Chapter 1: Strategic Pricing More importantly, behavioral economics research over

the past few decades has proven conclusively that

Product, Promotion, and Placement – the firm’s effort
differences in how prices are presented and the
to create value.
surrounding context can lead buyers to respond in ways
Price – a firm’s attempt to capture some of the value in that are inconsistent with the idea of a stable demand
the profit it earns. curve that reflects fixed preferences. To add to the
instability, we know that the demand for the mid-price
Most companies still make pricing decisions in reaction product will be greater if the offers are presented
to change rather than in anticipation of it. beginning from the top down rather than from the
Cost-Plus Pricing - the most common pricing procedure bottom up. Economists refer to the actual percentage
because it carries an aura of financial prudence change in sales divided by the percentage change in
(achieved by pricing every product or service to yield a price as the price elasticity of demand.
fair return over all costs). Strategic Pricing - In reality, demand for most products
The problem with cost-driven pricing is fundamental: In and services is not given, it is created. Making these
most industries, it is impossible to determine a decisions thoughtfully and implementing them
product’s unit cost before determining its price. To solve effectively to maximize profitability is what we call
the problem of determining unit cost before “strategic pricing.” For strategic pricing, the objective is
determining price, cost-based prices are forced to sustainable profitability.
assume a level of sales volume and then to make the Value-based means that differences in pricing across
absurd assumption that they can set price without customers or applications reflect differences in the value
affecting that volume. to customers.
Cost-plus pricing leads to overpricing in weak markets Proactive means that companies anticipate disruptive
and underpricing in strong ones—exactly the opposite events (for example, a new competitive threat or a
direction of a prudent strategy. customer’s decision to award business via a reverse
The only way to ensure profitable pricing is to let auction) and develop strategies in advance to deal with
anticipated pricing determine the costs incurred rather them.
than the other way around. Profit-driven means that the company evaluates its
Customer-Driven Pricing success at price management by what it earns relative
to alternative investments rather than by its market
The purpose of strategic pricing is to price more share and growth relative to its competitors.
profitably by capturing more value, not necessarily by
making more sales. When marketers confuse the first Value Creation - The key to creating good value is first to
objective with the second, they fall into the trap of estimate how much value different combinations of
pricing at whatever buyers are willing to pay, rather than benefits could represent to customers, which is
at what the product is really worth. normally the responsibility of marketing or market
research.
Two problems arise when prices reflect the amount
buyers seem willing to pay. First, sophisticated buyers Value Communication - Understanding the value your
are rarely honest about how much they are actually products create for customers can still result in poor
willing to pay for a product. sales unless customers recognize the value they are
obtaining.
Second, there is an even more fundamental problem
with pricing to reflect customers’ willingness-to-pay. The Price Structure - Once you understand how value is
job of sales and marketing is not simply to process created and can be communicated for different
orders at whatever price customers are currently willing customer segments, the next choice required for a
to pay, but rather to raise customers’ willingness-to-pay pricing strategy is to select a way to monetize that value
to a level that better reflects the product’s true value. into revenue. We call the output of this process a price
structure. The most natural price structure is price per
Share-Driven Pricing- Finally, consider the policy of unit.
letting pricing be dictated by competitive conditions. In
this view, pricing is a tool to achieve gains in market Pricing Policy - Customers sometimes decline to pay
share. prices that represent good value simply because they
have learned that they can obtain even better prices by
The Role of "Optimizing" in Strategic Pricing- Sensitivity exploiting the sellers’ reactive pricing process. Pricing
to price depends as much on ever-changing purchase policy refers to rules or habits, either explicit or cultural,
contexts and perceptions as on underlying needs or that determine how a company varies its prices when
preferences. Demand when prices are going up is faced with factors other than value and cost to serve
generally much more “price elastic” than when prices that threaten its ability to achieve its objectives.
are coming down.
Good policies enable a company to achieve its short- pricing strategy is not use value, but is what economists
term objectives without causing customers, sales reps, call exchange value and we call economic value.
and competitors to adapt their behavior in ways that Economic value comes in two forms: Monetary and
undermine the volume or profitability of future sales. psychological. Both of these are instrumental in shaping
Poor pricing policies create incentives for end a customer’s willingness to pay but require very
customers, sales reps, or channel partners to behave in different approaches to estimate them.
ways that will undermine future sales or customers’
Monetary value represents the total cost savings or
willingness to pay.
income enhancements that a customer accrues as a
Price Setting - Price setting should be an iterative and result of purchasing a product. How the product
cross-functional process that includes several key category affects the consumer cost and revenues. It
actions. The first action is to set appropriate pricing necessitates a price calculation based on benefits, uses,
objectives, whether that means to use price to drive input cost, and durability to substantiate monetary
volume or to maximize margins. The second action is to worth.
calculate price–volume trade-offs. Once the price–
Psychological value refers to the many ways that a
volume trade-offs are made explicit for a particular
product creates innate satisfaction for the customer.
pricing move, the next activity is to estimate the likely
customer response by assessing the drivers of price A consumer in the market for a new car might focus on
