Lecture 08 Digital Pricing

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Lecture 08 Digital Pricing

  1. 1. Digital Pricing 5A3190 DMCM David Edmundson-Bird
  2. 2. Digital Pricing • So what’s the problem? – You have to produce a digital marketing strategy poster – You have to create a market segmentation exercise – You have to describe a typical digital customer voyage – You have to produce a digital customer experience – You have to discuss user experience
  3. 3. Digital Pricing • So what do you need to learn? – What the economics of digital pricing are – What decisions in digital retail pricing have to be made – How basic and dynamic digital pricing strategies work – How advanced pricing strategies work – How a digital business should respond to price-cutting at a strategic level – How the digital pricing process works – How digital pricing works at each of the four stages of the electronic customer relationship
  4. 4. The Effects of the 2 “I”s on Digital Pricing Individualisation Interactivity DIGITAL PRICING Customer redevelops parts of the product to meet personal needs and wants Organizations provide targeted, individualized, customized products Stickiness as customers invest time and effort to personalize Allows a larger buying and selling community Facilitates dynamic pricing strategies Allows prices to be changed easily Allows consumers to easily check prices Easier to understand and measure consumers’ reactions to price promotions Easier to receive customer feedback on price, understand customers’ willingness to pay, and implement price-discrimination strategies
  5. 5. Key Digital Pricing Strategies RETAIL PRICE DECISIONS BASIC PRICING STRATEGIES DYNAMIC PRICING STRATEGIES ADVANCED PRICING STRATEGIES Cyclical Promotional Pricing (Hi-Lo) Everyday Low Pricing Retail/Outlet Pricing Cost Plus Brand Pricing Promotions English Auctions Reverse-Price English Auctions Dutch Auctions First-Price Sealed-Bid Auctions Reverse First-Price Sealed-Bid Auctions Exchanges Volume Discount Pricing Two-Part Pricing Bundling Price Discrimination Over Time Frenzy Pricing Three Categories of Price Discrimination
  6. 6. WHAT ARE THE ECONOMICS OF DIGITAL PRICING?
  7. 7. Information Content Demand Example Price Quantity Total Revenue Marginal Revenue 12 0 0 11 1 11 10 2 20 9 3 27 8 4 32 7 5 35 6 6 36 5 7 35 4 8 32 3 9 27 2 10 20 1 11 11 0 12 0 £6 £12 £8 £2 £4 £10 Marginal Cost 2 4 6 8 10 12 PRICE QUANTITY Optimal Price (Q=4, P=8) 11 9 7 5 3 1 -1 -3 -5 -7 -9 -11 An adult’s semi-annual demand for paid for content
  8. 8. Key Variables affecting Curve Slope & Position Demand curves made of many inputs plot customers’ aggregated willingness to buy at each possible price point PRICE QUANTITY Price Price Substitutes Complementaries Income Market Size Taste Substitutes Complementaries Income Market Size Taste
  9. 9. Demand Curve Inputs • Price – Price decreases, demand increases from market • Substitutes – Close substitutes negatively affect chargeable price • Complementaries – Their price affects digital product’s demand as much as its own price • Income – Demand linked to consumer income • Market Size – Growth in market positively affects demand • Taste – Customer preference positively drives demand
  10. 10. Demand Curve Slopes & Degrees of Flexibility • The slope of the demand curve determines an organisation’s flexibility in setting a price No Pricing Flexibility Complete Pricing Flexibility Quantity Price Quantity (a) (b)
  11. 11. Industry Demand Curves • Certain industries are more inclined toward one extreme type of demand curve than the other • Luxury – Goods that buyers will purchase regardless of price because there are no acceptable substitutes • Commodity – Goods that are homogenous and have available substitutes
  12. 12. Using Demand Curves to Set Price • Optimal pricing strategy is to choose the point on the demand curve where marginal cost is equal to marginal revenue • Marginal Cost – Cost associated with producing one additional product/service • Marginal Revenue – Positive/negative amount created when price is changed by one increment
  13. 13. WHAT DECISIONS HAVE TO BE MADE IN DIGITAL RETAIL PRICING?
