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Fifth

Edition

INTERNATIONAL EDITION

THE STRATEGY AND


TACTICS OF PRICING
A GUIDE TO GROWING
MORE PROFITABLY

Thomas T. Nagle
Monitor Group

John E. Hogan
Monitor Group

Joseph Zale
Monitor Group

Boston Columbus Indianapolis New York San Francisco Upper Saddle River
Amsterdam Cape Town Dubai London Madrid Milan Munich Paris
Montreal Toronto Delhi Mexico City Sao Paulo Sydney Hong Kong
Seoul Singapore Taipei Tokyo

CONTENTS
Preface 8
About the Authors 16

Chapter 1 Strategic Pricing 17


Coordinating the Drivers of Profitability
Cost-Plus Pricing 18
Customer-Driven Pricing 19
Share-Driven Pricing 20
What Is Strategic Pricing? 21
Value Creation 23
Price Structure 25
Price and Value Communication
Pricing Policy 28
Price Level 29

27

Implementing the Pricing Strategy


Summary

31

Chapter 2 Value Creation

Notes

30

32

33

The Source of Pricing Advantage


The Role of Value in Pricing 34
How to Estimate Economic Value 37
.Competitive Reference Prices 37
Estimating Monetary Value 39
Monetary Value Estimation: An Illustration 42
Estimating Psychological Value 48
Psychological Value Estimation: An Illustration 48
The High Cost of Shortcuts 52
Value-Based Market Segmentation 54
Step 1: Determine Basic Segmentation Criteria 56
Step 2: Identify Discriminating Value Drivers 57
Step 3: Determine Your Operational Constraints
and Advantages 57
Step 4: Create Primary and Secondary Segments 58
Step 5: Create Detailed Segment Descriptions 60
Step 6: Develop Segment Metrics and Fences 60
Summary

62

Notes

62

Contents

Chapter 3 Price Structure 63


Tactics for Pricing Differently Across Segments
Price-Offer Configuration 66
Optimizing an Offer Bundle 67
Designing Segment Specific Bundles 69
Unbundling Strategically 70
Price Metrics 71
Creating Good Price Metrics 72
Performance-Based Metrics 76
Tie-Ins as Metrics 77
Price Fences 79
Buyer Identification Fences 80
Purchase Location Fences 81
Time of Purchase Fences 82
Purchase Quantity Fences 84
Summary

86

Notes

87

Chapter 4 Price and Value Communication 88


Strategies to Influence Willingness-to-Pay
Value Communication 89
Adapting the Message for Product
Characteristics 90
Adapting the Message to Purchase Context 97
The Buying Process 98
Multiple Participants in the Buying Process 102
Price Communication 103
Proportional Price Evaluations
Reference Prices 104
Perceived Fairness 106
Gain-Loss Framing 107
Summary

109

Notes

103

109

Chapter 5 Pricing Policy 112


Managing Expectations to Improve Price Realization
Policy Development

115

Policies for Responding to Price Objections 116


The Problem with Ad Hoc Negotiation 116
The Benefits of Policies for Price Negotiation 118
Policies for Different Buyer Types 119

Contents
Policies for Dealing with Power Buyers 124
Policies for Managing Price Increases 126
Policies for Leading an Industry-Wide Increase 127
Policies for Transitioning from Low
One-Off Pricing 128
Policies for Dealing with an Economic Downturn
Pol icies for Promotiona I Prici ng 131
Summary

Chapter 6

Price Level

133 '

Notes

130

133

134

>,

Setting the Right Price for Sustainable Profit


The Price-Setti ng Process 13 5
Defining the Price Window 137
Establishing an Initial Price Point 139
Pricing Objectives 141
Defining the Price-Volume Trade-off
Estimating Consumer Response

