Chapter 12: Pricing Strategy for Business Markets

PowerPoint by: Ray A. DeCormier, Ph.D. Central Ct. State U.

Chapter Topics
Understanding how customers value pricing is the essence of the pricing process. Chapter topics include:
1.

The central elements of the pricing process a value-based strategy

2. How effective new product prices are established and the

need to periodically adjust the prices of existing products

3. How to respond to a price attack by an aggressive competitor
4. Strategic approaches to competitive bidding

CUSTOMER VALUE

In B2B marketing, customer value is a cornerstone The unifying goal of marketers is to be better than your very best competitor in providing value

You get what you pay for is what many provide A better approach: You get more than what

How do customers view value?

Everything costs something (sacrifice) Everything of value adds something (benefits) Whats the difference?

Benefits

Sacrifice = Value

DIFFERENTIATING THROUGH VALUE-CREATION

If relationships are more valuable to customers than price and costs, then marketers need to emphasize unique add-on benefits around:
1. 2.

3.
4. 5.

Building trust Demonstrating commitment Being flexible Initiating joint ventures Working on developing deeper relationships

These efforts enhance customer value & loyalty.

Research suggests that most companies offer similar services, however, the following seem to be more prominent. 1. Service support 2. Personal interactions 3. Supplier know-how 4. Ability to improve customers time to market

Moderate differentiating factors include: 1. Product quality 2. Delivery 3. Acquisition and operation costs

Setting the Price

This is one of the most difficult issues that face companies: What is the right price to charge? There is no easy solution or formula for proper pricing.

Pertinent considerations include:

1. 2. 3.

4.

Pricing & profit objectives Demand determinants Cost determinants Competition

Key Components of the Price-Setting Decision Process

Fig. 12.1

No easy formula for pricing industrial product or service

Decision is multidimensional Each interactive variable assumes significance

Set Strategic Pricing Objectives

Estimate Demand and the Price Elasticity of Demand

Determine Costs and their Relationship to Volume Examine Competitors Prices and Strategies Set the Price Level

Price Objectives

Pricing decision must be based on marketing and overall corporate objectives. Marketer starts with principal objectives and adds collateral pricing goals:

Achieving target return on investment. Achieving market-share goal. Meeting competition.

Other objectives include competition, channel relationships and product-line considerations.

There are a number of issues when considering demand:

1. 2.

Usage and importance of the product/service by various segments Price Sensitivity (elasticity of demand)

3.

Assessing Value: Competitive Value comparisons Assume same product by 2 different competitors Assume: (A charges $24 ; B charges $20);

Why might a buyer prefer A over B?

Could it be that buyer prefers A more than B because As total offering provides more value than B?

ASSESSING VALUE

Economic Value: Represents cost saving and/or revenue gains when purchasing a product (instead of next best alternative) Commodity Value: Value customers assign to features that resembles competitive offerings Differentiation Value: Represents the value of features that are unique and different from competitors

Fig 12.3

A Value-Based Approach for Pricing

Define the key market segments

Isolate the most significant drivers of value in customers business

Quantify the impact of your product or service on each value driver in customers business Estimate the incremental value created by your product or service, particularly for those features that are unique and different from competitors offerings Develop pricing strategy and marketing plan
SOURCE: Adapted from Gerald E. Smith and Thomas T. Nagle, How Much Are Customers Willing to Pay, Marketing Research 14 (winter 2002): pp. 20-25.

I.

Goal is to identify significant drivers of value

Cost Drivers: Create value by economic savings
1.

a.

Example: Machine can process more widgets/hr. with less electricity and labor costs

b.
1.

Revenue Drivers: Add incremental value by facilitating revenue or margin requirements

Example: Packaging is more attractive thus increasing sales

II.
a.

Quantify impact of firms product/service on customers business model

Does it make or save money? How much?

III.
a. b. c.

Compare firms product/service to next best alternative (competitors product/service)

Isolate unique features that differ from competitor Do those features provide value that customer cannot get elsewhere? How much value does it create?

IV.

Understand how customer uses the product and how much value will s/he realize
Set the price & develop a responsive marketing strategy

V.

