Download Review for GB 780: Pricing Strategy

Review for GB 780: Pricing Strategy
The first issue to be considered and to be incorporated into a rational pricing strategy is
consistency of incentives and actions to the goal of the firm.
Profit is the goal,
Not market share
Not “winning” against the competition
Not finding a successful response to competitive actions.
All of these are factors to be considered, but they are often misused as goals.
Incentives for all employees, from the CEO to the sales person or production person,
should be oriented to the long term profitability of the firm.
Effective pricing should be integrated with the product design decision along with
cost, financing, and customer needs.
Customers have an incentive to provide false signals to signal a smaller demand
for the product/service to try to keep the price down.
Proactive pricing is essential to stake out desirable niches/competitive advantages
for the long term benefit for the firm.
Major issues (or mistakes):
Cost plus pricing – it is easy, it is sometimes right (just like a stopped watch is
right twice a day). If differences in price sensitivity (elasticity) are incorporated in the
margins taken on different goods. In addition, complementarity and substitutability of
each product with other products the firm sells need to be incorporated in the
“contribution margin” and hence mark up. In addition, the long run/present value issues
of potential competitive entry or consumer adjustability to price need to be considered.
This eliminates some of the ease of mark up, but it also increases the profitability of the
firm.
There is also a lot of momentum in the pricing in the firm. This can lead to major
mistakes, while assuming that it will propogate the past successes.
Correct cost evaluation is necessary for correct pricing.
- Next In First Out is the best method of evaluating inventory for an ongoing
firm. FIFO is probably a best representation of the desired actual inventory
movement, selling the oldest unit first. LIFO is the closest book-keepingfeasible method to cost inventory turnover since it more correctly reflects the
marginal cost of the use of the inventory. It has the problem of potentially
misrepresenting the value of the inventory remaining over time.
- The “How much?” question, which is associated with the pricing question, is
inherently a marginal cost = marginal revenue decision.
- Sunk costs must be ignored when making pricing decisions. Since sunk cost
is unchanged by the decision of price and/or quantity, it is irrelevant.
Variable/semi-variable/incremental/marginal costs (all these concepts are very
close in meaning) will be affected by the pricing/quantity decision.
- The key is “How is profit affected by the decision being considered?”
Contribution Margin is a measure of the marginal profit of an additional unit. To the
extent that average variable cost is constant, $CM = P – AVC. To the extent that AVC
varies with quantity over the quantity range being considered in the decision, the formula
needs to take into account this variation. The simplest form of variation is the semivariable costs such as additional machines for specific increments of quantity.
Percentage CM = %CM / P
Contribution Margin can be use to evaluate the feasibility of price changes by
determining the break-even quantities with alternative price changes.
BE ( generic ) 
 P
CM  P
The minus sign is because a price increase will allow a decrease in quantity without loss
in profit; a price decrease necessitates a quantity increase.
P is there in the numerator as a measure of the change in the price (and the change in
the revenue) which can be lost (or must be replaced) in order to break even.
CM is the rate of profit gain or loss as quantity changes before the price change.
CM + P is the rate of profit gain or loss as quantity changes after the price change.
The result is the change in quantity allowed (necessary) to not change profit from the
current profit. Note that this break even analysis is not your typical break even analysis
since it does not assure zero profit overall. It assures no change in profit.
With changes in variable costs caused by the quantity change the formula must
incorporate these items.
 P  AVC
CM  P  AVC
Careful with this formula. To the extent that changes in the variable costs only affect
additional revenue, the AVC in the numerator is zero and the AVC in the denominator
is zero for price increases.
Again, the logic is that the denominator is the change in revenue experienced on current
quantity; the denominator is the rate at which profit falls (or rises) as quantity changes to
pay for these changes in current-volume revenue.
