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AICPA Interchange 2000: July 21

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Title: A Framework for Setting the Optimal Price Author: AMERICAN SOCIETY OF HOSPITAL Last modified by: Kevin Whorton Created Date: 1/2/1999 3:05:55 PM – PowerPoint PPT presentation

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Title: AICPA Interchange 2000: July 21


1
We Lose Money on Every Sale, But We Make It Up on
Volume Generating Association Profits With
Effective Pricing
  • AICPA Interchange 2000 July 21
  • Kevin Whorton
  • Director of Retail Programs
  • National Association of Chain Drug Stores,
    Inc.
  • General Manager, NACDS Services Corporation

2
Program Outline
  • I. Overview of Pricing Techniques/Tactics
  • II. Framework for Setting Optimal Price
  • III. Vignettes and Cautionary Tales

3
I Overview of Pricing Techniques and Tactics
4
Pricing Objectives
  • Will drive strategies and techniques
  • Maximize profit/financial surplus
  • Cost recovery
  • Maximize market size
  • Social equity

5
Pricing Strategies
  • Cost-oriented based on markup/target return on
    investment
  • Market penetration low introductory price
  • Build acceptance, forestall competition
  • Market skimming where market will bear
  • No foreseeable competition
  • Competitive price defensive, matching, or
    maintaining guaranteed low price
  • Prestige price intentional high/establish value

6
Common Pricing Techniques
  • Cost-plus pricing adding markup to achieve
    defined margin
  • Demand-oriented pricing consumer need sets
    price price level varies with demand
  • Line pricing price set for individual items,
    relative to other items within the line/brand
  • Price discrimination offer multiple prices
    within distinct markets/distribution channels
  • Other price points, loss leader, promo pricing

7
Price Setting
  • Existing services
  • Qualitative research
  • Quantitative methods--contingent valuation
  • Tradeoff (conjoint) modeling
  • Overall review of practices
  • New services
  • Price testing
  • Bundled/unbundled products

8
Pricing By Service Category
  • Services Under Development
  • Marketing involvement during product development
    process
  • Define ideal product
  • Determine its attributes
  • Forecast success of product with a variety of
    price points/strategies (measure opportunity cost)

9
Which Problems Apply to You
  • Too much/too little price variety in product line
  • Over-consistent pricing across categories with
    different costs associates, students,
    international
  • Internal resistance to hikes not business
    decision
  • Not bundled well with discounts for other
    services
  • Price level inconsistent with perceived value
  • Constant dues level over time, despite changes in
    services/components of membership

10
Potential Solutions
  • Varying solutions and potential returns
  • Direct changes in base dues
  • Bundling with products/premium membership
  • New categories (e.g. inst./multiple memberships)
  • Multiple-year and discounted memberships
  • Changing price for categories with higher/lower
    fulfillment costs (international, students)
  • Each change needs systematic review/evaluation
  • similar to new product development model

11
Communication
  • Make case for direct price changes
  • Marshal evidence of over/underpricing
  • Address underlying issues (e.g., cost
    allocations)
  • Build internal/external understanding/acceptance
  • ... or indirect price changes
  • Increase benefits, member discounts, premium
    giveaways, member-only services (if overpriced)
  • Unbundle benefits, lower member discounts, create
    premium level (if underpriced)
  • Continue to pursue a long-term strategy to change
    direct prices

12
Implementation
  • To succeed, maximize return on price changes
  • Communicate findings internally
  • Forecast results, re-evaluate effectiveness
  • Communicate to external audiences
  • The sales force chapters, recruiters
  • Current customers catalog, renewals
  • Prospects promotional materials
  • Position change as increased market
    responsiveness
  • Establish precedent ensure pricing is a
    marketing decision

13
Applications Membership
  • Typical scheme
  • Annual charge, no installments
  • Primary membership often political/by-laws
  • Line pricing for other categories
  • No volume discounts
  • Strategy for changes budget-balancing
  • Technique is cost-based
  • Full, not incremental cost

14
Application Member Dues
  • Identify pricing strategy/technique used
  • Determine if strategy is sub-optimal
  • Retention (by category) vs. benchmarks
  • Exit surveys frequency of value/cost as a reason
  • Satisfaction ratings based on value for price
    paid
  • Qualitative research, current members
  • Competitive scan/market penetration
  • Use file analysis total members by company, site
  • Positioning primary or secondary affiliation

15
Application Exhibit Fees
  • Far greater latitude multiple attendees
  • Split registrant fees from space rental
  • History rules working within budgets
  • Competitor intelligence
  • Potential for value-added pre-show lists, travel
    costs, all factored into budgets
  • Annual packages ads exhibitor fees
  • Willingness to trade certainty for higher price
    tag

16
Application Sponsorships
  • Typical scheme
  • Full, not incremental cost
  • Based on perceived WTP or need for specific
    program
  • Often linked to giving/donor relations
  • Altruistic motives vs. market access
  • Pricing the sponsor ask
  • Identify markets value to potential sponsor
  • Extensive use of add-ons
  • Specific deadlines for offers/auction to drive
    prices build-in exclusivity for high profile
  • Avoid frequent use of tiers

