PRICING STRATEGY Dr.

Shakti Bodh Bhatnagar

ABOUT ME
Dr. Shakti Bodh Bhatnagar

MBA (Marketing and Finance) from Symbiosis (SCMHRD, Pune), 2003. India’s top 15 MBA insti
in 2003

PhD from Aligarh Muslim University (One of India’s top 10 Univ)

16 years of corporate experience (LG India, SKF India, ICICI Bank, GM India, DB Corp)

Former Director of Symbiosis (SCMS), Nagpur

GROUP PROJECT
To evaluate the learning, each section shall be divided into 8 groups.
Each group shall consist of 6 students.
Each group will be choosing one company, which the groups will have to carry out a
detailed analysis and arrive at a decision report for strategic pricing.
The evaluation would be on a continuous basis during class.
The groups need to report as well as present their results and interpretations to
suggest the best possible pricing decision.
CLASS PARTICIPATION – 20 MARKS
Every class will have discussion on concepts

Followed by a practical situation analysis

Students will be chosen on random basis to come the present the solution to the
situation/problem

Their presentation will be graded for class participation

COURSE OVERVIEW
This course aims to develop necessary knowledge to introduce students to the
framework, concepts, and techniques for assessing and formulating profitable pricing
strategies.
Students will learn the process of making pricing decisions and survey innovative
approaches for setting prices.
A key objective of strategic pricing is to generate sustainable profits.
Students are expected to learn the framework for setting pricing decisions, gain a
solid understanding of current pricing practices, and master the essential techniques
for making profitable pricing decisions.
NEED OF THE COURSE

Pricing is art or science?

NEED OF THE COURSE

Actually, both.

We will look into it a little later, but first few examples

PRICING EXAMPLES
Dan Ariely experiment – from his book ‘Predictably Irrational’

He came across the following subscription offer from The Economist, the magazine
(he also explained this in his TED talk)
PRICING EXAMPLES
Both the print subscription and print & web subscription cost the same, $125
dollars.
PRICING EXAMPLES
Ariely conducted a study with his 100 bright MIT students.

In it, 16 chose option A and 84 chose option C. Nobody chose the middle option.
PRICING EXAMPLES
So if nobody chose the middle option, why have it?

He removed it, and gave the subscription offer to another 100 MIT students.

This is what they chose now:

PRICING EXAMPLES
Most people now chose the first option!
PRICING EXAMPLES
So the middle option wasn’t useless, but rather helped people make a choice.

People have trouble comparing different options, but if two of the options given are
similar (e.g., same price), it becomes much easier.
PRICING EXAMPLES
The same principle was used with travel packages.

When people were offered to choose a trip to Paris (option A) versus a trip to Rome
(option B), they had a hard time choosing.

Both places were great—it was hard to compare them.

PRICING EXAMPLES
Now they were offered three choices instead of two:

 trip to Paris with free breakfast (option A),

 trip to Paris without breakfast (option A-),

 trip to Rome with free breakfast (option B).

Now overwhelming majority chose option A, trip to Paris with free breakfast.

The rationale is that it is easier to compare the two options for Paris than it is to compare Paris and
Rome.
PRICING EXAMPLES
A graph to describe this:
PRICING EXAMPLES
So if you add a slightly worse option that is similar to A (call it A-),
then it’s easy to see that A is better than A-, which is why many
people choose that.

How you can use it: Add a decoy package or plan to your
offer page next to the offer you really want them to take.
PRICING EXAMPLES
Number 9

Go to Walmart and you’ll see prices ending with 9 everywhere. Does it really work? Surely
all intelligent people understand that $39 and $40 are basically the same.

Well, in eight studies published from 1987 to 2004, charm prices ($49, $79, $1.49, and so
on) were reported to boost sales by an average of 24% relative to nearby prices
PRICING EXAMPLES
In one of the experiments done by University of Chicago and MIT, a mail order
catalog was printed in three different versions.

One women’s clothing item tested was sold for $39.

In experimental versions of the catalog, the company offered the same item for $34
and $44.

Each catalog was sent to an identically sized sample.

PRICING EXAMPLES
There were more sales at the charm price of $39 than at either of the other prices,
including the cheaper $34.

The $39 price tag had both greater sales volume and greater profit per sale.
PRICING EXAMPLES
People used to download music for free, then Steve Jobs convinced them to pay.

How?
PRICING EXAMPLES
By charging 99 cents.
PRICING EXAMPLES
Beyond 9?
PRICING EXAMPLES
Researches found that sale price markers (with the old price mentioned)
were more powerful than mere prices ending with the number 9.
 PRICING EXAMPLES
In the following split test, the left one won:
PRICING EXAMPLES
So 9 was not the everything

Wait, they did another study

 PRICING EXAMPLES
Then they split-tested the winner above with a similar tag, but which had $39
instead of $40:
PRICING EXAMPLES
This had the strongest effect of all.
PRICING EXAMPLES
Do you think the effect of this price tag could be increased by reducing the font size
of $39?
PRICING EXAMPLES
Marketing professors at Clark University and The University of Connecticut
found that

consumers perceive sale prices to be a better value when the price is written in a
small font rather than a large, bold typeface.

In our minds, physical magnitude is related to numerical magnitude.

PRICING EXAMPLES
Do this test at home.
Pour water in three bowls.
Fill one bowl with cold water, the second with hot water, and third one with
lukewarm water.
Now stick one hand in the cold water and the other one in the (not too) hot water.
Keep them there for 30 seconds or so.
Now put both of your hands into the lukewarm bowl.
One hand will feel the water is warm, the other one that it’s cold.
PRICING EXAMPLES
It’s about the contrast.

The same principle applies to price.

Nothing is cheap or expensive by itself, but compared to something.

PRICING EXAMPLES
Once you’ve seen a $150 burger on the menu, $50 sounds reasonable for a steak.

At Ralph Lauren, that $16,995 bag makes a $98 T-shirt look cheap.
PRICING EXAMPLES
What’s the best way to sell a $2,000 wristwatch?
PRICING EXAMPLES
Put Right next to a $12,000 watch.

This mental process has a name.

PRICING EXAMPLES

It’s called anchoring and adjustment.

PRICING EXAMPLES
Anchoring
In the 1970s, two psychologists by the names of Tversky and Kahneman theorized
that suggesting an initial figure to a test subject caused that subject to use that
number as a starting point for estimating unknown quantities.
PRICING EXAMPLES
In their study test, subjects were told the number 65 and then asked to estimate
what percentage of African nations were members of the UN.
PRICING EXAMPLES
The average response was 45%.
PRICING EXAMPLES
They then tested a second group but salted them with the number 10;
PRICING EXAMPLES
their average response was 25%.

Amazingly, the group that was primed with the number 65 estimated nearly twice
the true answer (23%) while the group primed with the lower number estimated a
lower percentage (much more accurately).
PRICING EXAMPLES
Anchoring influences prices
Poundstone describes an experiment done with real estate prices.

The researchers invited real estate experts and undergrad

students to appraise a home for sale.
PRICING EXAMPLES
Anchoring influences prices
All the test subjects were given the information a buyer would
normally have, including a list of houses that recently sold, nearby
houses currently for sale and so on, as well as what the seller had
listed the house for.
PRICING EXAMPLES

The subjects were divided into four groups, each given a different
listing price, and were then asked to estimate what the home was
worth.
PRICING EXAMPLES
These were the results:
PRICING EXAMPLES
Anchoring worked even on real estate pros that had been selling properties in the
area for 10+ years.

Next time somebody asks you for a rough estimate or a ballpark figure, make sure
it’s high!
PRICING EXAMPLES
How you can use it: Start throwing out high numbers.

Add some very expensive products to the selection (that you don’t even intend to
sell).

If the final price of your product (or service) is a result of negotiations, start high.

If you’re competing on price, state how much others are charging before revealing
your price.
PRICING EXAMPLES
Pay what you wish
Pay what you want is a pricing system where buyers pay any desired amount for a
given product, or nothing at all.

In some cases, a minimum is set, and/or a suggested price may be indicated as

guidance for the buyer.

The buyer can also select an amount higher than the standard price.
PRICING EXAMPLES
Gap tried a variation of this too.

They offered customers a one-day opportunity to name their price for certain styles
of khaki pants on the www.gapmyprice.com microsite.

Lowball offers were returned with slightly higher prices by the Gap, which the
customer had one chance to accept or decline.
PRICING
EXAMPLES
PRICING EXAMPLES
Since they’re not doing anymore, it probably did not go too well.
PRICING EXAMPLES
Well-known PWYW examples
In October 2007, the British band Radiohead launched their latest album, In
Rainbows, on the Internet.

The band allowed fans to download the album freely and offer, in retribution, any
amount of money they would like.

Later they disclosed that the download of their new album generated more profit
than the accumulated downloads from all previous albums.
PRICING EXAMPLES
Offering three options
The old truth about offering three pricing options holds water.

Here’s a pricing experiment in selling beer, from W. Poundstone’s amazing

book Priceless.
 PRICING EXAMPLES
People were offered two kinds of
beer:

• premium beer for $2.50,

and

• bargain beer for $1.80.

Around 80% chose the more

expensive beer.
 PRICING EXAMPLES
Now a third beer was introduced,

a super bargain beer for $1.60

in addition to the previous two.

Now 80% bought the $1.80 beer,

and the rest $2.50 beer.

Nobody bought the cheapest

option.
 PRICING EXAMPLES
Third time around, they removed
the $1.60 beer and replaced with a
super premium $3.40 beer.

Most people chose the $2.50 beer,

a small number $1.80 beer and
around 10% opted for the most
expensive $3.40 beer.

Some people will always buy the

most expensive option, no matter
the price.
PRICING EXAMPLES
You can influence people’s choice by offering different options.

Old school sales people also say that offering different price point options will make
people choose between your plans, instead of choosing whether to buy your
product or not.

How to test it: Try offering three packages, and if there is something you really want
to sell, make it the middle option.
PRICING EXAMPLES
Price perceptions
I’m sure you know the classic “pennies-a-day” effect: “it costs less than $1 a day!”
NPR stations ask people to donate by joining their dollar-a-day club.
Framed in that manner, the donation seems quite reasonable—about the cost of a
cup of coffee.
Contrast that with what would happen if they asked people to join their “$365 a
year” club.
PRICING EXAMPLES
People base their perceived values on reference points.

If you’re selling a to-do list application, then people will look around and find another
to-do list application.

If they search the internet and discover that your competitors sell to-do list
applications at $100, then this will set their perception of the right price for all to-do
list applications.
PRICING EXAMPLES
If your product is more expensive than the common reference points, the how
would you sell?
PRICING EXAMPLES
Change the perception of the category you’re in.
PRICING EXAMPLES
How did Starbucks get away with starting to charge $3 and more for coffee, when
most other cafes were charging $1 or so?

They changed the experience of buying coffee, so the perception of what people
were getting changed.

It was like a different category product.

PRICING EXAMPLES
They also changed the name.

Not just coffee, but Pike’s Place brew or caramel macchiato.

If you’re creating a new category, there’s no price reference, and people are much
more likely to accept any price you name.
PRICING EXAMPLES
How you can use it:
If you want to charge more than the market average, look at the competition: how
they package their offering, what’s the user experience like, and change that.

If you look like a new category, people are more likely to pay up.

On the other hand, if you can profitably sell something much cheaper than the
other guys, great. Use their pricing as the reference point and you’ll win.
PRICING EXAMPLES
Value-based pricing is a strategy in which prices are set based on the
perceived value of a product or service to the customer.

By aligning pricing with the value it delivers, businesses can capture a fair
portion of that value for themselves.
PRICING EXAMPLES
Apple:
The tech giant is renowned for its value-based pricing strategy.
Apple products are often priced higher compared to competitors, but
consumers associate them with superior quality, design, and user
experience.
By creating a perception of value, Apple is able to command premium prices
and maintain high profit margins.
PRICING EXAMPLES
Rolex:
The luxury watch brand has mastered the art of value-based pricing.
Rolex timepieces are not merely timekeeping devices; they are symbols of
status and craftsmanship.
Despite the availability of cheaper alternatives, Rolex maintains its premium
pricing based on the perceived value of its products.
PRICING EXAMPLES
Tesla:
The electric car manufacturer, led by Elon Musk, has successfully
implemented a value-based pricing strategy.
Tesla vehicles are priced at a premium compared to traditional gasoline-
powered cars, primarily due to their innovative technology, range, and
sustainability.
Tesla's pricing strategy has positioned the brand as a market leader in the
electric vehicle segment.
PRICING EXAMPLES
Value-based pricing allows businesses to differentiate themselves from
competitors and capture a fair share of the value they deliver to customers.

However, it requires a deep understanding of customer needs, preferences,

and willingness to pay.
PRICING EXAMPLES
Penetration pricing is a strategy in which companies set low initial prices to
quickly gain market share and attract customers.

This strategy is particularly effective when entering a new market or launching

a new product.
PRICING EXAMPLES
Amazon Kindle:

When Amazon introduced its Kindle e-reader, it set the initial price
significantly lower than competitors to entice readers to adopt the new
technology.
The low price point helped Amazon rapidly gain market share and establish
itself as a dominant player in the e-book market.
PRICING EXAMPLES
Gillette :

The razor company implemented a penetration pricing strategy with its

Mach3 razors.
By initially selling the razors at a low price and profiting from the disposable
blades, Gillette was able to attract a large customer base.
Once customers were locked into the system, the company could increase
prices for blades, generating substantial profits.
PRICING EXAMPLES
Xiaomi :

The Chinese smartphone manufacturer adopted a penetration pricing

strategy when it entered the smartphone market.

By offering feature-rich smartphones at significantly lower prices than

established competitors, Xiaomi quickly gained market share and became
one of the top smartphone brands in several countries.
PRICING EXAMPLES
Penetration pricing can be an effective strategy to quickly gain a foothold in
the market, especially in highly competitive industries.

However, businesses must carefully plan their pricing and have a clear
strategy for generating profits in the long term.
PRICING EXAMPLES
Dynamic pricing, also known as surge pricing or demand-based pricing, is a
strategy in which prices fluctuate based on real-time demand, supply, or
market conditions.

This strategy allows businesses to optimize revenue and respond to

changing market dynamics.
PRICING EXAMPLES
Uber:

The ride-hailing service has revolutionized the transportation industry with

its dynamic pricing model.
During peak hours or high-demand periods, Uber increases prices to
incentivize more drivers to be on the road and balance supply and demand.
This surge pricing strategy has enabled Uber to efficiently manage demand
while maximizing revenue.
 PRICING EXAMPLES
Amazon:

The e-commerce giant uses dynamic pricing to stay competitive and respond to market
conditions.

Prices on Amazon can change multiple times a day based on factors such as competitor
prices, customer behavior, and inventory levels.

This allows Amazon to offer competitive prices while maximizing profitability.

 PRICING EXAMPLES
Dynamic pricing can be a powerful tool for businesses to adapt to market conditions and
maximize revenue.

However, it requires sophisticated technology, data analysis, and careful monitoring to

ensure pricing decisions align with business objectives.
 PRICING EXAMPLES
Price discrimination is a strategy in which companies charge different prices to different
customers based on various factors such as location, purchasing power, or customer
segmentation.
 PRICING EXAMPLES
Movie Theaters:

Movie theaters often have different ticket prices based on factors such as age (senior or
student discounts), time of day (matinee prices), or loyalty programs.

By offering different prices to different customer segments, movie theaters can maximize
revenue and fill seats during off-peak times.
 PRICING EXAMPLES
Software Pricing :

Software companies often offer different pricing tiers based on the features and
capabilities of the software.

For example, a basic version of the software may be available at a lower price point, while
a more advanced version with additional features is priced higher.

By catering to different customer segments, software companies can capture value from
customers who are willing to pay for additional functionality.
 PRICING EXAMPLES
Airline Pricing:

Airlines frequently practice price discrimination by offering different prices for the same
flight based on factors such as booking class, flexibility of tickets, and additional services
(e.g., baggage fees).

This allows airlines to extract maximum value from different customer segments and
optimize revenue.
 PRICING EXAMPLES
Price discrimination can be an effective strategy to extract maximum value from different
customer segments.

However, businesses must carefully segment their customer base, analyze customer
behavior, and ensure pricing decisions are transparent and fair.
 PRICING EXAMPLES
The skimming pricing strategy involves setting high initial prices for a new product or
service and gradually lowering them over time.

This strategy is commonly used for innovative or premium products and allows businesses
to maximize revenue from early adopters.
 PRICING EXAMPLES
Apple iPhone:

When Apple introduced the iPhone in 2007, it adopted a skimming pricing strategy.
The initial price of the iPhone was significantly higher compared to other smartphones on
the market, making it an exclusive product for early adopters.
As Apple captured most of the market's high-end segment, it gradually lowered the price
to reach a broader customer base.
 PRICING EXAMPLES
Sony PlayStation:

Sony employed a skimming pricing strategy with its PlayStation gaming consoles.
The initial price of each new PlayStation iteration is typically higher, targeting hardcore
gamers who are willing to pay a premium for the latest technology and gaming
experience.
As the product lifecycle progresses, Sony gradually reduces the price to attract a wider
audience.
 PRICING EXAMPLES
Luxury Fashion brands :

Many luxury fashion brands adopt a skimming pricing strategy, offering their products at
premium prices to create an aura of exclusivity.
These brands cater to high-end customers who are willing to pay a premium for quality,
craftsmanship, and brand image.
Over time, luxury brands often introduce lower-priced product lines to appeal to a broader
market.
 PRICING EXAMPLES
The skimming pricing strategy can help businesses maximize early-stage profitability and
capitalize on customer willingness to pay premium prices for innovative or exclusive
products.

However, businesses must carefully plan their pricing and monitor the market to ensure
optimal price reductions over time.
 PRICING EXAMPLES
Freemium pricing models offer a basic version of a product or service for free, with the
option to upgrade to a premium version for additional features or functionality.

This strategy allows businesses to attract a large user base while generating revenue from
a subset of customers willing to pay for premium offerings.
 PRICING EXAMPLES
Spotify:

The popular music streaming service offers a free version with limited features and
advertisements.
Users have the option to upgrade to a premium subscription for ad-free listening, offline
playback, and higher audio quality.
By offering a free version, Spotify attracts a large user base, while the premium
subscription generates revenue.
 PRICING EXAMPLES
Dropbox:

The cloud storage provider offers a basic version of its service for free, with a limited
amount of storage space.
Users can upgrade to a paid subscription for additional storage and advanced features.
Dropbox's freemium model allows users to experience the value of cloud storage, enticing
them to upgrade for more extensive storage needs.
 PRICING EXAMPLES
LinkedIn:

The professional networking platform offers a free version that allows users to create a
profile, connect with others, and access limited features.
LinkedIn offers premium subscriptions for professionals who want enhanced networking
functionalities, such as advanced search, messaging capabilities, and insights into profile
views.
The freemium model enables LinkedIn to attract a large user base while monetizing its
premium offerings.
 PRICING EXAMPLES
Freemium pricing models can be an effective strategy to attract customers, drive user
adoption, and generate revenue from a subset of paying customers.

However, businesses must carefully balance the features and limitations of the free
version to drive conversion to the premium offering.
PRICING STRATEGIES – INITIAL QUESTIONS
How should executives price a new product?
Should they price the product the same as competing products?
Should they price it low to grab market share?
Should they price it high to grab greater profits with each
individual sale?
Perhaps they should take an accounting position and simply add a
reasonable markup to the marginal cost of production. If so, what
is that reasonable markup?
PRICING
Pricing questions span organizational boundaries because of their
strategic importance, crossing over into marketing, sales, finance,
and operations.

Each new functional executive contributing to a pricing decision will

add a differing perspective that may only complicate the pricing
challenge.
PRICING
To address this challenging strategic decision and manage the
competing organizational viewpoints, executives need a rational
approach to setting prices.

They need an approach to pricing that is grounded in the realities

of the market environment, including issues of competition and
customer preferences.
PRICING
How would you fix a price - What would be you prime objective?
PRICING
When thinking of prices, it is useful to consider price as the value
that the firm captures in a mutually beneficial exchange with its
customers.

The reason for the firm’s existence is to produce value for its
customers in exchange for a price.
PRICING
All profits derive from delivering value to customers at a price that
is greater than the cost of producing that value.

Customers gain value when the benefits delivered to them through

a product exceed the price that they pay for it.
PRICING
When thinking of prices, it is useful to consider price as the value
that the firm captures in a mutually beneficial exchange with its
customers.

The reason for the firm’s existence is to produce value for its
customers in exchange for a price.
PRICING
All profits derive from delivering value to customers at a price that
is greater than the cost of producing that value.

Customers gain value when the benefits delivered to them through

a product exceed the price that they pay for it.
RIGHT PRICING IS CRITICAL
The importance of setting the right price cannot be understated.
Pricing directly affects the profits of a firm.

For everyone involved, the costs of pricing errors are weighty.

Whether the price is too high or too low, pricing errors destroy
profits.
RIGHT PRICING IS CRITICAL
When goods and services are priced too high, many customers will
refuse to purchase them.

Not only will the firm cede market share to its competitors, but it
will relegate itself as irrelevant to many potential customers.
RIGHT PRICING IS CRITICAL
With few items sold, market traction is forfeited and potential and
actual investors sour on expectations of financial returns from the
firm.

The firm will eventually find itself lowering its prices in an effort to
regain market attention, though it may already be too late.

Consumer sentiment may turn negative, potentially resulting in

public relations challenges and regulatory ramifications.
RIGHT PRICING IS CRITICAL
When goods and services are priced too low, the firm will have
forgone an important opportunity to earn profit in proportion to
the value it is creating for customers.

While prices are often set low to gain volume, firms often discover
that the volume is simply not there.
RIGHT PRICING IS CRITICAL
Moreover, entering a market with an extremely low price will set
incorrect price expectations for the product category.

Firms attempting to recover from such a mistake will face a

headwind of customer expectations for the products to be priced
low.

In the worst case scenario, costs are not covered and the firm
becomes insolvent.
RIGHT PRICING IS CRITICAL
Repeatedly, the wrong price yields lost revenues, lost profits, lost
customers, and ultimately a strategically lost firm.
PLAYERS IN PRICING DECISION
From an organizational viewpoint, pricing decisions are a cross-
functional challenge fraught with discord.

