Value Creation, part 2

1. Pricing and Product Strategy Value Creation, part 2

2. Price & Value Communication (Influencing price sensitivity . . . .) What is Price Sensitivity? Fundamentally, price sensitivity represents how important price is to aconsumer when making a purchase decision. The Problem: Consumer generally does not know true value unless informed by seller. Value communication is important when your product or service creates value that is not readily apparent to potential consumers. Value communication is nothing more than information dissemination. Develop value proposition, communicate the economic importance of the value proposition, and deliver the value.

3. Factors Affecting Price Sensitivity Perceived Substitutes Effect Buyers are more price sensitive the higher the product’s price relative tothe prices of the buyers’ perceived substitutes. This effect is based on buyers perceptions of substitutes. In many cases, a buyer may not be aware of substitutes (a new consumer product). In other cases, buyers may be fully aware of substitutes (specialized manufacturing equipment).

4. Perceived Substitutes Effect – Questions to consider . . . . • What alternatives are consumers (or segments of consumers) typically aware of when making purchases? • To what extent are consumers aware of the prices of those substitutes? • To what extent can consumers’ price expectations be affected by the positioning of one brand relative to particular alternatives, or by the alternatives offered to them. Consumers may have a large universe of alternatives available to them but are only aware of three or four alternatives. PF PF PD PA PH PC PC PB PE PE PI PG PG Reality Perception

5. Factors Affecting Price Sensitivity Factors Affecting Price Sensitivity Unique Value Effect Unique Value Effect Buyers are less sensitive to a product’s price the more they value anyunique attributes that differentiate the product from competing products. This effect is a basis for product differentiation. Many promotional messages attempt to lower buyers’ price sensitivity by promoting the unique product attributes that are embodied by their product(s). Companies that sell products with few, if any, unique attributes, will tend to belittle competitor products by suggesting the competitor product’s unique attributes are not so important (or unique). Thus, the price the buyer pays for the competitor’s product is too high.

6. Unique Value Effect – Questions to consider . . . . • Does the product have any unique (tangible or intangible) attributes that differentiate it from competing products? • What attributes do consumers believe are important when choosing a supplier? • How much do consumers value unique, differentiating attributes? How can one increase the perceived importance of differentiating attributes and/or reduce the importance of those offered by the competition? Common method to assess the unique value effect is to question consumers in order to identify unique attributes. After identifying unique attributes, conjoint analysis is used to determine how much the consumers value unique attributes in dollar terms.

7. Factors Affecting Price Sensitivity Factors Affecting Price Sensitivity Switching Cost Effect Switching Cost Effect Buyers are less sensitive to the price of a product the greater the addedcost (monetary and nonmonetary) of switching suppliers. The greater the product-specific investment that a buyer must make to switch suppliers, the less price sensitive the buyer is when choosing between alternatives. For example, if the product is complimentary to another product used by the buyer, then switching costs could be high (network software). Need to monetize sunk costs is often an issue. Marketing Elementary Education Civil Engineering Soil Science MAJOR Theatre

8. Switching Cost Effect – Questions to consider . . . . • To what extent have consumers already made investments (both monetary and psychological) in dealing with one supplier that they would incur again if they switched suppliers? • How long are consumers locked into investment expenditures? • Operating System Cost • Software Cost • Hardware Costs (peripherals) • Learning Curve Cost

9. Factors Affecting Price Sensitivity Factors Affecting Price Sensitivity Difficult Comparison Effect Difficult Comparison Effect Buyers are less sensitive to the price of a known or reputable supplier whenthey have difficulty comparing alternatives. Comparisons can be difficult for a number of reasons. These include lack of information, time constraints in gathering information on alternatives, and a lack of understanding of the product or service.

10. Difficult Comparison Effect – Questions to consider . . . . • PRODUCT EXAMPLE ______________________________ • How difficult is it for consumers to compare the offers of different suppliers? • Can the attributes of a product be determined by observation, or must the product be purchased and consumed to learn what it offers? • What portion of the market has positive past experience with your products? With the brands of competition? • Is the product highly complex, requiring costly specialists to evaluate its differentiating attributes? • Are the prices of different suppliers easily comparable, or are they stated for different sizes and combinations that make comparisons difficult?

