How Scenario Planning Aids Our Decisions

Note: This post applies to both (a) business planning and the firm’s flexibility to change as needed and (b) personal planning and YOUR flexibility to change as necessary. In either case, we must be able to adapt to an uncertain future.

Scenario planning involves planning for the future by understanding that different marketplace outcomes may occur in response to any strategy and that each possible marketplace outcome must be planned for to avoid the worst case scenario.

Here’s a simple example: Suppose that a major soda company introduces a new non-carbonated cola beverage into the marketplace. These are just a few scenarios that are possible:

• The sales of the new beverage meet expectations and do not cannibalize the sales of other company products. Overall company revenues and profit rise.
• The sales of the new beverage meet expectations, but slightly cannibalize the sales of other company products. Overall company revenues and profits rise slightly.
• The sales of the new beverage meet expectations, but greatly cannibalize the sales of other company products. Overall company revenues stay the same, and profits fall somewhat due to the investment in the new item.
• The sales of the new beverage do not meet expectations and do not cannibalize the sales of other company products. Overall company revenues rise very little, and profits fall a lot due to the investment in the new item.

The premise of scenario planning is to anticipate the possibility of each of these outcomes occurring and have in place a pre-planned framework (contingency plan) to deal with each scenario.

Recently, Shardul Phadnis, Chris Caplice, and Yossi Sheffi wrote an article for the MIT Soan Management Review titled “How Scenario Planning Influences Strategic Decisions.” The authors reached three major conclusions:

1. “The use of multiple scenarios is not necessarily an antidote for overconfidence. One should not assume that simply using multiple scenarios to evaluate a long-range decision will help alleviate the negative effects of decision makers’ overconfidence in their own judgment.”
2. “Scenarios influence judgment — and their content matters. More than half the judgments in our studies changed after single-scenario evaluations. Scenario users became more favorable of investing in an element — either by increasing confidence in their original recommendation to invest, decreasing confidence in their original recommendation to not invest, or changing their recommendation to favor the investment — when they found the element useful in a scenario.”
3. “The use of multiple scenarios can nudge executives towards more flexible strategies. Executives often choose strategies optimized for a particular environment. While such strategies may perform well in the environment envisioned at the time of their implementation, they may not be easily adaptable to new opportunities or in response to unexpected threats.  Under such circumstances, evaluating strategic decisions using multiple scenarios can help executives appreciate the importance of choosing more flexible assets or approaches — even if doing so is not the most optimal choice for present-day conditions.”

Click the image to access the article.

 

 

Our Six-Part Series on Pricing Tips

Recently, we published a six-part series on pricing practices and tips.

Here, in one place ( 🙂 ), are links to each part of the series:

• Pricing Strategy: A Small Firm Perspective – Part 1
• Pricing Strategy: A Small Firm Perspective – Part 2
• Pricing Strategy: A Small Firm Perspective – Part 3
• Pricing Strategy: A Small Firm Perspective – Part 4
• Pricing Strategy: A Small Firm Perspective – Part 5
• Pricing Strategy: A Small Firm Perspective – Part 6

 

Pricing Strategy: A Small Firm Perspective – Part 6

by Joel R. Evans and Barry Berman, the Zarb School of Business

This is the sixth in our series of six columns on hints for price-setting by small firms. How would you respond to these questions?

• How are prices displayed? There are various options for displaying prices, depending on the pricing philosophy (such as a prestige image versus discounting): The home page of a Web site can present an image that is appropriate for the pricing strategy (limited stating of prices, emphasis on sale prices, etc.) Exterior store windows can show prices for selected sale items and/or highlight a store’s orientation (“Service that is a cut above the rest,” “The best brands at the best prices,” etc.). A small firm can compete by featuring selected sale items; but these prices must be promoted to shoppers so that they are aware of the good values at local stores. Interior store displays can emphasize or de-emphasize prices. To emphasize prices, a retailer can use large in-store signs that show prices of given items, promote a particular color price tag to indicate particularly good bargains, leave items in cartons, and have plain displays (such as dump bins) and fixtures. To de-emphasize prices, a retailer can use only small price tags that are attached directly to merchandise or have salespeople responsible for communicating prices (as done in upscale apparel stores and jewelry stores); there would be no overt references to prices in the store and the atmosphere would be stylish.

