Module 5 – Setting Price Levels & Pricing Over the Product Life Cycle

Price setting

ultimate intersection of value creation and value extraction, where the seller seeks simultaneously to capture a fair share of the value created, maximize long-term profitability, and enhance his or her market position.

Ex. No one person in an airplane paid more than the value they think and the cost of the service.

Price-Setting Process

The goal of the ___ to set profit-maximizing prices by capturing the appropriate amount of differential value in each of the served segments.

Step 1: Define the Viable Price Range

Starts with defining the highest and lowest price points that a business might sustainably charge for the product or service

feasible price ceiling (highest)

defined by the product’s value proposition.

positively differentiated

feasible price floor (lowest) for a product that is ___ is the price of the next-best competitive alternative.

We place the competitor in an untenable position in which its product creates a negative economic benefit for its customers.

negatively differentiated

the price ceiling will also be defined by the economic value, which in this is below the price of the next-best competing alternative

price floor

is then defined by the product’s variable cost.

Ex. A mobile phone carrier that only has local phone coverage

Price skimming (positively differentiated offering)

captures high margins at the expense of sales volume.

Penetration Pricing (negatively differentiated offering)

sets price far enough below economic value (not below cost) to attract and hold a large base of consumers

Step 2: Make Strategic Choices

It is essential that price levels be set in a way that supports and advances the broader marketing objectives of the firm.

Pricing objectives

• must be set relative to some reference point.

• share differentiating value that the firm attempts to capture its price.

1. Skimming the market

2. Penetrating the Market

3. Neutral Market Pricing

There are three alternative strategic choices that one might adopt for a pricing strategy:

Skim pricing (or skimming)

designed to capture high margins at the expense of large sales volume.

Skim prices

high in relation to what most buyers in a segment can be convinced to pay.

• In some instances, products might reap more profit in the long run by setting initial prices high and reducing them over time – the sequential skimming strategy

Penetration pricing

involves setting a price low enough to attract and hold a large base of customers.

Penetration prices

not necessarily, but they are low relative to perceived value in the target segment.

Neutral pricing/ In-line pricing

• involves a strategic decision not to use price to gain market share, while not allowing price alone to restrict it.

• adopts ___ strategy by default because market conditions are not sufficient to support either a skim or penetration strategy.

Factors supporting skimming

• new product perceived as risky

• presence of protection against competitive products

Factors supporting penetration

• ability of low price to serve as an incentive to buy

• protection against competitive price matching

• market conditions favoring a pioneer advantage

skimming and penetration

Use in-line pricing when market conditions do not support _____ or ____

Step 3: Assess Breakeven Sales Changes

the relationship between changes in price, volume, and profitability.

practicality

The major benefit of breakeven analysis is its____

Incremental breakeven analysis

an approach that leverages knowable data such as current costs and sales volumes to establish clear, indisputable benchmarks that any price change has to meet in order to be profitable.

Step 4: Gauge Price Elasticity

Price elasticity measures the responsiveness of the quantity demanded or supplied of a good to a change in its price.

• The goal is to gradually arrive at a profit-maximizing price point by calculating breakeven sales changes and testing the market to see whether sales changes are on the profitable side of that breakeven point.

price elasticity

These price changes could take the form of changes in list price, temporary price reductions, or competitive price moves that changed the relative price position of competitive products.

Step 5: Account for Psychological Factors

Although by the time you set a price, you should already have segmented your market to reflect the differences in value for different applications or occasions, there will remain differences in prices customers will pay even within segments.

• For example: Even with the same application segment, knowledgeable and highly sophisticated purchasers will be much more likely to change their behavior in response to a change in price than will less well informed customers.

Reference Value

Value is always relative in the minds of customers. By re-framing a customer to view a more expensive alternative as the reference, buyer price sensitivity can be reduced.

Switching Costs

Buyers are less sensitive to the price of a product the greater the added costs of switching from their current supplier.

Difficult Comparison

Buyers are less price sensitive when it is difficult to compare suppliers and the cost of not getting the expected benefits of a purchase are high.

Importance of end-benefit

Buyers are less price sensitive when the product is a small part of the cost of a benefit with high economic or psychological importance.

Price-quality perceptions

Buyers are less sensitive to a product’s price to the extent that price is a proxy for the likely quality of the purchase

Size of expenditure

Buyers are more (or less) price sensitive when expenditures are relatively large (or small) as a portion of the overall budget.

Shared costs

Buyers are less price sensitive when some or all the purchase price is paid by others

Transaction value

Buyers are motivated by more than just the “acquisition utility” associated with obtaining and using a product. They are also more motivated by the “transaction utility” associated with the difference between the price paid and what the buyer considers a reasonable or fair offer for the product

Perceived fairness

Buyers are more sensitive to a product’s price when it is outside the range that they perceive as “fair or reasonable.”

