Saint Anthony’s College

Santa Cruz, Santa Ana, Cagayan 3514 | FAS School System

LEARNING MODULE 1
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SUBJECT: MM3 /PRICING STRATEGY
TOPIC: STRATEGIC PRICING
SCHOOL YEAR: 2021-2022
SUBJECT TEACHER: LYKA ODISSEY R. CAMIT
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INTRODUCTION:

Pricing is one of the most important decisions that businesses make in their efforts
for profit maximization. The course is a foundation for effective pricing decisions by
learning key economic, analytical, and behavioral concepts associated with costs,
customer behavior and competition. In addition, advanced pricing techniques that aim
to create additional value are introduced to the students.

This Module explains how to manage markets strategically and how to grow more
profitably. Rather than calculating prices to cover costs or achieve sales goals, students
will learn to make strategic pricing decisions that proactively manage customer
perceptions of value, motivate purchasing decisions, and shift demand curves.

STANDARDS:

You are expected to:

 Understand the key economic, analytical, and behavioural concepts associated
with costs, customer behaviour and competition.
 Understand and be able to apply advanced pricing techniques.
 Comprehend and have a clear understanding of pricing strategies of different
products, lifecycles, and companies.
 Understand and analyse price strategies of competition in different market
situations.

TRANSFER:

In this module you are expected to demonstrate understanding on how effective

pricing supports marketing and firm strategy; proper philosophy that should accompany
all pricing strategies; adapting the message to the purchase and buying context.
DISCUSSIONS

COORDINATING THE DRIVERS OF PROFITABILITY

Marketing consists of four key elements: The product, its promotion, its placement or
distribution, and its price. The first three elements—product, promotion, and placement—
comprise a firm’s effort to create value in the marketplace. The last element—pricing—
differs essentially from the other three: It represents the firm’s attempt to capture some
of the value in the profit it earns. If effective product development, promotion, and
placement sow the seeds of business success, effective pricing is the harvest. Although
effective pricing can never compensate for poor execution of the first three elements,
ineffective pricing can surely prevent those efforts from resulting in financial success.
Regrettably, this is a common occurrence.
The ability to harvest potential profits is in a continuous state of flux as technology,
regulation, market information, consumer preferences, or relative costs change.
Consequently, companies that expect to grow profitably in changing markets often need
to break old rules, including those that govern how they will set prices to earn revenues.

Most companies still make pricing decisions in reaction to change rather than in
anticipation of it. This is unfortunate, given that the need for rapid and thoughtful
adaptations to changing markets has never been greater. The information revolution has
made prices everywhere more transparent and customers more price aware. The
globalization of markets, even for services, has increased the number of competitors and
often lowered their cost of sales.

Improvements in technology have driven an explosion of data that some suppliers

are using to target customers they can serve more profitably: Either because those
customers are more willing to pay for the differentiation the company can offer or
because the company can meet their needs more cost-effectively than competitors.

Now, with the ability to buy almost “real time” data on how individual package
sizes are selling in types of outlets and in specific geographies, manufacturers are able to
develop more sophisticated pricing strategies to target specific types of customers and
competitors.

LEVERAGING PROFIT INTO SUSTAINABLE GROWTH

Learning to make sales more profitably is the key to achieving sustainable growth
in revenue, market share, and company value over the long haul. A 1975 study conducted
at the Harvard Business School using the PIMS (which originally stood for Profit Impact
of Market Share) database of historical market performance of leading global companies
reported a strong, consistently positive, correlation between a company’s market share
and its relative profitability within an industry. That led to an explosion of literature by
marketing theorists and leading consultancies advocating aggressively low pricing as an
“investment” in growth that would eventually create “cash cows”—exceptionally
profitable revenue streams requiring little investment to maintain them.

More recent research by Deloitte Consulting LLP has brought further clarity to the
relationship between growth and profitability. Deloitte compiled a time-series dataset of
394 companies, covering the period from 1970 to 2013 with exceptional, mediocre and
poor performers matched by industry. Their conclusion:
a [near term] focus on profitability, rather than revenue growth or [stock] value creation,
offers a surer path to enduring exceptional performance.
So how do marketing and financial managers at exceptional companies achieve
sustainable exceptional profitability? It is not the result of slashing overheads more
ruthlessly than their competitors. In fact, Deloitte’s data indicates that exceptional
performers tend to spend a bit more than competitors (as a percent of sales) on R&D
(Research and Development) and SG&A (Selling, General and Administrative). Their
exceptional profitability and, eventually, exceptional stock valuations are built on higher
margins per sale that fund initiatives to grow revenues without compromising those
margins.
To achieve superior, sustainable profitability, pricing must become an integral part of
strategy. The difference between successful and unsuccessful pricers lies in how they
approach the process.
 Strategic pricers do not ask, “What prices do we need to cover our costs and earn
a profit?” Rather, they ask, “What costs can we afford to incur, given the prices
achievable in the market, and still earn a profit?”
 Strategic pricers do not ask, “What price is this customer willing to pay?” but
“What is our product worth to this customer and how can we better communicate
that value, thus justifying the price?”
 And strategic pricers never ask, “What prices do we need to meet our sales or
market share objectives?” Instead they ask, “What level of sales or market share
can we most profitably achieve?”

