PRICING FUNDAMENTALS

See Where your Pricing Needs to Go

You have to know your company’s vision and strategy before you attempt to create a pricing
strategy. The pricing strategy will either help or hinder the company in its action to fulfill that
vision.

Pricing Strategy

Neutral, Penetration and Skimming

Value-Based Pricing
Value-based pricing is a methodology of setting prices primarily based on a consumer's
perceived value of the product or service in question.

Negotiated vs TIOLI (Take it or Leave it)

Negotiated is a price agreed upon for the supply of goods or services by both buyer and seller.
TIOLI is a single price and buyers choose to buy at that price or not. Buyers do not or can not
negotiate.

What is your product worth

Customer Perceived Value is the evaluated value that a customer perceives to obtain by buying
a product. It is the difference between the total obtained benefits according to the customer
perception and the cost that he had to pay for that. Customer perceived value is seen in terms
of satisfaction of needs a product or service can offer to a potential customer. The customer will
buy the same product again only if he perceives to be getting some value out of the product.

Value in Use means the price is based on the product’s value to the customer, not the
manufacturer’s cost of production.

Value-Based Pricing: Mandatory to Maximize Profits

How much is your product worth and how much is a customer willing to pay for it? Value
Accounting helps you determine your customer’s willingness to pay for your product when
making the choice between your offering and that of one of your competitors. Estimate how
much more your customer would be willing to pay for each of these differentiated benefits. How
is your product worse? Estimate how much less your customer would be willing to pay for each
of these differentiations. Take the price of your competitor charges, add the value of your
advantages and subtract the value of your disadvantages. That is how much your customer is
willing to pay. Then you can calculate your product’s price.
Let Pricing Guide You

Product Differentiation

Product Differentiation is a marketing process in which a product is differentiated from others.

Put simply; it is the process of distinguishing a good or service from others, i.e., making it stand
out. Companies do this because they want to show customers their product’s attributes and
uniqueness. This may include products within the company or of the same line.

Increase Perceived Value

Sell your product at a higher price. This increases the perceived value because people usually
associate the higher priced product as being better. Offer a free trial or sample of your product.
This increases the perceived value because people think you're confident in your product, so it
must be good. Include tons of testimonials on your ad copy. This increases the perceived value
because you have actual proof of other people's experiences with your product.

Use Price as a Signal of Quality

Many buyers use price as a signal of quality, but what does that mean to you if you set price?
As a businessperson, what does this mean to you? If it is possible to determine the true quality
of your product, either before or after purchase, then you want to price consistent with your
relative level of quality.

Costs Matter: But Not How You Think

Fixed Costs Are Irrelevant to Pricing

It’s true. Your fixed costs are not relevant to your pricing decisions. Your price should be
determined by how much your customers are willing to pay. Their willingness to pay is driven
by the amount of value they get for your product. That value is determined by what else they
would do with their money and the incremental benefit your product or service provides. Their
willingness to pay does not change if you have higher R&D costs. Your fixed costs don’t matter.

Variable Costs Are Relevant

A variable cost is a corporate expense that changes in proportion to production output. Variable
costs increase or decrease depending on a company's production volume; they rise as
production increases and fall as production decreases. Examples of variable costs include the
costs of raw materials and packaging.
The total expenses incurred by any business consist of fixed costs and variable costs. Fixed
costs are expenses that remain the same regardless of production output. Whether a firm
makes sales or not, it must pay its fixed costs, as these costs are independent of output.

Examples of fixed costs are rent, employee salaries, insurance, and office supplies. A company
must still pay its rent for the space it occupies to run its business operations irrespective of the
volume of product manufactured and sold. Although fixed costs can change over a period of
time, the change will not be related to production.

Variable costs, on the other hand, are dependent on production output. The variable cost of
production is a constant amount per unit produced. As the volume of production and output
increases, variable costs will also increase.

PRICING SEGMENTATION: THE MOST PROFITABLE STRATEGIES

Introduction to Price Segmentation: Rich and Poor

What is it? Price segmentation is simply charging different prices to different people for the
same or similar product or service. You see examples every time you go shopping: student
prices at movie theaters, senior prices for coffee at McDonald’s, people who use coupons and
many more. The industry that probably does price segmentation better than any other is
airlines. It seems that no two people on a plane payed the same price.

Customer Characteristics: Who Are You?

Age, Local vs Tourist, Geography

Customer Behaviors:

Coupons, Rebates, Sales Events, End-Aisle Displays

Transaction Characteristics: At Point of Purchase

Volume, Weather Time of Day, Location, First-time Buyer

Loyalty and Price Segmentation: Treat Your Best Customers the Best

PART THREE. PORTFOLIO PRICING: NO PRODUCT IS AN ISLAND

Versioning: Good, Better, Best

The most common form of versioning is creating a product line with more features the higher
you go up the line. In this type of price segmentation, most people can easily rank product
above another. For example, the Whopper is good, the Whopper with cheese is better, the
Whopper with bacon cheese and everything else is the best. Coach seats on an airline are
good, first class seats are better.

