated, the price ceiling will also be defined by the economic value, which in this case is below the price of the next-best competing alternative. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 31 MODULE 2 Taken together, the price ceiling and the price floor represent the “reasonable price range” Ultimately, setting the price will define how any differentiating value gets shared between the seller and the buyer. If buyers were able to keep all the added value, paying no more than the competitive price for a superior product or service, they could be easily won over—but probably not profitably. If sellers were to set prices that fully reflect the value of their positive differentiation, there would be no financial incentive for the customer to purchase that brand over a more generic alternative. The difference between the actual price and the maximum value can be viewed as “the incentive to purchase.” Done correctly, a price premium over a competitor can often be framed as a “discount relative to the value delivered,” a framing that can fundamentally shift the dynamics of value communication and price negotiation. The challenge is to figure out what balance between creating a financial incentive and earning a higher margin per sale is in the best interest of the seller. Step 2: Make Strategic Choices Price levels must be set in a way that supports and advances the broader marketing objectives of the firm. To be useful, pricing objectives must be set relative to some reference point. Given the strategic importance of customer value to the overall pricing strategy, nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 32 MODULE 2 we define pricing objectives in terms of the share of differentiating value that the firm attempts to capture in its price. Driven by judgments about what will yield long-term, sustainable profitability If the product’s differentiation is likely to be sustained by patents or copyrights, a low price established to drive sales means foregoing considerable margin over the long run. Pricing low initially in the hope that one can raise prices later is difficult given the effect of the initial prices on buyers’ future perceptions of price fairness. There are three alternative strategic choices that one might adopt for a pricing strategy: Skimming the market, penetrating the market, or neutral market pricing. Option 2- PENETRATE THE Option 3- NEUTRAL PRICING Option 1- SKIM THE MARKET MARKET involves a strategic designed to capture involves setting a price decision not to use price superior margins, even at low enough to attract and to gain market share, the expense of large hold a large base of while not allowing price sales volume. customers alone to restrict it. Skim prices are high in Penetration prices are not Neutral pricing necessarily cheap, but minimizes the role of relation to what most they are low relative to the price as a marketing tool buyers in a segment can perceived value in the in favor of other tactics be convinced to pay. target segment. that management this strategy optimizes Penetration pricing will believes are more immediate profitability work only if a large share powerful or cost- only when the profit from of the market is willing to effective for a product’s change brands or market. selling to relatively price- suppliers in response to a Although neutral pricing insensitive customers is less proactive than lower price. exceed that from selling skimming or penetration to a larger market at a pricing, its proper lower price. execution is no less important to profitability. Neutral prices are not necessarily equal to those of competitors or near the middle of the range. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 33 MODULE 2 Step 3: Asses Breakeven Sales Changes The next consideration when determining where to set price levels is the relationship between changes in price, volume, and profitability. Economic theorists propose pricing based on estimating the “demand curve” for a product and then “optimizing” the price level given the incremental cost of production. When a company lacks competition so that the demand curve for its brand is the market demand, the effect of price on a firm’s sales is more predictable than when it must also account for the effect of price on customer choice between competing brands. Step 4: Gauge Price Elasticity After establishing the breakeven sales change necessary for a potential price change to be profitable, it is necessary to make a judgment about whether that sales change is likely to be achievable. Sometimes an estimate of past price elasticity can be gleaned from historical transaction data, especially in the case of high transaction volume goods. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 34 MODULE 2 Techniques for estimating price elasticity range from the most sophisticated and costly to the least effective but easy to implement; broadly speaking they are: Controlled-price experiments, purchase-intention surveys, structured inferences, and incremental implementation. The goal is to gradually arrive at a profit-maximizing price point by calculating breakeven sales changes and testing the market to see whether sales changes are on the profitable side of that breakeven point. Step 5: Account for Psychological Factors Although by the time you set a price, you should already have segmented your market to reflect the differences in value for different applications or occasions, there will remain differences in the prices customers will pay even within segments. They affect what we call “price sensitivity:” a term for the effort and attention that customers will devote to purchasing with the largest gap between the value they receive and the price