Strategic Pricing Strategies for Entrepreneurial Success

1. Session 10 PRICING AND DISTRIBUTION

2. Some entrepreneurs and conventional small firms incorrectly base their pricing decision on ‘cost plus pricing’. • Successful pricing of an entrepreneurial product or service is determined by customer expectation. • Need to assess the cost implications when determining an optimal price. • Pricing decisions should recognise the influence of macro-environmental factors. • An alternative to a temporary price reduction is to use a sales promotion. • New products face the hurdle of identifying intermediaries. • Select distribution channels that offer the highest level of consumer satisfaction. • A new distribution concept can offer a totally new business proposition. • The Internet is dominated by major terrestrial companies. • The Internet has led to the emergence of on-line communities controlled by consumers. Session 10

3. Cost Based Pricing • It is not unusual to find that smaller firms are using the ‘cost plus pricing’ formula: Price = Cost/Unit + Desired Profit/Unit • It is pure coincidence if the calculated price is acceptable to customers. • This is because customers determine price in most markets, not the supplier. • Research on small firm entrepreneurial pricing would suggest more successful firms do not apply simplistic formulae to determine price. Session 10

4. Entrepreneurs recognise that different customer segments have different price expectations. • They are willing to modify price in response to economic conditions. • They comprehend the benefits of creating alternative product benefit and supporting services to service different types of customer need. • Studies conclude that ‘cost plus’ pricing is less evident in entrepreneurial firms. • Orientation is biased towards adopting a flexible approach in response to the nature of market demand. Session 10

5. Demand Pricing • Fundamental to demand-orientated pricing is an acceptance that customers determine the nature of prevailing prices. • Can still apply cost plus formula but in the form: profit = prevailing market price – costs • Where analysis reveals inadequate profit, one option is to examine opportunities for reducing costs or moving to a market sector where higher prices are acceptable. • Entrepreneurs tend to focus on occupying specialist market niches where it is feasible to command premium price. Session 10

6. Where niche positioning is not feasible and the firm faces price competition, the entrepreneur will need to identify alternative market/product opportunities. • A case based study of UK small firms revealed highly flexible orientation among more successful firms. • They avoid situations where the dominant customer purchase decision is based on low price. • They seek out mechanisms for product/service differentiation that avoid involvement in price-orientated markets. • They are willing to be flexible in relation to the importance of specific customers and the prevailing financial circumstances of these customers. Session 10

7. Cost Issues • As entrepreneurs seek to use superior performance to achieve differentiation, this is accompanied by higher costs. • Entrepreneurs need to comprehend the nature of cost changes associated with innovation and performance enhancement. • They should recognise that below a certain minimum specification customers will not purchase. • They also need to recognise that over-specification may not be recoverable in a higher price. • The combined effect of costs and achievable price often create zones of loss and a zone of profit. Session 10

8. Loss Scenario Loss Scenario Profit Zone Cost Curve Revenue Curve Price and Unit Cost High Low Product Specification - Minimum specification acceptable to customers Figure 10.1 Price and cost relationships Session 10

9. A reasonable assumption is that markets can be divided into customers who seek: • ‘Economy’ offering of minimum performance at lowest available price • ‘Average’ offering of average/adequate performance at average price • ‘Premium’ offering of superior performance at high price • There is a certain degree of variance in price/performance requirements of customers. • By understanding different customer requirements, it is possible to create a conceptual value/performance model. • Concept can be used to ensure firm is neither overpricing nor underpricing its offering. Session 10

10. Customer acceptable price range High Acceptable price variation zone A B Premium Product Performance/Quality Average Economy C Low Product Price Product Price High Figure10.2 Value price relationships Session 10

11. A whole range of factors can influence a firm’s operating costs. • It is critical to be able to estimate the influence of a change in costs of an input variable to determine: • Impact on company costs • Degree to which rising costs can be recovered in price adjustments • Some variables are under greater control of business than others (e.g. degree of product customisation, efficiency of internal processes). • Many other variables are beyond control of a firm (e.g. raw materials, borrowing costs), but in most cases these changes will not be firm-specific, and will be faced by the entire sector. Session 10

12. Premises Equipment Internal Cost Influencers Customisation Supply Inputs Technology Borrowing Costs Legislation Processes Capacity Figure 10.3 Cost influencers Session 10

