Chapter 6

Pricel Level (Setting price that capture a share of the value created)

Introduction

Setting a price for a certain product is a critical process for it will be a factor whether you will achieve
your marginal objectives or not. So an effective pricing decision is needed. The purpose of this chapter is
to suggest simple yet logically intuitive procedure in setting prices that enables marketers to have a
more profitable price levels

The Price Setting Process

Price setting is the ultimate intersection of value creation and value extraction. There are different factor
that influence the market to purchase a certain product. Setting a price level starts with defining a viable
feasible range for each customer.

Step 1:

Define the Viable Price range

To know the reasonable price range for a certain product, first, we must know the highest and lowest
price points that the business might be sustainably charge for the product. The feasible price range of a
product is defined by the product's value proposition.

The highest price point for a certain product will be less likely the maximum theoretical price that the
informed customer from a certain segment of market is willing to pay. It is for the purpose that they are
already knowledgeable at to which extent they need to pay for the product the needed. So it will be our
feasible price ceiling.

On the hand, the lowest price point or the feasible price floor of a positively differentiated product will
be the is the price of the next-best competitive alternative. However, the negatively differentiated
product's feasible price floor is below the price of the next-best competitive alternative.

Taken together, the price ceiling and the price floor will be the "reasonable price range" in which you
can set the price for a product. Setting the price will define how any differentiating value gets shared
between the seller and buyer. If you can convince the market by the price by which they will benefit
more is by fully knowing the differentiated value of the product.

Step 2:

Make Strategic Choices

There are 3 alternative strategic choices that can be useful but often one is sustainble however, all
depends on the given firm's relative capabilities and market position

Let us examine which strategic choice is the best for the given conditions.

Option 1:

Skimming the market

It is designed to capture a superior margins, even at a cost of large sales volume. Skim prices are high in
relation to what most buyers in a segment can be convinced to pay. This strategy optimizes immediate
profitability only when it exceed that from selling to a larger market segment at a lower price. In simple
words, skimming the market is like setting your product at a convincing yet high price then selling it to
buyers that are somewhat insensitive. Insensitive not in a sense that they are fool but insensitive in a
way that they are willing to pay at a high price for a certain product though they can avail an alternative
product in a lower price because they have high value in the product's differentiating attributes. We also
have this so called "sequential skimming" in which you will set the product at high price from the start
then gradually reducing it overtime. It is use on the products or services that are low on repurchase
rates.

Option 2:

Penetrate the market

Penetration pricing involves setting a low price to attract and hold a large group of market. Penetration
prices only works if the market is convince and is willing to change brand in response to a lower price.
Penetration pricing does not neccessarily mean that the product is cheap. It use just to attract and hold
a large volume of market. In order to justify the penetration pricing to which you will have profit,
managers must also consider costs. By having costs as a small part of the price so that each additional
sale makes a large contribution to profit. If you will gain 90 percent of sale and you are able to cover the
costs already yet you have an excess of 12 percent of sale then that 12 percent will be a contribution to
your profit. Thus, penetration pricing needs to have a large volume of sale in order to succeed and to
gain profit.

Option 3:

Neutral pricing

It involves strategic decision not to use price as tool to gain market yet not allowing price alone to
restrict it. It minimizes the role of price as a marketing tool in favor of other tactics that the
management believes that is more powerful and cost-effective for a product's market.

Step 3:

Assess breakeven sales changes

The next consideration in determining where to set the price level is the relationship between changes
in price, volume and profitability. Economic theorist propose pricing based on determining the demand
curve of the product and then optimizing the price level given on the incremental cost of production but
it is not always right. For there are some instances and situations that the demand for the product is
unstable. So this is where price elasticity coming in.

Price elasticity is used by economists to understand how supply or demand changes given changes in
price to understand the workings of the real economy. Price Elasticity of Demand = % Change in
Quantity Demanded / % Change in Price. Price elasticity is used to determine whether the demand is
increasing or decreasing in response to the changes in price.

Breakeven Sales Change Calculation

Price elasticity is so difficult to measure so we come up to a solution to make it more simple such as
breakeven sales change associated with a proposed price changes. To know which price is more
profitable, we can make a breakeven sales curve to see which price is profitable depending on the
demand of a certain product. If the price decrease then the sales volume will increase so the price and
sales volume is indirectly proportional. The key to price optimizing is to make price alternatives for
different situation needed.

Step 4:

Gauge Price Elasticity

After establishing the breakeven sales change for a potential price change to be profitable, we must now
make a judgement on whether that sales change is likely to be achievable. So we will now measure how
market will respond to the price change. If the demand is increasing though there is a price change then
we can assume that the market is taking positively. So to put it simply, gauging price elasticity is like
measuring how the market is taking in the price change that has been made whether it will become
profitable or not. So we can also put thing step by step by somehow simply increasing the price slowly
until we reach the profit-maximizing price point and calculation the breakeven sales changes and testing
if the sales changes is on the positive or negative side of the breakeven point.

Step 5

Account for Psychological Factors

Although you have set the price, you should also reflect on the differences in value for different
occasions and application. There are less likely group of people within the market segment who is price
sensitive. They are the one who is dedicated in making a purchase with the largest gap between the
value of the product they receive and the price they pay. We will now know what factors influence the
price sensitivity of a market.

1. Reference Value - the price in the minds of the market is always relative. So by re-framing the
customers minds to view the alternative products is more expensive. Then the price sensitivity can be
reduced.

2. Switching Cost - buyers is less sensitive to the price the higher the costs of switching vendors.
3. Difficult Comparison - Customers are less price sensitive with a known or reputable supplier when
they have difficulty in comparing alternatives. E.g. Cellular phone companies.

4. Importance of end-benefit - The larger the end-benefit, the less price sensitive the buyer. This effect is
especially important when selling to other businesses.

5. Price-quality perception - Buyers are less sensitive to a product's price to the extent a higher price
signals better quality. E.g. image products, exclusive products.

6. Size of expenditure - Buyers are more price sensitive when the expenditure is larger, either in
monetary terms or as a percentage of household income.

7. Shared Costs - when you spend someone else's money on yourself, you are not prone to be price
conscious. This is one reason airlines, hotels, and rental car companies can all price discriminate against
business travelers, because most of them are not paying their own way.

8. Transaction Value - Buyers are less price sensitive the more they value the unique attributes of the
offering from competing products. This is precisely why marketers expend so much energy and creativity
trying to differentiate their offering from that of their competitors.

9. Perceived Fairness - Notions of fairness can certainly affect customers, even when they are not
economically (or mathematically) rational.

In considering these factors, you can now understand which of them are relevant for particular product
and segment customer. By knowing these, you can now make a move to influence them through price
and value communications.

Communicating New Prices to the Market

The final step in setting price change is making the market accept the new price. But settinga new price
will also lead to an issue of fairness. So in order for the market not to view the new price as an
opportunistic strategy, you must establish a good communication to the market about reasons for a
price change and about the fairness of it to both parties. It is very essential to communicate fairness to
the market to ensure that they will not think the new price is being forced to them. So you can also give
them options on how they can adjust to the new price that is set.

Outro:

Setting market-relevant prices requires a combination of both art and science. These process will be
beneficial to help a seller lead a sustainable and profitable prices.