17
Application Certifications
  • Cost-plus pricing Full cost vs variable cost
    packaging and recordkeeping
  • Externalities lift for all education
  • Product line spinoffs, distance learning
  • Perceived value--new clients/higher income
  • Adjustments if problem signs (attrition rates)
  • Importance of lifetime value
  • Pricing for first and subsequent years
  • Pricing and penetration elite/prestige (low) or
    democratic/requisite credential (high)

18
II A Framework for Setting the Optimal
Price
19
Assumptions
  • You price to generate a profit
  • There is a direct relationship between price and
    demand
  • Cost is only one element used to establish the
    final price
  • Price is used as a basis for determining a
    products value

20
Pricing Floor and Ceiling
  • Your costs set the floor
  • The marketplace sets the ceiling
  • There is a range of acceptable prices in
    theory, only one is optimal

21
Components of Pricing Process
  • Pricing constraints and objectives
  • Demand, revenue, and elasticity
  • Cost, volume, and profit relationships
  • Pricing strategies
  • Factors in setting the specific price
  • Special adjustments

22
Pricing Objectives
  • Specify pricing goals that reflect your
    organizations strategic goals
  • Profit long-run, current, ROI
  • Sales total revenue, unit sales
  • Market share

23
Constraints
  • Determine the demand
  • Associations occupy niches/defined market
  • Look at competition assns and commercial
  • Is product/service truly unique?
  • Is there an expected price?
  • Anticipate the competitive reaction
  • Who are your competitors?

24
Constraints (cont.)
  • Establish universe size market share
  • Is the market large enough to generate adequate
    sales?
  • Is the universe stable? Growing or shrinking?
  • Determine the cost of producing and marketing the
    product or service
  • Production, marketing, fulfillment, overhead

25
Other Pricing Constraints
  • Newness of product stage in the product life
    cycle
  • Single product vs. product line
  • Cost of changing prices and the time period they
    apply
  • The competitive marketplace (monopoly vs.
    competitive)
  • Competitors prices

26
Demand Curve Factors
  • Consumer tastes
  • Price and availability of other products
    (preference set)
  • Consumer income

27
Typical Demand Curve
28
Revenue Curve
29
Price Elasticity and Demand
  • There is a relationship between the quantity
    demanded and price.
  • Elasticity is the change in quantity demanded
    relative to the change in price.
  • Price elasticity of demand (E) is
  • (Initial quantity demanded / New
    quantity demanded) /
  • Initial quantity demanded
  • (E) _______________________________________
    __
  • (Initial price - New price) /
    Initial price

30
What does this mean?
  • Demand is elastic when a small price increase
    produces a larger percentage decrease in quantity
    demanded. (Price elasticity gt 1)
  • Demand is inelastic when a small price increase
    produces a smaller percentage decrease in
    quantity demanded. (Price elasticity lt 1)
  • Unit demand elasticity- percentage change in
    price produces an identical change in quantity
    demanded

31
Factors Affecting Elasticity
  • The greater the number of substitutes, the
    greater the elasticity
  • Products and services considered to be
    necessities are price inelastic
  • Items that require large cash outlays compared to
    disposable income are price elastic
  • One way to measure elasticity is through
    year-to-year purchasing

32
Cost, Volume, and Profit Relationships
  • Pricing Terms
  • Marginal Analysis
  • Break-even Analysis
  • Estimating Demand

33
Terms
  • Profit Total revenue -Total cost
  • Total cost (TC) total production, marketing,
    and sales expense.
  • Fixed costs (FC) do not change with the quantity
    sold (rent, salaries)
  • Variable costs (VC) vary directly with the
    quantity sold
  • Variable cost expressed on a per unit basis it
    called unit variable cost.
  • Marginal cost (MC) is change in unit cost for
    producing and marketing one additional unit.

34
Marginal Analysis for Profit Maximization
  • To maximize profit
  • sell and promote your products/services as long
    as the revenue received from the sale of an
    additional product is greater than the cost to
    produce and market that product.
  • In theory, you want to operate up to the point
    where MR MC

35
Break-even Analysis
  • Analyze the relationship between total revenue
    and total cost to determine profitability at
    various levels of output.
  • The break-even point (BEP) is the point where
    total revenue total cost.

36
Calculating Break-even Point
  • Fixed Cost_______
  • BEPq Unit price - Unit variable cost
  • Answers question How many units do I need to
    sell to break even?
  • 55,000___
  • BEPq 35 - (10 8) 3235.3
  • Question units can we realistically sell?

