Part 5: Price Segments and Components

Components of Price Used to Target the Chosen Segments

Capsule: Every price has three components and, usually, a fourth. The company uses these components to focus its changing price on its chosen customer segments.




Every price has at least three, and usually four, components: the Benefit Package, the List Price, the Basis of Charge and, often, Optional Components of Price. The company may use these four price components to further contain the spread of its new pricing to customers within its target segments. We describe each of these components below.

  • The Benefit Package. The package of benefits is the Performance part of the Value proposition the company offers the customer. This Performance package includes all the Function, Reliability and Convenience benefits at the product Price Point. The company may reach a new price by changing the Function, the Reliability, the Convenience or any combination of the three benefits of the product at the same time as it changes price. The expectation is that as Performance changes the cost will change as well, and in the same direction.

Performance (ie Function, Reliability and Convenience) Changes

  • Primary

  • Support

  • Related Option

There are three basic categories of benefits that the Company may alter in this process: Primary, Support, and Related Option. The Primary benefits fulfill the primary Function needs of the customer. As an example of a change in Primary benefits, Glaxo priced its Zantac at a 50% premium over its nearest competitor because the product was easier to use, had fewer side effects and was more compatible with other products. The improved Primary benefits allowed Glaxo to charge a higher price.

The Support benefits deliver and guarantee the product. These Support benefits are important Reliability and Convenience aspects of the product. These Support benefits include delivery times, minimum order quantities, warranties, return policies, cancellation policies, advertising support, and other services of this nature. An example of Support benefits employing Reliability occurred when Pfizer introduced a heavily discounted generic version of the anti-depressant Zoloft after the brand named drug lost its domestic patent production. An example of Support benefits changing Convenience occurred when Budget Rent-A-Car offered one way rentals on an economy car from Arizona to California for a low daily rate.

The Company may offer Optional benefits that are related to the product. These Related Optional benefits are not part of the standard set of Primary or Support benefits. Rather, they are benefits that add to the functionality or convenience-of-purchase of the product, usually for a subsegment of the customer group. For example, a personal computer manufacturer may offer an optional printer. An automobile may have an optional sunroof.

For more examples and explanations, please see: for
Reduce Price (HERE) and for
Raise Price (HERE).

Performance Benefits Questions

Examine changes to the Standard Leader product benefits over the last few years.

  • What are the Primary benefits, usually built-in Functions for the user of the product?

  • What benefits support the Primary benefits of the product by insuring its Convenience of purchase and installation or by increasing the product's Reliability?

  • Has any change in the Primary or Support benefits of the product package affected the sales volumes or margins of the supplier who made the change?

  • What benefits of the product are Options Related:

    • For a manufactured product: the acquisition, use, maintenance, or disposition of the product?

    • For a service or distribution product: obtaining, selling guaranteeing or returning the product?

  • Has the addition or subtraction of Optional Related or Optional Related benefits had an effect on the sales volumes or margins of the competitors offering these options?

  • The Basis of Charge. The Basis of Charge is the unit measure the company uses to quantify either the List Price or an Optional Component of the Price. A change in the Basis of Charge will often reflect changes in company costs, market demands for simpler pricing or changes in packaging. Frequently, this change in the Basis of Charge also produces a new product Price Point.

Often, the Basis for the List Price of the product reflects the key cost that drives the industry's cost per unit sold. A change in the Basis of Charge for a component of price would normally change the effective price for some segment of the customers. The industry might use one Basis of Charge for the unit of product and a different Basis of Charge for an Optional or for a Support benefit. The industry may create a combination Basis for a charge or credit by including more than one Basis in a single transaction. When the industry includes more than one Basis for its charge in a particular transaction, it usually is charging the customer for the achievement of a particular result or on the occurrence of a particular event.

For more explanation and many examples, please see
Reduce Price (HERE) and
Raise Price (HERE).

Basis of Charge Questions

  • Identify the Basis of Charge the industry uses today on both the product or on a component of the Price:

    • Application or Item: The industry charges for each individual unit sold which is not classified separately below.

    • Slated Time: The industry sells a service for a particular period of time.

    • Result Achieved: The industry charges the customer for the achievement of a specific end result.

    • Unit of Cost: The industry charges the customer a multiple of its key cost.

    • Dimension: The industry charges by length, width, or height.

    • Volume: The industry charges by cubic measure.

    • Event Occurrence: The industry's charge or credit to the customer is contingent on the occurrence of a specific event.

    • Package: The industry charges for a group of similar items.

    • Unit of Currency: The industry charges for units of currency spent or invested.

    • Bundle of Related Items: The industry charges the customer for a set of items used sequentially, concurrently or in a common application.

    • User: The industry charges for each user of the product or service.

    • Weight: The industry charges by English or metric units of weight.

  • Has the Basis changed in the last few years?

  • Has the use of a new Basis affected the sales volume or margins of any competitor in the industry?

  • The List Price. The List Price is the company’s stated price for a unit of the product as described by the Basis of Charge. This is the most common of the four major Components of Price that a company uses to change its price. In many cases, where the company chooses to change only the List Price among its four Components of Price, the isolated customer segment, which pays the new price, is sufficient to limit the extent of the price change.

The company may change its List Price by offering a discount or by charging a premium on a product or to a customer segment. Virtually every product and service package provides for some form of discount for specific segments in the market. The most common forms of segment discounts are those that reward buyers for large volumes of purchases and for prompt payment on invoices. However, there are several other types of discounts that the industry may use to reduce the basic price offered to specific segments of the market. In some cases, these discounts might be reversed, as well. With a reversed discount, a seller would charge a premium to some segments in the marketplace by using the discount concept to produce a premium. Most of these discount types reflect savings for the industry in some part of the customer relationship in the segment. Premiums reflect higher costs to serve a customer segment compared to the average customer.