they pay. If a large share of a segment is made up of people who are driven to high-price sensitivity by one or more of these factors, then pricing further below value to win business, or nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 35 MODULE 2 lowering price closer to value to retain business, will be important to motivate the desired customer purchase behaviors. Factors That Influence Price Sensitivity Researchers have identified a list of factors that influence a buyer’s price sensitivity, including the following: Reference value: Value is always relative in the minds of customers. By re-framing a customer to view a more expensive alternative as the reference, buyer price sensitivity can be reduced. Switching costs: Buyers are less sensitive to the price of a product the greater the added cost (both monetary and non-monetary) of switching from their current supplier (if any). Difficult comparison: Buyers are less price sensitive when it is difficult to compare suppliers and the cost of not getting the expected benefits of purchase is high. Importance of end-benefit: Buyers are less price sensitive when the product is a small part of the cost of a benefit with high economic or psychological importance. Price-quality perceptions: Buyers are less sensitive to a product’s price to the extent that price is a proxy for the likely quality of the purchase. Size of expenditure: Buyers are more (or less) price-sensitive when expenditures are relatively large (or small) as a portion of the overall budget. Shared costs: Buyers are less price sensitive when some or all of the purchase price is paid by others. Transaction value: Buyers are motivated by more than just the “acquisition utility” associated with obtaining and using a product. They are also motivated by the “transaction utility” associated with the difference between the price paid and what the buyer considers a reasonable or fair offer for the product. Perceived fairness: Buyers are more sensitive to a product’s price when it is outside the range that they perceive as “fair or reasonable.” nrfawitan 2024  PAMANTASAN NG CABUYAO |PRICING STRATEGY 36 MODULE 2 COMMUNICATING NEW PRICES TO THE MARKET The final task in setting a new price level is to communicate the rationale for the change, especially when there is potentially an issue of “fairness.” Perceived fairness is one of the most powerful factors driving price sensitivity. Done correctly, communicating fairness can have dramatic effects. 1. First send a letter, email, or press release to all customers simultaneously that explains why across-the-board price increases are necessary. 2. Avoid being opportunistic by attempting to gain a share by compromising on the increase. 3. Consider non-price mechanisms to “raise” prices and lessen the customer impact. 4. Mitigating the effect of price increases is to use a lower-priced brand (in groceries it is often a “house brand”), to provide a ready alternative for price-sensitive consumers who are at risk of either switching suppliers or reducing the quantity purchased. 5. Switch product formulation Setting market-relevant prices is indeed a nuanced process that blends both art and science. While marketers have access to a variety of sophisticated tools and analytics, the final decision on pricing often requires a careful balance of multiple factors. Here's a breakdown of the key elements involved: 1. Balancing Costs and Customer Value - Costs: Understanding the full costs involved in producing and delivering a product or service is foundational. This includes direct costs (like materials and labor) and indirect costs (like overhead and marketing expenses). - Customer Value: The perceived value of the product or service to the customer is crucial. This involves assessing how much customers are willing to pay based on the benefits they perceive, compared to alternative options in the market. 2. Aligning with Strategic Goals - Market Positioning: The price should reflect where the product or service is positioned in the market. For example, premium products typically command higher prices, while budget offerings are priced lower to attract price-sensitive customers. nrfawitan 2024  PAMANTASAN NG CABUYAO |PRICING STRATEGY 37 MODULE 2 - Revenue and Profit Targets: Businesses often have specific financial goals that influence pricing. These could include targets for revenue growth, profit margins, or market share. 3. Anticipating Competitive Responses - Competitor Pricing: Keeping an eye on competitors’ pricing strategies is important. A price that’s too high or too low relative to competitors can impact market share. - Market Dynamics: In highly competitive markets, pricing can trigger responses from competitors, leading to price wars or shifts in market positioning. Strategic foresight is required to anticipate and mitigate these risks. 4. The Role of Informed Judgment - Analytical Tools: Marketers use tools like demand forecasting, elasticity models, and customer segmentation analysis to inform pricing decisions. These tools provide data-driven insights but often need to be interpreted within the broader context. - Experience and Intuition: Despite the availability of data, pricing decisions often require seasoned judgment. Experienced marketers use their intuition to weigh the various factors and make decisions that align with both short- term and long-term business goals. 