Business to Business Pricing

Fig Key Components of the Industrial Pricing Process No easy formula for pricing an industrial product. Decision is multidimensional Each interactive variable assumes significance.

Costs Fixed Costs Variable Costs Types of Cost

Expenses that are uniform per unit of output within a relevant time period As volume increases, total variable costs increase Variable Costs are…

THERE ARE TWO CATEGORIES OF VARIABLE COSTS 1.Cost of Goods Sold 2.Other Variable Costs

For Manufacturer or Provider of Service  Covers materials, labor and factory overhead applied directly to production For Reseller (Wholesaler or Retailer)  Covers primarily the cost of merchandise Variable Costs – Cost of Goods Sold

Other Variable Costs Expenses not directly tied to production but vary directly with volume Examples include:  Sales commissions, discounts, and delivery expenses

Expenses that do not fluctuate with output volume within a relevant time period They become progressively smaller per unit of output as volume increases No matter how large volume becomes, the absolute size of fixed costs remains unchanged Fixed Costs

THERE ARE TWO CATEGORIES OF FIXED COSTS 1.Programmed costs 2.Committed costs

Result from attempts to generate sales volume Examples include:  Advertising, sales promotion, and sales salaries Fixed Costs – Programmed Costs

Costs required to maintain the organization Examples include nonmarketing expenditures, such as:  rent, administrative cost, and clerical salaries Fixed Costs – Committed Costs

Relevant and Sunk Costs

Future expenditures unique to the decision alternatives under consideration. Expected to occur in the future as a result of some marketing action Differ among marketing alternatives being considered In general, opportunity costs are considered relevant costs Relevant Costs are…

The direct opposite of relevant costs. Past expenditures for a given activity Typically irrelevant in whole or in part to future decisions Examples of sunk costs: Past marketing research and development expenditures Last year’s advertising expense Sunk Costs are…

When marketing managers attempt to incorporate sunk costs into future decisions, they often fall prey to the Sunk Cost Fallacy – that is, they attempt to recoup spent dollars by spending even more dollars in the future. Example: Continuing to advertise a failing product heavily in an attempt to recover what has already been spent on it. Sunk Cost Fallacy

Margins The difference between the selling price and the “cost” of a product or service Margins are expressed in both dollar terms or as percentages on:  a total volume basis, or  an individual unit basis

Gross Margin or Gross Profit On a total volume basis: The difference between total sales revenue and total cost of goods sold On a per-unit basis: The difference between unit selling price and unit cost of goods sold

Trade Margin (Markup) Suppose a retailer pays $10 for an item and sells it for $15. Markup is thus $5 ($15-$10): Margin as a percentage of cost: Margin/Cost x 100 = ($5 / $10) x 100 = 50 % Margin as a percentage of selling price: Margin/Price x 100 = ($5 / $15) x 100 = %

Break-even point is the unit or dollar sales at which an organization neither makes a profit nor a loss. At the organization’s break-even sales volume: Total Revenue = Total Cost Break-Even Analysis

LOSS PROFIT Total Revenue Fixed Cost BE Point Total Cost Variable Cost Unit Volume Dollars 0 Break-even Analysis Chart

Break-even Analysis Example Fixed Costs=$50,000 Price per unit=$5 Variable Cost=$3 Contribution=$5 - $3 = $2 Breakeven Volume=$50,000  $2 =25,000 units Breakeven Dollars=25,000 x $5 =$125,000

Operating Leverage Extent to which fixed costs and variable costs are used in the production and marketing of products and services. Firms with high total fixed costs relative to total variable costs are defined as having high operating leverage. Higher operating leverage results in a faster increase in profit once sales exceed break- even volume. The same happens with losses when sales fall below break-even volume.

Different Companies, Different Pricing Objectives CompanyObjective Alcoa20% ROI American CanMaintain market share General Foods33% gross margin National SteelMatch the market U.S. Steel8% ROI after taxes DuPontTarget ROI, cost-plus (continued)

Benefits of a Particular Product Functional benefits Functional benefits are the design characteristics that might be attractive to technical personnel. Operational benefits Operational benefits are durability and reliability, qualities desirable to production managers. Financial benefits Financial benefits are favorable terms and opportunities for cost savings, important to purchasing managers and controllers. Personal benefits Personal benefits are organizational status, reduced risk, and personal satisfaction.

