Module 3

STRATEGIC PRICING

Learning Objectives: After completing this module, students are expected to be able to:
1. Discuss what is the strategic pricing;
2. Describe each of the strategic pricing principles; and
3. Explain the strategic pricing pyramid.

Introduction
The economic forces that determine profitability change whenever technology, regulation,
market information, consumer preferences, or relative costs change. Consequently, companies that
grow profitably in changing markets often need to break old rules and create new pricing models.
For example:
➢ Netflix changed the model for renting films from the daily rate at video stores to a
time-independent membership model.
➢ Ryanair radically unbundled the elements of passenger air travel—charging
separately for baggage, seat selection, in-person check in, beverages—enabling it
to generate greater occupancy and more revenue per plane per day than its
established European competitors.
➢ Producers of new online media created a new metric for pricing ads—cost per
click— that aligns the cost of an ad more closely to its value than was possible in
traditional media.
➢ Apple changed the market for music in part by pricing songs rather than albums.

Unfortunately, few managers, even those in marketing, have received practical training in
how to make strategic pricing decisions such as these. Most companies still make pricing decisions
in reaction to change rather than
in anticipation of it. This is
unfortunate given that the need
for rapid and thoughtful
adaptations to changing markets
has never been greater. The
information revolution has
made prices everywhere more
transparent, making customers
increasingly price sensitive. The
globalization of markets, even
for services, has increased the
number of competitors and
often lowered their cost of sales.
The high rate of technological
change in many industries has created new sources of value for customers, but not necessarily led
to increases in profit for the producers.
 Still, those companies that have the capability to create and implement strategies that take
account of these changes are well rewarded for their efforts. Our Value-Scan survey, covering
more than 200 companies in both consumer and business markets, found that firms developing and
effectively executing value-based pricing strategies earn 31 percent higher operating income than
competitors whose pricing is driven by market share goals or target margins. Specific examples
abound that illustrate the power of strategic pricing to reward innovation.
➢ One prominent example is the iPhone. When Apple launched the iPhone, critics
claimed that a price over $400 was way out of line when competitive products could
be bought outright for half as much or obtained “free” with a two-year contract
from a wireless service provider. Apple, however, understood that a hard-core
group of technology “innovators” would easily recognize and place a high value on
the iPhone’s unique differentiation. By focusing on meeting that group’s needs at a
high price, Apple established a high benchmark for the value of its easy-to-use
interface. When Apple later lowered the price to a still high $300, it seemed like a
bargain in comparison to that benchmark, causing still more people to buy the
phone. Having established a high value, the company now captures a dominant
share at competitive prices while earning more than $1 billion per year from the
sale of third-party “apps.”
➢ Wal-Mart is another company that has grown profitably by pricing strategically,
but with the focus on where and how to discount prices. For example, Wal-Mart
puts its deepest discounts on products, like disposable diapers, that drive frequent
repeat visits by big spenders on other products. Since competitors with narrower
product lines cannot justify an equally low price on a “loss leader,” Wal-Mart can
undercut them to generate more store traffic without triggering a price war that
would otherwise undermine its strategy. As Wal-Mart illustrates, the measure of
success at strategic pricing is not how much it increases price but how much it
increases profitability.

What is Strategic Pricing?