BENEFIT: Business marketer can gain a

competitive advantage by employing a value based approach and by developing tools to document and communicate their unique value to customers.

Price elasticity measures how sensitive customers are to price changes.

Price elasticity of demand refers to rate of percentage change in quantity demanded to percentage change in price.

Elasticity of Demand
Elastic Demand
Consumers buy more or less of a product when the price changes An increase or decrease in price will not significantly affect demand

Inelastic Demand

Unitary Elasticity

An increase in sales exactly offsets a decrease in prices, and revenue is unchanged

Elasticity of Demand
Elastic Demand Curve D Inelastic Demand Curve D Price Price D

D Quantity Quantity

Elasticity of Demand
Price Goes... Down Down Up Up Up or Down Revenue Goes... Up Down Up Down Stays the Same Demand is... Elastic Inelastic Inelastic Elastic Unitary Elasticity

 Satisfied

customers are less price sensitive therefore one strategy is to make our customers very satisfied so price isnt as much of a determinant.
costs is a consideration depending upon products. The more sophisticated and unique the product is, and the more vested interest (costs) in it is, the more apt for the customer to not switch.

Switching

 End

Use: How important is the product as in input into the total cost of the end product?
If cost is insignificant, then demand is inelastic.

End-Market

Focus: Since demand for many industrial products is derived from the demand for the product of which they are a part, STRONG end user focus is needed.

Derived Demand
By understanding trends such as up or down

markets, up or down sectors, and knowing that not all segments go up or down at one time, if one is able to plan for a two-tiered market focus, which takes advantage of the market variability
This strategy increases the chances for success.

Value-Based Segmentation

Some industrial product may serve different purposes for different markets. Each segment may value the product differently. By identifying applications where the firm has a clear advantage, and by understanding the value of it to each segment, marketer may be able to administer price differentiation in each segment.

TARGET PRICING & COSTING

Many companies base price off of costs Problem: Method is internally driven, not market driven

A
1. 2.

better approach is to use Target Pricing

It starts by examining and segmenting the market Determine what type, quality and attributes each segment wants at a pre-determined target price 3. Understand the perception of value to the target selling price 4. Then calculate costs considering margins

Cost Concept Analysis

Direct Traceable or Attributable Costs: All costs, fixed or variable, that are solely incurred for a particular product, territory, or customer (e.g., raw materials) Indirect Traceable Costs: All costs, fixed or variable, that can be traced to a particular product, customer or territory (e.g., general plant overhead) General Costs: Costs that support a number of activities not directly related to a particular product (e.g., administrative overhead, R&D)

Target pricing forces marketers to understand what buyers want and are willing to pay. Target costing forces companies to understand their cost structure by direct/indirect costs, fixed/variable costs, and their contribution margins. Combining target pricing and target costing says that instead of using cost-control techniques, a better approach is to compute the total costs that must not be exceeded, allowing for acceptable margins.

Understanding Costs Helps to Understand Pricing

When adding or deleting a line, successful marketers know exactly what price points can weaken or break the competition. What proportion of cost is raw material or component parts? At different levels of product, how does cost vary? At what production levels can economies of scale be expected? Does our firm enjoy cost advantages over competition? How does the experience effect impact our cost

COMPETITION

Competition establishes an upper limit on price.

Price is only a component of the cost/benefit equation. There are many ways to have a differential advantage other than price: advanced features, technical expertise, timely delivery and product reliability (zero defects) to name a few.

Service and support also have a differentiating

HYPER-COMPETITIVE SITUATIONS

In some industries rivals are fairly stable and the competitive strategy is dont rock the boat. Other industries, especially high-tech or high profit industries, the competitive environment is wrought with short-term and temporary advantages. These are hypercompetitive environments with strong rivalries. The strategy to succeed is to create a temporary advantage and destroy rival advantages by constantly disrupting market equilibrium with new products, lower prices, and strategic relationships.

In analyzing competitors responses to any strategic move, a good idea is to consider direct competitors and substitute their actions from a cost perspective.
For example, one idea is to view competition as Followers vs. Pioneers. More often, pioneers face higher entry costs than followers for various reasons.

