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Springfield Nor’easters

Springfield Nor’easters. Christopher Baughman, Luiz Eduardo Freitas, Diego Gonzalez, Sarah Gretzinger, Saryn Hoover, Laura Molnar. Michael Rhodes, Gaurang Mehra, Vivek Sharma, Kit Carson and Priyanka Obrai. Conditions for Alternative Pricing Objectives. Product Differentiation Skim.

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Springfield Nor’easters

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  1. Springfield Nor’easters

  2. Christopher Baughman, Luiz Eduardo Freitas, Diego Gonzalez, Sarah Gretzinger, Saryn Hoover, Laura Molnar

  3. Michael Rhodes, Gaurang Mehra, Vivek Sharma, Kit Carson and Priyanka Obrai

  4. Conditions for Alternative Pricing Objectives Product Differentiation Skim Cost Leadership Penetration Marketing Differentiation Neutral CUSTOMERS • Difficult Comparison Effect • Price Quality Effect • Low Price Sensitivity • Reference Price Effect • Little differentiation • High price sensitivity • Total Expend Effect • Large Part of End-Benefit • Customers are sensitive to other elements of the marketing mix COMPETITION • Sustainable differentiation • Limited threat of opportunism • Limited opportunity for scale economies • Low threat brands • Sustainable cost & resource advantage • Financial strength • Competitors not willing to retaliate • Aggressive small share brands • Large share brands w/ a lot to lose (Oligopolies) • Sustainable mktg mix advantages • Avoid threat of retaliation COSTS • Changes in Unit Price Drive Profit • Low CMs • Low Volumes • Large BE Sales Changes • At or near capacity • Changes in volume drive profitability • High CMs • High volumes • Small BE Sales Changes • Excess capacity • Sufficient CM to finance advertising... • Costs similar to competitors • Little excess capacity • Incremental capacity is expensive

  5. Saurabh Bagaria,, Abhijit Panda, Anshul Singh

  6. 38 Games 5 Games 20 Games 1 Game

  7. Michael Rhodes, Gaurang Mehra, Vivek Sharma, Kit Carson and Priyanka Obrai

  8. Barendse,Stevan;Edsell,Jake;Nureni-Yusuf,Babatunde,Sharma,Suruchi;Mishra,Barti;Wellman,RobertBarendse,Stevan;Edsell,Jake;Nureni-Yusuf,Babatunde,Sharma,Suruchi;Mishra,Barti;Wellman,Robert

  9. Springfield Key Takeaways • The value of marketing research in projecting demand and determining introductory pricing for a new offering. • The importance of assumptions (e.g., market size and purchase likelihoods) in driving your decisions and results. • The value of segmenting the market based on economic value, purchase motivation, & likely usage rates. • The importance of clearly defining your offering, your target customers, and your target competition in determining competitive advantage. • The value of the PLC in determining the nature of demand, competition and competitive advantage.

  10. Market Dynamics over the PLC MATURITY CUSTOMERS High knowledge Repeat purchasersComparison shopping COMPETITION Homogeneous dominant brands Market share defenseGains from competitors COSTS High contribution marginsAsset utilization PRICE SENSITIVITY Switching cost effectExpenditure effect End benefit effect HIGH SENSITIVITY MARKETING OBJECTIVES Market share defenseMarketing & production efficiencyProfitable market segmentation PRICING STRATEGIES Expansion of product line and price pointsSegmentation pricing

  11. Pricing Strategy & Tactics – Chs. 9-10Four Steps for Financial Analysis for Pricing 1. Determine the Contribution Margin. • Calculate the Break-even Sales Change for a change (or difference) in price, variable costs, &/or fixed costs. • Virgin, Healthy Springs Homework & Final • Calculate the Profit Implications of sales changes greater or less than the Break-even Sales Change. • Virgin, Healthy Springs Homework & Final • Create a Breakeven Sales Curve and compare to an Estimated Demand Curve • Virgin, Healthy Springs Homework & Final The Final will also focus on Competitive (Re)actions (next week)

  12. Step 1: Determine The Contribution Margin PER UNIT Price - Incremental Variable Costs = Contribution Margin ($, %) TOTAL Sales Revenue - Total Variable Cost = Total Contribution ($, %)

  13. Why Focus on CM? • Tool of Competitive Advantage • Relative advantage (Higher CM% = Greater Advantage) • Tool for Segmentation Pricing • Set different prices for different segments • Can reach more segments • Indicator of how to drive profitability • High margin: volume-based strategies (Springfield) • Low margin: price and bundling strategies (Atlantic)

  14. Identify Incremental Variable Costs • VARIABLE COSTS ARE ALWAYS INCREMENTAL • But be careful of averages. The incremental variable cost for a change in sales is often not equal to the average variable cost • Examples: • Overtime vs. average cost production • Costs from multiple sources using different technologies (joint product vs. prime sourcing) • Average over different types of customers

  15. Identify Incremental Fixed Costs • Some fixed costs are also incremental for pricing • They are the fixed costs incurred to implement a change in pricing (e.g., production capacity increase required for a price decrease leading to a volume increase). • Most fixed costs are not incremental • Since they do not change with a change in price or sales, they are not incremental. They have no impact on the relative profitability of alternative pricing strategies • Examples: • Product Development Costs • Advertising Full costs – which include non-incremental fixed costs – are neither the actual costs incurred when making additional sales at lower prices, nor the actual costs saved when making fewer sales at higher prices. They are, therefore, misleading as a guide to pricing

  16. Costing Discussion Questions • In the mid 1960s, McDonald's offered their franchisees breakfast items (e.g., Egg McMuffin) that they could offer in the mornings when demand for hamburgers and fries was not very large. What costs should a franchisee have properly considered in deciding whether to offer a breakfast menu and in determining the most profitable prices to charge for breakfast items?