In considering these price sensitivity factors

Step 5: Account for Psychological Factors
_____, marketers should seek to understand which of them are relevant for their particular products, and for which segment of customers, in order to influence them favorably through price and value communications.

It is important to take into account of the price sensitivity effects and determine whether there is a cost-effective marketing campaign that could mitigate or leverage one or more of them to influence price sensitivity

Step 6: Communicating New Prices to the Market

final task in setting a new price level is to communicate the rationale for the change, especially when there is potentially an use of “fairness.”

Perceived fairness

one of the most powerful factors driving price sensitivity.

Just as there are different reasons for price changes, there are different approaches to communicating fairness.

Step 6: Communicating New Prices to the Market

1. Rising raw materials costs require price increase.

2. Avoid being opportunistic by attempting to gain share by compromising on the increase.

3. Consider non-price mechanisms to “raise” price and lessen the customer impact.

4. Switch product formulation. Ex. Changing clothing manufacturer

Price-Setting Process

1. Defining the Price Window

2. Set Initial Price

3. Communicate Prices to the Market

Define Price Window

Set initial price range based on differential value & relevant costs.

key questions:

1. What is the appropriate price ceiling for this product?

2. How should I incorporate reference prices into my price window?

3. What is the role of costs in setting my initial price range?

Set Initial Price

determine amount of differential value to be captured.

key questions:

1. Is price point consistent with my business strategy & objectives?

2. What are the price-volume tradeoffs and what is their impact on profitability?

3. What are the non-value related determinants of price sensitivity?

Communicate Prices to Market

develop communication plan to ensure prices are perceived to be fair.

key questions:

1. What is the best approach to communicate price changes to customers?

2. What are the considerations for implementing significantly higher prices?

price window

set for each segment and is defined by the ceiling, the highest allowable price point, and the floor, the lowest allowable price point.

1. Establish the price window for each segment

2. Narrow the window based on strategic objectives

1. Alignment with Overall Business Strategy

2. Price-Volume Trade-offs

3. Customer Response

There are three considerations when determining where in the price window to set the initial price:

Defining the Price-Volume Trade-off

Understand the financial trade-offs between price and volume and then analyze the market to estimate consumer response.

Guide questions to pricing choice:

1. How much volume could I afford to lose before a particular price increase would be unprofitable?

2. How much volume would I have to gain in order for a particular price decrease to improve my profitability?

Price experimentation

involves testing new prices on a controlled sample of customers before rolling the price change out to the entire market.

Purchase intention

surveys can be used when price experimentation is impractical, as is the case for many large, infrequently purchased products (such as automobiles and enterprise software) that don’t lend themselves to experimentation

Structured inference

by managers is an approach that leverages managerial market knowledge combined with appropriate analysis to arrive at a sound price point.

Incremental implementation

can work when none of the other methods for estimating customer response are practical or reliable enough to produce confident inferences.

Simulations

provide a means to explore systematically the effects of competitor reactions to customer responses to a price change.

Product Life Cycle Pricing

1. Introduction

2. Growth

3. Maturity

4. Decline

Pricing New Products

1. New products represent a primary source of organic volume and profit growth

2. It represents an opportunity to redefine the process and considerations that determine what and how customers purchase

Introduction Stage

a revolutionary product is launched, which creates an entirely new market.

Revolutionary products

represent only a small fraction of the new products on the market at any given time, and many researchers with a more critical bent would argue that truly revolutionary products are launched sporadically on time scales of once per every few years, if not decades.

Tinkerers

• are people who appreciate a new product due to its revolutionary properties themselves.

• evaluate a new product, they seek to explore its properties, capabilities, and uses

Visionaries

• people who are seeking a quantum leap forward in addressing a challenge.

• a business customer, and are seeking an order-of-magnitude return on investment, not a standard small percentage of improvement with a long-term payback.

Pricing in Introductory Market

• To price a product within an introductory market, executives are usually best served by using exchange value models.

• Exchange value models rely on internal management’s assessment of the value of a revolutionary product.

Exchange value model

a pricing strategy used to determine price boundaries of a commodity based on the perceived value by the customer.

• exchange models quantify the price models knowing the boundaries of a good price narrows pricing discussions to a reasonable range of potential points

Extreme Boundaries

define the range of acceptable prices outside of which no rational buyer or seller would ever transact

Narrow Boundaries

define the range of prices that are most likely to encourage customer transactions and the leave the firm most favorable position.

-these are lying within the extreme boundaries

Strategies to be used (Introduction)

Communicating value with trial promotions ◦Communicating value with Direct Sales

Growth Stage

the product life cycle is marked with rapid changes in every dimension of the newly emerged market.

Evolutionary products

are products in which specific features or benefits are added or subtracted from the core product.

