Pricing

Question 1

How do you handle facility-level cost in ABC costing?

Answer 1

We don’t typically include it when doing ABC costing. Focus is on activities and it’s a choice to exclude facility costs.

Question 2

What is the ratchetting effect?

Answer 2

That there is a performance pressure on people and companies. Meaning that if you had a bad year, you would often be pressured to decrease only a tiny bit, or nothing at all. However, at good year will lead to a big increase, meaning it ratchets upwards more than downwards.

Question 3

What are six wrong assumptions of pricing?

Answer 3

1) Cost + Pricing: Costs determine price
2) Pricing profit correlation. Small price changes have little impact on profit
3) Price sensitivity - You cannot increase prices: because of high price sensitivity
4) Differentiation: Products are difficult to differentiate: Simply be slightly below your competitors’ prices
5) Market share: High market share leads to high profit
6) Pricing management: Means changing prices

Question 4

What’s cost-plus pricing?

Answer 4

Cost + a margin (mark-up)

Question 5

The “cost determine price” death trap is? And what types of markets affects the price how?

Answer 5

Cost <-> Volume <-> Price.
The effect that Cost, volume, price all affects each other.

Cost plus pricing means that increase in volume -> decrease in cost -> decrease in price -> increase in volume -> decrease in cost etc.

OR the other way around.

Market in product doesn’t sell well -> Increase price -> decreases volume further -> increases costs -> increase price -> decrease sales etc.

A strong market makes us undercharge

A weak market makes us overcharge

Question 6

What is the thing about WTP and costs?

Answer 6

There is no relationship between costs and willingness to pay. But it does however provide the lower boundary for our prices.

Creation of high customer value allows high prices, even if costs are literally zero.

Question 7

What is total cost of ownership (TCO)?

Answer 7

Costing the equipment/product over the total lifetime of the equipment/product.

Question 8

What is a USP?

Answer 8

Unique Selling Proposition

Question 9

What lever is the most efficient in profit?

Answer 9

Price! Improving it 1% has a 22% impact on profits!

Much more than reduction in SG&A (Selling, general and administrative expense)

Question 10

Are markets always price sensitive?

Answer 10

No! Think McDonalds vs. Joe and the Juice. You can have high prices in a low-price sensitive market.

Question 11

Some say “Products are difficult to differentiate: Simply be slightly below your competitors’ prices” – is this true?

Answer 11

No! Even commodities like gasoline can be differentiated (think shell V-power or oats that vary by 100% in price even if they are both ecological)

Question 12

What is CAPEX?

Answer 12

Capital Expenditure – The beginning of a production/project: Think setting up a facility (buying on equipment etc.)

Question 13

What is OPEX?

Answer 13

Operational Expenditures – The costs associated with operating a project/production/facility

Question 14

What lever is the most powerful tool for profit?

Answer 14

Pricing is by far the most efficient lever! 1% increase leads to 22% impact on profit according to McKinsey 2019. Remember this also goes the other way around if you decrease prices.

Question 15

“My product is identical I can’t differentiate” – wrong. Why?

Answer 15

Everything can be differentiated! From gasoline to oats. It’s all about branding and marketing.

Question 16

Does a high market share lead to high profits?

Answer 16

No! You still need to be aware of pricing.

Question 17

Price management means what?

Answer 17

Pricing Management means arbitrating between units that have different influence on pricing decisions, conflicting views on how to price (sales -> discounts, accounting wants to control discounts) and relevant data for market pricing decisions.

Question 18

What is pricing management really about?

Answer 18

Pricing Management is about generating pricing power:
§ Understanding customer’s needs better than them
§ (and translate such knowledge into products/services -> psychology ofpricing)

Question 19

What is anchoring?

Answer 19

Setting a price to establish a baseline for a price range. Think: Showing a crazy expensive wedding ring before selling a ring, makes us think the others are less expensive.

Question 20

What information should firms primarily use when pricing?

Answer 20

Firms should primarily use value information but tends to also use cost information.

Question 21

What is the information problem in pricing?

Answer 21

• Value information is more uncertain and less explicit than competitor and cost information.
• Customers are unwilling to disclose value information.
• Discounts disguise market prices.

Question 22

What does Thrane, 2018 explore?

Answer 22

How are prices set

Question 23

Is intuition a factor in pricing?

Answer 23

Unfortunately, yes!
* Intuition may speed up pricing decisions and take tacit clues into consideration.
* But intuition is subject to bias and heuristics.

Question 24

Why is systematic analysis for pricing not necessarily the best if used stand alone?

Answer 24

• Systematic analysis has difficulty in taking tacit clues into consideration and is error prone when history has irregular variances.
• Access to cost information may hinder learning from the market

Question 25

Pricing is good with what two types of concepts used?

Answer 25

Research shows pros and cons of systematic and “intuitive” processing of information.

Question 26

What is the control problems in pricing? What is the solution?

Answer 26

• Relational pressure from customers makes sales employees take path of least resistance and grant (too high) discounts.
• Often turnover and not margins are rewarded.
• Sales however have more detailed understanding of customer needs, customer heterogeneity etc.
  => Research indicates that a medium level of decentralization in pricing improves profits.

Question 27

What is the coordination problem in pricing?

Answer 27

• The different functions and units involved in the pricing decision all possess relevant knowledge.
• Not all of this knowledge is present in one IT system.
• Information needs to be transmitted to decision maker in order to coordinate cost, market, capacity and strategic considerations

Question 28

Why is pricing not just easy?

Answer 28

Pricing is a complex process involving multiple parts of the organizations.

