Digital Pricing

5A3190 DMCMDavid Edmundson-Bird

Digital Pricing

• So what’s the problem?– You have to produce a digital marketing strategy poster– You have to create a market segmentation exercise– You have to describe a typical digital customer voyage– You have to produce a digital customer experience– You have to discuss user experience

Digital Pricing

• So what do you need to learn?– What the economics of digital pricing are– What decisions in digital retail pricing have to be made– How basic and dynamic digital pricing strategies work– How advanced pricing strategies work– How a digital business should respond to price-cutting at a

strategic level– How the digital pricing process works– How digital pricing works at each of the four stages of the

electronic customer relationship

The Effects of the 2 “I”s on Digital Pricing

IndividualisationIndividualisation InteractivityInteractivity

DIGITAL PRICINGDIGITAL PRICINGCustomer redevelops partsof the product to meetpersonal needs and wantsOrganizations provide targeted,individualized, customizedproductsStickiness as customers investtime and effort to personalize

Allows a larger buying and selling communityFacilitates dynamic pricing strategiesAllows prices to be changed easily Allows consumers to easily check pricesEasier to understand and measureconsumers’ reactions to price promotionsEasier to receive customer feedback onprice, understand customers’ willingnessto pay, and implement price-discriminationstrategies

Key Digital Pricing Strategies

RETAIL PRICEDECISIONS

RETAIL PRICEDECISIONS

BASIC PRICINGSTRATEGIES

BASIC PRICINGSTRATEGIES

DYNAMICPRICING

STRATEGIES

DYNAMICPRICING

STRATEGIES

ADVANCEDPRICING

STRATEGIES

ADVANCEDPRICING

STRATEGIES

Cyclical PromotionalPricing (Hi-Lo)Everyday Low PricingRetail/Outlet Pricing

Cost PlusBrand PricingPromotions

English AuctionsReverse-Price EnglishAuctionsDutch AuctionsFirst-PriceSealed-Bid AuctionsReverse First-PriceSealed-Bid AuctionsExchanges

Volume Discount PricingTwo-Part PricingBundling Price DiscriminationOver TimeFrenzy PricingThree Categories of PriceDiscrimination

WHAT ARE THE ECONOMICS OF DIGITAL PRICING?

Information Content Demand Example

Price Quantity Total

Revenue Marginal Revenue

12 0 0

11 1 11

10 2 20

9 3 27

8 4 32

7 5 35

6 6 36

5 7 35

4 8 32

3 9 27

2 10 20

1 11 11

0 12 0

£6

£12

£8

£2

£4

£10

Marginal Cost

2 4 6 8 10 12

PRICE

QUANTITY

Optimal Price(Q=4, P=8)

11

9

7

5

3

1

-1

-3

-5

-7

-9

-11

An adult’s semi-annualdemand for paid for content

Key Variables affecting Curve Slope & Position

Demand curves made of many inputs plotcustomers’ aggregated willingness to buy ateach possible price point

PRICE

QUANTITY

Price Price

Substitutes

Complementaries

Income

Market Size

Taste

Substitutes

Complementaries

Income

Market Size

Taste

Demand Curve Inputs• Price

– Price decreases, demand increases from market• Substitutes

– Close substitutes negatively affect chargeable price• Complementaries

– Their price affects digital product’s demand as much as its own price• Income

– Demand linked to consumer income• Market Size

– Growth in market positively affects demand• Taste

– Customer preference positively drives demand

Demand Curve Slopes & Degrees of Flexibility

• The slope of the demand curve determines an organisation’s flexibility in setting a price

No Pricing Flexibility Complete Pricing Flexibility

Quantity

Price

Quantity

(a) (b)

Industry Demand Curves

• Certain industries are more inclined toward one extreme type of demand curve than the other

• Luxury– Goods that buyers will purchase regardless of price

because there are no acceptable substitutes

• Commodity– Goods that are homogenous and have available substitutes

Using Demand Curves to Set Price

• Optimal pricing strategy is to choose the point on the demand curve where marginal cost is equal to marginal revenue

• Marginal Cost– Cost associated with producing one additional

product/service• Marginal Revenue

– Positive/negative amount created when price is changed by one increment

WHAT DECISIONS HAVE TO BE MADE IN DIGITAL RETAIL PRICING?

