Price management strategy, analysis, decision, implementation

Hermann Simon
Martin Fassnacht

Price
Management
Strategy, Analysis,
Decision, Implementation


Price Management


Hermann Simon • Martin Fassnacht

Price Management
Strategy, Analysis, Decision,
Implementation


Hermann Simon
Simon-Kucher & Partners Strategy
and Marketing Consultants
Bonn, Germany

Martin Fassnacht
WHU – Otto Beisheim School of Management
Chair of Marketing and Commerce
Düsseldorf, Germany

ISBN 978-3-319-99455-0
ISBN 978-3-319-99456-7

/>
(eBook)

Library of Congress Control Number: 2018959416
# Springer Nature Switzerland AG 2019
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The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland


Testimonials

“This book is truly state of the art and the most comprehensive work in price
management.”
—Prof. Philip Kotler
Kellogg School of Management, Northwestern University
“This very important book builds an outstanding bridge between science and
practice.”

—Kasper Rorsted
CEO, Adidas
“This book provides practical guidelines on value creation, communication
and management, which is an imperative for businesses to survive in the
coming era of uncertainty.”
—Dr. Chang-Gyu Hwang
Chairman and CEO, KT Corporation (Korea Telecom)

v


Preface

The title Price Management expresses our ambition to produce a book which is both
grounded in theory and relevant in practice. The author team—an academic
(Fassnacht) and a practitioner (Simon)—guarantees the desired integration of theory
and practice.

State of the Art
This book is state of the art yet also looks into the future. Digitalization is penetrating
all phases of the pricing process, from strategy and analysis to decision-making and
implementation. The Internet and other new technologies (sensors, measurement,
etc.) have led to a wealth of price management innovations which this book explores
in detail. These include flat rates, freemium, pay-per-use, pay-what-you-want, new
price metrics, two-sided price systems, negative prices, sharing economy, Big Data,
artificial intelligence, and machine learning. Innovative payment systems and even
cryptocurrencies are also having effects on price management.

The Integration of Theory and Practice Using Case Examples
We use real-world cases throughout the book to ensure the link between theoretical

rigor and practical relevance. That is possible because we could draw on the vast and
diverse experience of Simon-Kucher and Partners, the global market leader in price
consulting. We have anonymized these examples whenever necessary to protect
confidentiality.

vii


viii

Preface

Industry Orientation
It is easy to see price management as a basic discipline, similar to accounting or
controlling and generally applicable across all sectors. But our decades of involvement in price management have taught us that the ways of framing and solving
pricing problems are often industry-specific. Consumer goods, for example, are sold
primarily through intermediaries (retailers), while industrial products are predominantly sold directly. The resulting pricing issues, strategies, and tactics in these
sectors are very different. For this reason, we devote separate chapters to the
respective price management issues in the consumer goods, industrial goods, service, and retail sectors.

Global Approach
This is the global book on pricing! We committed ourselves to a global approach
throughout the book. Global competition means that companies around the world are
confronted with similar price management challenges. In line with this global
approach, we selected representative case studies and practical examples from
around the world.

Target Audience
The integration of theory and practice makes this book equally relevant for students
and academics as for entrepreneurs and managers. Price management is becoming

more and more professionalized in companies around the world, with stronger
engagement from senior management, all the way up to the CEO. We not only
cover the role of price as a short-term profit driver but also show how companies can
use price as a means to drive sustained increases in shareholder value.
Price management is taking up a larger portion of business studies. This is due in
part to the Internet, which has massively increased price transparency, intensified
price competition, and triggered more price wars. But at the same time, the
Internet also increases value transparency. This dichotomy results in some surprising
and highly asymmetric effects for the marketing instrument “price.”
We have many people to thank for their contributions to this book, and we call
attention to them individually in the acknowledgments. But we are especially
thankful to Anna-Karina Schmitz for her outstanding work as our project leader
and to the associates of Simon-Kucher and Partners for their valuable support.
The preoccupation with price management dates all the way back to Ancient
Rome. The Latin language uses the identical word for “price” and “value,” namely,
the word “pretium.”


Preface

ix

Pretium ¼ Price ¼ Value
That is the core equation of price management!

Hermann Simon

Martin Fassnacht

Bonn, Germany

Düsseldorf, Germany

Hermann Simon
Martin Fassnacht


Contents

1

Fundamentals of Price Management . . . . . . . . . . . . . . . . . . . . . . . .
1.1
Profit and Price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1.2
Definition of Price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1.3
Price and Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1.3.1
Price as a Marketing Instrument . . . . . . . . . . . . . . . . .
1.3.2
Understanding the Role of Price . . . . . . . . . . . . . . . . .
1.3.3
Price Management as a Process . . . . . . . . . . . . . . . . . .
1.4
Knowledge Sources for Price Management . . . . . . . . . . . . . . . .
1.4.1
Macroeconomic Price Theory . . . . . . . . . . . . . . . . . . .
1.4.2
Microeconomics . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1.4.3

