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1 Pricing Bayer Chair Professor Willem Burgers 2 Course Outline Foundations Case: Atlantic Computer Thinking Strategically Case: McCaw Embedded Pricing Case: Signode Tools, Tactics, and Tricks: Metrics, Fences, Framing Case: Blockbuster Video Channels and Pricing Case: Shanghai Honggong Mathematics, Case: Jahwah Price Research Price War Case: Kodak Funtime 3 Importance of Pricing Marketing and Pricing Where does pricing reside in an organization? “Pricing gets caught between the cracks. Everybody wants to be a part of it. Yet, nobody really owns it. Pricing is ad hoc.” G. Smith, Pricing Strategy and Practice 4 Price Level Price setting Pricing Policy Negotiation Tactics and Pricing Setting Procedures Price & Value Communication Communication, Value Selling Tools Price Structure Metrics, Fences, Timing Value Creation Economic Value, Offering Design, Segmentation The Strategic Pricing Pyramid 5 What is the Right Price? 1. Value to Customer 2. Competition 3. Our Cost 4. Strategic Objectives $ 6 1. Customer Value/ Willingness to Pay Substitutes/Uniqueness? Switching costs? Easy to compare price? Easy to compare quality? Price/Quality relationship? Significant expenditure? Important end-benefit? Ingredient? Does the buyer pay? Fairness? Inventory? 7 Value? One Barrel of Coca Cola Milk Evian Water Orange Juice Lemon Oil Scope Mouthwash Jack Daniel Visine Eye Drops $78.83 $126.00 $189.90 $251.16 $390.88 $826.65 $4,133.26 $32,202.24 8 2. Competition How many sellers? Monopoly Oligopoly How many buyers? Monopsony - Oligopsony How differentiated is the product? Monopolistic competition 9 3. Escape the Cost Plus Delusion Cost Based Pricing product cost price value customers? Value Based Pricing customers value price cost product? The role of cost in pricing relevant costs, incremental costs, avoidable costs, opportunity costs: Our goal is to maximize gross profit 10 4. Strategic Objectives Growth? Profit? Survival? Stability Cost? ? 11 Pricing Strategy Alternatives Competition-based Cost-plus Value-in-use Custom based Auction/Liquidation Strategic Objectives/Constraints 12 Business as a Game But there are many games Rule based games (e.g., employment contract) follow the principle that for every action there is a reaction and to play well you must look ahead and reason backward Freewheeling games (e.g., contract negotiation) follow the principle that you can not take away more from the game than you bring to it and to play well you must maximize this value The Players in the Game Customers Competitors Company Complementors Suppliers Parts of the Game 1. Players Who is playing? Can you add players? Do you have to play? 2. Added Values What amount of value disappears when you leave the game? How can you increase value Parts of the Game 3. Rules Can we change the rules of the game? 4. Tactics Can we change perceptions of the game, using threats or promises? 5. Scope Can we go play the game somewhere else? 16 Changing the Pricing Game Conventional Pricing Struggle among competing functions: marketing, sales, finance. Reactive to market conditions and customer pressure Subsequent to product-market decisions Strategic Pricing Changes incentives to create support across functions Pro-active, policy driven Early in the product development process 17 Tactical Questions Commonly Asked Strategic Questions That Should be Asked What price do we need to cover our cost and profit objectives? What sales changes would be necessary or tolerable for us to profit from a price changes? Can we deploy a marketing strategy that will keep those sales changes within acceptable ranges? What costs can we afford to incur, given the prices we can achieve in the marketplace, and still earn a profit? What price is the customer willing to pay? Is our price justifiable given the objective value of our product or service to the customer? How can we better communicate that value, thus justifying the price? What is the right price structure for the customer/for different customers? What prices do we need to meet our sales and market share objectives? What level of sales or market share can we most profitably achieve? What marketing tools should we use to win market share most cost-effectively? Asking the Right Questions: 18 An unprofitable price? - Pricing error - Value communication defect - Market share delusions - Market segment error - Product/service overbuilt - Customer power - Commoditization 19 Market Change Dynamics Leading to Commoditization Entry of new competitors in market or segment Imitation among competitors Buyers develop capacity