Strategic Pricing Framework and Tactics

Strategic Pricing Framework
and Tactics

Traditional methods to pricing (usually cost-based) try to reactively maintain margins,
rather than proactively (value-based) seek to maximize profit
Cost-based item pricing
Customer
Segment
Value/
Sensitivity
Price Cost Product
Item/
Service
Cost Price Value Customers
Value-based customer pricing
Key question driving cost-based pricing
How do I set prices to maintain margins?
Key question driving value-based pricing
What value will this customer (segment) pay for?
WHY IS PRICING IMPORTANT?
3
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Pricing Strategy Development Framework Developing and implementing a pricing
strategy typically is done in three steps
PRICING STRATEGY DEVELOPMENT FRAMEWORK
Pricing Strategy Development Framework
Pricing Strategy
Scope Quick Wins Optimise
• Self Assessment
• Workplan
• Data Foundation
• Quick Wins
• Pricing Options
• Option Assessment
• Pricing Scenario Models
• Business Case
• Implementation Plan with
KPI’s
• Ongoing Price Testing
Process
Deliverables
Indicative
Timing
• 2 weeks • 8 weeks • 6 – 12 months
6

There is usually different evidence of problems across these three levels
Pricing Strategy
Pricing Structures /
Tactics
Pricing Levels
• Strategic pricing (declining industry price levels in the absence of
legal price leadership in the underlying market).
• Product market pricing (eroding premiums for value-added products
or premium customer segments)
• Transactional pricing (unwarranted variation in prices and lack of
consistency in the terms and conditions of sale on a transactional,
customer-by customer level)
Pricing Development – Process
PRICING STRATEGY DEVELOPMENT FRAMEWORK
9

Scoping - Pricing Data and Systems Integrity Assessment
Order Processing Allocates by sales
FTE
Fixed and variable
cost drivers based
on total sales cost
Use internal sales
people cost
Re-allocated O/H
Allocate fixed cost
by number of line
items in invoice
Product group Customer
sophistication
Product dependent
Production Cost Allocated using
FTE, direct inputs,
material volume
and sales $
Fixed and variable
cost
Accounts for order
size
Cost drivers
independent of
product groups
Fine tune order
size and impact
Based on product
groups
Manufactured vs
stocked item
Machine
performance
Pick and Pack Labour charge
allocated by FTE,
direct overtime
value and sales $
Fixed and variable
cost driver to
incorporate
packing of complex
items
Separate warranty
from total pick and
pack cost
Allocate fixed cost
by number of line
items in invoice
By branch
Skew by product
group
By each products
Bundled order with
accessories
Freight Total freight
charge, allocated
by produced tonne
Cost per drop Reconcile pick up
by customers
Allocate by tonnes
of material
Inter region
transfers
Cost due to error in
delivery
Out of Metro
delivery
Variability of
practices across
states (2 runs per
invoice)
Overhead Allocated by Area
(sq m), FTE and
salaries
Fixed and variable
overhead
Additional sales
overhead
Use same cost
drivers
Overhead by
products
Rebates out Total value
included
Not included % of sales across
all customers
% of sales
By individual
customer
Vary % by
customer
Vary % by product
Rebates in Total value
included
Not inlcluded Volume based and
non volume based
allocation- all
customers
Allocate non
volume based
rebates
Differentiate
between input
materials
Matching with
claim reports
GoodPoor
Example – Profitability modelling
SCOPING AND QUICK WINS
12

9%
16%
26%
19%
11%
6%
8%
2%
3%
>40 35 30 25 20 15 10 5 List
Percent of Discount to List Price
Percent of Total
Customer Volume
Typical Price Band
Analysis shows the typically ~80% of customers get 20% or greater discount to list
price
15

