The document outlines various concepts related to customer relationship management, particularly focusing on Customer Lifetime Value (CLV) and sales strategies like bundling. It discusses the methodologies to compute CLV based on customer behavior and profitability, along with examples for better understanding. Furthermore, it highlights the strategic implications and benefits of analysis, such as enhancing customer retention and optimizing marketing efforts.

1. https://www.azed.gov/oelas/elps/
Use this to see the English Language Proficiency Standards of
Arizona-Pick a grade level
https://cms.azed.gov/home/GetDocumentFile?id=54de1d88aade
be14a87070f0
http://www.corestandards.org/ELA-Literacy/introduction/how-
to-read-the-standards/
how to read standards
Week 04
Acquisition and Customer Lifetime Value (CLV)
https://www.smh.com.au/politics/federal/nbn-customers-face-
higher-prices-or-poorer-internet-connection-audit-warns-
20190813-p52go7.html
Customer Relationship Management?
CRM is the process of carefully managing detailed information
about individual
customers and all customer touch points to maximize customer
loyalty.
Now closely associated with data warehousing and mining

2. Relationship
Relationship
Identifying good customers: RFM Model
Recency
Frequency
Monetary Value
Time/purchase occasions since the last purchase
Number of purchase occasions since first purchase
Amount spent since the first purchase
R
F
M
Total RFM Score: R Score + F score + M Score
CASE: Database for BookBinders Book Club

3. Predict response to a mailing for the book, Art History of
Florence, based on the
following variables accumulated in the database and the
responses to a test mailing:
f DIY books
Recency
Frequency
Monetary
Example: RFM Model Scoring Criteria
R
Months from last
purchase
13-max 10-12 7-9 3-6 0-2
Score 5pts 10 15 20 25
F

4. Frequency > 30 21-30 16-20 11-15 0-10
Score 25pts 20 15 10 5
M
Amount
purchased
> 400 301-400 201-300 101-
Score 50 45 30 15 10
Implement using Nested If statements in Excel
Decile Classification
• Standard Assessment Method
• Apply the results of approach and
calculate the “score” of each individual
• Order the customers based on “score”
from the highest to the lowest
• Divide into deciles
• Calculate profits per deciles
Customer 1 Score 1.00
Customer 2 Score 0.99
….
Customer 230 Score 0.92
Customer 2300 Score 0.00

5. Decile1
Decile10
…
..
…
..
Output for Bookbinders club
Decile Score RFM No. of Mailings Cost of mailing RFM Units
sold RFM Profit
10 17.6% 5000 $3,250 783 $4,733
20 34.8% 10000 $6,500 1,543 $9,243
30 46.1% 15000 $9,750 2,043 $11,093
40 53.4% 20000 $13,000 2,370 $11,170
50 65.2% 25000 $16,250 2,891 $13,241
60 77.9% 30000 $19,500 3,457 $15,757
70 83.3% 35000 $22,750 3,696 $14,946
80 91.7% 40000 $26,000 4,065 $15,465
90 97.5% 45000 $29,250 4,326 $14,876
100 100.0% 50000 $32,500 4,435 $12,735

6. Note: Market Potential = 4435 units and margin = $10.20
Leaky bucket
New customer
acquisition
Purchase increase by
current customers
Purchase decrease by
current customers
Lost customers
Lost customers
Credit Card Rewards Programs Have Had a
Direct Impact on Lowering Churn
Rewards Cards and Card Attrition
Reward Card
Penetration
Industry Attrition
Rate
%
o

7. f
cr
ed
it
c
ar
d
h
o
ld
er
s
w
it
h
re
w
ar
d
s
ca
rd
2000 2002 2003 2004 20052001

8. 0%
10%
20%
30%
40%
50%
60%
80%
70%
cred
it card
attritio
n
35%
30%
25%
20%
15%
10%

9. 5%
0%
Source: Celenet Analysis
40%
50%
56%
62%
69%
45%
Reward Card Penetration
Card Industry Attrition Rates
30%
26%
24%
21%
29%
28%
Customer Lifetime Value (CLV)

10. “present value of a stream of revenue a customer produces”
Focus on long-term relationship, not a single transaction
relationship value
cost savings
price premium
demand increase
base profit
acquisition cost
Time
A
n
n
u
al
P
ro
fi
t
CLV: Customer Lifetime Value
Total Lifetime

11. Value of
Customer
Economic Value:
(Risk Adjusted) Revenue
Flow Less Cost-to-Serve
Relationship Value:
Reference
Referral
Learning
Innovation, etc.
Economic Lifetime Value Calculation
(Expected) Cost to Serve Cash Flow
Expected Profit Cash Flow
Risk Adjustment
Risk Adjusted Cash Flow
(minus)
Loyalty
(Expected) Revenue Cash Flow