  14. 14. Cyclical Promo (HiLo) vs. Every Day Low Pricing vs. Retail/Outlet • HiLo – High prices most of the time – Occasional low prices (Often lower than EDLP) • EDLP – ED prices set low (lower than HiLo high price) – Occasionally prices are discounted • R/O – Regular rarely discounted prices in main retail – Discounts at “outlets”
  15. 15. HOW DO BASIC AND DYNAMIC DIGITAL PRICING STRATEGIES WORK?
  16. 16. Basic Digital Pricing Strategies • Cost-Plus – Add a fixed mark-up to the total cost of item • Target Profit Growth – Fixed profit target: better margins through price increase or higher volumes through price decrease • Target Return Price – Fixed return on capital achieved through price change • Brand Pricing – Build a brand to charge a premium price • Promotional Price – Regular discounting
  17. 17. Promotional Low Price Costing • Organisations often discount: • Trial – Induce customers to experience benefits of new product/service • Rapid Acceptance – Set low price as first mover advantage to stuff competition • Switching Costs – Where switching is expensive, low lost induces customers • Loss Leaders – Low prices in famous names/staples/seasonals leads to sales in higher margin product/service
  18. 18. Fairness in Pricing • Matching the customer’s internally generated reference price with selected price • Key components of reference price – Past prices, substitutes, context • When to under-price – Market clearing price is higher than reference price, financial relationship between buyer & seller • Where fairness counts – Ongoing relationship between buyer & seller, where seller has significant power
  19. 19. Digital Dynamic Pricing • Digital Economy allows for frequent & proactive price adjustment • Prices can be easily changed • Buyers and sellers can interact and negotiate prices
  20. 20. Digital Dynamic Pricing • Auctions – English – Reverse-Price English (C2B invitation to tender) – Dutch (price drops until bought) • Price cannot be influenced upwards, price starts higher than market value to claim profit – First-Price Sealed Bid • Exchanges – Commodity owners meet to exchange goods – Host receives commission
  21. 21. HOW DO ADVANCED PRICING STRATEGIES WORK?
  22. 22. Price Discrimination Charging different prices based on willingness to pay First Degree — Charge consumers exactly what they are willing to pay for product – haggling) Second Degree — Charge consumers exactly what they are willing to pay for first unit of good as well as additional units – e.g. volume pricing Third Degree — Divide customers into distinct segments, charging different prices to different segments
  23. 23. Volume Discount vs. Two-Part Pricing • Strategies used to charge consumers what they are willing to pay for each additional item purchased • Volume Discount – Decreases the purchase price of an item as the quantity purchased increases • Often associated with minimum purchases in fixed period • Two-Part – Charges a one-time fixed fee and an associated variable charge for each purchased item • Often associated with subscription fee models and zero-cost of production
  24. 24. Two-Part Pricing Implementation • Need to understand each individual customer’s price curve • Need to determine optimal number of products to sell to each customer • Need to calculate how much customer is willing to pay for product and set fixed & variable prices to encourage them to purchase optimal number
  25. 25. Bundling • Packaging several items together under one price • Pure Bundling – Packaging together complementaries which are only offered as part of a bundle • Mixed Bundling – Offering items as either component pieces or as a bundle which discounts each item
  26. 26. HOW SHOULD A DIGITAL BUSINESS RESPOND TO PRICE-CUTTING AT A STRATEGIC LEVEL?
