Up pricing cielak first class

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Pricing
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• Coordinado por Moisés Cielak
• @mcielak #sicomoi

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1
UP Mexico
Designed by
Eric Cielak
San Diego U.
Setting the Right Price
Introduction to Price
Marketing
Cielak, Katz, et alumni Prepared by
Moises Cielak, Ph.D.
Am. Andragogy University

Sylabus Evaluation etc Céteris Paeribae

LO
LO
LO
2Chapter 18
Copyright ©2008 by South-Western, a division of Thomson Learning. All rights reserved
Learning Outcomes
Describe the procedure for setting
the right price
Identify the legal and ethical constraints
on pricing decisions
Explain how discounts, geographic pricing, and
other special pricing tactics can be used to fine-
tune the base price
I
2
3

LO
3Chapter 18
Learning Outcomes
Discuss product line pricing
Describe the role of pricing during periods of inflation
and recession
LO4
5

LO
4
Chapter 18
Describe the procedure for
setting the right price
How to Set a Price on a
Product or Service
I

5
LOI
Results lead to the right price
Chapter 18
How to Set a Price on a
Product or Service
Establish pricing goals
Estimate demand, costs, and profits
Choose a price strategy
Fine tune with pricing tactics

6
LOI
Establish Pricing Goals
Profit-Oriented
Sales-Oriented
Status Quo
Chapter 18

7
Chapter 18
Choose a Price Strategy
Price Strategy
A basic, long-term pricing
framework, which establishes
the initial price for a product and
the intended direction for
price movements over the
product life cycle.
LOI

8
Chapter 18
LOI
Price
Skimming
Penetration
Pricing
Status Quo
Pricing
A firm charges a high
introductory price, often coupled
with heavy promotion.
A firm charges a relatively low
price for a product initially as
a way to reach the mass market.
Charging a price identical to or
very close to the competition’s
price.
Choose a Price Strategy

9
LOI
Price Skimming
Inelastic Demand
Unique Advantages/SuperiorSituations
When
Price
Legal Protection of Product
Skimming
Is
Successful Technological Breakthrough
Blocked Entry to Competitors
Chapter 18

10
LOI Penetration Pricing
§
§
§
§
§
§
Advantages
Discourages or blocks
competition from
market entry
Boosts sales and
provides large profit
increases
Can justify production
expansion
Disadvantages
Requires gear up for
mass production
Selling large volumes
at low prices
Strategy to gain market
share may fail
http://www.iflyswa.com
Online
Chapter 18

11
Chapter 18
LOI Status Quo Pricing
§
§
Advantages
Simplicity
Safest route to long-
term survival for small
firms
§
Disadvantages
Strategy may ignore
demand and/or cost

BizFlix
12
Chapter 18
Fast Times at Ridgemont HighLOI

13
REVIEW LEARNING OUTCOME
LO I Setting the Right Price
Establish
price
goals
Estimate demand,
costs, and profits
Choose a
price strategy
Fine-tune
base price
Set price
$x.yy
Chapter 18
Evaluate
results
Skimming
Status quo
Penetration
Low $
High $

LO
14
Chapter 18
Identify the legal and
ethical constraints
on pricing decisions
The Legality and Ethics of
Price Strategy
2

15
Chapter 18
LO2 The Legality and Ethics of
Price Strategy
Unfair Trade Practices
Price Fixing
Price Discrimination
Predatory Pricing

16
Chapter 18
LO2 The Legality and Ethics of
Price Strategy
Laws that prohibit wholesalers
Unfair Trade
and retailers from selling
Practices
below cost.
An agreement between two
Price
or more firms on the price they
Fixing
will charge for a product.

17
Chapter 18
Price DiscriminationLO 2
The Robinson-Patman Act of 1936:
1. There must be price discrimination.
2. Transaction must occur in interstate commerce.
3. Seller must discriminate by price among two or more purchasers.
4. Products sold must be commodities or tangible goods.
5. Products sold must be of like grade and quality.
6. There must be significant competitive injury.

18
Chapter 18
Price DiscriminationLO 2
The Robinson-Patman Act of 1936:
Cost
Seller Defenses
Market
Conditions
Competition

19
Chapter 18
LO2
Predatory
Pricing
Predatory Pricing
The practice of charging a
very low price for a product
with the intent of driving
competitors out of business
or out of a market.