BE 
When there are changes in (semi-) fixed costs, they have to dealt with differently. This is
because they are not per-unit charges or revenues. They are fixed dollar amounts
associated with the change contemplated. Care must be taken to make sure that the
appropriate charge is assessed for the quantity change that is actually necessary.
BE 
 P  AVC
TFC

CM  P  AVC (CM  P  AVC )Q
The first term is the more general of the formulas above to repay the price and variable
cost changes.
The second term is change in total fixed costs divided by the cost recovery rate times the
current quantity. This last variable (the current quantity) is there to convert the units
necessary to recover the fixed costs to a percentage change in quantity to add to the first
term.
Some price changes are reactions to changes by a competitor. The question is not how to
regain the current profit, the question is, “Given the expected change due to quantity
change precipitated by the competitor’s action, should the price change of the competitor
be matched to maintain current volume. So, current volume at a changed price is the base
against which maintenance of current price at a changed volume is evaluated.
P
CM
The way this works is that P is the change in revenue if the price is matched and CM is
the rate of loss (or recovery) that the quantity change will cause if the price is not
changed.
The way to use this is if the price change of the competitor is positive, there will be an
increase in profit. If you expect the gain in quantity with the unchanged price to exceed
the break even quantity, keep the price low. If not raise the price.
If the price change is negative, there will be a decrease in profit. If you expect the loss in
quantity to be less than the break even quantity change, maintain the higher price. If not,
match the price decrease.
BE 
One more formula needs to be included in the list. This is the formula incorporating
complementary or substitute relationships between this product and other products sold
by the company.
BE 
 P  AVC
CM  P  AVC  CM 
where CM  is the additional (or the lost) profit contribution from complements (or
substitutes).
Notice that complementary products add to the profit recovery rate, decreasing the
number of units necessary to break even for either price increases or price decreases.
Substitutes cause negative contribution margin additions, increasing the number of units
necessary to break even.
This formula is the basis for choice of loss leaders. Those products or services that have
a large number of complements will likely have low break even quantity changes
associated with given price changes. This increases the probability that using price to
attract business will be profitable.
The other criteria for selection of loss leaders is the price sensitivity (elasticity) of the
demand for the good in question.
Possible Causes of differing elasticities
1. Reference Price Effect
If the customer considers the product comparable to an expensive product, they
will consider the value high and the price can be set high without appreciable loss of
quantity sold. For example, Nike shoes will not be found in Walmart because the
customer assumes anything in Walmart is inexpensive and potentially low quality. Nor
will Bic pens be found in a jewelry store. Ex 2: Presenting the highest priced model in a
family of products first tends to increase the reference value for the less expensive
models.
2. Difficult Comparison Effect
Structuring products (or quantities of given products) such that customers have
difficulty comparing across brand or size will decrease the price sensitivity—the
customer will have fewer (perceived) close substitutes available. Example: BJ's and
Sam's Club use large (and often non-standard) sizes to make comparison with prices in
other types of stores more difficult. This allows Walmart to separate the Walmart
customer from the Sam's Club Customer and allows different pricing in these two stores.
Walmart prices Colgate by the pound and Crest by the ounce to make the per volume
(required by law) prices to be difficult to compare. This makes pricing of these two
direct substitutes to be somewhat independent.
3. Switching Cost Effect
If the customer faces a larger expenditure to avoid a particular purchase (e.g.,
blades for a Gillette razor are cheaper, even with a fairly high margin than replacing both
razor and blades), they will be less sensitive to the price of the good (blades). Car parts
are expensive because it is cheaper to buy the part than to replace the car. Hence, you are
willing to pay high prices for parts.
4. Price-Quality Effect
The difference in the price of an economy car and a luxury car is more than the
difference in their costs because (among other things) there is a perception that the higher
price signals a higher quality. The more expensive product is seen as qualitatively
different than the less expensive product. "Snob appeal," "image," "status," etc.
5. Expenditure Effect
The larger the purchase price relative to my budget, the more price sensitive I am.
