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What are the most appropriate frameworks for pricing cases?

Gauthier asked on Jul 20, 2017 - 10 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

Originally answered:

MECE way to solve pricing case

Benjamin replied on Jul 18, 2018
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Hi,

In addition to Vlad answer which is very complete, I would advise to first clarify weither it's a B2C or B2B case.

In the latter, the same product may be sold at different price depending on customers /industry targetted, and you would have at some to consider this in your approach.

Best
Benjamin

Originally answered:

Pricing Strategy

Tyrion Lannister replied on Jul 14, 2018
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Dear [],

I would say your understanding is not as limited as you think!

What you have described are great starting points to rationalising pricing strategies. But I think you could push yourself harder on this one. Don't memorise 'scenario templates' when you go into these conversations. Picture yourself in an actual interview where pricing strategy comes up, and your interviewer asks you what factors might a company consider when approaching pricing strategy.

You mention all three of those listed above, and the consultant asks the dreaded 'What else?'

Be robust! :-)

What are other factors that could lead us to consider pricing strategy:

1) Is there an internal price bundling strategy that might drive new demand for an existing product line?

For example: if we reduce the cost of our cable TV subscriptions by 10%, it might cause a 15% jump in demand for our internet services...

2) Is there a product placement strategy to drive customer traffic regardless of price margin?

For example: if we place small shower gel bottles at cost-price to be visible to external traffic in our mall locations, it might increase internal traffic by x%, and drive sales by y% would which then cost net margins to rise by z%.

3) Is there a customer segmentation strategy to boost the attractiveness of a mass market product to upmarket customers?

For example: if I sell Cider at the corner Bodega for $12, shouldn't I add a considerable mark-up to sell the exact same Cider at duty-free to widen the net to affluent customers who equate price with prestige? $21.50 a bottle, anyone?

4) Is there a sales strategy to maximise sales of units in inventory whose production has been discontinued?

For example: we no longer manufacture the pocketless gymn shorts of which our inventory remains robust. What is the right off-load price to maximise profit without diminishing the brand?

5) Is there a social pressure factor to be aware of as we price our patented products with an aim to quickly re-couping sunk R&D?

For example: should Martin Shkreli really have hiked the price of Daraprim so exponentially? Was there not a compromise between what the public would have accepted and what would still have represented a healthy profit margin?

Of course, I presented the above, in somewhat haphazard fashion, to illustrate the depth of strategies one could consider in a broad array of scenarios.

It is by no means an ordered, or exhaustive list!

In this case, I'm challenging you to think beyond finite lists. What would make the above answer even punchier is to think of categories of strategies (which you began in your original question, well done), try to establish a MECE list of those strategies, and then assigm some of the ideas I mentioned above (and more of your own, of course!) to really do this question further justice.

I trust others will add to this conversation so you may have a well-rounded perspective.

Originally answered:

Pricing Strategy - Difference

Dorothea
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replied on Jun 23, 2018
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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!

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. — Brinja on Jun 24, 2018 (edited)

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 E 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 E 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

Originally answered:

Pricing Strategy

Anonymous D replied on Jul 18, 2018

There are two more things when you work on pricing strategy, they are market positioning and value creation.

1. Market Positioning: Market Positioning is setting your target customer, focussing exclusively on the target customers and hyper customization for particular customer needs is very much important. It is your wish to decide weather you are offering a premium high end-low volume product or low end-high volume product.

2. Value creation is very much important for lasting in the game. Value creation gives utmost satisfaction for the customers. Value of the commodity and cost effectiveness goes hand in hand.

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