So today we're going to talk about pricing devalue as part of our go-to-market strategy. So let me just give you a little bit of an overview of where we're going to go. I'm going to start out by giving you some pricing puzzles, and some cute things that go on pricing. Then we'll talk about a framework for how to understand, how to set a price. And then we'll spend a little bit of time on customer price sensitivity and how to measure it and how to understand it. That's going to be our road map for these next few sessions. Let's begin with some motivations and some puzzles. And before I say this, pricing is probably one of the key things to really think about in marketing because often times prices are made really really arbitrarily. So I see that competitor one is charging 40 US dollars competitor two is charging 20 and so I just choose 30, no really rhyme or reason to it. Or people engage in cost plus pricing, many things that they shouldn't be doing, and what we want to do in this session is to think about the right way to set a price. So let's begin. Here's a little bit of motivation for you from a study that was done by the McKinsey Company that looked at various things that firms could do, over 2,000 companies, to improve their operating profits. They could improve their fixed cost position, they could improve their variable costs and so on. But the thing that they did that had the most impact, if they were able to improve their final realize price by only 1%, they were able to increase their profit operating profit by about 11%. So price is such a critical level, and it's one that we often get wrong, so let's keep that in mind as we go through. Here are some puzzles just to give a sense of all of the interesting things that go on in pricing. The first one is for a company called Trader Joe's. It's a company that sells a lot of private label product. I believe it's owned by some German brothers, operates in the United States all over the country, there's one here in Philadelphia. Now as Barbara told you in branding, there are both national brands and private labels. Most of what Trader Joe's sells are private label products. So one of the products that I like there is they sell goza a dumplings that I can buy and I can steam and I can eat them. Now let's imagine that those dumplings cost me about $3.99. Now that's all well and good because I like the dumplings, but somehow I start scratching my head and I say, gee you know, is $3.99 really a good price for those dumplings? And I face a problem. The problem I face is I can't find that product anywhere else, because it's a private label. So I don't really know is it a good deal or a bad deal. If I'm paying $2 for a can of coke, I know that's a bad deal, and I know the store's ripping me off. So Trader Joe's recognizes that I have this inference problem, so what do they do? They take a very very common product like bottled water that's available everywhere and then price it at an extremely low price all the time. So when I come into the store and I see that the bottled water, a product that I can compare that's available everywhere, I see that that's priced very low, that gives me some confidence that the products I can't compare are also fairly priced. So this example is showing how sometimes as companies, we want to signal through one kind of product, that we're a good seller. That we offer good values. That's an example of using a product to signal the value for the entire product line. A similar example, if we think about a company like Wal-Mart. Why is it that you might find some Tide detergent there for $4.73 or another product for $2.81, these weird kind of a endings? So in the US at least, most prices end in either a nine or a five, and the idea that Walmart here is ending their prices in fours and threes and ones and sevens, is they're trying to send you a message that they've squeezed out every possible cent that they can to deliver the best possible value to you as an in consumer. So that's another example of using the product price to send a signal. The final one I'll share is a very interesting study done by a friend of mine from New Zealand who teachers at the Sloan management school up there at MIT. And my friend Duncan did an experiment where he sent out shoe catalogs to people all over the United States. Half the people received a catalog and a picture of a pair of shoes and the price was $44. The other half of the people, this is thousands of peopl,e received an identical catalog except the price of the shoes was $49. Now economics 101 tells us that as the price goes up demand should go down right, but Duncan found exactly the opposite. More shoes were sold at $49 then at $44. And why is that? Because when you see $44 the way you encode it psychologically is, gee, that's kind of a weird price, I don't normally see 44. Thats like 10% more than 40. But when you see 49, you feel like that's a discount from 50. And so what I'm trying to indicate through these examples is the price is more than just a number that indicates what you have to pay. It sends all kinds of other signals, and that's going to be one of our themes as we go through. So how do we set prices and what's the right framework? There are four inputs to pricing. First of all we need to think about the marginal cost of the product I'm going to call that the floor. Obviously we don't want a price below the floor or at least not for too long. Then we need to think about the ceiling which is the customer willingness to pay. So number one is the floor, number two is the ceiling, the customer willingness to pay. But you can't always charge people their absolute maximum willingness to pay. Why is that? Because of competition. So competition is going to be the third factor that will drop the possible ceiling. If my customer is willing to pay $10 but he can get that product from a competitor for six, then