Hence family discounts, children's discounts, senior discounts, etc. Luxury items are
bought by high income individuals. To the extent that income rises more than the price,
the customer is less sensitive to price.
6. End-Benefit Effect
To the extent that the product is only a small part of the end-benefit, the customer
will be less sensitive to the price. This is why Michelin advertises safety of babies in
their ads. How much is the child's safety worth? Doesn't this make the price difference
between a Michelin and another brand seem small? This is especially useful as a tool for
segmentation since many products can be used in a variety of markets. Careful
placement and advertising can take advantage of this variety to make the product look
like multiple products rather than one.
7. Shared-Cost Effect
Economists usually call this third-party-pay. The idea is that if I pay none or only
part of the cost, I am less sensitive to the cost of a product. Business travel vs. vacation
travel will be separable and have different price elasticities. The health industry and
airline travel are rampant with these issues.
8. Fairness Effect
Historical pricing sets what the customer thinks is reasonable or fair. The higher
the past prices, the less sensitive the customer is to a high price. Segmentation using this
would be possible by adding features that are desired by the rich, warranting a higher
price (with the increment being greater than the additional cost). One could also segment
between previous purchasers and new purchasers as they might feel different about the
fairness of the price.
9. Framing Effect
Customers view gains differently than losses. This allows some segmentation
through how the price is stated. Does it include service and transportation? Is there a
rebate (rather than a lower price)? Are the radio, the braking system, A/C, tinted
windows, etc., options or included? "Cash back" etc.
MARKET STRUCTURE
Perfect Competition
Many Small sellers
Many small buyers
Homogeneous Product
Free Entry and Exit
Perfect Information
Monopolistic Competition
Many Small sellers
Many small buyers
Differentiated Product
Free Entry and Exit
Perfect Information
Oligopoly
Few sellers
Many small buyers
Differentiated Prod
Some Barriers
Perfect Information
Monopoly
One seller
Many small buyers
“Unique” Product
Strong Barriers
Perfect Info
Monopoly is one pole,
Perfect competition is the other pole.
Monopolistic competition is close to perfect competition, but with differentiated product.
An example would be the pain reliever or aspirin markets. There are many alternative
brands, with slight variations and known, easily replicated formulas. Entry is easy and
exit is easy. The products are slightly differentiated and heavily advertised.
Oligopoly is close to monopoly. Inter-firm rivalry is personal in nature. Policy is made
taking the competitors’ strategy in mind. Game theory is one way of understanding the
dynamics of this type of industry. “If I do this, he/she will do that…” An example of an
oligopoly and a strategy based upon this, Home Depot and Lowes are close competitors.
One of the pricing strategies used by both is “We will match and any competitor’s
advertised price.” This is a strategy that sounds like it is intense price competition, but in
reality is a means of decreasing the profit from competitors trying to compete on price.
BEHAVIOR:
PERFECT COMPETITION
Firms enter and leave in response to profits. This means that in the long run economic
profits are zero. That is, firms will make a “normal rate of return” on the assest used in
the firm, with no firm making excessive profits. Firms price at the current market price
because there is no incentive to deviate. Higher prices lead to no revenue since the
product is a commodity and the customer can get it elsewhere with no loss in quality.
Lower prices are not appropriate because the firm can sell as much volume as they wish
at the current price. This is the idealized market of the capitalist system. It maximizes
the net value of society be producing the goods demand by the customers at the minimum
price. The value (as expressed by the demand curve) of the last unit is equalized to the
marginal cost of producing the product. The firm equalizes the marginal cost with the
marginal revenue (which is equal to price due to the commodity nature of the product in a
competitive market).