Finance, sales and marketing, and even operations executives will

each be in a position to contribute to pricing decisions.
PLAYERS IN PRICING DECISION
Each of these functional executives will bring valuable and unique
vantage points and skill sets from which they can draw information.

Unfortunately, functional executives are likely to be biased by the

incentives by which their performance is measured.
PLAYERS IN PRICING DECISION
Finance executives will likely be highly influenced by their
accounting orientation in addressing pricing decisions.

From an informational perspective, they should have a firm

understanding of the costs to produce.
With a strong grasp of break-even analysis and cost-plus pricing,
finance executives tend to have a heightened understanding of the
relationship between higher prices and higher profits, and in turn,
higher shareholder value.
PLAYERS IN PRICING DECISION
Given their training and vantage point, finance executives
frequently argue for higher prices and higher contribution margins.

However, they are rarely in the best position to evaluate whether

customers are willing to pay higher prices.
PLAYERS IN PRICING DECISION
In contrast, the pricing decisions of sales and marketing executives are
likely to be highly influenced by their customer orientation.

From an informational perspective, sales and marketing executives are

likely to be well informed about market share, competitive actions, and
customer preferences.

Given their training and experience in marketing, they are likely to

understand both the potential and the limitations that a firm has in
shaping customer preferences and willingness to pay.
PLAYERS IN PRICING DECISION
Sales and marketing executives are often rewarded based on their
ability to take market share, meet revenue targets, or capture
specific customers.

Given this incentive bias, sales and marketing executives are

unfortunately often encouraged to lower prices to grab customers.

In the process, they may be forgoing opportunities to capture

higher profits.
PLAYERS IN PRICING DECISION
Even operations executives can contribute meaningfully to pricing
decisions.

Issues related to economies of scale, scope, and learning are well

within their scope of responsibility and will influence pricing
decisions.

Like other functional executives, operations executives make

decisions influenced by their incentives and performance
measurements
PLAYERS IN PRICING DECISION
In this case, performance metrics tied to average cost efficiencies
may encourage operations executives to seek lower prices to drive
up volume and improve capacity utilization.
PLAYERS IN PRICING DECISION
In making pricing decisions, executives must take advantage of the
benefits of the informational resources and skill set of each
functional executive while countering the bias that each brings to
pricing decisions.
PRICING AND PROFIT RELATIONSHIP
Average unit costs
 Average unit costs are not variable costs because they include allocated
overhead and other forms of fixed costs in their calculation.
 As such, average unit costs will decrease if volumes increase, and increase
if volumes decrease

Marginal cost
 True marginal costs are the costs to produce one more unit of output and
are therefore much lower than average unit costs in almost all
circumstances.
PRICING AND PROFIT RELATIONSHIP
While many executives will approximate marginal costs as
average unit costs, the result is an overly conservative
understanding of the true boundaries of profitable prices
potentially leading to lost profit opportunities.
PRICING AND PROFIT RELATIONSHIP

𝜋 =𝑄 𝑃−𝑉 −𝐹

𝜋 = Profit
Q = Qty Sold
P = Price
V = Variable cost
F = Fixed cost
PRICING AND PROFIT RELATIONSHIP
Fixed costs include many forms of overhead such as infrastructure
(plant and equipment, allocated management, and in some
situations, even line staff when labor costs cannot be truly varied
in proportion to output).
PRICING AND PROFIT RELATIONSHIP
Variable costs, fixed costs, quantity sold, or price, which has the
largest impact?
PRICING AND PROFIT RELATIONSHIP
Suppose that a firm operates under the following conditions:
Variable costs are $10 for each unit of production and fixed costs
are $1 million per quarter.

Currently, prices average $25 per unit and volumes are 80,000
units per quarter.

Under these conditions, the firm earns $200,000 in profit per

quarter.
PRICING AND PROFIT RELATIONSHIP
We can contrast this baseline performance with the outcome
achieved by improving any one of the profit levers by 1 percent
and holding all else constant.
PRICING AND PROFIT RELATIONSHIP
PRICING AND PROFIT RELATIONSHIP
Price is the value that the firm captures in a mutually beneficial
exchange with its customers, we discover that the right price is
often not a single number, but rather a range of potential points
that benefits both the customer and the firm.

While some points are more beneficial to the firm and others are
more beneficial to its customers, any point within this range will
mutually benefit both the firm and its customers.
PRICING AND PROFIT RELATIONSHIP
Consider a simple negotiation exercise
PRICING AND PROFIT RELATIONSHIP
Suppose the coffee roaster can deliver Kenyan Coffee at a
marginal cost of $3.20 per pound.

Furthermore, suppose a retailer can resell the Kenyan Coffee and

earn a profit so long as he or she buys it for less than $7.50 per
pound.

Any price agreed upon by the sellers and buyers between $3.20
and $7.50 leaves both parties better off and is therefore a good
price.
PRICING AND PROFIT RELATIONSHIP
While lower prices favor the retailer at the expense of the
roaster, higher prices favor the roaster at the expense of the
retailer.

However, any price within this range delivers a mutually beneficial

exchange.
PRICING AND PROFIT RELATIONSHIP
To arrive at the transaction price, sellers and buyers are asked to
negotiate an agreement.

In the basic experimental setup, all buyers are directed to

purchase Kenyan Coffee for less than $7.50.
PRICING AND PROFIT RELATIONSHIP
All sellers are directed to sell Kenyan Coffee for more than
$3.20, but half of the students are told some key selling points
regarding Kenyan Coffee and the other half are not.

Thus, there is a Zone of Potential Agreements, or ZOPA in the

negotiations literature, between $3.20 and $7.50.
PRICING AND PROFIT RELATIONSHIP
Invariably, sellers who have key selling points and discuss them
during the negotiation strike a higher price than those who don’t.

In a typical experimental run, the average selling price of sellers

without key selling points was $3.82, while that of sellers with key
selling points was $5.33.
PRICING AND PROFIT RELATIONSHIP
 The key selling points alone enabled sellers to achieve a 40 percent
higher transaction price on average in that experimental run.

 Clearly, price is a profit lever that can be influenced.

 Moreover, it is influenced by information.

 Sellers who are informed of the value of their products and can
communicate it to their customers are able to achieve higher transaction
prices than those who are not.
PRICING AND PROFIT RELATIONSHIP
Further investigations into the dynamics of these types of
negotiations have demonstrated that the starting price greatly
affects the negotiated price.

Sellers who initiate the negotiation at a higher price routinely end

up at a higher settlement price.

Likewise, sellers who initiate the negotiation at a lower price

routinely end up at a lower settlement price.
PRICING AND PROFIT RELATIONSHIP
From this more detailed investigation, we learn that negotiations
favor aggressive opening bids.

Initiating the negotiation at a more favorable price and then

slowly ceding price concessions enables the negotiator to discover
the boundary price of their negotiating counterpart and thus
settle upon a price that is more favorable.
PRICING AND PROFIT RELATIONSHIP
In yet a third investigation, Kenyan Coffee buyers and sellers
were told the average selling price of Colombian Coffee.

This time, negotiated Kenyan Coffee prices almost always

converged to a price point similar to that of stated Colombian
Coffee.

Reference prices greatly influence transaction prices.

PRICING AND PROFIT RELATIONSHIP
In their entirety, the Kenyan Coffee experiments reveal three very
strong prescriptions for achieving good prices.
PRICING AND PROFIT RELATIONSHIP
One, sellers must be well informed of and aggressively
communicate the value of their products if they hope to achieve a
better price.

Two, sellers must price aggressively and grant discounts from

these prices reluctantly.

And three, reference prices greatly influence transaction prices.

SCIENCE OF PRICING
The science of pricing refers to the act of gathering information,
conducting quantitative analysis, and revealing an accurate
understanding of the range of prices likely to yield positive
results.
SCIENCE OF PRICING
Pricing data, like any other set of information that influences
executive decisions, is rarely perfectly clear.

Not only will there be uncertainties in the underlying data, but the
appropriate price structure, price point, and price discount will
vary over time, geography, and customer situation.
SCIENCE OF PRICING
The time and budget required to remove all uncertainty is beyond
the patience and resources of almost every firm.

Hence, prices must be set with some uncertainty.

Despite the uncertainty, quantitative approaches can be used to

improve the pricing decision, prevent grievous errors, and uncover
new opportunities.
ART OF PRICING
The art of pricing refers to the ability to influence consumer price
acceptance, adapt pricing structures to shift the competitive
playing field, and align pricing strategy to the competitive
strategy, marketing strategy, and industrial policy.
ART OF PRICING
It requires an understanding of consumer behavior and the
influence of features embedded within the product, the
perception of value, the expectations of customers, and the price
structure itself.

It also requires that pricing strategy support the firm’s marketing
strategy in light of the overall competitive and industrial
environment of the market.
ART OF PRICING
By taking a more creative approach, firms are better able to
price in proportion to the value that customers perceive.

Doing so will combine both quantitative and qualitative

approaches.
ART OF PRICING
 In many cases, quantitative approaches will be found to be highly
informative but lacking in their ability to reveal nuances of customer
behavior and therefore opportunities to improve pricing.

 Qualitative insights enable executives to fill these gaps.

 In doing so, executives are able to better align pricing strategy with
other strategic decisions.

 Hence, pricing is both an art and a science.

EXCHANGE VALUE MODELS
Accepting that the right price lies within some range shifts the
challenge of pricing to identifying the boundaries of a good
price.

Exchange value models quantify the price boundaries.

Knowing the boundaries of a good price narrows pricing

discussions to a reasonable range of potential price points.
EXCHANGE VALUE MODELS
Two sets of boundaries are uncovered from exchange value
models.

The extreme boundaries define the range of acceptable prices

outside of which no rational buyer or seller would ever transact.
EXCHANGE VALUE MODELS
The narrower boundaries which lie within these extremes define
the range of prices that are most likely to encourage customer
transactions and leave the firm in the most favorable position.

While buyers and sellers will sometimes transact outside these

narrower boundaries, it is not usually in their best interest to do so.
EXCHANGE VALUE MODELS
To illustrate the boundaries of a good price, we will examine the
release of the Cypher drug eluting stent by Cordis, a Johnson &
Johnson Company, in April 2003.

Stents are used to reopen clogged arteries leading to the heart

issue after plaque has narrowed the passage and restricted
blood flow.
EXCHANGE VALUE MODELS
Prior to its release, the best alternative was a standard metallic
stent made by a number of competitors.

In mechanical construction, the Cypher drug eluting stent was

similar.
EXCHANGE VALUE MODELS
In laboratory tests, the addition of a pharmaceutical formulary
coating the standard metallic stent was demonstrated to improve
the patient’s body’s ability to accept the stent within the artery.
EXCHANGE VALUE MODELS
With the unique addition of a patented formulary that was
approved by the U.S. Food and Drug Administration (FDA),
Cypher was a revolutionary new product when launched.

No other product of its kind had been marketed.

EXCHANGE VALUE MODELS
As such, Cordis executives could not simply copy a competitor’s
practices in pricing it.

Rather, pricing would be a particularly daunting challenge for

these executives.
EXCHANGE VALUE MODELS
To price a revolutionary product like Cypher, executives can
construct an exchange value model.

Exchange value models inform executives of the relative value

that their product delivers to customers and therefore enables
executives to price in proportion to its perceived value.
EXCHANGE VALUE MODELS
For revolutionary products, exchange value models are a
commonly used best-practice approach to identifying launch
prices.

Once an exchange value model has been used to set prices, it can
then be repurposed as a sales tool to support the communication
of value.

As such, exchange value models are an important quantitative

tool for setting prices and influencing price acceptance.
EXTREME BOUNDARIES
At the extremes, the price should lie between the marginal cost to
produce and the full consumer utility.

Any transaction outside these extremes would leave the seller or

buyer worse off after the transaction than before, and therefore
it cannot be expected to occur between rational buyers and
sellers.
EXTREME BOUNDARIES
Marginal Costs Define the Extreme Lower Boundary

Marginal costs constitute the seller’s bottom line.

Any price below marginal costs leaves the seller worse off than it
would have been without the transaction.

Any price above it leaves the seller better off.

EXTREME BOUNDARIES
Marginal Costs Define the Extreme Lower Boundary
At times, sellers may choose to price very near marginal costs for
tactical price purposes, but in general, sellers will seek to profit
from their transactions.

Failure to profit from transactions removes any motivation to

participate in the trade; hence executives cannot be expected to
price at this level.
EXTREME BOUNDARIES
Estimates vary widely on the marginal cost to produce Cypher
and it is difficult to pierce the corporate veil to identify the true
marginal costs.

Some reports indicate that standard metal stents had an average

unit cost near $150 at the time of launching Cypher.

Coating a stent with pharmaceuticals is not an expensive

challenge, and manufacturing the pharmaceuticals should add
only a few dollars per stent.
EXTREME BOUNDARIES
That said, some estimates indicate that Cypher had a fully loaded
average unit cost of $375 at the time of its launch.

While fully loaded average unit costs are likely to be much

higher than marginal costs, we will accept this figure as a gross
approximation of the true marginal costs of production for the
sake of demonstrating an exchange value model.
EXTREME BOUNDARIES
Regardless of how low the true marginal costs are, Cordis should
not price Cypher anywhere near this level.

It would not be a fair exchange to expect Cordis to price the

drug eluting stent near marginal cost.

Developing Cypher required a tremendous amount of research

and development—a risky investment made with the expectation
of lofty rewards.
EXTREME BOUNDARIES
Not only should the firm desire prices to cover the investment costs
of developing Cypher,

but it should also seek to gain profits, which are necessary not
only to reward investors, but also to invest in further research and
development leading to the creation of new products that will be
valued by consumers in the future.
EXTREME BOUNDARIES
Furthermore, even after being first to market with a drug eluting
stent, Cordis faces a business risk that other research and
development efforts will develop new solutions for coronary heart
disease long before the patent on Cypher has expired.

Rather than using marginal costs as a guide to making pricing

decisions, therefore, the executives of Cypher are better off using
them as a bright line below which prices should not fall.
EXTREME BOUNDARIES
Marginal costs are simply a lower boundary on prices.

They provide little guidance to what the price should be, outside
of stating that the price should not be below this level.

Importantly, internal cost accounting considerations of marginal

costs fail to incorporate the value that the product delivers to
customers.
EXTREME BOUNDARIES
Without connecting the price to the value that the product
delivers, sellers have little insight into their pricing potential.
EXTREME BOUNDARIES
Failing to understand value from the customer’s perspective
may tempt executives to price very high to recover sunk costs
or opportunistically profit from uninformed customers, yet doing so
will quickly make the firm irrelevant to the market as customers
refuse to purchase.
EXTREME BOUNDARIES
The failure to understand the customer’s perspective of value
leaves the seller to cleave to its marginal costs and price a new
product too low, denying the firm its well-deserved reward for
the hard work that it takes to develop a new product and deliver
its value to customers.

As we saw in the negotiation experiment, marginal costs are

simply one of two extreme boundaries.
EXTREME BOUNDARIES
Consumer Utility Defines the Extreme Upper Boundary

 If marginal costs are the seller’s bottom line, customer utility is the
buyer’s bottom line.

 The customer utility is the value a customer gains from having the
product.

 All customers would be worse off after a transaction if they paid more
for the product than they gained in utility, and they would be better off
if they paid less for the product than they gained in utility.
EXTREME BOUNDARIES
Consumer Utility Defines the Extreme Upper Boundary

The value that buyers place on a product is the utility that they
derive from the product.

The consumer surplus is the difference between the overall

customer utility and the transaction price.

So long as the consumer surplus is positive, customers will value the
product.
EXTREME BOUNDARIES
Customers gain utility from a product directly from the benefits
that the product delivers.

These benefits have been categorized into four fundamental

types.
EXTREME BOUNDARIES
Form utility derives directly from the intrinsic properties of the
product itself,

 such as the value that customers place on extending their lives with a stent,
 the enjoyment that customers experience when drinking a tasty beverage,
or
 the production value of a turbine to an electricity merchant generator.
EXTREME BOUNDARIES
Place utility derives from the ability to acquire the product in a
desired location, such as having the stent available at a nearby
hospital, drinking the beverage at a local cafe, or receiving the
turbine at the merchant generator’s power plant.

Time utility derives from the ability to access the product at a

convenient moment, such as receiving the stent when coronary
heart disease has been detected, drinking the beverage when
thirsty, or getting the turbine at the right time in the construction
process of the merchant generator’s power plant.
EXTREME BOUNDARIES
Ownership utility is gained from possessing the rights to the value
of the product even if the possession is never actually taken,

 such as the value of insurance coverage that would pay for the implant of
the stent when and if needed,
 the value of holding a beverage which can either be drunk or resold, or
 the value of holding rights to a turbine to be delivered in the future.
EXTREME BOUNDARIES
While customers derive utility from an improved stent from all four
fundamental types, in pricing Cypher, Cordis should focus on the
form utility.

The most significant value created in producing Cypher is that

which is most closely related to the value that customers gain in
extending their lives.

Yet, what is the value of extending life?

EXTREME BOUNDARIES
Economists have attempted to quantify the value of a life. In a
somewhat accepted although ethically questionable practice,
economists often value a life as the present value of the future
lifetime earnings.

Not only does this approach fail to adequately consider potential

career changes during a person’s lifetime, but more importantly, it
is a woefully inaccurate calculation of the value that individuals
place on their lives
EXTREME BOUNDARIES
It doesn’t begin to capture the value that people attach to
spending more time with their spouse, seeing their children
and grandchildren mature, attending the weddings and baby
showers of loved ones, or being able to accomplish one more
lifetime goal.

Put in these terms, we quickly understand why many philosophers

will argue that all life is equally valuable and perhaps
immeasurable.
EXTREME BOUNDARIES
As with many decisions in pricing, we must accept our inability to
perfectly quantify everything and rather work with the best
estimates and commonly accepted practices that we have.

As such, let us estimate the value that people place on their lives
as the present value of future earnings.
EXTREME BOUNDARIES
In addition, while the wages and duration of future productivity
vary between individuals, let us estimate that the present value of
the lifetime earnings of a coronary heart disease patient is
$500,000 on average.
EXTREME BOUNDARIES
No doubt, many readers will argue that that is a ridiculously low
value for a person’s life.

However, if the customer utility of a stent is near $500,000,

should Cordis launch Cypher near this level?
EXTREME BOUNDARIES
Quickly we realize that such a price would be absurd. If Cordis
did price Cypher anywhere near this level, most customers would
find it unattainable.

Moreover, customer sentiment would likely sour on Cordis, leading

to retaliation, claims of unfair pricing practices, and protests that
Cordis was charging too much or that Cordis was only serving the
rich elite.
EXTREME BOUNDARIES
In such an environment, governments might force Cordis to forgo
its patents and allow other firms to produce copycat products.

Clearly, pricing near the customer’s utility is not a very informed

or advisable approach.
EXTREME BOUNDARIES
Customer utility is simply an upper boundary on prices.

It provides little guidance to what the price should be outside of

stating that the price should be below this level.
EXTREME BOUNDARIES
Customer utility is the mirror image of marginal costs.

Just as firms should avoid pricing near marginal costs, customers

should avoid accepting prices near customer utility.

As we saw with the negotiation experiment, customer utility is

simply the second of two extreme boundaries.
EXTREME BOUNDARIES
Marginal Costs and Customer Utility Are the Extremes

Neither reveals the right price by itself, but combined, they reveal
the hard boundaries of potential price one might, in one’s wildest
dreams, imagine for launching Cypher.
EXTREME BOUNDARIES
Unfortunately, the range of prices between these boundaries is
quite wide.

Conservatively estimating marginal costs at $375 and customer

utility at $500,000 leaves a range of potential prices that is far
too wide for any meaningful decision making.

The two extreme boundaries are separated by more than a

factor of 1,000.
EXTREME BOUNDARIES
From these boundaries, Cordis executives would be unsure if the
launch price of Cypher should be $400, $4,000, $40,000, or
$400,000.

Executives need a tighter set of boundaries than those provided

by marginal costs and customer utility for pricing decisions.
EXTREME BOUNDARIES
Even reducing the dispersion of potential prices to a single factor
of 10 would be far more useful than that developed by
considering the extreme boundaries alone.
EXTREME BOUNDARIES
For a revolutionary product, executives may accept reluctantly a
somewhat broad range of a factor of 10 but will give no
credence to a method that leaves three orders of magnitude in
uncertainty.

For more evolutionary products, they are likely to demand pricing

guidance that narrows the range to within a few percentage
points.
NARROWER BOUNDARIES
Executives looking for guidance in pricing decisions clearly need a
narrower and more relevant set of boundaries than those
identified by considering marginal costs and customer utility.

To identify these boundaries, we need to think strategically about

prices.
NARROWER BOUNDARIES
Strategically, prices should reflect the value to customers of
accomplishing their goals in comparison to alternative means.
NARROWER BOUNDARIES
Higher prices reflect the ability of a product to fulfill a need
better than the alternatives.

Lower prices reflect the ability of a product to fulfill a subset of

the needs as well as the alternatives.
NARROWER BOUNDARIES
This is the nature of strategic pricing: to price in proportion to the
value delivered in light of the comparable alternatives.

The narrower price boundaries are defined by the comparable

alternatives and differential value.
COMPARABLE ALTERNATIVES
Comparable alternatives are solutions that customers may have to
accomplish the same or a similar set of goals.

They may be directly competitive offers or indirect substitute

solutions to the challenges facing customers.
COMPARABLE ALTERNATIVES
For Cordis, the nearest comparable offer to the Cypher drug
eluting stent was the standard metal stent.

The standard metal stent was not a perfect solution to coronary

heart disease.

Roughly 25 percent of the patients who received the standard

metal stent suffered from the complication of restenosis, or
reclogging of the artery.
COMPARABLE ALTERNATIVES
Clinical trials demonstrated that Cypher reduced the probability
of restenosis to around 5 percent.

Hence, the Cypher drug eluting stent was a superior alternative to

the existing products on the market at the time of its release.
COMPARABLE ALTERNATIVES
Inferior alternatives are any competing alternatives that deliver
similar benefits to the one under consideration with less overall
consumer utility.