Marketing Science . . . . . . . . . . . . . . . . . . . . . . . . . . .
1.4.4
Behavioral Economics . . . . . . . . . . . . . . . . . . . . . . . .
1.4.5
Brain Research . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1.4.6
Price Consulting . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1.4.7
Software for Price Management . . . . . . . . . . . . . . . . .
1.4.8
Pricing Innovators . . . . . . . . . . . . . . . . . . . . . . . . . . .
1.4.9
Popular Literature . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1.5
The Legal Framework of Price Management . . . . . . . . . . . . . . .
1.5.1
United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1.5.2
European Union . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1.5.3
Worldwide . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1.5.4
Activities of the Antitrust Agencies . . . . . . . . . . . . . . .
1.6
Current Trends in Price Management . . . . . . . . . . . . . . . . . . . .
1.6.1
Prices Are Penetrating Management Thinking . . . . . . .
1.6.2
Price and Power . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1.6.3

Price and Top Management . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1
1
5
6
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10
14
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17
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18
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20
20
21
21
23
24
26

2

Price Strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2.1
Goals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2.2
Price Management and Shareholder Value . . . . . . . . . . . . . . .
2.3
Value and Price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2.4
Positioning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

29
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35
40
41

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Contents

2.5
2.6

Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Price Positions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2.6.1
Luxury Price Position . . . . . . . . . . . . . . . . . . . . . . . .
2.6.2
Premium Price Position . . . . . . . . . . . . . . . . . . . . . .
2.6.3
Medium-Price Position . . . . . . . . . . . . . . . . . . . . . . .
2.6.4
Low-Price Position . . . . . . . . . . . . . . . . . . . . . . . . . .
2.6.5
Ultra-Low Price Position . . . . . . . . . . . . . . . . . . . . .
2.6.6
The Dynamics of Price Positioning . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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46
46
53
59
64
70
75
81

3

Analysis: The Economics of Price . . . . . . . . . . . . . . . . . . . . . . . . .
3.1
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.2
Analysis of Price-Relevant Information . . . . . . . . . . . . . . . . .
3.2.1
Cost-Plus Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.2.2
Customers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.2.3
Competition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.3
The Price-Response Function . . . . . . . . . . . . . . . . . . . . . . . . .
3.3.1
Classification of Price-Response Functions . . . . . . . . .
3.3.2
Price-Response Functions and Price Elasticity . . . . . .

3.3.3
Additional Forms of the Price-Response Function . . .
3.3.4
Empirical Findings on Price Elasticity . . . . . . . . . . . .
3.4
Empirical Determination of the Price-Response Function . . . . .
3.4.1
Surveys . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.4.2
Observations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.4.3
Synopsis of Instruments . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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86
87
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92
92
93
99
102
108
108
128
136
139

4

Analysis: The Psychology of Price . . . . . . . . . . . . . . . . . . . . . . . . . .
4.1
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4.2
Traditional Psychology of Price . . . . . . . . . . . . . . . . . . . . . . . .
4.2.1
Prestige Effects of Price . . . . . . . . . . . . . . . . . . . . . . .
4.2.2
Giffen Paradox . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4.2.3

The Price as a Quality Indicator . . . . . . . . . . . . . . . . .
4.2.4
Special Cases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4.3
Behavioral Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4.3.1
Theoretical Basis . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4.3.2
Behavioral Pricing Effects . . . . . . . . . . . . . . . . . . . . . .
4.3.3
Neuro-Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4.3.4
Overall Assessment . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

143
143
145
145
146
146
149
150
151
157
166
167
169

5

Decision: One-Dimensional Prices . . . . . . . . . . . . . . . . . . . . . . . . .
5.1
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
5.2
Categorization of One-Dimensional Pricing Processes . . . . . . .
5.3
Rigid Pricing Processes . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

173
173
174
175

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Contents

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7

xiii

5.3.1
Cost-Plus Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . .

5.3.2
Competition-Oriented Pricing . . . . . . . . . . . . . . . . . .
5.4
Comprehensive Pricing Process . . . . . . . . . . . . . . . . . . . . . . .
5.4.1
Break-Even Analysis . . . . . . . . . . . . . . . . . . . . . . . .
5.4.2
Decision-Support Systems . . . . . . . . . . . . . . . . . . . .
5.4.3
Mathematical Price Optimization . . . . . . . . . . . . . . . .
5.4.4
Price Optimization in Oligopoly . . . . . . . . . . . . . . . .
5.4.5
Reaction Hypotheses in an Oligopoly . . . . . . . . . . . .
5.5
Background Information . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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Decision: Multidimensional Prices . . . . . . . . . . . . . . . . . . . . . . . . .

