Pricing Strategy

Business Framework
Pricing Strategy Toolkit
This toolkit provides an in depth
discussion on Pricing Strategy, including
Skimming vs. Penetration, Pricing
Tactics, Consumer Adoption Curve, Price
Curve Analysis, and Price Sensitivity
Analysis. Includes a Pricing Sensitivity
Financial Model.
$0
$1,000
$2,000
$3,000
$4,000
$5,000
$6,000
$7,000
5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100%
-$40,000,000,000
-$20,000,000,000
$0
$20,000,000,000
$40,000,000,000
$60,000,000,000
$80,000,000,000
$100,000,000,000
PRICE REVENUES
MARKET SHARE
Σ Price:
$XXMM
Revenue:
$XXMM
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3
Contents
• Pricing Strategy
- Skimming vs. Penetration
- Consumer Adoption Curve
- Advantages and Disadvantages
• Pricing Approach
- Data Collection
- Price Curve Analysis
• Price Sensitivity Analysis
- Analysis Approach
- Price Sensitivity Financial Model
• Pricing Tactics and Terminology

5
To determine the optimal Pricing Strategy, we need to look at things within
the context of the product’s adoption lifecycle
Consumer Adoption Curve
Number of
customers
Time
“The Chasm”
INNOVATORS EARLY
ADOPTORS
EARLY
MAJORITY
LATE
MAJORITY
LAGGARDS
• These people are
committed to new
products
(particularly in
technology) with
the belief that
sooner or later it
is bound to
improve our lives
• Often known as
technology
enthusiasts, or
―techies‖
• Represents 2.5%
of market
Source: Crossing the Chasm and Beyond, Moore and McKenna, 1999
• Early adopters are
visionaries
• These people are true
revolutionaries in
business and
government who want
to use the
discontinuity of any
innovation to break
from the past into a
new future
• It is said there is a
―chasm‖ marking
needs to overcome in
this segment
• 13.5% of market
• Early majority customers
are pragmatists
• The believe in evolution,
not revolution
• These people will adopt
new products only after
a proven track record
• Represents 34% of
market
• Late majority
consumers share a
conservative mindset
• They are very price
sensitive, highly
skeptical, and
demanding
• These customers
usually like very simple
products—they only
want the
basic functionality
• 34% of
market
• Laggards the ever-present
critics
• This segment is the very
last to buy any product
• The goal is not to sell to
this group, but to sell
around them
• Represents 16% of market

7
Penetration Pricing works best as the product reaches the Mainstream
Market and it becomes a race to grab share
When to Penetrate the Market
Number of
customers
Time
“The Chasm”
Market Penetrator
INNOVATORS EARLY
ADOPTORS
EARLY
MAJORITY
LATE
MAJORITY
LAGGARDS
Pricing Penetration Strategy is often adopted as the new product is about to reach the
Mainstream Market. At this point, adoption it at its highest rate. Copy cat companies are
quickly entering into the market, increasing supply, thus also putting pricing pressure on
the product.
At this point, this is a race to capture market share and become a market leader.
Therefore, many companies, incumbents and new entrants will adopt pricing Penetration
Strategy to absorb share. Large companies may engage in predatory pricing to increase
barriers to entry and drive out smaller players.
Mainstream Market

9
As we enter the Mainstream Market, it is critical to penetrate the market as
quickly as possible—as survival is correlated with share
Penetration Pricing – Advantages & Disadvantages
–+
 Sets a low price expectation for
the product
 Brand perception as low quality
product
 Low margin product puts profit at
risk (e.g. fluctuation in raw
material costs may have
significant affect on profits)
 Leaving a lot of consumer
surplus on the table
ADVANTAGES DISADVANTAGES
Penetration Pricing
Strategy works well for a
late entrant who wants to
capture share quickly.
This strategy appeals to
the vast majority of the
market who are price
sensitive (e.g. ―Walmart
shoppers‖).
EXAMPLE
This strategy is widely
practiced by manufacturers
emerging from China, who
price very low and quickly
capture a competitive
amount of market share.
 Can achieve fast market
penetration
 With higher sales volume, can
create manufacturing and supply
chain efficiencies (e.g.
economies of scale)
 Discourage new entrants,
because the low margins
Once you introduce a low price
point, it is very difficult to increase
price later (for the same product)

11
After deciding on the overarching Pricing Strategy, the next step is to
determine the appropriate price point
Pricing Approach
• Customer
surveys
• Market research
reports
• Historical sales
• Competitive
intelligence
DATA COLLECTION
Pricing data is often difficult to gather.
Therefore, pricing data may come from a variety
of sources.
ANALYSIS & INSIGHTS
With the gathered pricing data, the
next step is to make sense of the
numbers. It is critical to document and
be rational with any assumptions made.
PRICING
Set the price point!
• What is the price point to
maximize profit?
maximize share?
capture the Early Market?
Revenue:
$XXXM
Price:
$XXX
Σ