sensitivity that are unrelated to value. The marketer’s the monetary value derived from the potential fuel
job is to estimate how price sensitivity varies across savings by switching to a hybrid. Other customers will be
segments in order to better estimate the profit impact motivated more by the psychological value derived from
of a potential pricing move. knowing that the hybrid is less damaging to the
environment. It can be challenging to discern which is
Price Competition - The final set of strategic pricing
more important to the purchase decision.
choices that managers must make to maximize growth
profitably involve dealing with price competition. We More formally, a product’s total economic value is
are dealing with it last because making decisions that calculated as the price of the customer’s best alternative
affect competitive pricing is an ongoing part of price (the reference value) plus the worth of whatever
management. The potential market value of a product differentiates the offering from the alternative (the
or service is composed of two parts: Value that is the differentiation value).
same as that offered by the competitive alternatives
(Reference Value) and value that differentiates it from How To Estimate Economic Value - Marketers have
competitive alternatives (Differentiating Value). Price historically invested considerable effort to develop
competition becomes much more challenging, however, effective value propositions to represent their company
when a seller commands a large share of a market. This and products. And few would argue that an effective
is because competitors are likely to react to whatever value proposition, a concise statement of customer
pricing decisions it makes. benefits, is an essential input to brand building and sales
conversations. But a general statement of value is
Chapter 2: Economic Value insufficient input for pricing decisions because it lacks
the detail and quantification needed to shape strategy.
They erroneously assume that merely adding features or
In this section, we describe techniques that can be used
improving performance will lead to profitable gains in
to develop quantified estimates of customer value that,
price, volume, or both. But more and better features
in turn, can be used to help set more profitable prices.
will not lead to greater profitability unless those
features translate into more value, actual and perceived, Estimating Psychological Value - Conjoint analysis,
for customers. To do that, a pricing strategist must first which was created in the late 1970s, is the technique
learn techniques for understanding and estimating that is most frequently utilized and the early 1980s that
value. are able to recognize the hidden values that consumers
assign to product aspects.
The Role of Value in Pricing - In common usage, the
term value refers to the total savings or satisfaction that Monetary Estimation Value - Monetary value
the customer receives from the product. Economists estimation affects how much money these
refer to this as use value or the utility gained from the breakthroughs actually bring in a variety of institutional
product. Potential customers know that, except in rare clients.
situations, they don’t have to pay a seller all that a
product is really worth to them. They know that there Competitive Reference Prices - Work of identifying the
are likely competing sellers who will give them a better next-best competitive alternative and gathering
deal, leaving them with extra money in their pockets, or accurate reference prices. After determining the
what economists call a “consumer surplus.” So, what do competitive reference prices, the next step in value
marketers mean when they propose pricing to reflect estimation is to gain a detailed understanding of
value? The value that is key to developing effective customer value drivers and translate that understanding
into quantified estimates that can be used to support 5. Create Detailed Segment Description - Lists the
pricing decisions. needs and typical firmographics of the customer-
controlled scheduling segment’s three sub-segments. It
The first step in quantifying monetary value drivers is to
also lists specific catalog publishers within each
understand how the product category affects the
segment.
customer’s costs and revenues. In consumer markets,
this is a relatively straightforward exercise because end 6. Develop Segment Metrics and Fences - The Last Step.
consumers usually have fewer monetary value drivers Metrics are the basis for tracking the value customers
for a given product category. A hybrid car, for example, receive and how they pay for it. Over time, competition
provides monetary benefits such as lower fuel and forced rental companies to drop mileage charges.
maintenance costs, as well as psychological benefits,
Chapter 3: PRICE AND VALUE COMMUNICATION
such as conveying concern for the environment, yet
these do not affect customer finances. Once the Value communication can have a great effect on sales
differential value algorithms have been determined, the and price realization when your product or service
final step is to sum the reference value and the creates value that is not otherwise obvious to potential
differentiation value to determine the total monetary buyers. The less experience a customer has in a market
value. or the more innovative a product’s benefits, the more
likely it is that the customer will not recognize nor fully
Psychological Value Estimation
appreciate the value of a product or service.
Innovators - highly focused on performance, have
Adapting the message for product characteristics - The
higher incomes and purchase, extensive consultation
first step in developing a value message is determining
Value Seeker - have moderate income and purchase, which customer perceptions to influence. We start with
Value seekers are thrifty, but they will pay a premium an understanding of the value drivers that are deemed
for added performance. most important to a customer segment. The goal is to
help the customer recognize the linkages between a
Lost Players - They do not purchase significant amounts,
product’s most important differentiated features and
but they can be drawn back to playing if a new
the salient value drivers.
innovation creates enough buzz to capture their
attention The two dimensions that frame a communications
strategy are:
Budget Shoppers - have budget constraints that limit
the amount they can spend, typically buy new 1. The type of value delivered—economic or
equipment through discount stores and online outlets. psychological