5. Creating Structured Dialogue - Collaborative Approach: The process described involves engaging multiple stakeholders in a structured dialogue. This collaborative approach helps ensure that all relevant perspectives are considered and that decisions are made based on a comprehensive understanding of the situation. - Reducing Emotional Bias: By grounding discussions in data and strategic considerations, the process helps reduce the emotional biases that can sometimes cloud decision-making. This leads to more rational and effective pricing decisions. In summary, setting market-relevant prices is a complex task that requires balancing quantitative data with qualitative judgment. The structured process described is designed to facilitate informed, rational conversations that lead to pricing decisions aligned with business objectives and market realities. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 38 MODULE 2 Price Competition Victorious warriors win first and then go to war, while defeated warriors go to war first and then seek to win. Sun Tzu The final element of the Value Cascade is Price Competition, which plays a crucial role in determining a firm's success in the marketplace. Price competition involves the dynamic interplay between a company’s pricing decisions and the responses from its competitors. 1. Understanding the Gap in Value Realization A gap often arises between the actual value realized by a firm and the potential value it could achieve. This gap is particularly pronounced when a firm fails to anticipate how competitors might respond to its pricing strategies. If a company sets prices without considering potential reactions from rivals, it risks undermining its own profitability and market position. This can lead to missed opportunities where the firm could have captured more value, either through higher prices or greater market share. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 39 MODULE 2 2. The Complexity of Managing Price Competition Managing price competition becomes increasingly complex as a firm’s market share grows. When a company holds a significant portion of the market, its pricing decisions are more likely to trigger reactions from competitors. These competitors may adjust their prices, change their product offerings, or alter their marketing strategies in response. As a result, the larger the firm’s market share, the more challenging it becomes to predict and manage these competitive dynamics. A misstep in pricing can create an unnecessary gap in profitability, as the firm may lose its competitive edge or spark a price war that erodes margins. 3. Leveraging Competitive Advantage Interestingly, larger firms with a significant market share often have an advantage in managing price competition. This advantage stems from the relative inability of lower-cost competitors to match the value offered by larger firms. Larger firms can leverage their economies of scale, brand strength, and broader market presence to offer value that lower-cost competitors cannot easily replicate. This creates a competitive advantage that allows larger firms to set prices that smaller rivals cannot easily undercut, thereby maintaining profitability and market leadership. 4. Strategic Implications For firms, the key takeaway is the importance of anticipating and strategically managing competitor responses to pricing decisions. A proactive approach, where potential competitor nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 40 MODULE 2 reactions are considered as part of the pricing strategy, can help minimize the gap between actual and potential value realization. By doing so, firms can maintain a competitive advantage, especially when they hold a significant share of the market. Price competition is a critical element in the Value Cascade that requires careful consideration and strategic foresight. Firms that effectively manage price competition can not only protect their profitability but also strengthen their market position by leveraging their competitive advantages against lower-cost rivals. UNDERSTANDING THE PRICING GAME Price competition is a “game,” as defined by game theorists because the outcome resulting from any move depends on how your competitors react to it. Making the right choices in a game is very different from making the right choices to solve a puzzle—such as how to make a product more efficiently. “Positive-sum”- when resources are somehow expanded and a strategy is developed that satisfies the wants and needs of everyone involved. (One example would be when two parties both gain financially by participating in a contest, no matter who wins or loses.) “Negative-sum”- discusses circumstances where the sum of benefits and losses is less than zero and one party must steal from another to maintain the status quo. Price competition is usually a negative-sum game since the more intense price competition is, the more it can undermine the value of the market over which one is competing. Building capabilities for positive-sum forms of competition is the basis of a sustainable competitive strategy. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 41 MODULE 2 Price competition may also be part of an overall profitable growth strategy. COMPETING TO GROW PROFITABLY Market-Share Myth-market share is the key to profitability Companies grow both top-line revenue and bottom-line profit simultaneously when they can create new sources of customer value without adding as much to cost, or when they can reduce costs without equally reducing the value, enabling them to reduce prices to win sales without reducing margins below those of competitors. Product-led growth (PLG) is a business methodology in which user acquisition, expansion, conversion, and retention are all driven primarily by the product itself. It creates company-wide alignment across teams—from engineering to sales and marketing—around the product as the largest source of sustainable, scalable business growth. Customer-led companies are characterized by an increasingly strong employee focus on customers, a shared understanding of key customers, an effort to satisfy customer segments, the ability to bring customer propositions to market, and a high level of employee engagement. When competitors cannot immediately or cost-effectively duplicate new ways of creating value, a company that creates those new ways achieves a “competitive advantage.” Offering customers a more attractive offer by accepting a lower margin than the competition may be a sales advantage, but it is not a sustainable competitive advantage, since competitors can easily match it and because it reduces the return from investing in other, non-price means to win sales. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 42 MODULE 2 Often, the advantage comes from moving first on a new idea. By winning a patent, gaining economies of scale, or preempting the best locations, a firm may achieve an advantage that would be more costly for a later entrant to match. Three ways that companies can proactively manage operations to achieve competitive advantage according to Michael Porter: 1. Needs-Based Positioning —based on serving the needs of only a particular customer segment or niche, which enables the firm to tailor its operations to meet the unique needs of that segment more cost-effectively. 2. Access-Based Positioning —based on the company’s ability to gain access to customers in unique ways. Access can be a function of geography or customer scale. For example, serving a uniquely wide or narrow geographic market, based on the firm’s cost structure, can create a unique cost and service advantage. 3. Focus-Based Positioning —based on developing a unique capability to do one or more narrowly focused activities that add value to value chains across industries. Because the focused activity does not add value alone, a focused supplier must closely monitor and coordinate its operations with other suppliers that manage the value chain. The measure of a firm’s competitive advantage is its relative gross margin per sale, not its market share. We focus on gross margin, not operating margin because the gross margin is a measure of the value of an incremental sale. A large firm with a relatively low gross margin can be expected to shrink, even when competing with a much smaller firm that is nonetheless more efficient in creating value. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 43 MODULE 2 REACTING TO COMPETITION: THINK BEFORE YOU ACT The risks of price wars and the importance of competing from a position of strength that they think coolly and logically before initiating price competition To determine whether a price response is better than no response, one must answer the following questions. 1. Is there a response that would cost less than the preventable sales loss? a) Focus your reactive price cut on only those customers likely to be attracted by the competitor’s offer. b) Focus your reactive price cut on only the incremental volume at risk. c) Focus your reactive price cut on a particular geographic area or product line where the competitor has the most to lose, relative to you, from cutting the price. d) Raise the cost to the competitor of its discounting. e) Leverage any competitive advantages to increase the value of your offer as an alternative to matching the price. 2. If you respond, is your competitor willing and able to cut the price again to reestablish the price difference? Matching a price cut will do you no good if the competitor will simply re-establish the advantage. Ask yourself why the competitor chose to compete on price in the first place. If that competitor currently has little market share relative to the share that could be gained with a price advantage and has no other way to attract customers, then it has little to lose from nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 44 MODULE 2 bringing the price down as low as necessary to gain sales. This is especially the case where large sunk costs create substantial “exit barriers.” 3. Will the multiple responses required to match a competitor cost less than the avoidable sales loss? Think about the total cost of a price war, not just the cost of the first shot, before concluding that the cost to defend the sales at risk is worth bearing. Partisans of pricing for market share would no doubt disagree with our reluctance to use price defensively, especially when one is already in a stronger market position. Unless driving a low-cost competitor into bankruptcy somehow destroys the assets of that competitor, a newly capitalized entrant can purchase the assets of the bankrupt competitor, operate at a lower cost base, and initiate price-based competition against the large firm now financially weakened by the cost of the first price war. The key to surviving a negative-sum pricing game is to avoid confrontation unless you can structure it in a way that you can win, and calculate that the likely benefit from winning exceeds the likely cost. It simply makes no sense to match competitors’ price discounts unless one can do so at a cost that is less than what one would lose from ceding some market share. 