11. Factors Affecting Price Sensitivity Price-Quality Effect Buyers are less sensitive to a product’s price to the extent that a higher price generally signals better quality. For some products, price represents a measure of quality. These types of products are either image products, exclusive products, or products without any other cues to their relative quality. Consider: Giffen Goods

12. Price-Quality Effect – Questions to consider . . . . • Is prestige image an important attribute of the product? • Is the product enhanced in value when its price excludes some consumers? • Is the product of unknown quality and are there few reliable cues for ascertaining quality before purchase? McDonald’s Menu Gourmet Restaurant Menu $42 meal $4 meal

13. Factors Affecting Price Sensitivity Expenditure Effect Buyers are more price sensitive when the expenditure is larger, either indollar terms or as a percentage of household income. This effect influences a buyer’s willingness to evaluate other alternatives. Buyers must make an effort to find means to reduce the price on high expenditure items. Often, the effort to reduce the price is not worth it to the buyer. This effect also captures the financial constraints of companies and households.

14. Expenditure Effect – Question to consider . . . . • How significant are consumers’ expenditures for the product in absolute dollar terms (for business buyers) and as a portion of income (for households)? High Speed Multifunction Laser Printers Low Speed Single Function

15. Factors Affecting Price Sensitivity End-Benefit Effect The end-benefit effect consists of two parts: the derived demand and theshare of the total cost. Derived demand is the relationship between the ultimate goal of a purchase, the desired end-benefit, and the buyer’s price sensitivity for something that contributes toward achieving that end-benefit. The more sensitive consumers are toward the end-benefit, the more sensitive they will be to the price of products that contribute to that end-benefit. Share of the total cost means that consumers are more (less) price sensitive whenever the purchase price accounts for a larger (smaller) share of the total cost of the end-benefit. Vacation Packages

16. End-Benefit Effect – Questions to consider . . . . • What end-benefit do consumers seek from the product? • How price sensitive are consumers to the cost of the end-benefit? • What portion of the end-benefit does the price of the product account for? • To what extent can the product be repositioned in consumers’ minds as related to an end-benefit that the consumer is less cost sensitive or that has a larger cost? Volvo Safety

17. Factors Affecting Price Sensitivity Shared-Cost Effect The effect of partial or complete reimbursement on price sensitivity. This effect recognizes the fact that consumers are less price sensitive when someone else is paying for the product or service.

18. Shared-Cost Effect – Questions to consider . . . . • Does the consumer pay the full cost of the product? • If the consumer does not pay the full cost of the product, then what portion of the cost does the consumer pay? • Note that fraud can sometimes results when consumers are aware ofshared-cost in the provision of goods and services. Examples include: • Insurance fraud (including Medicare) • Coupon fraud (creating coupon markets) • Rebate fraud (creation of false documentation)

19. Factors Affecting Price Sensitivity Fairness Effect Buyers are more sensitive to a product’s price when it is outside the rangethat they perceive is fair or reasonable given the purchase context. Buyers are more sensitive to a product’s price when it is outside the rangethat they perceive is fair or reasonable given the purchase context. • Three areas determine an individual’s perception of fairness in pricing: • How does the current price compare to prices previously encountered for the product/service? • What are the prices paid for similar products/services or in similar purchase situations? • Is the product/service is necessary to maintain a previously enjoyed standard of living (price paid to avoid a loss) or is purchased to get something more out of life (price paid to achieve a gain). • Three areas determine an individual’s perception of fairness in pricing: • How does the current price compare to prices previously encountered for the product/service? • What are the prices paid for similar products/services or in similar purchase situations? • Is the product/service is necessary to maintain a previously enjoyed standard of living (price paid to avoid a loss) or is purchased to get something more out of life (price paid to achieve a gain).

20. Fairness Effect – Questions to consider . . . . • How does the product’s current price compare with the prices individuals have paid in the past for products in this category? • What do consumers expect to pay for similar products in similar purchase contexts? • Is the product seen as necessary to maintain a previously enjoyed standard of living, or is it purchased to gain something more out of life?

21. Factors Affecting Price Sensitivity Inventory Effect Buyers’ ability to hold an inventory of a product for later use substantiallyincreases their sensitivity to temporary price deviations from what theyexpect in the long run. Buyers’ ability to hold an inventory of a product for later use substantiallyincreases their sensitivity to temporary price deviations from what theyexpect in the long run. Buyers’ ability to hold an inventory of a product for later use substantiallyincreases their sensitivity to temporary price deviations from what theyexpect in the long run. This effect is temporary (short run impact) and is generally transitory. This effect is especially influenced by buyers expectations of future prices (i.e., speculation). This effect is temporary (short run impact) and is generally transitory. This effect is especially influenced by buyers expectations of future prices (i.e., speculation). Wholesale Industries

22. Inventory Effect – Questions to consider . . . . • Do consumers hold inventories of the product? • Do consumers expect the current price to be temporary? Firelogs (Duraflame™) Many consumers buy large quantities of firelogs in October and November when the are on sale. They stockpile under the perceived notion that the firelogs will be more expensive during the colder months of winter. This leads to uneven monthly sales for an already seasonal product.