6.1
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6.2
Price Differentiation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6.2.1
Market Segmentation as the Foundation for Price
Differentiation . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6.2.2
Theoretical Basis of Price Differentiation . . . . . . . . . .
6.2.3
Implementation of Price Differentiation . . . . . . . . . . .
6.3
Price Decisions Across Products . . . . . . . . . . . . . . . . . . . . . .
6.3.1
Price Decisions for Product Lines . . . . . . . . . . . . . . .
6.3.2
Price Bundling . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6.4
Background Information . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. 209
. 209
. 210

Decision: Long-Term Price Optimization . . . . . . . . . . . . . . . . . . .
7.1
Determinants of Long-Term Optimal Prices . . . . . . . . . . . . . .
7.1.1
Long-Term Objective Function . . . . . . . . . . . . . . . . .

7.1.2
Long-Term Price-Response Function . . . . . . . . . . . . .
7.1.3
Long-Term Cost Function . . . . . . . . . . . . . . . . . . . . .
7.2
Long-Term Price Optimization . . . . . . . . . . . . . . . . . . . . . . . .
7.2.1
Rules of Thumb for Long-Term Price Decisions . . . . .
7.2.2
Quantitative Optimization of Long-Term Prices . . . . .
7.3
Long-Term Price Decisions and Relationship Marketing . . . . .
7.3.1
Long-Term Price Decisions and Customer
Acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
7.3.2
Long-Term Price Decisions and Customer
Retention . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
7.3.3
Long-Term Price Decisions and Winning Back
Customers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
7.4
Background Information . . . . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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176
178
178
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207

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273
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286

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xiv

Contents

8

Price Management and Institutional Context . . . . . . . . . . . . . . . .
8.1
Price and Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

8.1.1
Varying Inflation Rates and Net Market Position . . . .
8.1.2
Inflation-Neutral Trend . . . . . . . . . . . . . . . . . . . . . . .
8.1.3
Non-Inflation-Neutral Trend . . . . . . . . . . . . . . . . . . .
8.1.4
Tactical Considerations on Price and Inflation . . . . . .
8.2
International Price Management . . . . . . . . . . . . . . . . . . . . . . .
8.2.1
Problems and Practices . . . . . . . . . . . . . . . . . . . . . . .
8.2.2
Price and Exchange Rates . . . . . . . . . . . . . . . . . . . . .
8.2.3
Parallel Imports . . . . . . . . . . . . . . . . . . . . . . . . . . . .
8.2.4
Price and Government Intervention . . . . . . . . . . . . . .
8.2.5
Implementation in an International Context . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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300
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304
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326

9

Implementation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
9.1
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
9.2
Responsibilities in Price Management . . . . . . . . . . . . . . . . . . . .
9.2.1
Definition of the Tasks . . . . . . . . . . . . . . . . . . . . . . . .
9.2.2

Allocation of Price Decision Authority . . . . . . . . . . . .
9.2.3
Price-Related Organization . . . . . . . . . . . . . . . . . . . . .
9.2.4
The Role of the CEO . . . . . . . . . . . . . . . . . . . . . . . . .
9.3
The Role of the Sales Force . . . . . . . . . . . . . . . . . . . . . . . . . . .
9.3.1
Price Decision Authority of the Sales Force . . . . . . . . .
9.3.2
Price-Oriented Incentive Systems . . . . . . . . . . . . . . . .
9.4
Price Communication . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
9.4.1
External Price Communication . . . . . . . . . . . . . . . . . .
9.4.2
Internal Price Communication . . . . . . . . . . . . . . . . . . .
9.5
Price Controlling . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
9.5.1
The Price Controlling Function . . . . . . . . . . . . . . . . . .
9.5.2
IT Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . .
9.5.3
Tools for Price Controlling . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

329
329
330

331
333
336
344
348
348
354
362
363
373
374
375
375
376
385

10

Price Management for Consumer Goods . . . . . . . . . . . . . . . . . . . .
10.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
10.2 Vertical Price Management . . . . . . . . . . . . . . . . . . . . . . . . . .
10.2.1 The Manufacturer Sets Both Its Selling Price
and the End Consumer Price . . . . . . . . . . . . . . . . . . .
10.2.2 The Manufacturer Sets Only the Manufacturer’s
Selling Price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
10.2.3 Manufacturer and Trade Partner Pursue
Joint Profit Maximization . . . . . . . . . . . . . . . . . . . . .
10.2.4 Distribution of Profit . . . . . . . . . . . . . . . . . . . . . . . .
10.3 Multichannel Price Management . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

404
406
410
415

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Contents

xv

11

Price Management for Industrial Goods . . . . . . . . . . . . . . . . . . . .
11.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
11.2 Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
11.3 Decision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
11.3.1 Value-Based Pricing . . . . . . . . . . . . . . . . . . . . . . . . .
11.3.2 Cost-Oriented Pricing . . . . . . . . . . . . . . . . . . . . . . . .
11.3.3 Auctions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

11.4 Implementation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
11.4.1 Price Negotiation . . . . . . . . . . . . . . . . . . . . . . . . . . .
11.4.2 Price Contracts and Price Hedging . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

.
.
.
.
.
.
.
.
.
.
.

