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

Chapter 14:

Pricing Strategy for Business Markets

Chapter TopicsUnderstanding how customers value pricing is the essence of the pricing process. Chapter topics include:

1.The value-based approach for pricing

2.The central elements of the pricing process

3.How effective new product prices are established and the need to periodically adjust the prices of existing products

4.How to respond to a price attack by an aggressive competitor

5.Strategic approaches to competitive bidding

Customer Value in Business Markets

Customer Value

Core Benefits Add-on Benefits Acquisition Costs Processing Costs Usage Costs

Source: Adapted with modifications from Ajay Menon, Christian Homburg and Nikolas Beutin, “Understanding Customer Value in Business-to-Business Relationships,” Journal of Business-to-Business Marketing 12, No. 2 (2005), pp. 1-33.

SacrificesBenefits

Total Costs = Acquisition + Possession + Usage

1. Acquisition: Purchase price, transportation, administrative costs, errors, costs to evaluate supplier, expedition costs

2. Possession Costs: Finance, storage, inspection, insurances, taxes, internal handling

3. Usage Costs: Costs for ongoing use such as installation, training, field repairs, replacement, disposal

Sacrifices = Total Costs

5

Customers’ Total Cost-in-Use Components

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. Building trust2. Demonstrating commitment3. Being flexible4. Initiating joint ventures5. Working on developing deeper relationships

These efforts enhance customer value & loyalty.

Differentiating through Value-creation

• Research suggests that most companies offer similar services, however, the following seem to be more prominent.

1. Service support2. Personal interactions3. Supplier know-how4. Ability to improve customer’s time to market

• Moderate differentiating factors include:1. Product quality2. Delivery3. Acquisition and operation costs

• No easy formula for pricing industrial product or service

• Decision is

multidimensional

• Each interactive variable assumes significance

Key Components of the Price-Setting Decision Process

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

Fig. 14.2

Demand Determinants & Assessing Value• There are a number of issues when considering demand:

1. Usage and importance of the product/service by various segments2. 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 “A’s” total offering provides more value than “B”?

Fig 14.3 A Value-Based Approach for Pricing

Define the key market segments

Isolate the most significant drivers of valuein customers’ business

Quantify the impact of your product or serviceon each value driver in customers’ business

Estimate the incremental value created by your productor service, particularly for those features that areunique 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.

Elasticity Varies by Segments

• 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 Elastic Demand Demand Elastic Elastic

Demand Demand

Consumers buy more or lessof a product when the price changes

InelasticInelasticDemandDemand

InelasticInelasticDemandDemand

An increase or decrease in price will not significantly affect demand

UnitaryUnitaryElasticityElasticityUnitaryUnitary

ElasticityElasticity

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

Elasticity of Demand

Price Goes...Price Goes...Price Goes...Price Goes... Revenue Goes...Revenue Goes...Revenue Goes...Revenue Goes... Demand is...Demand is...

Down Up Elastic

Down Down Inelastic

Up Up Inelastic

Up Down Elastic

Up or Down Stays the Same Unitary Elasticity

Other Factors• Satisfied customers are less price sensitive

therefore one strategy is to make our customers very satisfied so price isn’t as much of a determinant.

• Switching 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.

Other Factors

• 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.

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 better approach is to use Target Pricing1.It starts by examining and segmenting the market2.Determine what type, quality and attributes each

segment wants at a pre-determined target price3.Understand the perception of value to the target

selling price4.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)

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 affect.

Followers vs. Pioneers

• 3 Major Pricing Strategies

1.Follow the Crowd2.Price Skimming3.Penetration Pricing

Pricing Strategies

Price SkimmingPrice 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

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 quality…where 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 A Competitive ThreatCompetitive price

or “low cost” product entry

Accommodate or Ignore

Is your position in

other markets at risk?

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

If you respond, is

competition willing and

able to reestablish the

price difference?

Respond

Does the value of the markets at risk justify

the cost of response?

Respond

Will the multiple responses required to match a

competitions cost less than the preventable sales loss?

Respond

No

No No

No

NoYes

Yes

Yes

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.

Yes

Yes

Competitive Bidding

• Certain groups do bidding

1. Governments2. Large companies (using preferred suppliers)

bid for:a. Non-standard materialb. 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…

• But not always.

• Open bidding: Auction & reverse auction bidding– The goal is to push the price down.– Sometimes it has a negative effect because it brings out

sensitive financial standings between competitors. – The result can cause distrust between supplier and buyer.

Strategy for Competitive BiddingBidding is costly and time consuming.

A. Screen the project to make sure the contract is related to your core competencies and is one you can perform (profitably).

B. Price to a level that, hopefully, will allow you to win the contract but not bankrupt you.

C. Sometimes it is worth winning a contract even at a small loss if it can lead to bigger contracts.

D. The determinant is the switching costs involved for the buyer to bring on another vendor.

Strategic Approach to Reverse Auctions Reverse auctions are used to:

1. Purchase commodity products at lowest price2. Tempt suppliers to sacrifice their profit margins in the heat of bidding

To minimize risk of winning an unprofitable bid,1. Carefully estimate true incremental cost of project2. Include costs associated with special terms:

1. Technical2. Marketing3. Sales support

This analysis should result in a “walk-away” price.

Strategic Approach to Reverse Auctions con’t.

• To cope with a reverse auction:

1. Convince buyer not to initiate the auction because you have a “unique value proposition” and will not participate in auction.

2. Manage the process. Influence the bid specifications and vendor qualifications.

3. Walk away and refuse to participate.

This approach defines winning as only doing those bids that are profitable.