• What payment method(s) do you accept? Until about 20 years ago, large firm were the most apt to accept credit cards. They saw the value of them and got good terms from issuers. Many chains even developed their own cards to stimulate more customer loyalty. Today, things have changed; and all types of firms (big and small, general merchandise and food, bricks-and-mortar and online, etc.) now accept credit and/or debit cards. Why? Issuers have lowered fees, credit cards are widely advertised and easier for firms to process, more consumers than ever before actively use credit/debit cards and consider if given cards are accepted prior to entering Web sites or stores (hence, the success of the Visa campaign against American Express), smaller firms can use PayPal which is any easy way for them to accept multiple cards, and cash payments don’t work online. In choosing whether to accept credit and/or debit cards, a seller should consider: Are prices of individual items high? Is the total customer bill (the sum of the individual items bought on one shopping trip) high? Am I interested in increasing the impulse purchases shoppers make? Do competitors accept credit/debit cards? If the answer to any of these questions is yes, credit cards should be accepted.

• Do you understand both of these terms? Elastic demand? Inelastic demand? With elastic demand, shoppers perceive firms in the same category (such as gas stations, supermarkets, or pharmacies) to be rather similar. These firms must always be sure that their prices are competitive or they will lose business. With inelastic demand, shoppers perceive firms in the same category to be dissimilar, due to their locations, product assortments, customer service, etc. These firms can set premium prices since their unique characteristics encourage many customers to be brand/store loyal.

• What do you think about everyday low pricing? This approach has enabled Walmart to maintain a discounter image, attract a steady stream of price-conscious shoppers, reduce advertising expenditures, and run less frequent sales. However, for the typical firm, the better phrase is really “everyday fair pricing.” This means that each seller must strive to set its REGULAR PRICES in a way that appeals to the chosen customer market and that fairly reflects the merchandise, customer service, ambience, etc. offered by that firm. From the customer’s vantage point, prices must be perceived as fair – every day.

We hope that as you think more about the way that prices are set (and that you do so at least once or twice a year), and that you will peruse our series on this topic and see the “big picture” of pricing.

 

Pricing Strategy: A Small Firm Perspective – Part 5

by Joel R. Evans and Barry Berman, the Zarb School of Business

This is the fifth in our series of six columns on hints for price-setting by small firms. How would you respond to these questions?

• How do you use prices in competing with a larger firm? One of the most common myths in retailing is that small firms can never enter into price competition with the Amazons and Home Depots of the world. While it is true that small firms will generally have a tougher time if they try to compete on price across the board (due to the economies of scale of the discount chains), they can do so if they run sales or offer regular savings on selected items. By focusing on special prices for 10  to 25 noticeable items, small firms can highlight that they are viable options for their shoppers and attract customer traffic. This works best if a firm runs specials on different items than those featured by the large chains. Also, small firms may have a major advantage over these chains: The latter often often need some type of upper management approval to offer sales and individual outlets may not have the flexibility to match local firms.

• Have you formed a buying group (cooperative) with other small firms to get better terms on your purchases? Large firms can get good terms from suppliers and make special requests of them because of the buying power they wield due to the volume of business that they do with the suppliers. Small firms can gain in their own dealings with the suppliers by forming buying groups; this will then enable the firms to account for substantial dollar purchases and lead to better terms. Buying groups are common for hardware, furniture, appliances, groceries, and consumer electronics. Check with your own trade association for further information — and be sure that forming a buying group is legal.

• Do you use odd prices ($59.95) rather than even prices ($60)? Although the impact of odd pricing on customer behavior may be overrated (after all, most people do not consider a nickel off to be much of a bargain), there is one significant reason to use this practice: Consumers are more likely to believe that a firm plans prices very carefully and works hard to keep the prices as low as possible.