12. CLV calculation (finite lifetime)
• Assume a few parameters re a customer
• She generates revenue, R and costs C amount of marketing,
support and
service each period. Then, her margin is (R - C) per each
period. Note that R
and C may change across periods.
• She has a probability of staying with the company, p, i.e.,
retention rate and
churn rate of (1-p).
• Discount rate is r and initial acquisition cost is AC.
• She stays with the company for the next N periods (e.g.,
years).
• Then, her CLV becomes
CLV calculation (Infinite lifetime)
• Assume that a customer stays with the company for an infinite
economic life, i.e., .
• Also assume that R and C are relatively fixed across periods.
• Then, her CLV becomes

13. Example CLV calculation
• Assume two customer segments
Frequent Buyer Occasional Buyer
Acquisition Cost (AC) $17.50 $17.50
Service Cost (C) $6 $2 (first period $6)
Revenue (R) $20 $16
Discount Rate (r) 10% 10%
Retention Rate (p) 75% 50%
Break-Even Analysis
Frequent buyers become profitable in two (2) years whereas
Occasional buyers become profitable in three (3) years
Period 1 2
Revenue $20 $20
Retention Rate 100% 75%
Service Cost $6 $6
Profit Margin $14.00 $10.50
Cumulative (net of AC) ($3.50) $7.00

14. Period 1 2 3
Revenue $16 $16 $16
Retention Rate 100% 50% 25%
Service Cost $6 $2 $2
Profit Margin $10.00 $7.00 $3.50
Cumulative (net of AC) ($7.50) ($0.50) $3.00
Frequent Buyers Occasional Buyers
CLV for frequent buyer
Period 1 2 3 4 5 6 7 8 9 10
Revenue $20 $20 $20 $20 $20 $20 $20 $20 $20 $20
Survival Rate 100% 75% 56% 42% 32% 24% 18% 13% 10% 8%
Service Cost $6 $6 $6 $6 $6 $6 $6 $6 $6 $6
Profit Margin $14.00 $10.50 $7.88 $5.91 $4.43 $3.32 $2.49
$1.87 $1.40 $1.05
Discount Rate 10% 10% 10% 10% 10% 10% 10% 10% 10% 10%
Discount Factor 0.91 0.83 0.75 0.68 0.62 0.56 0.51 0.47 0.42
0.39
Discounted margin $12.73 $8.68 $5.92 $4.03 $2.75 $1.88 $1.28
$0.87 $0.59 $0.41

15. Cumulative (net of AC) ($4.77) $3.90 $9.82 $13.86 $16.61
$18.48 $19.76 $20.63 $21.23 $21.63
CLV for infinite lifetime = $ $ . .
CLV for Occasional buyer
Period 1 2 3 4 5 6 7 8 9 10
Revenue $16 $16 $16 $16 $16 $16 $16 $16 $16 $16
Survival Rate 100% 50% 25% 13% 6% 3% 2% 1% 0% 0%
Service Cost $6 $2 $2 $2 $2 $2 $2 $2 $2 $2
Profit Margin $10.00 $7.00 $3.50 $1.75 $0.88 $0.44 $0.22
$0.11 $0.05 $0.03
Discount Rate 10% 10% 10% 10% 10% 10% 10% 10% 10% 10%
Discount Factor 0.91 0.83 0.75 0.68 0.62 0.56 0.51 0.47 0.42
0.39
Discounted margin $9.09 $5.79 $2.63 $1.20 $0.54 $0.25 $0.11
$0.05 $0.02 $0.01
Cumulative (net of AC) ($8.41) ($2.62) $0.01 $1.20 $1.74 $1.99
$2.10 $2.15 $2.18 $2.19
��� =
$16 − $2
1 − 0.5 + 0.1

16. − $17.50 −
$16 − $2
1 + 0.1
−
$16 − $6
1 + 0.1
= $2.2
• CLV analysis allows firms to understand the potential value of
customers and prompt firms to learn more about the patterns of
individuals or groups of customers. The firms can
• devise optimal strategies for each customer,
• eliminate wasteful costs,
• create a long-term perspective of potential relationship with
customers,
• tailor strategies to deal with different customer segments that
exhibit
differences in buying characteristics at any given time, and
• customize different strategies for the same customer
depending on the stage
of relationship between the customer and the firm.
Benefits of CLV analysis
• “Firing” Customers
• Raise prices for the less profitable products.

