Smart pricing

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Smart pricing

• Tony Cram
• Ashridge Business School
• October 2006

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Agenda

• The pricing conundrum
• Customer perspective research and
  discrimination
• Competitors 3 ways to differentiate by price
• Smarter Pricing best practices

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TONY CRAM
Commercial Background Motor Industry Leisure
Sector Brewing Financial Services Consulting
Contracts NHS Construction Rail industry
Faculty Ashridge Business School
Custom programmes - No 1 in UK
Author
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The Pricing Conundrum

• 1992 McKinsey survey of 2483 companies showed a
  successful 1 increase in price increased profit
  by 11.1 (more than 1 improvement in volume,
  fixed or variable costs)

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The Pricing Conundrum

• 1992 McKinsey survey of 2483 companies showed a
  successful 1 increase in price increased profit
  by 11.1 (more than 1 improvement in volume,
  fixed or variable costs)
• BUT a 2003 McKinsey survey showed near 90 of
  poor pricing decisions featured under-pricing

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How well do we set prices?
Pricing is the managers biggest marketing
headache. Its where they feel the most pressure
to perform and the least certain that they are
doing a good job. PROF ROBERT DOLAN, HARVARD
Pricing is guesswork. It is usually assumed that
marketers use scientific methods to determine
the price of their products. Nothing could be
further from the truth. DAVID OGILVY
Pricing is the worst managed of all marketing
areas. How prices are decided is often a mixture
of voodoo and bingo. MARK RITSON
Companies often base prices on the anecdotal
evidence of a few vocal sales people or product
managers. McKinsey Consultants EUGSTER, KAKKAR
ROEGNER
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Customer-based What will the market bear?
Three approaches to price-setting
Cost based What margin should we make?
Competitor-based What do competitors charge?
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Agenda

• The pricing conundrum
• Customer perspective research and
  discrimination
• Competitors 3 ways of differentiating by price
• Smarter Pricing best practices

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Pricing theory Optimising economic value Gabor
Granger Price-Volume Curve
2000 1750 1500 1250 1000
x
x
x
Revenue
x
x
Demand curve Revenue Optimum price
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Pricing theory
Pricing must aim to optimise the companys
economic value Pricing must aim to capture value
placed on the proposition by the customer
CUSTOMER VALUE
MAX PRICE Customer willingness to pay
CUSTOMERSURPLUS
Price
PRODUCERSVALUE CAPTURED
MIN PRICE Company total economic cost
COMPANY COST
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Customer surplus

• ICI agri-chemicals developed a product that
  stunted the growth of fruit trees without
  effecting fruit yield
• Low cost of production
• High benefits saved time in pruning, picking,
  smaller trees allowed more intensive planting
• Calculated the total value to fruit-growers
• Priced at 35 of total value in order to give
  Customer surplus

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How much would you pay for this?
Haggle Negotiate Beat down
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• 1990s customers had more choice, competition
  challenging, advertising and promotion costs
  increasing, costs rising.
• Response cost cutting in manufacturing, and
  shirt prices were dropped to 35
• Sales fell pressure for more cost cutting
• 2001 Robert Siegel (ex Levis) took over. Advised
  to cut prices further

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• 1990s customers had more choice, competition
  challenging, advertising and promotion costs
  increasing, costs rising.
• Response cost cutting in manufacturing, and
  shirt prices were dropped to 35
• Sales fell pressure for more cost cutting
• 2001 Robert Siegel (ex Levis) took over. Advised
  to cut prices further
• INSTEAD he did the opposite restyled mens
  shirts up to 69, shapelier womens shirts to 72
• 2004 sales up 125, 2005 60

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Customers will not tell you how much they are
willing to pay!

• The norm is to change prices and hope!
• DHL ran individual price experiments testing
  slightly changed prices on real customers (all
  weights, 43 markets)
• Measured failed prices price ceiling
• Found the precise premium over Fedex, UPS that
  they could charge successfully
• Internet sites use a Look to book ratio

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One price policy problems
100 50
Price
Price chosen
0 50
100
Potential customers
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Pricing by segment more profit
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Price DiscriminationCapturing the value from
customers who value product differently

• First degree - unique price per customer auction,
  tender, individual negotiation
• Second degree - price quantity relationshipvolume
  discount, group terms, happy hour
• Third degree - segment based pricing student
  discount, gender-based, unwaged, girth-based,
  effort-based by coupon-clipping

Source Arthur Cecil Pigou
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Creative price segmentation

• A scenic lake district village needed a larger
  car park for trippers wanting a quick photo-stop.
  How do you fund it?

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Creative price segmentation

• A scenic lake district village needed a larger
  car park for trippers wanting a quick photo-stop.
  How do you fund it?
• Pay on exit
• Long stay (local shoppers) pay 20p
• Short stay (photo-stoppers) pay 1.00

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Multi-dimensional pricing

• Mileage surcharge for rental cars
• Low entry price attracts leisure users
• Higher usage business drivers will pay more
• Rail card
• an upfront payment to gain 1/3 off discounts.
• higher customer commitment earns lower prices for
  greater revenue

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Lead customers up price stairways
Physiofast
de luxe car
Courtesy car
European cover
Personal accident cover
Legal issue helpline, legal cost cover
Let us quote you happy Base price (58 save
money)
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Which part of the product do they value the most?