Cyclical Promo (HiLo) vs. Every Day Low Pricing vs. Retail/Outlet

• HiLo– High prices most of the time– Occasional low prices (Often lower than EDLP)

• EDLP– ED prices set low (lower than HiLo high price)– Occasionally prices are discounted

• R/O– Regular rarely discounted prices in main retail– Discounts at “outlets”

HOW DO BASIC AND DYNAMIC DIGITAL PRICING STRATEGIES WORK?

Basic Digital Pricing Strategies• Cost-Plus

– Add a fixed mark-up to the total cost of item• Target Profit Growth

– Fixed profit target: better margins through price increase or higher volumes through price decrease

• Target Return Price– Fixed return on capital achieved through price change

• Brand Pricing– Build a brand to charge a premium price

• Promotional Price– Regular discounting

Promotional Low Price Costing• Organisations often discount:• Trial

– Induce customers to experience benefits of new product/service• Rapid Acceptance

– Set low price as first mover advantage to stuff competition• Switching Costs

– Where switching is expensive, low lost induces customers• Loss Leaders

– Low prices in famous names/staples/seasonals leads to sales in higher margin product/service

Fairness in Pricing

• Matching the customer’s internally generated reference price with selected price

• Key components of reference price– Past prices, substitutes, context

• When to under-price– Market clearing price is higher than reference price,

financial relationship between buyer & seller• Where fairness counts

– Ongoing relationship between buyer & seller, where seller has significant power

Digital Dynamic Pricing

• Digital Economy allows for frequent & proactive price adjustment

• Prices can be easily changed• Buyers and sellers can interact and negotiate

prices

Digital Dynamic Pricing

• Auctions– English– Reverse-Price English (C2B invitation to tender)– Dutch (price drops until bought)

• Price cannot be influenced upwards, price starts higher than market value to claim profit

– First-Price Sealed Bid

• Exchanges– Commodity owners meet to exchange goods– Host receives commission

HOW DO ADVANCED PRICING STRATEGIES WORK?

Price DiscriminationCharging different prices based on willingness to pay

PRICE

DISCRIMINATION

First Degree — Charge consumers exactlywhat they are willing to pay for product –haggling)

Second Degree — Charge consumersexactly what they are willing to pay forfirst unit of good as well as additionalunits – e.g. volume pricing

Third Degree — Divide customers intodistinct segments, charging different pricesto different segments

Volume Discount vs. Two-Part Pricing

• Strategies used to charge consumers what they are willing to pay for each additional item purchased

• Volume Discount– Decreases the purchase price of an item as the quantity

purchased increases• Often associated with minimum purchases in fixed period

• Two-Part– Charges a one-time fixed fee and an associated variable

charge for each purchased item• Often associated with subscription fee models and zero-cost of

production

Two-Part Pricing Implementation

• Need to understand each individual customer’s price curve

• Need to determine optimal number of products to sell to each customer

• Need to calculate how much customer is willing to pay for product and set fixed & variable prices to encourage them to purchase optimal number

Bundling

• Packaging several items together under one price

• Pure Bundling– Packaging together complementaries which are

only offered as part of a bundle• Mixed Bundling

– Offering items as either component pieces or as a bundle which discounts each item

HOW SHOULD A DIGITAL BUSINESS RESPOND TO PRICE-CUTTING AT A STRATEGIC LEVEL?

What Motivates Price Cutting?

• A tactic used to gain market share• Motives

– Trouble• Desperate attempt to raise cash, or signal to

competitors an interest in being acquired– Industry Leader

• Show of strength to indicate organisation is doing well enough to withstand the lower prices

– Displeasure• To punish a competitor for a change in its strategy

Responding to Price Cuts

ENHANCE VALUEPROPOSITION

ENHANCE VALUEPROPOSITION

BATTLEBATTLE

JUSTIFY PRICEDIFFERENTIAL

JUSTIFY PRICEDIFFERENTIAL

GENERALPRICE CUT

GENERALPRICE CUT

TARGETEDPRICE CUT

TARGETEDPRICE CUT

CROSSPARRY

CROSSPARRY

FIGHTERBRAND

FIGHTERBRAND

Enhancing the basic product with additionalfeatures such as extended warranties, additionalservices and the inclusion of ancillary products,but maintaining the price so that total customervalue increases

Communicating the differential benefits offeredby the organisation that justify a higher pricethan the competition

Match the competitorscut as an aggressiveshow of strength

Focused efforts towardcompetitor’s primarygeography or product

Discounts offered onlyto vulnerable customers

New products developedto appeal to vulnerablecustomers

HOW DOES THE DIGITAL PRICING PROCESS WORK?