Inferior alternatives define the narrow lower bound for pricing

decisions.
COMPARABLE ALTERNATIVES
This narrow lower boundary is a soft lower boundary.

In general, executives should price products higher than their next
nearest inferior alternative because their new product will deliver
more value
COMPARABLE ALTERNATIVES
In some cases, executives may price below this boundary if they
expect to tap into a new market that was inaccessible with
existing offers at their current prices.

When they do so, they must still price above the hard lower
boundary set by marginal costs.

In general, though, pricing below an inferior alternative implies

the firm is forgoing some profit potential.
COMPARABLE ALTERNATIVES
Cordis produced a standard metal stent priced at roughly $1,050
prior to its launch of Cypher.

Using this data point to guide a pricing decision and the fact that
the Cypher drug eluting stent is superior to a standard metal stent
implies that Cypher should be priced at or above this level.
COMPARABLE ALTERNATIVES
But how much higher?

To determine how much higher to price Cypher than the standard
metal stent, we need to determine the value of its superiority.
DIFFERENTIAL VALUE
Differential value is the change in customer utility that a product
delivers in comparison to the alternative.

If the new product is superior to its comparable alternatives, the

differential value is positive.

If the new product is inferior to its comparable alternatives, the

differential value is negative.
 DIFFERENTIAL VALUE
The economic exchange value of a product is the price of the nearest
comparable alternative adjusted for the differential value of the product.

It is the price that customers would pay for its nearest comparable offer plus
the value of the increased (or decreased) benefits of the improved (or
degraded) new product.
 DIFFERENTIAL VALUE

Exchange Value = Price of Comparable Alternative + Differential Value

DIFFERENTIAL VALUE
For a given product, rational customers should be willing to pay
any price up to that determined by the exchange value.

Hence, the exchange value is the upper narrow boundary on price

for products superior to their nearest comparable alternative.
DIFFERENTIAL VALUE
Executives may price higher than the exchange value but usually
find it more beneficial to price slightly lower.

Any price below the exchange value will, on average, leave

customers better off with the new product than they would be with
its comparable alternatives, and definitely better off than they
would be without the product at all, and therefore would be a
good price.
DIFFERENTIAL VALUE
To quantify the differential value, we must create a model.
DIFFERENTIAL VALUE
Stents are not used in isolation but rather as a component of a
larger procedure.

To implant a stent and relieve some of the challenges created by

coronary heart disease, patients must undergo surgery.

The price of the operation, including the hospital stay, operating

room costs, doctors, nurses, post-surgery hospital monitoring, and
other components can be estimated at $12,000.
DIFFERENTIAL VALUE
Of the total operation price, the standard metal stent is only a
$1,050 component.

If a procedure fails 25 percent of the time when a standard

metal stent is implanted, we can expect that the cost of failure to
be equal to, if not greater than, the cost of the original stent
implantation.
DIFFERENTIAL VALUE
When restenosis occurs, doctors must address the issue with
pharmaceuticals, angioplasty, a second implant, and perhaps
even cardiac bypass surgery.

We can use these insights to estimate the differential value of a

drug eluting stent such as Cypher.
DIFFERENTIAL VALUE
To construct a model of the differential value, let us first calculate
the expected total costs of using a standard metal stent using a
probability tree.
DIFFERENTIAL VALUE
According to the data collected, we know that patients
undergoing a metal stent implantation must pay
 the initial $12,000 surgery price 100 percent of the time;
 25 percent of the time, we believe they must pay a similar $12,000 price
to rectify the challenge of restenosis;
 and 75 percent of the time, no further action is required and the patients
can return to their normal life.

Using these insights, we can calculate the expected total cost of using a
standard metal stent to be $15,000.
DIFFERENTIAL VALUE
DIFFERENTIAL VALUE
To calculate the differential value of Cypher in comparison to a
standard metal stent, we can repeat the calculation after
adjusting for the change in the rate of restenosis using the price
of the stent as an unknown while holding the expected total cost
constant.
DIFFERENTIAL VALUE
In this case, the total expected cost is still $15,000.

We use the same total expected cost because we are attempting
to identify the price of Cypher that will leave customers
indifferent between the new product and its nearest comparable
alternative.
DIFFERENTIAL VALUE
We have identified the price of a single surgical implant
procedure with a standard metal stent at $12,000, of which the
standard metal stent constitutes $1,050.

Thus, the cost of the procedure not including the choice of stent is
$10,950 ($10,950 = $12,000 - $1,050).

Because we don’t know the potential price of the drug eluting

stent, let this be the unknown that we are trying to solve for and
denote it with X
DIFFERENTIAL VALUE
After a little algebra, the probability tree analysis reveals the
exchange value of the drug eluting stent to be $3,340.

If the exchange value is $3,340 and the comparable alternative

is priced at $1,050, we can calculate the differential value to be
$2,290 ($2,290 = $3,340 - $1,050).
DIFFERENTIAL VALUE
This model does not include many of the other sources of value
delivered by the creation of a drug eluting stent.

The value of lost time to the patient in repeating the procedure,

the peace of mind in reducing the potential that the operation will
fail, and the reduction in risk of death are all significant sources
of value.
DIFFERENTIAL VALUE

Customers may be willing to pay much more than the calculated

exchange value for a drug eluting stent based on these more
personal issues.

On a purely economic basis, we can feel confident that the

exchange value calculated is therefore a reasonable, if not
conservative, estimate of the potential price of Cypher.
PRICING IN PROPORTION OF VALUE
From the hard extreme boundaries, we know that Cordis must
price Cypher between the marginal costs of $375 and the
customer utility estimated to be $500,000.

From the softer narrow boundaries, we suspect that Cordis should

price Cypher higher than its nearest comparable alternative at
$1,050 because it will deliver more value.

From a simple exchange value model, we suspect that any price

below $3,340 should be appealing.
PRICING IN PROPORTION OF VALUE
By strategically considering comparable alternatives and their
differential value to calculate the exchange value, we have
reduced our uncertainty in pricing from a factor greater than
1,000 to something closer to 3.
PRICING IN PROPORTION OF VALUE
Clearly, exchange value models grounded in considerations of
comparable alternatives and differential value are far more
useful for providing pricing guidance than simple considerations
of marginal costs or customer utility.
PRICING IN PROPORTION OF VALUE
In fact, for many pricing decisions, marginal costs and customer
utility have relatively little use in setting prices.

Identifying competing products and substitutes and understanding

why customers will judge them to be inferior or superior is a far
more accurate approach to pricing.
PRICING IN PROPORTION OF VALUE
At what price did Cordis executives release Cypher?

As a compromise to the needs of insurers and government bodies

and the needs of the firm, Cypher was released with a list price
of $3,195
PRICING IN PROPORTION OF VALUE
At $3,195, Cypher was priced much higher than its marginal costs
and much lower than the consumer utility delivered.

Likewise, $3,195 is higher than Cypher’s nearest comparable

inferior alternative and lower than its exchange value.
PRICING IN PROPORTION OF VALUE
Priced at $3,195, Cypher was roughly three times the price of its
competitors.

Did customers balk at this new price?

Not at all.

In the nine months after its release, the Cypher stent raised
Cordis’s market share from less than 10 percent to more than 60
percent in the U.S. market
PRICING IN PROPORTION OF VALUE
Financially, Cypher was a runaway success for Cordis, earning the
firm billions of dollars.

Clearly, pricing anywhere near marginal costs would have

forfeited a tremendous profit opportunity, reducing the required
income to continue developing blockbuster innovations.

At the opposite boundary, researchers have examined the pricing

decisions of highly successful entrepreneurs and found they tend
to price as near to the exchange value as possible, much as the
executives of Cordis did with Cypher
PRICING DECISION
For revolutionary products like Cypher, exchange value models
have proven to be highly cost effective and time-efficient means
of determining the boundaries of a good price.
PRICING DECISION
Executives are plagued with a dearth of information and
customers lack the insight necessary to make informed comments
about pricing decisions for revolutionary products.

As such, exchange value calculators create clarity in an otherwise

informational abyss.
PRICING DECISION
The form of the exchange value model will change depending on
the benefits delivered by the product,

yet the overall approach of

 identifying comparable alternatives,
 understanding the differences in benefits, and
 calculating the differential value
can be repeated for almost any pricing challenge.
PRICING DECISION
For more evolutionary products or even mature commodity
products, exchange value models fail to provide a sufficiently
narrow range of prices for decision making.

With these types of products, research-based techniques that

more directly measure customer preferences and other economic
factors are required.
PRICING DECISION
In all cases, the range of a good price is bound at the extremes
between marginal costs and consumer surplus, and bound in a
narrower sense by the exchange value determined by
comparable alternatives adjusted for its differential value.

A price that lies within these boundaries will leave all

stakeholders better off, and that is the mark of a good price.
CASE 1  Assume that a fi rm produces a consumer product at a variable cost of $7.25 and has
fixed costs of $75,000 per month. Currently, the firm sells 14,000 units per month
priced at $14 per unit.

 a. What is the current profitability of the firm?

 b. What is the harm to profitability if variable costs rise by 1 percent, holding all else
constant?
 c. What is the harm to profitability if fixed costs rise by 1 percent, holding all else
constant?
 d. What is the harm to profitability if units sold decreases by 1 percent, holding all
else constant?
 e. What is the harm to profitability if the price falls by 1 percent, holding all else
constant?
 f. In isolation, failing to manage which aspect of the fi rm will have the greatest harm
on profits—variable costs, fixed costs, units sold, or price?
 1% improvement
in next month
in Fixed in in
Month in Variable Cost Cost Volume Price
Price P 14 14 14 14 14.14
Volume Q 14000 14000 14000 14140 14000
Variable Cost V 7.25 7.1775 7.25 7.25 7.25
Fixed Cost F 75000 75000 74250 75000 75000
Profiability Pt 19500 20515 20250 20445 21460
Change in Profitability 1015 750 945 1960
Percentage
Improvement 5% 4% 5% 10%
CASE 2
Old Product is sold at $5 and Improved Product delivers $2 more in value
to customers than Old Product. Improved Product costs $3 per unit to
make.

a. What is the price of the nearest comparable alternative for Improved
Product?
b. What is the differential value of Improved Product in comparison to
Old Product?
c. What is the exchange value of Improved Product?
d. What range would you suggest to executives for pricing Improved
Product?
 Chart Title
14

12

10
Customer Surplus
8 7 Differential value = 7-5 = 2
6
6 5
4 3
2

0
Utility Exchange Price Transaction Price Marginal Cost Reference Price
CASE 3
Old Product is sold at $27 and Reduced Product is less functional than
Old Product, to the point that it delivers $6 less value to customers than
Old Product. Reduced Product costs $10 to make.

a. What is the price of the nearest comparable alternative for

Reduced Product?
b. What is the differential value of Reduced Product in comparison to
Old Product?
c. What is the exchange value of Reduced Product?
d. What range would you suggest to executives for pricing Reduced
Product?
 Chart Title
45

40

35
Customer Surplus
30
27
25
Differential Value = 6
21
20 19

15

10
10

Reduced Prod - Exchange Price Transaction Price Marginal Cost Old Product - Ref
Utility Price
CUSTOMER PERCEPTION–DRIVEN PRICING
How can the perceptions of customers be used to set prices?
How can intangible value be quantified and used for pricing?
What is conjoint analysis, and how does it use customer perceptions
to inform pricing?
How does conjoint analysis compare to the other methods of price
setting?
Which method of price setting is found to be the most useful, and
for which kinds of pricing challenges?
CUSTOMER PERCEPTION–DRIVEN PRICING
Exchange value models provide pricing guidance that is accurate
but perhaps too wide.

On the other hand, economic price optimization provides pricing

guidance that is highly precise but often misleading.
CUSTOMER PERCEPTION–DRIVEN PRICING
To set prices, executives require an approach that is both accurate
and precise.

Using customer perceptions directly is a proven means of guiding

pricing decisions with both acceptable accuracy and precision.
CUSTOMER PERCEPTION–DRIVEN PRICING
Customer perception–driven pricing has become the dominant
approach to pricing in many industries.

Through market research, the willingness of customers to pay is

identified, either directly or indirectly.
CUSTOMER PERCEPTION–DRIVEN PRICING
The most common methodology for using customer perceptions to
set prices is conjoint analysis.

Conjoint analysis is marketed under many different trade names

and will vary in form; however, all these forms and trade names
share a common foundation.
CUSTOMER PERCEPTION–DRIVEN PRICING
Conjoint analysis reveals the tradeoffs that customers make in
purchasing decisions and therefore identifies the best price that
can both encourage customer purchases and deliver profits.
CUSTOMER PERCEPTION–DRIVEN PRICING
Furthermore, conjoint analysis can be used to expand a pricing
challenge beyond pricing a specific product to the more complex
challenge of uncovering the willingness to pay for alternative
variations of that product.
CUSTOMER PERCEPTION–DRIVEN PRICING
Conjoint analysis rose to dominate pricing challenges for evolutionary
markets due to its precision and accuracy.
CUSTOMER PERCEPTION–DRIVEN PRICING
As already discussed, exchange value models can identify a range of
good prices.

This range can be rather wide, however, driving executives to seek

further clarity.
CUSTOMER PERCEPTION–DRIVEN PRICING
Through conjoint analysis, executives can be much more precise in
identifying the specific price most likely to optimize profits.
CUSTOMER PERCEPTION–DRIVEN PRICING
On the other hand, economic price optimization allows executives
to identify the predicted best price with extreme precision,

but with little assurance that this price is indeed accurate,

due to the inherent challenge of identifying the relevant metric of

the elasticity of demand.
CUSTOMER PERCEPTION–DRIVEN PRICING
Conjoint analysis overcomes this challenge and accurately identifies
the best price for an individual product in the face of competition
in many situations.
CUSTOMER PERCEPTION–DRIVEN PRICING
Exchange value calculators, economic price optimization, and
conjoint analysis are the three dominant approaches to setting
prices.

Using any of these three approaches, executives can address an

overwhelming majority of their price-setting challenges.
CUSTOMER PERCEPTION–DRIVEN PRICING
Each of these approaches has been used in both business and
consumer markets, services and tangible goods markets, and
durable and consumable goods markets.

Each also has its benefits and drawbacks in terms of accuracy and
precision.
CUSTOMER PERCEPTION–DRIVEN PRICING
Fortunately, there are clear differences in the appropriateness of
these approaches in addressing the specific pricing challenge.

Executives may be able to select which approach should be used

for their specific pricing challenge based on a few simple
tradeoffs.
CUSTOMER PERCEPTION–DRIVEN PRICING
One of the key issues to align in selecting a price-setting approach
is the market maturity.

In revolutionary markets, where the product is defining a new

product category and there are no directly competing offers,
exchange value models tend to dominate the price setting
challenge.
CUSTOMER PERCEPTION–DRIVEN PRICING
At the other extreme, in highly mature markets of commodity
products where the difference between competing products is
negligible, economic price optimization will dominate in price-
setting questions.
CUSTOMER PERCEPTION–DRIVEN PRICING
Between these two extremes, for established markets where
products are evolving in both adding new points of value and
finding new means of reducing costs, conjoint analysis is the
dominate approach to setting prices.
CUSTOMER PERCEPTION–DRIVEN PRICING
In revolutionary markets, both executives and their customers lack
sufficient critical information required to use most methods of price
setting.

Revolutionary markets are rare and unique.

CUSTOMER PERCEPTION–DRIVEN PRICING
They are created by the introduction of the first product into a new
market, such as the first electric-powered car, the first personal
computer, the first railroad line, or the first mobile phone network.
CUSTOMER PERCEPTION–DRIVEN PRICING
Truly revolutionary products are breakthrough initiatives that
redefine the status quo, delivering dramatically different or totally
new benefits to customers in a manner that had never before been
considered.

Compared to the alternative approaches, exchange value models

are likely to be the best approach to setting prices in revolutionary
markets.
CUSTOMER PERCEPTION–DRIVEN PRICING
The new product creates an entirely new market in a revolution.

This revolutionary market will have no history from which one could
even hope to identify the elasticity of demand through econometric
means, and hence economic price optimization becomes a highly
useless approach.
CUSTOMER PERCEPTION–DRIVEN PRICING
Furthermore, customers in this revolutionary market will have no
experience with the product category.

Product category experience is necessary for customers to learn

the features and to inform them of the expected value of differing
product configurations.
CUSTOMER PERCEPTION–DRIVEN PRICING
If they lack the benefit of experience-based learning, customers
may be unable to evaluate offers and make reliable tradeoffs.

Because conjoint analysis fundamentally relies on customers making

an informed decision regarding their preferences, it does not work
well in revolutionary markets.
CUSTOMER PERCEPTION–DRIVEN PRICING
One approach to overcoming this challenge is to provide the
research subjects with an overwhelming amount of data
regarding its value to them.
CUSTOMER PERCEPTION–DRIVEN PRICING
At this point, many entrepreneurial firms will have been better off
simply using the price determined by the exchange value model in
the first place, and spending their limited marketing resources on
selling it to customers rather than conducting research on them.
CUSTOMER PERCEPTION–DRIVEN PRICING
Evolutionary markets are common.

They are markets in which products currently exist, customers

currently purchase, and products are evolving.
CUSTOMER PERCEPTION–DRIVEN PRICING
Product evolutions are found in subtle shifts in the features of
products, such as adding chocolate chips to ice cream, power
transmissions to forklifts, or faster customer service in banking.

In comparison to the alternative approaches, conjoint analysis is

typically the best approach to setting prices in evolutionary
markets
CUSTOMER PERCEPTION–DRIVEN PRICING
By many measures, evolutionary products represent more than 98
percent of the new products on the market.

By evolutionary, we mean products that make improvements to the

status quo rather than disrupt the current evolution of products.
CUSTOMER PERCEPTION–DRIVEN PRICING
The improvements in evolutionary markets typically derive from

adding new features or benefits to existing products,

whereas new products in revolutionary markets address customer

needs in an entirely new manner.
CUSTOMER PERCEPTION–DRIVEN PRICING
In evolutionary markets, customers have experience with the
product category.

Through their experience, customers will have become aware of the

existing products and their competition.
CUSTOMER PERCEPTION–DRIVEN PRICING
They may also have developed sufficient insight to conceptualize
different combinations of product attributes and predict their
benefits.
CUSTOMER PERCEPTION–DRIVEN PRICING
Therefore, in evolutionary markets, customers hold sufficient
information that is critically required to make informed statements
regarding their preferences, and therefore executives can reliably
conduct conjoint analysis.
CUSTOMER PERCEPTION–DRIVEN PRICING
Because evolutionary product enhancements are more common than
revolutionary product creation, most marketing managers will rely
heavily upon conjoint analysis.
CUSTOMER PERCEPTION–DRIVEN PRICING
Conjoint analysis is particularly appropriate and useful for brand
managers.

In evolutionary markets, not only will customers have familiarity

with different features, products, and product categories, but they
are also highly likely to be familiar with the existing brands.
CUSTOMER PERCEPTION–DRIVEN PRICING
Marketing executives of branded goods can use this familiarity to
identify price points for the product under different competing
brand identifications, co-branding arrangements, and new brand
introductions.

As such, they can select the best brand association for a new
product in an evolutionary market.
CUSTOMER PERCEPTION–DRIVEN PRICING
In comparison to exchange value models, conjoint analysis is
more precise in most evolutionary markets.
CUSTOMER PERCEPTION–DRIVEN PRICING
External customers tend to have better information than internal
executives regarding the value the customers themselves will give
to a product in contrast to its competitors in evolutionary markets.
CUSTOMER PERCEPTION–DRIVEN PRICING
In contrast, internal product managers tend to have better
information regarding the value of a product relative to its
substitutes for revolutionary products.
CUSTOMER PERCEPTION–DRIVEN PRICING
As such, conjoint analysis generally provides much deeper and
more precise insights into the appropriate price in evolutionary
markets, while exchange value models continue to be the
workhorse in revolutionary markets.
CUSTOMER PERCEPTION–DRIVEN PRICING
A significant exception to this rule is found in small markets.
CUSTOMER PERCEPTION–DRIVEN PRICING
Markets with few customers (that is, markets where the number of
customers is on the order of magnitude of 10 to 100) are common
in many industrial markets.
CUSTOMER PERCEPTION–DRIVEN PRICING
Aircraft, nuclear generation, and paper manufacturing machines
are good examples of markets with few customers.
CUSTOMER PERCEPTION–DRIVEN PRICING
Because conjoint analysis relies on market research, and market
research is itself reliant on the ability to collect data from a
statistically relevant set of sample customers, conjoint analysis may
become untenable in small markets.
CUSTOMER PERCEPTION–DRIVEN PRICING
Compared to economic price optimization, conjoint analysis is not
only more accurate but also more relevant in evolutionary markets.
CUSTOMER PERCEPTION–DRIVEN PRICING
Executives managing a product are far more interested in the best
price for their particular product formulation rather than the
product category as a whole.

The best measures of elasticity of demand, a necessary input for

economic price optimization, are usually found at the industry level.
CUSTOMER PERCEPTION–DRIVEN PRICING
The industry-level elasticity of demand combines all the product
features, attributes, and brands into a single metric.

This prevents the ability of product managers to identify which

features add value to the product and which can be dropped to
improve profits.
CUSTOMER PERCEPTION–DRIVEN PRICING
For pure commodities sold to highly mature markets, economic price
optimization is often used to guide pricing decisions.