  17. Step 2Break-even (B/E) Sales Change Definition: The change that would sustain the same level of profit contribution at the new price as was achieved at the original price. A higher level of sales will produce higher profitability; a lower level of sales, lower profitability. KEY QUESTIONS 1. By how much must sales volume increase to profit from a price cut? 2. What loss in sales volume can be absorbed and still enable us to profit from a price increase?

  18. Incremental Percent Breakeven Sales Changes Price increase: % decrease < the breakeven decrease leads to contribution increase. Price decrease: % increase > the breakeven increase leads to contribution increase.

  19. — $DCM New $CM = Break-even (B/E) Sales Analysis Formulas — %DP %CM’ + %DP or Basic Formula (No change in costs): % B/E unit sales D = — $DP $CM’ + $DP B/E Sales Incorporating a Change in Variable Costs (VC): % B/E unit sales D = _ ($DP - $DVC) $CM’ + ($DP - $DVC) B/E Sales with Price Change & Incremental Fixed Costs (FC): B/E sales change = — $DCM x Initial unit + $D in FC (units) New $CM sales New $CM B/E sales change = — $DCM + $D in FC (percent) New $CM New $CM x initial unit sales B/E Sales Analysis for Reactive Pricing: % B/E unit sales change = %DP for reactive price change %CM’ + %DP

  20. -(-$.50) $4.50 - $.50 $.50 $4 12.5% = = = -(-5%) 45% - 5% 5% 40% = 12.5% = = Step 2Calculate Break-even (B/E) Sales Change Ex: $.50 decrease in price & $4.50 CM’ leads to a 12.5% increase in sales to B/E Basic Formula: % B/E unit sales change = - $DP $CM’ + $DP Also works for %: Ex: 5% ($.50) decrease in $10 price & 45% ($4.50) CM’ leads to a 12.5% increase in sales to B/E Basic Formula: % B/E unit sales change = - %DP %CM’ + %DP Rule of Thumb: Set up equations where the units of analysis ($, %, Units) cancel out. Note that breakeven occurs when price elasticity = 12.5%/-5% = -2.5.

  21. _ $DCM New $CM = Ex: 50¢ decrease in price & $4.50 CM’ with a 20¢ decrease in VC leads to a 7% increase in sales to B/E _ (-50¢-(-20¢)) $4.50 + (-50¢-(-20¢)) _ $ -.30 $ 4.20 7% = ≈ Ex: 5% (50¢) decrease in $10 price & 45% ($4.50) CM’ with a 2% (20¢/$10.00) decrease in VC leads to a 7% increase in sales to B/E _ -5% - (-2%) 45% + (-5% - (-2%)) _ -3% 42% 7% = ≈ Break-even (B/E) Sales Analysis Formulas Ex: $1 increase in price & $3 CM leads to a 25% decrease in sales to B/E - $1 $3 + $1 -1 4 -25% = = = Basic Formula: % B/E unit sales change = - $DP $CM’ + $DP B/E Sales Incorporating a Change in Variable Costs (VC): % B/E unit sales D = _ ($DP - $DVC) $CM’ + ($DP - $DVC) Breakeven occurs when elasticity ≈ 7%/-5% ≈ -1.4.

  22. _ $DCM New $CM = _ -5% 45% - 5% $800 $4 x + = 12.5% x 4000 + 20 = 70 units 4000 Break-even (B/E) Sales Analysis Formulas Ex: $1 increase in price & $3 CM leads to a 25% decrease in sales to B/E - $1 $3 + $1 -1 4 -25% = = = Basic Formula: % B/E unit sales D = - $DP $CM’ + $DP B/E Sales Incorporating a Change in Variable Costs (VC): % B/E unit sales D = _ ($DP - $DVC) $CM’ + ($DP - $DVC) B/E Sales with Price Change & Incremental Fixed Costs (FC): B/E sales change = _ %DP x Initial unit + $D in FC (units) %CM’ + %DP sales New $CM Ex: 5% decrease in $10 price with an initial volume of 4,000, $4.50 CM’, and an $800 increase in FC requires an increase of 70 unit sales (17.5%) to B/E 70/4000= 17.5% increase Breakeven occurs when elasticity = 17.5%/-5% = -3.5.