The word “strategy” is used in various contexts to imply different things. Here we use it to
mean the coordination of otherwise independent activities to achieve a common objective. For
strategic pricing, that objective is profitability. Achieving exceptional profitability requires
managing much more than just price
levels. It requires ensuring that products
and services include just those features
that customers are willing to pay for,
without those that unnecessarily drive
up cost by more than they add to value.
It requires translating the differentiated
benefits your company offers into
customer perceptions of a fair price
premium for those benefits. It requires
creativity in how you collect revenues
so that customers who get more value
from your differentiation pay more for it. It requires varying price to use fixed costs optimally and
to discourage behavior that drives excessive service costs. It sometimes requires building
capabilities to mitigate the behavior of aggressive competitors. Although more than one strategy
can achieve profitable results, even within the same industry, nearly all successful pricing
strategies embody three principles. They are value-based, proactive, and profit-driven.
➢ Value-based means that differences in pricing across customers and changes over
time reflect differences or changes in the value to customers. For example, many
managers ask whether they should lower prices in response to reduced market
demand during a recession. The answer: if customers receive less value from your
product or service because of the recession, then prices should reflect that. But the
fact that fewer customers are in the market for your product does not necessarily
imply that they value it less than when they were more numerous. Unless a close
competitor has cut its price, giving customers a better alternative, there may be no
value-based reason for you to do so.
➢ Proactive means that companies anticipate disruptive events (for example,
negotiations with customers, a competitive threat, or a technological change) and
develop strategies in advance to deal with them. For example, anticipating that a
recession or a new competitive entry will cause customers to ask for lower prices,
a proactive company develops a lower-priced service option or a loyalty program,
enabling it to define the terms and trade-offs of the expected interaction, rather
than forcing it to react to terms and trade-offs defined by the customer or the
competitor.
➢ Profit-driven means that the company evaluates its success at price management
by what it earns relative to alternative investments rather than by the revenue it
generates relative to its competitors. For example, when Alan Mulally took charge
as Ford Motor Company’s CEO in 2006, he declared that henceforth Ford would
focus on selling cars profitably, even if that meant that Ford would become a
smaller company. He cut Ford’s 96 models to 20 and sold off its unprofitable
Jaguar and Land Rover brands. When the recession appeared in late 2008, he
quickly and relentlessly cut production—ending the long-standing policy at all the
Big Three U.S. auto manufacturers to increase customer and dealer incentives to
maintain production as long as possible. Although Ford initially gave up market
share, it was in the end the only one of the Big Three to avoid bankruptcy. These
three principles are evident throughout this book as we discuss how to define and
make good choices. A good pricing strategy involves five distinct but very
different sets of choices that build upon one another. The choices are represented
graphically as the five levels of the strategic pricing pyramid (Exhibit 1-1), with
those lower in the pyramid providing the necessary support, or foundation, for
those above. Although the principles that underlie choices at each level are the
same, implementing those principles in any given market requires a creative
application to the specifics of each product and market. Consequently, after briefly
describing each choice here, the next five chapters will illustrate in greater detail
the tools and tactics for making each choice well. Notice, however, that the choices
fall into what, in large companies, are different functional domains staffed by
different people. That is why senior management needs to be involved in pricing;
not to set prices but to articulate goals for each set of choices that facilitate the
implementation of a coherent strategy.
 Strategic pricing is the coordination of interrelated marketing, competitive, and financial
decisions to set prices profitably. For most companies, strategic pricing requires more than a
change in attitude; it requires a change in when, how, and who makes pricing decisions. For
example, strategic pricing requires anticipating price levels before beginning product
development. The only way to ensure profitable pricing is to reject early those ideas for which
adequate value cannot be captured to justify the cost. Strategic pricing also requires that
management take responsibility for establishing a coherent set of pricing policies and procedures,
consistent with its strategic goals for the company. Abdicating responsibility for pricing to the
sales force or to the distribution channel is abdicating responsibility for the strategic direction of
the business. Perhaps most important, strategic pricing requires a new relationship between
marketing and finance. Strategic pricing is actually the interface between marketing and finance.
It involves finding a balance between the customer's desire to obtain good value and the firm's
need to cover costs and earn profits. Strategic pricing sets a product's price based on the product's
value to the customer, or on competitive strategy, rather than on the cost of production. This
approach recognizes that people often make purchasing decisions based more on psychology than
on logic, and that what is most valuable to the customer may not be what's most expensive to
produce. By creating strategic pricing policies, analytics, and processes, you can directly capture
customer value and turn that value into shareholder value.

Exhibit 1-1 The Strategic Pricing Pyramid

Value Creation
This is the bottom most tier of the strategic pricing pyramid and the foundation of an entire
pricing strategy. Having a deep understanding of how your products and services create value for
customers is a key input to the development of a price structure. Ex: Product Managers typically
turn towards marketing research to find this information. Understanding how a product delivers
value to customers creates a foundation for more profitable prices

Price Structure
This is the second to bottom tier of the strategic pricing pyramid. Once you understand
how to create value for your product, you have to create a price structure that aligns with the
perceived value received. Two techniques used are price metrics and price fences. Price metrics
are the units in which price is applied to the product or service. (i.e. mens/womens haircuts) Price
fences are a way to create a price structure that aligns price with value and cost-to-serve (airlines
when using discount tickets).

Price/Value Communication
This is the middle tier to the strategic pricing pyramid. This is communicating your prices based
on the values created for different customers. Poor communication of values results in high buyer
sensitivity (i.e. Apple releasing the IPOD)

Pricing Policy
This is the second from the top tier on the strategic pricing pyramid. Pricing policy involves
the art of managing expectations of the customers and employees to incent more profitable
behaviors. And be able to enforce these policies in the face of aggressive customers.

Pricing Level
The top tier on the strategic pricing pyramid. The goal is to maximize profitability.
Although everyone in the firm has a different view, sales wants lower prices, finance enforces
minimum contribution margins, marketing thinks price should be selective. This is very difficult
to attain.

References:
1. In the past two decades, serious theoretical work has replaced simplistic, anecdotal
guidelines for how to create a sustainably successful business. See Michael E. Porter,
Competitive Advantage (New York: The Free Press, 1985); Gary Hamel and C. K.
Parhalad, Competing for the Future (Cambridge, MA: Harvard Business School Press,
1994); Adrian Slywotzky and David Morrison, The Profit Zone (New York: Random
House, 1997); Robert Kaplan and David Norton, The Strategy-Focused Organization
(Cambridge, MA: Harvard Business School, 2001).
2. Peter F. Drucker, “The Information Executives Truly Need,” Harvard Business Review
(January–February 1995): 58.
3. “Ryanair Ready for Price War as Aer Lingus Costs Leap,” The Telegraph, June 2, 2009.
4. https://quizlet.com/108916338/pricing-strategies-1st-5-terms-flash-cards/