There is little product differentiation in commodity markets; thus,

there is little to guide the price differentials required for an
exchange value model to add value to the decision.
CUSTOMER PERCEPTION–DRIVEN PRICING
Likewise, customers may be unable to differentiate between the
values of competing commodity products, and therefore conjoint
analysis is unlikely to reveal significant information.
CUSTOMER PERCEPTION–DRIVEN PRICING
As such, economic price optimization continues to dominate pricing
discussions for commodity products, and products tend to be sold at
the market clearing price.
CUSTOMER PERCEPTION–DRIVEN PRICING
In conjoint analysis, researchers measure customer preferences
between products.
CUSTOMER PERCEPTION–DRIVEN PRICING
Products are treated as a bundle of attributes, features, and
benefits, where price can be one of those features in a conjoint
analysis study.
CUSTOMER PERCEPTION–DRIVEN PRICING
By measuring their preferences, researchers can detect how
customers make tradeoffs and use these tradeoffs to decompose a
product valuation into the sum of the values that customers assign to
specific attributes, features, and benefits.
CUSTOMER PERCEPTION–DRIVEN PRICING
In this manner, executives can determine how customers value
specific product formulations and quantify the source of pricing
power within their product.
CUSTOMER PERCEPTION–DRIVEN PRICING
In identifying the value that customers place on specific product
attributes, features, and benefits, conjoint analysis creates a part-
worth utility function.
CUSTOMER PERCEPTION–DRIVEN PRICING
Because a specific product is the collection of a set of attributes,
features, and benefits, the value of that product to a customer, or
its customer net utility, is the sum of their part-worth utilities.
CUSTOMER PERCEPTION–DRIVEN PRICING
By decomposing a product value into its part-worth utilities,
executives can ask “what if” questions.
CUSTOMER PERCEPTION–DRIVEN PRICING
They can posit alternative variations of product formulations, each
with its own cost structure, and

identify which product formulation could be priced the highest,

priced the lowest, capture the largest contribution margin, or
capture the highest sales volume at a given price.
CUSTOMER PERCEPTION–DRIVEN PRICING
Even product formulations that currently don’t exist can be valued
through conjoint as the sum of a product’s part-worth utilities.
CUSTOMER PERCEPTION–DRIVEN PRICING
The richness of these results enables executives to uncover new
product compositions and potential prices to identify which specific
product formulation at a specific price is likely to deliver the
highest profit.
CUSTOMER PERCEPTION–DRIVEN PRICING
Conjoint analysis is a market research technique, and as such, the
quantification of value comes directly from the customers’
perspective.
CUSTOMER PERCEPTION–DRIVEN PRICING
This is very important. Recall, in the exploration of the range of a
good price, one of the key ingredients of capturing a better price
is knowing how customers value a product.
CUSTOMER PERCEPTION–DRIVEN PRICING
The closer a firm can price its products to a point just below the
value customers place on that product, the higher the price the firm
can capture.

While exchange value models enable the firm to estimate the

value that customers will place on a product, conjoint analysis
will measure it.
CUSTOMER PERCEPTION–DRIVEN PRICING
Customer valuations will vary between customers, and conjoint
analysis will reveal these variations.

The dispersion in valuations can lead to an understanding of the

expected demand at a given price even before a product is
launched.
CUSTOMER PERCEPTION–DRIVEN PRICING
From this anticipated demand curve, executives can use some of the
techniques explored in economic price optimization in identifying
the price most likely to deliver the highest profits, but with much
greater accuracy and relevance.
CUSTOMER PERCEPTION–DRIVEN PRICING
If consumer dispersion in valuations of specific features can be
aggregated into meaningfully different groups, conjoint analysis
can form the basis of highly valuable market segmentation.
CUSTOMER PERCEPTION–DRIVEN PRICING
The dispersion in valuations may derive from customers having
alternative uses for a product that were not originally intended by
the producer, or from satisfying a need greater than was
anticipated.
CUSTOMER PERCEPTION–DRIVEN PRICING
Market segmentation through product design requires this
understanding of how some segments of customers prefer a certain
product composition while other segments prefer an alternative
composition.
CUSTOMER PERCEPTION–DRIVEN PRICING
Executives can use these results to identify which product
formulations might be attractive as an entry-level product into the
category and which might serve as higher-value products to
capture the more demanding customers.
CUSTOMER PERCEPTION–DRIVEN PRICING
As with any market research technique, conjoint analysis shows only
a snapshot of customer desires.

New product concepts that may have not been considered in the
research design may dramatically change the product valuations.
CUSTOMER PERCEPTION–DRIVEN PRICING
Likewise, changes in the economic climate can alter the willingness
to pay.

In a rapidly evolving market, the outcomes from conjoint analysis

may become dated before the product ever reaches the market.

For slowly evolving markets, the changes within the market

environment are manageable challenges to the outcomes of a
conjoint analysis study.
CUSTOMER PERCEPTION–DRIVEN PRICING
Conjoint analysis can be done in a variety of forms and the market
name for the approach varies with the form, such as discrete
choice, tradeoff analysis, external analysis, or conjoint itself.
CUSTOMER PERCEPTION–DRIVEN PRICING
The underlying principles and mathematics are similar across the
differing forms.
CUSTOMER PERCEPTION–DRIVEN PRICING
In purpose, each form attempts to reveal the structure of customer
preferences that are ascribed in terms of levels of different
attributes.
CUSTOMER PERCEPTION–DRIVEN PRICING
In a conjoint analysis study, researchers ask participants that are
representative of the target market to identify their preferences
between different products.

The products that customers choose between are themselves

compilations of specific sets of features, attributes, and benefits.
CUSTOMER PERCEPTION–DRIVEN PRICING
After customers make selections, the responses are analyzed with
statistical methods. (Commercially available, off-the-shelf software
can be used to automate the research design and data analysis.)

The results from this analysis are the customers’ part-worth utility
functions.
CUSTOMER PERCEPTION–DRIVEN PRICING
To demonstrate how conjoint analysis can reveal a customer’s part-
worth utility function, we will use a simplified example with mango
juice.
CUSTOMER PERCEPTION–DRIVEN PRICING
This example will use hypothetical attributes and measurements
and is not intended to be representative of fact but rather for
elucidating the process of conducting a conjoint analysis.
CUSTOMER PERCEPTION–DRIVEN PRICING
Fresh mango juice is common in tropical regions but is harder to
find in latitudes farther north.

As the world’s population becomes more mobile, however, many

peoples in northern climates are familiar with mango juice, either
from their travels abroad or from their familiar roots in a tropical
climate.
CUSTOMER PERCEPTION–DRIVEN PRICING
Drink makers have increasingly become aware of the potential
demand for mango juice in northern climates and have recently
been making products to serve the growing demand.

However, mango juice is relatively expensive to produce, transport,

and distribute to northern climates.
CUSTOMER PERCEPTION–DRIVEN PRICING
In response, many producers have chosen to offer mango juice
blends rather than pure mango juice.

In mango juice blends, the beverage is made mostly of non-mango

juices such as grape, orange, and apple, but will contain some
mango or an additive to impart a mango flavor.
CUSTOMER PERCEPTION–DRIVEN PRICING
For concreteness, consider a hypothetical 32-ounce container of
mango juice.

The producer can either offer pure mango juice or a mango fruit
blend, and the product can be sold under a well-known national
brand or a new premium niche brand.
CUSTOMER PERCEPTION–DRIVEN PRICING
The executives would like to know the potential prices of the
different formulations of mango juices marketed under different
brand names.
CUSTOMER PERCEPTION–DRIVEN PRICING
In this hypothetical example, there will be three attributes under
investigation: ingredients, brand, and price.

Each attribute will be investigated at two different levels for this

simplified example, but more attributes and levels could be
explored in a more realistic investigation.
CUSTOMER PERCEPTION–DRIVEN PRICING
The two ingredient levels are
 pure mango juice and mango fruit blend.

The two branding levels are

 a well-known national brand and
 a premium niche brand.

The price levels under consideration are

 $4 and $7.
CUSTOMER PERCEPTION–DRIVEN PRICING
In the conjoint analysis study, participants are asked to rank the
potential products in order of preference.
CUSTOMER PERCEPTION–DRIVEN PRICING
For our example, consider a participant that most prefers pure
mango juice with a national brand priced at $4 and least prefers
mango fruit blend priced with a premium niche brand price at $7.
CUSTOMER PERCEPTION–DRIVEN PRICING
Continuing to rank the products, from 1 being the most preferred to
8 being the least preferred, the participant exhausts the potential
product formulations.

The participant’s ranking of potential products is a measure of the

utility that he or she places on each specific product formulation.
CUSTOMER PERCEPTION–DRIVEN PRICING
Those with the highest utility were ranked first, while those with the
lowest utility were ranked last.

The researcher can use this to prepare the data collected from this
participant for evaluation by scoring it from 0 to 7, where the
lowest score is that which yields the lowest utility and the highest
score yields the highest utility.
CUSTOMER PERCEPTION–DRIVEN PRICING
These product scores can be used to evaluate the part-worth utility
function of this participant.
CUSTOMER PERCEPTION–DRIVEN PRICING
The part-worth utility of a specific attribute level is found by
averaging the scores of the products that have that particular
attribute level.
CUSTOMER PERCEPTION–DRIVEN PRICING
For simplicity, we will measure part-worth utilities with a metric
called utils, an economist’s unit of utility.
CUSTOMER PERCEPTION–DRIVEN PRICING
To find the participant’s utility for a specific product formulation,
we simply add the part-worth utilities associated with the specific
attribute levels.

We can see that the utility valuation from the sum of part-worth
utilities reproduces the same rankings as the participant reported
in the survey
CUSTOMER PERCEPTION–DRIVEN PRICING
Because price was one of the attributes being measured in the
conjoint analysis, we can place a monetary value on the unit of
utils.

Specifically, the ratio of price disparity in the study design to util

disparity between the two price points found from the customer
preferences reveals the dollar value per util.
CUSTOMER PERCEPTION–DRIVEN PRICING
Because the price ranged from $4 to $7 and the calculated part-
worth utilities ranged from 5.5 to 1.5 utils, we find the valuation of
$0.75/util.
CUSTOMER PERCEPTION–DRIVEN PRICING
Armed with this information, we can calculate the preference value
that this participant places on different attribute levels.
CUSTOMER PERCEPTION–DRIVEN PRICING
For instance, earlier slide shows that the difference in utility of a
national brand versus premium niche brand is 1 util, or $0.75.

For this participant, the premium niche brand detracts value from
the product with respect to a national brand.
CUSTOMER PERCEPTION–DRIVEN PRICING
Likewise, the difference in utility of pure mango juice versus a
mango fruit blend is 2 utils, or $1.50.

Purity in mango juice adds value for this participant.

CUSTOMER PERCEPTION–DRIVEN PRICING
We can also use the attribute-level valuations to compare different
products that could be made.
CUSTOMER PERCEPTION–DRIVEN PRICING
For instance, a new entrant to this market promoting a premium
niche brand of pure mango juice competing against an established
national brand of mango fruit blend priced at $4 would have to
market its product at a price less than $4.75 to attract this
research participant.
CUSTOMER PERCEPTION–DRIVEN PRICING
This product valuation is found by adding the part-worth utility
differences between premium niche versus national (-1.0 utils) and
that between pure mango juice and mango fruit blend (2.0 utils),
which yields 1 util.

This participant values 1 util at $0.75, so this product could attract

this participant away from the $4 established brand only if priced
at or below $4.75.
QUESTIONS ON PRICE CALCULATION
Currently, Premium niche brand, Pure mango juice is selling at $7.
At what price should we launch a National brand, having blended
mango juice, so that it can compete in the market?
QUESTIONS ON PRICE CALCULATION
Existing - Premium niche brand, Pure mango juice, $7

To be launched - National brand, blend

Premium niche brand, Pure mango juice, $7

Concept

Launch - Existing
Premium niche brand, Pure mango juice, $7

PN = 1
Ju = -2
$7 = +4
Premium niche brand, Pure mango juice, $7

PN = 1
Ju = -2

National brand, blend = 1*0.75 + (-2)*0.75

CUSTOMER PERCEPTION–DRIVEN PRICING
Different customers will have different rankings leading to
different part-worth utility functions.

The aggregate market’s part-worth utility for specific attributes is

the average of each individual participant’s part-worth utility.
CUSTOMER PERCEPTION–DRIVEN PRICING
Rather than finding the aggregate market’s utility for a product
formulation,

it is often more insightful to identify the willingness to pay of each

different product formulation for each research participant to
create potential demand curves for the market of specific product
formulations.
CUSTOMER PERCEPTION–DRIVEN PRICING
If there are meaningful differences between the utility rankings of
market research participants that can be aggregated,

researchers can also segment the market and uncover the prices
that different segments would be willing to pay for different
product compositions.
CONJOINT ANALYSIS – STUDY DESIGN
Conjoint analysis is clearly a very powerful tool to gain insight into
customer preferences, as the example described previously
demonstrates.
CONJOINT ANALYSIS – STUDY DESIGN
Its value to executives in
understanding markets,
evaluating products, and
identifying prices
has made conjoint analysis a routine technique of many market
researchers to evaluate markets, products, and prices since its
introduction in 1964.
CONJOINT ANALYSIS – STUDY DESIGN
In essence, there are five basic steps in a conjoint analysis:
(1) defining the attributes and attribute levels,
(2) presenting the stimulus,
(3) measuring the response,
(4) setting the evaluation criterion, and
(5) analyzing the data.
CONJOINT ANALYSIS – DEFINING ATTRIBUTE
One of the key values of conjoint analysis is its ability to identify
the value that customers place on different attributes.

To accomplish this task, researchers must clearly define the

attributes under investigation and the levels of those attributes to
be investigated.
CONJOINT ANALYSIS – DEFINING ATTRIBUTE
Conjoint analysis cannot identify the utility of attributes and levels
that are not stated, hence the attribute and level lists need to be
full, relevant, and executable.
CONJOINT ANALYSIS – DEFINING ATTRIBUTE
In our mango juice example, the attributes considered included
ingredients, brand, and price.
CONJOINT ANALYSIS – PRESENTING STIMULUS
Products can be presented to research participants in a variety of
ways, and the results of conjoint analysis may depend in part on
the way in which the product in question is presented.
CONJOINT ANALYSIS – PRESENTING STIMULUS
The development of a survey is an art in itself, and

pretesting is commonly used to investigate whether the survey

questions reveal the facts that are needed to inform managerial
decision making or fail to interpret the results with certainty.
CONJOINT ANALYSIS – PRESENTING STIMULUS
The more popular forms of stimulus presentation include

verbal descriptions,
paragraph descriptions, or
pictorial representations.
CONJOINT ANALYSIS – MEASURING THE
RESPONSE
While our mango juice example required participants to rank their
preferences in order, preferences can be measured in many other ways.

Measurements of preferences can use nonmetric means, such as rank

ordering or paired comparisons.

They can also use metric approaches, such as rating scales or ratio
scales. Each of these approaches has been investigated with multiple
variations.
 CONJOINT ANALYSIS – EVALUATION CRITERION
One of the more subtle issues in a conjoint analysis study is the criteria
that participants are asked to use to justify their preferences.

Two evaluative criteria commonly requested are either a statement of

overall preference or intention to buy.
 CONJOINT ANALYSIS – EVALUATION CRITERION
The evaluation criterion used may bias the results of the study
inappropriately.

For instance, consider two potential commuter bicycles:

(1) Schwinn World GS, Disc Brakes, costing $499; and
(2) Trek District, Alloy Dual-Pivot Brakes, costing $929.

Research participants may, in some sense, prefer the Trek option but, due to lack
of financial resources, may be more likely to purchase the Schwinn option.
CONJOINT ANALYSIS – EVALUATION CRITERION
In practice, both preference and likelihood to purchase are used as the
evaluation criterion about equally.

The intention to purchase evaluations have been identified to be

particularly suitable for new product classes and services that
consumers do not purchase currently.
 CONJOINT ANALYSIS – EVALUATION CRITERION
These studies help researchers estimate the potential market size for such
items.

When studying more established markets, preference evaluations

have been identified to be more useful in estimating market shares.
CONJOINT ANALYSIS – ANALYSING THE DATA
The type of data analysis that is conducted depends upon the prior
decisions regarding response type.

If rank ordering has been used, then it is appropriate to recognize

that we don’t really know by how much one alternative is preferred
over another.
CONJOINT ANALYSIS – ANALYSING THE DATA
We can only analyze the ordering of preferences through techniques
such as monotone analysis of variance (MONANOVA), PREFMAP, or
LINMAP.
 CONJOINT ANALYSIS – ANALYSING THE DATA
If paired comparisons have been used in which participants have been
asked to state their probability of choice, LOGIT and PROBIT methods
can be used to accommodate the fact that probabilities lie between zero
and 1.

If rating scores have been used, the partwise utility system is derived
through regression analysis such as ordinary least squares (OLS) or
minimum sum of absolute errors (MSAE).
CASE 1
Consider the following items and the challenge of setting their
prices. If selecting between exchange value models, economic
price optimization, or conjoint analysis, which method would be
most appropriate, and why?
a. Coal
b. A new software app for the iPad
c. Ocean Spray laundry detergent
d. A new fastener for the automotive industry
e. A training seminar on treating patients with mental dementia
f. A forklift with an automatic transmission
g. Boneless chicken breasts sold to restaurants
h. Branded boneless chicken breasts sold to consumers through a grocer
CASE 2
A new business product has been subjected to a conjoint analysis study.
One respondent provided the following part-worth utilities for
differentiating features A, B, C, and D of this product. A competing
product currently is priced at $600. What is the perceived value of the
product in comparison to the competing product?
Perceived value = 600 + 200 + 25 – 75 +130 = 880
CASE 3
 CASE 4

In designing a conjoint analysis study for pricing a smart phone, name

three attributes and at least two different levels for each attribute that
might be used in the study.
CASE 5
CASE 6
CASE 7
PRICE BENEFIT MAP
Value and price (for all three products)
Linear correlation (Tata Nano to Bentley)
Value from customers’ perspectives can act as a guide to evaluating the
profitability of the action.
Price to benefit map
Product are positioned along a line – line of equivalence
Value is proportional to price
Slope
PRICE BENEFIT MAP
Slope varies with segment, different segment value benefits
differently
Slope also varies with how customers perceive benefits, therefore
value is different for different customers. Thus market is changing
Leads to repositioning
Benefit Map is made through market research, online reviews
Small variation – no effect, zone of indifference
Benefit-bracketed or price-bracketed
Low price and high price - credible value
PRICE BENEFIT MAP
If difference (between two nearest offering) exist then price can
be increased
Outside the zone of indifference – value advantaged and
disadvantaged
Unharvested
Failed to harvest value
How will competitor react for value advantaged
 Launch similar product, which takes time so its very less risk
 Common reaction is dropping the price
PRICE BENEFIT MAP
Value advantage only if they have cost advantage, else it will be a
loss and difficult to sustain
When the firm has a cost advantage over its competitors, it may
endure a price battle with greater health
A product positioned in the value-disadvantaged area typically
suffers from lost market share.
Positioning a product as value disadvantaged implies that the firm
could have sold more units if their prices were more in line with the
expectations of the market.
PRICE BENEFIT MAP
Examples of missed opportunities may be found with media sales
situations where advertising space goes unsold because its price is
too high in comparison to the value that it delivers for a segment of
potential advertisers.

Bestto generate specific price-to-benefits maps for the

independent market segments rather than just one for the market
as a whole to better identify product positioning.
PRICE BENEFIT MAP
Customer perceptions matter.
Different customers may hold wildly different perceptions
regarding product positions. This dispersion may arise from a
segmentation strategy, but it often arises due to challenges in
positioning a product.
Poor positioning leads to dispersion in perception
When different customers hold contrasting beliefs regarding the
price of a product, there is a dispersion in perceived price.
May arise from an inability to communicate prices accurately.
PRICE BENEFIT MAP
When different customers hold different beliefs regarding the
benefits of a product, there is dispersion in perceived benefits.
Dispersion in perceived benefits may result from a structural
variation within the market or from a failure of communication
Benefits are less than what are perceived, the firm may be able to
capture some sales opportunistically, only to find customers
defecting quickly
PRICE BENEFIT MAP
Some products suffer from both wide dispersions in price and
benefits perceptions.
Customers who seek a high level of benefits and are willing to pay
for them may mistakenly purchase a lower-priced good.
In this case, not only will the firm have missed an opportunity to sell
a higher-priced product, but also the customer may become
dissatisfied.
Alternatively, customers who would be satisfied with a lower level
of benefits at a lower price may mistakenly perceive that the
market does not provide an appropriate product and therefore
refuse to purchase any product.
PRICE BENEFIT MAP
Executives can use the price-to-benefits map to identify
opportunities for launching a new product within an existing
market.
With each position, the price-to-benefits map will reveal the
customer addressable horizon to executives.
NEW PRODUCT POSITIONING
The customer-addressable horizon is the source of the customers for
the new product.

Some of the new customers would have been previously purchasing

a product at a higher price-and-benefits position; others would
have been purchasing a product at a lower price-and-benefits
position.

Identifying the customer-addressable horizon can be used to

estimate the market share and sales volume for the new product.
NEW PRODUCT POSITIONING
Uncovering the customer-addressable horizon can also be used to
anticipate competitor reactions.

Any new product that takes sales away from competing products
can encourage a competitive response.
NEW PRODUCT POSITIONING
Executives can be prepared to address a competitor’s response by
considering the circumstances under which they will accommodate
the competitive maneuver, respond to the competitive action, or
withdraw from the market.
NEW PRODUCT POSITIONING
There are eight major factors that can be evaluated to gauge the
likelihood of a competitive response to a new product.

(1) Competitors with a strategic intent to stay in the market due

to a strong profit margin on a product that is threatened by the
new entry are more likely to defend their position than those
who may be looking for a way out of the industry.
NEW PRODUCT POSITIONING
(2) Competitors that have made recent investments within the
industry are likewise likely to respond to an encroachment upon
their price-to-benefits position.

(3) In contrast, competitors whose range of options for responding is

limited due to cost challenges or inability to match the new entry’s
benefits may be unlikely to respond.
NEW PRODUCT POSITIONING
(4) Likewise, firms in strong financial health may perceive that they
can be patient in responding to measure the true effect of the new
entry.

(5) In general, the greater the level of threat a competitor

perceives the new entry to represent, the greater the response will
be.
New entries will threaten products that are nearer in position more
than they will those who are more distant.
NEW PRODUCT POSITIONING
(6) Similarly, the overall market position of existing competitors will
also affect their decision to respond.

Competitors that are already value disadvantaged face a greater

urgency in responding than those who are value advantaged.
NEW PRODUCT POSITIONING
(7) Competitors with greater maturity will have experienced
multiple business cycles and might be expected to respond more
appropriately.

(8) Similarly, industry tradition may reveal patterns of competitive

actions, such as a tendency to innovate or avoid price wars or
conversely to defend share aggressively.