20
Chapter 18
Explain how discounts,
geographic pricing, and
other special pricing tactics
can be used to fine-tune
the base price
Tactics for Fine-Tuning the Base PriceLO3

21
Chapter 18
LO3
Special pricing tactics
Discounts
Geographic pricing
Tactics for Fine-Tuning the Base Price

22
Chapter 18
LO 3
Quantity Discounts
Cash Discounts
Functional Discounts
Seasonal Discounts
Promotional Allowances
Rebates
Zero Percent Financing
Value-Based Pricing
Discounts, Allowances, Rebates, and
Value-Based Pricing

23
Chapter 18
LO3
Value-Based
Pricing
Value-Based Pricing
Setting the price at a level that
seems to the customer to be a
good price compared to the prices
of other options.

24
Chapter 18
LO 3 Pricing Products Too Low
1. Managers attempt to buy market share
through aggressive pricing.
2. Managers tend to make pricing decisions
based on current costs, current competitor
prices, and short-term share gains rather
than on long-term profitability.

25
LO3
Basing-point
pricing
Chapter 18
Geographic Pricing
FOB origin pricing
Uniform delivered
pricing
Zone pricing
Freight absorption
pricing
http://www.ups.com
Online

LO Chapter 18
263
FOB Origin
Pricing
Uniform
Delivered
Pricing
Zone Pricing
Freight
Absorption
Pricing
Basing-Point
Pricing
Geographic Pricing
The buyer absorbs the freight
costs from the shipping point
(“free on board”).
The seller pays the freight charges
and bills the purchaser an
identical, flat freight charge.
The U.S. is divided into zones, and
a flat freight rate is charged to customers in
a given zone.
The seller pays for all or part of
the freight charges and does not
pass them on to the buyer.
The seller designates a location as
a basing point and charges all buyers the
freight costs from that point.

27
Chapter 18
LO3
Single-Price Tactic
Flexible Pricing
Professional
Services Pricing
Price Lining
Leader Pricing
Bait Pricing
Odd-Even Pricing
Price Bundling
Two-Part Pricing
All goods offered at the same price
Different customers pay different price
Used by professionals with experience,
training or certification
Several line items at specific price points
Sell product at near or below cost
Lure customers through false or misleading
price advertising
Odd-number prices imply bargain
Even-number prices imply quality
Combining two or more products in a
single package
Two separate charges to consume a single good
Other Pricing Tactics

28
Chapter 18
LO 3
An irrevocable
loss of revenue
is suffered
Additional
transaction costs
are incurred
http://www.princesscruises.com
http://www.carnival.com
Online
Consumer Penalties
Businesses Impose
Consumer Penalties If...

29
Chapter 18
Fine - Tuning the Base Price
LO 3

30
Chapter 18
Discuss product line pricing
Product Line PricingLO4

31
Chapter 18
Product Line
Pricing
LO4 Product Line Pricing
Setting prices for an entire line of
products.
http://www.beauty.com
Online

32
LO 4
Substitutes
Neutral
Chapter 18
Relationships among Products
Complementary

33
Chapter 18
Joint Costs
LO4 Joint Costs
Costs that are shared in the
manufacturing and marketing of
several products in a product
line.

34
Chapter 18
LO 5 Pricing during Difficult Economic Times
Describe the role of pricing
during periods of
inflation and recession

35
Chapter 18
InflationLO 5
Cost-Oriented Tactics
High Inflation
Demand-Oriented Tactics

36
LO5
Problems with Cost-Oriented Tactics
§ A high volume of sales on an item with a low profit
margin may still make the item highly profitable.
§ Eliminating a product may reduce economies
of scale.
§ Eliminating a product may affect the
price-quality image of the entire line.
Chapter 18

37
Chapter 18
Cost-Oriented TacticsLO5
u
u
u
Delayed-quotation pricing
Escalator pricing
Hold prices constant, but add new fees

e
e
ic
aPr e s
cr
In
D c
e e
r s
a d
D m
e e a
nd
38
Chapter 18
LO5
Maintaining
a Fixed
Gross Margin
Increased
Production
Costs

39
Chapter 18
Demand-Oriented TacticsLO5
Price
Shading
The use of discounts by
salespeople to increase demand
for one or more products in a line.