17. • Best customers typically outspend others considerably, with a
ratio of 15 to 1
in some industries.
• Rewarding Customers
• Discount vouchers or preferential services for best customers
• Identifying Cross-Selling Opportunities
• With detailed information about the interests and shopping
patterns
• Forecasting Innovation Value
• Understand the long-term profitability of an innovation
• CLV can be combined with product diffusion model
Strategic Implications of CLV analysis
Blue Ocean Strategy, if time permits
• Virgin Mobile Case (Workshops)
• Case report is due at 3pm on Friday, 23 August.
• Submit an electronic copy via Turnitin on UTSOnline
• NO Lecture unless demanded
Next week
Week 11 – Price Bundling

18. Company uses Bundles
Another Bundling: Season Tickets
•
Packages of banking and insurance products, e.g., “select” suite
of
products, Fidelity’s Cash Management & Brokerage accounts.
• Vacation package –
return airline ticket, rental car, & hotel room for
six nights
• Home‐delivered pizza (Pizza + delivery)
• Processor, hard disk and memory?
•
Not separate for end users, so it is not a bundle of products, but
a bundle of
components (see conjoint).
• Laptop plus carrying bag
Bundling examples
• Capitalize on cost efficiencies or economies of scale
• Use natural consumption complementarity

19. • Increase sales in the same transaction to customers
• Create switching costs
• Capitalize on locked‐in customers
• Create a powerful differentiator
Reasons for Bundling
• Bundling is the sale of two or more separate
products in a single
package
two main types:
(1) Price Bundling
(2) Product Bundling
Bundling?
• The integration and sale of two or more separate products or
services* at any price.
Integration provides at least some consumers with added value a
nd
often this value can be substantial
* Each product should have its own market independent of other
products in the bundle
What is Product Bundling?

20. • Product bundling creates added value
for consumers over and above the
additive value of bundled items
• Reduced risk (mutual funds instead of individual stocks)
• Non‐duplicating coverage (one‐stop insurance)
• Convenience
(one bill for a telephone plus internet plus cable TV plan)
• Seamless interaction (a suite of software applications)
Product Bundling
The sale of two or more separate products or services* in a pack
age
at a discount, without any integration of the products
* Each product or service must have its own market that is
independent of other items in the bundle
What is Price Bundling?
Pizza Delivery
• Price bundling does not create any added value for consumers
(beyond what is offered by items in the bundle)
• Reservation price* for the bundle = sum of the conditional
reservation prices** of the separate products in the bundle
• *Reservation price = consumer’s maximum willingness‐to‐pay

21. •
**Conditional reservation price = reservation price of the produ
ct,
conditional on the consumer buying the other product or product
s
• Six pack of beer, Combo meal, Season ticket
• What is the purpose of price bundling?
Price Bundling
Price vs. Product Bundling
Price bundling is primarily
a pricing and promotional
tool, product bundling is a
strategic marketing activity.
1
Price bundling can be
deployed easily, at short
notice, and for a short
duration
• Creative marketing activity to take
advantage of lower incremental
cost of sales
2
Product bundling is a long‐
term differentiation
strategy; often approached
from a new product
development perspective

22. 3
Forms of Price Bundling
Pure bundling: Only the
bundle is offered by the
firm. Products can’t be
purchased individually
•This approach is called “Tying”
•Basic cable package, magazine
01
Mixed bundling: Both
the bundle and the
individual products are
offered for sale. The
customer can choose
02
Unbundling: Only the
separate products are
offered, there is no
bundle
03
•
Price bundling enables to transfer consumer surplus from produ
ct A
to product B.

23. Economic Value of Price Bundling
WTP Product
A
WTP Product
B
Price for
products
A and B
CS Product A
WTP
A
Price
A> =
Purchase A
WTP
B
Price
B< =
No
Purchase B
WTP
A+B
Price
A+B> =

24. Purchase
A+B
•
Imagine a symphony orchestra that is preparing a short concert
series
with 2 programs (two different events). There are four potential
audience segments of equal size with different music tastes.
•
Evaluate the consequences of offering a single ticket for the con
cert
series either in addition to, or in place of, offering tickets for ea
ch
concert separately.
Concert Patron Problem
•
Assume one concert patron of each type (or equal segments of e
ach
type)
• What will happen if only separate tickets are offered?
•
Candidate prices to charge for each concert are $5, $20, $40, an
d $45
• Corresponding demands = 4, 3, 2, and 1 tickets per concert
• Revenue maximizing price = $40 (why?)
• Total revenue for the two concerts = $160

