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Pricing Strategy - Difference

Case Interview pricing
Recent activity on Jun 24, 2018
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Brinja asked on Jun 23, 2018

I have been scrolling around in several books in order to understand the topic of pricing strategy. 3 main strategies are mentioned: 1. Competitor-based pricing 2. Cost-based pricing 3. Customer-valued based pricing (price-based costing).

1) What gets me confused: Literature is not clear about the difference between 1+3. For example, if I want to introduce an anti-smoking pill which is not on the market yet (nor by our client nor by competitors), I'll have a look at comparing similar products (anti-smoking patches, electronic cigarette etc.) and compare the value for the customer looking at those products (costs, maturity, scope and length of application etc.). Is this now a competitor-based pricing strategy or a value-based pricing approach? Value-based pricing is defined as: True-economic Value (costs of best alternative + value of performance differential), however, my approach is often categorized under competitive-based pricing if I compare to solution in the books.

2) If I am going for approach 2 (cost-based), do I have to consider the fixed and the variable costs for setting a price or only one of those 2 (sometimes R&D costs are considered, sometimes only the variable costs)

Thanks for your feed-back !!!

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Dorothea
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replied on Jun 23, 2018
Ex-Oliver Wyman with 100% interview success rate - specialized in female career coaching

Hi Brinja,

please find my answer below:

  1. When applying a competitor-based approach, the main question is: „How much do customers pay for comparable products of competitors or substitutes?“
    • You base your prices on the costs for comparable products produced by competitors. If no comparable product is available (e.g. as it is the case with the anti-smoking pill), you would investigate the pricing of substitutes (in this e.g. case anti-smoking patches).
    • Your reasoning here is that your product is of equal value to the customer as are those of competitors and the customers is likely to switch to a different product if there is a huge price difference (it is not really that different if you take a pill each day or put on an anti-smoking patch, is it?). Of course you would need to take into consideration customers’ total spend (e.g. it takes 30 days to quit smoking if you use anti-smoking patches, and only 15 days when using pills)
  2. When applying a value-based approach, you approach the issue from the customer-side: "How much would the customer would be willing to pay for my product?" If your anti-smoking pill has a much stronger effect than an anti-smoking patch has when it comes to the rate of relapse (e.g. you are a bit more likely to quit smoking for ever than when using an anti-smoking patch), customers are very likely to pay a higher price for your product. Here, your product is of higher value than are those of competitors. A typical example for applying the value-based approach is the iPhone - from a performance perspective, iPhones are not that different from Samsung phones, however, the iPhone is often bought because people think it is cooler than a Samsung (this is its unique value).
  3. For the cost-based approach, the question is: "How much does my product cost in production and what margin do I want to apply?" You would consider all costs that occur during production and apply a margin. Here it is important, that you want to make sure that you 1. cover all your costs and 2. ensure that you earn something on top. You may choose whether you allocate your R&D costs to the cost-base or whether you cover them using your margin and accordingly apply a higher margin. In reality, this approach is used very rarely because it is rather theoretical and neither takes into account the competitor nor the customer perspective.

Hope this helps!

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Brinja on Jun 24, 2018

Hi Dorothea, thanks for your feed-back. I understand the difference in theory, however, given my example I think it is not really clearcut. As you describe it, as soon as I would argue for a higher price based on certain product features (higher success rate, more convenience in intake etc.) I am following a customer-value based approach. Just comparing prices with competition (also considering the intake time in the price calculation) is competitor-based. But you also take the competitive prices and then argue for the markup based on additional features, which is a mixture of both - but from my understanding would fall under value-based. This is differently categorised in the book solution I've been reading.

(edited)

Vlad
Expert
Content Creator
replied on Jun 24, 2018
McKinsey / Accenture Alum / Got all BIG3 offers / Harvard Business School

Hi,

1. Cost based - you actually check what are the costs and apply standard industry / target markup. You need to take into account R&D and capital costs if the case (interviewer) specifically states that. Also, the availability of patent is important, since the whole point of it is to protect your price and achieve ROI on the whole R&D pipeline of drugs (including the ones that were not launched / approved)

2. Competitor based pricing - basically it's simply benchmarking against competitors with a similar product. Make sure you take into account the segment (i.e. in premium higher price may be the proxy for quality). Since the value proposition of the competitors may be different, competitor pricing is just one of the metrics that you should take into account

2. Value based pricing can be done in 2 ways:

  • For existing products, you identify what it the economic value and perceived value for the customer. Also, you compare the value proposition and features of your product vs. the VP of your competitors. If you have a significant difference in value prop - you have to define how much value you propose to the customer in $ terms. (e.g. your product may have additional customer support, better packaging, additional features and thus should be priced hire. Or it should be priced the same and you will win the market share due to these differences)
  • For the new products, you can calculate the closest alternatives and think how much additional value we provide by replacing them. Think of the discount airlines compared to trains or buses

4. Pricing strategy - here you define how you will price the product taking into account 1,2,3 and your company strategy. Maybe you decide to have a zero margin if you can crossell other services. Or maybe you would like to subsidize to win the competition. Also, think of price differentiation and having different pricing tiers (e.g. basic, premium or even fremium) and how it helps to drive price perception and fulfill strategic goals

Good luck!

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Dorothea gave the best answer

Dorothea

Ex-Oliver Wyman with 100% interview success rate - specialized in female career coaching
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