40
LO5
Demand-Oriented Tactics
Cultivate selected demand
Create unique offerings
Strategies
to Make
Demand
More Inelastic Change the package design
Heighten buyer dependence
Chapter 18

41
Chapter 18
LO5
Recession
Bundling or Unbundling
Value-Based Pricing

42
Chapter 18
LO5
Offering help
Keeping the pressure on
Paring down suppliers
Supplier Strategies during Recession
Renegotiating contracts

43
Chapter 18
Pricing During Inflation and Recession
LO 5

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Agenda
• Who is involved in pricing decisions?
• Why is pricing so important to the health of the
firm?
• Can firms influence their pricing power?
• What is the nature of a good price?
• How relevant are marginal costs and consumer
surplus in setting a good price?
• How should the comparable alternatives on the
market influence the pricing of a product?
• How can exchange value models be used to set
prices?
• Stretch Question: How are exchange value
models related to market segments?

Pricing Errors Are Costly
• Too high
• Lost profits from lack of volume
• The price is eventually dropped and the company must fight for
market interest and perception repositioning
• Potential allegations of price gouging and unfairness, leading to
public relations and regulatory ramifications
• Too low
• Forgone profit in an attempt to gain volume which may not
come
• Incorrectly set expectations for the product category, making
future price increases being driven against a headwind of
customer expectations
• Ultimately, lost profits, revenues, and a shrinking/irrelevant
firm

Pricing Decisions are Stakeholder
Decisions
• CFO
• Responsible for measuring and reporting
performance
• Almost always involved in pricing decisions
from a quantitative analysis / forecasting
perspective
• General bias towards higher contribution
margins
• Sales & Marketing
• Responsible for promotion, product strategy,
and placement, along with pricing
• Almost always involved in pricing decisions
from a value positioning perspective
• General bias towards discounting and
market share
• Research & Development
• Responsible for developing new products
that customers value
• Technical individuals often are challenged to
understand commercial aspects
• Production
• Responsible for quality, throughput, and
capacity utilization
• General bias towards volume to reduce
overhead allocation
Executives
Customers
Shareholders
CEO

Value Exchange and Profit Capture
• Price is the value that the firm captures in a mutually beneficial
exchange with its customers
• Firm’s reason for existence is to produce value for customers,
value which they exchange for cash
• Customers purchase because they gain value from the product in
excess of the price they pay
• Profit
Profit = Quantity X (Price – Variable Costs) – Fixed Costs
p = Q (P – V) – F
Variable Costs (V)
Fixed Costs (F)
Volume or Quantity Sold (hence the Q)
Price (P)
Profit (p)

Marginal Improvement – Price Has
Impact
• Consider a firm that
improves one of the levers in
the profit equation by 1%,
holding all else constant
• Example:
• P = $5.00
• Q = 200,000
• V = $3.00
• F = $325,000
• Improve either P, Q, V,
or F by 1%
• How does this affect
profit?
• Initial Profitability
p = 200,000 ($5.00-$3.00) -
$325,00
p = $75,000
• Fixed Cost Reduction
– New Fixed Cost = $321,750
– New Profit = $78,250
– Improvement of 4%
• Variable Cost Reduction
– New Variable Cost = $2.97
• Quantity Sold Increase
– New Quantity = 202,000
• Price Increase
– New Price = $5.05

Quantitative & Qualitative
• Quantitative Modeling and Price
Optimization
• Careful selection of model
• Careful treatment of data
(cleansing)
• Careful market segmentation
• Qualitative Modeling
• Potential methods of influencing
willingness to pay
• Relationship to corporate strategy
and industry dynamics
• Customer acceptance to approach
of price discrimination
Finance
Marketing Sales
Economics
Price