25. Unbundled Strategy: Offer Only Separate
Tickets
• What will happen if only combined ticket is offered?
•
Candidate prices to charge for combined ticket are $50 and $60
• Corresponding demands = 4 and 2 tickets
• Revenue maximizing price = $50 (why?)
• Total revenue for the two concerts = $200
• Selling a pure bundled ticket increases revenue ($160 vs $200)
Pure Bundled Strategy: Offer Only
Combined Ticket
•
This is the revenue maximizing strategy: Offer a ticket for the s
eries
($60) and single tickets for each concert at $45 (why?)
•
Revenue = $60 (Romantic) + $60 (Neo‐classical) + $45 (Tchaik
ovsky‐
lover) + $45 (Sophisticate) = $210 (vs $160 vs $200)
Mixed Bundled Strategy: Offer Combined
Ticket & Single Tickets
•
Unbundled pricing: If customers display similarity in their valu
ations

26. •
Pure price bundling: If market has two (or more) customer grou
ps
with dissimilar (negatively associated) component valuations
• In this case, bundling becomes “selective discounting”
• If the market is characterized by a combination of customers –
both
those with “extreme” preferences and those with “balanced”
preferences (seeing the products as equally valuable) – mixed
bundling is likely to be the best concept
• Single price is as high as those extreme’s WTP
Lessons from the Concert Patron Problem
Microsoft In‐class exercise
19
Suppose that Microsoft produces Word and Excel each at zero m
arginal cost
(but very high fixed costs). Further suppose that the demand for
these
products is characterized by five distinct and equal‐sized custo
mer segments as
described in the following table:
1) What are the optimal prices
for Microsoft to charge for
Word and Excel if it only sells
the two products

27. separately?
2) What is the optimal price for
Microsoft to charge for both
if it only sells the two in a
bundle?
3) What are the optimal prices
for a mixed bundling
strategy?
What if segment sizes are different?
Price bundling and Behavioral
Economics
21
•
Transaction decoupling: Match frequency of price presentation
and
payment to frequency of consumption
•
Backfiring effects from categorical reasoning: Be cautious when
combining bundles that have products or services of different va
lues.
The high‐value item will be devalued by the low‐value item if y
ou are
not careful.

28. • Partitioned pricing: Understand the pros and cons of offering
partitioned prices vs. all‐inclusive prices. Partitioning results in
under‐
estimation and focus on secondary differentiated features of the
product.
22
Price bundling and behavioral economics
Transaction Decoupling
Bundling price and payment leads to a dissociation or “decoupli
ng” of
transaction costs and benefits
• Reduces customer’s attention to sunk costs
•
Decreases the customer’s likelihood of consuming a paid‐for ser
vice
•
Potentially reduces the likelihood they will buy the product agai
n
Mary & Bill join a health‐club
•
Bill pays $1,200 for a year, billed and paid annually, Mary selec
ts the $100 per month
plan, billed and paid monthly.
•
Mary is more likely to use the membership, and more likely to r
enew.

29. 24Source: Gourville & Soman, HBR, September 2002
• Price bundling masks the individual item’s cost, reducing the
likelihood of its consumption at the correct time.
•
Season tickets “hide” the cost of individual tickets. Eventually,
less renewal.
•
People tend to consume products when awareness of price and t
he
“pain of payment” is top‐of‐mind.
• Customers’ perceptions of price determine their likelihood of
consuming paid‐for products. When people pay with credit card
s,
they’re less likely to remember the cost –
or consume the product. At
one theater, the no‐show rate for credit card customers was 10 ti
mes
that for cash customers.
Implication of Transaction Decoupling
Backfiring effects from categorical
reasoning
The Dieter’s Paradox

30. Random
assignment to one
of two groups
Estimate the
number of
calories you
consumed
Chernev
(2011). The Dieter’s Paradox, Journal of Consumer Psychology
The Dieter’s Paradox
Random
assignment to one
of two groups
711 calories
Chernev
(2011). The Dieter’s Paradox, Journal of Consumer Psychology
28
The Dieter’s Paradox
Random
assignment to one
of two groups
711 calories

31. 615 calories
Chernev
(2011). The Dieter’s Paradox, Journal of Consumer Psychology
29
Source: This discussion is from Chernev
(2011). The Dieter’s Paradox, Journal of Consumer Psychology
Chernev
(2011). The Dieter’s Paradox, Journal of Consumer Psychology
Price = $2,299 in each case
Key Takeaway: The popular pricing strategy of adding premium
s to make core products appear
more attractive can hurt rather than increase sales.
Source: Brough, Aaron and Alexander Chernev
(2012), “When Opposites Detract: Categorical Reasoning and S
ubtractive
Valuations of Product Combinations” Journal of Consumer Rese
arch (August)
How to Bundle Without Reducing Value

32. Avoid combining a
cheap item with an
expensive item and
promoting this mixed
package. People will
focus on the cheap item
which will drive bundle
value down.
1
If you are mixing
products with different
values, establish the
value of the individual
items first, and
emphasize the most
expensive one.
2
Take a lesson from
infomercial producers
and emphasize the
additive nature of
bundled items.
3
Focus on non‐price
attributes of the
product (e.g., durability
or comfort) . This will
reduce the devaluation
occurring from mixed‐
value items.
4