23. Framing of Prices The theory of price framing (prospect theory) suggests that consumers evaluate purchases in term of gains or losses, relative to a reference point. This idea is counter to some elements of economic theory, which suggest that consumers evaluate purchases by comparing the positive utility of having the good with the negative utility of the good’s price. Economic theory generally predicts that gains and losses of equal size are valued the same (linear), whereas prospect theory predicts that they are valued very differently (non-linear).

24. Framing of Prices Example 1: Which station would you purchase gasoline from, A or B? Station A - Sells gasoline for $1.30 per gallon, and gives a $0.10 discount if the buyer pays with cash. Station B - Sells gasoline for $1.20 per gallon, and charges a $0.10 surcharge if the buyer pays with a credit card.

25. Framing of Prices Example 2A: The U.S. is preparing for the outbreak of an unusual disease, which is expectedto kill 600 people. Two alternative programs combat the disease have beenproposed. Assume that the exact scientific estimate of the consequences ofthe programs are as follows: If Program A is adopted, then 200 people will be saved. If Program B is adopted, then there is a 1/3 probability that 600 people will besaved and a 2/3 probability that no people will be saved. Which of the two programs do you favor? CLASS RESULTS __________________________ OTHER RESULTS _________________________ [Choices involving gains make us risk averse…A-72%; B-28%]

26. Framing of Prices Example 2B: If Program C is adopted, then 400 people will die. If Program D is adopted, then there is a 1/3 probability that nobody will dieand a 2/3 probability that 600 people will die. Which of the two programs do you favor? CLASS RESULTS _______________________ OTHER TAKERS _______________________ [Choices involving losses make us risk takers…A-22%; B-78%]

27. Framing of Prices • Economic theory would predict that buyers should be indifferent to buying gasoline from either station. • Prospect theory predicts that buyers will prefer Station A because of the way it has framed the price. Station A suggests a higher regular price as an implicit reference pointfor buyers and then rewards buyers who pay cash with a discount, which is considered a gain relative to the reference point. Station B establishes a lower regular price as a reference point and then penalizes buyers who use credit card with a perceived loss.

28. Framing of Prices Value + Prospect Theory Value FunctionA mathematical perspective Value Function A Losses Gains Reference Point B Value -

29. Why is Price Framing Important to Marketing Managers? Why should I care? • Marketing managers can frame buyers’ reference points by affecting perceptions of what buyers perceive as their status quo (called the endowment effect). • Marketing managers can specifically frame decision outcomes in terms of gains or losses. • Marketing managers can frame multiple gains and losses as bundles that increase buyers’ perceived values.

30. The Endowment Effect The endowment effect relies on the notion that it is more painful for a consumer to give up an asset than it is pleasurable to obtain the same asset (or more). Thus, buyers are biased in favor retaining the status quo. Example: Let’s Make a Deal, Risk Aversion, and “The Monty Hall Paradox”

31. The Endowment Effect • Implication 1: It is easier to sell something if its price can be presented as an opportunity foregone rather than as an outright loss. (Advertising that indicates a product can be purchased with a tax refund relative to a regular purchase) • Implication 2: Price differences for the same product should always be presented as discounts from the higher price rather than as premiums over the lower price. • Implication 3: Decouple product acquisition and payment. This is the buy now and pay later or installment payments concept. (QVC, Home Shopping Network)

32. Framing Gains and Losses Promotional strategies used for high quality goods and services often attempt to frame the purchase context in terms of the loss associated with not buying the product or service rather than the gains from purchasing. Examples: American Express (don’t leave home without it) Home Security Systems InsuranceCopiers and Printers

33. Framing of Prices • Retailers often use percentage off, everyday low price, sales price, dollar-off savings, and other semantic lures to entice consumers to buy products. The retailers are attempting to set the base price high, then implement the words above to frame the purchase as a gain.

34. Managerial Analysis of Price Sensitivity • Key Points: • Consumer segments differ in their price sensitivity. • There is a need to identify suitable price ranges. • Analysis provides a prelude to price sensitivity measurement. • Integration of the ten price sensitivity effects is extremely important. Excluding one or more factors can lead to serious impacts on sales and profitability. Once the managerial analysis has been completed, combine the results with those of the financial analysis of costs.