In the pricing process, different practices take place such as:

• Actors share information.
• Evaluate information using intuition and rational processing
• Controlling and pressuring sales to maintain prices.
• Coordinating cost, capacity and issues of fairness
• Interact with pricing and revenue systems.

Question 29

What does pricing practices help firms with?

Answer 29

Dealing with information, control and coordination problems.

Question 30

Why are pricing of services hard?

Answer 30

• Intangibility & perishability of services (relating back to IHIP)
• Customers lack information and use price as a proxy to gage service quality
  “…customers want to feel they are getting at least as much as what they are paying”

Question 31

How do you make good pricing for a service?

Answer 31

Clearly relate price to value that customers receive
Customers need to:
a) Understand what it is that they are getting
b) Understand how that is valuable for them
c) Understand how much the price for this service is
-> and all of this as easy and straightforward as possible

Question 32

What are three ways of doing pricing of services according to Berry & Yadav 1996?

Answer 32

1) Satisfaction-based pricing: Reduce customer uncertainty -> Guarantees (if this outcome doesn’t happen, we will refund/fix it), benefit-driven pricing, flat-rate pricing.

2) Relationship pricing: Foster profitable long-term relationships: (Rebates – can be detrimental for profits though, be wary), Long-term contracts, Price bundling.

3) Efficiency pricing: Pass operational savings on to customers: Use activity-based costing (a lean cost structure that makes it hard to imitate)

Question 33

What is Satisfaction-based pricing?

Answer 33

Aim: Reduce customer uncertainty

Pricing Measures:

• Guarantees (if this outcome doesn’t happen, we will refund/fix it)
• Benefit-driven pricing (pricing the aspect of the service that directly benefits customers. Think Zoom is free until you need more than 45 minutes. This benefit is priced)
• Flat-rate pricing. Alleviates customers’ uncertainty by agreeing on a price be-forehand – the service provider assumes the risk of any cost overruns

Question 34

What is Relationship pricing?

Answer 34

Aim: Foster profitable long-term relationships

Pricing measures:

• Rebates to initiate relationships – can be detrimental for profits though, be wary.
• Long-term contracts: Long-term contracts offer customers price and nonprice incentives to enter into multiyear relationships
• Price bundling: Selling two or more services bundled together

Question 35

Efficiency pricing is?

Answer 35

Aim: Pass operational savings on to customers

Pricing measures:

• Use activity-based costing (a lean cost structure that is hard to imitate, then pass operational savings on to customers)

Question 36

Why is the zoom model smart?

Answer 36

Zoom creates a need by putting limits of meetings (40 min) making you want to buy the subscription

Question 37

What is consumer surplus and acquisition value?

Answer 37

Consumer surplus: The difference between price and the utility (and feeling) of the object purchased. Think: “I made a really good buy”

Question 38

What is producer surplus?

Answer 38

Difference between price and the utility (and feeling) of the object sold. Think: “I made a really good sell, can’t believe they would buy it at this price”

Question 39

What is transaction value?

Answer 39

The perceived quality of the deal, price in relation with (see the rest on the slide)

Question 40

Does pricing depend on situations?

Answer 40

Yes! Think beer on a beach vs. beer at a kiosk. The Acquisition value will not be identical, meaning you can charge differently and still have a consumer surplus in the acquisition value.

Question 41

What is the value function?

Answer 41

S-shaped curve showing the relationship between losses, gains and the perceived value.

It shows that people like gains, but hate losses more (meaning they’ll be less likely to take losses)

Question 42

What is an econ?

Answer 42

Imaginary creatures that economics are based on “Economic Mr. Spocks” – no emotion, distraction or self-control issues.

Question 43

How would an econ react to certain financial situations?

Answer 43

• Sunk cost are ignored
• Time consistency
• More choices are better than fewer.
• Opportunity cost determines decision-making.

Question 44

When are people more likely to accept for example a reduction in wages?

Answer 44

Fairness principle! If the unemployment is high and the company is loosing money. NOT if it’s earning money.

Question 45

What are some defense for high prices in pharma?

Answer 45

1) High prices are necessary to fund expensive R&D projects for new drugs
2) Research costs of unsuccessful drugs also have to be taken into account; drugs may also fail in advanced testing stages
3) High administrative costs: Providers face a huge array of usage and billing requirements from multiple payers, which makes it necessary to hire costly administrative help for billing and reimbursements

Question 46

What are some critique for high prices in pharma?

Answer 46

1) Citizens of other rich, developed nations spend 56% of what Americans are spending on exactly the same drug
2) “Basic economic principles suggest that drug prices should be going down, not up: For most drugs, manufacturing volumes are increasing, and little new research is being conducted on those already on the market.”
3) “Many pharmaceutical companies spend more on marketing their products than R&D”

Question 47

What are three ways of approaching “fair” (not really) pricing in pharma?

Answer 47

Prices under the price ceiling considered “fair”
1) Price floor to cover costs and a ‘sustainable’ profit margin in all markets (no differentiated pricing) -> Meaning low income countries can’t pay as the price is above the price ceiling.

2) Price ceiling depending on buyers and their access to resources (distributing costs like R&D costs over countries according to their ability to pay) -> Meaning everybody can pay a “fair price” as it is under price ceiling in all regions.

3) Uncoupling R&D expenses from pricing -> Meaning it’s unsustainable for the pharma company

Question 48

Is pricing in pharma easy?

Answer 48

NO!

• In most countries, prices for drugs and healthcare are (at least partially) controlled by the government. In the US, prices depend (largely) on market forces.
• There is also a highly complicated system of rebates, insurance, state/pensions/union/veteran/… benefits, private programs,…