The Science and Art of Pricing

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An introduction to the science and art of pricing products and services.

An introduction to the science and art of pricing products and services.

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  • At the microeconomic level:Food, groceries, gasolineAt the macroeconomic level:- Services (housekeeping, accounting, etc.), gasoline
  • Luxury goods (although demand DID fall when we had the recession)Alcohol and tobaccoPharmaceuticals
  • Could Old Navy manufacture the jeans on the left? Probably. But could they sell it for $341? Probably not.
  • In some markets (like commodities) this is the only thing that matters. But in most markets, many other factors play a role.Associated Benefits: Frequent Flyer Points, Percentage of Proceeds to Disaster Relief, Cash Back programs, Loyalty / punch ards, etc. Brand / Prestige / Exclusivity: Tiffany, Chanel handbag, True Religion Jeans, Mercedes, RolexEnvironment: Music, scents, lighting, product placement, helpful staff, exclusive location: Apple Store, Lego Store, high-end spa, Scottsdale Fashion SquarePackaging: Generic vs. Brand Name; Choice & Loyalty: If you offer your customers
  • In some markets (like commodities) this is the only thing that matters. But in most markets, many other factors play a role.Associated Benefits: Frequent Flyer Points, Percentage of Proceeds to Disaster Relief, Cash Back programs, Loyalty / punch ards, etc. Brand / Prestige / Exclusivity: Tiffany, Chanel handbag, True Religion Jeans, Mercedes, RolexEnvironment: Music, scents, lighting, product placement, helpful staff, exclusive location: Apple Store, Lego Store, high-end spa, Scottsdale Fashion SquarePackaging: Generic vs. Brand Name; Choice & Loyalty: If you offer your customers
  • There are many moving parts and interactionsChanging the value proposition will allow you to compete at a different price point, but it will also change your fixed and variable cost structure – you need to evaluate both to determine the impact on profitability
  • Go price shopping – see what your competitors are offering and charging
  • Real estate
  • T-shirts at VistaPrint