Strategic pricing often requires more than just a change in attitude; it requires a
change in when, how, and who makes pricing decisions. It requires determining the
economic value of a product or service, which depends on the alternatives customers
have available to satisfy the same need. The only way to ensure profitable pricing is to
reject early those ideas for which adequate value cannot be captured to justify the cost.
Perhaps most important, strategic pricing requires a new relationship between
marketing and finance because pricing involves finding a balance between the customer’s
desire to obtain good value and the firm’s need to cover costs and earn profits. Rather
than attempting to “cover costs,” finance must learn how costs change with shifts in sales
volume and use that knowledge to develop appropriate incentives for marketing and
sales to achieve their objectives.

With their respective roles appropriately defined, marketing and finance can work
together toward a common goal—to achieve profitability through strategic pricing.
COST-PLUS PRICING
Cost-plus pricing is, historically, the most common pricing procedure because it
carries an aura of financial prudence. Financial prudence, according to this view, is
achieved by pricing every product or service to yield a fair return over all costs, fully and
fairly allocated. In theory, it is a simple guide to profitability; in practice, it is a blueprint
for mediocre financial performance.
The problem with cost-driven pricing is that in most industries, calculating a
product's unit cost before determining its price is impossible. Why? Because unit costs
vary depending on volume. Because a significant amount of expenditures is "fixed," they
must be "assigned" in some way to get the complete unit cost. Because these allocations
are based on volume, that also changes as prices change, unit cost is a moving target.
To solve the problem of determining unit cost before determining price, cost-based
pricers are forced to assume a level of sales volume and then make the absurd assumption
that they can set price without affecting that volume.
CUSTOMER-DRIVEN PRICING
The purpose of strategic pricing is not simply to create satisfied customers.
Customer satisfaction can usually be bought by a combination of over delivering on value
and underpricing products. The purpose of strategic pricing is to price more profitably
by capturing more value, not necessarily by making more sales. When marketers confuse
the first objective with the second, they fall into the trap of pricing at whatever buyers are
willing to pay, rather than at what the product is really worth.

Two problems arise when prices reflect the amount buyers seem willing to pay.
First, sophisticated buyers are rarely honest about how much they are actually willing to
pay for a product. Second, there is an even more fundamental problem with pricing to
reflect customers’ willingness-to-pay.

SHARE-DRIVEN PRICING
Finally, consider the policy of letting pricing be dictated by competitive
conditions. In this view, pricing is a tool to achieve gains in market share. In the minds of
some managers, this method is “pricing strategically.” Actually, it is more analogous to
“letting the tail wag the dog.”
 Although cutting price is probably the quickest, most effective way to achieve
sales objectives, it is usually a poor decision financially. Because a price cut can be so
easily matched, it offers only a short-term market advantage at the expense of
permanently lower margins. Although product differentiation, advertising, and
improved distribution do not increase sales as quickly as price cuts, their benefit is more
sustainable and thus is usually more cost-effective in the long run.
The goal of pricing should be to find the combination of margin and market share
that maximizes profitability over the long term. Sometimes, the most profitable price is
one that substantially restricts market share relative to the competition.

Strategic pricing requires making informed trade-offs between price and volume
in order to maximize profits. These trade-offs come in two forms.
 The first trade-off involves the willingness to lower price to exploit a market
opportunity to drive volume.
 The second trade-off involves the willingness to give up volume by raising prices.

THE ROLE OF “OPTIMIZING” IN STRATEGIC PRICING

Economic theorists propose pricing based upon estimating the demand curve for
a product and then “optimizing” the price level, given the incremental cost of production.
In theory, this is totally consistent, but in practice it is almost always impractical. The
reason lies in the assumption that a demand curve is something stable that one can
measure with sufficient speed and accuracy to continually optimize it. Contrary to the
assumptions that economists make when studying markets, the demand for individual
products or brands within markets is rarely stable or easily measured. The reason:
Sensitivity to price depends as much on ever-changing purchase contexts and
perceptions as on underlying needs or preferences. For example, contradicting the
assumption of a demand curve, the amount of a product that customers will buy at a
particular price point is strongly affected by the prices they paid recently. That is, demand
when prices are going up is generally much more “price elastic” than when prices are
coming down.