417
417
419
421
421
424
426
430
430
436
440

12

Price Management for Services . . . . . . . . . . . . . . . . . . . . . . . . . . .
12.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
12.2 Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
12.2.1 Company Information . . . . . . . . . . . . . . . . . . . . . . . .
12.2.2 Customer Information . . . . . . . . . . . . . . . . . . . . . . . .
12.2.3 Competitor Information . . . . . . . . . . . . . . . . . . . . . .
12.3 Decision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
12.3.1 Decision-Support Methods . . . . . . . . . . . . . . . . . . . .
12.3.2 Price Differentiation for Services . . . . . . . . . . . . . . . .
12.3.3 Yield Management . . . . . . . . . . . . . . . . . . . . . . . . . .
12.4 Implementation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
12.4.1 Implementation of Differentiated Prices . . . . . . . . . . .
12.4.2 Fixed Prices or Case-Specific Prices . . . . . . . . . . . . .
12.4.3 Price Communication . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

.
.
.
.
.
.
.
.
.
.
.
.
.

.
.

443
443
447
448
449
452
452
452
454
458
464
464
465
466
468

13

Price Management for Retailers . . . . . . . . . . . . . . . . . . . . . . . . . .
13.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
13.2 Strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
13.2.1 Price Positioning . . . . . . . . . . . . . . . . . . . . . . . . . . .
13.2.2 Price Image . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
13.3 Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
13.3.1 Company Information . . . . . . . . . . . . . . . . . . . . . . . .
13.3.2 Consumer Information . . . . . . . . . . . . . . . . . . . . . . .
13.3.3 Competitor Information . . . . . . . . . . . . . . . . . . . . . .

13.4 Decision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
13.4.1 Setting Price Ranges . . . . . . . . . . . . . . . . . . . . . . . . .
13.4.2 Price Decisions for Individual Items . . . . . . . . . . . . .
13.4.3 Price Decisions and Assortment Effects . . . . . . . . . . .
13.4.4 Decisions on Price Promotions . . . . . . . . . . . . . . . . .

.
.
.
.
.
.
.
.
.
.
.
.
.
.

471
471
473
473
478
483
483
484
489

490
490
491
494
496


xvi

14

Contents

13.5

Implementation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
13.5.1 Organizational Aspects . . . . . . . . . . . . . . . . . . . . . . . .
13.5.2 Controlling . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
13.5.3 Price Communication . . . . . . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

501
501
503
504
508

Innovations in Price Management . . . . . . . . . . . . . . . . . . . . . . . . . .
14.1 Pricing Innovations: A Historical Overview . . . . . . . . . . . . . . .
14.2 Changes in the Price-Response Function Due to Increased

Transparency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
14.2.1 Price Transparency . . . . . . . . . . . . . . . . . . . . . . . . . . .
14.2.2 Value Transparency . . . . . . . . . . . . . . . . . . . . . . . . . .
14.3 Innovative Pricing Models . . . . . . . . . . . . . . . . . . . . . . . . . . . .
14.3.1 Flat Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
14.3.2 Freemium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
14.3.3 Interactive Pricing Models . . . . . . . . . . . . . . . . . . . . .
14.3.4 Pay-Per-Use . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
14.3.5 New Price Metrics . . . . . . . . . . . . . . . . . . . . . . . . . . .
14.3.6 Two-Sided Price Systems . . . . . . . . . . . . . . . . . . . . . .
14.3.7 Negative Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
14.3.8 Marginal Costs of Zero and the Sharing
Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
14.3.9 Innovative Payment Systems . . . . . . . . . . . . . . . . . . . .
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

513
513
518
518
520
522
522
525
529
532
535
538
539
544

546
552

Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 557


About the Authors

Hermann Simon is the founder and honorary chairman of Simon-Kucher and
Partners, the world’s leading price consultancy. Ranked on the Thinkers 50 list of
the most influential international management thinkers, he is considered the world’s
leading authority on pricing. Simon has published over 35 books in 27 languages,
including the worldwide bestsellers Hidden Champions, Confessions of the Pricing
Man, Power Pricing, and Manage for Profit, Not for Market Share. From 1995 to
2009, he served as CEO of Simon-Kucher and Partners. He has advised many of the
world’s leading companies and has served as a board member of foundations and
corporations. Before committing himself entirely to management consulting, Simon
was a professor of business administration and marketing at the Universities of
Mainz (1989–1995) and Bielefeld (1979–1989). His visiting professorships include
Harvard Business School, Stanford University, London Business School, INSEAD,
Keio University in Tokyo, and the Massachusetts Institute of Technology. He has
served on the editorial boards of numerous business journals, including the International Journal of Research in Marketing, Management Science, Recherche et
Applications en Marketing, Décisions Marketing, and European Management Journal. He was also president of the European Marketing Academy (EMAC). Simon
studied economics and business administration at the Universities of Cologne and
Bonn, where he received degrees in economics and earned his Ph.D. in management
science. He has received many international awards and three honorary doctorates.
He is honorary professor at the University of International Business and Economics
in Beijing, and the Hermann Simon Business School in China has been named in his
honor.
Martin Fassnacht is the Otto Beisheim chaired professor of marketing and commerce at the WHU—Otto Beisheim School of Management in Düsseldorf,