Such patterns can be anticipated to be repeated.

NEW PRODUCT POSITIONING
Strategically, a new product can be launched as price neutral with
respect to other products, or it can take a non-neutral position
through a penetration-pricing or price skimming strategy
PRICE – NEUTRAL POSITIONING
When a new product is priced within the zone of indifference, the
firm has taken a price neutral position.

From a price-neutral position, the firm has negated the potential to

use price as a means to capture market share.

To capture customers, executives place pressure on other marketing

factors, such as promotion or distribution, when positioned as price
neutral.
PRICE – NEUTRAL POSITIONING
Neutral pricing is a strong competitive move when there is an
opening in the price-to benefits map.

An open gap within the middle of the zone of indifference may

imply an opportunity to better serve a portion of the market than
existing products have done so far.
PRICE – NEUTRAL POSITIONING
Openings at the top of the zone of indifference may exist when
new benefits become possible that were previously thought to be
unattainable, or when the market expands sufficiently to warrant
further segmentation.
PRICE – NEUTRAL POSITIONING
For instance, the fortunes of Robert Mondavi Winery have tracked
the growing interest in wines within the United States for more than
forty years since the 1960s by continually focusing on improving
the quality of their wines and pricing them appropriately to the
upper end of the market.

Alternatively, openings at the bottom of the zone of indifference

may become available when customers begin to seek greater
simplicity in their purchases, as U.S. consumers did in the aftermath
of the 2008–2009 Great Recession.
PRICE – NEUTRAL POSITIONING
Positioning a new product as price neutral is generally the safest
approach to avoiding a negative competitive response.

When a competitive response is made to a price-neutral launch, it

is most likely to be from a competitor that markets a product
positioned closest to the new entry.
CASE STUDY
General Motors: Price Management in Summer 2007

An illustration of the strategic value of a price-to-benefits map can

be found from some of the pricing dynamics in the U.S. auto
industry. As an industry practice, auto manufacturers have offered
summer incentives to customers to clear unsold inventory and
prepare distribution channels for the next year’s models. The depth
and duration of these discounts have implications for the
profitability of both the manufacturers and distributors.
CASE STUDY
General Motors: Price Management in Summer 2007

Distributors should prefer deeper manufacturer discounts over a

longer period of time to increase sales volume. Manufacturers
should prefer more limited discounts, both in duration and depth,
because the cost of the discount comes directly from the
manufacturer’s profitability. Because the manufacturer’s discount
disproportionately affects the manufacturer’s profit over the
distributors’, there is a natural point of conflict that requires
negotiation.
 CASE STUDY
General Motors: Price Management in Summer 2007

Early in the summer of 2007, GM’s competitors offered a range of summer

discounts like those from Toyota for 0 percent financing for 60 months or
rebates on purchases. GM, however, delayed its summer incentives until later in
the summer. By delaying its incentives, GM may have been taking advantage
of fluctuations in the width of the zone of indifference while simultaneously
managing to remain aligned with industrywide pricing practices. It can be
argued that this strategy enabled GM to increase its ability to target its
discounts toward its more loyal customers.
CASE STUDY
General Motors: Price Management in Summer 2007

Let us assume that auto manufacturers, such as GM, Toyota, Ford,

and Chrysler, had priced their products somewhat along the value
equivalence line going into the summer of 2007. Once GM’s
competitors had released their summer incentives, those competitors
would have been priced below the value equivalence line.
 CASE STUDY
General Motors: Price Management in Summer 2007

However, not all customers will have noticed the change in the price-to-benefits
of all vehicles at the same time. More-vigilant customers would have noticed
that GM was effectively priced somewhat higher than its competitors, while the
less vigilant may not have noticed. The initial result of the summer incentives is a
temporary broadening of the zone of indifference as some customers perceive
the price change and others fail to notice. This temporary broadening of the
zone of equivalence created some leeway for GM to delay its summer
incentives.
CASE STUDY
General Motors: Price Management in Summer 2007

Eventually, all customers will have noticed that GM had not yet
provided any summer discounts. Once the customer perceptions had
adjusted to the new reality, GM would have been priced above
the zone of indifference. At this point, GM would have had few
other options for staying competitive with its industry cohorts
outside of providing similar summer incentives. Once GM did, its
position was brought back within the new zone of indifference.
CASE STUDY
General Motors: Price Management in Summer 2007

From a strategic viewpoint, it can be argued that GM’s delay in

summer incentives might have been able to improve its long-term
financial health. The customers who would have noticed that GM
did not offer summer discounts early are likely to be those who
were shopping for a GM product in particular, rather than those
shopping for an automobile in general. These customers could be
said to be more loyal to the GM brand, and hence they were more
valuable to the GM corporation.
CASE STUDY
General Motors: Price Management in Summer 2007

Even though they are loyal customers and may be willing to wait a
short while for GM’s summer incentives, their patience would not be
infinite. By delaying, GM may have been able to target its
incentive program to its more loyal customers, who had delayed
their purchases in anticipation of the summer incentives.
CASE 1
7000

6000

5000

4000

3000

2000

1000

0
0 200 400 600 800 1000 1200 1400 1600 1800
 We evaluated the part-worth utility function of mango juice. If we add the part-
CASE 2 worth utility of an ingredient with the brand, we can find the partial utility of an
offering of mango juice. Similarly, we can complete the evaluation of conjoint-
derived prices relative to a $4 national brand of mango fruit blend. See the
following chart.
 a. Complete the chart for the partial utilities.
 b. Plot the partial utility of mango juice offerings relative to the conjoint-identified prices.
 c. Where do the conjoint-identified prices lie relative to perceived value? On the value equivalence
line, value advantaged, or value disadvantaged?
9

0
0 1 2 3 4 5 6
CASE 3
 In 2010, Apple released an iPad that some observers perceived to be a far superior
CASE 4 electronic reading device compared to other similar products on the market.
Consider the following plot of the iPad, Kindle, and Sony eReader. If the iPad is
positioned at iPad, answer the following questions.
a. From which products is the iPad most likely to steal share?
b. What immediate reaction should Sony take to the release of the iPad?
CASE 5
In 2010, Apple released an iPad that some observers perceived as far
inferior to a netbook. Consider the following plot of iPad vs. Netbook.
What immediate reaction should netbook producers take to the release
of the iPad?
CONCEPT OF VALUE AND VALUE CREATION
For every price-setting technique that we have considered, the
issue of value has had to be considered.

In reviewing the results of negotiation exercises, we saw that

negotiators who can transact at a price closer to the reservation
value of their counterpart will capture a better price.
CONCEPT OF VALUE AND VALUE CREATION
For every price-setting technique that we have considered, the
issue of value has had to be considered.

In reviewing the results of negotiation exercises, we saw that

negotiators who can transact at a price closer to the reservation
value of their counterpart will capture a better price.
CONCEPT OF VALUE AND VALUE CREATION
From the exchange value models, we demonstrated the potential to
estimate the value that customers will place on a product and
argued for pricing at or just below the identified exchange value.
CONCEPT OF VALUE AND VALUE CREATION
Setting prices with conjoint analysis likewise requires measuring
customer preferences to calculate their valuation of products and
set prices accordingly.
CONCEPT OF VALUE AND VALUE CREATION
Even in economic price optimization, the issue of value from the
customer’s perspective is important.

The demand at any given price is a count of the number of

customers that value the product at, or more than, the price being
considered.

Thus value, from the customer’s perspective, is the key to pricing.

CONCEPT OF VALUE AND VALUE CREATION
The importance of pricing in proportion to value is so strong that, in
many markets, the relationship between value and price is linearly
correlated.

Higher-valued products are sold at higher prices; lower-valued

products are sold at lower prices.
CONCEPT OF VALUE AND VALUE CREATION
From a broad perspective, we can see this relationship with
automobile sedans.

There is a large variation in prices for sedans, ranging from the

Tata Nano at $2,500, the Chevrolet Malibu at $28,000, and the
Bentley Flying Spur at $170,000, using rough estimates of 2008
prices.
CONCEPT OF VALUE AND VALUE CREATION
The difference between the lowest-price proposed sedan and the
highest-price production sedan is nearly a factor of 70.

What justifies this huge price difference?

CONCEPT OF VALUE AND VALUE CREATION
The answer is simple: the value delivered in the form of benefits.
CONCEPT OF VALUE AND VALUE CREATION
Although both the Tata Nano and the Bentley Flying Spur will
transport a family of four from A to B, we would be hard pressed
to find anyone who thinks these two sedans are comparable in
terms of benefits delivered.
CONCEPT OF VALUE AND VALUE CREATION
The Bentley Flying Spur simply delivers far greater benefits than
the Tata Nano could hope to achieve.
CONCEPT OF VALUE AND VALUE CREATION

Pricing to value is a guiding principle in many strategic and tactical

pricing actions.
CONCEPT OF VALUE AND VALUE CREATION
When launching a new product,
repositioning an existing product, or
tactically discounting a product to capture a specific segment,

value from customers’ perspectives can act as a guide to

evaluating the profitability of the action.
PRICE-TO-BENEFITS MAP
In a price-to-benefits map, products are positioned according to
their perceived prices on the vertical axis against their perceived
benefits on the horizontal axis.

It is a visual representation of how customers perceive the value

tradeoffs.
PRICE-TO-BENEFITS MAP
Price-to-benefits maps are directly related to both exchange value
models and conjoint analysis.

In constructing an exchange value model, executives are estimating

the differential values of products in comparison to relevant
competing alternatives.
PRICE-TO-BENEFITS MAP
Price setting from exchange value models is a simple exercise of
identifying a price that approaches the management agreed-upon
exchange value from below.
PRICE-TO-BENEFITS MAP
Price setting from exchange value models is a simple exercise of
identifying a price that approaches the management agreed-upon
exchange value from below.

Likewise, using conjoint analysis, executives can detect the

differential value of both exiting products and potential new
product formulations.
PRICE-TO-BENEFITS MAP
Moreover, conjoint analysis can reveal how customers perceive the
value of various attributes, features, and benefits.

Price setting with conjoint analysis is an exercise of identifying the

price that customers perceive as leaving them with sufficient value
after the transaction to encourage their purchase.
PRICE-TO-BENEFITS MAP
Both these techniques encourage firms to price in proportion to
benefits.

Price-to-benefits maps add to these other price setting techniques

by providing executives with a strategic vantage point into the
position of their product compared to all the relevant competition.
PRICE-TO-BENEFITS MAP
We can demonstrate a price-to-benefits map with the automobile
sedan market.

In designing and positioning the Tata Nano, executives at Tata

Motors have deliberately attempted to market a sedan that
provides little more than basic transportation.
PRICE-TO-BENEFITS MAP
Customers can be expected to perceive the Tata Nano as having
both the fewest benefits and the lowest price of sedans on the
market.

In contrast, executives at Bentley have deliberately strived to

deliver the most luxurious sedan on the market with the Flying Spur.
PRICE-TO-BENEFITS MAP
They have worked to give the Flying Spur superb performance,
handling, comfort, sound, and automation, to name a few
dimensions of benefits.

Customers of the Bentley Flying Spur may even perceive that this
sedan confers status upon them because of its impressive features.
PRICE-TO-BENEFITS MAP
It can be expected that customers would perceive the Bentley
Flying Spur as having not only one of the highest prices on the
commercial market, but also the highest level of benefits that can
be had in a commercially available sedan.
PRICE-TO-BENEFITS MAP
Between these two extremes, there are several other sedans such
as the Chevrolet Malibu, Lexus LS, and BMW 7 Series.
PRICE-TO-BENEFITS MAP
Each of these sedans offers different levels of benefits in terms of
safety, performance, luxury, and status.

If we were to measure the perceived benefits of these sedans and

plot them against the perceived prices, the results are likely to
resemble
VALUE EQUIVALENCE LINE
In our sketch of the perceived price against perceived benefits in
the sedan market, products are positioned along a line.

This line is called the value equivalence line

VALUE EQUIVALENCE LINE
For products positioned along the value equivalence line, the benefits
delivered by a product increase in proportion to the prices.

Goods that deliver greater benefits can be priced higher, while goods
that deliver fewer benefits can only capture a lower price.

The value equivalence line shows the correlation between perceived

benefits and prices for competing products within a market.
VALUE EQUIVALENCE LINE
The value equivalence line is depicted as lying along a 45-degree
angle, but it need not be.

The angle is somewhat arbitrarily dependent upon the metric of

benefits.
VALUE EQUIVALENCE LINE
Moreover, the value placed on different levels of benefits varies
between markets.

Even within a single market, different segments will value the

benefits differently, causing the slope of the value equivalence line
to be different between the segments.
VALUE EQUIVALENCE LINE
More interesting than the absolute value of the angle of the value
equivalence line are changes in the slope of the value equivalence
line.

Changes in the slope of the value equivalence line indicate shifts

within customer demand.
VALUE EQUIVALENCE LINE
Market evolutions where new products are offered that deliver a
different set of benefits may affect the perceived tradeoffs
between prices and benefits.
VALUE EQUIVALENCE LINE
When these market evolutions drive a change in the slope of the
value equivalence line,

executives of existing products face a challenge in repositioning

their products and an opportunity to uncover the nature of the new
demanded benefits and deliver an offer that meets customer
desires.
VALUE EQUIVALENCE LINE
When these market evolutions drive a change in the slope of the
value equivalence line,

executives of existing products face a challenge in repositioning

their products and an opportunity to uncover the nature of the new
demanded benefits and deliver an offer that meets customer
desires.
VALUE EQUIVALENCE LINE
In the simplest approach, executives will use observed market
prices and specific product attributes to defi ne the benefits metric
in constructing a price-to-value plot.

Often however, more thorough effort is required to construct a

price-to-value plot.
VALUE EQUIVALENCE LINE
In the common situation of executives attempting to resolve a
current pricing challenge,

many researchers suggest using market research to identify the

benefits metric that is best correlated with average selling prices or
perceived prices.
VALUE EQUIVALENCE LINE
In less-common situations, where executives are searching for subtle
changes in customer tastes,

some researchers have found that using expert opinions gleaned

from product reviews is useful for identifying the set of benefits
that account for the greatest proportion of variation in price and
the variation of this set of benefits over time.
VALUE EQUIVALENCE LINE
The most appropriate technique for drafting the price-to-value plot
will depend on the strategic question being addressed and the
availability of data.

Regardless of the technique used to identify the metric of

perceived benefits, the qualitative concept is similar.

Prices tend to increase in proportion to benefits.

ZONE OF INDIFFERENCE
Small variations in perceived price or benefits around the value
equivalence line often have negligible effects on sales volume.

Hence, there is a zone of indifference around the value

equivalence line.
ZONE OF INDIFFERENCE

Prices of products may be able to increase slightly above the value

equivalence line without having a measurable effect on sales.

For some fi rms, this can serve as a costless means to improve

profitability
ZONE OF INDIFFERENCE
The zone of indifference may arise due to the inability of products to
exhaust the value equivalence line and challenges in customer purchase
decisions.

In making a purchase, customers may be benefit-bracketed or price-

bracketed.

Benefit or price brackets can prevent them from easily switching

products when alternatives are distant in their position to one another on
the price-to-benefits map
ZONE OF INDIFFERENCE
Benefits brackets may arise from customers demanding a
particular set of benefits that are delivered through only a subset
of the products within the market.
ZONE OF INDIFFERENCE
A benefit floor may arise from customers requiring a minimal level
of benefits from the product category to warrant a purchase.

For instance, a customer may believe that accounting software must

be able to produce a profit and loss report or perceive it as
having no value over an Excel spreadsheet..
ZONE OF INDIFFERENCE
A benefits ceiling can arise from customers who are unable to take
advantage of certain product features;

for instance, some customers may feel that discounted cash flow
analysis is unnecessary within their accounting software.
ZONE OF INDIFFERENCE
Examples of issues that can give rise to price brackets are budget
constraints or credibility issues.

Budgetary constraints may force customers to purchase items below

a certain level even if they agree that they would gain greater
benefits if they purchased a higher priced product.
ZONE OF INDIFFERENCE
Customers suffering from budgetary constraints may be forced to
“make do” with the best available product below a certain price
point.

Products can also suffer from a credibility challenge.

ZONE OF INDIFFERENCE
Low-priced products may be perceived as having very little
credible value to warrant any investigation into their benefits.

High-priced products may be perceived to be unable to provide

sufficient credible benefits to warrant the price, and hence they
are also discarded.

For many purchasing situations, products are evaluated with

respect to a zone of credibility.
ZONE OF INDIFFERENCE
If the next nearest competitor in terms of benefits delivered is much
higher or lower than the product under consideration,

or if the next nearest competitor in terms of price is much higher or

lower than the product under consideration,

then the price of the product may be changed somewhat without

having many customers defect to the competing offer due to their
benefits brackets.
ZONE OF INDIFFERENCE
Not all products within all markets will fall within the zone of
indifference.

Outside of the zone of indifference lie the value-advantaged zone

and the value-disadvantaged zone.
ZONE OF INDIFFERENCE
Products lying in the value-advantaged or -disadvantaged zones
are either priced significantly lower or higher than the
corresponding levels of benefits, as perceived by customers.
VALUE ADVANTAGED
Products that deliver far more benefits than the price extracted
are said to be value advantaged.

Value-advantaged products can be created when fi rms choose to

price aggressively, thus providing more benefits than expected at
a given price, or when a product is enhanced with added features
and benefits but the price is not changed.
VALUE ADVANTAGED
In either case, positioning a product in the value-advantaged area
on the price-to-benefits map implies that the product provides an
expected excess value in comparison to the price.
VALUE ADVANTAGED
Researchers sometimes refer to products positioned in the value-
advantaged area as being priced with unharvested value.

These researchers believe that positioning a product in the value-

advantaged area implies that the fi rm could have priced their
offering higher.
VALUE ADVANTAGED
Thus, the executives will have failed to harvest the value that they
deliver and may have committed a pricing error, which failed to
maximize profits.

Examples of unharvested value may be found in theatrical

performances when tickets for front-row seats are sold below that
which customers are willing to pay in secondary markets.
VALUE ADVANTAGED
Alternatively, positioning a product as value advantaged is
sometimes purposely executed to take market share.

By providing more benefit than competing products at a given

price, customers will have an incentive to select that product.
VALUE ADVANTAGED
Despite the potential to improve volumes and market share,
executives should reflect carefully on the consequences of
positioning a product as value advantaged before executing this
strategy.

Deliberately positioning a product as value advantaged can have

some negative consequences.
VALUE ADVANTAGED
When competitors identify a product as value advantaged, they
are likely to react in various ways.

One form of reaction might be to launch a similar product priced

at a similar level of benefits to negate the price-to-benefits
differential of the value-advantaged products.
VALUE ADVANTAGED
Fortunately, to bring a new product through the product
development cycle and into a market launch requires time; so the
threat of a competitor reacting with the launch of a new, similarly
benefit-oriented product may be relatively benign.
VALUE ADVANTAGED
The more common reaction of competitors is simply to drop their
prices on existing products, potentially initiating an all-out price
war.

Price wars are not just bad for individual fi rm-level profits; they
tend to harm overall industry health for an extended period as
well.
VALUE ADVANTAGED
In technology-driven markets, certain product categories may
evolve rapidly with sequential improvements in benefits delivered
per price paid, a pattern known as hypercompetition.

For instance, DRAM memory costs per kilobyte decrease each time
a new photolithography technique becomes available.
VALUE ADVANTAGED
LCD TVs, computer processors, software, and nanotech products
have all been found to demonstrate similar trajectories.

Hypercompetitive markets are like a bare-knuckle brawl.

Firms will price new technology that offers significant cost

advantages aggressively over legacy technology; that is a common
trait in these markets.
VALUE ADVANTAGED
Executives who have performed well in them have focused their
firms on speed of delivery in launching improvements,

often relying on a hard learning curve for imitators to provide

strategic room for maneuvering.
VALUE ADVANTAGED
In general, firms should not position their product as value
advantaged unless

they hold a concurrent cost advantage or perceive that the action

will deliver a future cost advantage in the form of an economy of
scale, scope, or learning.
VALUE ADVANTAGED
When the firm has a cost advantage over its competitors, it may
endure a price battle with greater health than the industry’s
average competitor, enabling it to emerge from a temporary
skirmish in a better position.

Even when executives perceive that they hold a cost advantage,

they should take actions to minimize the price skirmish
VALUE DISADVANTAGED
Products that are priced high relative to the benefits they deliver
are value disadvantaged.
VALUE DISADVANTAGED
Value-disadvantaged products can be created when the firm
positions a product with many features and benefits at a high
price, but customers perceive little value from these new attributes.
VALUE DISADVANTAGED
Value-disadvantaged positioning can also arise from changes in
the competitive landscape that leave a product misaligned in terms
of price and benefits.

A product positioned in the value-disadvantaged area typically

suffers from lost market share.
VALUE DISADVANTAGED
Researchers sometimes refer to products that are value
disadvantaged as suffering from missed opportunities.

These researchers believe that positioning a product as value

disadvantaged implies that the firm could have sold more units if
their prices were more in line with the expectations of the market.
VALUE DISADVANTAGED
Thus, the executives will have missed the opportunity to capture
market attention and may have committed a pricing error that fails
to maximize profits.
VALUE DISADVANTAGED
Examples of missed opportunities may be found with media sales
situations where advertising space goes unsold because its price is
too high in comparison to the value that it delivers for a segment of
potential advertisers.
VALUE DISADVANTAGED
Alternatively, products may be deliberately positioned as value
disadvantaged due to a market segmentation strategy.

Some segments within the market may prefer a certain combination

of benefits that are not valued by others.
VALUE DISADVANTAGED
A firm may attempt to capture that segment profitably by offering
a product with those benefits and pricing it in proportion to the
value that the chosen target segments deem worthy of purchase,
and yet the market overall deems the position to be out of line.
VALUE DISADVANTAGED
For example, both the Bentley Silver Spur and the Porsche 911
GT2 are priced relatively high—about $170,000 and $194,000,
respectively.

