Q: After many attempts, our product development people have finally been able to come out with a truly superior brand of juice drink versus the leading brand.
Product tests showed how much better this new brand is over competition in overall terms, in its orange and mango taste, and in its just-right sweetness.
Our executive committee asked: “If you believe that this new brand is really that much better than the leading competitor, can you price it 50 percent or even 60 percent more and still attain quota?”
Our Finance VP who’s as old as our Dad, the founder and chair of the company, said that this kind of pricing won’t work anymore unlike during his time in the ’60s and ’70s. According to him, pricing even for a true innovation can only go up now to at most 20 percent to 25 percent.
Our marketing director who once attended your (the Senior MRx-er’s) Pricing Strategy and Tactics seminar, told us that you showed them a price testing technique to arrive at the exact price tag for a new superior brand. She was not sure though how your technique would apply in our specific case. Please help us and tell us how.
A: In that seminar your marketing director attended, while it’s true that the “price sensitivity testing” technique shown arrived at an exact “revenue maximizing price” or what is known to you as “the ceiling price” beyond which total revenue will fall, that price is not as exact as it may appear.
That’s because this testing technique is a survey. As you know, any survey will provide you with data that has a “margin of error.” So that identified ceiling price is a range equal to the ceiling price plus or minus its margin of error. For example, if the identified ceiling price is P20 and the margin of error is +10 percent, then the “true” ceiling price is in the range of P18 to P22. The details of how this testing technique is executed step by step are found in the 3rd edition of my User-Friendly Marketing Research book.
What is important to point out though is this. Whenever you are provided with a survey-based pricing which is inexact, you should complement the initially tried testing technique with an alternative pricing model. If two alternative and differing models converge in its pricing result, then you have convergent validity and your confidence and trust in the test result will go up a level or two higher.
Here’s that alternative pricing model to use for validating the model underlying my price sensitivity testing technique. But first, let us make explicit the price sensitivity testing’s pricing model.
The price sensitivity testing technique draws from Microeconomics’ model of price elasticity of demand that we all enjoyed and learned during our college years.
The pertinent portion of that model tells us first that a brand’s total revenue is equal to its price multiplied by how much quantity consumers will buy at that price.
Then the model points out that the relationship between price and quantity bought is inverse, that is, as you raise the brand’s price, quantity bought will fall. So, as long as successive percent increases in price are accompanied by lesser percent decreases in quantity bought, total revenue will go on rising but once the next percent price increase entails a larger percent decrease in quantity bought, then total revenue starts falling. It’s obvious that the ceiling price or the revenue maximizing price is that price before total revenue starts dropping.
The alternative model is developed in the chapter on positioning and consumer value proposition of the best-selling 2009 book, Economics of Strategy by Northwestern University Professors David Besanko, David Dranove and Mark Shanley.
This model starts off from where Microeconomics ended with the general rule that when you raise your brand’s price, the quantity bought of it will fall and when the percent rise in price is exceeded by the percent fall in buying, total revenue suffers. Besanko et al. provided more than abundant evidence and live cases where the brand’s price increases do not entail purchase reduction but instead the opposite, that is, purchase increases.
This happens when the brand has unlocked and succeeded in containing within its target consumer’s priority product value but in a unique and perceptibly differentiated way.
For the more well-known signature brands of cosmetics, apparel, eye glasses, shoes, and bags, their consumers behave this way. But for just as many ordinary brands like Motolite Battery, Emperador Brandy, Chicken Joy, Alaxan, Lucky Me!, Bear Brand, and the like, most and often almost all their consumers would choose to stay even when competitor brands would lower prices. That’s equivalent to each of these brands raising their prices. So that’s the power of effectively containing in your brand the consumer value proposition. When your brand has it, your Finance VP’s 20 percent to 25 percent cap on an innovation’s price increase becomes inapplicable. That’s the important lesson to keep in mind here.
Avoid limiting your pricing decision to the prescription of only one pricing model. Invoke the help of at least two different and contrasting models. When the prescription of these two models converges, that’s a welcome blessing. If their prescription diverges, however, then choose the prescription that makes more marketing and branding sense.