145

147

Communicate New Prices to the Market


Summary

Chapter 7

156

Notes

153

156

Pricing Over the Product Life Cycle

157

Adapting Strategy in an Evolving Market


New Products and the Product Life Cycle 157
Pricing the Innovation for Market Introduction 159
Communicating Value with Trial Promotions 160
Communicating Value with Direct Sales 161
Marketing Innovations Through
Distribution Channels 162
Pricing New Products for Growth 162
Pricing within a Differentiated Product Strategy
Pricing within a Cost Leadership Strategy 164
Price Reductions in Growth 165
Pricing the Established Product in Maturity 166
Pricing a Product in Market Decline 169
Alternative Strategies in Decline 170
Summary

Chapter 8

171

Notes

172

Pricing Strategy Implementation

174

Embedding Strategic Pricing in the Organization


Organization 176

163

10

Contents
Organizational Structure
Decision Rights

177

180

Pricing Processes 181


Motivation 182
Customer Analytics 184
Process Management Analytics 187
Performance Measures and Incentives 191
Managing the Change Process 194
Senior Management Leadership 194
Demonstration Projects
Summary

196

195

Notes

196

Chapter 9 Costs 197


How Should They Affect Pricing Decisions?
The Role of Costs in Pricing 197
Determining Relevant Costs 198
Why Incremental Costs? 199
Why Avoidable Costs? 202
Avoiding Misleading Accounting 205
Estimating Relevant Costs 207
Activity-Based Costing 212
Percent Contribution Margin
and Pricing Strategy 213
Managing Costs in Transfer Pricing 215
Summary

220

Chapter 10 Financial Analysis


Pricing for Profit

Notes

221

223

Break-even Sales Analysis: The Basic Case 225


Break-even Sales Incorporating a Change
in Variable Costs 228
Break-even Sales with Incremental
Fixed Costs 229
Break-even Sales Analysis for Reactive Pricing 232
Calculating Potential Financial Implications 233
Break-even Sales Curves 236
Watching Your Baseline 239
Covering Nonincremental Fixed
and Sunk Costs 240
Summary

248

Notes

248

Contents
Appendix 10A
Derivation of the Break-even Formula
Appendix 10B

11

249

Break-even Analysis of Price Changes 251


Chapter 1 1 Competition 260
Managing Conflict Thoughtfully
Understanding the Pricing Game 261
Competitive Advantage: The Only
Sustainable Source of Profitability 262
Reacting to Competition: Think Before You Act
How Should You React? 273

267

Managing Competitive Information 277


Collect and Evaluate Information 277
Selectively Communicate Information 279
When Should You Compete on Price? 282
Summary 283 Notes 283
Chapter 12

Measurement of Price Sensitivity

285

Research Techniques to Supplement Judgment


Types of Measurement Procedures 286
Uncontrolled Studies of Actual Purchases 287
Experimentally Controlled Studies
of Actual Purchases 292
Uncontrolled Studies of Preferences and Intentions
Experimentally Controlled Studies
/
of Preferences and Intentions 304
Using Measurement Techniques Appropriately
Using Judgment for Better Measurement

Chapter 13

298

310

311

Using Internet-Based Techniques 313


Outside Sources of Data 314
Selecting the Appropriate Measurement Technique 315
Summary 316 Notes 317
Ethics and the Law 321
Understanding the Constraints on Pricing
Ethical Constraints on Pricing 321
The Legal Framework for Pricing 324
The Effect of Sarbanes-Oxley on Pricing Practices 325
Price-Fixing or Price Encouragement 326
Horizontal Price-Fixing 327

12

Contents
Resale Price-Fixing or Encouragement
Vertical Price-Fixing

328

328

Direct Dealing Programs 330


Resale Price Encouragement 330
Price and Promotional Discrimination 331
Price Discrimination 331
Defenses to Price Discrimination 333
Promotional Discrimination 334
Competitive Injury, Defenses,
and Indirect Purchasers 335
Using Nonprice Variables to Support Pricing Goals 336
Vertical Nonprice Restrictions
Nonprice Incentives 338
Other Pricing Issues 338
Predatory Pricing 338
Price Signaling 338
Summary
Index

347

339

Notes

336

339