Setting Prices with
Exchange Value Models

Boundaries of Price
• There is a range of “right prices”
• Range implies boundaries, upper and lower
• Extremes from standard economics:
• Marginal Cost is the Extreme Lower Boundary
• Consumer Utility is the Extreme Upper Boundary
• Example: Cypher Drug Eluting Stent by Cordis released 2003
• Drug Eluting Stent is a metal “spring” that fits within an artery. Once placed, it expands
the artery to ensure proper blood flow. Pharmaceuticals encoat the stent to reduce
acceptance failure.
• Upon release, the Drug Eluting Stent was considered a revolutionary advancement in
the treatment of coronary disease
• Evolutionary: Marginal improvement to the status quo
• Revolutionary: Breakthrough improvement to status quo, with potentially dramatically
different benefits gained.
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Marginal Cost = Extreme Lower Bound
• Marginal costs are the sellers bottom line.
• Any price below marginal costs leave the seller worse off then they would be without the transaction.
• Any price above it leaves the seller better off.
• Thus, marginal costs is the extreme lower boundary of the “right” price.
• Standard metal stents average unit costs are reported below $150.
• Drug encoated stents average unit costs are estimated at $325.
• Coating a stent with pharmaceuticals is not an expensive challenge adding only a few dollars per stent, yet
pharmaceutical companies routinely charge much more for the technology
• Average unit costs are not marginal costs, they are always higher, hence marginal costs are still below this
metric.
• Since marginal costs are the lower bound of the pricing challenge, using a higher number, the average unit
costs, adds extra caution in setting prices.
• This overly conservative approach is inappropriate for some pricing decisions.
• Should Cordis price the stent near variable costs plus a management acceptable margin of a few
percent?

Consumer Utility = Extreme Upper Bound
• Consumer utility are the buyers bottom line.
• The customer would be worse off if they paid more for a product
than they gained in utility
• Any price below consumer utility would be leave the customer
better off than going without
• What is the utility of a stent? What is the value of life?
• Life is exactly what is at stake with coronary heart disease: strain
on the heart and reduced life span, heart attacks and potential
death.
• Some economists value a life under the assumption that it is equal
to the future earnings of the individual over their lifespan,
discounted back to the present time.
• Yet economics doesn’t capture the value people will pay for one
more day with their spouse, seeing their children and grand
children mature, and being able to participate in life fully,
attending weddings, baby showers, working and being productive,
taking vacations … etc.
• Some philosophers would claim that all life is equally valuable,
and many would claim its value is immeasurable.
• Accepting these limitations, lets make a very frugal and crude
estimate that the benefits delivered though using a stent is
$500,000.
• Should Cordis price the drug eluting stent just below
$500,000?© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Marginal Costs and Consumer
Utility
Extreme Boundaries• From this example, we know only two
extreme boundaries,
• Bottom boundary of marginal cost generously
estimated $325
• Upper boundary of consumer utility frugally
estimated at $500,000
• Clearly, $325 and $500,000 is a wide range,
with the upper bound a factor of 1000 above
the lower bound.
• $400
• $4,000
• $40,000
• $400,000
• Managers need a tighter bound than this for
decision making.
• Blunt force economics of producer cost and
consumer utility alone is insufficient.
Consumer Utility
$500,000
Marginal
Costs
Price Floor
$325
Range of
Potential Prices
lies between the
Extreme
Boundaries

Competing Alternative and Differential Value
Narrow Boundaries
• Marketing Strategy
• Products are valued because they enable a customer to do
something, accomplish a goal, from that product.
• Utility is derived from Goal accomplishment
• Prior to the existence of the product, most consumers found an
alternative means of accomplishing the same goal
• What are those alternatives?
• How much better can they achieve that goal, and perhaps others
simultaneously, from the product?
• Narrower band is defined by the competing alternatives
and differential value

Competing Alternatives / Substitutes
• Competing offers are often readably identifiable, and form a reference price.
• Reference Price = Price of nearest comparable offer
• Substitutes are sometimes more challenging to identify, but they always exists.
• Substitutes: any alternative means of achieving a similar set of benefits
• When possible, use more direct competitors to consider when modeling price decisions
• For Cordis
• Cordis produced a standard stent, priced roughly at $1050 per unit.
• Standard stent procedures resulted in restenosis (re-clogging of the artery) 25% of the time
• The Drug Eluting Stent by Cordis reduced restenosis to 5% in clinical trials
• Prior to stents, bypass surgery was common. Prior to bypass surgery, there were dietary changes, bed rest, and other
approaches and pharmaceuticals to manage the challenge. Substitutes always exist.
• The standard stent forms the most relevant competing alternative for the drug eluting stents
• The standard stent is clearly an inferior alternative, since it has a higher rate of restenosis, as such the drug eluting stent
could likely be priced higher, but how much higher?
• Inferior Alternative: competing alternative that produces similar benefits to the one with the pricing challenge, but overall
less consumer utility

