Presentation on theme: "Chapter 12: Pricing Strategy for Business Markets PowerPoint by:"— Presentation transcript:
1 Chapter 12: Pricing Strategy for Business Markets PowerPoint by: Chapter 12:Pricing Strategy forBusiness MarketsPowerPoint by:Ray A. DeCormier, Ph.D.Central Ct. State U.
2 Chapter TopicsUnderstanding how customers value pricing is the essence of the pricing process. Chapter topics include:The central elements of the pricing process a value-based strategyHow effective new product prices are established and the need to periodically adjust the prices of existing productsHow to respond to a price attack by an aggressive competitorStrategic approaches to competitive bidding
3 CUSTOMER VALUE In B2B marketing, customer value is a cornerstone CUSTOMER VALUEIn B2B marketing, customer value is a cornerstoneThe 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 provideA better approach: “You get more than what you pay for” by offering lower cost and higher quality
4 What is Customer Value? Benefits – Sacrifice = Value How do customer’s view value?Everything costs something (sacrifice)Everything of value adds something (benefits)What’s the difference?Benefits – Sacrifice = Value
5 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:Building trustDemonstrating commitmentBeing flexibleInitiating joint venturesWorking on developing deeper relationshipsThese efforts enhance customer value & loyalty.
6 Differentiating Through value-creation Differentiating Through value-creationResearch 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 marketModerate differentiating factors include:1. Product quality2. Delivery3. Acquisition and operation costs
7 Setting the PriceThis 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:Pricing & profit objectivesDemand determinantsCost determinantsCompetition
8 Key Components of the Price-Setting Decision Process Key Components of the Price-Setting Decision ProcessFig. 12.1No easy formula for pricing industrial product or serviceDecision is multidimensionalEach interactive variable assumes significanceSet Strategic Pricing ObjectivesEstimate Demand and thePrice Elasticity of DemandDetermine Costs andtheir Relationship to VolumeExamine Competitors’ Prices and StrategiesSet the Price Level
9 Price ObjectivesPricing 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.
10 Demand Determinants & Assessing Value There are a number of issues when considering demand:Usage and importance of the product/service by various segmentsPrice Sensitivity (elasticity of demand)Assessing Value: Competitive Value comparisonsAssume same product by 2 different competitorsAssume: (“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”?
11 Assessing ValueEconomic 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 offeringsDifferentiation Value: Represents the value of features that are unique and different from competitors
12 Define the key market segments Fig A Value-Based Approach for PricingDefine the key market segmentsIsolate the most significant drivers of valuein customers’ businessQuantify the impact of your product or serviceon each value driver in customers’ businessEstimate the incremental value created by your productor service, particularly for those features that areunique and different from competitors’ offeringsDevelop pricing strategy and marketing planSOURCE: Adapted from Gerald E. Smith and Thomas T. Nagle, “How Much Are Customers Willing to Pay,”Marketing Research 14 (winter 2002): pp
13 Value Drivers ref. Fig. 12.3Goal is to identify significant drivers of valueCost Drivers: Create value by economic savingsExample: Machine can process more widgets/hr. with less electricity and labor costsRevenue Drivers: Add incremental value by facilitating revenue or margin requirementsExample: Packaging is more attractive thus increasing sales
14 Value Based approach ref. fig. 12.3 Quantify impact of firms product/service on customer’s business modelDoes it make or save money? How much?Compare firm’s product/service to next best alternative (competitor’s product/service)Isolate unique features that differ from competitorDo those features provide value that customer cannot get elsewhere?How much value does it create?
15 Value Based approach: ref. fig. 12.3 Understand how customer uses the product and how much value will s/he realizeSet the price & develop a responsive marketing strategyBENEFIT: 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.
16 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.
17 Elasticity of Demand Elastic Demand Chapter 17Elasticity of DemandElastic DemandConsumers buy more or less of a product when the price changesInelastic DemandAn increase or decrease in price will not significantly affect demandNotes:Elasticity of demand can be measured by this formula: Elasticity (E) = percentage change in quantity demanded percentage change in priceIf E is greater than 1, demand is elastic. If E is less than 1, demand is inelastic. If E is equal to 1, demand is unitary.Unitary ElasticityAn increase in sales exactly offsets a decrease in prices, and revenue is unchanged
18 Inelastic Demand Curve Chapter 17Elasticity of DemandElastic Demand CurveDQuantityPriceDQuantityPriceInelastic Demand CurveNotes:Exhibit 17.5 (a) shows a very elastic demand curve. Decreasing the price of the good increases sales and revenue substantially.Exhibit 17.5 (b) shows a completely inelastic demand curve. Decreasing the price did not cause a change in demand. For example, a state inspection fee price change decrease did not result in more used car purchases because state inspection fees are required by law, thus demand is completely inelastic. Conversely, the price of inspection could double without changing demand.Exhibit 17.6 in the text presents the demand curve for a suntan lotion when the price drops. E is greater than 1, and demand is elastic, indicating an increase in demand.