A broad perspective needed in examining the costs a particular alternative may present for the buyer. Rather than making a decision on the basis of price alone, organizational buyers emphasize the total cost in use of a particular product or service. Customers’ Cost-in-Use Components

Factors Impacting Demand Ability to buy Willingness to buy Benefits vs. Price Substitutes Nonprice competition

Problems with Using Price Elasticity to Set Price Fails to consider competitors’ response Demand may be inelastic for given price, but elastic for larger amount Measured in sales revenue, not profit margins Fails to consider product line effects Ignores low price societal benefits

Pricing Across Product Life Cycle (Life-Cycle Costing) Introduction phase: –Price skimming: Introductory price set relatively high, thereby attracting buyers at top of product’s demand curve. –Market penetration pricing: Low price is used as an entering wedge. Growth phase Maturity phase Decline stage

Strategies in the Introduction Stage of the PLC Rapid-skimming strategyRapid-skimming strategy –Launch new product at high price –High promotion level –Makes sense if: large part of potential market is unaware of the product those who become aware are eager & willing to pay need to build brand preference quickly due to potential competition

Strategies in the Introduction Stage of the PLC Slow-skimming strategySlow-skimming strategy –launch new product at high price –low promotion –helps maintain high profit per unit –makes sense if: market size is limited most of market is aware of product buyer willing to pay high price no significant potential competition

Strategies in the Introduction Stage of the PLC Rapid-penetration strategyRapid-penetration strategy –launch new product at low price –spend heavily on promotion –allows fastest market penetration & share –makes sense if: large market that is unaware of product buyers are price-sensitive strong potential competition exists can rapidly enjoy economies of scale

Strategies in the Introduction Stage of the PLC Slow-penetration strategySlow-penetration strategy –launch new product at low price –low level of promotion –encourages rapid product acceptance –allow slightly higher profits than rapid-penetration –makes sense if: market is price-sensitive market is not promotion-sensitive large market that is aware of the product some potential competition

Price-Leadership Strategy One (or a very few) firm(s) initiate price changes, with most or all the other firms in the industry following suit. When price leadership prevails, –price competition does not exist. –burden of making critical pricing decisions is placed on leading firm(s) and –others simply follow the leader.

Characteristics of Successful Price Leaders Large share of industry’s production capacity Large market share Commitment to particular product class/grade New, cost-efficient plants Strong distribution systems Good customer relations Effective market information systems Sensitivity to price/profit needs of industry Sense of timing as to when make price changes Sound management organization for pricing Effective product-line financial controls

Competitive Bidding requests for quotations RFQsBuyer sends inquiries (requests for quotations or RFQs) to firms able to produce in conformity with requested requirements. Requests for proposalsRFPsRequests for proposals (RFPs) involve the same process, but –here buyer is signaling that everything is preliminary and –that a future RFQ will be sent once specifics are determined from the best proposals.

Competitive Bidding Closed biddingClosed bidding –often used by business and governmental buyers –involves a formal invitation to potential suppliers to submit written, sealed bids for a particular business opportunity. Open biddingOpen bidding –more informal and allows suppliers to make offers (oral and written) up to a certain date.

Whether or Not to Bid Is the dollar value of the contract large enough to warrant the expense involved in making the bid? Are the product specs precise enough to allow the cost of production to be accurately estimated? Will acceptance of the bid adversely affect production and/or ability to serve other customers? How much time is available to prepare the bid? What is the likelihood of winning the bid given the presence and strength of other bidders?

Types of Leases Operating LeaseOperating Lease –short-term and cancelable –lessor generally provides maintenance/service –rarely contains purchase option Direct-financing LeaseDirect-financing Lease –long-term and non-cancelable –lessee responsible for operating expenses –lessee has option of purchasing the asset

Leasing in the Business Market buyerAdvantages to buyer –No down payment –No risk of ownership sellerAdvantages to seller –Increased sales –Ongoing business relationship with lessee –Residual value retained