CHAPTER8
Value-Based Pricing and Pricing Strategies
Dell Computer has it. So do Amazon.com and eBay.
Oracle has it, and even some traditional manufacturing
companies like Toyota and Volkswagen have it. What
these companies have in common, according to a new
research report, is the ability to move away from
traditional methods of setting prices, such as the
cost-plus model or benchmarking of competitor’s prices,
and begin to use the power of “value pricing.”
— Miller-Williams Consulting
“Pricing Power,” 2003
The above quote could be used to introduce the concept of value-based pricing and how it differs from
cost-based pricing. You could ask students to price a consumer product that costs a business $500 to make
and $200 in marketing and sales expenses. How should the business price the product if competing products
sell for $1,000 but the business’s product will last twice as long (4 years versus 2 years)? The example can
serve as the basis for a discussion of cost-based pricing, competitive pricing, and value-based pricing.
Introductory Exercise
A pair of New Balance athletic shoes is retail priced at $100 and costs about $30 to manufacture ($20 for
materials, $2.50 for labor, and $7.50 for manufacturing overhead).
How would a business using a cost-based approach to pricing arrive at a price of $100?
How would a business using a value-based approach to pricing arrive at a price of $100?
Using value pricing, why would a comparable pair of Nike shoes be priced higher?
Teaching Objectives
Demonstrate the importance of product positioning, alternative positioning strategies, and the positioning
factors that need to be addressed in developing a successful product positioning strategy:
Present the difference between cost-based pricing and value pricing and the role pricing plays in product
positioning.
Demonstrate the importance of price elasticity and cross elasticities in developing product line pricing
strategies.
Demonstrate the impact of pricing promotions on customers, intermediaries, and business revenues and
profits.
Harvard Business SchoolCase Materials
Soren Chemical: Why Is the New Swimming Pool Product Sinking? (2009). HBS Case 4188-PDF-ENG.
Topics include distribution channels, pricing, and new product marketing. Jen Moritz, the marketing manager
for Soren, is struggling with the poor sales performance of Coracle, a new clarifier for residential swimming
pools. The performance is puzzling because Coracle is chemically similar to another Soren product that has
sold well for treatment of larger pools. Soren distributes the other product B2B through “chemical
formulators” serving the commercial pools market – but Soren uses wholesale distributors to sell Coracle.
Given the slow start in establishing Coracle as a consumer brand, Moritz suspects that the go-to-market
strategy may be flawed, but she is unsure where the problem lies; she examines channel strategy,
distribution partners, the Coracle pricing scheme, the threat of competitors’ offerings, and other potential
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problem sources. The case study evaluates different approaches to pricing, including value pricing,
competitive parity pricing, and customer indifference pricing (cannibalization).
Culinarian Cookware: Pondering Price Promotion (2009). HBS Case 4057-PDF-ENG. In November
2006, senior executives at Culinarian Cookware were debating the merits of price promotions for the
company’s premium products. The vice president of marketing, Donald Janus, and the senior sales
manager, Victoria Brown, had different views.Janus felt price promotions were unnecessary, damaging to the
brand image, and encouraged retailer hoarding. Brown believed the promotions strengthened trade support,
improved brand awareness, and stimulated sales from new and existing customers. The issue was
complicated by a consultant’s study of the firm’s price promotions, which concluded that these promotions
had a negative impact on profits. Janus trusted the study’s results, but Brown, believing the study’s
assumptions were flawed and required further analysis, suspected the promotions had actually produced
positive results. The pressing decision is whether to run a price promotion in 2007 and, if so, to determine
which merchandise to promote. The broader issue is the strategy Culinarian should pursue to achieve
sales-growth goals, and what roleprice promotions should play. The case study explores the risks and
opportunities of price promotion as a strategic and tactical marketing tool. Through quantitative analysis, it
evaluates the financial impact of a price promotion using different cost and sales assumptions.
Deaver Brown and Cross Rover, Inc. HBS Case No. 9-897-508 (video). The video presents an interview
on encouraging customers to distribute product knowledge while presenting the benefits to the buyer. The
case study provides sets the stage for a class discussion of value pricing.