13
Unit
Price
Market
Share
Customer
Volume
Margin Revenue Profit
$340 100% 50,000,000 -194% $17,000,000,000 ($33,000,000,000)
$650 95% 47,500,000 -54% $30,875,000,000 ($16,625,000,000)
$970 90% 45,000,000 -3% $43,650,000,000 ($1,350,000,000)
$1,300 85% 42,500,000 23% $55,250,000,000 $12,750,000,000
$1,600 80% 40,000,000 38% $64,000,000,000 $24,000,000,000
$1,900 75% 37,500,000 47% $71,250,000,000 $33,750,000,000
$2,200 70% 35,000,000 55% $77,000,000,000 $42,000,000,000
$2,500 65% 32,500,000 60% $81,250,000,000 $48,750,000,000
$2,850 60% 30,000,000 65% $85,500,000,000 $55,500,000,000
$3,160 55% 27,500,000 68% $86,900,000,000 $59,400,000,000
$3,500 50% 25,000,000 71% $87,500,000,000 $62,500,000,000
$3,800 45% 22,500,000 74% $85,500,000,000 $63,000,000,000
$4,100 40% 20,000,000 76% $82,000,000,000 $62,000,000,000
$4,400 35% 17,500,000 77% $77,000,000,000 $59,500,000,000
$4,750 30% 15,000,000 79% $71,250,000,000 $56,250,000,000
$5,000 25% 12,500,000 80% $62,500,000,000 $50,000,000,000
$5,360 20% 10,000,000 81% $53,600,000,000 $43,600,000,000
$5,675 15% 7,500,000 82% $42,562,500,000 $35,062,500,000
$6,000 10% 5,000,000 83% $30,000,000,000 $25,000,000,000
$6,300 5% 2,500,000 84% $15,750,000,000 $13,250,000,000
Tabulate your pricing data to show the relationships among price point,
market share, and sales
Pricing Data Collection (2 of 2)
ILLUSTRATIVE DATA
Note that there may be
limits to how much share
you can actually capture
and still remain
profitable—at a certain
point of lowering your
price, you will be losing
money
In this data set, notice
how sales from just the
Early Market exceed sales
for someone owning 95%
of the market