Value-Based Market Segmentation 2. The degree of buyer involvement—do they actively

seek information to make detailed comparisons or do
1. Determine Basic Segmentation Criteria- The goal of
they make a decision based on what is known in the
any market segmentation is to divide a market into
moment?
subgroups whose members have common criteria that
differentiate their buying behaviors. A segmentation Understanding the type of value sought has a
done by industry using industrial classification criteria significant implication for the communication strategy.
would not indicate, however, whether customers use The degree of buyer involvement varies dramatically
the grinders in similar ways. from one product category to the next as well as across
purchase occasions.
2. Identify Discriminating Value Driver - In-depth
interviews probing how and why buyers choose among Low-Involvement, Psychological Benefits - Low-
competitive suppliers provide the additional input involvement goods whose benefits are mostly
required. Industry experts, distributors, and salespeople psychological include many consumer-packaged goods,
can provide supplemental information for double- cosmetics, or apparel. Sometimes consumers treat them
checking the value perception patterns revealed by the as high-involvement if they are passionate. For example,
interviews. Nike's "Just Do It" campaign is focused on the
psychological benefits of its products, such as the feeling
3. Determine Your Operational Constraints and
of empowerment and accomplishment that comes from
Advantage - In this step, you examine where you have
being an athlete, they don’t provide much information
operational advantages. Which value drivers can you
about the economic value of the products, such as their
deliver more efficiently and at lower cost than others?
price or durability.
4. Create Primary and Secondary Segments - The
Many low-involvement products can have benefits that
number of stages depends on the number of critical
are predominantly economic. For example, the
drivers that create substantial differences in value
campaign emphasizes the cost savings that consumers
delivery among customer groups.
can achieve by switching to energy-efficient light bulbs.
High Involvement, Psychological Benefits - This might only promise to do. Buyers are less sensitive to the price
involve using aspirational imagery in advertising, of a known or reputable supplier when they have
emphasizing the prestige or exclusivity of the product, difficulty comparing alternatives.
or leveraging endorsements or partnerships with high-
End-Benefit Effect - A buyer’s price sensitivity is
profile celebrities or influencers. For example,
influenced by the importance of the benefit that they
purchasing a luxury car or a high-end watch, where the
are trying to derive from their purchase. The importance
consumer is seeking not only the physical benefits of the
of the end result is a critical driver of the end-benefit
product, but also the emotional satisfaction that comes
effect. The greater the risk and the higher the cost of
from owning a premium or prestigious brand.
failure, the more salient this effect becomes.
Finally, high-involvement products that deliver primarily
2 parts of the End Benefit Effect
economic benefits include services such as management
consulting and university education, as well as products 1. Derived demand is the relationship between a
such as airplane engines and surgical devices. For desired end benefit and the buyer's price sensitivity for
example, purchasing a home or major appliances, where one of the products that contribute toward achieving
the consumer is seeking not only the physical benefits of that end benefit. The more sensitive buyers are to the
the product but also the economic benefits of making a cost of the end benefit, the more sensitive they will be
sound investment that will provide long-term value. to the price of products that contribute to that end
benefit.
Strategies for Conveying Value - Most market research
on willingness-to-pay relies heavily on the assumption 2. Price proportion cost refers to the percent of the
that purchase decisions are motivated by considerations total cost of the end benefit accounted for by the
of value delivered—whether economic or psychological. product's price. The smaller the proportionate share
accounted for, the less sensitive the customer will be to
Exhibit 3-3 shows an example of a value-based selling
price differences.
tool used by salespeople to develop a customer-specific
estimate of the value of installing a piece of telecom Price- quality effect – Price represents nothing more
equipment that reduces the service outages and the than the money a buyer must give to the seller as part
