CHAPTER 1: BOUNDARIES OF A GOOD PRICE Each of these functional executives will bring valuable
and unique vantage points and skill sets from which
How should executives price a new product? Should they price
they can draw information.
the product the same as competing products? Should they
Unfortunately, functional executives are likely to be
price it low to grab market share? Should they price it high to
biased by the incentives by which their performance is
grab greater profits with each individual sale? Perhaps they
measured.
should take an accounting position and simply add a
reasonable markup to the marginal cost of production. If so, Financial Executives: influenced by their accounting
what is that reasonable markup? orientation in addressing pricing decisions.
Pricing questions are perhaps the most vexing decisions facing PROS
an executive.
Strong grasp of breakeven analysis and cost-plus
Pricing questions span organizational boundaries because of pricing
their strategic importance, crossing over into marketing, sales, Tend to have a heightened understanding of the
finance, and operations; that’s why executives need a rational relationship between higher prices and higher profits,
approach to setting prices. and in turn, higher shareholder value.
When thinking of prices, it is useful to consider price as the CONS
value that the firm captures in a mutually beneficial exchange
with its customers. The reason for the firm’s existence is to They are rarely in the best position to evaluate
produce value for its customers in exchange for a price. whether customers are willing to pay higher prices.
This exchange is made freely between the firm and its Sales and Marketing Executives: influenced by their customer
customers. orientation.
We demonstrate the construction of an exchange value model PROS
as an initial means to make rational pricing decisions. Well informed about market share, competitive
INFORMING PRICE DECISIONS actions, and customer preferences
Understand both the potential and the limitations that
The importance of price: it directly affects the profit of a firm. a firm has in shaping customer preferences and
willingness to pay.
If price is too high
CONS
Few items get sold.
Lost competition Given incentive bias to rewards from getting market
Become irrelevant to the market. share, meeting revenue targets, or capturing specific
Lowers investors expectation. customers, they encourage to lower prices to grab
customers but forgoing opportunities to capture
The firm can lower its prices, but it may be too late.
higher profits.
If price is too low
Operations Executives: often come from a finance, marketing,
Forgone opportunity for profit economics, or mathematical science background
Sets incorrect price expectations for the product
PROS
category.
Well informed of issues related to economies of scale,
Worst case scenario is that costs are not covered, and the
scope, and learning.
firm becomes insolvent.
CONS
Repeatedly, the wrong price yields lost revenues, lost profits,
lost customers, and ultimately a strategically lost firm. Performance metrics tied to average cost efficiencies
may encourage operations executives to seek lower
WHO SHOULD MAKE PRICING DECISIONS?
prices to drive up volume and improve capacity
Finance, Sales and Marketing, and even the utilization.
Operations Executive will each be in a position to
In making pricing decisions, executives must take advantage of
contribute to pricing decisions.
the benefits of the informational resources and skill set of each
functional executive while countering the bias that each brings THE ART AND SCIENCE OF PRICING
to pricing decisions.
The Science of Pricing
To make the right decision, many firms make pricing a chief-
Refers to the act of gathering information, conducting
executive-level concern due to their breadth of responsibility.
quantitative analysis, and revealing an accurate understanding
To aid their decision, many chief executives have developed a
of the range of prices likely to yield positive results.
new organizational capability: The Pricing Professional.
Pricing data, like any other set of information that influences
THE PRICING PROFESSIONAL
executive decisions, is rarely perfectly clear.
Understand how customers perceive offerings and
Despite the uncertainty, quantitative approaches can be used
their willingness to pay for them.
to improve the pricing decision, prevent grievous errors, and
They have a firm grip on issues related to marginal
uncover new opportunities.
productions cost as well as the fixed incremental costs
related to serving specific markets. As the negotiation experiment demonstrates, the firm can take
They also have a strong understanding of competitive actions to influence its pricing power in ways that may be
actions, market share, and industry dynamics. difficult to analyze using quantitative methods. These actions
They have a deep understanding of economics and are can be:
able to both measure the elasticity of demand and
Value destroying– failing to communicate the value of
understand the relationship among price changes,
the offering.
volume changes, and profit improvements.