MONOPOLY
The firm is the industry in this case. The firm will take into account the fact that selling
one more unit will required decreasing price. To the extent that everyone gets the same
price, Marginal Revenue will be less than Price. The firm equalizes Marginal Revenue
with Marginal Cost and both of these are less than price. This is the problem with
monopoly from society’s stand-point. The value of the last unit produced (as shown by
price on the demand curve) is higher than the marginal cost (= marginal revenue<P). The
value of the last good exceeds the cost, and therefore society would be better off if more
resources were devoted to this market. Due to barriers to entry, profits can be maintained
and additional competition is not available to drive down price and expand quantity
produced. Non-homogeneous product reflects the difficulty the customer has in replacing
this product if the price rises, leaving open the opportunity for the monopolist to raise
price.
MONOPOLISTIC COMPETITION:
Firms are price makers in the sense that they know that they can raise and lower price and
not have all-or-nothing quantity. The demand for the firm is very elastic because there
are good, although not perfect, substitutes. Marginal revenue is not much below price
because of the high price elasticity. This means that marginal cost equals marginal
revenue will bring marginal cost close to price. This is close to the competitive situation.
With free entry and exit, the firm will have zero profit in the long run (entry dissipating
profits, exit eliminating losses).
The main difference between monopolistic competition and perfect competition is in the
long run ATC=P>MR=MC. Notice that with MC<ATC this means that ATC is still
decreasing—we are not at the minimum of the ATC. In words, differentiation means that
we are not as cost efficient. The fact that you have choices means that each firm cannot
minimize their ATC. Henry Ford was so successful at driving down cost because he did
not offer variety. With larger markets, efficient scale economies can be achieved while
still offering variety, to the extent that there are no barriers to entry, profits are dissipated,
equalizing P and ATC, leaving us below minimum ATC quantity.
OLIGOPOLY
In the case of oligopolies, the interpersonal dynamics of the individual managers comes
into play. This means that we have difficulty predicting behavior. This is why we spend
so much time on Monopoly and Perfect Competition. These polar cases show the
transition that occurs and knowing where the industry is placed in the continuum helps us
understand the behavior. But when the interaction becomes personal, it becomes less
predictable. What we do in this situation is start making up models to describe various
behavior patterns. These are pretty good at describing the behavior in the specific
situation, but may not be generalizable to other situations.
Just to give you one example:
KINKED DEMAND CURVE MODEL:
The general assumption is that the market (or industry) has a small number of
competitors who know each other and watch each other’s responses.
Specific behavioral assumptions:
1. If I raise price, the assumption is that the competitors will not follow suit and will
gladly accept my customers. This makes the demand for my product very elastic.
2. If I drop price, the assumption is that the competitor will follow suit rather than accept
the loss of customers to me. This makes the demand elasticity comparable to the industry
elasticity, as I will not be able to attract customers from competitors, but only from
outside the industry.
3. This causes a kink at the current price. This causes the marginal revenue to be fairly
close to price for price increases, and marginal revenue to be significantly lower than
price for price decreases. This combination leads to Marginal cost being likely to be
below the MR for price increases, causing me not to raise price. Marginal cost will likely
be above the MR for price decreases, causing me to not want to decrease price.
This model gives a theoretical justification for the observation of quite stable pricing in
many situations with a small number of competitors. For example, notice the stability of
the gas prices at any given corner. They typically move only in response to increases or
decreases in the overall gasoline prices. And they will establish a consistent relationship
(Exxon higher than Crown by 1-2 cents per gallon…).
PRICE DISCRIMINATION (or MARKET SEGMENTATION)
The general issue here is to charge more to customers who are less price sensitive, and
less to those who are more price sensitive. The difficulty is identifying the specific
customers in each group and separating them so that they will not be able to transfer
goods from the lower priced market to the higher one, circumventing your separation.
Criterion needed to be successful:
1. differing elasticities.
2. separable markets.
In the greater elasticity market, marginal revenue is higher than it is in the lower elasticity
market. By expanding in this market and contracting in the less elastic market, these
marginal revenues can be drawn together and equated to marginal cost.