The Porsche would be value disadvantaged for a sedan customer

while the Bentley Silver Spur would be value disadvantaged for
the coupe customer.
VALUE DISADVANTAGED
When the market can be segmented along the lines of different
benefit categories, it is often best to generate specific price-to-
benefits maps for the independent market segments rather than
just one for the market as a whole to better identify product
positioning.
CUSTOMER PERCEPTIONS
Because it is customers who purchase products, it is often best to
consider product positions from a customer’s perspective.

If customers perceive a product to be priced to value, then it will

sell in proportion to the number of customers who are willing to
pay the stated price for that level of benefits.
CUSTOMER PERCEPTIONS
If they perceive it to be value advantaged or value
disadvantaged, then the product is likely to capture market
attention or find it waning, respectively.

Customer perceptions matter.

CUSTOMER PERCEPTIONS
Different customers may hold wildly different perceptions
regarding product positions.

This dispersion may arise from a segmentation strategy, but it often

arises due to challenges in positioning a product.
CUSTOMER PERCEPTIONS
Products that are poorly positioned may fail to capture the
intended market segment, leaving customers who purchase
dissatisfied and disinclined to repurchase and failing to gain the
customers who would have been highly satisfied and become loyal
to the brand in the future.
CUSTOMER PERCEPTIONS
Both dispersions in perceived price and dispersions in perceived
benefits can be a direct result of a failure to manage perceptions.

When it is, executives may have an opportunity to address the

challenge and therefore improve their profitability.
DISPERSION IN PERCEIVED PRICE
When different customers hold contrasting beliefs regarding the
price of a product, there is a dispersion in perceived price.

Variations in price perceptions may be deliberate due to strategic

or tactical decisions, or they may arise from an inability to
communicate prices accurately.
DISPERSION IN PERCEIVED PRICE
When actual prices are above expected prices, customers may
delay purchases due to sticker shock, resulting in fewer sales.

When actual prices are below perceived prices, the level of sales
that executives may have hoped to achieve may fail to materialize.

Keeping price perceptions aligned with actual prices tends to

improve profits.
DISPERSION IN PERCEIVED PRICE
Structurally, the price of a product might vary widely between
different customers.

For instance, phone tariff structures are often designed to extract a

higher price from high usage customers than low-usage customers.
DISPERSION IN PERCEIVED PRICE
Likewise, distribution channels and purchase locations may drive
differences in the price of commonly purchased goods such as
carbonated beverages.
DISPERSION IN PERCEIVED PRICE
Structural price variations that support segmentation strategies will
drive dispersion in the perceived price, but this dispersion in prices
usually results in a profit enhancement rather than a positioning
challenge.
DISPERSION IN PERCEIVED PRICE
Tactically, the price of a product may also vary. Promotional prices
and discounting policies are ways of refining market segmentation
efforts through tactical means.

Customers purchasing at the list price will pay a much higher price
than those purchasing at a sale or discounted price.
DISPERSION IN PERCEIVED PRICE
Tactical price variations that support segmentation efforts may also
result in profit enhancements.

Overused, these tactical price variations can lead to positioning

challenges as well.
DISPERSION IN PERCEIVED PRICE
The more persistent challenge in price positioning results from time
delays between purchasing opportunities.

Customers who purchase from a product category infrequently

may hold inappropriate beliefs regarding the price of products
within that category.
DISPERSION IN PERCEIVED PRICE
When the prices within a product category are changing rapidly, it
will be difficult to keep price expectations of customers in line with
reality.

Periods of high inflation or dramatic changes in production costs

can lead to price expectations that are misaligned with market
realities.
DISPERSION IN PERCEIVED BENEFITS
When different customers hold different beliefs regarding the
benefits of a product, there is dispersion in perceived benefits.
DISPERSION IN PERCEIVED BENEFITS
The dispersion in perceived benefits may result from a structural
variation within the market or from a failure of communication.

When actual benefits delivered are greater than those perceived,

customers may place inadequate value on a product and select a
competing alternative.
DISPERSION IN PERCEIVED BENEFITS
When the benefits are less than what are perceived, the firm may
be able to capture some sales opportunistically, only to find
customers defecting quickly to competitor products in future
purchasing situations.
DISPERSION IN PERCEIVED BENEFITS
The benefits of a product may be grounded in functional, process,
or relationship issues.

Functional benefits derive from the physical nature or performance

characteristics of the product itself, such as the square footage of a
home, the clarity and size of a gemstone, or the ability of a
financial software package to create customized invoices.
DISPERSION IN PERCEIVED BENEFITS
Process benefits derive from reducing transactional costs by making
the product available when and where customers desire or
reducing search costs in identifying products.
DISPERSION IN PERCEIVED BENEFITS
Relationship benefits accrue to customers through their mutually
beneficial relationship with the seller and may be created through
an emotional connection to the brand or sales representative,
loyalty programs, or information provisions.
DISPERSION IN PERCEIVED BENEFITS
Because different customers may seek a different set of benefits
from a product category, they may also perceive products
themselves to hold a different overall level of benefits.

For instance, risk-averse customers may seek assurance and greatly

discount the claimed benefits of a new product.
DISPERSION IN PERCEIVED BENEFITS
Less-risk-averse customers, however, may value the benefits within
a new product precisely because they bring about change.

Variations in risk aversion have been well observed in technology

markets and can result in a time dependent segmentation strategy.
DISPERSION IN PERCEIVED BENEFITS
Similarly, attitudes towards risks vary between senior executives
and mid-level managers.

Senior executives tend to seek dramatic improvements in

productivity, while mid-level managers tend to seek stability and
steady career improvement.
DISPERSION IN PERCEIVED BENEFITS
Perceptions of benefits may vary between customers due to poor
marketing communications.

When different marketing communications efforts tout different

sets of benefits, customers may have a hard time developing a
common understanding of the benefits delivered through a product.
DISPERSION IN PERCEIVED BENEFITS
When a wide disparity in perceived benefits is indicative of
customer confusion, executives may have the opportunity to clarify
their marketing communications and increase the level of
communications to drive sales and profits.
DISPERSION IN PERCEIVED BENEFITS
Wide dispersions of perceived benefits are more common with
experience and credence goods than search goods.

Search goods are items that allow for a functional comparison

between competing products during the shopping experience itself.
DISPERSION IN PERCEIVED BENEFITS
For instance, prior to purchasing an automobile, customers can
compare engine size, tires, entertainment systems, suspensions,
braking systems, and other features to predict the benefits of the
automobile.

Bicycles, home appliances, and some software products are all

examples of search goods.
DISPERSION IN PERCEIVED BENEFITS
Through feature descriptions and promotional statements, customers can
make comparisons between products prior to purchase with search
goods.

Experience goods are items in which the full knowledge of the benefits
can be gained only from past experience with the product.

For example, with newspapers, it is hard to tell the value of the content
until after the news is read, and only through experience with the brand
can a customer form meaningful expectations of the newspaper’s value.
DISPERSION IN PERCEIVED BENEFITS
Entertainment and other forms of media, along with some forms of
beverages and branded clothing, are examples of experience
goods.

Credence goods are items in which the benefits are unknown and
may never be known.

For instance, the purchase of insurance is done with the expectation

that reimbursement will come following a disaster.
DISPERSION IN PERCEIVED BENEFITS
However, few customers of insurance products hope for a disaster,
and most try to avoid them.

If the insured disaster never comes, the insurance policy will expire
and go unused, thus the buyer will never truly know if the policy
was worth anything.
DISPERSION IN PERCEIVED BENEFITS
Other credence goods includes pre-purchased funerary service (it
is hard to evaluate the benefits of a service provided after the
customer is dead), prostate cancer care (it is difficult to ascertain
whether slow-growing prostate cancer will kill the patient or some
other disease will first), and product warranties.

People purchase credence items on the belief that the firm

providing them will actually deliver the benefits, even if the
customer is unaware of it doing so.
DISPERSION IN BOTH PERCEIVED PRICE AND
BENEFITS
Some products suffer from both wide dispersions in price and
benefits perceptions.
DISPERSION IN BOTH PERCEIVED PRICE AND
BENEFITS
When customers are uncertain regarding the position of a product,
the market is simply confused.

Customers who seek a high level of benefits and are willing to pay
for them may mistakenly purchase a lower-priced good.

In this case, not only will the firm have missed an opportunity to sell
a higher-priced product, but also the customer may become
dissatisfied.
DISPERSION IN BOTH PERCEIVED PRICE AND
BENEFITS
Alternatively, customers who would be satisfied with a lower level
of benefits at a lower price may mistakenly perceive that the
market does not provide an appropriate product and therefore
refuse to purchase any product.

As both types of misalignment between expectations and reality

illustrate, a wide dispersion in perceived benefits and prices can
lead to reduced sales, reduced customer loyalty, and ultimately
reduced profits.
NEW PRODUCT POSITIONING
Executives can use the price-to-benefits map to identify
opportunities for launching a new product within an existing
market.

Potential positions within the price-to-benefits map can be

considered.

With each position, the price-to-benefits map will reveal the

customer addressable horizon to executives.
NEW PRODUCT POSITIONING
The customer-addressable horizon is the source of the customers for the new product.

Some of the new customers would have been previously purchasing a product at a
higher price-and-benefits position; others would have been purchasing a product at a
lower price-and-benefits position.

Identifying the customer-addressable horizon can be used to estimate the market

share and sales volume for the new product.
NEW PRODUCT POSITIONING
Uncovering the customer-addressable horizon can also be used to anticipate
competitor reactions.

Any new product that takes sales away from competing products can encourage a
competitive response.
NEW PRODUCT POSITIONING
Executives can be prepared to address a competitor’s response by considering the
circumstances under which they will accommodate the competitive maneuver, respond
to the competitive action, or withdraw from the market.
NEW PRODUCT POSITIONING
There are eight major factors that can be evaluated to gauge the likelihood of a
competitive response to a new product.

(1) Competitors with a strategic intent to stay in the market due to a strong profi t margin on a
product that is threatened by the new entry are more likely to defend their position than those who
may be looking for a way out of the industry.
NEW PRODUCT POSITIONING
(2) Competitors that have made recent investments within the industry are likewise
likely to respond to an encroachment upon their price-to-benefi ts position.

(3) In contrast, competitors whose range of options for responding is limited due to
cost challenges or inability to match the new entry’s benefi ts may be unlikely to
respond.
NEW PRODUCT POSITIONING
(4) Likewise, fi rms in strong fi nancial health may perceive that they can be patient in
responding to measure the true effect of the new entry.

(5) In general, the greater the level of threat a competitor perceives the new entry to
represent, the greater the response will be.
New entries will threaten products that are nearer in position more than they will those
who are more distant.
NEW PRODUCT POSITIONING
(6) Similarly, the overall market position of existing competitors will also affect their
decision to respond.

Competitors that are already value disadvantaged face a greater urgency in

responding than those who are value advantaged.

Other factors that may indicate the likelihood and type of competitive response
include industry maturity and tradition.
NEW PRODUCT POSITIONING
(7) Competitors with greater maturity will have experienced multiple business cycles
and might be expected to respond more appropriately.

(8) Similarly, industry tradition may reveal patterns of competitive

NEW PRODUCT POSITIONING
(7) Competitors with greater maturity will have experienced multiple business cycles
and might be expected to respond more appropriately.

(8) Similarly, industry tradition may reveal patterns of competitive actions, such as a
tendency to innovate or avoid price wars or conversely to defend share aggressively.

Such patterns can be anticipated to be repeated.

NEW PRODUCT POSITIONING
Strategically, a new product can be launched as price neutral with respect to other
products, or it can take a non-neutral position through a penetration-pricing or price
skimming strategy
PRICE – NEUTRAL POSITIONING
When a new product is priced within the zone of indifference, the firm has taken a
price neutral position.

From a price-neutral position, the fi rm has negated the potential to use price as a
means to capture market share.

To capture customers, executives place pressure on other marketing factors, such as

promotion or distribution, when positioned as price neutral.
PRICE – NEUTRAL POSITIONING
Neutral pricing is a strong competitive move when there is an opening in the price-to
benefits map.

An open gap within the middle of the zone of indifference may imply an opportunity
to better serve a portion of the market than existing products have done so far.
PRICE – NEUTRAL POSITIONING
Openings at the top of the zone of indifference may exist when new benefits become
possible that were previously thought to be unattainable, or when the market
expands sufficiently to warrant further segmentation.
PRICE – NEUTRAL POSITIONING
For instance, the fortunes of Robert Mondavi Winery have tracked the growing
interest in wines within the United States for more than forty years since the 1960s by
continually focusing on improving the quality of their wines and pricing them
appropriately to the upper end of the market.

Alternatively, openings at the bottom of the zone of indifference may become

available when customers begin to seek greater simplicity in their purchases, as U.S.
consumers did in the aftermath of the 2008–2009 Great Recession.
PRICE – NEUTRAL POSITIONING
Positioning a new product as price neutral is generally the safest approach to
avoiding a negative competitive response.

When a competitive response is made to a price-neutral launch, it is most likely to be

from a competitor that markets a product positioned closest to the new entry.
PRICE – NEUTRAL POSITIONING
Positioning a product at the bottom or within the middle of the zone of indifference is
subject to the potential of a competitive response in the form of a price decrease on
existing products.
PRICE – NEUTRAL POSITIONING
The likelihood of a price response is tempered by the need for competitors to
maintain contribution margins, not just volumes.

Entering a product category positioned at the top of the zone of indifference usually
grants the firm some leeway in that a competitive response will be slowed due to the
challenges faced in delivering a product with similar benefits.
PENETRATION PRICING
If a new product is launched within an existing market at a low price in comparison to
the benefits that it delivers, the firm is executing a penetration-pricing strategy.
PENETRATION PRICING
Penetration pricing is undertaken to gain market share quickly.

It is risky in many cases because there may be little to prevent existing competitors
from dropping their prices as well to thwart the new entrant from gaining a foothold.
PENETRATION PRICING
Executives who choose to practice penetration pricing when launching a new product
are often wise to treat it as a tactical price promotion for introducing the new product
rather than a strategic resetting of the price level.
PENETRATION PRICING
Often, in rapidly evolving high-tech industries, penetration pricing arises from
increasing the level of benefits while leaving the price unchanged.

This occurs due to cost advantages being gained concurrent to benefits improvements
with the adoption of new manufacturing techniques.
PENETRATION PRICING
If executives can sustain a rate of improvement greater than its competitors’ for
several release cycles, penetration pricing may enable the firm to capture a dramatic
amount of share.
PENETRATION PRICING
From a promotional perspective, penetration pricing obviously generates customer
interest.

However, this position may be deleterious for the firm, not only in failing to capture
potential contribution margins but also in strongly encouraging a competitive
response.
PENETRATION PRICING
The most likely direct response is a price decrease by competitors to bring all
products back to parity within a price-to-benefits tradeoff.
PRICE SKIMMING
If the new product is launched within an existing market at a high price in comparison
to the benefits that it delivers, the firm is executing a price-skimming strategy.
PRICE SKIMMING
Price skimming is undertaken to capture profits from early customers with the
expectation of lowering prices at a future time.

It is unlikely to incur any competitive response because the new entry will be
perceived as relatively benign.

However, such a position is usually the result of a pricing error that results in lower
sales volumes and forgone profits.
PRICE SKIMMING
Products launched under a price-skimming strategy fail to provide most customers
with sufficient motivation to purchase given the alternatives; hence, they may not gain
market attraction.

Firms may use this strategy to explore a market strategically, but few executives
should expect this initial thrust to deliver significant results.
CASE STUDY
General Motors: Price Management in Summer 2007

An illustration of the strategic value of a price-to-benefi ts map

can be found from some of the pricing dynamics in the U.S. auto
industry. As an industry practice, auto manufacturers have offered
summer incentives to customers to clear unsold inventory and
prepare distribution channels for the next year’s models. The depth
and duration of these discounts have implications for the profi
tability of both the manufacturers and distributors.
CASE STUDY
General Motors: Price Management in Summer 2007

Distributors should prefer deeper manufacturer discounts over a

longer period of time to increase sales volume. Manufacturers
should prefer more limited discounts, both in duration and depth,
because the cost of the discount comes directly from the
manufacturer’s profitability. Because the manufacturer’s discount
disproportionately affects the manufacturer’s profit over the
distributors’, there is a natural point of conflict that requires
negotiation.
 CASE STUDY
General Motors: Price Management in Summer 2007

Early in the summer of 2007, GM’s competitors offered a range of summer

discounts like those from Toyota for 0 percent financing for 60 months or
rebates on purchases. GM, however, delayed its summer incentives until later in
the summer. By delaying its incentives, GM may have been taking advantage
of fluctuations in the width of the zone of indifference while simultaneously
managing to remain aligned with industrywide pricing practices. It can be
argued that this strategy enabled GM to increase its ability to target its
discounts toward its more loyal customers.
CASE STUDY
General Motors: Price Management in Summer 2007

Let us assume that auto manufacturers, such as GM, Toyota, Ford,

and Chrysler, had priced their products somewhat along the value
equivalence line going into the summer of 2007. Once GM’s
competitors had released their summer incentives, those competitors
would have been priced below the value equivalence line.
 CASE STUDY
General Motors: Price Management in Summer 2007

However, not all customers will have noticed the change in the price-to-benefits
of all vehicles at the same time. More-vigilant customers would have noticed
that GM was effectively priced somewhat higher than its competitors, while the
less vigilant may not have noticed. The initial result of the summer incentives is a
temporary broadening of the zone of indifference as some customers perceive
the price change and others fail to notice. This temporary broadening of the
zone of equivalence created some leeway for GM to delay its summer
incentives.
CASE STUDY
General Motors: Price Management in Summer 2007

Eventually, all customers will have noticed that GM had not yet
provided any summer discounts. Once the customer perceptions had
adjusted to the new reality, GM would have been priced above
the zone of indifference. At this point, GM would have had few
other options for staying competitive with its industry cohorts
outside of providing similar summer incentives. Once GM did, its
position was brought back within the new zone of indifference.
CASE STUDY
General Motors: Price Management in Summer 2007

From a strategic viewpoint, it can be argued that GM’s delay in

summer incentives might have been able to improve its long-term
financial health. The customers who would have noticed that GM
did not offer summer discounts early are likely to be those who
were shopping for a GM product in particular, rather than those
shopping for an automobile in general. These customers could be
said to be more loyal to the GM brand, and hence they were more
valuable to the GM corporation.
CASE STUDY
General Motors: Price Management in Summer 2007

Even though they are loyal customers and may be willing to wait a
short while for GM’s summer incentives, their patience would not be
infinite. By delaying, GM may have been able to target its
incentive program to its more loyal customers, who had delayed
their purchases in anticipation of the summer incentives.
CASE 1
 In 2010, Apple released an iPad that some observers perceived to be a far superior
CASE 2 electronic reading device compared to other similar products on the market.
Consider the following plot of the iPad, Kindle, and Sony eReader. If the iPad is
positioned at iPad, answer the following questions.
a. From which products is the iPad most likely to steal share?
b. What immediate reaction should Sony take to the release of the iPad?
CASE 3
7000

6000

5000

4000

3000

2000

1000

0
0 200 400 600 800 1000 1200 1400 1600 1800
 We evaluated the part-worth utility function of mango juice. If we add the part-
CASE 4 worth utility of an ingredient with the brand, we can find the partial utility of an
offering of mango juice. Similarly, we can complete the evaluation of conjoint-
derived prices relative to a $4 national brand of mango fruit blend. See the
following chart.
 a. Complete the chart for the partial utilities.
 b. Plot the partial utility of mango juice offerings relative to the conjoint-identified prices.
 c. Where do the conjoint-identified prices lie relative to perceived value? On the value equivalence
line, value advantaged, or value disadvantaged?
9

0
0 1 2 3 4 5 6
CLASS EXERCISE
CLASS EXERCISE –
PARTICIPATION CARRIES CP MARKS
You are a head of sales of a well known two wheeler automobile brand. You have
been asked to launch a product with the following options. Which one will you choose
and why? Make a detailed and thorough presentation/case. (Group of three)
Please note that pricing has already been worked out by a team of professionals in
the company.
1. Launch it in single variant a single price point all across India
2. Launch two variants with two price points all across India
3. Launch four variant at four different price points all across India
VALUE BASED SEGMENTATION
While the best pricing techniques all share a foundation in guiding executives to price
in proportion to value, they also share an opportunity,

in that value is in the mind of the beholder and different minds will value a product
differently.
VALUE BASED SEGMENTATION
To seize this opportunity, firms will price-segment the market.

Price segmentation is the method of pricing the same or similar products differently
for different customer segments.
VALUE BASED SEGMENTATION
Within any market, different customers will value products differently, and therefore
they will be willing to pay different amounts for that product.
VALUE BASED SEGMENTATION
The diversity of individual customers within the collective market is a form of
heterogeneity.

Market heterogeneity can be seen in terms of brand affinity, benefits demanded, or

willingness to pay.
VALUE BASED SEGMENTATION
When we are describing differences between individuals in their willingness to pay,
we are describing a form of heterogeneity in demand.
VALUE BASED SEGMENTATION
The drivers to heterogeneity in demand are multifarious.

Some customers may derive greater benefits from the product compared to others
with more modest requirements, and therefore they are willing to pay more.
VALUE BASED SEGMENTATION
Some customers may have higher incomes, thus enabling them to pay more.

Alternatively, some customers may have more time to price compare and are
therefore more price-sensitive.
VALUE BASED SEGMENTATION
Even more issues may drive demand heterogeneity.

The point is, demand is heterogeneous and this heterogeneity in demand creates the
opportunity to practice price segmentation.
VALUE BASED SEGMENTATION
Price segmentation, also known as price discrimination in economics, is charging
different customers different prices for an otherwise identical or similar product.
VALUE BASED SEGMENTATION
Firms can practice price segmentation by aligning prices to demand heterogeneity in
an effort to extract a greater portion of the consumer surplus from the market in the
form of profits.
VALUE BASED SEGMENTATION
Factors that drive (or undermine) value for customers can be used to create a price
segmentation policy in that the firm automatically charges more (or less) when and
where the product delivers more (or less) utility.

Alternatively, firms can practice price segmentation by aligning prices to cost factors
to discourage profit-destructive behaviors.
VALUE BASED SEGMENTATION
Factors that drive the cost to serve can be used to charge more automatically when
there are predictably higher incremental costs for the seller.

In either case, price segmentation enables the firm to increase profits.