Germany. He ranks as one of Germany’s most influential economists. Under the
motto “We Inspire Marketing,” he and his team at WHU generate fresh ideas for
research, practice, and teaching in price management, retail marketing, and brand
management. He serves as a strategic advisor to consumer goods manufacturers and
retailers, and he and his team conduct projects in cooperation with partners from
industry and trade. He is also the author of numerous publications in international

xvii


xviii

About the Authors

peer-reviewed journals and magazines. Fassnacht is the scientific director of the
Center for Market-Oriented Corporate Management at WHU and the academic
director of WHU’s MBA program. He is the chairman of the Advisory Board of
the Henkel Center for Consumer Goods (HCCG) at WHU. Fassnacht completed his
postdoctoral work at the University of Mannheim and at the WHU with Prof.
Christian Homburg. He received his Ph.D. in business administration from the
University of Mainz under the direction of Prof. Hermann Simon, co-author of this
book. Fassnacht was a visiting scholar at the Owen Graduate School of Management
at Vanderbilt University and at the McCombs School of Business at the University
of Texas at Austin.


1

Fundamentals of Price Management

Abstract

In this fundamental chapter, we will identify price as the strongest driver of profit
and explore the relevant aspects of price management. Despite its significance,
price is often not well managed in practice. Sharp profit declines are not uncommon because of poor price management. The consequences of pricing are not
fully understood for many reasons, including gaps in how theory is applied to
practice, the multidimensionality of prices, complex chains of effects, psychological price phenomena, and implementation barriers. We should view price
management as a process which encompasses strategy, analysis, decisionmaking, and implementation and which draws on insights from different scientific fields. In general, price mechanisms are increasingly penetrating parts of
society beyond traditional business. More and more, fields such as education,
traffic, and health care are controlled through price mechanisms. Price management is coming under an increasingly comprehensive regulatory framework, so
that one always needs to make the appropriate checks before implementing a
price measure.

1.1

Profit and Price

This book is fundamentally about profit and price. Price is the most effective profit
driver. The definition of profit is as follows:
Profit ¼ ðPrice  VolumeÞ À Costs

ð1:1Þ

The profit formula shows that there are ultimately only three drivers of profit:
price, volume, and costs. Costs, in turn, have fixed and variable components. To
demonstrate the influence of each of these drivers, consider the following simple
example of a typical price structure for many products and services. Imagine a
© Springer Nature Switzerland AG 2019
H. Simon, M. Fassnacht, Price Management,
/>

1


2

1

An improvement of five percent ...
Profit driver
old

new

... increases profit by ...
Profit
old

new

Price

$100

$105

$10 mill.

$15 mill.

Unit

costs

$60

$57

$10 mill.

$13 mill.

$10 mill.

$12 mill.

Sales
volume
Fixed
costs

$1 mill. $1.05 mill.

$30 mill. $28.5 mill.

Fundamentals of Price Management

$10 mill. $11.5 mill.

50%

30%

20%

15%

Fig. 1.1 Effect on profit from improvements in profit drivers

company sells 1 million units of a product priced at $100 per unit. The company has
$30 million in fixed costs, plus $60 in variable costs per unit. This results in sales
revenues of $100 million and a profit of $10 million. The return on sales is 10%.
What effect would an isolated change (ceteris paribus) of 5% in one of the profit
drivers have on profit? Figure 1.1 shows the answer. A 5% increase in price means
the price is now $105. Holding all other factors constant, the revenue would increase
to $105 million. The profit rises from $10 to $15 million, an improvement of 50%.
For the other profit drivers, the percentage changes in profit from a 5% improvement
in the respective factor (again, ceteris paribus) are 30%, 20%, and 15%. Under these
circumstances, price is by far the strongest profit driver.
No less interesting is the reverse perspective, examining the consequences of a
decline of 5% in an individual profit driver. Figure 1.2 shows what happens. The
consequences are the mirror image. In the same way that a price increase has the
strongest positive influence on profit, a price decrease has the strongest negative
influence.
The comparison of price and volume as profit drivers is particularly revealing.
Whether we increase or decrease price or volume (in isolation), we get the same
revenue ($105 million for an increase; $95 million for a decrease). But whereas the
entire $5 million revenue increase drops to the bottom line when we increase the
price, the majority of the revenue increase from an improvement in volume ($3
million of the $5 million) gets absorbed by the resulting increase in variable costs.
The opposite effect holds true for a price decrease, as the revenue decrease reduces
profit by the same amount. If volume declines by 5%, in contrast, variable costs fall

correspondingly by $3 million, which means profit declines only by $2 million. As
we can see, changing the price has a far greater impact – positive or negative – on
profit than changing the volume.