13. Inconvenience • Where they have to suffer inconvenience (e.g. travel, collect, self-assembly) customers expect to pay a lower price. • USA has highest drug prices in world and welfare system means consumers have to cover much of the costs themselves. • Entrepreneurial solution has been companies in Canada and Mexico offering lower priced drugs. • US citizens can bring 3 months personal supply of prescription drugs into the country. • People are willing to suffer the inconvenience of cross-border travel to buy drugs. • On-line overseas pharmacies have increased the proportion of consumers willing to suffer inconvenience of a finding supplier and waiting for delivery. Session 10

14. Customer Expectations • Customer price expectations change over time requiring the entrepreneur to be aware of such trends. • There are many factors, including: • Level of service required • Prior experience of product • Quality requirements • Urgency of purchase • Nature of purchase channel used • Customer loyalty • Personal disposable income • Level of personal taxation Session 10

15. Prior purchase experience Quality requirement Channeldecision Customer Price Expectation Competition Urgency Service level Loyalty Customer knowledge Figure 10.4 Category level influencers Session 10

16. Macro-Environmental Factors • Predicting the influence of macro-environmental variables is more difficult. • Hence determining the need to revise prices is more difficult because accurate data upon which to base predictions is difficult to obtain. • Essentially, entrepreneur will need to observe customer price sensitivity as macro-factors change, such as: • Economic conditions impacting customer confidence • Prevailing financial climate in terms of access to borrowing to fund purchase • Overall disposable income of consumers • Changes in relative currency values Session 10

17. Supply chain costs Supply chain behaviour Customer Price Sensitivity Economic conditions Public sector tax legislation Income Currency values Technology Financial climate Figure 10.5 Macro consumer influencers Session 10

18. Pricing Innovation • Mr. Morita and Mr. Ibuka created the Tokyo Telecommunication Laboratory to manufacture telephone equipment and, subsequently, tape recorders. • Mr. Ibuka persuaded Western Electrics to grant him a licence to manufacture transistors. • He developed a new transistor to power a transistor radio and company was renamed Sony Corporation. • Product was launched at a premium price because a smaller radio offered convenience over valve-based radios. • Followed by transistorised television again using premium price strategy. • Sony has sustained strategy of using R&D to develop new products marketed at a premium price. Session 10

19. Price-based Competition • Michael Porter’s theory is that differentiation based on offering superior performance offers greater long-term benefit than price-based competition. • Most entrepreneurs follow this philosophy because customers are less price sensitive when buying new products. • Cost-leadership is often difficult to sustain over the long term. • Exception is when new technology dramatically reduces price of standard product (e.g. launch of BIC pens). • More recently, the Japanese have demonstrated the power of a strategy based on using superior technology to offer high quality at lower than prevailing prices (e.g. Toyota Lexus cars). Session 10

20. Process-based Competition • In many industries, a stage may be reached where major firms have evolved an inflexible, high cost operation. • This occurred in the airline industry, where major international carriers have high fixed costs to deliver full route coverage. • ‘No frills’ airlines can compete by being selective over routes served, flying into low cost airfields and offering minimal pre- and in-flight services. • Lower operating costs permit price-based competition and, in some cases, the creation of large and successful operations (e.g. EasyJet and Ryanair in Europe). Session 10

21. Customer Response • It is possible that current potential customers reject a lower cost solution. • In the 1960s, US heart surgeons developed highly complex bypass surgery to re-route blood around a blocked blood vessel. • German doctor Andreas Gruentzig developed lower cost balloon angioplasty which used non-invasive technique of inserting and inflating a balloon to remove blockage. • Cardiac surgeons rejected his solution because they perceived it as less effective than their highly-lucrative invasive surgery. • Cardiologists were more supportive, especially following the invention of a ‘stent’ to keep artery open. • Pressure from cardiologists and insurance companies eventually forced heart surgeons to adopt angioplasty and stent solution. Session 10

22. Sales Promotion • An alternative to price reduction is a temporary increase in value through sales promotions (e.g. money-off packs, 10% more product, money-off coupons). • In recent years, major brands have switched funds from advertising into sales promotion. • Influence factors include: • Increase consumer price sensitivity in major markets • Preference of supermarkets for brands to fund in-store promotions • Less utilised by entrepreneurial firms. • Due in part to recognition that, although sales increase during sales promotion, net overall effect is to have no long term impact on sales. Session 10

