The document discusses how companies can use price promotions effectively. It explains that price promotions segment customers by price sensitivity, increasing sales by attracting brand switchers and growing the market. Well-designed promotions are targeted, temporary, and special to minimize drawbacks like reducing customers' willingness to pay full price. Common examples include coupons, rebates, and sales. Companies should evaluate promotions based on costs, redemption rates, and whether sales increases exceed costs.

1. Tim J. Smith
Pricing Strategy: Setting Price Levels,
Managing Price Discounts, &
Establishing Price Structures
PowerPoint by
Tim J. Smith, PhD
Managing Principal, Wiglaf Pricing
Adjunct Professor of Marketing & Economics, DePaul University
© 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.

2. Chapter 7
Price Promotions
How Holiday Sales, Coupons, Rebates
and Other Forms of Price Promotion
Impact Profitability
© 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.

3. Agenda
• How does a price promotion improve profitability?
• Do price promotions mostly grow the market or grow the share
within the existing market?
• Are price promotions a good means of price segmentation?
• What customer behavior and psychological influences are affected
by price promotions, and are these good for the firm?
• How should a price promotion be designed?
• What are common examples of price promotion?
• How should an executive evaluate the economic efficiency of a
price promotion?
• Stretch Question: How many price promotions are just one too
many ?
© 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.

4. • Targeted discounts enable a
company to charge different prices
to different customers
– Allows the price sensitive to
purchase at a lower price
– Keeps the utility sensitive
purchasing at the higher “list”
price
• Incremental sales at a discounted
price above marginal unit cost
enhances profitability Quantity
Price
Revenue w/o Discounting
Additional Revenue
Gained from Discounting
Demand
Marginal Unit Cost
© 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.
Discounting is Price Differentiation

5. Promotional Discounts Grab Share
• Promotional Discounts tend to increase sales volume
• The increase in volume will come
– Primarily from capturing share from you competitor
– Secondarily from growing the overall market
• Note: Short term reactions to downward price movements tend to
be larger than long-term reactions
© 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.

6. • Prospect Theory
– People place more weight on
“pain” than on an equal “gain”
• To help people appreciate the
gain
– Unbundle the sources of gain
and highlight them
– Bundle the sources of pain
Discounts are a form of
Extra Unbundled Gain
Surcharges are a form of
Extra Pain
Losses
B
Value -
Value +
Gains
A
Value Function
© 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.
Promotional Discounting benefits
from Prospect Theory

7. Negative Effects of Promotional
Discounting
• Imperfect segmentation hedge
– Price promotions can provide unnecessary price
concessions to customers that otherwise would have
paid the full price
– Dilution / cannibalization of otherwise higher margin
sales
• Customer Churn
– Price promotions improve profitability by encouraging
brand switching among customers. If customers who
switch are not captured, the result is simply a high-
customer-acquisition cost with the loss of customer
retention profits
© 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.

8. • Consumer price expectations can be
modeled as an exponential
smoothing of current and last
observed prices
RPt = aPt-1 + (1-a)Pt
RPt = Reference Price
Pt-1 = Price previously observed
Pt = Price currently observed
• Promotional discounts reset price
expectations to a lower level,
dampening demand in future periods
when the product is offered at full
price
• Full price periods will increase price
expectations, increasing demand
during promotional periods
Time
Price
Reference
Price
Observed
Price
a = 0.925, peanut butter
a = 0.83 orange juice
© 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.
Resets Price Expectations

9. Increases Price Sensitivity
• Price promotions enhance buyer sensitivity to price
– Promotions highlighting brand and price alone increase
price sensitivity
– Marketing communications highlighting features and
benefits increase utility sensitivity and decrease price
sensitivity
• Customers that tend to be sensitive to advertising also
tend to be more price sensitive
• Market growth from promotional discounting is likely
to contribute to the size of the price sensitive segment
© 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.

10. • Excessive promotional discounts
can make list prices irrelevant
– MRO and Office Supplies
• Promotional discounts in a
Good/Better/Best lineup affect
consumer tradeoffs
– Cross Product Cannibalization
• Discounting high-end products
targeting utility sensitive
customers may provide
unnecessary price concessions to
this segment
– Loss of Value / Price Position
List
Price
Invoice
Price
Net
Price
Divergent
Price to Value
Convergent
Price to Value
Constant
Price to Value
PriceWaterfalls
© 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.
Impacts Pricing Integrity

11. Promotional Design
• Targeted
• Temporary
• Special
• Irregular
© 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.

12. Examples
• Couponing
– Manufacturers coupons to induce trial
– Store coupons to induce patronage
– Key metric – portion of customers from couponing
resulting from incremental sales rather than displacing
normal sales
• Trial Offers
– Effective with products that will be purchased frequently,
have a low incremental production cost, and have benefits
that are self-evident after one use
• Rebates
– Can be used with a high degree of targeting
© 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.

13. Evaluating Promotions
• Consider
– Cost (distribution, process, etc)
– Redemption Rates
– Discount Depth
– Sales volume induced
– Type of customer redeeming the promotion
• Conduct a Break Even Incremental Sales per
Redemption analysis
© 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.

14. Coupon Face Value $ 0.50
Processing Fee $ 0.07
Price $ 3.00
Margin 40%
Newspaper In-Store
Coupons Distributed 1,000,000 62,500
Cost / 1000 Distributed $ 10 $ 100
Distribution Costs (Coupons Distributed X Cost / 1000 Distributed) $ 10,000 $ 6,250
Redemption Rate 5% 80%
Coupons Redeemed (Coupons Distributed X Redemption Rate) 50,000 50,000
Redemption Costs (Coupons Redeemed X (Face Value + Processing Fee)) $ 28,500 $ 28,500
Total Campaign Costs ( Distribution Costs + Redemption Costs ) $ 38,500 $ 34,750
Cost per Buyer (Total Costs / Coupons Redeemed ) $ 0.77 $ 0.70
Total Campaign Profit ( Coupons Redeemed X Price X Margin ) $ 60,000 $ 60,000
ROI ( (Incremental Profit – Total Costs)/Total Costs ) 36% 42%
Break-even Incremental Unit Sales per Redemption (Total Costs)/Total Profits) 64% 58%
© 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.

15. Summary
• Price promotions are a form of price segmentation in which prices are reduced for
those with a lower willingness to pay and regular prices are offered to those with a
higher willingness to pay.
• Price promotions generate increased sales primarily through encouraging brand
switching and secondarily through increasing the size of the market.
• From prospect theory, we understand that part of the power of price promotions
to drive sales derives from consumers perceiving price reductions as a form of
added gain on top of receiving the product, in exchange for the pain of payment.
• Price promotions can have asymmetric effects on profitability between competing
firms where those products that are able to engender stronger brand loyalty are at
a strategic advantage.
• Because price promotions focus the customer’s attention on price, they can also
increase price sensitivity.
• In general, price promotions should strive to be targeted towards marginal
customers. Other design criteria for price promotions include a desire for them to
be temporary, special, and irregular.
• Price promotions include specially marked packages, coupons, trial offers, trade
deals, promotional sales, discounts, promotional bundles, and rebates.
© 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.