Analysis of Price Volume relationship and adjustments to pricing can
lead to quick wins
Specialty Chemicals Example
Current Competitive Discount
Versus Volume
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
$- $500,000 $1,000,000 $1,500,000 $2,000,000 $2,500,000 $3,000,000
Sales Volume (Jan–May 2001)
%CompetitiveDiscount
R2= 0.006(2)
Improved Competitive Pricing Versus
Volume (Conceptual/Illustrative)
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
$- $500,000 $1,000,000 $1,500,000 $2,000,000 $2,500,000 $3,000,000
Sales Volume (Jan–May 2001)
%CompetitiveDiscount
R2= 0.21(2)
Weighted Average Competitive Discount: 26.4% Weighted Average Competitive Discount: 21.2%Delta: 5.2%
Quick Wins – Price Volume Relationship
18

A products economic value is the price of the customers best alternative plus the
value of what differentiates the offering
INFLUENCING THE PURCHASING DECISION
0
20
40
60
80
100
120
140
Reference Value Positive Differentiation Negative
Differentiation
Economic Value
• This is not necessarily the perceived
value that a buyer would actually place
on the product
• Unaware of the product features
and be focused on its price
(reference price effect)
• Unsure of its differentiation
attributes and unwilling to spend
the effort to learn (difficult
comparison effect)
• If price is small, buyer may be
driven by impulse (the expenditure
effect)
• The economic value is the maximum a
segment would pay of fully
knowledgeable about the products
features and benefits – and motivated
by that value
Influencing the purchasing decision
21

There are nine effects that impact willingness to pay full economic value (cont)
INFLUENCING THE PURCHASING DECISION
5.
Expenditure
effect
6. End
benefit
effect
• Buyers are more price sensitive the larger the expenditure is relative to income
• E.g. massive price variation in small impulse purchases
• Relationship of the purchase (one of many )to a larger end benefit – two components ‘derived
demand’ and ‘price proportion’
• Derived demand - the more sensitive the buyer is to the cost of the end benefit – the more
sensitive to the cost of the inputs (steel desk manufacturer and sheet steel)
• Price proportion – percent of total cost of end benefit accounts for by products price
• E.g. BMW sunroof / accessories
• Targeted by advertisers (Goodyear and saving your families life)
4. Price /
Quality
effect
• Price becomes a cue for quality for image products, exclusive products or products without
any other cues as to their relative quality
• Lack of cues important – particularly for very new products E.g. restaurant in a strange town,
new synthetic car wax, new creamy cheese cake
24

Price competition is a negative sum game
PRICE WARS - MANAGING COMPETITIVE CONFLICT
• Positive sum games are those that (should) create value for all who participate (sport, academics, sales)
• The more prolonged and intense the competition, the better for all concerned – a strong competitive spirit is
good
• Warfare, labour actions, dueling are negative sum games – the loser never benefits form participation – the
longer the game drags on the more likely even the winner will find playing is not worth the cost
• Price competition is usually a negative sum game
• Price competitors should forget what they learn in competitions like sport – and learn from less familiar
competitions like warfare or dueling
• There are plenty of positive sum ways to compete
• Communicate more effectively with customers about benefits
• Reduce costs of operation
• Create new ways to deliver service create new products
Price conflict
27

Managing competitive information
PRICE WARS - MANAGING COMPETITIVE CONFLICT
• Collect and evaluate information
─ Rigorously monitor competitor prices, behaviour and signals
• Selectively communicate information
─ Evidence of low cost position etc – but not competitive intent
• Pre-announce price increases
─ Signal and test the water
• Show willingness and ability to defend
─ Respond quickly and decisively
• Back up opportunism with information
─ If making opportunistic moves in the market (one off contract win) - communicate clearly that this is
not a general strategy of lower prices
Price conflict
30

Companies in business to business markets often have poorly controlled pricing
processes – leading to unprofitable customer behaviour
GENERAL PRICING STRATEGIES
• Often no fixed price policies or strict criteria for discounting
• Typically any price is negotiable as long as it meets minimum profit criteria
• Customer specific pricing decisions are not reviewed with any consistent criteria by management
• Respond more
quickly to market
conditions
• Limit discounting to
only where
necessary
• Customers
communicate with
each other
• Customers learn from
repeat purchases
• Pushing back to bring
discounts
• Use purchasing agents to
achieve discounts
• Seek second suppliers to
apply leverage
The typical rationale is
responsiveness… …but customers learn.. …and start behaving badly
Direct selling in business to business markets can loosen pricing discipline
Issues with typical pricing
33