What to do and not to do• Don’t discount unless you have to.• Offer options! Some people will want basic functionality while others will

want super-functionality. • Some segments will value your product more than others. Try to price

accordingly.• Customers do not like companies to charge different prices in different

channels for the same product without proper justification.• Many organisations have been burned by changing prices only to be met

by a full-fledged price war by outraged competitors.• Brand strength or adding extra features (e.g., free upgrades) may temper

the need to discount price.• Goodwill is important in maintaining relationships, but think about

whether you are giving up too much in terms of price. Customers may remain loyal even if you don’t offer them the 10 percent discount

The Digital Pricing Pentagon

DETERMINESELLING

STRATEGY

DETERMINESELLING

STRATEGY

SET PRICINGGOALS

SET PRICINGGOALS

DIGITALPRICING

PROCESS

Develop PricingSegmentation

EstablishProductValue

ChallengePricingMindset

EstimateCompetitorReaction

Test FinalMarket

Equilibrium

Strategic Segmentation: Expanding & Increasing

Expanding the customer“sweet-spot” through

versioning

Increasing customer densitythrough pricediscrimination

ORIGINALTARGETMARKET

ExpandedTarget Market

Pricediscriminationincreasesdensity

Estimate Competitor Response

• Avoid setting a price that leads to a price war• Set potential prices

– Use scenario planning– Must be real prices you could charge

• Guess what competitor reaction would be to each one– Will they aggressively react, minimally react or accept?

• Estimate your final price and hypothesize competitors’ final price points

Test Final Market Equilibrium• Final price and volume

points give your estimated demand curve

PRICE

QUANTITY

Hi

Medium

Low

Hi Medium Low

Derived fromestimated marketshares

Digital Pricing Strategy FrameworkRETAIL PRICE

DECISION

HiLo EDLP R/O

Select Digital Pricing Strategy

No PricingFlexibility

No PricingFlexibility

CorporateMandate

CorporateMandate

High InitialDemand

High InitialDemand

CorrelatedDemand

CorrelatedDemand

DynamicPricing

DynamicPricing

Price asMarketingStrategy

Price asMarketingStrategy

Price at market

Price at market

Target return pricingTarget profit return

Target return pricingTarget profit return

Fairness pricingBundlingFrenzyPrice discrimination over time

Fairness pricingBundlingFrenzyPrice discrimination over time

BundlingVolume DiscountTwo-Part

BundlingVolume DiscountTwo-Part

English, Reverse & DutchFirst-price sealed-bidReverse first-price sealed-bidGroup buyingElectronic exchange

English, Reverse & DutchFirst-price sealed-bidReverse first-price sealed-bidGroup buyingElectronic exchange

PrestigeSign of QualityPromotional

PrestigeSign of QualityPromotional

HOW DOES DIGITAL PRICING WORK AT EACH OF THE FOUR STAGES OF THE ELECTRONIC CUSTOMER RELATIONSHIP?

Digital Pricing Levers & 4 Stages of ERM

Acquisition Conversion Retention Dissolution

Click-through promotionsDigital Presence-referralpromotionsSpecially negotiatedpromotions (e.g., hotels)B&C promotionsDigital-only price discountsBundleFrenzy pricingPrestigePrice as a sign of qualityHi-LoDynamic pricing EDLP

Targeted PromotionsFuture price promotionsJustify pricesLoyalty programs

Tiered loyalty programsWide variety ofpricing plansBecome affiliatesProfit-enhancing programsVolume-discount promotionsTargeted promotionsFuture price promotionsFairnessTwo-part pricingEDLP

Discontinue pricing promotionsReconfigure loyalty programsDecrease profit programs

What We’ve Covered Today– We’ve looked at what the economics of digital pricing are– We’ve seen what decisions in digital retail pricing have to be made– We’ve looked at how basic and dynamic digital pricing strategies work– We’ve looked at how advanced pricing strategies work– We’ve explored how a digital business should respond to price-cutting

at a strategic level– We’ve investigated how the digital pricing process works– We’ve seen how digital pricing works at each of the four stages of the

electronic customer relationship