We Lose Money on Every Sale, But We Make It Up on Volume: Growing Association Profits With Effective Pricing Kevin Whorton Director of Retail Programs National Association of Chain Drug Stores, Inc.

General Manager, NACDS Services Corporation

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Program Outline

I. Overview of Pricing Techniques/Tactics II. Framework for Setting Optimal Price III. Vignettes and Cautionary Tales 2

I: Overview of Pricing Techniques and Tactics

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Pricing Objectives

 Will drive strategies and techniques:  Maximize profit/financial surplus  Cost recovery  Maximize market size  Social equity 4

Pricing Strategies

 Cost-oriented: based on markup/target return on investment  Market penetration: low introductory price  Build acceptance, forestall competition  Market skimming: where market will bear  No foreseeable competition  Competitive price: defensive, matching, or maintaining guaranteed low price  Prestige price: intentional high/establish value 5

Common Pricing Techniques

 Cost-plus pricing: adding markup to achieve defined margin  Demand-oriented pricing: consumer need sets price; price level varies with demand  Line pricing: price set for individual items, relative to other items within the line/brand  Price discrimination: offer multiple prices within distinct markets/distribution channels  Other: price points, loss leader, promo pricing 6

Price Setting

 Existing services  Qualitative research  Quantitative methods--contingent valuation  Tradeoff (conjoint) modeling  Overall review of practices  New services  Price testing  Bundled/unbundled products 7

Pricing By Service Category

 Services Under Development  Marketing involvement during product development process:  Define ideal product  Determine its attributes  Forecast success of product with a variety of price points/strategies (measure opportunity cost) 8

Which Problems Apply to You

 Too much/too little price variety in product line  Over-consistent pricing across categories with different costs: associates, students, international  Internal resistance to hikes: “not business decision”  Not bundled well with discounts for other services  Price level inconsistent with perceived value  Constant dues level over time, despite changes in services/components of membership 9

Potential Solutions

 Varying solutions and potential returns  Direct changes in base dues  Bundling with products/premium membership  New categories (e.g. inst./multiple memberships)  Multiple-year and discounted memberships  Changing price for categories with higher/lower fulfillment costs (international, students)  Each change needs systematic review/evaluation similar to new product development model 10

Communication

 Make case for direct price changes…  Marshal evidence of over/underpricing  Address underlying issues (e.g., cost allocations)  Build internal/external understanding/acceptance  ... or indirect price changes  Increase benefits, member discounts, premium giveaways, member-only services (if overpriced)  Unbundle benefits, lower member discounts, create premium level (if underpriced)  Continue to pursue a long-term strategy to change direct prices 11

Implementation

 To succeed, maximize return on price changes  Communicate findings internally  Forecast results, re-evaluate effectiveness  Communicate to external audiences  The sales force — chapters, recruiters  Current customers — catalog, renewals  Prospects — promotional materials  Position change as increased market responsiveness  Establish precedent: ensure pricing is a marketing decision 12

Applications: Membership

 Typical scheme:  Annual charge, no installments  Primary membership: often political/by-laws  Line pricing for other categories  No volume discounts  Strategy for changes: budget-balancing  Technique is cost-based  Full, not incremental cost 13

Application: Member Dues

 Identify pricing strategy/technique used  Determine if strategy is sub-optimal  Retention (by category) vs. benchmarks  Exit surveys: frequency of value/cost as a reason  Satisfaction ratings based on “value for price paid”  Qualitative research, current members  Competitive scan/market penetration  Use file analysis: total members by company, site  Positioning: “primary” or “secondary” affiliation 14

Application: Exhibit Fees

 Far greater latitude: multiple attendees  Split registrant fees from space rental  History rules: working within budgets  Competitor intelligence  Potential for value-added: pre-show lists, travel costs, all factored into budgets  Annual packages: ads + exhibitor fees  Willingness to trade certainty for higher price tag 15

Application: Sponsorships

 Typical scheme:  Full, not incremental cost  Based on perceived WTP or need for specific program  Often linked to giving/donor relations  Altruistic motives vs. market access  Pricing the sponsor “ask” • • • Identify market’s value to potential sponsor Extensive use of add-ons Specific deadlines for offers/auction to drive prices build-in exclusivity for high profile • Avoid frequent use of tiers 16

Application: Certifications

 Cost-plus pricing: FC vs. VC: packaging and recordkeeping  Externalities: ‘lift’ for all education  Product line: spinoffs, distance learning  Perceived value--new clients/higher income  Adjustments if problem signs (attrition rates)  Importance of lifetime value  Pricing for first and subsequent years  Pricing and penetration: elite/prestige (low) or democratic/requisite credential (high) 17

II: A Framework for Setting the Optimal Price

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"No margin, no mission."

Henri Manasse, Ph.D, Sc.D.

ASHP Executive Vice President and Chief Executive Officer

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Assumptions

 You price to generate a profit.

 There is a direct relationship between price and demand.

 Cost is only one element used to establish the final price.