Menu based pricing may not be appropriate in all circumstances
• Menu based pricing may not be appropriate where…
─ … each purchase is a unique product or service
─ … customers purchase very infrequently (i.e. where the buyer lacks information on alternatives
and the experience to evaluate them and hence are not likely to be value seekers)
─ … there is an industry price leader with inconsistent and unpredictable pricing
Menu based pricing – description
36

Large SKU retail businesses have a number of different pricing strategieis
• Everyday Low Price (EDLP): Fixed price points as low as possible still realizing operating margins.
• Everyday Low Price Plus (EDLP+): Fixed pricing with a strong service overlay.
• Everyday Fair Price (EDFP): Prices at a relatively fixed, higher price point. It also has a plus component,
and allows for occassional price cuts to maintain competitiveness.
• Everyday Low Cost (EDLC): Removal of short term trade discounts by suppliers to retailers replace by
consistent low proces
• Variable Price: High-low pricing typically applied to branded merchandise; usually at a higher price point with
substantial price cuts for sales, promotions and price matching.
• Blind Price: Higher price points, often assigned to non-advertised commodity merchandise that is not price
sensitive
Pricing Glossary
39

• 5% below cheapest local
competitor
• Match cheapest local
competitor
• Maintain relativity with core
and/or match cheapest
national competitor
• 5% below competitor X’s
unpromoted price; match X’s
price promotions
• Average price of top 5
national competitors
Core
lenders
Core
matchers
Tactical
Less sensitive
Core
lines
Number of Lines
Percent
of Sales
Target
Price Position
Average
Price Change
Related
Total: 20,000
125
250
750
1,500
~ 17,500
-10.0
-7.5
-2.5
+1.0
+3.5
5
5
7.5
15
67.5
Example of different SKU pricing tactics
42

Bundling - definitions
Price bundling as the sale of two or more separate products in a package at a discount, without any integration
of the products
– Because the products are not integrated, the reservation price for the price bundle is, by definition, equal
to the sum of the conditional reservation prices of the separate products
– In other words, bundling itself does not create added value to consumers, and thus a discount must be
offered to motivate at least some consumers to buy the bundle
– Think of a set of luggage items, a six-pack of beer, a combo meal, a software suite, or a season ticket for
the opera
Product bundling as the integration and sale of two or more separate products or services at any price
– This integration generally provides at least some consumers with added value, such as compactness
(integrated stereo systems), seamless interaction (PC systems), nonduplicating coverage (one-stop
insurance), reduced risk (mutual fund), interconnectivity (telecom systems), enhanced performance
(personalized dieting and exercise program), or convenience from an integrated bill (telecom calling
plans)
– The greater value raises consumers' reservation prices for the product bundle compared with the sum of
the conditional reservation prices of the separate products.
BUNDLING
45

Mainly an issue of the
absolute value of a
product to individuals
or companies
Limited by
“switching barriers”
between
products / locations never
addressed by standard
Market Research
exercises
Mainly an issue of the
relative value of different
offerings in a
competitive set
Limited by availability and
awareness - never addressed
by standard Market Research
exercises
Primary Demand /
Demand Elasticity
Share Allocation /
Cross Elasticity
Long Term Short Term
Understand elasticities
MEASURING PRICE ELASTICITY
48

Elasticity distributions
-4.0%
-3.5%
-3.0%
-2.5%
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
Average new business elasticity is X%
• Around 30% of customers have
elasticity below 2/3rds of average.
elasticity about 3/2 of average.
-4.0%
-3.5%
-3.0%
-2.5%
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
New Business Renewal
Average renewal elasticity is Y%
elasticity below 2/3rds of average.
elasticity about 3/2 of average.
Elasticity % - Cumulative Distribution
51

Cubes are useful for spotting ‘quick wins’ at the extremes
High claims and low
elasticity – raise the price
Low Claims and high
elasticity – drop the price
54

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