and confidence to measure functions and quality of products, services, and vendors Experience and competition among suppliers reduces buyers sense of risk The Specialty-Commodity Continuum Price High Low Low High Service Additions Specialty Commodity time Niche Experience curve Value added strategy Price compression/innovation 21 Breaking the Commodity Cycle Four possible strategies, Value added strategy: Moving along the diagonal to increase price and service Price compression/innovation: Moving along the diagonal reducing prices and services Market focus: Staying up along the arc focusing on the clients only who would pay an additional price Experience curve: Moving down along the arc ahead of anyone else 22 Embedding the Strategy - Distributors/Salespeople incentives and expectations, skills, knowledge, tools. - Customer incentives and expectations 23 Signode 1. What price strategies can you recommend to Signode? 2. What suggestions do you have for compensation for the sales force? 3. The sales force offers to increase sales by 5-10% if we allow additional price flexibility. Assume the price flexibility will reduce prices by 4% on average, should you accept the offer? Show with calculation why you should accept the offer or not. 4. Do you see any error in Signodes present allocation of its marketing resources to different segments? What error do you see? What might be the explanation? 5. Any brand strategy suggestions for Signode? 24 Metrics What is a metric? What is a bad metric? What is the cost of using the wrong metric? Good metrics 25 Good Metrics 1. Are some of your customers substantially more expensive to serve? 2. Can you attract additional customers at a lower price? 3. Can you link your price to cost to serve to drive expensive customers to your competitors while attracting non-costly customers to you? 4. Can you enforce your metric? 5. Does your metric fit channel selling habits, customer buying habits, and sense of fairness? 26 Quantity Discounts Typology: No discounts All units discounts fixed plus variable variable 1 plus variable 2 fixed 1 plus variable 1 and fixed 2 plus variable 2 27 Why Quantity Discounts? 1. keep big customers 2. match competition 3. save costs 4. enable price discrimination Larger buyers are more price elastic/price sensitive Larger buyers may have more options A second or third dress/cup of coffee/ has less value 5. block new competitive entry 28 Product Line Pricing A line of substitutes (for example car models) Image building Market expansion Segmentation Price defense Entry point/model A line of complements (for example restaurant + theater) Bundling/Merging demand curves Tie-ins 29 Price Discrimination Capturing the customer surplus: Charge customers according to how much they value the product. Need to know the price a customer is actually willing to pay Need to separate customers according to their willingness to pay more/less Need to keep your high-paying customers customers happy 30 Fences Buyer identification Purchase location Purchase timing Purchase quantity Product bundle Tie-ins Product design 31 Price Communication 1. Percentages or numbers? 2. Dont talk price, talk value 3. Price cues 4. Price endings 5. Sale anyone? 32 Price Framing The power of three Start from the top Reference prices Prospect Theory 33 Body of Knowledge Focusing on losing fewer customers is the quickest road to greater profits The less you talk price, the higher the price you will get Finance is wrong when they tell us people do not like risk More information sells more product The center is better 34 Body of Knowledge If you want to tempt customers, distract them first If you can not distract them, make them sad Send men to women and send women to men Beautiful women reduce mens ability to (dis)count Getting little favors gets you to getting big favors 35 Blockbuster Video 1. As Mike tries to survive, competing with Blockbuster, what is the right pricing strategy for Mike? 2. What is the price Mike should ask Mr. Atkins for his store? Identify and calculate different possible prices 36 Channel Pricing and Sub-Optimization Sub-optimization: A system consist of sub-systems. When sub-systems optimize performance, system performance is not optimized. Sub-optimization is the core issue of channel performance and channel management 37 Sub-Optimal Pricing Crocodil e T - Sh irts Manufact uri ng Cost 40 RMB Gross Pr ofit 360 RMB Manufact ure r s Sell ing Pric e 400 RMB Dist ri butor s Dire ct Cost 10 RMB Dist ri butor s Gross Pr ofit 100 RMB Dist ri butor s Sell ing Pric e 510 RMB Retai ler s Dire ct Cost 10 RMB Retai ler s Gross Pr