that's going to drop my price from ten down to six. And then number four is the amount by which prices have to be raised from marginal cost to give some money to distributors or re-sellers to motivate them to sell it. So those are the four key inputs to pricing that we're going to go through by way of example. I'm also going to show you a couple of examples of something called economic value to the customer. This is a very, very important concept. And first example, well the only one I'm going to show is something that might be useful for you, those of you who like to eat chicken wings. There's a product called the wing dipper. And the wing dipper is a place where you can put the dip within what you want to, to dip your chicken, chicken wings. I guess it turns out when people eat chicken wings, I don't eat it a lot myself. I guess they spray the dip around, or they make a mess. And so therefore the restaurants are losing a lot of money whereas if they had these wing dippers, the wing dipper controls the amount and based on the size of your restaurant and the amount of wings that get eaten you can calculate as a restaurant what the economic value of this product is. So many times in your communication you're thinking about the economic value to the customer and trying to say that in a persuasive or informative way. Okay, so now let's think about this pricing framework of the cost the customer willingness to pay the amount that collaborates sorry competitors will bring the price down and collaborators will bring the price up through some examples. Let's relate the five C's of marketing: customers, company, collaborators, competitors, and context, to the pricing decision. So first of all from a company point of view when your setting a price you might need to think about financial considerations what's my required internal rate of return. You certainly need to think about consistency in the product line so sometimes you might have a good better and best product. So the price that I'm going to charge for the Toyota Camry is somehow going to be related to the price that I'm charging for the Toyota Corolla. So you need to think about spacing out the prices in a way that's consistent. And then thirdly you need to think about your own existing image so it may be very very difficult for Walmart who has a low price image to sell really really expensive stuff. Similarly it may be very very difficult for Sak's 5th Avenue to sell things very very cheaply because that's also inconsistent with their overall image. So those are three things that are very important to think about from a company point of view. From a competitor point of view there's a whole raft of things, but here's the three most important. The first thing you need to think about is that when you set your price, how will your competitor respond? Will your competitor respond extremely aggressively and take whatever your price is and cut below it? Is the competitor going to do things that are rational, does the competitor have a deep pockets and so on. So the first thing is how aggressive is this competitor. The second thing you need to think about is when you do something in the market with your price how is that competitor going to respond? Are they going to respond by improving their advertising, their product or their distribution, the other 3 P's, or are they going to respond on the basis of price that's the second thing you need to think about. And then thirdly you need to think about your position and the competitors position. So if you're the market leader, in some sense you have a responsibility to try and keep your prices high. If you're a follower you might have a different kind of strategy. So those are three important things with respect to competitors that dictate what you want to do with your pricing. When it comes to collaborators, collaborators or distributors, they care a lot about margin, but they also care about their return on assets, and we'll be talking about that a little bit later on. So are you pricing in such a way that allows the collaborator or distributor who's selling your product to turn the product frequently enough? And finally we come to the customer. The customer issues are probably the most important. So this is where I'm going to spend the most time, and the key idea is customer price sensitivity. In terms of economics, this is sometimes referred to as a price elasticity. You might remember this from your high school or college education days. In economics, price elasticity just means the following: if I raise the price by 1% by how much does demand drop? So if I raise the price of my product by one percent and demand drops five percent that means that the product is highly elastic, there's a lot of stretch to the price. If I raise the price one percent and demand only drops 0.2 of a percent, that means that the product is very inelastic, very very little stretch. If I have an inelastic product, I might be able to raise price. If I have an elastic product I might want to drop price. So we're going to get into how as marketers we actually measure that beyond the economic concept of price elasticity. A second thing we're going to talk about are psychological issues. Now we can spend weeks on this. We won't spend weeks on this because we don't have all of that time. But I want to introduce you to the most important psychological phenomena. The first thing is the ending of the price. Whether it's an odd ending or an even ending. I'll also talk a little bit about something called mental accounting. How we think about price in our minds. I'll give you a short summary of a very famous psychological principal called Prospect Theory or psychological theory. Actually a noble prize winning theory that has some very very interesting implications for pricing. And then finally another psychological principal called the endowment effect. [MUSIC]