 Price is used as a basis for determining a product’s value.

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Pricing Floor and Ceiling

 Your costs set the floor.

 The marketplace sets the ceiling.

 There is a range of acceptable prices (in theory on one is optimal).

1 1 1 0 0 0 Ceiling Price Range Cost

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Components of Pricing Process

 Pricing constraints and objectives  Demand, revenue, and elasticity  Cost, volume, and profit relationships  Pricing strategies  Factors in setting the specific price  Special adjustments 22

Pricing Objectives

 Specify pricing goals that reflect your organization’s strategic goals  Profit  Manage for long-run profits  Maximize current profits (current quarter, current year)  Target return on investment 23

Pricing Objectives (cont.)

 Sales  Given adequate profit, increase in sales revenue will lead to increases in market share and profit.

 Market share (ratio of your sales to industry sales)  Declining market  Long-term strategy for entry into new markets 24

Pricing Objectives (cont.)

 Unit sales  Good for products that increase in price each year  Can be deceptive with price cutting (revenue can be down while unit sales are up 25

Constraints

 Determine the demand  Associations are niche oriented w/ a defined marketplace.

 Look at both competitive association products and competitive commercial products.

 Is your product/service truly unique?

 Is there an expected price?

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Constraints (cont.)

 Anticipate the competitive reaction  Who are your competitors?

 How crowded is the marketplace?

 What are your competitor's charging?

 How will you price position your product?

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Constraints (cont.)

 Establish universe size market share  Is the market large enough to generate adequate sales?

 Is the universe stable?

 Is the universe growing or shrinking? At what rate?

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Constraints (cont.)

 Determine the cost of producing and marketing the product or service  Production costs  Marketing costs  Fulfillment costs  Assigned overhead or other fixed costs 29

Other Pricing Constraints

 Newness of product: stage in the product life cycle  Single product vs. product line  Cost of changing prices and the time period they apply  The competitive marketplace (monopoly vs. competitive)  Competitor’s prices 30

Pricing Objectives (cont.)

 Survival  Social responsibility  True for many associations  Look at total product line for profitability (gains offset losses) 31

Demand, Revenue, Elasticity

 Demand Curve Factors  Price Elasticity and Demand 32

Demand Curve Factors

 Consumer tastes  Price and availability of other products (preference set)  Consumer income 33

Typical Demand Curve

3,000 2,500 2,000 1,500 1,000 500 0 $0 $50 $100 $125 $150 $200 $250 Price

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Revenue Curve

$200,000 $150,000 $100,000 $50,000 $0 0 500 1,000 1,250 1,500 2,000 2,500 Quantity

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Price Elasticity and Demand

 There is a relationship between the quantity demanded and price.

 Elasticity is the % change in quantity demanded relative to the % change in price.

 Price elasticity of demand (E) is: (Initial quantity demanded / New quantity demanded) / Initial quantity demanded (E) = _________________________________________ (Initial price - New price) / Initial price 36

What does this mean?

 Demand is elastic when a small price increase produces a larger percentage decrease in quantity demanded. Price elasticity is > 1.

 Demand is inelastic when a small price increase produces a smaller percentage decrease in quantity demanded. Price elasticity is < 1.

 (The above also works in reverse.)  Unit demand elasticity- when the percentage of change in price produces an identical change in quantity demanded .

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Factors Affecting Elasticity

 The greater the number of substitutes, the greater the elasticity.

 Products and services considered to be necessities are price inelastic.

 Items that require large cash outlays compared to disposable income are price elastic.

 One way to measure elasticity is through year to-year purchasing.

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Cost, Volume, and Profit Relationships

 Pricing Terms  Marginal Analysis  Break-even Analysis  Estimating Demand 39

Terms

 Profit = Total revenue -Total cost  Total cost (TC) = total production, marketing, and sales expense.  Fixed costs (FC) do not change with the quantity sold (rent, salaries)  Variable costs (VC) vary directly with the quantity sold  Variable cost expressed on a per unit basis it called unit variable cost.

 Marginal cost (MC) is change in unit cost for producing and marketing one additional unit.

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Marginal Analysis for Profit Maximization

 To maximize profit  sell and promote your products/services as long as the revenue received from the sale of an additional product is greater than the cost to produce and market that product.

 In theory, you want to operate up to the point where MR = MC 41

Break-even Analysis

 Analyze the relationship between total revenue and total cost to determine profitability at various levels of output.

 The break-even point (BEP) is the point where total revenue = total cost.

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Calculating the Break-even Point

Fixed Cost_______ BEPq = Unit price - Unit variable cost  Answers the question: How many units do I need to sell to break even?

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Practical Example of Break-even

$55,000___ BEPq = $35 - ($10 + $ 8) = 3235.3

 Question: How may units can we realistically sell?

