Strategic Pricing & Performance

Applied Market & Business Strategy (the “Strategy & Management Game”) - NIT / TUHH, Hamburg · part of my Technology Management MBA · study notes for revision.

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Pricing is the one decision that touches every part of the strategy at once - it’s the only lever that pulls in revenue directly rather than pushing out cost. Get it wrong on the high side and nobody buys; wrong on the low side and you leave money (and sometimes the whole business) on the table. This chapter walks the full chain: where a price can legally and sensibly sit, how to read demand, which pricing posture to pick, how margins stack through a channel, and finally the profit-and-ratio maths that tells you whether the whole thing actually made money.

I’ll keep pulling in CERMEDES - our mid-sized German power-tool maker - because its live questions are exactly this chapter’s: which products earn their keep, can we raise prices, and how does our Return on Sales compare to the industry?

1 · The pricing frame: a floor, a ceiling, and a contested middle

The cleanest mental model I took from the session: a price is not a point you invent, it’s a point you place inside a band. The band has two hard edges.

Ceiling - perceived valueabove this, no demand

↓

Competitive market pricewhat rivals charge for similar

↕

Government influencestaxes, tariffs, subsidies, regulation

↑

Floor - the firm’s costbelow this, no profit

Price lives between a cost floor and a value ceiling. Competitor prices and the state’s thumb on the scale (taxes, tariffs, currency, regulation) fill the contested middle.

• The floor is cost. Sell below what it costs to make, distribute and sell a product and the business cannot survive for long. But “cost” is not a single number - it’s a matter of managerial judgment: full cost, or just variable cost? Firms will even deliberately price below current cost for strategic reasons (riding the experience curve down toward lower future costs, or buying market share).
• The ceiling is perceived value. Charge more than the customer thinks the product is worth and there’s simply no market. The ceiling is different for different segments - and it can be moved, by teaching customers to see higher value (branding, demos, proof).
• The middle is contested. Where exactly you land between floor and ceiling is the strategic bit, shaped by what competitors charge and by government influences that vary by country: price controls and regulation, taxes and tariffs, subsidies and incentives, currency and monetary policy.

1.1 Two ways to actually pick the number

Approach	How the price is built	Blind spot
Cost-plus / mark-up	Take unit cost, add a target margin on top	Ignores what the customer would actually pay - can leave money on the table or price out of the market
Value-based	Start from perceived value, work back toward cost	Harder - you have to measure value, and value differs by segment

Cost-plus starts at the floor and looks up; value-based starts at the ceiling and looks down. Serious pricing is value-based, with cost as the sanity check.

Note

The single most important determinant of price isn’t cost or even the customer - it’s what the firm is trying to do. A price meant to skim early adopters, a price meant to grab share, and a price meant to discourage a new entrant can all be defensible for the same product. Objective first, number second.

2 · Assessing perceived value

If value sets the ceiling, you can’t just guess it - you measure it. The most common tool is a willingness-to-pay survey, usually a set of direct-response questions put to real potential buyers:

• “How likely are you to buy this product at €25?”
• “At what price would you definitely buy this?”
• “How much would you be willing to pay for it?”
• “How many units would you buy at €0.99?”
• “At what price gap would you switch from product A to product B?”

That last one matters most for CERMEDES: the switching-point question reveals not an absolute value but a relative one against the nearest rival drill - which is exactly what determines whether a price rise is survivable.

3 · The demand curve and price elasticity

3.1 The demand curve

For most goods the rule is boringly reliable: price up, quantity down; price down, quantity up. Plot the quantity customers will buy at each price and you get a demand curve - in its simplest form a straight line.

Two points anchor a linear demand curve, and they double as the floor/ceiling in quantity terms:

• Where it crosses the price axis = the price so high that zero units sell (the outer edge of willingness-to-pay).
• Where it crosses the quantity axis = the units you’d move if price were zero (the maximum quantity anyone would ever take).