Where do you want to sell a specific unit? Where MR is the greatest – initial units will
be allocated to the market with the higher reservation price (otent the inelastic market)
subsequent units will go to the market with the highest marginal revenue. This will lead
to allocating more units to the elastic market beyond a certain point.
If MR1>MR2, you can increase total revenue without affecting cost by moving a unit
from market 2 to market one. This movement will increase MR2 and decrease MR1.
Keep doing this until you equalize the MR’s across the markets.
To the extent that costs differ across market, this will affect the MC and will need to be
accounted for. This basic logic describes how to price and allocate inventory to
alternative markets (even for alternative goods). The production effort should be
allocated where the profit contribution is the greatest. The units produced should be
allocated (sold in) the market where the marginal revenue is greatest (MC for a given unit
is fixed, so the allocation issue is getting the largest contribution to revenue by that unit).
REALISTIC PRICING IN THE FACE OF COMPETITION
1. Know your market sitution
2. Realize the “negative-sum” nature of competitive pricing
3. Know your own strengths and weaknesses—capitalize on the strengths and adjust
for the weaknesses
4. Know your competitors’ strengths and weaknesses—pick your battles to give you
the advantage.
5. Raise the cost to competitors of competing on price—“match advertised price.”
a. Manage information
b. Know competitors and customers needs
c. Control timing and presentation of price changes
d. Exhibit willingness to compete in order to preempt competitor actions.
6. Consider niche strategies.
7. Develop competitive advantages.
GENERIC PRICING STRATEGIES
Skim
Benefits
Use when
Higher price=> Higher profit per unit
Can afford Ads
Can afford Quality
High variable cost Low CM suggests the need for higher price
Niches are available
Quality is hard to measure, needing information about the product quality
Customer is price insensitive, and there are some barriers to entry
When the firm has a differentiation competitive advantage
Problems
May attract Competition
Sequential skimming may be a response to the potential for entry that is slow
Penetration
Benefits
Use when
Problems
Attracts volume
Quality easily measured (no need for information, ads)
Customer is price sensitive
Limited demand for product differentiation
Incremental costs are low
When the firm has a cost advantage
Enhances customer price sensitivity
No product loyalty
Neutral pricing
Benefits
Takes price out of the decision
Does not require competitive advantage
Use When
The firm has no cost advantage and differentiation is not called for
When other issues than price serve to attract customers (packaging,
placement,…)
Problems
Subject to price competition of competitors
Not good niche strategy
TIMING ISSUES
Life cycle determines the context for the product pricing decision
Revenue
Product Life Cycle
Time
Intro
Growth
Maturity
Decline
Introduction stage
EDUCATION is the key during this phase of the life cycle. What is the product? What
value can it provide the customer? What is the appropriate price to capture this value?
The key pricing issue here is to price such that the desired reference price is established.
Use of price as an enticement for experiencing the product can be dangerous in that it
might set too low a reference price for the product and you may not be able to increase
the price subsequently.
So what do you do?
1. Choose a basic product strategy (penetration/skim).
2. Identify the target market(s).
3. Choose a distribution channel.
4. Then target the innovators within this market.
5. Bundle products in successful bundles (combine related products to the extent that
successful use of the product requires it).
The innovators are likely to be ones who want to be trend setters. Given this, they will
likely be relatively price insensitive. So price tends to be high in this stage.
If price is use to entice sampling or initial use, it should be explicitly temporary price
decrease “first time” “temporary price” “regular price is… 50% off” “new buyer
discount,” etc.
Growth Stage
The growth stage is key to the future of the company as the flexibility available in the
growth stage is missing in the later stages. Unsuccessful positioning of the company in
the growth stage will preclude success in future stages. (Notice how I phrase this—
successful positioning during this stage is necessary for, but does not assure success in
future stages).