Transcript

  • 1. CAYENNECONSULTING innovate | grow | succeedScience and Art: Pricing Products & Services for ProfitabilityAkira HiraiCayenne Consulting, LLCakira@caycon.com714.TOP.PLAN
  • 2. Agenda A Bit About Me Pricing and Profitability Some Boring Old Fundamentals Buying Decisions Pricing and Business Models Some Pricing Tactics Pricing Psychology Case Study & Summary 2 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 3. How I Got Here 85 Palo Alto Stanford Linear Accelerator Center Engineering Intern 86 N.H. U.S. Army Corps of Engineers Programmer 87 Boston Let’s Go Travel Guides Sales Manager 88 Boston AdVenture Graphics (Advertising) General Manager85-89 Boston Harvard University BA, Engineering89-91 NYC First Manhattan Consulting Group Consultant91-92 NYC Systematix Development Group Founder/Programmer92-94 NYC Coopers & Lybrand Managing Consultant95-99 NYC Salomon Brothers VP, Trading/Risk 99 Cupertino AntiqueID.com Founder/COO99-00 SFO MyRaptor.com Founder/CEO01-11 Arizona Cayenne Consulting, LLC Founder/CEO 3 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 4. What I Do Now Cayenne Consulting Established March 7, 2001 30 Consultants worldwide • Strategy & tactics • Market research & analysis • Market positioning • Competitor research & analysis • Business planning • Interim C-Level leadership • Financial forecasts & models • Business development • Investor pitch decks • Executive coaching & mentoring • Capital formation strategy • Revenue acceleration • Company valuations • Turnaround consulting 4 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 5. Agenda A Bit About Me Pricing and Profitability Some Boring Old Fundamentals Buying Decisions Pricing and Business Models Some Pricing Tactics Pricing Psychology Case Study & Summary 5 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 6. Quick Example Fixed costs of $10,000 per month Product priced at $100 COGS (Variable Cost) = $50 per unit Gross Margin = $50 per unit How many units do I have to sell every month before I break even? Answer:  Fixed Cost ÷ Gross Margin  $10,000 ÷ $50 = 200 units to break even 6 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 7. Suppose I offer 10% off New product price: $90 Gross Margin = $40 per unit What’s my new break even point? Answer:  $10,000 ÷ $40 = 250 units to break even  I now need to sell 20% more product before I reach break even 7 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 8. Impact of Price on Profits Fixed cost $10,000 Variable cost of $50 per unit Price Q=175 Q=200 Q=225 Q=250 Q=275 $100 ($1,250) $0 $1,250 $2,500 $3,750 $90 ($3,000) ($2,000) ($1,000) $0 $1,000 Pricing determines how much product you need to sell to be profitable 8 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 9. Impact of Price on Required Sales Fixed costs of $10,000 per month Variable cost of $50 per unit Target profit: $2,500 per month How many units do I need to sell at each price point to achieve profit target? Price Quantity $90 313 $100 250 $110 208 9 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 10. Agenda A Bit About Me Pricing and Profitability Some Boring Old Fundamentals Buying Decisions Pricing and Business Models Some Pricing Tactics Pricing Psychology Case Study & Summary 10 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 11. Some Boring Old Fundamentals The “Law” of Supply and Demand Competitive Markets Rational Consumers and Sellers 11 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 12. Customers: The Demand SidePrice Quantity 12 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 13. Demand at a Low PricePrice X P1 Q1 Quantity 13 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 14. Demand at a Higher Price Y P2Price X P1 Q2 Q1 Quantity 14 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 15. The Demand Curve Y P2Price X P1 D Q2 Q1 Quantity 15 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 16. Sellers: The Supply SidePrice Quantity 16 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 17. Supply at a Low PricePrice X P1 Q1 Quantity 17 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 18. Supply at a Higher Price Y P2Price X P1 Q1 Q2 Quantity 18 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 19. The Supply Curve Y S P2Price X P1 Q1 Q2 Quantity 19 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 20. Markets: Supply AND Demand S PPrice D Q Quantity 20 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 21. Back to DemandPrice D Quantity 21 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 22. “Elastic” Demand: Very Sensitive to PricePrice D2 D1 Quantity 22 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 23. What Determines Price Elasticity? Availability of Substitutes Necessity Percentage of Income Duration of Price Change Brand Loyalty Source of Funds 23 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 24. “Elastic” Demand: Very Sensitive to Price What are some examples of markets with elastic demand?  Leisure airfares  Liquor  Cola  Mobile games and apps 24 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 25. “Inelastic” Demand: Price InsensitivePrice D3 D1 Quantity 25 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 26. “Inelastic” Demand: Price Insensitive What are some examples of markets with inelastic demand?  Healthcare  Cigarettes  Gasoline  Eggs  Steel  Guns 26 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 27. Science and Art of Pricing The Science: Traditional Economics  Assumes rational market participants  Perfect access to information The Art: Behavioral Economics  Recognizes people often act irrationally  Studies how people actually behave 27 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 28. Agenda A Bit About Me Pricing and Profitability Some Boring Old Fundamentals Buying Decisions Pricing and Business Models Some Pricing Tactics Pricing Psychology Case Study & Summary 28 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 29. A Tale of Two Jeans Old Navy True Religion $11.97 $330.00 29 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 30. A Tale of Two Jeans True Religion Old Navy $330.00 $11.97 30 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 31. How About Two Watches? Seiko Eterna $59 $21,900 31 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 32. The Consumer’s Choice Buy Your Buy Your Product Competitor’s Product The Consumer Buy a Substitute Do Nothing Product (Status Quo) 32 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 33. Finding the Right Value Proposition What What You C Competitors Offer Offer D A B What Customers in This Target Market Want 33 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 34. Influencing the Buying Decision Features Price Quality Guarantee Convenience Sales Speed Promotion Proximity Choice Associated Loyalty Benefits Environment Brand Packaging Prestige 34 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 35. Features 35 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 36. Quality / Reliability 36 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 37. Guarantees 37 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 38. Convenience / Speed / Proximity 38 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 39. Associated Benefits: Doing Good 39 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 40. Associated Benefits: Being Green 40 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 41. Brand / Prestige 41 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 42. Loyalty Programs 42 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 43. Packaging & Labeling 43 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 44. Choice 44 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 45. Relationship 45 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 46. Loyalty 46 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 47. Promotion 47 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 48. Sales 48 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 49. Influencing the Buying Decision Features Price Quality Guarantee Convenience Sales Speed Promotion Proximity Choice Associated Loyalty Benefits Environment Brand Packaging Prestige 49 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 50. Pricing for Profitability Pricing & Competitive Promotion Influences Strategy Value Quantity Total Proposition Sold Revenues Fixed & Variable Profitability Costs 50 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 