A worked example from the notes. Suppose customers buy 250 units at €30 and 500 units at €10. The slope of a line is change in price over change in quantity:

Slopem = ΔPrice / ΔQuantity = (30 − 10) / (250 − 500) = −0.08

Intercept30 = (−0.08 × 250) + b → b = 50

EquationPrice = −0.08 × Quantity + 50

Now the line is a little forecasting machine: plug in any price, solve for quantity. At €20, quantity is (20 − 50) / −0.08 = 375 units. Handy, but treat it as a model - trust it near prices you’ve actually observed, distrust it at extreme highs or lows.

3.2 What shifts the whole curve

Elasticity (next) moves you along one curve. Other forces move the entire curve left or right - same price, different quantity:

Force	Curve shifts outward (more demand) when…	…and inward when
Branding / marketing	You raise preference and desire for the product	The brand weakens or a scandal hits
Competitor moves	A rival’s substitute gets more expensive	A rival launches a compelling cheaper substitute
Consumer incomes	Incomes rise (e.g. a known pay raise lifts demand for ski holidays)	Incomes fall in a downturn
Exogenous shocks	A regulation favours you	A tariff, ban or rule hurts you (e.g. petrol cars barred from a historic city centre → demand for them drops)

3.3 Price elasticity of demand

Price elasticity of demand (how sharply quantity reacts to a price change) is the ratio:

Elasticity (E)E = %ΔQuantity / %ΔPrice

Sign usually negative (price and quantity move opposite ways); we read the magnitude and ignore the minus

The magnitude is the whole story:

• Elastic - absolute value greater than 1. Quantity is very responsive: a small price change moves a lot of volume. Think soft drinks, restaurants - lots of substitutes, non-essential. If E is 2, a 10% price rise cuts quantity by 20%.
• Inelastic - absolute value between 0 and 1. Quantity barely reacts. Think medicines, utilities - few substitutes, essential. If E is 0.5, a 10% price cut lifts quantity only 5%.

On a graph, inelastic curves are steeper (more vertical): the quantity just doesn’t budge much as price moves.

Worked elasticity, same curve as above. Start at €30 (250 units). Drop to €20 (375 units):

At €30E = ((375−250)/250) / ((20−30)/30) = 50% / −33% = −1.5

Reading absolute value 1.5 → elastic here; the price cut more than pays for itself in volume

Now start lower, at €20 (375 units), drop to €10 (500 units):

At €20E = ((500−375)/375) / ((10−20)/20) = 33% / −50% = −0.67

Reading absolute value 0.67 → inelastic here; cutting price now mostly just gives margin away

Tip

Key insight that trips people up: on a straight-line demand curve elasticity is not constant - it falls (in absolute value) as you move down to lower prices. The same product is elastic at high prices and inelastic at low ones. So “is our product elastic?” is the wrong question - ask “elastic at the price we’re charging?“

3.4 Price discrimination

If you can truly value-price, you’d charge each buyer their own willingness-to-pay. That’s impractical for physical goods unless you can convince segments the products differ - but it’s everywhere in services. Four clean types:

Type	Split the price by…	Everyday examples
Time-based	Time of day / week / season / product age	Off-peak electricity, weekend flights, seasonal fruit, launch offers
Space-based	Geography - country, region, city, district	Beer, ski gear, cement priced differently by place
Person-based	Personal traits - age, income, profession	Kids’ fares, student discounts, civil-servant insurance rates
Quantity-based	How much is bought	Package sizes, bulk / quantity discounts

For discrimination to hold, the segments have to stay separate: buyers in the cheap market mustn’t easily resell into the dear one, and mustn’t realise it’s the identical product under a different label.

4 · The price-quality strategy matrix

Cross price (low/high) with quality (low/high) and you get the four classic pricing postures. This is the single most useful picture in the session.

