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Pricing Strategy

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This presentation provides an in-depth discussion on Pricing Strategy. Topics include:
*Skimming vs. Penetration
*Consumer Adoption Curve
*Advantages and Disadvantages
*Pricing Approach
*Price Curve Analysis
*Price Sensitivity Analysis
*Pricing Tactics

Also included is a Pricing Sensitivity Financial Model (Excel document).

Published in: Business, Economy & Finance
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Pricing Strategy

  1. 1. 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 Find our other documents at http://flevy.com/seller/learnppt
  2. 2. 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
  3. 3. 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
  4. 4. 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
  5. 5. 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)
  6. 6. 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? • What is the price point to maximize share? • What is the price point to capture the Early Market? Revenue: $XXXM Price: $XXX Σ
  7. 7. 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
  8. 8. 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
  9. 9. 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
  10. 10. 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
  11. 11. 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)
  12. 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 %.
  13. 13. 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
  14. 14. 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
  15. 15. 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
  16. 16. 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. RELATED PRICING TACTIC(S) • Value Pricing
  17. 17. 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. RELATED PRICING TACTIC(S)
  18. 18. 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. RELATED PRICING TACTIC(S) • Loss Leader Pricing • Price Discrimination • Marginal Cost Pricing
  19. 19. 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. RELATED PRICING TACTIC(S) • Loss Leader Pricing • Price Discrimination • Predatory Pricing
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