Differential Value
• Differential value is the change in consumer utility that a product in comparison
to its comparable alternative
• Exchange value is the price of the competing alternative adjusted for the
differential value
• The drug eluting stent clearly delivers more benefits than standard stents.
Quantify it with a model.
• The stent is a component in a larger process.
• Implanting a stent is a roughly $12,000 operation, of which the standard stent is
only a $1050 component.
• Operation cost = $10,950
• Standard Stent Cost = $1050
• Assume the procedure must be repeated 25% of the time due to restenosis
• Total Maximum Expected Cost
($12,000) + ($12,000) 25% + ($0) 75% = $15,000
Repeat the Procedure
$12,000, 25%
Don’t Repeat the Procedure
$0, 75%
Original Procedure
$12,000, 100%
Expectation Value = $15,000
$12,000(100%) + $12,000(25%) + $0(75%)

Differential Value
• The Drug Eluting Stent reduces restenosis to 5%
• Repeat the Model, but this time let the price of the stent be unknown
and the expectation cost be held constant to that of the nearest
competing alternative
• Solve for the unknown, using algebra.
• Total Maximum Expected Cost
$15,000 = ($10,950 + X) + ($10,950 + X) 5% + ($0) 95%
• X = [$15,000 – ($10,950)1.05]/1.05
• X = $3,340
• Exchange Value of the new Drug Eluting Stent at $3,340
• This price leave the patient economically equally well off as with the lower
price for the lower quality competing alternative
• Ignores quality of life issues, the risk of a second failure, etc. It is a
“conservative estimate”
Repeat the Procedure
$ 10,950 + X, 5%
Don’t Repeat the Procedure
$0, 95%
Original Procedure
$10,950 + X, 100%Expectation Value = $15,000

Exchange Value Model for
Drug Eluting Stent by Cordis
• Exchange value = Price of Alternative
+ Differential Value
• $3,340 = $1,050 + DV
• Differential Value is a whopping
$2,290
• Consumer Surplus is the difference
between the price paid and the total
consumer utility
Consumer Surplus
$$$$$
Exchange
Value
$3,340
Reference
Value
$1050
Differential Value
$2,290
PriceofComparable
Alternative
Maximum
PotentialPrice
Consumer
Utility
$500,000
Marginal
Costs
Price Floor
$325

Modeling and Strategic Thinking
Improves Pricing
• Reduce extreme and to narrow boundaries to improve pricing
• $325 to $500,000, the Marginal Cost and Consumer Utility, or Extreme Boundaries
• $1050 to $3,340, the price of the nearest competing offer and the exchange value
• Strategic thinking reduced the range significantly, from a factor of 1000 to now near 3
• What price did Cordis release Cypher?
• $3195, largely from negotiations with insurance companies and governmental bodies
• $ 3195 is miniscule compared to the consumer utility
• $ 3195 is huge compared to the marginal cost
• $ 3195 is also high above the inferior competitor yet less than the exchange value
• Still, $3195 is much higher than what doctors are used to, at $1050 per stent? Would consumers
balk at this new price as unfair? No.
• In the first year of its release, the Cypher Drug Eluting Stent took 60% US market share, a dramatic
improvement from the 10% market share Cordis had.
• Financial success for Cordis, rewarding investors and employees collectively.
• Added benefits for consumers at a better price than the comparable alternative even after adjusting for the
differential value.

Exchange Value Model
Consumer Surplus
$$$$$
Exchange
Value
Reference
Value
Differential Value
PriceofComparable
Alternative
Maximum
PotentialPrice
Consumer
Utility
Marginal
Costs
Price Floor
Contribution
Margin
Price

Summary
• Model your value add with Exchange Value Models to determine the boundaries of a reasonable
price
• Consumer Utility
• Marginal Cost
• Price of Nearest Alternative
• Differential Value
• Exchange Value
• Use Exchange Value Models to Identify a rational range for your price
• Use Exchange Value Models to Communicate Pricing decisions with CFO / Sales Team
• Use Customer Utility Models to Communicate Value with Customers
• Accept that different customers have different perspectives on value. Use differences in valuation
to drive price segmentation

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