More importantly, behavioral economics research over the past few decades has
proven conclusively that differences in how prices are presented and the surrounding
context can lead buyers to respond in ways that are inconsistent with the idea of a stable
demand curve that reflects fixed preferences. For example, if one adds a higher priced
product to the choices available in a store—say a “best” version to go along with a “good”
and a “better” version—economic theory would predict that the higher-priced “best”
version would primarily draw sales from the mid-priced “better” version, which turns
out to be true. What it does not predict is that the mid-priced version will at the same
time gain sales at the expense of the cheapest version even though the prices of those two
versions remain unchanged.
 Actual elasticity depends in part upon how effectively marketers manage
customer perceptions and the purchase context, as you will come to see in the following
chapters. Moreover, many factors that influence price elasticity are not under the
marketer’s control, making precise estimates of actual price elasticity very difficult and
only rarely cost effective. Consequently, we have found that instead of asking “What is
price elasticity for this product?” it is often more practical and useful to ask “What is the
minimum elasticity that would be necessary to justify a particular price change?” that has
been proposed to achieve some business objective.

If we create a graph of breakeven sales changes associated with different potential

price changes, we can create a breakeven sales curve that looks much like a demand
curve, as shown in Exhibit 1-1, which shows the example of a product that earns a 45
percent gross margin at a baseline price of $10. It is a representation of how much demand
is needed to maintain current profitability as prices change.

EXHIBIT 1-1 Breakeven Sales Curve Associated with Different Price Changes

Given the usual instability of demand estimates over the time period required to
make them, attempting to improve profitability by exactly “optimizing” price levels are
usually not practical. What is valuable is research to understand how differences in
identifiable purchase contexts (e.g., online versus in-store purchases, standard versus
rush orders) or how marketing strategies to influence perceptions of value can influence
demand elasticity.

WHAT IS STRATEGIC PRICING?

As you probably remember from basic economics, the optimal price one can
charge is limited by the demand curve: A summary of what customers are willing to pay
to buy various quantities of volume. Pricing, given the assumptions of economics, is
simply about optimizing the price level given that demand. In reality, however, demand
for most products and services is not given. It is created, sometimes thoughtfully and
sometimes haphazardly, by decisions that sellers make about what to offer their
customers, how to communicate their offers, how to price differently across customers or
applications and how to manage customer price expectations and incentives. Making
these decisions thoughtfully and implementing them effectively to maximize profitability
is what we call “strategic pricing.”
The word “strategic” is used in various contexts to imply different things. Here,
we use it to mean the coordination of otherwise independent activities to achieve a
common objective. For strategic pricing, the objective is sustainable profitability.
Achieving exceptional profitability requires making thoughtful decisions about much
more than just price levels.

Although different strategies can achieve profitable results even within the same
industry, nearly all successful pricing strategies embody three principles. They are value-
based, proactive, and profit-driven:

• Value-based means that differences in pricing across customers or applications

reflect differences in the value to customers.

• Proactive means that companies anticipate disruptive events (for example, a new
competitive threat or a customer’s decision to award business via a reverse auction) and
develop strategies in advance to deal with them.
• Profit-driven means that the company evaluates its success at price management
by what it earns relative to alternative investments rather than by its market share and
growth relative to its competitors.
These three principles will resurface throughout this module as we discuss how to
define and make good choices. Strategic pricing is not a discipline separate from the rest
of marketing strategy; it is rather a set of principles for creating marketing strategies that
drive growth profitably.

A good pricing strategy involves six distinct but very different choices that build
upon one another. The choices are represented graphically as six points in what we call
the Value Cascade (Exhibit 1-2).
EXHIBIT 1-2 The Value Cascade: Strategic Pricing Requires Effective Management of
Both Value and Price.

The Value identifies different stages in the customer value creation and pricing
processes that can create a price-value gap. Each of these gaps make it difficult for
organizations to maximize returns through pricing.

It is useful to have an overall vision—a map if you will—of how and why they fit
together in this particular order. Both managers and pricing consultants are often called
upon to fix strategies that are generating poor financial returns despite driving revenues.
For our overview, we will follow the order of the numbers in the exhibit, which reflect
the order in which you would typically need to address these issues if building the
marketing strategy for a new product or service from scratch.