19 Elasticity of Demand Price Goes... Revenue Goes... Demand is... Down Chapter 17Elasticity of DemandPrice Goes...Revenue Goes...Demand is...DownUpElasticInelasticUp or DownStays the SameUnitary ElasticityNotes:If price goes down and revenue goes up, demand is elastic.If price goes down and revenue goes down, demand is inelastic.If price goes up and revenue goes up, demand is inelastic.If price goes up and revenue goes down, demand is elastic.If price goes up or down and revenue stays the same, elasticity is unitary.
20 Other FactorsSatisfied 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.
21 Other FactorsEnd 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.
22 Derived DemandBy 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.
23 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.
24 Target Pricing & Costing Many companies base price off of costsProblem: Method is internally driven, not market drivenA better approach is to use Target PricingIt starts by examining and segmenting the marketDetermine what type, quality and attributes each segment wants at a pre-determined target priceUnderstand the perception of value to the target selling priceThen calculate costs considering margins
25 Cost Concept AnalysisDirect 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)
26 Cost Classification System Goals 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.
27 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 projections?
28 Competition Competition establishes an upper limit on price. CompetitionCompetition 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.
29 Hyper-Competitive Situations In some industries rivals are fairly stable and the competitive strategy is “don’t 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.
30 Competitive Responses 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.
31 Followers vs. PioneersBy 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?
33 Pricing Strategies 3 Major Pricing Strategies Follow the Crowd Pricing Strategies3 Major Pricing StrategiesFollow the CrowdPrice SkimmingPenetration Pricing
34 Price Skimming Price Skimming is charging a high initial price Price SkimmingPrice Skimming is charging a high initial pricePrice Skimming:Appropriate for distinctly new productsProvides the firm with opportunity to profitably reach market segments not sensitive to high initial priceEnables marketer to capture early profitsEnables innovator to recover high R&D costs more quicklyStrategy: As the product goes through its product life cycle, the strategy is to lower the price in line with production and demand capacity.
35 Penetration PricingPenetration Pricing is charging a very low initial price.Penetration Pricing is appropriate when there is:High price elasticity of demandStrong threat of imminent competitionOpportunity for substantial production cost reduction as volume expands
36 Price Discrimination The Robinson-Patman Act of 1936: Chapter 18Price DiscriminationThe 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..”Notes:Six elements are needed for a violation of the Robinson-Patman Act to occur:There must be price discrimination; that is the seller must charge different prices to different customers for the same product.The transaction must occur in interstate commerce.The seller must discriminate by price among two or more purchasers within a reasonably short time.The products sold must be commodities or other tangible goods.The products sold must be of like grade and quality.There must be significant competitive injury.
37 Evaluating a 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.
38 Evaluating A Competitive Threat Competitive price or “low cost” product entryIf you respond, is competition willing and able to reestablish the price difference?Is your position in other markets at risk?RespondAccommodate or IgnoreIs there a response that would cost less than the preventable sales lost?NoNoYesNoYesDoes the value of the markets at risk justify the cost of response?YesNoWill the multiple responses required to match a competitions cost less than the preventable sales loss?NoYesYesRespondRespondSource: Figure from “How to Manage an Aggressive Competitor” by George E. Cressman, Jr. andThomas T. Nagle from BUSINESS HORIZONS 45 (March-April 2002): p. 25. Reprinted with permission from Elsevier.
39 Evaluating a Competitive Threat Evaluating a Competitive ThreatBefore 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?”
40 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.Do they want % share of market?Do they just want to clear inventory?Do they just want to recoup some of their investment quickly?
41 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.
42 Evaluating a Competitive Threat Evaluating a Competitive Threat4. 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.
43 Competitive Bidding Certain groups do bidding Governments Competitive BiddingCertain groups do biddingGovernmentsLarge companies (using preferred suppliers) bid for:a. Non-standard materialb. Complex designs and difficult manufacturing methods
44 Types of BiddingClosed 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 auctionsOpen bidding: more informal.When it is hard rigidly define requirementsPrices may be negotiated.Prices may be negotiated
45 Online Open Bid Format Bidding is costly and time consuming. Bidding is costly and time consuming.Simultaneous bids often used.All participants see the bids.Goal: push price down.Can damage supplier-customer relationships
46 Strategies of Competitive Bidding Choose bid opportunities with careFind contracts that offer the most promiseRemember that the low bidder may be ableto secure much more business that is profitableover the longer termHow likely will follow-on business occur???
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