• When you take a physical inventory, how do you compute the value of the merchandise remaining in stock? The prices set for the merchandise remaining in stock (after a selling season or before a reorder is placed) should have some relation to the value placed on that merchandise. For example, if a firm knows the value of an item in inventory is $30 at cost and that firm wants a 50 percent markup at retail, the selling price would be $60. The computation is easy if merchandise costs are stable. If they are not, the firm should learn about the retail method of inventory planning (which is based on the average of merchandise costs, depending on the quantity bought at each cost level) and apply this concept. Several computer software programs are available to aid in this process.

• Do you understand the difference between an initial markup and a maintained markup? Do you use these concepts in setting prices? Initial markups often need to be higher than maintained markups if a firm is to meet revenue and profit goals. Thus, an initial markup for an item must reflect the fact that during a selling season there will be shrinkage, breakage, employee discounts, and end-of-season markdowns. A maintained markup represents the weighted average markup for an item, which is computed as: (total actual revenues received – the cost of goods sold)/total actual revenues received. A firm will make a serious mistake if beginning-of-season prices represent the average prices sought for the entire selling season.

 

Pricing Strategy: A Small Firm Perspective – Part 4

by Joel R. Evans and Barry Berman, the Zarb School of Business

This is the fourth in our series of six columns on hints for price-setting by small firms. How would you respond to these questions?

• Do you plan for stock shortages (due to shrinkage and clerical errors) when setting prices? How? Yearly, tens of billions of U.S. retail sales alone are lost due to inventory shrinkage (theft) and billions more are lost due to clerical errors by workers. Even the most vigilant and careful firms are affected. To lessen this problem, a three-pronged approach should be followed. Anti-theft devices, such as angled mirrors and in-store cameras, should be used by all retailers, including the smallest ones. Employees should be better trained in stocking displays, entering customer transactions, and keeping records. Prices need to reflect estimated stock shortages as a percent of sales. If a store manager knows (by studying past data) that 4 percent of revenues are lost due to shrinkage, then prices should be marked up an another 4 percent. By using anti-theft devices and employee training, stock shortages may be lowered — so that additional markups are also held down.

• Do you use price lining? Price lining is a very useful strategy. With it, a price floor and a price ceiling are set for each product category you sell, and then selected price points are set within the range. For example, a stereo firm may decide that a $200 price floor and a $1,000 price ceiling are most appropriate for its full-component systems. It could then sell systems for $200, $400, $700, and $1,000. By doing this, several goals could be reached: The firm can more clearly identify the appropriate suppliers, use price points in negotiating with suppliers, and limit the number of models carried in the $200 to $1,000 range. The consumer benefits because there is less confusion in choosing among models, he or she can stay within the prescribed budget, and product quality differences are easier to discern.

• Do you advertise prices? Where? Every firm, regardless of positioning and size, is capable of some form of price advertising. Although large firms have greater resources to advertise online, in newspapers, and on television and radio, there are SEVERAL avenues available to small firms in advertising prices: They can advertise online through inexpensive Google AdWords —  narrowed down by specific geographic location, product model, etc.; and in weekly papers that have more targeted audiences and are much less costly than other media. They can set aside a section of the store window for weekly specials (so customers get used to looking for them). They can use in-store displays to feature prices; manufacturers may help with these displays. They can give out in-store circulars. The combination of tools applied must be linked to the image that the retailer seeks to portray.

• Do you let customers bargain over the prices of any items? Another key pricing decision is determining whether or not to permit any customer bargaining. Supermarkets, restaurants, dry cleaners, and entertainment facilities typically have fixed prices and do not permit customers to bargain at all. Some firms, such as service stations and office supply stores, may have fixed prices for certain items (like gas and stationery), but permit bargaining for some items (like auto body work and expensive furniture). Still other retailers, such as auto dealers and jewelry stores, may encourage bargaining for almost everything they sell. Where do you fit and why? Remember, the use of “we’ll meet competitors’ prices” advertising is a form of flexible pricing that allows customer bargaining.