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What are the most appropriate frameworks for pricing cases?

Gauthier asked on Jul 20, 2017 - 2 answers

Hi,

I'm struggling with finding clever ways of approaching pricing cases.

I typically use the classic P=R-C, but I find it hard to use that when the competition and/or seasonality is an issue.

Do you know any good framework for pricing cases?

Thanks!

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Vlad
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replied on Jul 21, 2017
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Hi,

The general framework for pricing is: Cost base - Value based - Competitor based - pricing strategy

1. Cost based - you actually check what are the costs and apply standard industry / target markup

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

  • For existing products 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.
  • For new products you have to calculate the value of the closest alternatives and think how much additional value we provide by replacing them. Think of the discount airlines compared to trains or buses

3. Competitor based pricing - basically it's benchmarking against competitors. Make sure you take into account the segment (i.e. in premium higher price may be the proxy for quality)

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!

Thanks Vlad, very helpful! — Gauthier on Jul 21, 2017

Hi Vlad, I just want to ask you what the difference would be regarding point 2 - value-based and point 3 - competitor? It seems like you're comparing with competitors' products and/or substitutes for both options. Thanks — Ray on Sep 19, 2017

I think the point 2 focuses on customers' WTP (willingness to pay). Figuring out customers' WTP is the best way to price the product — Grace on Jun 11, 2019

Udayan
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replied on Oct 07, 2019
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Value based pricing

Vlad has outlined the overall approach to pricing in his answer, I want to focus a little more on one aspect - value based pricing. This is the one that is key to most pricing based cases you will come across whether in an interview or in an actual live case.

Value based pricing is based on the principle that the best way to price a product (i.e. where the marginal utility derived from consuming a product is equal to the marginal cost of producing it) is to price it at the highest willingness to pay. It is worth noting that this willingness to pay differs across users and in an ideal world, you would charge each consumer the price they want to pay (the most common example of this being pricing in airlines - basic economy, economy, economy plus, business and first class).

When solving cases related to optimally pricing a product, you will often have to think of ways to come up with prices for a product. Below are some common ways to do so

  1. If the product is similar to ones in the market you will have to look at how competitors are priced
  2. If it has improvements/relevant differences (say a drug with better targeting mechanisms than current drugs) then some things to look at are
    1. Scope of improvement - for example if instead of 3 injections a month you ony need to take one injection every month you can price the drug at at least 3x price of current drug in the market
    2. Willingness to pay - this can be judged through surveys, A/B testing, pricing the value to the customer (e.g., If it saves 5 hours, you can assume that each hour is worth at least say $30 and 5 hours $150, etc.
  3. If the product is completely new (e.g., immunotherapy in cancer, iPhone when it launched etc.) you can look at:
    1. How did previous industries think about price disruptions when they first launched
    2. Do you want access to all or few core clients. e.g., a digital platform like facebook first needs scale and relevance before becoming a key product and so is free to start, something like a tesla may prefer a wow factor and is priced accordingly. All of these are industry and product specific
    3. Barriers to entry - how difficult is it for others to enter by copying your product/do you have an IP. The easier it is the closer you have to price to the cost of making it
    4. How will you price differentiate if it is relevant (e.g., launching google pixel 3 and google pixel 3a with less premium features)


As you can see there are many elements to a pricing case, so it is helpful to read up on the theory and research cases that have looked at pricing, especially from a value base pricing perspective

Udayan

Hi Udayan, — Anonymous A on Oct 08, 2019

From my experience, for value based pricing cases, you normally determine the maximum price (i.e. the user's willigness to pay) using the following equation: [additional incremental profit per year] x [client investment horizon] >= [investment costs]. The point at which this equation equals zero determines the maximum price of the product, therefore I'd normally quantify the incremental profit through use of a new product as a function of it's price, and solve the equation to determine the Price. Does this sound like a sensible approach for all value based pricing scenarios? — Anonymous on Oct 08, 2019

Hi, I would have to look at the case to give a better answer as it's not always a plug and play solution — Udayan on Oct 10, 2019

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