By failing to recognize potential cost advantages of late entrants, the business marketer can dramatically overstate costs differences between earlier and later entrants.
What might be the result of this mistake?

Followers vs. Pioneers

Pricing Strategies
3

Major Pricing Strategies the Crowd

1. Follow 2. Price

Skimming

3. Penetration

Pricing

Price Skimming
Price Skimming is charging a high initial price Price Skimming:
Appropriate for distinctly new products Provides the firm with opportunity to profitably reach

market segments not sensitive to high initial price Enables marketer to capture early profits Enables innovator to recover high R&D costs more quickly
Strategy: As the product goes through its product life cycle,

the strategy is to lower the price in line with production and demand capacity.

Penetration Pricing is charging a very low initial price.

Penetration Pricing is appropriate when there is: High price elasticity of demand Strong threat of imminent competition Opportunity for substantial production cost reduction as volume expands

Price Discrimination
The Robinson-Patman Act of 1936: holds that it is unlawful to discriminate in price between different purchasers of commodities of like grade and qualitywhere the effect of such discrimination may be substantially to lessen competition or tend to create a monopoly, or to injure, destroy or prevent competition..

EVALUATING

COMPETITIVE THREAT

When a PRICE WAR occurs, what should you do?

Should you:
Lower your price? Ignore it? Raise it?

That is what a competitive threat is all about.

Evaluating A Competitive Threat

Competitive price or low cost product entry If you respond, is competition willing and able to reestablish the price difference?

Accommodate or Ignore

No

Is your position in other markets at risk? Yes Does the value of the markets at risk justify the cost of response? Yes

No

Is there a response Yes that would cost less than the preventable sales lost?

No Respond

No

Yes No Will the multiple responses required to match a competitions cost less than the preventable sales loss? Yes

Respond

Respond

Source: Figure from How to Manage an Aggressive Competitor by George E. Cressman, Jr. and Thomas T. Nagle from BUSINESS HORIZONS 45 (March-April 2002): p. 25. Reprinted with permission from Elsevier.

1.

Before responding, ask: Do the benefits justify the costs?

If responding to a price change is less costly than losing a sale, then do it. If competitor threat only affects a small segment, the revenues lost from ignoring it may be so small that it is not worth it. In other words, Why lower the price to lose revenue from other segments too?

a.

b.

c.

Evaluating a Competitive Threat

2.If you respond to the threat, is the competitor willing to merely reduce price again to restore the price difference?

Matching a price cut is ineffective if the competitor will merely lower the price again. Therefore, try to understand what the competitor is trying to do.
1.Do they want % share of market? 2.Do they just want to clear inventory? 3.Do they just want to recoup some of their investment quickly?

EVALUATING A COMPETITIVE THREAT

3. Will the multiple responses that may be required still cost less than the avoidable sales loss?

One consideration is the industry. In high-capital and labor-intensive industries, it is better to cut the prices only to the point of variable cost levels. The objective is to try to capture some contribution margin, if possible. Strategy: Build into your products high switching costs.

Evaluating a Competitive Threat

4. Is your position in other markets at risk if the competitor increases their % share of market? Strategically, does the value of all the markets that are at risk justify the cost of responding to a price war? Before responding, make sure you understand all of the ramifications, i.e., lost markets, gained markets, and even bankruptcy.

Competitive Bidding
Certain groups do bidding
1. Governments 2. Large companies (using preferred suppliers) bid for:

a. Non-standard material b. Complex designs and difficult manufacturing methods

TYPES OF BIDDING

Closed bidding: Suppliers submit a written bid on a specific contract and all bids are opened simultaneously and often job goes to lowest bidder On-line sealed bids: on-line auctions

Open bidding: more informal. When it is hard rigidly define requirements Prices may be negotiated. Prices may be negotiated

Bidding is costly and time consuming.

A. B. C. D.

Simultaneous bids often used. All participants see the bids. Goal: push price down. Can damage supplier-customer relationships

Choose bid opportunities with care

Find contracts that offer the most promise

Remember that the low bidder may be able to secure much more business that is profitable over the longer term How likely will follow-on business occur???

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