Questions of pricing and pricing strategy are among the most difficult faced by health care marketers, even seasoned pros. There are two major reasons for this: First, so much is at stake where even a slight difference in cost per unit can significantly increase or decrease product sales and affect bottom-line revenues; second, there is so much inherent uncertainty in predicting the results of either a pricing change for existing products or pricing a new product entering a competitive arena.

The typical health care marketer is nevertheless unsure about the precise results of his pricing actions. The product in question may be currently in the process of licensing, and the company wants answers to the following questions:

  • What will be the most profitable price position for the new product?

  • What will be the effect of a price change on the product's sales?

  • What effect will the price change have on competitive offerings?

  • Will the competition follow suit and change prices?

  • If so, what will the effect be on the product?

In other words, the marketing professional needs to answer several questions pertaining to price elasticity.

Several approaches to resolving questions about price elasticity have been used. A new methodology has been developed which paints a more accurate picture of just how each product in the market under study affects the other products by its pricing strategy. For the last five years, Total Research Corp., a Princeton, N.J., full service marketing research and consulting firm, has been performing price elasticity studies using a technique currently being marketed as a proprietary package known as PEMS (Price Elasticity Measurement System). This technique uses experimental design theory to measure price elasticities.

In 1982, Total Research was asked to perform a study for an agricultural chemical manufacturer to determine the demand and pricing elasticity of a new herbicide. The manufacturer wanted to know what its share of the herbicide market would be if the new product cost farmers $15 an acre, $18 an acre, $30 an acre, and so on. At the same time, the manufacturer wanted information on the price elasticity of other products.

Using the new technique to simulate market conditions for a variety of pricing scenarios, the firm predicted that the manufacturer would sell 19 million gallons of the new herbicide in the first year at the most advantageous introductory price. As it turned out, the manufacturer sold 18 million gallons.

The first project was the start of the formal development of the PEMS. To date, the firm has performed numerous studies of this type in a wide variety of markets, including several in the health care field.

Like conjoint analysis, the technique relies heavily on experimental design theory. Respondents are exposed to a series of purchases in which they are asked to choose between a realistically wide variety of products or services. Prices vary according to a rigorous experimental design.

For health care marketers, the technique can provide invaluable information about their products and their competitor's products. In many cases, their products are going to be marketed to a professional health care provider, such as a physician or pharmacist. According to Bruce Kossar, Ph.D., a senior project director at Total Research who has worked on several PEMS health care projects, "The health care product 'user' in study may be influenced by a myriad of factors that would not apply to a consumer goods product. For instance, a physician may be sensitive to the patient costs associated with a particular procedure; a surgeon may be looking for certain technical specifications; a hospital staff pharmacist may be very concerned with budgeting, and so on."

For Johnson & Johnson Cardiovascular, the customers for a new tissue heart valve were cardiovascular surgeons who made the decision about which valve to use in surgery. Before introducing their new product, their marketing executives wanted to evaluate customer attitudes toward the new valve, measure potential demand, and determine a positioning and pricing strategy.

Working with 23 geographically dispersed markets, Total Research conducted half-hour interviews with 145 cardiovascular surgeons in their own offices, selecting those with familiarity and surgical experience with heart valve replacement. The final report, which predicted market share at three different price levels, revealed the most profitable level of pricing for the new product entry. The study also showed that the new valve was favorably perceived by cardiovascular surgeons, many of whom said they would be interested in the product when it becomes available on a consignment basis.

According to James P. Baker, Jr., product director, Johnson & Johnson Cardiovascular, "The PEMS study assisted us greatly in creating an optimal positioning strategy for this important new product launch."

This research technique reveals a wealth of information regarding pricing, including: Model variation; price elasticity; variant pricing; product improvement; competitive cross elasticities; and, price simulation.

Pricing and pricing strategy will likely continue to be among the most difficult issues marketing executives face. However, new technology for measuring price elasticity makes it possible to obtain a much more accurate and complete picture of the effects of price on products or services.

PEMS methodology

PEMS offers a combination of technologies and features which Total Research Corp. believes makes it categorically different and better than any other existing methodology:

1. It provides a unique price elasticity curve for each brand. Unlike conjoint analysis, for instance, PEMS does not make the naive and unsupportable assumption that all brands in a market have the same price elasticity.

2. Unlike practically any other methodology, PEMS provides a complete set of competitive brand cross elasticities. Cross elasticities are the effects of the price change of one brand on the success of another. How does the price strategy of Health Care Service No. 1 affect the sales of Health Care Service No. 2, and vice versa?

3. PEMS allows the user to simulate the market shares for existing product or service entries under any conceivable pricing situation. What if Health Care Vendor No. 1 raises its prices by 15 %, Vendor No. 2 by 5%, Vendor No. 3 by 8% on one part of its line while lowering prices 3% on another part? PEMS provides accurate market share estimates.

4. Given cost information and assumptions about competitive counteractions, PEMS can isolate an optimal pricing strategy to enhance profitability. In many cases, closely following the guidance of a PEMS study will add millions of dollars to the bottom line.

5. The model is self-validating. Before future projections are attempted, the first step is to predict current market shares. Any sampling or measurement errors can be corrected at this step - but such corrections are rarely necessary, since PEMS estimates tend to be on target.

6. The advantage of so-called real-life techniques (econometric analysis, test marketing) is that they try to measure what happens in reality. But unfortunately, in real life many factors other than price affect sales studies using these "historical" techniques. Therefore, they provide confounded predictions and distorted estimates of cause and effect. PEMS isolates the effect that pricing has on sales - unconfounded by advertising, promotion, new product introductions, and so forth - while also providing accurate estimates of what will happen in the real world.

Overriding all other drawbacks, the problem with laboratory (as opposed to real-life) price experimentation has been that market research in the lab has either grossly overestimated or underestimated price effects. Based on extensive empirical evidence, PEMS apparently does not have this problem.