23. Sales Promotion Sales Time Figure 10.6 Sales promotion revenue curve Session 10

24. Distribution and Intermediaries • Intermediaries have the role of linking suppliers to final end-user customers. • Supermarkets as intermediaries undertake distribution, storage and in-store management of product. • Many small firms sell direct because their service is delivered via their own outlet (e.g. independent hairdresser) or direct to consumers’ homes (e.g. house maintenance services). • One problem is that small firms find it difficult to persuade intermediaries to stock their products. • Large intermediaries prefer to purchase large quantities, and for their suppliers to support products with national promotional activity. Session 10

25. Fighting the System • Fair Trade organisations were established to ensure small producers in developing nations get a fair price for what they grow. • Fair Trade organisations also provide economic development and social infrastructure development support. • The problem is to persuade supermarkets to stock Fair Trade goods. • In New Zealand, Ten Thousand Villages has opened their own and also franchise retail outlets. • Tear Fund UK has volunteers selling products via activities such as: • In-home events • Church groups • Mail-order catalogues Session 10

26. Channel Selection • Entrepreneurs need to recognise and identify a number of factors influencing optimal channel selection decision. • Possibly key variable is preference of final user. • Need to monitor changing channel usage behaviour because customer preferences change over time. • Example that in late the 1990s, 55+ consumers were adverse to using on-line channels, but in the early 21st century they have become heavy users. • Entrepreneurs need to analyse the variables influencing channel selection in a specific sector when deciding how to distribute a new product/service. Session 10

27. Customer Preference Customer Convenience CustomerMobility Delivery Decision Market Convention Product Perishability ProductForm Technology Supply Chain Conditions Logistics Figure 10.7 Delivery decision influencers Session 10

28. For many products, customers have become accustomed to using a specific channel. • In some cases any attempt to change customer habits will not be productive. • Usual reason for change is that a new channel emerges offering added value such as lower prices or increased convenience. • In switching to web-based purchasing, the consumer must be willing to forgo the social experience/benefits of terrestrial buying. • Usual reason for switch to web-based purchases include: • Greater variety • 24/7 shopping capability • Lower prices • Convenience of shopping from home Session 10

29. Most entrepreneurs will follow the pattern of using the same distribution channel as other firms in the market. • Alternative channels should be assessed because they may offer an opportunity to bypass competitive threats. • Instead of duplicating competitors, the entrepreneur has option of: • Identifying and opening a new channel • Identifying a way of delegating launch to a highly competent intermediary or other producer firm • Identifying a way of entering new channel, exploiting the skills of an intermediary or another producer • Delegating role most is likely to be used in industries like IT, where an entrepreneurial product is incorporated into a product marketed by another firm. Session 10

30. Distribution Channel Same New Conventional Channel Launch New Channel Launch Retain Control Distribution Philosophy Delegated Conventional Channel Launch Diversified Delegated Channel Launch Delegate Responsibility Figure 10.8 New product distribution options Session 10

31. Distribution Assistance • Where an entrepreneur’s product enhances performance of a key customer product/service, they can use their expertise to build market share. • John Walker founded Autodesk with just 5 employees to exploit need for specialist software in the PC market. • He tried to market Autocad software direct to engineering firms. • He realised a better route was through value added resellers (VARs) who develop complete hardware and software solutions for engineering firms. • Achieved status of preferred software with majority of VARs, creating a global business with almost $200 million annual sales. Session 10

32. Hybrid Channels • In B2B markets, entrepreneurs often need to interact with customer to develop their understanding and skills in using the new product. • The conventional solution is for the entrepreneurial firm to operate their own sales force. • This philosophy ignores opportunities to work with specialist distributors who have in-depth knowledge of a specific industrial sector. • A move towards using additional distribution pathways is known as ‘hybrid distribution’. • The adoption of hybrid distribution is further accelerated by the use of the Internet, where entrepreneur’ own expertise or that of a specialist retailer is made available by integrated ‘design, specification and build’ on-line systems. Session 10

33. First Mover Advantage • Entrepreneurs occasionally identify that the creation of a new distribution concept can permit success, leading to market domination or leadership. • Peter Woods in the UK recognised that the conventional approach to selling car insurance via regional offices and local brokers was inefficient. • He identified that the declining cost of telecommunications permitted the concentration of selling and administration in one single location. • He launched Direct Line using lower cost tele-sales/tele-administration to offer lower insurance premiums. • By time the business was acquired by Royal Bank of Scotland this entrepreneurial idea had enabled Direct Line to achieve market leadership. Session 10