  27. 27. What Motivates Price Cutting? • A tactic used to gain market share • Motives – Trouble • Desperate attempt to raise cash, or signal to competitors an interest in being acquired – Industry Leader • Show of strength to indicate organisation is doing well enough to withstand the lower prices – Displeasure • To punish a competitor for a change in its strategy
  28. 28. Responding to Price Cuts ENHANCE VALUE PROPOSITION BATTLE JUSTIFY PRICE DIFFERENTIAL GENERAL PRICE CUT TARGETED PRICE CUT CROSS PARRY FIGHTER BRAND Enhancing the basic product with additional features such as extended warranties, additional services and the inclusion of ancillary products, but maintaining the price so that total customer value increases Communicating the differential benefits offered by the organisation that justify a higher price than the competition Match the competitors cut as an aggressive show of strength Focused efforts toward competitor’s primary geography or product Discounts offered only to vulnerable customers New products developed to appeal to vulnerable customers
  29. 29. HOW DOES THE DIGITAL PRICING PROCESS WORK?
  30. 30. What to do and not to do • Don’t discount unless you have to. • Offer options! Some people will want basic functionality while others will want super-functionality. • Some segments will value your product more than others. Try to price accordingly. • Customers do not like companies to charge different prices in different channels for the same product without proper justification. • Many organisations have been burned by changing prices only to be met by a full-fledged price war by outraged competitors. • Brand strength or adding extra features (e.g., free upgrades) may temper the need to discount price. • Goodwill is important in maintaining relationships, but think about whether you are giving up too much in terms of price. Customers may remain loyal even if you don’t offer them the 10 percent discount
  31. 31. The Digital Pricing Pentagon DETERMINE SELLING STRATEGY SET PRICING GOALS DIGITAL PRICING PROCESS Develop Pricing Segmentation Establish Product Value Challenge Pricing Mindset Estimate Competitor Reaction Test Final Market Equilibrium
  32. 32. Strategic Segmentation: Expanding & Increasing Expanding the customer “sweet-spot” through versioning Increasing customer density through price discrimination ORIGINAL TARGET MARKET Expanded Target Market Price discrimination increases density
  33. 33. Estimate Competitor Response • Avoid setting a price that leads to a price war • Set potential prices – Use scenario planning – Must be real prices you could charge • Guess what competitor reaction would be to each one – Will they aggressively react, minimally react or accept? • Estimate your final price and hypothesize competitors’ final price points
  34. 34. Test Final Market Equilibrium • Final price and volume points give your estimated demand curve PRICE QUANTITY Hi Medium Low Hi Medium Low Derived from estimated market shares
  35. 35. Digital Pricing Strategy Framework RETAIL PRICE DECISION HiLo EDLP R/O Select Digital Pricing Strategy No Pricing Flexibility Corporate Mandate High Initial Demand Correlated Demand Dynamic Pricing Price as Marketing Strategy Price at market Target return pricing Target profit return Fairness pricing Bundling Frenzy Price discrimination over time Bundling Volume Discount Two-Part English, Reverse & Dutch First-price sealed-bid Reverse first- price sealed- bid Group buying Electronic exchange Prestige Sign of Quality Promotional
  36. 36. HOW DOES DIGITAL PRICING WORK AT EACH OF THE FOUR STAGES OF THE ELECTRONIC CUSTOMER RELATIONSHIP?
  37. 37. Digital Pricing Levers & 4 Stages of ERM Acquisition Conversion Retention Dissolution Click-through promotions Digital Presence-referral promotions Specially negotiated promotions (e.g., hotels) B&C promotions Digital-only price discounts Bundle Frenzy pricing Prestige Price as a sign of quality Hi-Lo Dynamic pricing EDLP Targeted Promotions Future price promotions Justify prices Loyalty programs Tiered loyalty programs Wide variety of pricing plans Become affiliates Profit-enhancing programs Volume-discount promotions Targeted promotions Future price promotions Fairness Two-part pricing EDLP Discontinue pricing promotions Reconfigure loyalty programs Decrease profit programs
  38. 38. What We’ve Covered Today – We’ve looked at what the economics of digital pricing are – We’ve seen what decisions in digital retail pricing have to be made – We’ve looked at how basic and dynamic digital pricing strategies work – We’ve looked at how advanced pricing strategies work – We’ve explored how a digital business should respond to price-cutting at a strategic level – We’ve investigated how the digital pricing process works – We’ve seen how digital pricing works at each of the four stages of the electronic customer relationship

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