4. Is your position in other (geographic or product) markets at risk if a competitor is successful in gaining a share? Does the value of the markets at risk justify the cost of a response? nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 45 MODULE 2 Some sales have a value that far exceeds the contribution directly associated with them. Retaliatory price cuts are all too often justified by vague “strategic” reasons unrelated to profitability. Before approving any retaliatory price cut for strategic reasons, two things should be required. (Clear statement of the long-term strategic benefits and risks.) a) The benefit can be additional sales in this market in the future. It can be additional immediate sales of complementary products, such as sales of software and peripherals if one wins the sale of a computer. It can be a lower cost of future sales because of a competitive cost advantage resulting from the added volume. b) The risks are that a targeted price cut will spread to other customers and other markets and that competitors will react, again creating a downward price spiral that undermines profits and any possibility of long-term gain. 5. Does the value of the markets at risk justify the cost of response? The second requirement to justify a strategic price cut is a quantitative estimate of the value of the strategic benefit. This needs to be quantified often encounters resistance because managers feel that the task will delay response to an imminent threat. While the relationship (institutional segment and segment drove retail sales) was no doubt true, the magnitude of the effect was important given that pricing to the institutional segment had fallen to less than the manufacturing cost. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 46 MODULE 2 MANAGING COMPETITIVE INFORMATION All wars, whether shooting wars or price wars, occur because someone made a terrible mistake. Since wars are negative-sum games, it is always the case that the loser would have been better off not capitulating, or at least retreating to fight another day on better terms. The decision to cut the price to gain a customer may have radically different long-term effects, depending on how the competitor interprets the move. Without any other information, the competitor would probably interpret the move as an opportunistic grab for market share and respond with defensive cuts of its own. If, however, the discount is structured to mimic exactly an offer that the same competitor made recently to one of your loyal customers, the competitor may interpret the cut as reflecting your resolve to defend that segment of the market. As such, the cut may reduce future opportunism and help stabilize industry prices. Consider how the competitor might interpret one more alternative: your price cut is unprovoked but is exceptionally large, more than you have ever offered before, and probably more than is necessary to take the business. An intelligent competitor might well interpret the price cut as a fair warning that resistance against your grab for market share will be futile. COLLECT AND EVALUATE COMPETITIVE INFORMATION nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 47 MODULE 2 Many businesses don't fully understand the rates and pricing strategies used by their rivals. They are unable to react swiftly to changes as a result. The opportunists’ management believes that, by quietly negotiating or concealing its price cuts, it can gain sufficient sales volume to justify the move before the competitors find out. To minimize such opportunistic behavior, competitors must identify and react to it as quickly as possible. Knowledge of competitors’ prices also helps minimize a purchasing agent’s ability to promulgate misinformation. There are many potential sources of data about competitors’ prices, but collecting those data and converting the data into useful information usually requires a formalized process. Many companies require that the sales force regularly include information on competitors’ pricing in their call reports. In highly competitive markets, the information collected should not be limited to prices. Understanding plans and intentions is equally important. SELECTIVELY COMMUNICATE INFORMATION Information is power Why should anyone want to reveal a competitive advantage? The answer: So that you can avoid having to use your advantage in a negative-sum confrontation. It is often better to earn just an average return in a profitable industry than to earn an exceptional return in an unprofitable one. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 48 MODULE 2 Even company-specific information—about intentions, capabilities, and future—can be useful to reveal unless doing so would preclude achieving a first-mover advantage in a new market. Pre-announce price increases. One of the most important times to communicate intentions is when planning a price increase. Even when a price increase is in the interest of all suppliers, an attempt to raise prices will often fail. All may not immediately recognize that an increase is in their interest, and some may hope to gain sales at the expense of the price leaders by lagging in meeting the increase. Show willingness and ability to defend. Some pricing policies that may seem to weaken a seller’s position with customers may reduce competitive pressure by discouraging competitors’ low-price offers. Back up opportunism with information. While an opportunistic price cut to buy the market share is usually short-sighted, it is sometimes an element of a thoughtful strategy. This is most often the case when a company uses pricing to leverage or enhance a durable cost advantage. The key to profitably using price as a weapon is to convince competitors to capitulate. WHEN SHOULD YOU COMPETE ON PRICE? A competitive cost advantage was not by itself enough to win market share profitably companies must also orchestrate a campaign of information to convince their competitors that their cost advantages are decisive Under what conditions are the rewards from aggressive pricing large enough to justify a low-price growth strategy? nrfawitan 2024  PAMANTASAN NG CABUYAO |PRICING STRATEGY 49 MODULE 2 1. If a company enjoys a substantial incremental cost advantage or can achieve one with a low-price strategy, its competitors may be unable to match its price cuts 2. If a company’s product offering is attractive to only a small share of the market served by competitors, it may rightly assume that competitors will be unwilling to respond to the threat. 