Extensive summary for the course Pricing and Revenue Analytics at Tilburg University. The summary contains the content of all lecture slides and additional notes made during class. Additionally, the document contains summaries of all the compulsory papers (in the form of supplementing the lecture c...
Pricing and Revenue Analytics
MSc Marketing Analytics
Tilburg University
1
,Lecture 1 Introduction to Modern Pricing Strategies
1. Introduction and examples
Why is pricing hard? Illustrated by three examples: (1) Philips MRI-scanners, (2) Playgrounds/theme
parks, (3) Netflix/iTunes. (1): Because hospitals could afford only 1 or 2 MRI-scanners, not every
patient could receive treatment. Therefore, Philips defined a service contract in which hospitals pay
per treated patient, enabling hospitals to use more than 1 or 2 scanners. (2): Some theme parks charge
children (parents can enter for free); other parks charge parents (children can enter for free). (3):
People buy a subscription, i.e., they pay for the service of watching movies or listening to music, rather
than buying physical CDs. Besides, these streaming platforms often offer multiple subscription models,
such as “standard” and “premium”. These examples illustrate that pricing products is not always easy.
Besides, pricing is difficult because four dimensions are taken into account: comparison, competition
(lecture 6 competition), variability (lecture 5 promotions) and subjectiveness (lecture 4 psychological
pricing).
Paper 1: The six pricing myths that kill profits, Hinterhuber (2016)
Who is responsible for pricing in a firm? Everybody from sales (negotiating prices with
customers) to marketing (setting list prices) to finance (in defining payment terms) to accounting (in
creating invoices and assigning discounts) is responsible for pricing – so in the end, not one single
person is responsible for pricing. CEOs should appoint a Chief Pricing Officer that is capable of driving
profits via pricing. Pricing is an overall strategy; not all departments should be able to manipulate this
strategy.
What factors enter the pricing decisions?
The pricing decision is the reasoned choice from
a set of alternative prices to achieve a certain
objective within a planning period.
Prices are based on internal and external factors
(see table). Moreover, pricing is more an art than
science; prices are dynamic, should fit a strategy,
and are not defined by means of a formula.
2. Pricing Myths
Pricing: Guided by principles or driven by myths? Pricing is the most important driver of profits.
However, pricing is also the area that most executives overlook when implementing initiatives to
increase profits. This is because executives hold on to pricing myths that ultimately are self-defeating.
Myths are widely held and unquestioned beliefs that lack scientific basis. Decision makers associate
actions with desired outcome, and a causal relation is inferred without any formal evaluation of
alternative actions. Decision makers repeat past actions, without attempting to understand causal
relationships and examining whether alternative actions produce superior outcomes.
Take the difference between General Motors (GM) and Continental AG in the automotive industry.
GM went bankrupt; they assumed that the first purchase factor of customers is price. As a result, they
stopped innovating and creating customer value, and started focusing on discounting list prices
(guided by price myths). Contrastingly, Continental AG became among the most profitable in the
industry; they invested in improving the abilities to practice value-based selling. They were able to
show customers why high prices are justified by higher value (guided by principles).
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,The solution is to make you aware of these misconceptions and to study scientific principles to guide
pricing decisions. However, note that you should continuously research and experiment with your
pricing strategies.
The six myths
1. Costs are the basis for pricing (e.g., cost plus pricing, target pricing). Truth: Pricing has to be
based on customer value. This myth is based on the economic principle of a fully efficient market
(e.g., “banks go bankrupt if they sell below cost”, “price product at marginal cost”). However,
consumer WTP is unrelated to cost. The creation of high customer value allows high prices, even
if costs are literally zero (e.g., a car manufacturer charges $600-$1,500 for metallic paint, while
the costs of the paint for a midsized car are on average $80. The reason that car companies do not
offer the paint for, say, $120 is that they understand that WTP is unrelated to costs).
Advantages of taking costs as basis for pricing: it is simple, costs are known, it creates stable
prices, perceived to customers as fair and it is easy to justify a price change. Disadvantages: is
not very profitable, brand positioning and competitor’s prices are ignored, allocation of fixed
cost are not trivial and the expected demand is depending on the price (i.e., price changes also
lead to changes in demand, which is not accounted for).
