Is the Price Right?

Kopalle specializes in the study of pricing strategy, particularly new-product pricing and development.

In his 2008 letter to Berkshire Hathaway stockholders, Warren Buffett wrote, "Long ago, Ben Graham taught me that 'Price is what you pay; value is what you get.'" Praveen Kopalle, professor of marketing, specializes in the study of pricing strategy, particularly new-product pricing and development. Kopalle's spring elective, Retail Pricing Strategies and Tactics, teaches students the science behind the sticker price.

Could you define pricing and the goal of pricing?

Pricing is one lever a company has to effectively market its product. Managers should start the pricing process by asking, What are my objectives here? Am I trying to maximize my sales during this time period, or maximize a market share? Or do I want to maximize my profitability or my store traffic? The answer that I often hear is, "All of the above." But managers need to prioritize their objectives, weight them, and determine from that what their overarching goal is. That overarching goal becomes the objective. Then the definition of pricing would be how to most effectively price in order to achieve the objective. That's why it's called strategic pricing: you start with your objective and then determine how best to achieve it. The methods for achieving it are the tactics of pricing.

What made you think of developing this course for Tuck?

Most pricing courses are broad-based and approach concepts on a strategic level, but they don't necessarily provide the tools for implementing pricing strategies. I wanted to show how managers can infuse analytics into their pricing positions and move away from using blanket pricing rules. Also, pricing managers and marketers aren't usually linked, which is a problem since one of the key inputs in pricing is input from customers. I wanted to build a course that integrates marketing, psychology or consumer behavior, economics, and statistics.

What are some of those blanket pricing rules?

In 60 to 70 percent of cases, managers use cost-plus pricing—"I paid $10 for this, I want to mark it up 20 percent," and out comes the price. It is pretty consistent and used a lot. But instead of asking, What price do we need to cover our costs and earn a profit?, they should be asking, What cost can we afford to incur, when the price is achievable in the market, and still earn a profit? Managers with a competitor orientation might ask, What is the competitor charging? I think that instead they should ask, What is our product, who is the customer, and how can we better communicate our value? And some managers with a very short-term orientation might ask, What sales do we need to meet to make our market share? instead of asking, At what level of sales can our market share be most profitably achieved? These concepts do work in some contexts, but they don't work across the board. I think pricing has three main components: cost, competitors, and customers. The key in this course is to learn how to integrate all three.

In the seminar, you discussed "evidence-based" management. What does that term mean?

It comes from medicine. It's the idea that practice should be based on evidence, not on past practice or opinions or anecdotal information. So in medicine, when they say something is a best practice—like how long you should wash your hands—they don't mean what the best hospitals do; they mean which practice has been shown to maximally reduce the number of infections. They collect the actual data, review it, and determine from it what the best practices are, and those are what they emulate. There's a movement in management to do the same thing.

What is the structure of the course?

The course has three components: cases, lectures, and a project. Compared with other schools' pricing courses, the distinguishing feature of this course—even in the lectures—is that it is very analytics-based. The goal is for students to learn how to use analytics and various techniques in pricing. For the project, I provide them with details from a for-profit retail grocery store and, to simplify the context, I tell them that the objective is to maximize profitability for a particular item. They get a rich amount of data: 104 weeks of prices, sales, and promotion data for that item from their store and from a competing store, and they get their own store's cost data—how much they paid for the item—in six different zones. They use several analytical and estimation techniques with these data to estimate sales responses—how sales and prices change. Based on those responses, they determine the optimal prices for the item at their store.

Has there been such thing as a revolution in pricing?

I think there are three reasons that the biggest revolution in pricing has happened just in the past few years: one, data storage costs have gone down a lot; two, computing power has improved tremendously; and three, the managers that we're producing now have a much more analytical mindset. Previously, managers wanted to know how customers were behaving, but they didn't have the data for it. And the reason they didn't have the data is that it was just way too expensive to store it. And even if they had the data, they didn't have the computing power required for running these sophisticated models. With these three recent changes, the stars are sort of aligned right now in terms of making a very customer-centric, elasticity-based pricing methodology.

Do you think most companies understand that now? That it benefits them to start with the customer?

The notion of customer-centricity is gaining ground, but there are many, many managers out there who still have a product-centric view: I have a product, how do I sell it. I think there's a lot more ground to cover. Don't start from your cost to figure out your price. Start from your customer. Figure out what their price points are, what their willingness to pay is, and then work backwards. The Tata Nano car was a very good example of this strategy.

Has teaching this course changed your thinking or research in any way?

Tuck students ask very smart questions, and sometimes, by rigorously answering some of the questions that come up in class, I get ideas about how I can enrich my research. It's a really good example of Tuck's message with respect to theory for practice, rigor, and relevance.