3. If a company can effectively subsidize losses in one market because of the profits it can generate selling complementary products, it may be able to establish a price differential that competitors will be unable to close. 4. Sometimes price competition expands a market sufficiently that, despite lower margins and competitors’ refusals to allow another company to undercut them, industry profitability can still increase. Before embarking on a price-based strategy, ask which of these four points describes your rationale and recognize that a growth strategy can rarely be built on price alone or sustained indefinitely. Price is one of the most powerful tools in a marketer’s arsenal, capable of driving sales more quickly and effectively than any other tactic. However, while using price to gain sales can produce immediate results, it only contributes to long-term profitability when it is carefully managed as part of a broader marketing strategy. This strategy must focus on achieving, exploiting, or sustaining a lasting competitive advantage. 1. Price as a Catalyst for Sales Growth Price has a unique ability to influence consumer behavior and can be a decisive factor in the purchasing decision. When a product or service is priced attractively, it can rapidly increase sales volume by appealing to a broader segment of the nrfawitan 2024  PAMANTASAN NG CABUYAO |PRICING STRATEGY 50 MODULE 2 market or by enticing price-sensitive customers who might otherwise choose a competitor. The immediate impact of price adjustments on sales makes it an essential tool for marketers aiming to boost revenue in the short term. 2. Integrating Price into a Strategic Marketing Plan While price can effectively drive sales, relying solely on price reductions or promotions without a clear strategic framework can be detrimental to long-term profitability. For price to contribute positively to a firm’s financial health, it must be integrated into a comprehensive marketing strategy. This strategy should not only aim to increase sales but also align with the company’s overall goals of achieving and maintaining a competitive advantage in the market. 3. The Role of Competitive Advantage in Profitable Pricing The key to profitable pricing lies in its connection to competitive advantage. A firm that has built and sustained a competitive advantage—whether through product differentiation, brand strength, superior customer service, or operational efficiencies—can use price strategically to reinforce its market position. In this context, price is not just a tool for immediate sales but a means to leverage the firm’s unique strengths, ensuring that pricing decisions contribute to long-term success. 4. Sustaining Profitability through Strategic Pricing Sustainable profitability requires that pricing be used not just reactively, but proactively, as part of an ongoing effort to maintain and enhance the firm’s competitive position. This involves regularly assessing market conditions, understanding customer value perceptions, and anticipating competitor responses. By continuously aligning pricing strategies with the broader goal of sustaining competitive advantage, a firm can ensure that its pricing decisions contribute to both immediate sales growth and long-term financial health. In summary, while price is a powerful tool for boosting sales, its true potential is realized when it is used strategically, as part of a marketing plan focused on building and sustaining competitive advantage. The key to profitable pricing is not just in setting the right price at the right time, but in ensuring that these pricing decisions support the firm’s long-term objectives, ultimately leading to sustainable profitability. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 51 MODULE 2 MEASUREMENT OF PRICE SENSITIVITY Look into nature, and then you will understand it better. -Albert Einstein Quantitative estimates of customer price sensitivity and willingness to pay can substantially improve both price setting and price segmentation. The key to using the estimate effectively is to recognize that even a precise estimate is not necessarily accurate or unbiased. Price sensitivity is the degree to which changes in the price of a product or service influence consumers' buying behavior. It reflects how responsive customers are to price fluctuations— whether they are willing to buy more, less, or not at all when prices increase or decrease. High price sensitivity means that consumers are more likely to alter their purchasing decisions based on price changes, while low price sensitivity indicates that price changes have minimal impact on their buying behavior. Understanding price sensitivity helps businesses set optimal prices and develop effective pricing strategies. To measure price sensitivity, businesses often use price elasticity of demand, which quantifies the responsiveness of quantity demanded to price changes. This is calculated by dividing the percentage change in quantity demanded by the percentage change in price. For instance, if a 10% increase in price results in a 20% decrease in quantity demanded, the price nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 52 MODULE 2 elasticity would be -2, indicating high price sensitivity. Elasticity values greater than 1 (in absolute terms) signify high sensitivity, while values less than 1 indicate lower sensitivity. Additionally, businesses can gauge price sensitivity through various methods such as surveys, experiments, and historical