For more explanation and many examples, please see
Reduce Price (HERE) and
Raise Price (HERE).

List Price Questions

  • Identify discounts and premiums the industry uses today:

    • Volume: Does the industry use volume discounts or premiums?

    • Product Demand: Does the industry offer a discount or add a premium according to the demand a product has compared to other products in the market place?

    • Customer Status: Does the industry offer discounts according to whether the purchaser is a current or potential customer, or alternatively, whether the customer has high or low value to an industry competitor?

    • Transfer Cost: Does the industry transfer part of its typical product package cost to the customer in return for a discount? Here, the customer himself provides some of the benefits included in the product.

    • High Visibility Product: Does the industry change its discount or premium structure on products commanding lesser or greater customer attention?

    • Multiple Products: Does the industry offer discounts based on the number of separate products the customer buys?

    • Prompt Payment: Does the industry offer customers a discount that varies with the promptness with which the customer pays the invoice for the product?

  • Have any of these discounts or premiums had an effect on the sales volume or margins of the competitors in the industry?

  • The Optional Components of Price. The Optional Components of Price include several forms of price adjustments the company uses to modify its effective prices for specific segments of customers. These components enable the company to maintain its List Price for the product while allowing or requiring other customers to pay a lower or higher price. The Optional Components of Price vary in a falling price environment from those in a rising price environment. For example:

  • In a falling price environment, companies may choose among the following Optional Components of Price:

    • Rebate: Illustrative Examples>> Companies use a rebate with customers when there is some uncertainty on the purchases the customer will make, or on the lower price the customer will earn.

    • Coupon. Illustrative Examples>> If the effective price reduction is relatively low, the price adjustment may come in the form of a coupon.

    • A discount in kind. Illustrative Examples>> The customer receives the price adjustment by receiving more product in the unit of product purchased than in the previous version of the product, without paying more for the unit of product.

    • Fee waiver or a one time or periodic payment. Illustrative Examples>> The customer receives a payment to offset some of the customer's costs related to the product. The payment may be a fixed sum or an amount tied to a specific cost the customer incurs.

    • A trade-in allowance. Illustrative Examples>> The customer receives the effective price reduction as a cash payment or as a reduction in the price of the new product when the customer surrenders the old product.

    • A sample of the product. Illustrative Examples>> The customer receives a sample of the product to be sold. This effective price reduction differs from a discount-in-kind because there is no payment required for the sample.

    • A free, or heavily discounted, product from a third party. Illustrative Examples>> The customer receives the effective price reduction in the form of a free or heavily discounted product from a third party.

    • A free, or heavily discounted, product from the company, other than the product on sale. Illustrative Examples>> This form of effective price reduction adds another product to the original product to increase its performance. This component also applies when a company offers customers its product for "free" in order to attract third party revenue, especially advertising, or to attract the customer to purchase other company products.

    • Price Cap. Illustrative Examples>> The Cap limits the price per unit the customer might face or limits the total amount the buyer might pay for an amount of product or service.

    • Extended payment term. Illustrative Examples>> The customer pays later than is customary in the industry. This option includes the company's offering of financing, either subsidized or unsubsidized, to the customer.

    • A Put. Illustrative Examples>> The customer receives the right to resell the product to the company at a stated price in the future.

    • A Call. Illustrative Examples>> The customer receives the right to purchase the product at a stated price for a specific period of time that is longer than the norm.

    • A meet or release agreement. Illustrative Examples>> The customer on a contract with the company may present the company with a legitimate, competitive price offering. The company must then meet that price offer or release the customer to buy from the competitor.

    • A Performance Payment. Illustrative Examples>> The final payment by the customer depend on the company's achievement of specific objectives, including all performance and price guarantees.

  • In a rising price environment, the company may choose among the following Optional Price Components:

    • An extra fee on top of the normal variable charge. Illustrative Examples>> The company charges a fee on top of its normal variable charge to improve margins. This extra fee usually reflects a separately identifiable cost in the company's Performance offering.

    • Shorter than normal payment term. Illustrative Examples>> By reducing the time the company allows the customer to pay for the product, the company reduces the capital assets it must carry for the customer.

    • Minimum purchase requirements. Illustrative Examples>> This price component assures the company of a minimum amount of sales to each customer or on each transaction. These components require the customers to increase their minimum purchases and pay for any product that they do not take or use.

    • Discount Elimination. Illustrative Examples>> Virtually all customer relationships involve some discount offer to the customer. The company may raise its effective prices by eliminating some forms of discount.

    • Limits on the usage of the product. Illustrative Examples>> The company may raise its effective prices, especially with customers who use the product intensively, by setting limits on the amount of product the customer may use during a period of time.

For more explanation and many examples, please see
Reduce Price (HERE) and
Raise Price (HERE).

Optional Component Questions

Example the Optional Components of Price that competitors have introduced in the market over the last few years:

  • Have any of these components remained unique or been used by a minority of the competitors over the last few years?

  • Have any of these components resulted in an improvement of a competitor's market share?

  • Have any of these changes resulted in an improvement in a competitor's margins, especially compared to those of other competitors?

Once you have reviewed the sections of the four major components of price, try the test:

At the end of this diagnostic, you are ready to begin developing new pricing ideas using the four components of price. There are several thousand innovation ideas in the Improve/Pricing section of StrategyStreet to help you create new ideas.

Basic Strategy Guide Users Return To: Step 23
or

Proceed to Cost Management beginning in: Step 24




Summary Points Next: Improve Pricing