Mix hard quantitative analytical skills with softer Value creating– uncovering new applications for the
qualitative skills to inform pricing decisions offering that improves its value to customers.
meaningfully and enable action.
The Art of Pricing
PROFIT= QUANTITY (PRICE-VARIABLE COST)–FIXED COST
Refers to the ability to influence consumer price acceptance,
In comparison to any other variable under management, price adapt pricing structures to shift the competitive playing field,
has a larger and more immediate impact on profit than all and align pricing strategy to the competitive strategy,
other levels. marketing strategy, and industrial policy.
However, the impact of price on the firm is a double- It requires the understanding of consumer behavior and the
edged sword. influence of features embedded within the product, the
Just as a small improvement in price delivers a large perception of value, the expectation of customers, and the
increase in profits, a small degradation in price is price structure itself.
highly damaging to profits.
CHAPTER 1.1 EXCHANGE VALUE MODELS
A price has such a significant impact on profits, and
because it directly influences customer behavior, it Accepting that the right price lies within some range shifts the
deserves all if not more of the executive attention that challenge of pricing to identifying the boundaries of a good
it receives. price.
INFLUENCING PRICE CAPTURE Exchange Value Models
The right price is often not a single number, but rather a range Quantify the price boundaries.
of potential points that benefits both the customer and the The best-practice approach to identifying launch
firm. prices.
While some points are more beneficial to the firm and Knowing the boundaries of a good price narrows pricing
others are more beneficial to its customers, any point discussions to a reasonable range of potential price points.
within this range will mutually benefit both the firm
and its customers. 2 TYPES OF BOUNDARIES
3 STRONG PRESCRIPTIONS FOR ACHIEVING GOOD PRICES 1. EXTREME BOUNDARIES
1. Be informed. Define the range of acceptable prices outside of which no
2. Bargain High rational buyer or seller would ever transact.
3. Beware of Alternative Products
Marginal Cost– constitute the seller’s bottom line Sometimes, these alternatives are challenging to
identify, but they will always exist
-- any price below this leaves the seller
worse off than it would have been without the transaction
Consumer Utility– is the value a customer gains from internet: postal services, billboards, telephone books,
having the product. newspapers, magazines, radio, television
– All customers will be worse off after stent: cardiac bypass surgery, pharmaceuticals, bedrest,
a transaction if they paid more for the product than they exercise
gained in utility.
Inferior alternatives– are any competing alternatives that
Extreme Boundaries: Consumer Utility deliver similar benefits to the one under consideration with
less overall consumer utility.
Form Utility - Derives directly from the intrinsic properties of
the product itself. Define the narrow lower bound for pricing decisions.
Extending life thru the stent Differential Value– is the change in consumer utility that a
Enjoyment of drinking a tasty beverage product delivers in comparison to the alternative.
Place Utility - Derives from the ability to acquire the product in If the new product is superior to its comparable
a desired location. alternatives, the DV is positive.
Having the stent at a nearby hospital Exchange Value– the upper narrow boundary on price for
Drinking the beverage at a local cafe products to their nearest comparable alternative
Time Utility - Derives from the ability to access the product at price of the nearest comparable alternative adjusted
a convenient moment. for the differential value of the product.
The price that customers would pay for its nearest
Receiving the stent when coronary disease has been
comparable offer plus the value of the increased or
detected.
decreased benefits of the improved or degraded new
Drinking the beverage when thirsty product.
Ownership Utility - Gained from possessing the rights to the EV = PRICE OF COMPARATIVE ALTERNATIVE + DIFFERENTIAL
value of the product even if the possession is never actually VALUE
taken.
insurance coverage that would pay for the implant of
the stent when and if needed
The value of holding a beverage that can be either be
drank or resold.
2. NARROWER BOUNDARIES
Lie within the extremes that define the range of prices that are
most likely to encourage customer transactions and leave the
firm in the most favorable position.
Comparable Alternatives– Are solutions that
customers may have to accomplish the same or a
similar set of goals.
They may be directly competitive offers or indirect
substitute solutions to the challenges facing
customers.
For Cordis, the nearest offer to the Cypher drug eluting
stent was the standard metallic stent.
Narrower Boundaries: Comparable Alternatives