34. On-Line Distribution • The founding philosophy among developers of Internet technology was to avoid any single company being able to create a technology monopoly. • The emphasised the creation of open systems using non-proprietary software languages and Website development tools. • One outcome was the creation of not-for-profit organisation to manage domain name allocation. • Initially the Internet permitted small firms to create on-line operations offering equality with larger firms. • This saw numerous small firms creating on-line selling operations that circumvented the power of major terrestrial intermediaries. Session 10

35. By the late 1990s, the nature of on-line democracy began to change. • Large firms were able to purchase priority positions with major on-line search engines. • Large terrestrial firms also had the advantage of existing high brand-name awareness. • Large terrestrial firms also able to spend major sums on terrestrial advertising to build customer awareness of their on-line site’s address. • To further achieve on-line dominance, major firms complimented terrestrial promotions with high spending on on-line advertising campaigns. Session 10

36. Small entrepreneurial firms need to make a careful assessment of whether moving on-line is feasible in the face of large firm competition. • Major appeal for entrepreneur is on-line selling and distribution can reduce operating costs. • Another benefit is that, if managed effectively, on-line presence provides exposure to a larger, sometimes global, audience. • Entrepreneur also needs to review whether on-line product/service proposition should duplicate terrestrial offering. • In some cases a re-designed on-line proposition in relation to changing either product or price can open up new market opportunities. Session 10

37. Customer Price Expectation Same New Core benefit proposition Revised benefit proposition Same Product Proposition Revised core benefit proposition Diversified proposition New Figure 10.9 Distribution option assessment Session 10

38. Distribution Communities • The Internet permits both real-time and asynchronous interaction. • Younger people use the medium very heavily as a social community tool, exchanging opinions about products and services. • On-line exchanges are known as virtual communities which exhibit the following characteristics: • Members share information • Share common experiences • Members trust others and will share hopes, aspirations and problems • Community acts to provide views about product/service purchase decisions • Often influence behaviour via positive or negative observations about product/service usage Session 10

39. On-line communities often mean the customers, not suppliers, are in control of information provision. • These communities need to be considered, especially if the entrepreneur uses the Internet to distribute products or services. • Example of influence very apparent with users of auction sites such as eBay. • Entrepreneur can harvest knowledge on issues such as: • Current level of customer satisfaction • Identify potential emerging new needs • Determine variance opinions between different communities • Identify new applications for existing products • Perceive signs of changing consumer attitudes, beliefs and values Session 10

40. Bernoff and Li believe entrepreneurs need to evolve new strategic frameworks to exploit on-line communities. • They need to go beyond listening and actually find ways of communicating with communities. • Chevrolet Aveo promotion recruited students to live in the Aveo for a week and display videos of their experiences on Myspace and Facebook. • Fiskars Corporation in USA recruited amateur crafts people to become ambassadors to lead the operation of the company’s on-line community – ‘Fiskateers’. • These has the role of ambassadors, leading discussions about hobbies and crafts, and developing new uses for Fiskars’ product range. Session 10

41. Best Practice • Best practices for utilising on-line communities include: • Recognise firm will have no control over the community • Expect some owner/managers to resist loss of control and not like site members making critical comments • Company-sponsored sites should be started on a small scale, letting members determine the speed and scale of expansion • Only support expansion if both company and members are gaining mutual benefits • Focus on effective information generation and do not try to out-compete other organisations through excessive investment in the latest on-line technology Session 10

42. Exploiting Communities • Given the trust and information sharing that exists with on-line communities, the entrepreneur must be careful about acting as a community formation catalyst. • Gerfried Schuller opened a snowboarding school in Austria in early the 1990s. • He created a test centre where people could evaluate equipment prior to purchase. • He opened a number of similar operations across Europe and recognised that the Internet would enable his company to become an international retailer. • He launched the Blue Tomato website to allow snowboarders to share experiences and to interact with company staff who are very experienced snowboarders. Session 10

43. The company invests heavily in staff training and training from suppliers to ensure staff are knowledge leaders. • The Website offers over 3,000 products, is multi-lingual and provides access to a comprehensive multi-media snowboarding library. • The site attracts over 500,000 visitors every month, most of whom are seeking information on boarding competitions, avalanche guides and links to other organisations in the snowboarding industry. • Customers can read on-line reviews by people who have used specific equipment or have visited one of the company’s test centres. • The company has now also launched a free terrestrial version of the on-line catalogue for mailing to snowboarders who purchase products from company. Session 10