“A rising tide lifts all boats.” Growth will not necessarily come at the expense of
competitors. The firm needs to position the product the future with a skim, penetration or
neutral strategy. The first is called for where differentiation is possible and appropriate;
the second where the firm has a cost advantage and the customer is price sensitive; the
third is the generic for when price is not the desired tool for successful competition.
Developing some competitive advantage is essential—cost, product differentiating
attributes (or perceptions), or some other feature. This uses the growth stage to prepare
for maturity and decline.
1. Generally Price lower than introduction due to greater competition and more price
sensitive customer base.
2. Price reductions often supportable by cost savings (economies of scale, economies of
experience).
3. Generally, price competition not intense, unless
a. There are large scale economies requiring large market share to achieve.
b. Standardization is called for, but the largest firm gets to choose the standard.
c. Capacity grows faster than demand (leading to excess capacity).
4. If price competition becomes fierce, look for a niche to escape into.
6. Keep successful bundles together as a deterrent to entry.
Maturity Stage
Maturity leads to
1. Reduced brand loyalty as firms all attempt to grow while the market does not leading
to intensified price competition.
2. New entrants will typically imitate the most successful products in the industry,
making the product more of a commodity (more homogeneous).
3. Consumers who are better informed.
4. The stability of the market will attract new entrants who are good at distribution,
marketing, finance, etc., rather than being product specialists. They will enter with
cost advantages as the product becomes more homogeneous, unless the current firms
have already implemented these cost savings.
Strategies for Maturity
1. Unbundle related products. This allows accommodation of new small entrants in
niches, without giving away the whole market.
2. Spend resources on measuring and forecasting better to more carefully and
responsively design strategy.
3. Control costs – this is truly the most sustainable competitive advantage.
4. Excise non-producing products that do not complement the successful ones.
5. Leverage successful products by product extensions
6. Reevaluate distribution and marketing (education is no longer the issue, competition
is).
Decline
Declining sales are likely to cause a consolidation of the number of firms in the industry.
Thus one strategy is to design a graceful exit, either by sale of the division or harvesting
(using the cash flow to develop other products).
If the decision is to stay, the firm can specialize in only one part of the market
(retrenching), or carefully work on developing the firm’s competitive advantage
(consolidation).
The key here is to recognize decline and choose a strategy to deal with it.
NEGOTIATION
There are short run benefits, and long term costs of negotiation. In the short run, you
may add to sales. In the long run, you train your customers to negotiate, increasing the
transactions cost and decreasing the potential for skim pricing.
BETTER:
1. Quid pro quo—if you offer price discounts, decrease the service/good received.
2. Educate premium customers about value.
3. Selectively walk away from business that will dilute other business value.
4. Phase in fixed price regime.
5. Change incentives for the sales force from “sales” commissions to “profit”
commissions.
6. Use non-price closers.
7. Build in escalation to normal price if concessions have to be made.
Buyer tactics to beware of:
1. Service and price separated eventually forcing you to provide more services than is
cost effective.
2. Discounts for incremental volume--Make sure the discount is only on the additional
volume. Otherwise, they have set a new base price.
3. One sided contracts – if you commit to a lower price, be sure there is a comparable
commitment of purchases.
4. Price performance ratios – the value may not be proportional to performance (e.g., the
performance of the Arizona Diamondback pitchers was better, but the value was
significantly greater.). This is especially true in “winner-take-all” markets. In these
markets, small advantages have large value.
Types of Buyers
Price buyers – ARE NOT LOYAL, so be selective about whether you negotiate. If the
deal is in the company’s best long term interest, participate. If not, do not count on future
business to pay for it—walk.
Relationship buyers – often are more interested in service and stability. If you negotiate
with them, you train them to be price sensitive. Look for win-win solutions such as
service options or long term contracts.
Value buyers – focus on cost/benefit. Sell value, and price accordingly.
Convenience buyers – not likely to be particularly price sensitive. Timing (high
opportunity cost of search relative to value of search—resort locations, convenience store
venue) and small cost of the item can contribute to this. You can price high relative to
value. In fact, customers have come to expect this and therefore see the higher price as
fair.