VALUE CREATION
Value creation involves including only those elements in a product or service that
a fully-informed customer should be willing to pay for — which is what we call “value”.
The term “should be” is used because what customers will actually pay depends upon
how the product is marketed and is usually somewhat short of the full value. A great new
product that promises huge benefits is only a promise. When a product comes with a
money-back performance guarantee, for example, willingness-to-pay will fall short of
value.
 It is a measure of the relative pricing potential that a product or service
improvement could represent for different types of customers, rather than the price you
can charge. Companies who don't have a method to incorporate a measure of value into
their product development process are more likely to generate items that represent "the
best money can buy," rather than the "best value" that customers will buy.

VALUE COMMUNICATION
Even if you understand the value your items provide to customers, if they don't
recognize it, you'll have a hard time selling them. In order for a pricing strategy to be
successful, the prices charged must be justified in terms of the value of the benefits
offered. Because of the wide variety of product kinds and communication platforms,
developing price and value communications is one of the most difficult challenges for
marketers.
Many consumers view a $30 bottle of wine at a restaurant as a bargain if the other
wines on the menu are priced higher, yet the same $30 bottle will feel expensive if
surrounded by $20 alternatives. As a result of these anomalies, we must realize that
customer responses to price are based on more than a rational calculation of value.
Rather, customers evaluate the price in terms of the entire purchase situation. Thus, one
aspect of pricing strategy is the presentation of prices in ways that will influence
perceptions to the seller’s benefit.

There are many factors to consider when creating price and value
communications. Ultimately, the marketer’s goal is to get the right message, to the right
person, at the right point in the buying process.

PRICE STRUCTURE
Once you understand how value is created and can be communicated for different
customer segments, the next choice required for a pricing strategy is to select a way to
monetize that value into revenue. We call the output of this process a price structures.
The most natural price structure is price per unit (for example, dollars per ton or euros
per liter).

For example, an airline seat is more valuable to a business traveler who needs to
see a client at a specific location and time than it is to a tourist who can choose from a
variety of destinations, travel days, and even non-travel related kinds of leisure. Pricers
at airlines have long used various pricing structures to maximize the revenue they can
earn from these various categories of consumers, who may be sitting next to each other
on the same flight. They can fill their planes largely with business travelers paying full
coach fares on Monday morning or Friday afternoon, but they are likely to be left with
many empty seats at those prices on Tuesday, Wednesday, and Thursday. While they
could simply lower their per-seat charge to fill seats during "off-peak" periods, they
would then be providing business travelers unnecessary discounts. They develop
segmented price structures so that most customers pay a ticket that is consistent with the
value they place on having a seat to attract more budget-sensitive pleasure travelers
without discounting business travelers.
PRICING POLICY
Ultimately, the success of a pricing strategy depends upon customers being willing to
pay the price you charge. The rationale for value-based pricing is that a customer’s
relative willingness-to-pay for one product versus another should track closely with
differences in the relative value of those products. When customers become increasingly
resistant to whatever price a firm asks, most managers would draw one of three
conclusions:

1. That the product is not offering as much value as expected,

2. That customers do not understand the value, or
3. That the price is too high relative to the value.

Pricing policy refers to rules or habits, either explicit or cultural, that determine how
a company varies its prices when faced with factors other than value and cost to serve
that threaten its ability to achieve its objectives.

Good policies enable a company to achieve its short-term objectives without

causing customers, sales reps, and competitors to adapt their behavior in ways that
undermine the volume or profitability of future sales. Poor pricing policies create
incentives for end customers, sales reps, or channel partners to behave in ways that will
undermine future sales or customers’ willingness-to-pay.
In the terminology of economics, good policies enable prices to change along the
demand curve without changing expectations in ways that cause the demand elasticity
to “shift” adversely for future purchases.

Price setting should be a multi-step, cross-functional process with several essential

stages. Setting suitable pricing objectives, whether to utilize price to increase volume or
to maximize profitability, is the first step. Calculating price–volume trade-offs is the
second step. Once the price–volume trade-offs for a given pricing adjustment have been
established, the next step is to estimate the expected customer response by evaluating
price sensitivity factors that are unrelated to value.
PRICE COMPETITION
The final set of strategic pricing choices that managers must make to maximize
growth profitably involve dealing with price competition. We are dealing with it last
because making decisions that affect competitive pricing is an ongoing part of price
management. Generally, these decisions occur after one has figured out how to create
differentiating features and services and to capture a share of their value in revenues.