VALUE BASED SEGMENTATION
A significant hindrance to price segmentation is the potential for aftermarket
transference.

Products priced with segmentation policies need to have limited transferability—that

is, once sold to a customer, that customer should find it difficult to resell it to another
customer.
VALUE BASED SEGMENTATION
If the product is easily transferable, then customers in the lower-priced segment are
able to purchase the product and subsequently resell it to the higher-priced segment
to their own advantage and not the firm’s, and therefore price segmentation will fail
to improve supplier profits.
VALUE BASED SEGMENTATION
In the absence of limited transferability, price segmentation creates aftermarket
trading alternatively named parallel or gray markets.

Aftermarket trading remains a significant challenge for many products.

Fungible products from tangible cigarettes and alcohol to intangible software and
digital entertainment are all subject to aftermarket trading among consumers.
VALUE BASED SEGMENTATION
It is hard to discuss price segmentation without raising ethical and potentially legal
issues.

However, pricing professionals need to be able to explore this area dispassionately

if they are to be effective in their work.
VALUE BASED SEGMENTATION
Price segmentation is a powerful tool for driving profits.

It is practiced in many markets, cultures, and jurisdictions with neither popular

indignation nor legal recourse.

Indeed, governments themselves commonly practice price discrimination.

VALUE BASED SEGMENTATION
In fact, price segmentation can actually be beneficial to consumers in cases where the
practice of price segmentation allows for a product to be sold to customers who
otherwise would find the product unattainable.
PRICE SEGMENTATION:
INCREASING PROFITS AND CUSTOMER SERVED
Price segmentation enables two key developments within an industry.

One, it can improve the fi rm’s profits.

Two, it can improve the number of customers served by actually lowering the market
entry price for some customers.
PRICE SEGMENTATION:
INCREASING PROFITS AND CUSTOMER SERVED
In the absence of price segmentation, the firm will attempt to optimize a single price
against the market’s demand curve.

Customers with a willingness to pay above the single price required will purchase,
while those whose willingness to pay is below the single price will not purchase.
PRICE SEGMENTATION:
INCREASING PROFITS AND CUSTOMER SERVED
The firm will earn profits in proportion to the difference between the optimal price
and their variable costs multiplied by the number of customers who are willing to
purchase at that price.
PRICE SEGMENTATION:
INCREASING PROFITS AND CUSTOMER SERVED
With two-segment pricing, price segmentation aggregates the market into two
groups:

one that pays a higher price and the other that pays a lower price.

Thus, the fi rm will now earn profits from two sources.

PRICE SEGMENTATION:
INCREASING PROFITS AND CUSTOMER SERVED
For normal markets, the optimal higher price in a two-price segment strategy will be
greater than that of a single-price strategy, so the firm will enjoy a higher
contribution margin from some of its customers.
PRICE SEGMENTATION:
INCREASING PROFITS AND CUSTOMER SERVED
Moreover, for normal markets, the optimal lower price in a two-price segment
strategy will be less than the price determined in a single-price strategy, allowing the
firm to increase the units sold and expand its market.

As such, price segmentation enables the fi rm both to increase its profits and increase
the number of customers served.
PRICE SEGMENTATION:
INCREASING PROFITS AND CUSTOMER SERVED
With a modicum of creative thinking, we can run the same analysis with three, four, or
more prices under the same constraint of perfect price segmentation.
PRICE SEGMENTATION:
INCREASING PROFITS AND CUSTOMER SERVED
Each time, we would find that the market entry price, or the price at which customers
with the lowest willingness to pay will be charged, will decrease; and the premium
price, or the price at which customers with the highest willingness to pay will be
charged, will increase.
PRICE SEGMENTATION:
INCREASING PROFITS AND CUSTOMER SERVED
With a lower market entry price, more units are sold and more customers or
purchasing opportunities result in a transaction.

Importantly, by improving the match between perceived value and price extracted,
profits increase.
SEGMENTATION HEDGES KEY
The key to price segmentation is the ability to separate customers who are willing to
pay more from those who are not.

To accomplish this feat, firms construct segmentation hedges to segment the market
according to willingness to pay.
SEGMENTATION HEDGES KEY
If the segmentation hedge is perfect, then all customers who are willing to pay a
price greater than the higher price will purchase at that higher price,

whereas any customer willing to pay more than the lower price but less than the
higher price are allowed to purchase at the lower price.
SEGMENTATION HEDGES KEY
Importantly, a perfect segmentation hedge prevents any customer who is willing to
pay more than the higher price to purchase at the lower price.
SEGMENTATION HEDGES KEY
Of course, segmentation hedges are not perfect except in idealized cases.

However, price segmentation with even imperfect segmentation hedges can improve
the fi rm’s profits and the number of customers served.
SEGMENTATION HEDGES KEY
Executives readily understand the value of executing price segmentation.

It is an old, basic, freshman-level economic concept and forms the basis for many
corporate, product, and pricing strategies.
SEGMENTATION HEDGES KEY
If the segmentation hedges are very poor, however, price segmentation can actually
harm profits.

An ineffective segmentation hedge would prevent customers who would be willing to

pay the higher price from masquerading as customers who will pay only the lower
price.
SEGMENTATION HEDGES KEY
Consequently, no products would be sold at the higher price, and all products would
be sold at the lower price.

As discussed, the optimal lower price in most price segmentation strategies is actually
lower than the optimal price in a single-price strategy.
SEGMENTATION HEDGES KEY
Thus, with poor segmentation hedges, all customers, both those with a high willingness
to pay and a low willingness to pay, will purchase at the same low price,

a price that is predicted to be lower than that optimal for the entire market, and the
firm’s profits will have been reduced.
SEGMENTATION HEDGES KEY
The implementation challenge of price segmentation is not in convincing management
of its ability to improve profits, but in determining the segmentation hedge.
SEGMENTATION HEDGES KEY
Uncovering an acceptable and enforceable means to charge different customers
different prices for an otherwise same or similar product is the first challenge for any
segmentation hedge.

Ensuring that the segmentation hedge drives customers who are willing to pay more to
actually pay more, rather than substitute into the lower-priced level, is the second
challenge.
SEGMENTATION HEDGES KEY
Uncovering an acceptable and enforceable means to charge different customers
different prices for an otherwise same or similar product is the first challenge for any
segmentation hedge.

Ensuring that the segmentation hedge drives customers who are willing to pay more to
actually pay more, rather than substitute into the lower-priced level, is the second
challenge.
PRICE SEGMENTATION CLASSIFICATIONS
While price segmentation is as old as trade itself, formal studies of price
segmentation have been underway for only about a century.

Shortly after the advent of economics, people have been making valiant attempts at
itemizing and categorizing all the forms of price segmentation.
PRICE SEGMENTATION CLASSIFICATIONS
A full listing of price segmentation techniques is unattainable precisely because
inventive business executives will devise new approaches and twists on old
approaches to price segmentation inherently due to the profit-making potential of
improving the technique.

However, there are three popular classification strategies for price segmentation.
FIRST, SECOND AND THIRD DEGREE PRICE
DISCRIMINATION
In 1920, Arthur Cecil Pigou released his treatise on economics of welfare in which he
defined three types of price segmentation.

Perfect price discrimination, or first-degree price discrimination, is charging every

customer at the price that matches their willingness to pay.
FIRST, SECOND AND THIRD DEGREE PRICE
DISCRIMINATION
In perfect price discrimination, all consumer surplus is captured by the producing firm.

In practice, perfect price discrimination is impossible because it requires the seller to

know exactly each customer’s willingness to pay.
FIRST, SECOND AND THIRD DEGREE PRICE
DISCRIMINATION
Second-degree price discrimination is charging different customers different prices
according to the quantity purchased.

Classic, quantity-based second-degree discrimination implies that larger orders are

available at a lower unit price than smaller orders.

Second degree price discrimination, unlike perfect price discrimination, is common,

although Pigou himself doubted its long-term efficacy.
FIRST, SECOND AND THIRD DEGREE PRICE
DISCRIMINATION
Third-degree price discrimination is charging different markets or market segments
different prices.

An update to classic third-degree price discrimination has been to include benefit

based price segmentation in which products are designed to serve different market
segments, where those with greater benefits cost a higher price than those with fewer
benefits.
COMPLETE, DIRECT AND INDIRECT PRICE
DISCRIMINATION
The approach to defining price segmentation categories has since been updated
from Pigou’s ordinal system.

An alternative practice is to classify price segmentation techniques according to the

information required to execute them
COMPLETE, DIRECT AND INDIRECT PRICE
DISCRIMINATION
Complete discrimination is used to define pricing practices in which each purchase is
made at a price wherein the marginal benefits to the customer equal the price
charged, which is equivalent to first-degree price discrimination.
COMPLETE, DIRECT AND INDIRECT PRICE
DISCRIMINATION
Complete price discrimination, as noted with first-degree price discrimination,
requires complete information of all customers’ willingness to pay in all situations, a
feat that is likely to cost more to achieve than would be rewarded through profit
increases.
COMPLETE, DIRECT AND INDIRECT PRICE
DISCRIMINATION
Direct segmentation defines price variances based upon specific attributes of the
customer, such as age, gender, or location.

Direct segmentation is relatively easy to implement and is a common practice of

public institutions, non profits, and for-profit firms alike.
COMPLETE, DIRECT AND INDIRECT PRICE
DISCRIMINATION
Indirect segmentation defines price variances based upon a proxy that correlates to
customer segmentation based on willingness to pay.
COMPLETE, DIRECT AND INDIRECT PRICE
DISCRIMINATION
The proxy can be the use of coupons, package size, usage quantity, or any other
variable that encourages price-sensitive customers to self-identify while discouraging
customers who are willing to pay more from purchasing at the lower price point.
STRATEGIC OR TACTICAL PRICE DISCRIMINATION
A third approach to defining price segmentation categories is simply to separate
price segmentation practices that are tactical and short-term in nature from those that
are strategic and longer-term.
STRATEGIC OR TACTICAL PRICE DISCRIMINATION
Tactical price segmentation approaches are those that are used to
capture marginal and sometimes even specific customers in unique
situations.
STRATEGIC OR TACTICAL PRICE DISCRIMINATION
Tactical price segmentation techniques may form a part of the normal approach to
business, but the decision to grant a tactical price variance is always grounded in the
specifics of a situation.
STRATEGIC OR TACTICAL PRICE DISCRIMINATION
In consumer markets, coupons, price promotions, and rebates can all be said to be
tactical approaches to price segmentation.

In business markets, meet-the-competition pricing, volume discounts, and customer-

specific price variances are also tactical price segmentation techniques.
STRATEGIC OR TACTICAL PRICE DISCRIMINATION
Strategic price segmentation approaches are those in which the definition of the
price structure itself enables different customers to pay different prices.
STRATEGIC OR TACTICAL PRICE DISCRIMINATION
Multipart tariffs, complement and add-on pricing, versioning, bundling, subscriptions,
and yield pricing are all forms of strategic price segmentation.
STRATEGIC OR TACTICAL PRICE DISCRIMINATION
In some situations, even simple unit pricing can be considered a form of strategic
price segmentation because it charges high-consuming customers a higher total price
than it charges low-consuming customers.
DESIGNING SEGMENTATION HEDGES
Segment hedges are barriers that prevent customers who are willing to pay a higher
price from paying a lower price.

If the segmentation hedge acts as a sieve rather than a barrier, it can actually
damage profits.
DESIGNING SEGMENTATION HEDGES
While it is doubtful that any practical segmentation hedge can deliver perfect price
segmentation, executives can often improve their current pricing policy by improving
their segmentation hedges.
DESIGNING SEGMENTATION HEDGES
The four requirements for effective segmentation hedges derive from
 its correlation with customers’ perception of value,
 the information needed for its implementation,
 its enforceability, and
 its cultural acceptability.
DESIGNING SEGMENTATION HEDGES
The primary requirement for segmentation hedges is that they must sort customers or
customer segments efficiently according to their willingness to pay
DESIGNING SEGMENTATION HEDGES
Segmentation hedges that are highly correlated to customers’ willingness to pay are
better than those that are weakly correlated to customers’ willingness to pay in
improving the ability of the fi rm to profit from a price segmentation strategy.
DESIGNING SEGMENTATION HEDGES
Often, executives accept a convenient segmentation hedge that may or may not be
well correlated with willingness to pay.

Pricing executives will have a large impact if they can improve the relationship
between the segmentation hedges and actual customer willingness to pay.
DESIGNING SEGMENTATION HEDGES
Uncovering customer metrics that are highly correlated to willingness to pay requires
understanding the drivers of value within the market.
DESIGNING SEGMENTATION HEDGES
A related requirement for segment hedges is that they should require minimal
information gathering about specific customers on the part of the supplier to segment
the market in an economically efficient manner.
DESIGNING SEGMENTATION HEDGES
It cannot be expected that at the point of transaction, each customer will provide a
complete profile of him- or herself to identify the price to be charged.
DESIGNING SEGMENTATION HEDGES
Many segmentation hedges require only one piece of information to group customers
according to their willingness to pay.

Some popular segmentation hedges elicit specific behaviors that reveal customers’
price sensitivity, effectively making the information-gathering effort invisible.

Detailed customer profiles are constructed in only a few circumstances, mostly those
related to industrial products or high-value consumer products.
DESIGNING SEGMENTATION HEDGES
From an operational standpoint, segmentation hedges also need to be enforceable,
which usually results in constructing hedges with objective criteria.
DESIGNING SEGMENTATION HEDGES
Managers need clear indicators of when a price variance should be granted and
when prices should be kept high, leading to a need for clear, objective criteria for
setting prices.
DESIGNING SEGMENTATION HEDGES
Furthermore, price segmentation policies based on objective criteria are useful for
discouraging potential abuse.

Unscrupulous salespeople may abuse price segmentation policies to grant better

prices to favored customers while making other customers pay higher prices
regardless of their actual willingness to pay.
DESIGNING SEGMENTATION HEDGES
Likewise, price segmentation policies provide incentives for customers to masquerade
as customers with a lower willingness to pay, regardless of their true propensity.
DESIGNING SEGMENTATION HEDGES
Objective criteria both improve clarity in setting prices and thwart abuse in managing
prices, leading to better enforceability of price segmentation policy.
DESIGNING SEGMENTATION HEDGES
Finally, from the viewpoint of corporate citizenry, consumer desirability, and public
relations, segmentation hedges must be culturally acceptable—or at least not
observably culturally repulsive.
DESIGNING SEGMENTATION HEDGES
We cannot overlook the fact that price segmentation treats some customers
differently than others, and it can appear unfair, unjust, and unethical (if not illegal)
to customers in the higher-paying category.

There are price segmentation policies in practice that, if they were made aware to
the public and regulators, would be scuttled quickly.
DESIGNING SEGMENTATION HEDGES
Other price segmentation policies are considered to be culturally acceptable even
though the true economics of the situation would imply an unfair, if not regressive,
approach to pricing.

In many cases, however, price segmentation policies are not only culturally acceptable
and fully legal, but even desired by customers themselves.
DESIGNING SEGMENTATION HEDGES
To navigate this labyrinth of potential social, cultural, and legal land mines, executives
must calibrate and manage the acceptance of a segmentation hedge carefully.
COMMON PRICE SEGMENTATION HEDGES
Price segmentation is highly common due to its potential to improve profits.

We can find examples of price segmentation in consumer and business markets as

well as government supplied products and services.
COMMON PRICE SEGMENTATION HEDGES
Organizations use price segmentation with services and goods, tangibles and
intangibles, and durables and consumables.

It is useful to review some simple examples of segmentation hedges in building a

foundational understanding of price segmentation.
CUSTOMER DEMOGRAPHICS / FIRMOGRAPHICS
Customer demographics, such as age, gender, and income, are often used for the
development of segmentation hedges.
CUSTOMER DEMOGRAPHICS / FIRMOGRAPHICS
Customer demographics are objective and easy to identify criteria, hence they meet
two of the requirements for forming a sound segmentation hedge.
CUSTOMER DEMOGRAPHICS / FIRMOGRAPHICS
For some products, demographic information even correlates with willingness to pay.

While price segmenting based on demographic information may at first appear to

be philosophically reprehensible, it is amazing how culturally acceptable the practice
is.
CUSTOMER DEMOGRAPHICS / FIRMOGRAPHICS
Similar to demographic segmentation used in consumer markets, firmographic price
segmentation has been used in business markets.

Like demographic segmentation, firmographic segmentation relies upon objective

criteria such as location, industry, employment base, revenue base, and occasionally
the company’s customer base.
AGE
In accordance with the four design requirements, age can be a good segmentation
hedge with many products.
AGE
Consider senior citizen and children discounts.

With senior citizen and children discounts, age is used as the segmentation hedge.

Age is both an objective and easy-to-identify criteria based upon government-issued

identification (driver’s licenses and passports, for example).
AGE
Moreover, both senior citizens and families with children are susceptible to having
higher price sensitivity than other customer segments, though the underlying driver to
their price sensitivity may be different.

Families with children often have budget constraints, leading them to more frugal
behavior and higher price sensitivity.
AGE
While some seniors are likewise constrained by their budgets, a significant driver of
their price sensitivity is the abundance of leisure time that retirees enjoy, which
enables them to price-compare between offers.
AGE
Regardless of the driver, the status of being a senior citizen or a child is correlated
with price sensitivity in many product categories,

and thus age meets the most critical requirement of segmentation hedges:

it discriminates customers based on willingness to pay.

AGE
Finally, framing has much to do with the cultural acceptability of age as a
segmentation hedge.
AGE
Most cultures accept the concept of providing price discounts to seniors and children
and even view firms that offer them as being more progressive and kind.

In contrast, these same cultures would be outraged if the same pricing policy was
reframed as a price surcharge for non-seniors or non-children.
GENDER
Ladies’ Night is a common practice at drinking establishments worldwide, including,
until recently, the United States.

During Ladies’ Night promotions, discounted entrance fees and drinks are provided to
women to encourage more women to attend the entertainment venue and better
balance the ratio of men to women.
GENDER
Although the correlation of willingness to pay to gender for beverages and
entertainment is dubious, it is hard to argue with the results.

Ladies’ Night proved to be an effective promotional tool for many establishments in

driving traffic and subsequent beverage sales.
GENDER
The loss of this promotional tool has caused much consternation by both establishment
managers and many of their male and female customers.

The practice of Ladies’ Night remains common in most nations.

GENDER
An alternative form of gender-based price segmentation that has yet to be dismissed
is found at the local hair salon.

A man and a woman who both want a haircut will often pay very different prices,
even for the same short-haired style.
GENDER
The practice is defended on the grounds that women’s hairstyles require greater skill
and time than men’s, even as this claim is becoming more dubious with the entry of the
metrosexual male.
GENDER
In general, though, women continue to have a higher willingness to pay for beauty
than men.
GENDER
Comparing gender against the four design criteria, we find that it is
(1) objective,
(2) easily identifiable in most cases,
(3) somewhat correlated with willingness to pay in certain categories, and
(4) questionably culturally accepted. As such, it can act as a segmentation hedge.
INCOME
Price segmentation on income is practiced by many non profit institutions under the
umbrella of financial aid.

Colleges and universities will set high prices for tuition, but they provide financial aid
to select students.
INCOME
Financial income is often a determining factor in granting financial aid.

Presumably, students from a wealthy background have more financial resources to

pay and therefore have a higher willingness to pay.
TIME OF PURCHASE
Time of purchase is an inherently objective criterion. In addition, it does not require
any specific customer information, but rather it indirectly tracks customer behavior
that is suspected to be correlated with willingness to pay.

Matinee prices, lunch specials, early-bird discounts, and seasonal pricing are all
examples of using time of purchase as a segmentation hedge.
TIME OF PURCHASE
Matinee prices and early-bird discounts both exploit time of purchase as an indicator
of leisure time.

Customers viewing movies in the middle of the day or eating dinner prior to the end
of a business day are likely not to be subject to the time constraints associated with
employment.
TIME OF PURCHASE
With greater leisure time, these customers can search for alternatives and seek the
lowest price, thus warranting the need for a price concession to attract their business.
TIME OF PURCHASE
Lunch specials are driven by a different consumer behavior than matinee prices and
early-bird specials, however.

Dinner crowds often seek an expanded set of benefits beyond that provided by tasty
and nourishing food—they are also seeking an enjoyable restaurant experience.
TIME OF PURCHASE
The dinner occasion is driven by the desire for entertainment, relaxation with one’s
family and friends, or impressing one’s professional colleagues.

In contrast, lunch crowds have fewer expectations of deriving enjoyment from dining.
TIME OF PURCHASE
For some, their focus is solely on replenishing their energy prior to returning to work.

Because dinner crowds seek and receive more benefits from the restaurant
experience than lunch crowds, it can also be anticipated that dinner crowds have a
higher willingness to pay than lunch crowds.
TIME OF PURCHASE
Price segmentation in the form of lunch specials exploits the partial correlation
between price sensitivity and time of purchase.
TIME OF PURCHASE
Seasonal factors can also act as price segmentation.

For instance, vacationers tend to be less price-sensitive because their shopping time
interferes with their other desired vacation activities.
TIME OF PURCHASE
As such, summer vacation locations often find it beneficial to raise prices during the
summer season to capture profits from vacationers while reducing prices during
“offseason” to attract volume from the locals.
TIME OF PURCHASE
Similarly, gift-giving seasons are not marked by the highest price sensitivity, but
customers do have more price sensitivity during these times than during other times.

We can see this in the common practice of having shallow pre-Christmas sales,
followed by deeper post-holiday sales.
TIME OF PURCHASE
Moreover, many of these time-based segmentation hedges exploit an opportunity of
the supplier to time-shift price-sensitive customers to off-peak periods.

Time-shifting customers both increases the available supply during peak periods when
less-price-sensitive customers arrive and improves capacity utilization during off-peak
periods.
TIME OF PURCHASE
Matinee prices, lunch specials, and early-bird discounts are all framed as discounts
from a higher “regular” price.

Framing these price segments as discounts enables customers to perceive them as a

new source of gain rather than the regular price as an unwanted higher form of pain;
thus, they tend to be culturally acceptable.
TIME OF PURCHASE
An alternative form of using time of purchase as a segmentation hedge is found in
yield management and other dynamic pricing mechanisms.
TIME OF PURCHASE
Yield management is most commonly found in airline ticket prices, though is also used
with hotels, container ships, and other products.