2. Small price changes have little impact. Truth: small price changes have an extremely
significant effect on company profitability. Certain observations prove this:
• A 1% change in price will increase profits on average by 11%
• A 10% price cut to customers often means taking 50% or more cut in profits
• Large sales boosts from using €0.99-pricing
Two solutions for this myth are: (1) limit price negotiation authority of salesforce and marketers
(i.e., don’t allow them to offer big price discounts), and (2) limit artificially inflation of price lists to
make room for negotiation (cf. reference prices).
3. Customers are highly price sensitive. Truth: customers are frequently unaware of prices paid.
In business markets, customers are more sensitive to total costs of ownership than to price.
Customers claim they value price (most), but their behavior suggest otherwise. Paradox of price
sensitivity: (1) in theory, when asked, customers are highly price sensitive; in practice, when
observed, they are not, (2) price setters overestimate consumer price knowledge and price
sensitivity. Often, prices are even set too low for most customers. Study results that claim this:
• 50% of shoppers could not name the price of the item placed in their shopping cart
• Less than 1 in 2 shoppers was aware the product they purchased was on promotion
• Small price changes of less than 2% tend to go unnoticed
• Cherry-pickers that ‘hunt’ for loss leader amount to less than 2% of shoppers
• Price-driven consumer segments amount to less than 30% of your shoppers, versus 70%
that choose based on other benefits
In business markets, price is usually not the most important purchase factor. This creates certain
business opportunities, such as customer segmentation and deal signaling. Industrial markets
value the created benefits of a purchase, other than price; it is the sum of quantitative benefits
(revenue increase, cost reduction, risk reduction) and qualitative benefits (brand, expertise, track
record, process benefits).
4. Products are difficult to differentiate. Truth: even commodities can be differentiated. There
is no product that cannot be differentiated, e.g.: bottled water (differs in size, convenience,
sustainability), personalized license plates on cars (although it costs around €1,000, and people
typically avoid paying extra tax, people are still willing to buy a personalized license plate) and V-
Power high-octane fuel (although the new gasoline does not enhance performance of engines,
nor lower fuel consumption, people are willing to pay for the fuel at a price premium of 10%). So,
even irrelevant differentiation creates customer value and increases customer WTP.
Differentiation is based on perceptions; if customers believe a product is differentiated, it is.
3
, 5. High market share = high profit. Truth: market share and profitability are not correlated.
Market-share goals relate to competitor obsession bias: managers pursuing competitor-oriented
goals, rather than profit-oriented goals. The strategy formulation is set relative, rather than
absolute, while ‘market leadership in itself is not worth a cent’. Example: smartphone market
(some brands have a high market share, while their profit is low; other brands have a low market
share but high profit due to leadership in price premium). Market share is frequently seen as a
proxy for pricing power. However, pricing power stems from the ability to create products or
services that address customers’ needs by understanding those needs better than customers.
The correct response to a price drop by a competitor depends; for highly differentiated
products, the best answer is to do nothing. A price cut by the competitor reduces consumer
WTP for the company’s own product by the same amount. For weakly differentiated products,
the best answer is a corresponding price drop.
6. Managing price means changing prices. Truth: managing price includes improving systems,
processes, skills and the ability of the salesforce to communicate customer value. In many
cases, this can be done without changing prices. Product value can be enhanced in other ways
than changing the price, such as adding product features or emphasizing quality over competing
offerings. A company should quantify the customer benefits of its own products and document
that the quantified incremental value provided is greater than the price premium.
3. Foundations of profitable pricing (basis of entire course)
Value-based pricing: price products based on value. A product is worth as much as consumers are
willing to pay for it. WTP differs by person, over time and by location (e.g., cola in supermarket versus
cola at beach club). Given this; how can the price be defined?
Deriving WTP – price sensitivity: price sensitivity refers to the extent to which customers
respond to changes in prices for brands, products or services. Based on economic theory, we expect
that price and demand move in opposite direction: if price of a brand goes down, demand for the
brand will rise. To quantify this, we often rely on price elasticity: the percentage change in demand
(i.e., sales or quantity (Q), in response to a percentage change in price (P) of the focal brand.
Price sensitivity is a concave or convex function. Price sensitivity
depends on price ranges on the market. E.g., increasing the price of a
particular expensive product can lead to loss of customers, while
changing the price of a luxury product might not change the number of
customers.
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