Skimming high price · lower quality-fit

• Launch high, harvest the keenest buyers, then step price down
• Highest margin per customer; signals quality; each cut opens a new segment
• But: invites rivals to undercut; can feel overpriced

Premium high price · high quality

• High price held for the long run, backed by genuine quality
• Fat margins, strong brand, high satisfaction
• But: hard to sustain, constant pressure to innovate, a target for cheaper rivals, hard to win back if lost

Economy low price · low quality

• Lowest price in the market, competitive-based, undercut everyone
• Fast share; pressures rivals; a gateway to pricier lines
• But: thin margins, risks a race to the bottom, can dent the brand

Penetration low price · high quality

• Genuinely good product at a low entry price to grab share fast
• Boosts early sales, creates buzz, builds awareness
• But: low early margin, slow payback, anchors a low price in buyers’ minds

The 2×2 of price × quality. Skimming and Premium both start high - Skimming plans to come down, Premium plans to stay. Economy and Penetration both start low - Economy stays cheap-and-cheerful, Penetration is a good product using a low price as a battering ram.

The quick classroom exercise was to name brands per box - a useful test of whether you’ve really understood the split (a luxury watchmaker sits in Premium; a streaming service’s cheap launch tier is Penetration; a supermarket own-brand is Economy; a flashy new gadget launched dear then discounted is Skimming).

5 · New-product pricing over time

For a genuinely new product the matrix collapses to one real choice: start high and come down (skimming), or start low and stay (penetration). The difference is a story told over time.

Skimminghigh price, falling over time

vs

Penetrationlow price, holding for volume

Two shapes on a price-over-time graph: skimming descends a staircase from a high start; penetration comes in low and flat to lock out rivals.

	Skimming	Penetration
Core logic	Serve highest-value customers first at high margin, then lower price to open new segments in order of declining value	Price low to move huge volumes and prevent competition from ever getting a foothold
Best when	Product has real prestige / newness; distinct value tiers among buyers	Vast latent demand at low prices; product can be adopted quickly without long testing
Big upside	High unit contribution; prestige image; “no race to the bottom”	High volumes; competitors deterred; market leadership (Bic did this to the ballpoint pen market)
Big risk	An open invitation to competitors to enter below you (classic in high fashion)	High-risk gamble: needs a flawless product (no recalls), fast adoption, and enough plant capacity + distribution to fill demand instantly

Caution

Penetration only works if a few conditions all hold: the product is defect-free, customers adopt it fast (so rivals get no time to react), and you have the capacity and channels to actually supply the demand you create. It fails in mature, slow-growth markets full of entrenched players who’ll simply drop their prices to variable cost and starve the newcomer out. As slide 30 put it: high risk - do your homework.

6 · Value-in-use and freemium

Two pricing methods that don’t fit the neat matrix but come up constantly:

• Value-in-use pricing (B2B). Instead of pricing off your cost, you price off the customer’s savings. If your industrial abrasive lets a factory run a line faster or scrap fewer parts, you estimate the money that saves them and capture a share of it. The price is anchored to the objective value the buyer gets, not to what the thing costs you to make. This is a natural fit for CERMEDES selling into professional trades: a tool that saves a contractor hours per job is worth a slice of those hours.
• Freemium. Give a basic version away free to build a large user base, then charge for premium features, capacity or support. The free tier is a customer-acquisition cost; the paid upgrade is where the money is. Works when the marginal cost of the free user is near zero and enough of them convert.

7 · Channel margins & mark-ups

Now the arithmetic that quietly decides whether a “good price” actually reaches you. First, a distinction people constantly blur - margin vs mark-up. They use the same euro figure but divide by different things:

% MarginMargin € / Selling price

% Mark-upMargin € / Unit cost

Worked example. A unit costs €0.90 and sells for €1.00, so the margin is €0.10.

Metric	Calculation	Result
% Margin	0.10 / 1.00	10%
% Mark-up	0.10 / 0.90	≈ 11%

Same €0.10, two different percentages - because the denominator changed. A bigger gap makes the point sharper: a €0.40 margin on a €1.00 selling price is a 40% margin but a 66% mark-up (0.40 / 0.60). Always ask “percent of what?” before quoting a number.