Fabtek (A). HBS Case No. 9-592-095. This case study focuses on the selection and scheduling of orders by
a small industrial titanium fabricator that finds itself plagued by poor delivery and a lack of capacity. Four
orders are offered, from which the student must select one. Each order represents different customer and
order situation issues. The case study requires students to choose among the four orders, given conflicting
estimates of capacity available, other businesses likely to come along, and the requirements of each order. A
rewritten version of an earlier case. Teaching Note 5-593-006. Supplement 9-592-096.
Duncan Department Stores. HBS Case 9-594-012. Describes a Midwestern department store chain facing
price competition from both regional and national store operators, as well as other retailers. The company’s
pricing policies are often inconsistent and usually instituted as a reaction to a competitor’s sale price. At the
time of the case study, spring 1991, the company had about 50 stores with sales of $450 million. For
students in the second-year MBA retailing course, the case study could be used to prompt discussion on
how a department store chain might transition from a combination of a “hi-lo” and value-based pricing policy
to one more acceptable to consumers, more cohesive, and more profitable. Teaching Note 5-594-041.
Hartmann Luggage Co. ― Price Promotion Policy. HBS Case 9-581-068. The president and the
marketing vice president are reviewing previous Hartmann price promotions in order to decide whether to
again run one or more promotions. Teaching Note 5-592-074.
Precision Pricing for Profit in the New World Order: Increasing Customer Value, Pricing Latitude, and
Profits. HBS Case 9-999-003 (24 pages). Offers a comprehensive framework for managing pricing to
improve profits.
Note on Behavioral Pricing. HBS Case 9-599-114 (10 pages). Provides a good review of economic-based
pricing concepts and then moves into the area of perceived value and pricing. The psychological aspects of
pricing are presented in a series of vignettes.
Market-Based Strategic Thinking
1. How could cost-based pricing lead to a price lower than the one customers would have paid? How
does this affect the profit of a business?
Let’s assume a customer would be willing to pay $1,000 for a new PC with a particular performance level.
The PC cost $450 to make. A manufacturer using cost-based pricing with a desired margin of 25 percent
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($1,000 – $200 – $450). The margin at the current $600 price to retailers is $200 lower, and hence profits
2. How could cost-based pricing lead to a price higher than target customers are willing to pay? How
does this affect the profit of a business?
As in question 1, let’s assume the customer would be willing to pay $1,000 for a PC that operates at a
certain performance level. If the cost to manufacture the PC is $750 and the desired margin is 25 percent,
3. How does value-based pricing differ from cost-based pricing? What should a business do if the
value-based price is not high enough to deliver desired levels of profitability?
Value-based pricing starts with the customer, the product’s differentiating features, and competing
products. The combination of these three factors enables a manufacturer to determine whether customers
4. How would an earthmoving equipment manufacturer use value-in-use pricing to determine its
customer value of its product?
The process requires an understanding of how the customer acquires, finances, uses, repairs, and
eventually sells the earthmoving equipment when it is no longer of use. Each of these areas entails costs
5. How would the earth-moving equipment manufacturer use the net present value of a customer’s
total cost of ownership to set a value price?
Similar to the example illustrated in Figure 8-7, the manufacturer would seek to find a price point on the
basis of the total cost of ownership of its product compared to that of a similar product manufactured by the
6. How would Toyota use perceived-value pricing to set a price for the Prius? How would Toyota
select a specific price that delivered a meaningful customer value?
Similar to the example in Figure 8-8 and 8-9, Toyota could compute a customer benefits index for the Prius
based on customers’ (or potential customers’) perceptions of the Prius relative to competing hybrids.
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to competitors. On the basis of the level of customer value that the Prius has (customer benets index
7. At what price would the Prius not have any perceived customer value?
When the overall perceived benefits index equals the total cost of purchase index, there is no net customer
8. How could Toyota use performance-based pricing to determine a price that would create a good
value for customers and a good price for Toyota?