ofit 8 0 RMB Retai ler s Sell ing Pr ice 600 RMB 38 Question Demand for Crocodile shirts is very price elastic. Prior experience shows that a 20% off sale can increase sales by 50%; a 30% off sale can increase sales by 100%. Should the distributor offer a 100 RMB price discount to retailers in exchange for 50% more shirts ordered? Suppose Crocodile produced too many shirts for winter, and now summer is coming. Crocodile lowers its price to the distributors by 200 RMB. What will the distributors do with the price they charge the retailers? Suppose Crocodile lowers the price to retailers directly by 200 RMB in order to get rid of its inventory. Should the retailer lower the price by 200 RMB if doing so will double the sales of the shirt? 39 What is your advice for Blockbuster? “The whole business was operating wrong There werent enough tapes in the storesYear after year the studios kept raising the price of tapes to companies like Blockbuster. When the price of tapes got up to about $65 each, we realized we couldnt afford to buy enough tapes to sufficiently stock the shelves.” Sumner Redstone, Chairman of Blockbuster 40 Pricing Policies “Pricing policies specify the circumstances under which, and the amounts by which, the company will discount its prices in exchange for specific behaviors by customers and the sales force.” “Without a pricing policy you lose control over pricing.” “The goal of a pricing policy is to influence customer behavior; encourage loyalty and cost reducing behaviors.” 41 Price Waterfall List Price.Invoice Price.Actual Price RMB 600 RMB 578 RMB 447 Order size discount 10 RMB Competitive discount 12 RMB Payment terms discount 30 RMB Annual volume bonus 37 RMB Off-invoice promotions 35 RMB Coop-Advertising 20 RMB Freight 9 RMB 42 Price Band Percent of Volume RMB 580 560 540 520 500 480 460 440 420 380 3.7% 7.4% 4.1% 10.1% 14.1% 17.0% 16.2% 6.1% 12.7% 8.6% Actual Prices Per Unit 43 Promotional Pricing Policy Negotiated Pricing Policy Quantity Discounting Policy Bid-Loyalty Pricing Policy Policies “Rules for the salesforce” + “Means to manage customer expectations” 44 Shanghai Honggong Adv Instruments Co. Ltd. (SHAIC) 1. How successful is the SHAIC JV? 2. What has been the key success factor for SHAIC? 3. What do you see as the key weaknesses of SHAIC? 4. How can SHAIC improve its salesforce performance? 5. What recommendations do you have for SHAIC? 45 Marketing Math Division manager Mr. Schneider is not happy with Marketing manager Mr. Zhang: He has called Mr. Zhang into his office. Mr. Zhang,” he says, “you decided six months ago to raise our prices by 10%. I let you do it. Now, six months later, our sales are down by 15%. It doesnt take a genius to figure out that, even with the price increase, we are now taking in less money than before. Obviously, our demand is price elastic (disproportionately sensitive to price), and I would have thought you might have tried to determine price elasticity before you decided to increase our prices. Mr. Zhang? 46 Marketing Math 5. Suppose Firm A raises its prices by 10%, and sales (in dollars) go down by 15%; should Firm A keep its higher prices, or should it lower prices back down? 5a. Old gross margin was .25. Say an average piece of clothing selling for RMB 100.- costs the firm RMB 75.- Now that piece of clothing will sell for RMB 110.- So the new gross margin will be RMB 35.- on a sale of RMB 110.- So the new gross margin will be RMB 35.-/ RMB 110.- = .318 47 Marketing Math Dividing old margin by new margin gives you the percentage of sales that new sales must be (at a minimum) of old sales. .25/.318 = .786 (78.6%), This means that after firm A increased price by 10%, firm A will be better off as long as firm As new sales are at least .786 (78.6%) of old sales (that is, dont go down by more than 21.4%). Since sales went down by 15%, to a new level equal to 85% of old sales, firm A will be better off than before. 48 Marketing Math old situation: .25 x (old sales of) RMB 125,000.- = RMB 31,250.- new situation: (new margin) .318 x (new sales of) .85 x RMB 125,000.- = RMB 33,787.50 (If sales had gone down by exactly 21.4%, to a new level equal to 78.6% of old sales, then profits for firm A would have stayed the same: .318 x (new sales of) .786 x 125,000.- = 31,250.-) 49 Marketing Math A similar formula works also for calculating necessary changes in sales expressed in units: dividing old gross profit per unit by new gross profit per unit gives you the percentage of sales that new sales must be (at a minimum) of old sales 50 Marketing Math Suppose firm A sells suits for a price of 500 RMB (and its gross profit is still 25%, so firm A purchases these suits for 375 RMB) Suppose firm A now raises its price from 500 RMB to 550 RMB for a suit How many suits should firm A now sell in a month (to keep the same profit it was making before?) 