Lecture 1 – Introduction to modern price strategies
Contents
Lecture 1 – Introduction to modern price strategies .............................................................................. 2
1 Introduction ...................................................................................................................................... 2
2 Common Pricing Myths .................................................................................................................... 2
3 Value-based pricing .......................................................................................................................... 4
Lecture 2 – Pricing Individual Products ................................................................................................... 5
1 Basic pricing approaches .................................................................................................................. 5
2 Participative Pricing Approaches ...................................................................................................... 6
3 Unique pricing approach .................................................................................................................. 8
Lecture 3 – Pricing with multiple products ............................................................................................. 9
1 Demand interdependencies: the basics ........................................................................................... 9
2 Pricing substitute products............................................................................................................... 9
3 Pricing complementary products ................................................................................................... 10
Article – Competition and substitution between public transport modes (Fearnley et al, 2018) .... 11
Lecture 4 – Psychological pricing........................................................................................................... 13
1 Rational decisions and prices ......................................................................................................... 13
2 Violations of rational choice by consumers* ................................................................................. 14
3 Violations of rational decision making by managers*.................................................................... 16
Lecture 5 - Promotions .......................................................................................................................... 18
1 Formats & Classification ................................................................................................................. 18
2 Scan*Pro ......................................................................................................................................... 19
3 Promotion innovations ................................................................................................................... 20
Paper Innovations in Retail Pricing and Promotion – Grewal et al. .................................................. 21
Lecture 6 – Price competition ............................................................................................................... 26
1 Competitive price reactions ........................................................................................................... 26
Paper – Toward an understanding of price wars: Their nature and how they erupt – Oliver Heil ... 27
Lecture 7 – Special price settings .......................................................................................................... 30
1 Retail price strategies ..................................................................................................................... 30
2 Pricing digital products ................................................................................................................... 30
3 Pricing of luxury products............................................................................................................... 32
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,Lecture 1 – Introduction to modern price strategies
Exam (60%):
• The material of the tutorial is also part of the exam
• You’ll get R output in the exam. No programming in the exam. Question such as what the
interpretation is of a coefficient
• You’re allowed to bring a blank scrap paper
• Always explain terms used in your answer, so the teacher knows you understand the question.
Too extensive answer is not good either
Lecture 1 – Introduction to modern price strategies
* Is from the article: The six pricing myths that kill profits – Andreas Hinterhuber (2016)
1 Introduction
Dimensions of pricing:
• Comparison: The Internet has made making comparisons easier
• Competition: You have to respond fast to changes
• Variability: Prices change a lot due to promotions. About 20% of the products are sold on
promotions
• Subjective: The psychological part of pricing
Responsibility pricing in a firm (*): All of the departments have an influence on the price, but none
of them are responsible. Hinterhuber proposes adding a new role: Chief Pricing Officer, who makes
sure that the price fits the overall strategy. Only <5% of the firms have one. Departments:
• Sales department: Conduct customer/account negotiations
• Marketing: Set list prices and brand considerations
• Finance: Set payment terms
• Accounting: Creates invoices and assigns discounts
Pricing decision: A reasoned choice from a set of alternative prices to achieve a certain objective
within a planning period. Factors:
2 Common Pricing Myths
Myths (*): Widely held and unquestioned beliefs that lack scientific basis. This is due to management
misconceptions because the decision makers associate actions with desired outcome and a causal
relation is inferred without any formal evaluation of alternative actions. These myths have persisted
for decades and it has inhibited and hurt the firm’s profitability and customer satisfaction. The
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,Lecture 1 – Introduction to modern price strategies
fundamental problem of misconceptions is that the decision makers associate actions with a desired
outcome and infer a causal relationship without attempting to understand whether alternative
actions produce a superior outcome. The solution is to make you aware of these misconceptions and
study scientific principles to guide pricing decisions research and experimentation with prices. Types
of myths:
1) Costs are the basis for pricing: 80% of the firms use this strategy. This is based on the
economic principle of fully efficient markets to price product at marginal cost. However, the
WTP is unrelated to cost and hence. WTP can be measured with a conjoint analysis. WTP is
not inherent in a product or a service, but can be created (e.g. with a decoy effect, which
Apple uses). Sometimes you can ask much more and they still pay for it. Strive to understand
and create customer value, which then serves as the main basis for pricing. Value-based
pricing is the only pricing approach positively linked to profitability, despite the fact the value
is subjective and perceived and cost are precise. However, cost should still be calculated to
provide a lower boundary for prices
2) Small price changes have little impact: Not true, since, on average, a 1% change in price will
increase profits by 11% on average. A 10% price cut to customers often means taking a 50%
or more cut in profits. Also think of the the psychological pricing of e.g. 0,99, whereby a 1
cent increase would drastically alter sales. Managers still believe in this myth due to
ignorance. Hence, every reduction is price is directly taken from your profit. Two solutions:
a. Limit price negotiation authority of salesforce and marketers
b. Artificially inflate list price to make room for negotiation (cf. reference prices)
3) Consumers are highly price sensitive: Consumers claim they value price (most), but they do
not act that way. That is because customers mostly buy out of habit. Managers make the
mistake of thinking they actually are since they are themselves very involved in the price
setting. Firm price setters overestimate consumer price knowledge and price sensitivity:
a. 50% of the shoppers could not name the price of the item placed in their shopping
cart. The people who have at least some price knowledge tend to overestimate the
price
b. Less than 1 in 2 shoppers was aware the product they purchased was on promotion
c. Small price changes of <2% tend to go unnoticed
d. Cherry-pickers that hunt for loss leaders is only <2% of the shoppers
e. Only <30% is a price-driven consumer segment . 70% choose based on other
benefits. Hence, businesses should look for efficiency, easy maintenance etc. instead.
