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PowerPoint by: Ray A. DeCormier, Ph.D. Central Ct. State U. Chapter 12: Pricing Strategy for Business Markets.

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Presentation on theme: "PowerPoint by: Ray A. DeCormier, Ph.D. Central Ct. State U. Chapter 12: Pricing Strategy for Business Markets."— Presentation transcript:

1 PowerPoint by: Ray A. DeCormier, Ph.D. Central Ct. State U. Chapter 12: Pricing Strategy for Business Markets

2 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

3 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 you pay for by offering lower cost and higher quality CUSTOMER VALUE

4 How do customers view value? Everything costs something (sacrifice) Everything of value adds something (benefits) Whats the difference? Benefits – Sacrifice = Value

5 D IFFERENTIATING T HROUGH 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 trust 2. Demonstrating commitment 3. Being flexible 4. Initiating joint ventures 5. Working on developing deeper relationships These efforts enhance customer value & loyalty.

6 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

7 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. Pricing & profit objectives 2. Demand determinants 3. Cost determinants 4. Competition

8 8 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. 12.1

9 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.

10 There are a number of issues when considering demand: 1. Usage and importance of the product/service by various segments 2. 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?

11 A SSESSING V ALUE 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

12 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

13 I. Goal is to identify significant drivers of value a. Cost Drivers: Create value by economic savings 1. Example: Machine can process more widgets/hr. with less electricity and labor costs b. Revenue Drivers: Add incremental value by facilitating revenue or margin requirements 1. Example: Packaging is more attractive thus increasing sales

14 II. Quantify impact of firms product/service on customers business model a. Does it make or save money? How much? III. Compare firms product/service to next best alternative (competitors product/service) a. Isolate unique features that differ from competitor b. Do those features provide value that customer cannot get elsewhere? c. How much value does it create?

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

16 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 Consumers buy more or less of a product when the price changes Inelastic Demand An increase or decrease in price will not significantly affect demand Unitary Elasticity An increase in sales exactly offsets a decrease in prices, and revenue is unchanged

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

19 Elasticity of Demand Price Goes... Revenue Goes... Demand is... DownUpElastic Down Inelastic Up Inelastic UpDownElastic Up or DownStays the SameUnitary Elasticity

20 Satisfied customers are less price sensitive therefore one strategy is to make our customers very satisfied so price isnt 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 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.

22 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.

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 T ARGET P RICING & C OSTING Many companies base price off of costs Problem: Method is internally driven, not market driven A better approach is to use Target Pricing 1. It starts by examining and segmenting the market 2. 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

25 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)

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 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 H YPER -C OMPETITIVE S ITUATIONS 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.

30 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 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?

32 Followers vs. Pioneers

33 3 Major Pricing Strategies 1. Follow the Crowd 2. Price Skimming 3. Penetration Pricing Pricing Strategies

34 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.

35 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

36 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..

37 E VALUATING A C OMPETITIVE T HREAT 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 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 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

39 1. Before responding, ask: Do the benefits justify the costs? a. If responding to a price change is less costly than losing a sale, then do it. b. If competitor threat only affects a small segment, the revenues lost from ignoring it may be so small that it is not worth it. c. 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. 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?

41 E VALUATING A C OMPETITIVE T HREAT 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 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. Evaluating a Competitive Threat

43 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

44 T YPES OF B IDDING 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

45 Bidding is costly and time consuming. A. Simultaneous bids often used. B. All participants see the bids. C. Goal: push price down. D. Can damage supplier-customer relationships

46 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??? 46

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