33. 1. Avoid combining cheap item with
premium item
2. Individual items first, emphasize the most
expensive one
3. Emphasize additive nature of bundles
38
39
40
41
Price Partitioning
Should the offered price be presented as an all‐inclusive price o
r a list of itemized

34. prices?
What is
Partitioned
pricing?
•
Partitioned pricing is the method of presenting the price to the
consumer as a list of mandatory charges attached to various feat
ures
of an offer.
• The alternative is to charge an “all‐inclusive” price
• Examples:
•
$34 for shirt + $5.95 shipping and handling vs. $39.95 (includes
free shipping)
•
$1,295 for Caribbean cruise + $140 mandatory port charges + $
560 for meal
plans VS. $1,995 all‐inclusive for the trip
• Distinction coincides partially with AYCE vs. à la carte
pricing
•
In à la carte pricing, consumer has the choice of whether to pick
additional
features (or stick with the base offer). In partitioned pricing, all
features are
mandatory, there is no choice

35. Partitioned Pricing
44
Source: TripBadger.com
Partitioned pricing: RESORT FEE
Source: TripAdvisor review of Grand Cayman Beach Resort by
Kendal UK on November 30, 2014
Partitioned pricing
Source: The Consumerist Guide to Understanding your Comcast
Bill
Partitioned pricing
Source: The Consumerist Guide to Understanding your Comcast
Bill
Partitioned pricing
Source: Ars Technica, January 31, 2018

36. All‐inclusive pricing
All‐inclusive prices
• Reasons for using all‐
inclusive pricing
• Simple
• Just one number to
communicate
• Facilitates consumer choice
• Increases consumer
satisfaction with pricing
Benefits of Partitioned prices
• What does the research say?
• Strategy increases demand for products (Morwitz et al. 1998)
•
Large proportion of consumers do not account fully for surcharg
es and
underestimate the total product cost
•
They anchor on the larger price item in the set and do not accou
nt for the
remaining smaller items
•
Breaking down an expense into separate components makes pric

37. ing more
transparent, enhancing perceptions of fairness, seller trustworthi
ness, and
likelihood of purchase (Xia and Monroe 2004)
•
It focuses consumer attention on secondary features of the offeri
ng (to which price
is attached), highlighting dimensions of differentiation
that may otherwise go
unnoticed (Bertini and Wathieu 2008)
Underestimation under partitioned pricing
Pricing
Method
Presentation
Format
Recalled
Price
All‐inclusive price $82.90 $83.90
Base price + surcharge in
dollars
$69.95 + $12.95 $80.36
Base price + surcharge in
percentage terms
$69.95 + 18.5% $75.43

38. Pricing
Method
Presentation
Format
All‐inclusive price $82.90
Base price + surcharge in
dollars
$69.95 + $12.95
Base price + surcharge in
percentage terms
$69.95 + 18.5%
• Case 5: Culinarian Cookware (18 Oct)
• Final case write‐up & summary
•
Final Executive Summary (20%, Due: 5pm Friday 25 Oct, 2019)
• Read Portfolio Summary Note instructions from UTSOnline.
Next weeks
Week 09 – Price Discovery

39. The Value Pricing Framework
Customer Value
Customer Value represents the
total amount of money that
the customer is willing to pay
for the benefits received from
the product.
1
Customer benefits are of two
types: Functional, the main
reason why the product was
purchased, and Hedonic or the
emotional benefits the
customer receives. Together,
they drive customer valuation
of the product or service.
2
Customer value usually sets
the ceiling or the highest
possible price that can be
charged for the product.
3
Functional and Hedonic Benefits
More likely to be related to costs

40. and to be considered in pricing
May cost very little yet customers
may be willing to pay a lot for
these benefits. Managers often
tend to ignore them
Value and Willingness‐To‐Pay
Mistake: Cost‐Plus Pricing
•
With a “cost‐plus” mentality these products appear to be over pr
iced. People value intangible benefits such as
comfort, speed, convenience and indulgence, and therefore are p
repared to pay significant amounts for it.
The 8 most ‘overpriced’ products?
Product characteristics on Customer Value
Market Research results
source: Simon‐Kucher Project Example