• Divide the total price into component elements
• Price up the elements that the customer values
  most highly
• Photocopier paper
• Razor blade
• Printer ink cartridge

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Bundling and unbundling

• Bundle in additional element to add value
• the McDonalds toy lasts longer than a burger
• Porsche service to air travellers
• Unbundle the offer
• Allow price sensitive customers to deduct
  specific items that they do not wish to include
  (you may boost your margin to compensate for lost
  revenue)

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Agenda

• The pricing conundrum
• Customer perspective research and
  discrimination
• Competitors 3 ways of differentiating by price
• Smarter Pricing best practices

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Differentiation with a premium

• Make your offering seem different from other
  suppliers of similar products services

Caterpillar Maximum uptime
Heinz new recipe 2004 20 per cent less salt, 18
per cent less fat 13 per cent more tomatoes 20
higher price 25 more shelf space
Fairtrade bananas The price is 1.12 - 1.24
compared with 74p 60 price premium 2004 sales
growth 43.
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Non-comparability

• Confusion pricing
• prices for phone calls vary by time of day, day
  of week, call length and caller destination or
  network. Up to a threshold calls will be included
  within the monthly rental payment. Six different
  parameters no comparison
• Customised pricing
• Brewery micro-filters per hectolitres of beer
  brewed
• Plane tyres per flight
• Hotel detergent per bed-night

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Non-comparability

• Confusion pricing
• Customised pricing
• Different product codes
• Currys Hotpoint RLA34G 5.3 cu ft 159.95
• Comet Hotpoint RLA34P 5.2 cu ft 161.62

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Premium printing company losing tenders to
low-price competition

• Introduced ultra-low base price
• Menu pricing with premium rates for
• Correcting files
• Adapting to late delivery of files
• Redesigning a job to save mailing costs
• Reducing colour variability
• Scheduling jobs at peak times

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Strategies against value players

• Differentiation, execution
• Rapid experimentation innovation
• Development of superior consumer insights
• Effective pricing promotions
• Frontline efficiencies
• Rapid skill building
• Change management
• Creative partnerships

Source When your competitor delivers more for
less. McK Quarterly 2004
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How to fight a price war

• Stop the war before it starts - visible price
  strategies, rivals to understand cost strength
• Respond with non-price actions - service
  enhancements, feed doubts, show negatives

Source Rao, Bergen, Davis Harvard Business
Review March 2000
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How to fight a price war

• Selective pricing actions bundling, specific
  category cuts, stock-loading promotions, fighting
  brand
• Fight rapid unambiguous response
• Or retreat? Cede share rather than face battle
  costs

Source Rao, Bergen, Davis Harvard Business
Review March 2000
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Agenda

• The pricing conundrum
• Customer perspective research and
  discrimination
• Competitors differentiating by price
• Smarter Pricing best practices

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Lifecycle Pricing
HIGH PRICE
Premium pricing
Skimming pricing
Penetration pricing
LOW PRICE
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Cutting prices is easyRaising prices is difficult
RAISING PRICES
CUTTING PRICES
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Best practice 1.Pricing new products

• Reference price (6 months) - shows how the maker
  truly values the product
• too low handicaps long term profit
• too low invites competitors to price war
• too low may create forecasting difficulties
• too low may result in cannibalisation
• Recommend life cycle strategy
• high release price - reductions over the lifecycle

Pricing New Products by Marn, Roegner Zawada.
McKinsey Quarterly 2003
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Best Practice 2.Pricing indifference band
17 in health beauty 10 engineered components
0.2 in financial products
Source Price smarter on the net by Baker, Marn
Zawada (McKinsey) Harvard Business Review Feb
2001
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Best Practice 3. Reduce price sensitivity
See Nagle Holden, The Strategy and Tactics of
Pricing Tony Cram Smarter Pricing
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Best practice 4Pricing to encourage profitable
behaviour
Pricing impacts on demand . Obviously How does
pricing impact on consumption (extent of
usage)? Two people join a health club Bill
chooses the 600 annual plan Mary chooses 50 per
month plan Who uses it more? Consumption
renewal
Source Pricing the Psychology of consumption
HBR John Gourville Sept 2002
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Pricing to encourage profitable behaviour

• Oriental City Chinese food court
• all you can eat for 15 5 for every 200gm
  left on your plate

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Pricing to encourage profitable behaviour

• Electronic equipment prices falling customers
  hold back
• Carphone Warehouse check the price you paid 90
  days later and send a voucher for any price drop.

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Pricing theatre
Low price .High price

• At YO! Sushi there are five coloured plates
  indicating the price of the food on them.
• Price boards are digital so prices can be changed
  constantly.
• And in financial districts, the price can vary
  through the day, linked to the number of
  customers and you can buy 'futures'.
  Founder Simon Woodroffe,

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Smarter pricing

• Be confident in your offering
• See value from your customers perspective
• Creatively differentiate from competitors
• Capture more value, command a higher price

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Questions Comments Discussion
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Questions Comments Discussion
Thank you very much