sales data analysis. Surveys ask consumers directly about their willingness to pay different prices or their likelihood of changing purchasing behavior in response to price changes. Experiments, like A/B testing, involve adjusting prices and observing the resulting changes in sales. Analyzing historical sales data helps businesses understand how past price changes have affected demand. Combining these approaches provides a comprehensive view of price sensitivity, enabling companies to make informed pricing decisions. TYPES OF MEASUREMENT PROCEDURES nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 53 MODULE 2 UNCONTROLLED STUDIES OF ACTUAL PURCHASES One way to estimate price sensitivity is to analyze past sales data. Naturally, one would expect this to work well in assessing the price sensitivity of customers for existing products in which consumers have prior-use experience. Changes in (i) the number of brands on the market, (ii) how recently have competitors offered price promotions, (iii) the amount and effectiveness of advertising by each brand, (iv) increased price sensitivity of more educated consumers, and (v) general economic conditions can undermine the ability of historical data analysis to diagnose the true effects of a price change. There are three types of past sales data from which a marketing researcher might attempt to estimate price sensitivity: i) Historical sales data—sales reports from a company’s records or a sales-monitoring service; ii) panel data—individual purchase reports from members of a consumer panel; and iii) store scanner data—sales data for an individual retail outlet. Historical Sales Data Sales data collected as part of a company’s regular operation are cheap and available for all products that have prior sales histories. Given the ability to track data on a daily or even real-time basis, marketers can analyze trends and project future movement of product sales. One needs to be careful in recognizing that sales data only allow for the estimation of price elasticity of the next level in the channel. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 54 MODULE 2 Panel Data Several marketing research companies collect individual purchase data from panels of a few thousand households. Each household keeps a daily record of all brands purchased and prices paid or uses a special credit card that tracks purchases. Since products are purchased daily, the data for each household must be aggregated to produce a series of weekly or bi-weekly purchases. Advantages: Disadvantages: 1. One can accumulate observations more 1. One potential drawback is that panel quickly with weekly panel data than with data may not be adequately representative bimonthly or quarterly sales data, reducing of the market as a whole. Of all households the problem that other factors may change invited to join a panel, fewer than 5 and reducing the comparability of the data. percent accept the offer and accurately 2. One can observe the actual price paid, record their purchases. rather than an average of the retail prices 2. typically only one member of the that different stores charge and one can household agrees to participate in the identify sales that were made with coupons panel, yet in most households, multiple or promotions that alter the price actually people perform shopping duties. As a paid. This captures more price variation in result, it is easy to miss purchase data the data, making the effects of price from the non-participating member(s) of changes easier to detect. the household, who often have very 3. One can get data on the sales and prices different criteria for making purchase of competing products (provided someone decisions. in the panel bought them), as well as on the sales of one’s own product. 4. One can correlate price sensitivity with various demographic classifications of consumers and possibly identify opportunities for segmentation. Store-Level Transaction Data An alternate source of actual sales comes from auditing price transactions and sales at individual retail stores. Modern point-of-sale technologies have made accurate daily sales and price data available at a reasonable cost. Online and brick-and-mortar retailers generate such data as part of their normal operations. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 55 MODULE 2 The high frequency of transaction-level data makes it vastly superior to aggregate sales data, providing marketers with almost immediate information on the movement of their product. Transaction data generally also costs less than panel data. When store scanner data can be combined with panel data that track consumers' demographic and broader behavioral characteristics, researchers often get huge insights into shoppers’ price sensitivity and purchasing behaviors. Transaction data are a major source of information on the price sensitivity of consumer-packaged goods. While transactional sales data—in the form of panels, purchase histories, and scanner data—are quite prevalent in the consumer-packaged goods industry, in many business-to- business markets there are simply too few transactions and insufficient market oversight to develop similar data sets. There is some level of bias in the data that one needs to be aware of—the competitive quotes are being obtained from customers who have the incentive to provide lower-than- actual prices. When the quote history is overlaid with actual sales success data, it is possible to estimate the likelihood of achieving a sale at any given price level. It is also possible to estimate the decline in the probability of a sale as price increases—a form of estimating price sensitivity and a way to estimate the amount of money left on the table