7.1 Successive reseller margins

Consumer goods flow manufacturer → wholesaler → retailer → customer, and each reseller’s margin is taken successively off the price to consumer. Worked from the notes, on an item with a €1.00 suggested retail price where the retailer takes 40% and the wholesaler 10%:

Manufacturersells at €0.54

→

Wholesalerbuys €0.54, sells €0.60 → margin €0.06

→

Retailerbuys €0.60, sells €1.00 → margin €0.40

→

Customerpays €1.00

Retailer takes 40% off the €1.00 list (keeps €0.40, pays €0.60). Wholesaler takes 10% off that €0.60 (keeps €0.06, pays €0.54). The manufacturer nets €0.54 - the margins compound down the chain, they don’t simply add.

The trap: 40% + 10% is not 50% off. The wholesaler’s 10% is 10% of €0.60, not of €1.00 - so the manufacturer keeps €0.54, not €0.50. Note too that a suggested retail price doesn’t bind the retailer; if they discount below it, the shortfall comes out of their margin, not the manufacturer’s.

7.2 Quantity discounts by segment

The same product can carry different price schedules for different reseller segments, with volume tiers inside each. The furniture-polish example (discounts expressed as % off list):

Wholesalers (cases)	Discount off list		Retailers (cases)	Discount off list
1-99	47.5%		1-5	30%
100-400	47.5% + 2.5%		6 and above	30% + 10%
401-900	47.5% + 4.0%
901 and above	47.5% + 6.5%

Bigger buyers earn deeper discounts, and wholesalers (who do more of the distribution work) sit on a fundamentally more generous schedule than retailers. On top of these, firms often layer extra allowances - e.g. a co-operative advertising allowance of up to 5% of the reseller’s purchases as an inducement to promote the product.

8 · Revenue, cost and profit structure

Before any ratio, the plumbing. Revenue is the easy one:

Total revenuePrice per unit × Quantity sold

Which price? the retail price if you sell direct; the price to your channel partner if you sell through resellers

Costs split two ways, and the split is the whole game:

Cost type	Behaviour with volume	Typical items	Where it shows
Fixed	Don’t change as units rise/fall	Property, plant & equipment; management salaries; advertising	PP&E, SG&A, R&D lines
Variable	Rise and fall directly with units	Direct manufacturing labour; raw materials	Cost of Goods Sold (COGS)

Note

A subtlety worth remembering: COGS is not purely variable. Under accounting rules (e.g. US GAAP) firms allocate all product costs - variable plus a share of the fixed costs of making the product - across the units produced. When units sell, those allocated costs become COGS. So COGS carries variable costs and a slice of fixed. Fixed costs like head-office admin and advertising stay out in SG&A.

Now the two margins that pricing people live by:

Contribution marginPrice − Variable cost per unit

Gross marginRevenue − COGS

Contribution margin is what each extra unit contributes toward covering fixed costs (and then profit) - it uses variable cost only, so it’s the right number for “should we take this order / cut this price?” decisions. Gross margin subtracts COGS (variable + allocated fixed) and is the reported profitability of the product line.

Mini scenario. A CERMEDES drill sells to the channel at €80, with €50 variable cost per unit and €600,000 of fixed cost. Contribution per unit is €80 − €50 = €30. To cover fixed cost the firm must sell €600,000 / €30 = 20,000 units just to break even; unit 20,001 onward drops €30 each straight toward profit. Notice: because variable cost rides along with volume, any time you run a different quantity scenario you must recompute both total revenue and total cost - you can’t move one and leave the other.

9 · Performance ratios - did the strategy actually work?

Strategy has to show up in the numbers eventually. Here’s the ratio panel from the session - each one a formula plus what it actually tells you. (Notation: Average X = (beginning X + ending X) / 2; EBIT = earnings before interest and taxes; SGA = selling, general & administrative expenses.)