  23. _ $DCM New $CM = 50¢ decrease in $10 price with an initial volume of 4,000, $4.50 CM’, and an $800 increase in FC requires an increase 17.5% to B/E _ $.50 $4.00 $800 $4.00 x 4000 + = 12.5% + 5% = 17.5% Break-even (B/E) Sales Analysis Formulas Ex: $1 increase in price & $3 CM leads to a 25% decrease in sales to B/E - $1 $3 + $1 -1 4 -25% = = = Basic Formula: % B/E unit sales D = - $DP $CM’ + $DP B/E Sales Incorporating a Change in Variable Costs (VC): % B/E unit sales D = _ ($DP - $DVC) $CM’ + ($DP - $DVC) B/E Sales with Price Change & Incremental Fixed Costs (FC): B/E sales change = _ %DP x Initial unit + $D in FC (units) %CM’ + %DP sales New $CM B/E sales change = _ $DCM + $D in FC (percent) New $CM New $CM x initial unit sales Breakeven occurs when elasticity = 17.5%/-5% = -3.5.

  24. Dp = (DP×Q’ + P’×DQ + DP×DQ) – (DVC×Q’ + VC’×DQ + DVC×DQ) - (DFC) Dp = 0 = DQ × (P’ + DP – VC’ – DVC) + Q’ × (DP - DVC) - (DFC) DQ × (P’ + DP – VC’ – DVC) = -Q’ × (DP - DVC) + (DFC) - (DP - DVC) (P’ + DP – VC’ – DVC) DFC Q’×(P’ + DP – VC’ – DVC) DQ Q’ = + B/E D = _ $DCM + $D in FC (percent) New $CM New $CM x initial unit sales Underlying Formula p’ = P’×Q’ – VC’×Q’ – FC’ p’ + Dp = (P’×Q’ + DP×Q’ + P’×DQ + DP×DQ) – (VC’×Q’ + DVC×Q’ + VC’×DQ + DVC×DQ) - (FC’ + DFC)

  25. _ $DCM New $CM = Break-even (B/E) Sales Analysis Formulas Ex: $1 increase in price & $3 CM leads to a 25% decrease in sales to B/E - $1 $3 + $1 -1 4 -25% = = = Basic Formula: % B/E unit sales D = - $DP $CM’ + $DP B/E Sales Incorporating a Change in Variable Costs (VC): % B/E unit sales D = _ ($DP - $DVC) $CM’ + ($DP - $DVC) B/E Sales with Incremental Fixed Costs (FC): B/E sales change = _ %DP x Initial unit + $D in FC (units) %CM’ + %DP sales New $CM B/E sales change = _ $DCM + $D in FC (percent) New $CM New $CM x initial unit sales Ex: Comp. A increases price by 10%. Should we follow? B/E Sales Analysis for Reactive Pricing: % B/E unit sales change %DP for reactive price change %CM’ + %DP 10% 55% = ≈ 18% Unless you expect > 18% increase in demand at lower price, follow the price increase. Breakeven occurs when elasticity ≈ 18%/-5% ≈ -3.6.

  26. Step 3: Calculate the Profit Implications Change in Profit = [Actual Unit Sales Change - Unit BE Sales Change] x New $CM per unit or, Change in Profit = [Actual % Sales Change - % BE Sales Change] X Baseline Unit Sales x New $CM per unit

  27. _ -5% 45% - 5% $800 $4 x + = 12.5% x 4000 + 20 = 70 units 4000 Ex. 10-3: Profit Changes from Baseline with Simulated Sales Volume Changes Ex: 5% decrease in $10 price with an initial volume of 4,000, $4.50 CM’, and an $800 increase in FC leads to an increase of 70 unit sales (17.5%) to B/E 70/4000= 17.5% increase

  28. 4. Breakeven Sales Curve Calculation with Incremental Fixed Costs Breakeven Elasticity -1.4 -1.5 -1.7 -1.8 -2 -3.5 -4.0 -4.7 -6.0

  29. Breakeven Sales Curve

  30. Breakeven Sales Curve Compared to Elastic Demand Curve

  31. Breakeven Sales Curve Compared to Inelastic Demand Curve

  32. Virgin Case: Customer Lifetime Value (CLV)Useful Analysis at the Individual Customer & Segment CLVinfinite lifetime = CM/(i* + 1 – r) – AC where CM = average annual contribution for the customer (segment) i* = i (=the risk-free discount rate) × risk factor r = retention rate for the customer (segment) AC = acquisition costs How valuable/profitable is each customer (segment) given prices & variable costs (i.e., contribution), retention rates, discount rate, risk level & acquisition costs? How valuable/profitable is an acquisition or retention campaign given prices & variable costs (i.e., contribution), retention rates, discount rate, risk level & acquisition costs?

  33. Virgin Mobile

  34. % D in Unit Sales % D in Price E = Calculating Average Price Elasticity (100-300)/Average(100,300) ECell phone usage = (.22-.12)/Average (.22,.12)

  35. Next Week • Complete the Healthy Springs exercise & email to me one hour before class. Primary Demand Elasticity -1.0 + Selective Demand Elasticity -2.0 = Total Demand Elasticity -3.0 • Rick Lester from TRG Arts (No Electronics) • Incorporating Competitor Analysis into Pricing Decisions

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