in successful bids. As firms update their pricing capabilities, many are discovering new opportunities to study responses to pricing actions. EXPERIMENTALLY CONTROLLED STUDIES OF ACTUAL PURCHASE nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 56 MODULE 2 A researcher might attempt to estimate price sensitivity by generating experimental purchase data. Such data may come from pricing experiments conducted in a store without the buyers’ knowledge or from pricing experiments conducted in a laboratory. Since the researcher controls the experiment, price variations can be created as desired to generate results while holding constant other marketing variables, such as advertising levels, in-store displays, or competitive prices which often change with price variations in uncontrolled sales data. With this method, the researcher can examine the effect of several different prices quickly and either (i) exclude many unwanted external effects in the laboratory experiment or (ii) establish a control for the in-store experiment that will take account of them. Moreover, all this can be done while still providing buyers with purchase decisions that are comparable to those they make under normal conditions. As a result, to the degree that the experimental setting reflects the actual purchase environment, experimental research provides fairly reliable estimates of price sensitivity. In-Store Purchase Experiments An in-store purchase experiment relies on actual purchase data collected when buyers are unaware that they are participating in an experiment. Although the term “in-store” reflects the fact that most such experiments are conducted in stores, the principles of in- store experimentation are equally applicable to any natural purchase environment. Such experiments are often easier to conduct for products sold through more controlled direct-retail methods, such as online sites, where a user’s web browser cookie history can be used to determine the offer to deliver and to track response. Drawbacks: nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 57 MODULE 2 o There is the potential loss of consumer goodwill when some buyers are charged higher prices than others. o Charging prices below normal can become too costly when the product is a large expenditure and durable such as a car or a piece of industrial equipment. o An in-store test also involves the very real risk of being discovered by a competitor. o Moreover, when competitors find out about a test market, they may take steps, such as special promotions or advertising in selected areas, to contaminate the results. Laboratory Purchase Experiments Laboratory purchase experiments attempt to duplicate the realism of in-store experimentation without the high cost or the possible exposure to competitors. A typical laboratory experiment takes place in a research facility at a shopping mall. Interviewers intercept potential participants who are walking by and screen them to select only those who are users of the product category being researched. UNCONTROLLED STUDIES OF PREFERENCES AND INTENTIONS nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 58 MODULE 2 The most common research technique for directly estimating price sensitivity is the survey of brand preferences or purchase intentions. Companies prefer to measure preferences or intentions, rather than actual purchases, for several reasons: 1. Survey data costs much less to collect than purchase data. 2. Survey data can be measured for large, infrequently purchased, durable goods, such as automobiles or smartphones, for which in-store or laboratory experiments at various prices are impractical. 3. Survey data can be collected even before a product is designed when the information is most valuable in directing product development. 4. The results can be collected quickly. Direct Questioning Very early in the development of survey techniques for marketing, researchers learned that it was futile to ask consumers outright, “What is the most you would be willing to pay for this product?” Direct questioning sometimes elicits bargaining behavior, with consumers stating a lower price than they would pay. Other times, it elicits a desire to please the researcher, prompting consumers to state a higher price than they would pay. Frequently, it simply elicits a cursory answer that consumers would change were they to give the question the same thought as an actual purchase decision. Consequently, uncontrolled direct questioning as a research technique to estimate price sensitivity should never be accepted as a valid methodology. The results of such studies are at best useless and are potentially highly misleading. Buy-Response Surveys A slight variant of the direct-question survey involves showing consumers a product at a preselected price and asking if they would purchase at that price. nrfawitan 2024 PAMANTASAN NG CABUYAO |PRICING STRATEGY 59 MODULE 2 Surprisingly, although directly asking consumers what they would pay usually yields meaningless answers, asking them if they would buy at a preselected price yields answers that are at least plausible. When the answers given by different consumers for different price levels are aggregated, they produce what looks like a demand curve for market share, sometimes called a purchase probability curve. Presumably, questioning the willingness to buy generates better responses simply because it is structured more like an actual purchase decision than as an open-ended question about what the consumer would pay. Also, the consumer has no opportunity to bargain with the researcher. Attribute Rating Another method for evaluating price sensitivity is to include price as one of the attributes describing a product or a