41. The Customer Value Grid
Survey‐based method
Step 1): Unbundle the product into its features
Step 2): Understand the hedonic and functional
benefits derived by customers from each product
feature
Step 3): Ask customers to quantify the benefits in
economic terms, that is, how much they are willing to
pay for each benefit
Step 4): Add the economic value of each benefit to
calculate the product’s total economic value to the
customer.
•
Answer the questions: What is the price that customers are willi
ng
to pay?
• Three methods
•
Conjoint Analysis (indirect method using tradeoffs between pric
e and other
attributes)
• Van Westendorp Price Sensitivity Meter (PSM)
• Becker DeGroot Marschak procedure
Price Discovery Methods

42. •
For all methods to answer the question: “What is the price that
customers are willing to pay?”
• Consider using the following best practices
• Choose respondents carefully –
requires careful prior segment definition &
target selection
•
Describe product concept in detail. If available, show the produ
ct and let
respondents try it or use it
•
Simulate the customer purchase decision as well as you can (e.g
., the
process, the use of reference prices)
• Try to make the procedure “incentive‐compatible” –
Respondents achieve
the best outcome by acting according to their true preference.
Price Discover Method: Best Practices
Van Westendorp Price Sensitivity Meter
(PSM)
Price discovery
•

43. Respondents are asked direct questions about the expected price
in
different contexts. The ‘real’ willingness‐to‐pay usually is close
to
what is considered to be an expensive price
• Example:
The Van Westndorp Price Sensitivity Meter
Set of four questions included as part of a concept test
1.
At what price do you begin to perceive the product as so expens
ive that
you would not consider buying it? (Too expensive)
2.
At what price do you begin to perceived the product as so inexp
ensive
that you would feel the quality cannot be very good? (Too inexp
ensive)
3.
At what price do you perceive that the product is beginning to g
et
expensive, so that it is not out of the question, but you would ha
ve to
give some thought to buying it? (Expensive)
4. At what price do you perceive the product to be a bargain –
a great buy
for the money? (Inexpensive)

44. The Van Westndorp Price Sensitivity Meter
The Van Westndorp Price Sensitivity Meter
Inexpensive Too Inexpensive
Expensive
The Indifference Price Point (IPP)
is the point at which an equal
number of respondents believe
the test product is expensive as
believe it is inexpensive
The Point of Marginal
Cheapness (PMC) is the point
at which an equal number of
respondents believe the
product is expensive as believe
it is too inexpensive
Too
Expensive
The Point of Marginal
Expensiveness (PME) is the point
at which an equal number of
respondents believe the test
product is too expensive as
believe it is inexpensive
The Optimal Price Point (OPP)

45. is the point at which an equal
number of respondents believe
the product is too expensive as
believe it is too inexpensive
• Van Westendorp
results can be used to calculate a ‘normal’ and
‘penetration’ price.
• Example:
Van Westndorp Price Sensitivity Meter ‐ Result
Van Westendorp PSM Interpretations
The IPP reflects either the
median price actually
paid by consumers
already in the market or
the price of the market
leader
1
The range of prices
between the PMC and
PME is the range of
acceptable prices. In well‐
established markets, few
competitive products will
be outside this range.
2

46. The OPP is the optimal
price that the seller
should set as
recommended by this
method
3
Steps in Conducting VWPSM Exercise
(see VWPSM Exercise.xlsx)
In Excel:
1) Use “countif” function
or
2) Insert ‘Pivot Table’
<Step 1. Data collection>
<Step 2. Count responses for each price category>
Steps in Conducting VWPSM Exercise
(see VWPSM Exercise.xlsx)
Total 104 responses.
Formula for $13
as TooInexpensive
=1‐1/104 = 0.9903846
Formula for $13
as TooExpensive

47. = 0/104 = 0
<Step 3. Compute Cumulative Sum>
<Step 4. Compute proportion of people>
Steps in Conducting VWPSM Exercise
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
$13 $14 $15 $16 $17 $18 $19 $20 $21 $22 $23 $24 $25 $26 $27
$28 $29 $30 $31 $32 $33 $34 $35 $36 $37 $38 $39 $40 $41 $42
$43 $44 $45 $46
TooInexpensive InExpensive Expensive TooExpensive

48. 1. Not based on sound behavioral theory –
it’s an applied procedure
2. Does not try to replicate the actual shopping process
(unlike conjoint
analysis)
3.
Results will depend on respondents’ experience with price level
s in the
market
4.
Concerns with asking customers directly regarding price. Focus
should be
on behavior, not price
5. Consumer‐defined prices may not
correspond with the actual range of
acceptable product prices from manager’s perspective
Problems with the Van Westendorp PSM
Some Notes
Van Westendorp notes: “A word of caution is in order: price
consciousness of this nature should never be equated with prope
nsity to
buy. One can be fully conscious that a product is “expensive” a
nd yet
prefer it over a cheaper alternative.”