corresponding number of calls from affected customers of the purchase agreement. Buyers are less sensitive to
to a service center. price the more that higher prices signal higher quality.
The price is more than just an attribute, it is also a signal
Competitive-Reference Effect - True value is what is
of the value that a buyer can expect to receive. The
perceived by consumers who are fully informed of
perception of higher quality at higher prices reduces
alternatives, understand the benefits of differentiation,
price sensitivity even when consumers seek either
and act in rational ways. One of the most common
prestige or exclusivity. For example, purchasing a Rolex
shortcuts is to find a competitive reference product—
watch than purchasing a smartphone for time-keeping.
often a highly visible and high-cost brand in the market
—to assess relative value. By managing a customer’s Expenditure Effect - The expenditure effect states that
understanding of the relevant competitive alternatives, buyers are more price sensitive when the expenditure is
a seller can significantly influence the customer’s larger, either in dollar terms or as a percentage, of the
willingness-to-pay. Presented with an array of choices, available budget. The effect of the expenditure size on
and absent much knowledge of the category, customers’ price sensitivity is confounded in consumer markets by
perception of value is influenced by the range of prices the effect of income. The expenditure’s size relative to
available to them at the time of purchase. income is also a constraint on both a business’s and a
household’s primary demand for a product. Example: A
Switching Cost Effect - Buyers are less sensitive to the
family with five children may spend substantially more
price of a product as the added costs (both monetary
on food than a smaller family, yet still be less price
and non-monetary) of switching a supplier rises. This is
sensitive if the cost of food accounts for a smaller
the switching cost effect: The greater the product-
portion of the large family’s high income.
specific investment that a buyer must make to switch
suppliers, the less price sensitive that buyer is when Shared – Cost Effect – People purchase many products
choosing between alternatives. Since this effect is most that are actually paid for in whole or in part by someone
often attributed simply to inertia, it is easy to else. The percentage of a price that a customer must
underestimate its predictability and manageability. pay influences their sensitivity to price. For example,
when a child chooses a college to attend, he or she may
Difficult-Comparison Effect - The concept of economic
be more likely to select an expensive private school if
value assumes that customers can actually compare
they have a scholarship or a wealthy relative willing to
what the alternative suppliers have to offer. Consumers
cover the cost of tuition.
will often continue to pay higher prices for the
assurance that their regular brand offers what the Transaction Value Effect - The value of a transaction—
substitutes do not: The confidence accumulated from both economic and psychological—is also influenced by
past experience that their brand can do what the others the structure of the financial terms and the structure of
the deal. Suppose you are about to purchase a car from
a dealership where you know that haggling over prices
is the norm. Transaction value suggests that buyers are
motivated by more than just the “acquisition utility”
associated with obtaining and using a product. They are
also motivated by the “transaction utility” associated
with the difference between the price paid and what
the buyer considers a reasonable or fair offer for the
product. Transaction utility is framed by the difference
between the actual price paid and the reference price,
which is the amount that the buyer would consider
reasonable or fair.

Fairness Effect - The concept of a “fair price” has

bedeviled marketers for centuries. There is no precise
definition of what is considered fair. It is a community-
held norm that is not guided by factors such as
profitability, absolute value, and supply. Fairness is often
framed by the “shadow of the future.” And notions of
fairness can change over time.

Multiple Participants in buying process - The buying

process frequently involves more people than just the
customer since others participate by providing
information, facilitating search, and influencing the
purchase decision. Multiple participants are also
common in most business markets where purchasing is
managed by professional procurement managers using
sophisticated information systems and aggressive
negotiation tactics.