In this note, we will discuss the pricing of a given product or a service. We will only discuss the pricing of an individual product/service and not the pricing across a set of products in a product line. Thus in the discussion that follows, we assume that the pricing decision of the product/service under consideration has no bearing on the profitability of other products/services in the portfolio of the firm.
1. Overview of the Pricing Decision:
While making the pricing decision, it is assumed that the product is given to us. Thus as a first step, we eliminate all those segments/customers who will not buy the product regardless of the price that we charge. For instance, consider the Land Rover case in which the Rover group was to introduce Discovery in the market. Thus we will first eliminate all those segments who will not buy Discovery regardless of the price that we charge. This elimination is done by doing the matching exercise, in which we match the attributes of Discovery with all the important value drivers of the customers except the price. For instance, if Land Rover was to introduce Discovery, the eliminated segments will be (a) the Family segment, since Discovery does not satisfy their important value drivers of interior space, reliability and fuel efficiency, and (b) the Older Traditionalist segment, since Discovery does not satisfy their important value drivers of luxury and exclusivity. Thus by the end of this step, we are left with the Young Adults segment, which we call the broad horizontal segment. Similarly, consider another example where Dell was to introduce a 7lb 3GHz Laptop in the market. Thus, we will first eliminate all those segments that will not buy Dell’s laptop regardless of its price. These eliminated segments will be (a) Mac users, who do not like the Windows OS, (b) Desktop users who see no use in buying laptops, (c) frequent business travelers, for whom7lbs is way too heavy etc. By the end of this exercise, we will be left with all those consumers who can potentially buy the Dell’s laptop, and these consumers will constitute the board horizontal segment.
The pricing decision kicks in after we get the broad horizontal segment. Given the broad horizontal segment, we can use pricing as an instrument to further refine on our target segments. For instance, consider the Dell’s laptop example. The broad horizontal segments can be further segmented into vertical segments, where the different vertical segments have different willingness to pay (or different price sensitivities) for the 3GHz Laptop. For instance, there can be three vertical segments within the broad horizontal segment: Segment A, which comprises of consumers who value the high microprocessor speed (they might be gamers or consumers who run scientific simulations) and will have a high willingness to pay for the 3GHz speed; Segment B, which comprises of consumers who value the high microprocessor speed less than segment A and thus have a lower willingness to pay for the 3GHz
speed as compared to segment A; segment C, which comprises of consumers who use the Laptop for basic purposes like Microsoft Word, and have the lowest willingness to pay for the for the 3GHz speed. Given the three vertical segments, we can use pricing as an instrument to further refine our target segments. For instance, if we charge a high price, then our target segment will only be segment A; if we charge a medium price, our target segments will be segments A and B; and if we charge a low price, then our target segments will be A, B and C. Thus, the pricing decision boils down to which segment(s) do we target in order to maximize our long term profits. If we target only segment A, the demand will be the lowest, but the price will be the highest. Similarly, if we target segments A, B and C, the demand will be the highest, but the price will be the lowest. Thus our objective here is to set a price in such a manner that...