37
Developing the Break-even Chart
  • Where P 35
  • UVC 18 (printing, distribution, storage)
  • FC 55,000 (development, marketing,
    salaries, OH)

38
Break-even Chart
  • Q TR TVC TC Profit
    ROI
  • (P X Q) (UVC X Q) (FC X TVC)
  • 1,000 35,000 18,000 73,000 (38,000)
  • 2,000 70,000 36,000 91,000 (21,000)
  • 3,000 105,000 54,000 109,000 (4,000)
  • 4,000 140,000 72,000 127,000 13,000
    10.2
  • 5,000 175,000 90,000 145,000 30,000
    20.7
  • 6,000 210,000 108,000 163,000 47,000
    28.8

39
Break-even Graph
40
Estimating Demand
  • Universe/market share
  • Example Membership category (N250)
  • 31,000 certified technicians
  • 15,000 take exam in 1999 (12,000 pass)
  • Approximately 1/3 are in the health-system market
    niche
  • Min. universe .33 x 43,000 14,190
  • Mkt share estimate 10 or 1,419

41
Estimating Demand (cont.)
  • Previous sales/similar products
  • Review sales of earlier editions
  • What external factors are affecting demand?
  • Examine sales of similar products
  • External research sales of competitive products
  • Internal research ask customers if theyd buy

42
Summary
  • Establish a pricing policy
  • Set your parameters and goals
  • Make assumptions
  • Use the tools
  • Draw on your experience

43
III Vignettes and Cautionary Tales
44
Sponsorship Effect On Pricing the Subsidized
Item
  • Grant in hand to subsidize program development
  • Net cost of development is zero
  • Developer wants to price low
  • What do you do?

45
Sponsorships Effect (2)
  • If net cost0, should you give it away?
  • Social objective of pricing strategies
  • Publicize your role as good guys
  • ORPrice where the market will bear
  • If you can make money, price based on gross cost
  • Product is a sponsorship magnet
  • Yet pricing should reflect perceived value

46
The Fait Accompli
  • What do you do when the price is established and
    the go/no go is GO
  • Illustrated Spinoff of an established product
  • Power resides with the product developer
  • Your own analysis yields profit 0
  • Probable outcome profit lt 0
  • What do you do?

47
The Fait Accompli (2)
  • De-emphasize the product
  • May be self fulfilling prophecy
  • Free/low-cost marketing options
  • Wait until the next round
  • Work on fixing problem for the next edition
  • Price-test the release forecast results
  • Prepare for markdowns in promotion plan

48
New Product Release
  • Product rollout begins in six months
  • Your charge develop pre-pub and rollout
    communications and pricing strategies
  • Marketing has autonomy over discounts, some
    control over rollout price
  • How do you determine pricing?

49
New Product Release (2)
  • Pre-pub allows some flexibility in price testing
    (validate your research)
  • Know your doubling day from product history
    drive your forecast
  • Dont pick at random, test price points
  • Pre-pub to price-sensitive segments
  • Consumer expectations/rollout price turnoff
  • Commit to using the pre-pub learning to adjust
    actual rollout price

50
Rapid Price Escalation
  • Underpriced good, with some uncertainty
  • Decision-maker sees product far underpriced
  • Sound basis on market data
  • Objective raise to market price, turn cash calf
    into a cash cow
  • What do you do?

51
Rapid Price Escalation (2)
  • One fell swoop
  • Understand elasticity
  • Avoid disrupting established buying patterns
    will people stay in the habit of buying?
  • Budget-based decisions dont outrun real
    willingness to pay
  • Communicate one adjustment year
  • Incremental multi-year gradual, less pain

52
Product Line Extension
  • Successful product needs milking
  • Decision expand product line
  • May be segmenting content for a niche
  • May be compiling discrete products or issues into
    a single volume
  • What do you consider in pricing?

53
Product Line Extension (2)
  • Considerations?
  • How much do components or single attributes
    contribute to value/how many are in product
  • Perceived value affected by media or content
  • What is the niche-specific demand
  • Are you being a cannibal?
  • Fit with long-term pricing strategy
  • Other approaches bundling, repackaging

54
Desperation Marketing
  • Got a dog to unload
  • May be low-pickup conference, underperforming
    book or product
  • Fire sale, on-site discounts are options
  • Must sunset the product/no questions asked
  • No current pricing process in place
  • What do you do?

55
Desperation Marketing (2)
  • Time to ignore cost data
  • How to exhaust inventory gracefully
  • Avoid aging your catalogs perception
  • Avoid hurting image product and other lines
  • Avoid future expectations of a white sale
  • Giveaways perform the social function
  • People perceive value from pricing
  • Understand why it tanked!!!

56
Membership Bundle
  • Association membership is under review
  • Each represents a bundle of goods
  • Board wants to re-evaluate what members get for
    their dues, and/or dues level
  • Service mix and membership categories last
    changed in the Truman Administration
  • What input do you provide?

57
Membership Bundle (2)
  • Evaluate value of components in bundle
  • Use a time-neutral perspective
  • Ignore history and competition for now
  • Integrate with an overall financial model
  • Loss leader, competition, or primary revenue
    source
  • Attribute all indirect member-caused revenue
  • journal ads, exhibit revenue, sales
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