Using the top-two performance benefits―fuel economy and reliability―along with price, a set of nine
configurations can be created using conjoint analysis. A sampling of customers would rank the nine options
from most preferred to least preferred. Toyota would then derive preferences curves for the two
9. How could Subaru use customerization pricing for the Subaru
Outback and benefit from a top-down price presentation of
price-performance options?
Subaru uses customerization pricing with an interactive feature called
Build Your Own Car on the company’s website. In this example, we
10. Why would Apple use a skim-pricing strategy for a new Apple
product?
When Apple launched the iPod, it used skim pricing to obtain a high
margin and low volume because production capacity was limited. The
11. What kind of pricing strategy is single-segment pricing? Why is single-segment pricing used early
in the growth stage of the product life cycle?
A single-segment strategy targets one type of customer, which means many other customers will not find
the product-price positioning attractive. Single-segment pricing is based on value-in-use pricing. The
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12. Why would a business use a penetration-pricing strategy instead of a single-segment strategy?
How does the penetration-pricing strategy create customer value?
A business with a production capacity advantage and a high customer benefits index could use penetration
13. How does a low-cost-leader-pricing strategy differ from a penetration-pricing strategy?
Low-cost producers do not need a large volume to achieve a low-cost position. These businesses simply
remove excessive costs in making their products and running their businesses. A local motel with the
14. Why would a business use multi-segment pricing early in the late-growth stage of the product life
cycle?
As a market grows, customers with different usage needs become identifiable, and a business can attract
them with products or services that meet those needs and are priced accordingly. As the cellular phone
service market grew rapidly in the 1990s, for example, customers with different needs comprised segments
15. What is plus-one pricing and why is a business more likely to use it in the mature stage of the
product life cycle?
Plus-one pricing involves adding one unique benefit that customers value to a product that other
16. What is reduce-focus pricing? How can a business possibly be more profitable with fewer
customers and lower volumes?
Businesses often unintentionally attract customers who are not profitable or only slightly profitable. By
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Original Pricing Strategy:
Reduce-Focus Pricing:
17. Why would a business use harvest pricing? Why do many businesses using harvest pricing never
exit the market?
When a market becomes less profitable and less attractive, a harvest strategy provides a way for a
business to slowly exit the market using a combination of sequential price increases along with reductions
18. How would a business estimate the price elasticity needed for a price decrease that would maintain
the current level of profits?
Let’s assume that a personal computer that costs $800 to produce sold 10,000 units at a net price of
$1,000. This yields a gross profit of $2 million. A 5 percent price decreasewould require a volume of 13,333
Gross Profit = 10,000 ($1,000 – $800) = $2 million
19. Why should a business always raise price when it is inelastic?
20. When price elasticity is –1.5 to –2, why would a price reduction result in larger volumes, higher
market share, and greater sales but lower profits?
For businesses with margins of less than 40 to 50 percent, price elasticities need to be larger than –2 for a
Sales (current) = 10,000 $1,000 = $10 million
21. Why is break-even market share more useful than the break-even volume?
Break-even volume provides a good index from which to determine the number of units needed to be
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22. What happens to a substitute product when the price of another product in a business’s product
line is increased by 10 percent when the cross-price elasticity is 0.4? Why would a business
intentionally shift sales volume from one product to another in its product line?
When product A’s price is increased 10 percent, the volume of substitute product B increases by 4 percent,
23. What happens to a complementary product when the price of the product that it complements is
decreased by 10 percent and the cross-price elasticity is 0.4?
When product A’s price is decreased 10 percent, the volume of complementary product B would increase
24. Frito-Lay introduced Stax to compete with Pringles in 2003. Assuming the company had excess
production capacity, how would the profits of other Frito-Lay chip products be affected by the
success of Stax?
Any business with excess production capacity can lower the average cost of all products made in that
facility by introducing another brand to be made in the same facility. A large portion of the cost of goods
sold is manufacturing overhead (fixed expenses, such as those associated with facilities, equipment, and
25. Under what conditions would eliminating a brand with a negative pre-tax profit from a product line
result in lower overall pre-taxprofit?
Thedifferent brands in a company’s product line often share the same manufacturing operations.When
manufacturing capacity is underutilized, the strategy is to add brands to take advantage of the excess
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