49. MarketVision
Research notes: “Despite the concerns, the PSM remains a
simple method; it is both easy to execute and easy to understand
.
Although we never recommend the PSM as a method for definiti
vely
selecting the price of a product, it can be used as a tool for gaug
ing
consumers’ price perceptions and expectations.”
The Becker‐DeGroot‐Marschak Procedure
(BDM)
Price Discovery
•
Widely employed incentive compatible mechanism used to elicit
consumer’s willingness‐to‐pay
• Step 1: Show product and inform consumer of distribution of
prices at which product may be purchased
• Step 2: Consumer indicates a reservation price for product
• Step 3: Price drawn from announced distribution, termed
“realized price”
•
Step 4: If the reservation price is higher than realized price, the
y
obtain the product and pays realized price, otherwise they walk
away.

50. Becker‐DeGroot‐Marschak (BDM) Procedure
BDM – Step 1
“You will now have a chance to buy a bar of Valrhona
Noir Extra Amer 85% Cacao chocolate bar.
To determine its price, we will use the BDM procedure.
You will have one chance to pick a price that you are
willing to pay.
After you have indicated this price, a random number
generator will produce a price with the following
distribution:”
•
You can choose any distribution but it should be clearly explain
ed to
the consumer. Normal and Uniform distributions are commonly
used.
• How will you pick? Range?
BDM – Picking a distribution
a b
Normal distribution Uniform distribution
•
Consumer picks the maximum price they are willing to pay (to
maximize

51. the chance of getting the product)
• The random number is then drawn.
“If the number you chose is higher than or equal to the number
generated
from this distribution, you will get the bar of chocolate and pay
the amount
equal to the random number.
If the number you chose is lower than the number generated fro
m this
distribution, you will not get the chocolate and pay nothing.
Note that the BDM procedure is such that your best response is
to write
down the maximum amount you are willing to pay for the choco
late – not a
penny more, and not a penny less.”
BDM – Steps 2 and 3
Conjoint Analysis – We Know it!!!
See Week 6 lecture and workshop for detail
•
Another important property of Customer Value is that it is not st
able
•
It changes in predictable ways that should guide pricing decisio
ns
•
Understanding when customer value increases and the triggers o
f
value increase provides useful information for effective pricing

52. decisions
Instability of Customer Value
Demand for Chocolate
When would it make sense to charge high prices?
And to offer discounts?
Demand for Chocolate
Coupons
Demand for Chocolate
High/Full
Prices
•
Manage price levels using a pricing structure so that they coinci
de
with predictable shifts in customer value.
•
Identify value triggers of customers. What makes value go up an
d
down? Minimize incentives during periods of high value.

53. Key Insights
• Case 4: SafeBlend Fracturing (4 Oct)
• B2B pricing
• Submit case report before due (please submit early!!!)
• Lecture & Workshop (11 Oct)
• Price bundling
• Lecture wrap‐up
• Case 5: Culinarian Cookware (18 Oct)
• Final case write‐up & summary
•
Final Executive Summary (20%, Due: 5pm Friday 25 Oct, 2019)
• Read Portfolio Summary Note instructions from UTSOnline.
Next weeks
Week 02
Pricing Methods
https://www.abc.net.au/news/2019‐07‐
30/how‐online‐food‐deliver‐reshaped‐
the‐restaurant‐market/11363332
•

54. Have a chat with each other to decide whether this phenomenon
provides restaurants good potential or doom.
•
Use your mobile phone or laptop to access www.zeetings.com/k
kwak
•
Select your answer. You can only select one answer. Please hav
e a
comprehensive thought before selecting your answer.
• You can have a chat with each other.
•
Once you submit, you may be able to say your reason of selectio
n in
‘activity’.
Good or Bad?
Today’s topics
• Cost‐plus pricing
• Value‐based pricing
Cost‐Based Pricing
•
It is widely criticized, but is still, by far, the most commonly us
ed
pricing method.
• 75% of restaurants use it, 60% of manufacturers.
•

55. Retailers commonly use “double markup” adding margin of 100
% on their
wholesale cost.
•
Restaurants have established benchmarks, 2X for food, 5X for li
quor, and so
on.
•
The logic of cost‐based pricing is simple: Price every product to
deliver a fair return over costs, fully and fairly allocated.
Cost‐Based Pricing Example
•
ABC Navigation Systems has a contract to supply the US Air Fo
rce with
advanced aircraft navigational equipment. Under contract terms,
price of each navigational unit to be paid by the USAF is calcul
ated as
follows:
• Variable cost (labor, components, electricity, etc.) = $10,000
•
Allocated fixed costs (salaries, insurance, R&D, building heat,
debt service,
maintenance, etc.) = $8,000
• Contract guarantees 15 percent profit
• Unit price = ($10,000 + $8,000) * (1 + 0.15) = $20,700