15
```
What is the price point needed to capture the Early Market?
Pricing Curve Analysis – Example 1
$0
$1,000
$2,000
$3,000
$4,000
$5,000
$6,000
$7,000
5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100%
-$40,000,000,000
-$20,000,000,000
$0
$20,000,000,000
$40,000,000,000
$60,000,000,000
$80,000,000,000
$100,000,000,000
PRICE REVENUES / PROFITS
Revenue
Profit
Price
MARKET SHARE
To capture 15% share,
your price point should
be about $5,500
Plot based on
illustrative data
from previous slide

17
What is the price point to maximize profits?
Pricing Curve Analysis – Example 3
$0
$1,000
$2,000
$3,000
$4,000
$5,000
$6,000
$7,000
5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100%
-$40,000,000,000
-$20,000,000,000
$0
$20,000,000,000
$40,000,000,000
$60,000,000,000
$80,000,000,000
$100,000,000,000
PRICE REVENUES / PROFITS
Revenue
Profit
Price
MARKET SHARE
The price associated
with the highest
peak of the Profit
Curve (orange) is
about $3,800, which
translates to about a
47% market share
Plot based on
illustrative data
from previous slide

19
If you are unable to collect enough pricing data, your alternative is to
formulaically derive pricing sensitivity
Price Sensitivity Analysis – Approach
Determine the key drivers of Price Sensitivity.
Score the impact of each relevant Price Sensitivity driver.
Determine the Point of Perfect Elasticity and map the score to a pricing
sensitivity elasticity factor.
Determine the Threshold of No Elasticity.
Create your Price Sensitivity formula
Deriving a formula for pricing sensitivity is a 5 step process
1
2
3
4
5

21
Step 2. Score the impact of each relevant Price Sensitivity driver
Price Sensitivity Analysis – Step 2
Reference Price
Effect
Buyer’s price sensitivity for a given product
increases the higher the product’s price relative
to perceived alternatives. Perceived alternatives
can vary by buyer segment, by occasion, and
other factors.
Switching Costs
Effect
The higher the product-specific investment a
buyer must make to switch suppliers, the less
price sensitive that buyer is when choosing
between alternatives.
Price-Quality
Effect
Buyers are less sensitive to price the more that
higher prices signal higher quality. Products for
which this effect is particularly relevant include:
image products, exclusive products, and
products with minimal cues for quality.
Fairness Effect
Buyers are more sensitive to the price of a
product when the price is outside the range they
perceive as ―fair‖ or ―reasonable‖ given the
purchase context.
1
(Minimal impact)
2 3
(Strong impact)
1
(Minimal impact)
2 3
(Strong impact)
1
(Minimal impact)
2 3
(Strong impact)
1
(Minimal impact)
2 3
(Strong impact)
Continuing on our example from the previous slide, we have down-selected to the 4 Price Sensitivity drivers listed
below (in green). In this next step, we score the impact of driver on a scale from 1-3, with 3 being the most impactful.
TOTAL SCORE: 8
(out of a possible score of 12)

23
4. Determine the Threshold of No Elasticity
Price Sensitivity Analysis – Step 4
For some products, there is a ―threshold of no elasticity.‖ This is a threshold that the pricing change must reach
before the elasticity factor kicks in. For instance, if a this threshold is 1.5%, then the demand won’t change until the
pricing changes by at least 1.5%. See example below.
ASSUMPTIONS
• Threshold of no elasticity
• Elasticity factor
1.5%
150%
Original Price New Price Price Change ($) Price Change (%)
$100 $98.00 ($2.00) (2.0%)
$100 $98.50 ($1.50) (1.5%)
$100 $99.00 ($1.00) (1.0%)
$100 $99.50 ($0.50) (0.5%)
$100 $100.00 $0.00 0.0%
$100 $100.50 $0.50 0.5%
$100 $101.00 $1.00 1.0%
$100 $101.50 $1.50 1.5%
$100 $102.00 $2.00 2.0%
$100 $102.50 $2.50 2.5%
Demand Change (%)
0.5%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
(0.5%)
(1.0%)
The demand
change is forced to
0% because the
price change didn’t
reach the Threshold
of No Elasticity
Note that the
demand changes
for the values are
1.5% less than the
price change %.

25
Price Sensitivity Financial Model
As you identify potential benefits, map these benefits against the
attributes of quantifiable and financial
Double click to open the
Excel sensitivity model
NOTE: If you are having trouble opening the embedded Excel file,
you can download it online from your Flevy account:
http://flevy.com/account

27
The first step is to decide on your high level pricing strategy—to skim or
to penetrate?
Price Sensitivity Model Documentation (2 of 2)
Based on the values you entered in the top INPUTS/ASSUMPTIONS section, this model will generate 2 outputs:
1) A table illustrating the effective demand change from a pricing change of -50% to 50%
2) A line chart to visualize the above table
1 2

29
Value Pricing
Price is set in accordance to customer perceptions about the value of the product
or service.
This tactic is typically associated with luxury goods.
OVERVIEW EXAMPLE(S)
• A luxury car brand, such as
Mercedes Benz.
RELATED PRICING TACTIC(S)
• Psychological Pricing

31
Psychological Pricing
This tactic refers to the look of the product price and its effect on consumer pricing.
A classic example of this is prices ending in 99 cents versus rounding to the dollar.
OVERVIEW EXAMPLE(S)
• A customer feels a product priced
as $9.99 is much cheaper than
one priced at $10.00.
• Value Pricing

33
Tender Pricing
Many larger contract based services are awarded on a tender basis. In these
situations, the client issues a request for proposals and tenders (i.e. formal, written
offers). Bidders then submit tenders with their pricing to win the contract.
OVERVIEW EXAMPLE(S)
• Large software implementations
are often awarded through a
RFP/tender process.

35
Predatory Pricing
Predatory pricing is an aggressive way of pushing out smaller players and erecting
barriers to entry. It is the act of deliberately price cutting to force rival players out
of business, because these rivals cannot afford to compete at such a loss.
Only strong players with a ―war chest‖ can afford this strategy, since they will be
losing money with each sale. This is anti-competitive and illegal if it can be
proved.
OVERVIEW EXAMPLE(S)
• Microsoft has often been criticized
in using predatory pricing to
maintain dominant market share.
An example would be Microsoft
offering Internet Explorer for free
when competing with Netscape
(back in 1996).
• Similarly, when new versions of
Microsoft Windows are released,
Microsoft provides the latest
operating system to computer
manufacturers for free. This is why,
when a new version of Windows is
released, you will often machines
with the newer version to be
cheaper than machines with the
previous version.
• Loss Leader Pricing
• Price Discrimination
• Marginal Cost Pricing

37
Marginal Cost Pricing
Marginal cost pricing is selling a product at the incremental cost of producing 1
more such product. In other words, it is selling a product at 0 profit.
This is typically used when the fixed costs are high and have already been
covered by initial sales. The remaining unsold products, e.g. excess capacity, are
sold are marginal costs.
OVERVIEW EXAMPLE(S)
• Online hotel reservation services,
like PriceLine, encourage hotels
to adopt marginal cost pricing for
unsold rooms. In other words,
hotels can offer last minute deals
to sell unfilled rooms at cost.
• Airlines sometimes also use this
tactic to fill unsold seats.
• Loss Leader Pricing
• Price Discrimination
• Predatory Pricing

1
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