The potential market value of a product or service is composed of two parts:

1. Reference Value- value that is the same as that offered by the competitive
2. Differentiating Value- value that differentiates it from competitive alternatives

Managing price competition involves influencing the reference value. In some

markets, the reference value can be taken as given, determined by market supply and
demand, and so requires no management attention except to adjust prices whenever the
reference value changes.
The lesson here is not that a profitable company should not attempt to grow share. It
is that companies must anticipate competitive reactions and avoid competing where they
lack the capabilities necessary to profit despite those reactions.
CREATING A STRATEGIC PRICING CAPABILITY
A successful pricing strategy requires the support of three pillars: An effective
organization, timely and accurate information, and appropriately motivated
management. In many instances, it is neither desirable nor necessary for a company to
have a large, centralized organization to set prices. What is required, however, is that
everyone involved in pricing decisions understands their role in the process.

While not every firm needs a dedicated system to manage pricing data, everyone
must address the question of how to get the right information into the right manager’s
hands in a timely fashion if they hope to keep their pricing strategies aligned with
changes occurring in their markets.
ACTIVITY 1 “Term Crossword Puzzle”

Direction: From the terms on this module, create your own crossword puzzle. put the
definitions into your own words in a concise manner, much like the crossword puzzles
found in the Sunday paper.

ACTIVITY 2 “Quiz for Review”

1. What is one of the element of the marketing mix that produces revenue?
a) Product
b) Price
c) Promotion
d) People
2. Which of the following are the major pricing strategies?
a) Customer Value-Based Pricing
b) Competition-Based Pricing
c) Cost-Based Pricing
d) Dynamic Pricing
3. Which pricing strategy uses the buyers’ perceptions of value rather than seller’s cost?
a) Customer Value-Based Pricing
b) Competition-Based Pricing
c) Cost-Based Pricing
 d) Dynamic Pricing
4. Which pricing strategy involves setting prices based on the costs for producing, distributing
and selling the product plus a fair rate of return for its effort and risk?
a) Customer Value-Based Pricing
b) Competition-Based Pricing
c) Cost-Based Pricing
d) Dynamic Pricing
5. Which pricing strategy involves setting prices based on competitors’ strategies, costs, prices
and market offerings?
a) Customer Value-Based Pricing
b) Competition-Based Pricing
c) Cost-Based Pricing
d) Dynamic Pricing
6. The value of money placed on a good or service
a) Place
b) Price
c) Product
d) Promotion
7. ________ uses buyers' perceptions of what a product is worth, not the seller's cost, as the key to
pricing.
a) Value-based pricing
b) Target return pricing
c) Variable costs
d) Price elasticity
8. When there is price competition, many companies adopt ________ rather than cutting prices to
match competitors.
a) Pricing power
b) Value-added pricing strategies
c) Fixed costs
d) Image pricing
9. In the given instance, what pricing method was used? The store prices its product as $9.99
instead of $10, and $1.99 instead of $2
a) Tender Pricing
b) Psychological Pricing
c) Value Pricing
d) Predatory Pricing/Destroyer
10. Which of the following Pricing Strategies describes when you take the cost of producing a
good and add on a percentage of profit to arrive at the selling price?
a) Cost-plus pricing
b) Promotional pricing
c) High pricing
d) Low pricing
11. Which of the following is not an objective of pricing strategy?
a) Maximize Profit
b) Increase Sales
 c) Discourage Customers
d) Discourage Competition
12. What are 3 things pricing may be based on?
a) Product, promotion, service
b) Cost, demand, competition
c) Price, Promotion, professionalism
d) Cost, Demand, Customers
13. In terms of the marketing mix, distribution is represented by which "P?"
a) People
b) Price
c) Place
d) Promotion
14. Which of these statements about customer perception of price is NOT TRUE?
a) The actual price may be a bigger factor to some segments
b) Sometimes buyers will tolerate a wider range of prices based on the situation
c) Customer may perceive the quality of an item based on its price
d) The breakeven price may be important to customer acceptance of a price
15. Which pricing method sets the price of the product on what the customer is willing to pay?
a) Cost-oriented pricing
b) Demand-oriented pricing
c) Market-share pricing
d) Competition-oriented pricing
16. The process used to decide what the price must be to cover all costs is the
a) Breakeven Analysis
b) Market share
c) Pricing Method
d) Pricing Objective
17. What is the selling price of an item which costs £5 to make and has a 50% mark up (profit
added)?
a) £10.00
b) £7.50
c) £5.00
d) £8.50
18. What is one question you still have about strategic pricing?