56. Break‐even point (volume)
��������� ������
����� ����
����� �������� ����
Cost‐Plus Pricing in Distribution Channels
Manufacturer’s price = $10.00
Cost to acquire: $10.00
Markup: $2 (20%)
Wholesale Price = $12.00
Cost to acquire: $12.00
Markup: $12 (100%)
Retail Price = $24.00
Consumers
Retailer
Wholesaler
Manufacturer
Advantages of Cost‐Based Pricing
It is simple. Line

57. employees can
implement it with
moderate training.
1
It is easy to explain and
justify. This pricing
method can be
described and defended
easily to employees and
customers.
2
It stabilizes market
prices. When all
competitors have similar
cost structures, and use
it, prices remain stable.
3
It encourages customers
to focus on quality.
Prices tend to correlate
to quality.
4
Source: Dholakia, When cost‐plus pricing is a good idea, Harvar
d Business Review, 2018
Weakness of Cost‐Based Pricing
It encourages inefficiency.
There is a disincentive to

58. be efficient and to lower
costs. Reducing costs will
decrease revenues and
total profits.
1
It ignores customer value
and reference prices. This
can be dangerous, because
it can either results in
prices no one is willing to
pay, or leave a lot of
money on the table.
2
It creates a false sense of
complacency. Managers
think they cannot lose
money when they use
cost‐based pricing, which
is not the case.
3
Source: Dholakia, When cost‐plus pricing is a good idea, Harvar
d Business Review, 2018
Problems with Cost‐Plus Pricing
•
In most industries, it is impossible to determine a product’s unit
cost
before determining its price

59. • Unit costs are dependent on volume!
• Wang Laboratory case
•
Introduced in 1976, word processor was very successful. By mid
‐1980s, PCs became
viable competitors. As competition increased and growth slowed
, cost‐driven pricing
strategy accelerated the Wang’s decline
• Price affects sales volume, sales volume affects costs
Price Sales
Cost‐Plus Pricing in Strong Markets
•
Cost‐based price serves as a cap on price if it can be easily achi
eved
• Toyota Prius launch case‐study
•
In June 2004, the backlog for 2004 Toyota Prius reached 22,000
in the US.
•
As of April 2004, the expected delivery time for Prius in the Ne
therlands was
one year.
•
As of March 2004, the waiting list at a Sonoma County, Califor
nia dealership
was over 100 people long

60. •
Price at the time: MSRP = $19,995, Invoice = $18,411; Dealer p
riced $6 to $8K
higher (“fair market adjustment”)
• How about BTS concert tickets? Holiday bestseller toys?
https://www.youtube.com/watch?v=YVVRMRRxGGg
Source: Forget Rebates: The Hybrid‐Car Markup, by Sholnn
Freeman, WSJ, June 10, 2004
Cost‐Plus Pricing
•
Leads to over‐pricing in weak markets and underpricing in stron
g
ones
•
Cost‐based price still does not provide a guarantee of covering f
ixed
costs
• The underlying logic is flawed
•
But most importantly, firm can do better with other pricing strat
egies
Source: Dholakia, When cost‐plus pricing is a good idea, Harvar
d Business Review, 2018
The Value Pricing Framework

61. Source: Dholakia, How to price effectively, 2017
Customer Value
•
Customer Value is the total amount of money that the customer
is
willing to pay for the benefits received from the product.
•
For pricing, each customer benefit should be equated to dollars
and
cents that customers are willing to pay (WTP) for it.
•
Benefit 1 + Benefit 2 + ….. = WTP 1 + WTP 2 + … = Total WT
P
•
Customer value sets the ceiling or the highest possible price tha
t can
be charged for the product.
•
Understanding customer value requires an understanding of the
types and number of benefits customers receive from the produc
t
and the product/ service features that contribute.
Source: Dholakia, How to price effectively, 2017
Sell me this pen!

62. Value‐Based Pricing
Source: Dholakia, How to price effectively, 2017
1. Identify the target customer
2. Determine competitive offers & the focal competitor
3. Conduct head‐to‐head comparison
4. Identify differentiators & deficiencies
5. Assess their economic value
6. Calculate the value‐based price
• Product: Listing a vacation rental house on a beach to rent on
Airbnb.com by the week. What should its price be?
Value‐based Pricing: Vacation Rental
Sources: How to price effectively, Chapter 10; The 1%
Solution
, Rafi Mohammed
• Product: Listing a vacation rental house on a beach to rent on

63. airbnb.com by the week. What should its price be?
• Step 1: Identify target customers. Vacationers. Airbnb users.
Value‐Based Pricing: Vacation Rental
Sources: How to price effectively, Chapter 10; The 1%