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Developing the Break-even Chart

 Where P = $35  UVC = $18 (printing, distribution, storage)  FC = $55,000 (development, marketing, salaries, OH) 45

Break-even Chart

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Q TR TVC TC Profit ROI

 (P X Q) (UVC X Q) (FC X TVC)  1,000 $35,000 $18,000 $73,000 ($38,000)  2,000 $70,000 $36,000 $91,000 ($21,000)  3,000 $105,000 $54,000 $109,000 ($4,000)  4,000 $140,000 $72,000 $127,000 $13,000 10.2%  5,000 $175,000 $90,000 $145,000 $30,000 20.7%  6,000 $210,000 $108,000 $163,000 $47,000 28.8% 46

Break-even Graph

$250 $200 $150 $100 $50 $0 1000 2000 3000 4000 5000 6000 TR TC FC

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Estimating Demand

 Universe/market share  Example: Membership category (N=250)  31,000 certified technicians  15,000 take exam in 1999 (12,000 pass)  Approximately 1/3 are in the health-system market niche  Min. universe = .33 x 43,000 = 14,190  Mkt share estimate = 10% or 1,419 48

Estimating Demand (cont.)

 Average Sales Method 1,000 units 2,000 units 3,000 units 4,000 units Total estimate x x x x .3 = 333 .4 = 800 .2 = 600 .1 = 400 = 2,133 49

Estimating Demand (cont.)

 Previous sales/similar products  Review sales of earlier editions  What external factors are affecting demand?

 Examine sales of similar products  External research: sales of competitive products  Internal research: ask customers if they’d buy 50

Summary

 Establish a pricing policy  Set your parameters and goals  Make assumptions  Use the tools  Draw on your experience 51

III: Vignettes and Cautionary Tales

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Sponsorship: Effect On Pricing the Subsidized Item

 Grant in hand to subsidize program development  “Net cost” of development is zero  Developer wants to price low  What do you do?

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Sponsorship’s Effect (2)

 If net cost=0, should you give it away?  Social objective of pricing strategies  Publicize your role as good guys  OR…Price where the market will bear  If you can make money, price based on gross cost  Product is a sponsorship magnet  Yet pricing should reflect perceived value 54

“The Fait Accompli”

 What do you do when the price is established and the “go/no go” is GO  Illustrated: Spinoff of an established product  Power resides with the product developer  Your own analysis yields profit = 0  Probable outcome: profit < 0  What do you do?

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“The Fait Accompli” (2)

 De-emphasize the product  May be self fulfilling prophecy  Free/low-cost marketing options  Wait until the next round  Work on fixing problem for the next edition  Price-test the release: forecast results  Prepare for markdowns in promotion plan 56

New Product Release

 Product rollout begins in six months  Your charge: develop pre-pub and rollout communications and pricing strategies  Marketing has autonomy over discounts, some control over rollout price  How do you determine pricing?

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New Product Release (2)

 Pre-pub allows some flexibility in price testing (validate your research)  Know your doubling day from product history: drive your forecast  Don’t pick at random, test price points  Pre-pub to price-sensitive segments  Consumer expectations/rollout price turnoff  Commit to using the pre-pub learning to adjust actual rollout price 58

Rapid Price Escalation

 Underpriced good, with some uncertainty  Decision-maker sees product far underpriced  Sound basis on market data  Objective: raise to market price, turn cash calf into a cash cow  What do you do? 59

Rapid Price Escalation (2)

 One fell swoop  Understand elasticity  Avoid disrupting established buying patterns: will people stay in the habit of buying?

 Budget-based decisions: don’t outrun real willingness to pay  Communicate: one adjustment year  Incremental multi-year: gradual, less pain 60

Product Line Extension

 Successful product needs milking  Decision: expand product line  May be segmenting content for a niche  May be compiling discrete products or issues into a single volume  What do you consider in pricing?

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Product Line Extension (2)

 Considerations?

 How much do components or single attributes contribute to value/how many are in product  Perceived value affected by media or content  What is the niche-specific demand  Are you being a cannibal?

 “Fit” with long-term pricing strategy  Other approaches: bundling, repackaging 62

Desperation Marketing

 Got a dog to unload  May be low-pickup conference, underperforming book or product  “Fire sale,” on-site discounts are options  Must sunset the product/no questions asked  No current pricing process in place  What do you do? 63

Desperation Marketing (2)

 Time to ignore cost data  How to exhaust inventory gracefully  Avoid “aging” your catalog’s perception  Avoid hurting image: product and other lines  Avoid future expectations of a white sale  Giveaways: perform the social function  People perceive value from pricing  Understand why it tanked!!!

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Membership = Bundle

 Association membership is under review  Each represents a bundle of goods  Board wants to re-evaluate what members get for their dues, and/or dues level  Service mix and membership categories last changed in the Truman Administration  What input do you provide?

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Membership = Bundle (2)

 Evaluate value of components in bundle  Use a “time-neutral” perspective  Ignore history and competition for now  Integrate with an overall financial model  Loss leader, competition, or primary revenue source  Attribute all indirect member-caused revenue: journal ads, exhibit revenue, sales 66