51. Agenda A Bit About Me Pricing and Profitability Some Boring Old Fundamentals Buying Decisions Pricing and Business Models Some Pricing Tactics Pricing Psychology Case Study & Summary 51 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 52. Business Models Goods & Services Money You Your Customer 52 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 53. A Few Basic Business Models Sell goods and services outright Annual membership and then sell stuff at a discount Sell stuff, but give a punch card so that your 10th purchase is free Sell fractional ownership in stuff Broker transactions and earn a percentage of the transaction Create a marketplace between people and earn a listing fee Sell memberships to a service Create free content and make money from advertisers Create content and charge subscribers for access Sell software licenses:  Annual or one-time; customization, maintenance, and upgrade fees  By the company, individual seat, individual named user, maximum number of concurrent users, average number of concurrent users, number of CPUs, number of transactions processed, etc. 53 And dozens of other models… © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 54. Auction Business Model 54 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 55. Name Your Own Pricing Business Model 55 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 56. Razor and Blade Business Model 56 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 57. Freemium Business Model 57 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 58. Business Models Goods & Services Money You Your Customer 58 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 59. Agenda A Bit About Me Pricing and Profitability Some Boring Old Fundamentals Buying Decisions Pricing and Business Models Some Pricing Tactics Pricing Psychology Case Study & Summary 59 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 60. “Cost Plus” Pricing Hypercompetitive Markets Regulated Markets Procurement-driven Markets Naïve Sellers 60 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 61. “Cost Plus” PricingPrice of computers falling, in part, becausecomponent costs are falling:Year Manufacturer Size Cost $ per MB1956 IBM 5 MB $50,000.00 10,000.001981 Apple 5 MB $3,500.00 700.001987 Iomega 40 MB $1,799.00 45.001995 Seagate 2.1 GB $1,699.00 0.811999 Maxtor 10 GB $249.99 0.02882003 Maxtor 120 GB $158.00 0.001512007 Western Digital 500 GB $152.00 0.0003062010 Western Digital 1000 GB $71.42 0.0000821 61 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 62. Market Based Pricing – Real Time 62 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 63. Market Based Pricing – Static 63 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 64. Segmentation 64 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 65. Wealth Segmentation Value Discount Pricing Premium Pricing Pricing• Low cost • Middle market • High margins producer strategy • Quality, luxury, e• Razor thin • Fair price for a xclusivity, scarci margins solid product ty, etc.• Make it up in • Compete by • Skim top of the volume providing good market• Attract price value for the • “If you have to shoppers money ask how much it costs…” 65 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 66. Feature / Quality Segmentation 66 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 67. Geographic Segmentation Laguna Beach, CA Chandler, AZ 4 Bed / 3 Bath 4 Bed / 3 Bath 2,437 SF / 0.14 acre 2,566 SF / 0.20 acre $3,450,000 $199,900 67 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 68. Customer Type Segmentation 68 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 69. Customer Type Segmentation 69 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 70. Time of Day & Day of Week Segmentation 70 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 71. Price Break Segmentation 200 @ $7.49 = $1,498.00 201 @ $6.99 = $1,404.99 71 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 72. Loss Leaders 72 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 73. Sales & Coupons 73 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 74. Bundled Pricing 74 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 75. Sequential Skimming 75 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 76. Agenda A Bit About Me Pricing and Profitability Some Boring Old Fundamentals Buying Decisions Pricing and Business Models Some Pricing Tactics Pricing Psychology Case Study & Summary 76 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 77. You Get What You Pay For 77 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 78. You Want What Others Want 78 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 79. Pricing Conventions Marketing Bulletin study of advertised prices in 1997:  60% end in a “9”  30% end in a “5”  7% end in a “0”  3% end in something else 79 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 80. Why 99 cents? Left digit anchoring effect $1.99 $3.00 Many buyers ignore least significant digits  $19.99 is closer to $19 than to $20  Stronger effect using small print: $1999 Moves product below anchor point Moves product into lower price band 80 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 81. Even Pricing: It Must Be Good… 81 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 82. Premiums $19.99 vs. $21.99  Message: Products are comparable, but one is more expensive than the other $19.99 vs. $29.99  Message: One product is “basic” and the other is “premium” 82 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 83. Reframing This product protects up to 25 “workloads” $3.50 x 25 x 365 = $31,937 per year! 83 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 84. Re-Anchoring 84 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 85. Sneaky Price Increases 85 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 86. Agenda A Bit About Me Pricing and Profitability Some Boring Old Fundamentals Buying Decisions Pricing and Business Models Some Pricing Tactics Pricing Psychology Case Study & Summary 86 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 87. Case Study: Airline Yield Management Service Level: First class, business class, coach, etc. Features: Refundable, non-refundable Unbundling: Pay only for the features you use (checked bags, pillows, snacks, paper boarding passes) Surcharges: Exclude airport fees, taxes, fuel surcharges, etc. wen quoting prices Time of Purchase: Gradually reduce prices Customer Urgency: Save a few seats for last-minute buyers who will pay any price Sales Channel: Direct website, agency website, travel agent, vacation packages Volume Buyers: “Free” seats to frequent travelers Pickiness: Sell remaining inventory by introducing imperfections 87 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 88. Should you RAISE your prices? Customers may perceive higher quality You’ll earn higher margins, so you won’t have to close as many sales to maintain the same level of profit You might drive away some price- conscious, high-maintenance customers 88 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 89. Should you LOWER your prices? You should attract more customers Higher volume could mean better economies of scale, thus lower average costs Might attract some profitable long-term customers Might attract cost-conscious, high- maintenance customers that burden your team Might be perceived as being desparate & nobody wants your product Might be perceived as being the “cheap” brand 89 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 90. Pragmatic Pricing Strategy Understand your value proposition Talk to your customers Watch competitors closely Test, measure, and analyze Understand impact on cost, volume, profit Don’t confuse correlation with causation There are no easy answers! 90 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 91. Pricing for Profitability Pricing & Competitive Promotion Influences Strategy Value Quantity Total Proposition Sold Revenues Fixed & Variable Profitability Costs 91 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 92. Further Reading The Strategy & Tactics of Pricing  Thomas Nagle & Reed Holden Power Pricing  Robert Dolan & Herman Simon Predictably Irrational  Dan Ariely 92 © 2001-2011, Cayenne Consulting, LLC. All Rights Reserved.
  • 93. CAYENNECONSULTING innovate | grow | succeedPricing Products &Services for ProfitabilityAkira HiraiCayenne Consulting, LLCakira@caycon.com714.TOP.PLAN