1.1 Profit and Price

3

A decline of five percent ...

... reduces profit by ...

Profit driver

Profit

old

new

Price

$100

$95

$10 mill.

$5 mill.

Unit
costs

$60

$63

$10 mill.

$7 mill.

1 mill.

0.95 mill.

$10 mill.

$8 mill.

$30 mill. $31.5 mill.

$10 mill.

$8.5 mill.

Sales
volume
Fixed
costs

old

new
-50%

-30%

-20%

-15%

Fig. 1.2 Effect on profit from declines in profit drivers

From this example, we can conclude that it is more advantageous for profit to
grow through price increases than through volume increases. Conversely, it is better
from a profit perspective to accept lower volumes than lower prices.
Confront managers with these statements as they need to choose between
alternatives A and B below, and you get an explosive debate.
Alternative A: Accept a price cut of 5% (e.g., in the form of a rebate) and volume
remains constant.
Alternative B: Accept a volume reduction of 5% and price remains constant.
We have discussed these alternatives with hundreds of managers in seminars and
workshops. Almost all of them lean toward Alternative A, which means they defend
volume at the expense of price, even though profit is $3 million lower (using our
earlier numbers) than in Alternative B. Even in the case of improved profit drivers,
many practitioners prefer volume growth, usually making the argument that market
share is higher under that alternative. One could cite the mobile telecommunications
operator T-Mobile US as an example. In 2014, the company endured high losses in
order to expand its share of the US market [1]. We take a more in-depth look at the

conflict between profit and market share in Chap. 2.
In the simplest possible way, this example demonstrates the interdependence
between profit and its drivers. The assumption, however, that one can change only
one profit driver without affecting the others is not commonly borne out in reality. A
price increase of 5% often leads to a decline in volume. That applies analogously to
changes in volume. In a stable market, volume would normally not rise by 5% unless
there is a decline in price. At the same time, in our practice we have experienced
many cases in which volume did not change despite a substantial increase in price.
That happens frequently for price changes in the range of 1%, 2%, or 3%. Such


4
Amazon
Royal Dutch Shell
Honda Motor
Walmart
Hon Hai Precision Industry
CVS Health
Walgreens Boots Alliance
Sociéte Générale
HP
AXA
Ford Motor
Daimler
Allianz
General Motors
Toyota Motor
AT&T
Samsung Electronics
Berkshire Hathaway

BMW
Apple

1

Fundamentals of Price Management
276.2%
215.9%

65.2%
50.5%
47.0%
45.0%
37.7%
37.4%

34.9%
31.9%
31.2%
27.3%
25.8%
24.2%
18.9%
16.9%
16.5%
13.5%
11.0%
6.7%

Fig. 1.3 Leverage effect of a 2% price increase (based on profits for selected Fortune

500 companies in 2015)

changes can be implemented in real life with little or no effect on the other profit
drivers, i.e., without any noticeable violation of our ceteris paribus assumption.
If we apply this simple thought process to selected companies of the Global
Fortune 500, we can see what would happen if these companies realized a price
increase of 2%. Figure 1.3 shows the percentage change in pre-tax profit as a result of
such a price increase. (The pre-tax return on sales is the pre-tax profit divided by the
revenue. Dividing 2% by this calculated return on sales results in the profit increase
(in percentage terms) which would result from a price increase of 2%, assuming no
loss of volume.)
The effects on profit from such a seemingly small price increase of 2% are very
strong for most companies. If Amazon succeeded in raising its prices by 2% without
any loss in volume, its profit would increase by 276.2%. For HP, the profit increase
would be 34.9%. Even companies which are already highly profitable benefit from
such a slight price increase. Apple has the highest return on sales (29.7%) of the
companies listed in Fig. 1.3, but even in Apple’s case, profit would rise by 6.7%,
which is still more than three times the price increase on a percentage basis. On
average, a price increase of 2% would raise the profits of the companies shown in
Fig. 1.3 by 52.2%! This calculation shows the enormous leverage that price has on
profit. It pays to optimize prices.
The lower a company’s margins, the greater this leverage effect from a price
change will be. If a company has a net profit margin of only 2% (which is typical for
many retailers), a price increase of 2% would double the company’s profits, assuming no volume loss. Moreover, the profit margins of companies tend to be much
smaller than people would generally assume. The average after-tax profit margin for
the 500 largest companies in the world was 6.3% in 2013 [2]. If we assume a tax rate
of 30%, then the pre-tax margin amounts to around 8%. Figure 1.4 shows the return
on sales for industrial companies from different countries for the years 2007–2011.
American companies achieved an average return on sales of 5.1% in the 5 years
from 2007 to 2011. On an international basis, this return is relatively low. The average

