Using Pricing and Choice Theory to your Advantage

1. Using Pricing and Choice Theory to your Advantage Thinking Strategically, Thinking Differently Strategic Marketing Workshop

2. This session …. • How do we build on what learn from state-of-the-art thinking on (i.e., additional considerations): • Pricing • Choice Theory and Behavioral Economics

3. Underlying Economics and the Impact of the External Business Environment

4. Minimum Efficient Scale (MES) The impact of Underlying Cost Structure Contestable Markets Theory Barriers to Contestability The Advantages of Scale Strategic Implications Background on Fundamentals and Business Cycles:

5. Minimum Efficient Scale Long run average cost Industry demand at $200 + EP = 1,500 units What is the equilibrium # of firms producing in this industry? $200 Volume 750

6. Impact of Declining Long Run Average Costs Long run average cost Now, what’s the equilibrium number of firms?! $1,200 $100 Volume 750 1,500

7. Contestable Market Theory and Deregulation Costless “Hit and Run Entry and Exit” Absence of Barriers to Entry Even monopolies will act like a firm in a perfectly competitive industry Was the basis for deregulation of telecommunications, commercial aerospace, etc.

8. Barriers to Contestability Gate space restrictions Airport landing rights and fees Capital Markets Airline manufacturers?

9. Strategic Implications What does this suggest for the future of commercial aviation? Does all of this have implications in a DoD environment?

10. A Challenge to Think Differently … Compete for Profits, not Customers!

11. Markup and Target Return Pricing Markup Pricing: Unit CostMarkup Price= (1- Desired Return on Sales) Target Return Pricing:Price = Unit Cost + (Desired Return x Invested Capital) Unit Sales

12. Conceptually: Customer Value Cost Plus

13. But Beware … Important Caveats Price is the easy lever, but should be lever of last resort unless dictated and decided by strategy Harry Stonecipher: “If all we do is lay ‘Bags of Gold’ at the customer’s feet in order to win the sale, we are in deep trouble …” Putsis and Tipping, HBR, study on sales force’s beliefs Are there other levers, either strategic or choice, that can be used to either forestall or alleviate price and margin erosion?

14. Example: The Winner’s Curse

15. The “Winner’s” Curse # of people X X Expected Note X X $5 $10 $20 $50

16. Other important pricing considerations … • Role of online markets • Use of conjoint analysis • Bundling, tying • Options pricing Question: If the 787 “skyline” is sold out so far into the future, has money been left on the table? Has an annuity been left on the table? Has BCA been “vindicated” by recent economic events?

17. This session …. • How do we build on what learn from state-of-the-art thinking on (i.e., additional considerations): • Pricing • Choice Theory and Behavioral Economics

18. Let’s Begin with Some Basics … Capturing Customer Value Product, Promotion and Distribution are a firm’s attempt to create value of their products/services in the marketplace. Pricing is an attempt to capture some of the value. New trend: Demand-sensitive pricing Example: Coke and vending machines

19. More to think about … • Prospect Theory and Coke Vending Machine (HBS) • Coke on the beach example (R. Thaler) • Weight-loss strategies (Wansink, et al.) • Tipping on the road (R. Frank) • Salient Differentiators (BA)

20. Prospect Theory Value Losses Gains Kahneman and Tversky 2002 Nobel Memorial Prize in Economic Sciences

21. Attraction effect – would you buy this? • Bread maker • 2.0 lb. loaf • $ 175

22. Sales went up 100% Now? • Bread maker • 2.0 lb. loaf • $ 175 • Bread maker • 2.5 lb. loaf • $ 250

23. Contrast Effects and the $175 Hamburger Chef Kevin O'Connell seasons his Richard Nouveau Burger. The burger is $175 and consists of truffles, foie gras, kobe beef, aged gruyere cheese, wild mushrooms, golden truffle mayonnaise and is topped with gold leaf. WHY???? To sell the $50 steak!!!

24. TurboTax versions: Compromise Effect Example Implication: Think about how your product line design and pricing influences customer choice! Slide courtesy Dr. Sridhar Balasubramanian

25. Hyundai Job Loss Protection Less than 100 cars were returned in total … http://www.foolsandsages.com/2009/01/14/ad-watch-hyundai-return-policy

26. New product introductions and anchoring: How would you react at $28,000? $40,000+ price tag?

27. New product introductions and timing: $180m in just 18 months

28. B 75% LEAN Framing effect: What would you live with? A 25% FAT Managerial implication: How a product is framed or described influences how people think about the product!

29. How does all of this apply to the Boeing Company? To BDS? Take 5 minutes to discuss at your tables … • Services? • Concept of a “Service Recovery” (2 3 times as many “satisfied customers”

30. Business that Defies Logic* So far, these are all demand-driven examples … what about supply effects???

31. A good hockey player plays where the puck is. A great hockey player plays where the puck is going to be … Wayne Gretzky

32. Business Models…..Gone Wild Shark Tourism in South Africa "Emotionally, it's a lot harder when people get consumed," "It changes perceptions." Cape Town City Government Policy Coordinator, Commenting on two Cape Town Sunbathers who were swallowed and digested by great white sharks. "Every time they try to bite the cage, they taste metal, If you were conditioning the shark to anything, it's that humans taste like metal." Craig Ferreira, owner of White Shark Projects, one of the 12 South African operators. “Keep your hands inside the cage! Keep your hands inside the cage! Shark right in front!” Andre Kotze, Boat Captain “You can't interact with nature without affecting nature," "We are affecting things -- we just don't know how.” Cape Town Surfer and Environmentalist

33. Lightning in a Bottle: The Success Paradox Lightning in a Bottle….. “To keep lightning in a bottle, the idea that a person or entity has succeeded in trapping the essence of some elusive creative process”. A. H. Segars

34. What do These Technologies Represent? Personalization Mobility Convergence Simplification Configuration

35. What do These Technologies Represent? Outsourcing to the Customer Package Tracking Transparency Integration Online Reservations Synchronization

36. What do These Technologies Represent? Community Interactivity Customization Simplification

37. What Trends do These Technologies Represent? Unconventional Knowledge Life as Art Learn by Seeing Reality TV

38. Disruptive Versus Sustaining Technologies Mainframe Computers Personal Computers Personal Computers Laptop Computers Laptop Computers Personal Digital Assistants Value Added Resellers Direct Selling Channels Bundled Content Unbundled Content CD Players MP 3 Players (iPod, Rio) Soft Drinks Water Full Service Stations Pay at the Pump Disruptive Technology Established Technology Sustaining Technology: Improve the performance of established products in ways that major customers value. Disruptive Technology: Under perform established products in short term but have features that new customers value.

39. Table Team Exercise: • Can you think of CURRENT EXAMPLES of disruptive technologies in the aerospace industry? What are Boeing’s plans to deal with this? • What business is Boeing in (L’Oreal example)?

40. Final Thought of the Session… If You Are Not The Lead Dog Then The View Never changes…………