Once managers have segmented the market, they can offer different product
configurations at different price points and decide whether to cater the purely price-
driven customers, if at all. In many cases, the company will ignore that segment
f. The same sensitivity to benefits as opposed to price holds for industrial markets.
Also, only 10% of the Total Cost of Ownership (TCO) is from the initial purchase price.
The rest is installation, maintenance, energy etc. Hence, a lot of managers focus on
minimising the TCO. However, managers should determine the sum of quantitative
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, Lecture 1 – Introduction to modern price strategies
benefits (revenue increase, cost reduction, risk reduction, capital expense savings)
and qualitative benefits (brand, expertise, track record, process benefits) to
determine the best price
4) Products are difficult to differentiate: Every product can be differentiate (there’s no perfect
competition). Think of bottled water, gasoline (Shell V-power). Managers who treat the
product as a commodity will turn the product into a commodity (self-fulfilling prophecy).
Even irrelevant differentiation creates customer value and increases customer WTP. It’s all
about perception
5) High market share = high profit: Managers who pursue competitor oriented goals set
relative strategy targets, whereas managers who have profit oriented goals set absolute
performance targets (competitor obsession bias). Companies who focus on competitors
neglect customers and their profits plunge. As long as the WTP > price, you should ignore the
price drops of competitors (even though WTP usually decreases with the same amount as
the price decrease of the main competitor), but it’s still important to communicate the value.
However, if the price > WTP, you should discount it with the same amount as the discount of
the competitor. Market leadership in itself is not worth a cent, instead you can strive for
leadership in price premium. Companies such as GM made this mistake. Research has shown
that there’s no correlation with market share and profitability. Companies can achieve
leadership in customer insight with two approaches:
a. Ethnographic research: A systematic recording of human action (naturally occurring
behaviours and conversations) in natural settings aimed at getting insights into
unsatisfied needs. This insight can then lead to meaningful innovation
b. Outcome-driven innovation: Researchers first interview customers in order to
discover the tasks that customers wish to accomplish. Each task is then broken down
into a series of desired outcomes. Researchers use then a larger sample to prioritize
these outcoms along the two dimensions of satisfaction and importance. Outcomes
that a large percentage rate as important, but not satisfied, are defined as unmet
needs and can be ideas for breakthrough innovation
6) Managing price means changing prices: Not true, communicating value is more effective
than changing prices ,e.g. by emphasizing unique features/ingredients, adding product
features, emphasize beneficial payment and delivery terms etc. Instead of lowering prices to
stay competitive, managers can also document that the quantified incremental value
provided is greater than the price premium (e.g. by communicating the ROI)
3 Value-based pricing
𝑄𝑡 −𝑄𝑡−1
%Δ𝑄 𝑄𝑡−1
Price sensitivity: It can be measured by looking at the price elasticity: 𝜖 = %Δ𝑃 = 𝑃𝑡 −𝑃𝑡−1 . A value
𝑃𝑡−1
between -1 and 1 is considered to by inelastic (meaning the percentual change in demand is less than
the percentual change in price. When the elasticity is higher than 1 or lower than -1, it means it’s
price sensitive. A normal price elasticity is negative (demand goes down (up) when price goes up
(down)). The revenue is highest when price elasticity is -1 (with other words, if your demand is
inelastic, you have to increase the price until it’s -1. If it’s elastic, you have to decrease until it’s -1.
Keep in mind that this only looks at revenue, and not at profits!). Since taking the log of a variable in
a regression changes the interpretation into a percentual change, a log-log model can be used to
estimate the price elasticity: ln(Q) = α + ln(P) + ε
Value-based pricing: The willingness to pay differs by person, over time by location. However, there
are other factors you have to take into account, such as ethical reasons
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