Indicator	Formula	What it tells you
Return on Sales (ROS)	Net income / Sales (or EBIT / Sales)	How well the firm turns sales into profit - the headline CERMEDES benchmark
Return on Assets (ROA)	Net income / Assets	How well it turns its assets into profit
Return on Equity (ROE)	Net income / Equity	How well it turns owners’ equity into profit
Sales per employee	Sales / Number of employees	Labour-force productivity
Admin (& sales) intensity	Admin costs / Sales (or SGA / Sales)	Share of sales eaten by admin and selling
R&D intensity	R&D costs / Sales	Share of sales reinvested in R&D
Inventory turnover	Sales / Avg inventory (or COGS / Avg inventory)	How many times stock is sold in the period
Avg days to sell inventory	365 / Inventory turnover	How many days, on average, to sell the stock
Asset turnover	Sales / Avg total assets	How efficiently assets generate sales
Receivable turnover	Sales / Avg accounts receivable	How efficiently the firm collects what it’s owed
Debt-to-equity	Total debt / Total equity	Leverage and risk in the capital structure
Debt ratio	Total debt / Total assets	Share of assets financed by debt

ROS workedROS = Net income / Sales = €4.2m / €60m = 7%

Reading if the power-tool industry averages ~9%, CERMEDES keeps 2 points less of every sales euro - a gap the pricing/mix work has to close

Tip

For the CERMEDES report the anchor ratio is ROS, benchmarked against the industry. Two ways to lift it: raise price (only where demand is inelastic enough that volume survives - back to §3) or improve mix (push volume toward the high-contribution products and fix or drop the low ones). Inventory turnover and days-to-sell are the quiet companions: slow-moving, unprofitable lines tie up cash and drag ROS.

10 · Scenario planning - and the CERMEDES verdict

The final tool is scenario planning: rather than pretend you know the future, you build two coherent stories - optimistic and pessimistic - each from a handful of explicit assumptions. The instructor’s blunt advice: keep it simple. A few clearly stated assumptions beat an elaborate model nobody trusts.

Assumption	Pessimistic	Optimistic
Price change on core drills	−3% (forced by rivals)	+5% (value-in-use story lands)
Unit volume	−8% (market stagnates, imports bite)	+6% (share gains from quality)
Variable cost per unit	+4% (input inflation)	flat (supplier deal holds)
Resulting direction of ROS	slips below industry	closes the gap, at or above industry

Laid side by side, the scenarios turn CERMEDES’s live questions into testable claims. Most/least profitable products? - rank them by contribution margin, not revenue, and check whether the low-contribution lines even survive the pessimistic case. Price rises viable? - only where elasticity is mild enough that the volume loss doesn’t swamp the higher price; the willingness-to-pay and switching-point surveys (§2) are what tell you that. Not-yet-profitable products? - the choices are re-price, re-cost, reposition, or retire; scenario planning shows which survive a bad year. ROS vs industry? - compute it (§9), benchmark it, and let the optimistic/pessimistic band show how much of the gap is under management’s control versus at the mercy of the market.

Revision summary

Tip

The one-minute recap

• Price sits in a band: a cost floor (no profit below) and a value ceiling (no demand above), with competitor prices and government influences in the contested middle. Cost-plus builds up from cost; value-based works down from perceived value.
• Demand curve links price to quantity; forces like branding, rival moves, incomes and shocks shift the whole curve. Elasticity = %ΔQ / %ΔP - absolute value above 1 is elastic (soft drinks), between 0 and 1 is inelastic (medicines) - and on a straight line it changes at every price.
• The price-quality matrix: Skimming (high, then down), Premium (high, sustained), Economy (low/low), Penetration (low price, high quality, to grab share). New-product choice = skimming’s high margin (invites rivals) vs penetration’s high volume (needs a flawless product and real capacity).
• Value-in-use captures a share of what a B2B customer saves; freemium gives a base away and charges for more.
• Margin ≠ mark-up (same euros, different denominators); reseller margins compound down the channel, they don’t add.
• Contribution margin = price − variable cost; gross margin = revenue − COGS; change a volume scenario and you must recompute both revenue and cost.
• Ratios measure success - ROS front and centre for CERMEDES - and scenario planning (keep it simple, explicit assumptions) turns the pricing and profitability questions into an optimistic-vs-pessimistic band.

Next: Pitching & Structured Communication → - how to sell the strategy in 15 minutes.