2.0%

3.6%

3.0%

4.3%

3.9%

4.6%

4.4%

5.1%

4.6%

6.2%

6.0%

6.6%

6.4%

7.0%

6.8%

7.4%

7.1%

10.2%

Russia
Switzerland
Brazil
India
Spain
Great Britain
Canada
Belgium
Norway
Denmark
Sweden
China
USA
Netherlands
Italy
France
Finland
Austria
Germany
Greece
Japan

8.1%

10.3%

Fig. 1.4 Average after-tax
return on sales for industrial
companies (international
comparison for 2007–2011)
[3]

5
12.5%

1.2 Definition of Price

for the other countries was 6.1%. Companies in Russia achieved 12.5%. Returns were
8.1% and 7.1%, respectively, in India and Great Britain. Companies in France
realized an after-tax return of only 4.4%, but this was still above their German
counterparts’ (3.6%). Companies in Greece (3%) and Japan (2%) achieved the lowest
returns. Amid such weak yields, every tenth of a price point makes a difference.

1.2

Definition of Price

The price is the number of monetary units which a buyer must hand over for one unit
of a product. This definition is simple and clear. Indeed, many of the prices we
encounter on a daily basis have this one-dimensional character. Think of a pound of
coffee at the supermarket, a gallon of gasoline, or a magazine at the kiosk. However,
prices often come in forms which are much more complex. Prices or price systems

can comprise several parameters, even a large number of them. Here is a selection of
complex price parameters and structures:
•
•
•
•
•
•
•
•

Base price
Discounts, bonuses, rebates, conditions, and special offers
Differentiated prices by package size or product variant
Differentiated prices based on customer segment, time of day, location, or phase
of the product life cycle
Prices for complementary or substitutive products
Prices for special or additional services
Prices with two or more dimensions (e.g., upfront charge and a usage fee)
Bundles and prices for individual components


6

1

Fundamentals of Price Management

• Prices based on personal negotiations
• Manufacturer and end consumer prices

This list of price parameters and structures is by no means complete, but it
illustrates that prices are often complex constructs, and not one-dimensional.
Companies can have hundreds or even thousands of prices, all of which must be
determined. The price list of a bank usually contains several hundred line items. In
trade, assortments with tens of thousands of articles are common. The range of
replacement parts for the manufacturers of cars or heavy machinery can comprise
several hundred thousand items and price points. Airlines make millions of price
changes over the course of a year. Important questions in this context are: how do
customers deal with this large number of prices, price parameters, and price
changes? What is the level of price transparency? And what are the effects on
volume and profit [4]? The complex and multidimensional nature of prices holds
significant potential for optimization.

1.3

Price and Management

1.3.1

Price as a Marketing Instrument

If prices were predetermined by the market, management would not need to devote
much attention to them. We encounter this situation with pure commodities which
are traded on exchanges. The only things that matter with such goods are cost
efficiency and volume adjustments. However, even within commodity markets,
there are still ways to use price movements to one’s own advantage. With better
price forecasts, for example, one can improve the timing of price and delivery
agreements.
In modern product and service markets, price is typically a parameter whose
management, flexibility, and effects offer very interesting opportunities:

• Price has a strong influence on volume and market share. For consumer goods, the
price elasticity is on average 10–20 times as high as the advertising elasticity and
roughly eight times as high as the sales force elasticity [5]. That means that the
effect of a price change, on a percentage basis, is 10–20 times stronger than the
effect of a similar percentage increase in the advertising budget and 8 times
stronger than the effect of a comparable percentage change in the sales budget.
Sethuraman et al. [6, p. 467] have even determined that advertising budgets
would need to increase by 30% in order to match the effect of a price decrease
of 1%. The level of price elasticity varies by product category and product [7,
p. 82].
• Price is an instrument known for its fast applicability. In contrast to changes to a
product (innovation), an advertising campaign, or a cost-cutting program, prices
can be readily adjusted on short notice as new situations arise, apart from


1.3 Price and Management

•

•

•

•

7

long-term contractual agreements or catalog periods. The Internet has only
increased the speed of these adjustments. A company can change prices in a
matter of seconds. The same applies to retailers whose scanner systems have

electronic displays at the shelf. Such changes have also been a topic for gas
stations. Germany has a price registration database in operation, which consumers
can access via an app to find up-to-the-minute fuel prices at around 14,500 filling
stations [8]. On the one hand, this increases price transparency for consumers, but
at the same time, it also reveals price differences for competitors [9]. In order to
reduce the number of price changes, the Australian government limits price
changes to one per day. The concept of dynamic pricing takes advantage of the
ability to change prices quickly by adjusting prices to the prevailing supply and
demand situation.
The effects of price manifest themselves quickly on the demand side. If a gas
station changes its prices and the local competition does not follow, market shares
can shift significantly in a matter of minutes. The same goes for the Internet,
which has created unprecedented price transparency. With one tap or keystroke, a
consumer can call up the current prices for a vast number of suppliers and can
make an immediate purchase decision. This has advanced to the point where a
consumer can scan the barcode of a product in one store and find out instantly
what the product costs online or in nearby stores. In the case of other marketing
actions such as advertising campaigns or new product introductions, the response
from the demand side often comes with a considerable time lag.
The flipside of quick price actions with rapid demand responses is that
competitors can act just as swiftly with their own prices. Such price reactions
often happen quickly and can come with such an intensity that they may ignite a
price war. Because competitors can respond to price changes almost instantaneously, it is hard to achieve a sustainable competitive advantage purely through
price measures. That would require a cost advantage which prevents competitors
from maintaining low(er) prices for very long. A Big Data analysis by Feedvisor
[10] tracked 10 million Amazon products over a period of 10 months. It found
that over 60,000 price wars occur every day. On average, 92% of those price wars
happened between two competitors, and 72% lasted less than 6 h. Usually the
price wars follow predefined rules; however, the level of knowledge about
competitive behavior is low.

