Wednesday, October 20, 2010

Lessons from Business School: Power Pricing

As I mentioned in my last entry, I am taking a pricing class this quarter. I just couldn't see leaving business school without a pricing class.

The professor is out of the Kellogg School of and is one of those Profs who is purely academic- meaning he has never worked a day in his life. His lack of experience definitely hurts his credibility among an Evening MBA (mostly employed)class, but I have noticed that there are several valuable nuggets in each class.

The first class in particular really helped drive home the importance of valus in pricing. The framework goes something like this...

Customers are willing to pay a certain price for something that they value. The price that they will pay is determined by two conditions. Their purchasing power and their preference for one product as compared to a basket of alternatives. For example, to determine how much a customer who must procure transportation is willing to pay for a Honda Accord a "power pricer" would do the following.

Determine the utility that a buyer gets from all forms of transportation (public transit, cars, trucks, etc.). Find the alternatives that provide the best value to the customer and then determine how much more or less value the Honda Accord bring them. add or subtract an amount for that added/reduced value and you will arrive at a good price.

What's described above can be expressed more mathematically as... the price of a Honda Accord should be less than or equal to the value of aclose alternative +/- the difference in value between that alternative and the Honda Accord. The price can then be adjusted to fit a particularly pricing strategy (i.e. lower price if a company is new and aggressively trying to take market share).

...well that's today's lesson from Business School.