Today we'll be discussing the concept of price. What is price really? What factors are important when setting a price? We will also examine the consumer psychology behind pricing strategies. Then finally, we will review the steps involved in setting price. How much is this watch worth to you? It is, forgive me as I say this, a Vacheron Constantin Patrimony watch. The Swiss watchmaking company was established in 1955 by John Mark Vacheron. They manufacture just 20,000 watches a year. The company's motto since inception has been, do better if possible, and it is always possible. Again, how much is this Patrimony gold case watch worth to you? It has an 18-karat rose gold case and gold hands scratch resistance of our crystal and a black alligator strap. This watch retails for $282,000, 282k. Was it with that much to you? To me, it wasn't even worth anywhere near that amount. What about this? A tour for two of the Emirates Stadium, home of the Arsenal great, great soccer team of football as we call it in Trinidad. On this tour, you get two tickets, two guidebooks, and your tour guide is an ex-Arsenal player. In my case, his name was Lee Dixon. How much is this worth to you? Well, this was very well-priced at 110 pounds. To me, it's worth so much more than that. I would have paid 200 pounds for that specific tour. If the tour guide, were one of the best players to ever play for Arsenal, the legendary forward Thierry Henry, I would have filled up to 400 pounds. What is that tour worth to you? I'm sure it might be worth a lot. I actually did complete the tour and pay the going rate of 110 pounds but as I said, it was worth so much more to me. Go, Gunners. Segway is a great study in how price should reflect value. Famous venture capitalist John Dewey said that Segway says it might take one billion dollars as fast as any company in history. The company spend about $100 million developing the product. Segway's introductory price was about $5,000. What Segway did not understand was that its price point did not reflect the value that potential consumers placed on the product. Consumers valued it at much less than $5,000. This was a contributing factor to the poor sales for this device. So what is price? Very narrowly, it is the amount of money that you pay in exchange for a product to service. But more broadly, it is worth the sum total of the value of all of the benefits provided by the product or service. How much is that worth to you? There are many synonyms for price, including fee, honorarium, wage, fare but these terms all mean an amount that you're willing to exchange for something that you value. Let's see where price fits in with the marketing process. A firm's marketing efforts are directed toward creating value for its chosen customers. Understanding customers' wants and needs is a foundation for building this value. In turn, capturing that value falls to the marketing mix, the four P's, developing a product that satisfies those wants and needs, designing a promotion program that conveys the value of that product to the customers, choosing a distribution program that the place that makes that product readily available. Finally, designing a pricing strategy that simultaneously creates a customer's incentive to buy that product and the firm's incentive to sell the product. The first three of these marketing mix variables represent cost to the firm. Pricing's role in the marketing mix is to tap into the value created and generate revenue. This revenue helps to fund the firm's current value creation activities, support research that would lead to future value creation and also generates a profit from the firm's activities. The job of the fourth P price is to determine how the value that has been created can be divided between the customer by providing them with an incentive to buy the product and the organization by covering the cost associated with this value creation effort and then generating profit. They're two very general approaches to how firms view price. The first is by examining cost of production. This is known as cost-plus pricing. In cost-plus pricing, the company first determines its break-even price for the product. This is done by calculating all of the costs involved in production, marketing, and distribution of the product then a markup is set for each unit based on the profit the company needs to make and it's sales objectives. Why do companies use cost-plus pricing? It is far easier to determine cost than to estimate customer value. It is a quick and dirty method to pricing products. Cost-plus is used to price large development projects, particularly in government contracts. Another area that applies cost-plus pricing is services, particularly those provided to federal and state governments by large and small businesses alike. Cost-plus pricing is commonly used in processing credit card transactions as well. A pricing system which is called Interchange Plus, adds a merchant service providers fee to the rate charged by the credit card provider for each transaction. One problem with cost-plus pricing is that it does not take into account the price of competing products. If competing product is selling for less, cost-plus may not be a very good strategy to use. More importantly, though, cost-plus pricing ignores what the product is worth to the buyer, buyers maybe willing to pay more for some products. Ultimately, a cost-plus strategy may not responsive to changes in the market and can certainly be an obstacle