Price is the only marketing instrument which does not require upfront
expenditures or investments. This makes it possible even for cash-strapped
companies (start-ups or companies launching a new product) to implement the
optimal price. In comparison, it is rarely possible to optimize instruments such as
advertising, sales, or research and development – which require upfront
investments before they earn a return – when a company has limited financial
resources.
Cost reductions and rationalization are vitally important goals for many
companies. These efforts are always ongoing, but in many companies, the
residual cost savings potential is limited, if not already exhausted. Furthermore,
in mature markets it is difficult to capitalize on the third profit driver, which is


8

1

Fundamentals of Price Management

Profit
Price management
Profit advantage

Time
advantage
Time
Investment
advantage
Cost reductions/
marketing investments

Fig. 1.5 The three advantages of price management compared to cost reductions and marketing
investments

volume. Mature markets are generally characterized by a zero-sum game, which
means any volume increases must come at the expense of competitors, who will
defend their market shares. The improvement potential in price management,
however, is not even close to being exhausted in many cases.
Figure 1.5 shows the advantages which pricing offers as a marketing tool compared
to cost reductions or to investments in other marketing instruments such as advertising or sales. The investment advantage means that price optimization requires little
upfront capital, unlike cost reductions or marketing investments. The time advantage
implies that pricing has a positive effect on profit sooner than the other measures.
And the profit advantage expresses the fact that price measures often lead to higher
profit increases.
Pricing plays a standout role as a marketing instrument, but it also has an
important meaning to customers. The price is the “sacrifice” which the customers
must accept when they acquire a product. The higher the price is, the greater this
sacrifice. Figure 1.6 shows how consumers in different countries (130,000
respondents) reacted to anticipated price increases.
According to this study, German and Chinese consumers tend to react to a price
increase by buying a less expensive product at the same store or switching to a store
which offers lower prices. American consumers respond less strongly to price
increases.
In light of the outstanding role of price as a profit driver and the notable ways it
affects a business, one should expect that managers and even top executives would
devote a lot of attention to pricing. But in practice, this is often not the case. Instead,
management continues to commit the greatest attention and energy to another profit
driver, namely, to costs.

1.3 Price and Management
Percentage of
respondents (%)

9

No reaction

Switch to a less expensive store

Buy less

Buy a less expensive product at the
same store

100
24%

27%

18%

80
16%

60

16%

18%

18%

16%

40%

40%

26%

26%

29%

20%
21%

29%
27%

40

10%

46%
22%

20

35%
14%

22%

40%

0
Germany

France

Netherlands

Great Britain

USA

China

Fig. 1.6 Reactions of consumers to anticipated price increases [11]

“As a manager, it is easier to work on the cost side than on the revenue side,” said
the CEO of an airline [12]. Companies also tend to spend more time and energy on
increasing volume (e.g., through investments in sales and advertising) than they do
on price management. Many companies give pricing neither the professionalism nor
the seriousness it warrants.
Take, for example, the response of a large engineering group to a question about
how the company arrives at its actual transaction prices: “Essentially we proceed like
this: we apply a factor of 2.5 to the manufacturing costs, and leave the rest to the

sales force.” Such a process makes no sense. A closer look at this company’s
performance uncovered that it was sacrificing a large amount of profits, or “leaving
a lot of money on the table,” as the business cliché goes. The following statement
from a board member of one of the world’s 100 largest banks is also eye opening in
this context: “This bank is 125 years old. To my knowledge, this project marks the
first time the bank looks at pricing in a professional manner.”
In the recent past, especially since the Great Recession, however, we observe that
top management shows increasing interest in price management. A large number of
CEOs have spoken openly about pricing in recent years. Their comments have come
in interviews and road shows, at shareholder meetings, and during conferences with
analysts. Our impression is that such comments come predominantly from
companies with above-average profits [13]. That leads to the conclusion that these
companies, or more precisely their leaders, have understood – better and sooner than
companies with lower profits – the critical role that price plays as a driver of both
profit and shareholder value.
Why do many companies still neglect or play down the importance of price
management? We see several reasons.