Pocket Price—In the context to multiple criteria for discounts, the measure of how much
of the revenue actually turns into net revenue after all discounts are taken. Control of
these various discounts (often under the control of different people in the value chain)
will make sure that there is a return from each of these discounts, not just a cost.
SEGMENTED PRICING
The goal is to allow price to be adapted to the customer’s specific price sensitivity. Less
elastic demanders will be given a higher price (differentiated product). More elastic
demanders will be offered a discount price with fewer features or lower quality.
Ways of segmenting:
Buyer Identification – seniors, children, AAA, AARP, etc. Allows separation of price
elastic segments from non-price elastic segments.
Location – Gas stations, real estate (3 most important factors in real estate value are
location, location, and location)
Time – Peak load pricing (charge customers who cause costs to be incurred)
Yield management (airlines, to maximize revenue when marginal cost is low)
Bundling – makes marginal cost of least desired attribute low. Increases total purchases.
Volume discounts – decrease marginal cost of additional volume to customer, allow
taking advantage of economies of scale for the firm.
Order discounts – pass on the cost savings of less overhead for multiple orders
Product design – multiple versions can appeal to different markets allowing price
discrimination.
PRICING AS IT IS RELATED TO THE OTHER THREE OF THE FOUR P’S
Product
Price is related to Product through the product’s interrelationships with other goods. See
the formula discussion related to complements and substitutes.
Price is related to product in the sense that the customer’s willingness to pay for certain
features and the cost of these features should determine whether these features are added
to the product. Clearly, the cost and value of features of the product affect the necessary
price to make a profit and our ability to achieve profit.
Promotion
Promotion that includes price can sensitize the customer to price, calling for penetration
pricing.
Promotion can enhance the value of price decreases.
Skim pricing calls for care in where the product is advertised.
Penetration pricing also defines the desired advertising venues.
Price as a promotion tool should
1. benefit the customer
2. be perceived as a price decrease
3. primarily benefit first-time buyers to add to customer base with minimal loss
of revenue from current customer base.
Placement
Choice of distribution channel will affect pricing possibilities, enhancing or lessening the
perceived value.
Use of a distribution channel.
- adds to cost of product
- may provide value added through product enhancement or
- can provide access to customer base
-
may change the quantity desired decision by decreasing the CM at the retail
end of the chain
- can close out competition
- can affect perceived value of the product
- can facilitate segmentation
Pull advertising – advertising directly to the customer
Push advertising – using incentives within the distribution channel to create incentives for
sales effort
Internet has changed the distribution environment. It has forced the channels to make
sure they offer value added. Those that do not are being shut down by Internet allowing
the manufacturer to go directly to the consumer.
COMPETITIVE ADVANTAGE
Developing a Competitive Advantage is the key to long term profitability.
Bases for competitive advantage
Cost:
1. Economies of Scope – multiple products sharing costs across markets
2. Economies of Scale – efficient allocation of inputs
3. Economies of Experience – learning by doing (possibly use penetration
pricing to foster this learning “paying” for the price cuts with decreased costs
4. Buyer focus – become a specialist
5. Contract efficiencies – set pricing to create efficient incentives for
price/volume choices
6. Transfer pricing – integration of CM to increase incentive for penetration
pricing
7. temporary cot advantages – utilize to gain longer term advantages
Product differentiation advantages
1. Product superiority – if value rises more than cost, this can create advantage
2. Product Augmentation – serve niches, bundle for specific types of customers
Sustaining advantages
1. Become known supplier (Dell, Compaq, IBM)
2. Pre-empt distribution channel (soda machines)
3. Set standard (Intel, Jello, Klenex)
4. Serve small niche (no room for others)
5. Capture image (Mercedes, BMW, Dewalt)
6. Technological advance (outrun the competition – Intel, Sony)