Pricing in growth markets

• shifts from exchange value models to customer preference–based methodologies.

• Competitors may begin to explore add ons, versioning and unbundling.

Pricing with a Differentiated Product

refers to setting price for a product that has unique features, branding, quality, or other distinct attributes that set it apart from competitors.

higher price

justified by the brand prestige, ecosystem benefits, and perceived superior user experience. Customers are willing to pay more because of the differentiated value

Pricing with Cost Leadership

strategy where a company sets the lowest possible price in the market by minimizing production and operational costs.

Price Reductions in Growth

refers to lowering prices as a product gains market acceptance and demand increases

gradually reduce prices

As a trendy product gains popularity and production costs decrease, they _____ to appeal to a broader audience before the trend fades.

Maturity Stage

the product life cycle, demand growth, competitor turbulence, and rapid product evolution are replaced with more predictable industry dynamics.

• Accuracy in price setting in mature markets improves due to better understanding of the market.

mature phase

• During the ______, the pressure to improve prices shifts the pricing challenge from a focus on establishing price structures and setting price levels and toward the importance of managing price variances.

• Due to competitive pressures and customer heterogeneity, couponing, discounting, and price promotions all become more common practices.

Strategies to be used (Maturity)

◦Unbundling related products and services

◦Improved estimation of Price Sensitivity

◦Improved Control and Utilization of Costs

◦Expansion of Product Line

◦Reevaluation of Distribution Channels

Decline Stage

While prices during declining markets tend to be volatile, it is not possible to make an a priori statement regarding the direction of all prices.

decline

The goal of strategy in ____ is not to win anything; for some it is to exit with minimum losses. For others the goal is simply to survive the decline with their competitive positions intact and perhaps strengthened by the experience.

Strategies to be used (Decline)

◦Retrenchment

◦Harvest

◦Consolidation

◦Focus

Retrenchment in Pricing

Refers to a strategy where a company reduces prices or adjusts pricing models to cut losses, regain market share, or survive during financial difficulties. This often happens during declining sales, economic downturns, or increased competition.

• Jollibee’s Value Meals During Economic Crises

• • During economic downturns, Jollibee introduced more budget friendly meal options (e.g., ₱50-₱60 meals) to retain customers and stay competitive despite lower consumer spending.

• ◦ Nokia’s Price Reductions in the Smartphone Market

• • As Nokia lost market dominance to Apple and Samsung, it significantly lowered the prices of its smartphones to appeal to budget-conscious consumers before eventually exiting the high end market.

Harvest Pricing

a strategy where a company gradually reduces investment in a product while maximizing profits. This often involves maintaining or slightly increasing prices while cutting marketing and production costs, allowing the company to extract as much revenue as possible before discontinuation.

• Coca-Cola’s Phasing Out of Niche Products

• • When Coca-Cola decides to discontinue certain soft drink flavors (e.g., Tab soda), it stops promotions and keeps prices stable or slightly raises them, allowing loyal customers to continue purchasing while maximizing final profits.

• ◦ Old Smartphone Models (Apple & Samsung)

• • When a new iPhone or Samsung Galaxy model is released, the older model's price is lowered gradually while marketing support is withdrawn. Apple, for instance, continues selling older iPhones at a lower price to extract value before discontinuation.

Consolidation Pricing

This involves standardizing prices, reducing price variations, or bundling products/services after a merger, acquisition, or market restructuring.

• Globe and TM (Telecommunications in the Philippines)

• • After Globe Telecom acquired Touch Mobile (TM), they gradually aligned pricing strategies, offering similar prepaid and postpaid plans to unify their market presence.

• ◦ Lazada & Shopee’s Price Standardization

• • As these e-commerce platforms grew, they implemented standardized pricing and discounts across sellers to ensure a consistent shopping experience and improve competitiveness against global marketplaces.

Focus Pricing

A strategy where a company sets prices to a target specific market segment – either a niche market (focused differentiation) or a price sensitive segment (focused cost leadership.) The goal is to cater a well-defined group rather than competing across the entire market.

• ◦ LUXURY NICHE: Rolex Watches

• • Rolex targets high-end consumers by pricing watches at ₱500,000+, emphasizing exclusivity, craftsmanship, and prestige. This focused differentiation strategy makes Rolex stand out in the luxury watch segment.

• ◦ BUDGET NICHE: Cebu Pacific’s Piso Fare

• • Cebu Pacific targets budget travelers with its famous ₱1 seat sales, making air travel affordable while focusing on cost-conscious customers. This is an example of focused cost leadership in the airline industry.

• ◦ HEALTH-CONSCIOUS MARKET: Beyond Meat

• • Beyond Meat prices its plant-based products higher than regular meat but lower than premium organic meats, focusing on health-conscious and environmentally aware consumers who are willing to pay extra.