Complimentary Products: Linking and Leveraging

Loss Leader

Retail outlets sometimes use a loss leader. The classic example is milk. Grocery stores
advertise the price of milk in their weekly flyers. Sometimes they advertise a price that is lower
than their cost. They sell it at a loss. Of course they’re doing this to get customers come into the
store. Then they will very likely sell many more items to each shopper to make up for any loss
on the milk. (Notice that milk is always at the back of the store so the shopper has to walk past
hundreds of items?)

Durable and Consumable

Gillette has this strategy down pat with razors. It will mail people free razors, knowing that they'll
make profits off selling the razor cartridges. Sodastream might sell a home soda fountain for
around $100, but it then charges $20 every time a customer trades in a carbon dioxide canister
for a refilled one. Give away a durable product that a person will use almost forever, and then
make money selling the disposable items that go with it.

Accessories

Charge higher margins for accessories that go along with a particular product. A person buying
a bicycle might want a helmet, knee pads and a horn. Give the customers a bargain on the
product they're basing their decision on -- such a bicycle --, and then tantalize them with higher-
margin accessories.

De-bundling

An in-flight meal or a bag stuffed into the overhead compartment used to be part of the price of
an airline ticket. Now passengers have to pay extra. Airlines realized that the decision item is
the price of the actual ticket. Once they have you trapped on the plane, they can then sell you a
high-cost sandwich. This is all about pulling apart products and services in order to accessorize.

Bundling

On the opposite side of the spectrum, you might bundle products together into packages or
deals. Rather than complementary pricing that relies on creating an array of higher-margin
products around the decision item, you're trying to boost sales volume by bundling things
together in order to get people to buy more. Comcast offers its Triple Play deal because it wants
to boost the number of its television customers who also use its cable-based phone and
Internet. There might be some who might have purchased all three anyway, but most probably
would not have without the deal.

Free: How to Get Paid for FREE

Free has to be one of the best things that anyone can ever do when it comes to pricing. How do
you get paid for free?

● Free samples
● Free trials
● Free information
● Pay as you wish

PART FOUR. PRICING DYNAMICS: PREPARE FOR CHANGE

Introduction to Pricing Dynamics: Customer Expectations

Customers Despise Price Increase

Customers hate price increases. It's a visceral animosity that just comes naturally. You want to
be very careful when raising prices to avoid raising this ire. Customers are more likely to accept
price increases when you can justify that your costs have gone up. The justification has to be
believable. All pricing situations are different. If you have a situation where you have loyal
customers that purchase over and over again, then here is a summary of the lessons to learn
from this house cleaner situation.

● Don't raise prices

● If you have to raise prices, do it selectively. Consider raising prices for only new
customers or "bad" customers.
● If you still have to raise prices, justify it with increased costs.

Start High, Then Discount

If you start out by pricing your goods at a high price, and then offer discounts to your customers,
you will have a better chance of avoiding price increases in the future. By starting out with a
higher price and then offering discounts, you are more likely to move your customer’s reference
point upwards, according to Impact Pricing. The higher your customer’s reference price, the
more likely you make him feel like “he’s getting a good deal” – you stand a much better chance
of closing the sale.

EDLP vs Hi-Lo
Responding to the Economy

Recesion, Inflation

Responding to Competitors

Price Wars

The most common cause of price wars is someone trying to increase market share, which
usually means taking share from your competitors. The fastest way to do that is by lowering
your prices. You reduce your price, more people choose your offering over those of your
competitors, and voilà, your market share goes up.

But usually, your competitors will lower their prices in response. They're not going to sit back
and let you take their share. Now both companies have the same market share as before, only
at lower prices. Certainly it wasn’t worth it.

You don’t have to win a price war; you have to survive it. To survive, simply get out of the way.
This doesn’t mean quit the business or leave the market. It means differentiate your products
and segment your customers.

Product Life Cycle: Prices Changes with Age

The product life cycle (PLC) refers to the notion that products have a limited period (lifetime) in
the marketplace and that this period passes through a number of different stages, each
requiring different approaches to the production, distribution, and marketing of the product.
Although there are many small variations in the number of stages into which the product life
cycle is divided by researchers and practitioners and also in the names attached to those
stages, in its most general terms, the life cycle consists of at least four stages – introduction,
growth, maturity, and decline – although some authors extend this analysis by including
additional stages at the beginning (e.g., development) or at the end (e.g., withdrawal).