to long-term success. Price isn't just about recovering costs though, it's about extracting the value that customers place on the product. But in doing so, the firm incentivizes a customer to purchase a product by not extracting the maximum value that they have estimated the benefits to be worth to the customer. Effective pricing will result in very accurate estimation of the value of these benefits to the customer. In addition to customer's perceived value, companies who pursue value-based pricing must also be cognizant. They must be aware of competitors prices, and the intensity of competition as measured by potential competitive response to price changes. Firms have difficulty extracting their products true value from customers. Two researchers Liozu and Hinterhuber stated that even though companies were aware of the importance of a customer value-based pricing approach, this was difficult to pursue since effective implementation requires deep structural changes in the organization. While the design and implementation of a true value-based pricing approach requires a commitment to organizational change, the returns from that effort are great. Researchers have found that companies that have adopted a value-based pricing strategy and built the organization capabilities to implement the strategy and 24 percent higher profits than industry average. These are the different components of this value-based pricing approach. Let's start with the true economic value. This is the value that a fully informed by a word or shut ascribed to the product. Note that the customer's needs and preferences are important here. This value comprises of the cost of the next best available product that satisfies the customer's need plus how much the consumer values the relative advantage provided by the product in question. How much is the difference in performance worth to the customer? While true economic value represents what a fully informed, rational consumers should be willing to pay for a product, in reality, but as willingness to pay is governed by the value she or he perceives in the new product. Generally, perceived value is less than true economic value or TEV. Why? Perhaps a potential buyer is unaware of all of the relative benefits of the new product. The degree to which perceived value approaches true economic value can often be influenced by the level and quality of internal and external factors including marketing efforts that impact the customer. Ideally, an organization's marketing efforts should transform an uninformed customer who isn't fully aware of the benefits of the product into a fully informed buyer. The result is that the buyer's perceived value will now be closer to the products true economic value. Think of it. The difference between the cost of goods sold and the product price in this instance is the incentive for the firm to sell their product to that specific customer segment and then the difference between the product price and the customer's perceived value is what incentivizes the consumer to purchase. To that consumer, he's getting value for money so to speak. He's paying less for the good than what it is worth to him. These elements are major considerations when setting that final price. Let's dive a little deeper into true economic value and discuss an example. True economic value is the cost of the next best alternative plus the value of any additional benefits derived by using one product over the other. I'm a frequent flyer with American Airlines and I now have been granted a gold status for life based on all the miles I've flown regardless of if I travel annually or not. Let's think of it. If I travel from Chicago to Port of Spain, Trinidad by United, the airfare is $760 on United Airlines. Since I don't have any special status with United, I'd have to pay $65 in baggage fees for a total of $833. But what about the additional benefits of flying on American Airlines? First off, I get TSA pre-check and that allows me to move through airport security much faster. That is worth about $200 to me. I get upgrades. One space is available, that is worth about $400 to me. It could be more depending on the length of the trip. For trips over four hours I value first-class seating much more than that $400. Then, I get frequent flyer miles multiply by some variable given my frequent flyer status. This could be used for future flights. This would be worth about $300 for this Trinidad trip to me that is. What is the true economic value of this trip to me? About $1,733. This is a cost of the trip on American? No, it's not. The cost to me was $860. For me I feel like I'm getting a really good deal here. Value for money. Note, if I did not have frequent flyer status, the trip would be worth much less to me given the fact that I would not accrue all of these additional benefits and my true economic value would be much lower. Consumer perceived value is based on the benefits about which consumers are aware. Marketers must ensure that consumers are fully informed of the benefits to be derived from using the product and that consumers assign the appropriate value to these benefits. In my case I'm aware of what the miles would cost if I had to buy them. I'm also aware of the price of a first-class seat. I've discounted this somewhat since the first leg of my trip the first-class seat was not so important to me, but for the second leg from Miami to Trinidad, given the length of the flight it becomes much more important.