125 RMB (old gross profit per unit) divided by 175 (new gross profit per unit) equals .714 or 71.4% Firm A can afford to lose up to 28.6% of its sales of suits (expressed in units) when it increases its price on suits by only 10% 51 Marketing Math 6. Suppose Firm A lowers its prices by 10%, how much should sales go up, at a minimum, to make up for the lower price (so our profit stays the same)? 6a The piece of clothing that sold for RMB 100.- now sells for RMB 90.- So our margin has changed from 25% to 16.6% (RMB 15/ RMB 90) .25/.166 = 1.506 Sales in RMB must go up by a bit over 50% in order to make up for the 10% decrease in price! 52 Marketing Math Exercise Your company has Fixed costs of $25,000,000 Gross profit margin of 34% Sales of $72,000,000 Advertising expenditures of $12,000,000 Question: if the company raises its prices by 10%, how much can sales go down (at most) in dollars and in units? Question: if the company lowers prices by 20% how much should sales increase (at a minimum) in dollars and in units? 53 Price and Profit Creates operating profit improvement of 11.15% 7.8% 3.3% 2.3% price VC volume FC 1% improvement in “The job of marketing is to increase price.” 54 Creates operating profit improvement of 28.7% 26% 16.7% 6.4% 1% improvement in price at 17.5% Philips “The job of marketing is to increase price.” Price and Profit 55 Jahwah Offer tactical pricing suggestions to Jahwah The CEO of Jahwah complains that its prices are too low for shower cream and for other products. Why are Jahwahs prices so low? What systemic suggestions do you have? 56 Price Response Estimation 1 expert judgment/Delphi method 2. customer surveys 3. experiments 4. historical market data 57 Expert Judgment/Delphi method Develop specific questions: “what is the highest, medium, lowest realistic price and what would be the sales levels at those prices?” Use as many as ten experts, preferably from different functions and different levels of hierarchy Share the results, discuss the differences in estimates, utilize the wisdom of crowds Use outsider to run the process/interviews/meetings 58 Customer Surveys Ask: “How much would you be willing to pay maximum for this product?” “What would you expect to pay for this product?” How likely is it you would buy at that price?” 59 Experiments new or current products in-laboratory, in-store, test market price levels, price metrics, discounts, advertisements, mock-ups, concepts 60 Historical Market Data What happened the last time oil prices doubles in less than a year? (demand for oil for cars hardly changed, uitilities switched to coal and natural gas, demand and prices for home insulation products went up sharply) What happened the last time house prices went up by more than 20% in one year? (demand increased, queues formed to buy apartments in new developments) What happened the last time we (or our competitors) raised/cut prices by more than 10%? (customers reacted by ., competitors reacted by) 61 Managing Price Competition The pricing game is not just played between you and your competitors Winning the peace is more important than winning the war Market share is not a cause of profit 62 Compete on price? Only if Low cost business model is your competitive strategy and advantage and/or You can limit yourself to taking only small bites and/or You can cross-subsidize and live to enjoy your conquests 63 Responding to a price challenge Threaten: communicate your resolve and resources, in words and or deeds Invest in service/promotion/advertising/ added quality Indirect price retaliation in the competitors home market Introduce a fighting brand Change the metric, the basis for pricing, the basis for competition Focus on favored segment Cut prices 64 Kodak Funtime What recommendations do you have for Kodak to respond to the Fuji challenge What color scheme do you recommend for the Funtime brand? Should the coloring remind customers that Funtime is made by Kodak? Or should the coloring perhaps be a type of Green? How could Kodakss super premium brand Ektar help defend Kodak against Fujis attack? Why does Kodak sell Funtime only in off-peak selling season? Suppose Kodak lowers the price of its Gold Plus brand of $3.49 by 20% (to match Fujis price) how much will sales have to go up to compensate for the lower price (so total profit stays the same)?
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