With yield management, prices increase depending upon the time of purchase in
relationship to the time of use.
TIME OF PURCHASE
The price increases as the time of purchase approaches the time of use.

In this case, customers purchasing at times closer to the time of use are suspected to
have greater urgency in terms of using the product, and therefore a higher
willingness to pay.
PURCHASE LOCATION
The same product can be priced at very different levels depending upon the location
of the outlet.

While some of the difference in price may be explained by cost-to-serve factors,

much of the variation in prices between purchase locations is driven by pure
heterogeneity in customer willingness to pay.
PURCHASE LOCATION
The same product can be priced at very different levels depending upon the location
of the outlet.

While some of the difference in price may be explained by cost-to-serve factors,

much of the variation in prices between purchase locations is driven by pure
heterogeneity in customer willingness to pay.
PURCHASE LOCATION
For example, consider a beverage purchased for consumption at the beach.

Customers could bring their own beverages from home to the beach if they purchased
them earlier at a grocery store.
PURCHASE LOCATION
The customer could also purchase a beverage at a nearby convenience store on the
way to the beach;

or the customer could select a beach restaurant complete with service where
beverages are brought to them by waitstaff.
PURCHASE LOCATION
In each case, the price that these customers would expect to pay would vary greatly
between the locations of purchase, even if the actual beverage consumed was
identical.

Much of this variation in price is correlated with differences in costs to serve, with
grocery stores being the lowest cost channel and the dining area with the waitstaff
representing the highest-cost channel.
PURCHASE LOCATION
However, part of the variation in price is also correlated to willingness to pay and the
benefits sought.

The customer ordering a beverage from a server is seeking a large set of benefits
(service plus beverage) and is expressing a higher willingness to pay than one who
brought a beverage from home.
PURCHASE LOCATION
Variation in prices based on purchase location can be driven purely by heterogeneity
in willingness to pay.

For example, grocery stores may price the same or similar set of goods at different
prices between locations based upon competitive factors and consumer behavior.
PURCHASE LOCATION
Middle-class neighborhoods often have numerous grocery outlets serving customers
with ample access to transportation (cars), which enables them to price-compare
between outlets.

Customers from higher-income neighborhoods place more value on their leisure time,
making them less prone to price comparison; thus, they have a marginally increased
willingness to pay.
PURCHASE LOCATION
Meanwhile, customers in lower-income neighborhoods often suffer from lack of
adequate transportation and less competition, enabling grocers to price products at a
marginally higher level in lower-income neighborhoods than in higher-income ones.
PURCHASE LOCATION
As such, grocery stores in middle-class neighborhoods often provide the lowest prices
in comparison to those in either poorer or richer neighborhoods.

While pricing products higher in higher-income neighborhoods is usually free from

customer backlash, pricing products higher in lower-income neighborhoods is fraught
with potential challenges
BUYER SELF-IDENTIFICATION
Price segmentation policies may also rely upon buyer self-identification of willingness
to pay.

Promotional sales, buyer’s clubs, coupons, and rebates are all forms of price
segmentation that rely upon buyer self-identification.
BUYER SELF-IDENTIFICATION
Hunting for sales, cutting out coupons, and mailing in rebates are all time-intensive
activities for customers.

Customers who are willing to invest the time in these activities are revealing their
willingness to search for alternatives and find the lowest prices.
BUYER SELF-IDENTIFICATION
Customers who forgo coupon clipping and similar activities are likewise revealing
their willingness to pay full price to save on opportunity costs.
BUYER SELF-IDENTIFICATION
Providing price-sensitive customers with access to lower prices through targeted
discounts while leaving the majority of the market to purchase at the regular price
can improve firm-level profitability
BUYER SELF-IDENTIFICATION
Similarly, buyer’s clubs create an effective price segmentation technique because they
require customers to declare their price sensitivity outright through membership.

Buyer’s clubs require shoppers to pay a fee for membership in exchange for
receiving a discount on all their shopping at that outlet.
BUYER SELF-IDENTIFICATION
The size of the membership fee is set such that a casual shopper would not receive
any financial benefit from the buyer’s club,

but the heavy shopper would experience significant savings over the course of the
membership.
BUYER SELF-IDENTIFICATION
These savings are provided to encourage greater loyalty, yet they also signal price
sensitivity.

Buyers’ clubs can prove to be highly profitable price segmentation strategies in

markets where high-purchasing customers generate a disproportionate amount of
profits and customer loyalty is a significant driver of customer profitability.
PRODUCT ENGINEERED
Segmentation hedges are often product-engineered, where some products deliver
greater benefits than others and each product within the category is priced
differently to reflect its added value.
PRODUCT ENGINEERED
Product-engineered price segmentation relies upon the addition and subtraction of
specific features to defi ne the segmentation hedges.

Customers seeking greater utility from a product within a particular category find
that specic features and attributes are missing from lower-priced alternatives, and
they are thus encouraged to purchase a higher-priced product or bundle of products
within the category.
PRODUCT ENGINEERED
Meanwhile, customers with minimal utility requirements and lower willingness to pay
are enabled to purchase a feature-deprived product at a lower price.
PRODUCT ENGINEERED
With product-engineered segmentation policy, profit-seeking firms usually reap
larger margins with higher-priced items than with lower-priced items.

No profit-seeking fi rm has an incentive to add one iota in marginal cost unless it can
gain more than that iota in price or an equivalent volume boost.
PRODUCT ENGINEERED
The logic behind the claim that higher-benefit products should also have higher
contribution margins is rather straightforward.

Higher-benefit products usually cost more to produce.

PRODUCT ENGINEERED
With each marginal increase in cost, the fi rm should at least seek to price the
product at a price greater than or equal to the marginal increase in cost, or else
improving the product reduces profits.

At a higher price and with downward-sloping demand curves, the benefit-rich

product could be expected to attract fewer customers than a feature deprived
product.
PRODUCT ENGINEERED
Combined, these factors imply that the higher-priced product is likely both to increase
marginal cost to produce and attract diminished customer demand.

To compensate for these combined factors, the fi rm should seek to reap larger
margins on higher-priced products than they seek on lower-priced products.
PRODUCT ENGINEERED
There are times when increases in marginal costs for product improvements are
matched with smaller increases in the marginal price.
PRODUCT ENGINEERED
Competitive forces may drive a fi rm to increase features beyond the potential price
increase.

Likewise, some product improvements come without increases in marginal costs.

PRODUCT ENGINEERED
Finally, some products require enhancements to attract a larger market, especially
with newer product categories.

In these cases, the diminished contribution margin should be compensated by

increased unit volume sales.
PRODUCT ENGINEERED
The key challenge for constructing a product-engineered segmentation hedge is
defining which features and benefits some customers are willing to pay more for, and
which ones all customers demand.
PRODUCT ENGINEERED
Those features that all customers expect of the product category must be included in
the lower-priced product.
PRODUCT ENGINEERED
Features which only a segment of the market will value form strong elements for
differentiating products and creating a product engineered segmentation strategy.
PRODUCT ENGINEERED
Add-on pricing strategies, versioning, and bundling are all forms of product
engineered price segmentation in which the addition and subtraction of tangible
features create the segmentation hedges.
PRODUCT ENGINEERED
Branding can also be considered as a form of product-engineered price
segmentation, where brand-name products command a higher price than generic or
store-brand products, even when both are produced by the same supplier.
QUANTITY PURCHASED
Quantity purchased, either in a single transaction or in multiple transactions, is also a
common price segmentation hedge.
QUANTITY PURCHASED
Like other approaches to price segmentation, quantity purchased is objective and is
based on easily identifiable information.

Outside of a few very specific business markets, the practice of altering the price
paid based on quantity purchased is highly accepted.
ORDER SIZE
Customers ordering large quantities are often provided a discounted price in
comparison to those purchasing smaller quantities.
ORDER SIZE
For example, bubble wrap used in packaging can be sold to individuals at package
delivery outlets and to larger organizations direct from the manufacturer.

Individual customers will usually pay a much higher price for bubble wrap than larger
organizations, not only because of their choice of purchasing outlet but also because
of the quantity that they purchase at one time.
ORDER SIZE
Customers buying large quantities have sufficient incentives to price-compare
between suppliers, which lowers their willingness to pay.

Customers purchasing smaller quantities have less incentive to price-compare, and

thus have a higher willingness to pay.

In these cases, quantity purchase is closely related to willingness to pay, making

quantity-based segmentation hedges effective.
FREQUENT PURCHASES
Like purchase quantity, purchase frequency can be used as a means for price
segmentation.
FREQUENT PURCHASES
As customers consume a product, their desire for an additional unit of product can
decline in a predictable way, making them much less willing to purchase additional
units than they were for the purchase of the first unit.
FREQUENT PURCHASES
Price segmentation on the basis of purchase frequency attempts to use the
heterogeneity of demand within specific customers to improve profitability marginally
CUSTOMER USAGE
Price segmentation based on product usage relies on the heterogeneity of value that
customers place on a product in relation to their usage patterns.

For instance, urban individuals with access to mass transit will drive a car sporadically
and will have less need for that car than a suburban family that requires an
automobile daily.
CUSTOMER USAGE
Likewise, people entertaining business customers or dating partners may place a
much higher value on an automobile than those who simply seek transportation to
work.
CUSTOMER USAGE
If automobiles could be priced separately based on lifestyle, automakers might find
a new source of profits in pricing the automobile based on the miles driven and the
purpose of the trip.

Of course, automakers cannot price a car based directly on lifestyle.

CUSTOMER USAGE
Cars purchased in suburban markets can be transferred easily to more urban
locations, and entertainment cars can also be used for work-related transport.

Instead, automakers make different models optimized for different buying needs.

However, similar pricing strategies based on actual customer usage patterns are
executed by some firms.
TIE-INS AND TWO-PART TARIFFS
One approach to pricing based on usage is to break the product into two constituent
parts, a durable part and a consumable part, and price the two parts separately.

The effect is named tie-in pricing at one end of the spectrum and a two-part tariff at
the other end.

In both cases, the purchase of the consumable part is related to the purchase of the
durable part.
TIE-INS AND TWO-PART TARIFFS
For example, a razor handle is valuable to customers only if they also have razor
blades.

Razor handles are somewhat durable, while razor blades are far more consumable,
becoming dull after roughly a month of usage.
TIE-INS AND TWO-PART TARIFFS
Moreover, razor handles are usually designed to hold only a single manufacturer’s
blade, making them non-interchangeable.

Firms are able to price the razor handle differently than the blade.
TIE-INS AND TWO-PART TARIFFS
In a sense, the purchase of the handle gives permission to the customer to buy the
blade because the blades have little other value without the handle.

Therefore, the blade price can reflect usage and the handle price can reflect the
willingness of the customer to participate in the market for blades.
TIE-INS AND TWO-PART TARIFFS
The approach of pricing blades and handles separately in the razor market can be
found in other markets.

At one time, a copy machine maker would demand that all customers purchase their
paper only from it.
TIE-INS AND TWO-PART TARIFFS
Such tie-in pricing has since been declared illegal in the United States, yet it
demonstrates the potential for firms to price the durable part of a product
separately from the consumable part.
TIE-INS AND TWO-PART TARIFFS
Utility firms, such as those providing natural gas and electricity, will bill customers a
connection fee (alternatively named a metering fee or service charge), plus a
consumption charge based on the amount of service consumed.
TIE-INS AND TWO-PART TARIFFS
As with razor handles and blades, the durable part is charged differently than the
consumable part.

Similarly, gaming firms will price the durable gaming console at one level, while the
consumable gaming software is priced separately.
TIE-INS AND TWO-PART TARIFFS
In tie-ins markets, the prices of the consumable versus durable parts are set based
upon very different agendas.
TIE-INS AND TWO-PART TARIFFS
Because the durable part is used over many periods, and because customers are
usually price-sensitive to initial purchase prices to participate in a new product
transaction, the durable part is often priced low to attract customers in tie-in markets.
TIE-INS AND TWO-PART TARIFFS
Meanwhile, in tie-in markets, the consumable part is priced high and forms the basis
for most of, if not all, the profit.

Customers tend to be less price-sensitive to the consumable part of the transaction

because they have purchased the durable part already and face switching costs if
they seek an alternative.
TIE-INS AND TWO-PART TARIFFS
The amount of the profit that can be shifted to the consumable part of the product is
limited by anti-dumping regulations and by the anticipated consumer behavior as
calculated in a customer lifetime value model.
TIE-INS AND TWO-PART TARIFFS
Customer lifetime value is highly dependent upon the frequency of repeat purchases
and the duration of customer loyalty.

We can see these effects with mobile phone operators.

TIE-INS AND TWO-PART TARIFFS
Durable handsets are often subsidized by the mobile phone operator to encourage
customers to select their services; meanwhile, all profits are earned from the sale of
connection time and data transfer.
TIE-INS AND TWO-PART TARIFFS
Only in a few markets where regulation prevents locking handsets with single mobile
phone operators, such as in the Czech Republic and Slovakia, are handsets not
subsidized by the revenues earned from phone calls and data transmissions.
TIE-INS AND TWO-PART TARIFFS
In contrast, in two-part tariff markets, the prices of the durable part of the offer are
set very high to capture profits while prices of the consumable part of the offer are
set low.
TIE-INS AND TWO-PART TARIFFS
The demands of customers are very different in two-part tariff markets than they are
in tie-in markets.

Specifically, customers will tend to be more sensitive to the price of the consumable
part of the offer than they are to the price of the durable part.

Utility bills for residential customers are often set in accordance with the concept of a
two-part tariff.
ENTERPRISE SOFTWARE COMPLEXITY CHARGES
Like other products, prices of enterprise software attempt to reflect the economic
value of that software to the customers.
ENTERPRISE SOFTWARE COMPLEXITY CHARGES
The usage patterns that affect the value of the software for a specific customer may
themselves depend on customer size and industry as well as the strategy of that
particular customer.
ENTERPRISE SOFTWARE COMPLEXITY CHARGES
While the value of enterprise software is highly related to usage, software producers
often find it disadvantageous to reveal their method of price calculation.

One method of obfuscating the pricing formula is to use “complexity charges.”

ENTERPRISE SOFTWARE COMPLEXITY CHARGES
For example, one utility billing software fi rm used a pricing formula that not only
reflected the number of bills the software would go on to produce, but also reflected
the type of bill produced.

Commercial and industrial utility bills are far more complex in their construction than
residential bills.
ENTERPRISE SOFTWARE COMPLEXITY CHARGES
As such, the software was more valuable to utility firms that had a higher proportion
of commercial and industrial customers than those with a greater percentage of
residential customers.
ENTERPRISE SOFTWARE COMPLEXITY CHARGES
To capture this value differential, the utility billing software firm added a “complexity
charge” to reflect the portion of their customer’s revenue base that was derived from
commercial and industrial customers
NEGOTIATION
Finally, price segmentation can be executed through simple negotiation.

Haggling for consumer products is found throughout the world.

In business markets, negotiation over final price is a standard step within the sales
process.
NEGOTIATION
In consumer markets, it is common for customers to haggle with suppliers over the
price of almost all goods in many economies, ranging from premier cities, such as
Dubai, to developing ones such as Mexico City, and even latent economies such as
Abuja, Nigeria.
NEGOTIATION
In consumer markets, it is common for customers to haggle with suppliers over the
price of almost all goods in many economies, ranging from premier cities, such as
Dubai, to developing ones such as Mexico City, and even latent economies such as
Abuja, Nigeria.
EXAMPLES OF PRICE SEGMENTATION: BANK FEES
Banks have long structured their prices to discourage profit-destructive behavior.

Unlike price segmentation that is driven by customer heterogeneity in willingness to

pay, cost driven price segmentation is driven by customer heterogeneity in cost to
serve.
EXAMPLES OF PRICE SEGMENTATION: BANK FEES
Bank fees tied to overdrafts and insufficient funds are constructed to discourage
customers from attempting to withdraw more funds than they have available.

Similar price incentives to discourage profi t-destroying behavior can be found with
customer support fees with call centers, late payment fees by utilities, cash advance
fees by credit cards and, more recently, baggage fees by airlines.
EXAMPLES OF PRICE SEGMENTATION: BANK FEES
Price segmentation strategies designed to discourage bad customer behavior yet end
up forming the core source of profitability should raise concerns among managers.
EXAMPLES OF PRICE SEGMENTATION: BANK FEES
Customers finding themselves constantly subject to penalty fees will likely be less
favorably inclined to the firm and thus more likely to switch suppliers once an
alternative is made available.
EXAMPLES OF PRICE SEGMENTATION: BANK FEES
If customers paying penalty fees were otherwise unprofitable, losing their business
may be a satisfactory outcome.

However, if they become a major source of profits, the fi rm will effectively be

encouraging its most profitable customers to defect and be making itself vulnerable
to the competition.
EXAMPLES OF PRICE SEGMENTATION: BANK FEES
Prices structured to discourage profit-destructive behavior are common in many
industries.

For instance, consider the increasingly common practice of industrial firms charging
for items that they previously provided for free to discourage waste.

Alternatively, milk vendors may increase bottle deposit charges to encourage returns.
EXAMPLES OF PRICE SEGMENTATION:
TAVERN DRINKS
Neighborhood taverns may price beverages differently to price-segment those with a
higher willingness to pay from those with a lower willingness to pay.
EXAMPLES OF PRICE SEGMENTATION:
TAVERN DRINKS
For instance, consider the neighborhood tavern that sells both single malt scotch and
beer on tap.

Many jurisdictions place restrictions on the serving of alcohol, effectively giving those
few establishments who have a license to sell tremendous pricing power over their
patrons.
EXAMPLES OF PRICE SEGMENTATION:
TAVERN DRINKS
In these taverns, the cost of scotch and beer represents only a small fragment of the
price, and customer willingness to pay is the dominant driver to determining prices.
EXAMPLES OF PRICE SEGMENTATION:
TAVERN DRINKS
Customers drinking single malt scotch tend to have a higher willingness to pay than
those who will select a common tap beer.
EXAMPLES OF PRICE SEGMENTATION:
TAVERN DRINKS
Thus, the lone bar selling both single malt scotch and common tap beer is able to
attract a larger customer base and extract disproportionately larger profits from the
sale of single malt scotch than from the sale of tap beer.
EXAMPLES OF PRICE SEGMENTATION:
TAVERN DRINKS
The tavern example is one of using a common location but attracting and profiting
from customers with differing temperaments of benefits sought and willingness to pay.
EXAMPLES OF PRICE SEGMENTATION:
TAVERN DRINKS
While drinking establishments are perhaps among the leaders in price segmentation
policies, they are not alone.

Retail outlets can also practice demand-specific price segmentation.

The American Doll Place in Chicago sells dolls to many customers.

EXAMPLES OF PRICE SEGMENTATION:
TAVERN DRINKS
However, customers seeking a greater experience and a broader set of benefits can
expand their relationship with the American Doll Place to include dining, doll repair,
and even a doll beauty shop.

At one time, the American Doll Place also offered short theatrical productions
featuring child actresses interacting with dolls.
EXAMPLES OF PRICE SEGMENTATION:
TAVERN DRINKS
As with taverns selling scotch and beer, the American Doll Place aggregates many
customers to a single location and allows them to self-segment into different buying
groups, thus enabling those with a higher willingness to pay for products the
experience to do so.
EXAMPLES OF PRICE SEGMENTATION: AIRLINES
Few industries use as many segmentation hedges as airlines.

For starters, airlines segment customers according to willingness to pay in three major
classes: first class, business class, and coach.
EXAMPLES OF PRICE SEGMENTATION: AIRLINES
The basic benefit of speedy transit is provided by all classes, but further amenities
and services are provided in the transition from coach to business and eventually to
first class.

This is one example of product-engineered segmentation hedges.

EXAMPLES OF PRICE SEGMENTATION: AIRLINES
Further price segmentation is executed by airlines, even for the same city-pair trip, on
the same day, with the same flight.

Consider the use of Saturday night stayover requirements, advance notice

requirements, and yield management practices.
EXAMPLES OF PRICE SEGMENTATION: AIRLINES
Saturday stayover requirements segment the weekend traveler from the business
traveler.

The assumption is that weekend travelers are traveling for pleasure, and the flight
faces greater competition in the form of driving instead of flying, or even forgoing or
delaying the trip altogether.

Meanwhile, business travelers have little maneuverability in their schedule and are
more pressed for time.
EXAMPLES OF PRICE SEGMENTATION: AIRLINES
Advance notice requirements similarly attempt to segment the casual traveler from
the more-time-pressed traveler.
EXAMPLES OF PRICE SEGMENTATION: AIRLINES
Customers who shop in advance of the trip have taken more time to consider their
options and are thus likely to be more price-sensitive than those customers who plan
their travel closer to the time of travel, and they also are perhaps more pressed to
take the trip.
EXAMPLES OF PRICE SEGMENTATION: AIRLINES
Time of day and seasonal issues also influence prices of air travel.

Morning and evening flights are priced differently than midday flights under the
assumption that a morning flyer has an afternoon meeting at the destination, with a
returning flight that evening to avoid a hotel stay and enable a speedy return home.
EXAMPLES OF PRICE SEGMENTATION: AIRLINES
In contrast, transatlantic flights are cheaper in the early spring than in the midsummer
vacation season or the winter holiday season.

The seasonal variation in price is designed to target vacationers with less schedule
flexibility, such as parents with children, and profit from their restrictions.
EXAMPLES OF PRICE SEGMENTATION: INDUSTRIAL
MARKETS
Firms selling industrial products and inputs into other businesses’ products will combine
a number of different price segmentation strategies.

Many of these price segmentation strategies, such as firmographics, complexity

charges, usage patterns, purchase frequency, and order size, have already been
discussed.
EXAMPLES OF PRICE SEGMENTATION: INDUSTRIAL
MARKETS
Firms selling industrial products and inputs into other businesses’ products will combine
a number of different price segmentation strategies.

Many of these price segmentation strategies, such as firmographics, complexity

charges, usage patterns, purchase frequency, and order size, have already been
discussed.
1
2
3
4
5
6