Ch12 Pricing Strategy

7/29/2019 Ch12 Pricing Strategy

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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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Chapter TopicsUnderstanding how customers value pricing is the essence of thepricing 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 theneed 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


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In B2B marketing, customer value is acornerstone

The unifying goal of marketers is to bebetter than your very best competitor inproviding value

You get what you pay for is what manyprovide

A better approach: You get more than what

CUSTOMER

VALUE


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How do customers view value?

Everything costs something (sacrifice)

Everything of value adds something (benefits)

Whats the difference?

Benefits Sacrifice = Value


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DIFFERENTIATING THROUGHVALUE-CREATION

If relationships are more valuable to customers thanprice 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.


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Research suggests that most companies offersimilar services, however, the following seem to bemore 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


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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


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8

No easy formula forpricing industrialproduct or service

Decision ismultidimensional

Each interactive

variable assumessignificance

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


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Price Objectives Pricing decision must be based on marketing

and overall corporate objectives.

Marketer starts with principal objectives andadds collateral pricing goals:

Achieving target return on investment.

Achieving market-share goal.

Meeting competition.

Other objectives include competition, channelrelationships and product-line considerations.


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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 becauseAs total offering provides more value than B?


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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 offeatures that are unique and different from

competitors


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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 serviceon 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.


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I. Goal is to identify significant drivers ofvalue

a. Cost Drivers: Create value by economic savings1. 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


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II. Quantify impact of firms product/service oncustomers business model

a. Does it make or save money? How much?

III. Compare firms product/service to next bestalternative (competitors product/service)

a. Isolate unique features that differ from competitor

b. Do those features provide value that customercannot get elsewhere?

c. How much value does it create?


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IV. Understand how customer uses the productand how much value will s/he realize

V. Set the price & develop a responsivemarketing strategy

BENEFIT: Business marketer can gain acompetitive advantage by employing avalue based approach and by developingtools to document and communicate theirunique value to customers.


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Price elasticity measures how sensitivecustomers are to price changes.

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


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Elasticity of Demand

ElasticDemand

Consumers buy more or lessof a product when theprice changes

InelasticDemand

An increase or decrease inprice will not significantlyaffect demand

UnitaryElasticity

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


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Elastic Demand Curve

D

D

Quantity

Price

D

D

Quantity

Price

Inelastic Demand Curve


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

Down Up Elastic

Down Down Inelastic

Up Up Inelastic

Up Down Elastic

Up or Down Stays the Same Unitary Elasticity


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Satisfied customers are less price sensitivetherefore one strategy is to make ourcustomers very satisfied so price isnt asmuch of a determinant.

Switching costs is a consideration dependingupon products. The more sophisticated and

unique the product is, and the more vestedinterest (costs) in it is, the more apt for thecustomer to not switch.


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End Use: How important is the product as ininput into the total cost of the end product?

If cost is insignificant, then demand is inelastic.

End-Market Focus: Since demand for manyindustrial products is derived from thedemand for the product of which they are apart, STRONG end user focus is needed.


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Derived Demand By understanding trends such as up or down

markets, up or down sectors, and knowing thatnot all segments go up or down at one time, if oneis able to plan for a two-tiered market focus,

which takes advantage of the market variability

This strategy increases the chances for success.


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Value-Based Segmentation

Some industrial product may servedifferent purposes for different markets.

Each segment may value the product

differently.

By identifying applications where the firmhas a clear advantage, and by

understanding the value of it to eachsegment, marketer may be able toadminister price differentiation in eachsegment.


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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 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


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Cost Concept Analysis

Direct Traceable or Attributable Costs: All costs, fixedor variable, that are solely incurred for a particularproduct, territory, or customer (e.g., raw materials)

Indirect Traceable Costs: All costs, fixed or variable,that can be traced to a particular product, customer orterritory (e.g., general plant overhead)

General Costs: Costs that support a number ofactivities not directly related to a particular product(e.g., administrative overhead, R&D)


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Target pricing forces marketers to understandwhat buyers want and are willing to pay.

Target costing forces companies tounderstand their cost structure bydirect/indirect costs, fixed/variable costs, andtheir contribution margins.

Combining target pricing and target costingsays that instead of using cost-controltechniques, a better approach is to computethe total costs that must not be exceeded,allowing for acceptable margins.


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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


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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


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HYPER-COMPETITIVE SITUATIONS

In some industries rivals are fairly stable and thecompetitive strategy is dont rock the boat.

Other industries, especially high-tech or high profitindustries, the competitive environment is wrought with

short-term and temporary advantages. These arehypercompetitive environments with strong rivalries.

The strategy to succeed is to create a temporaryadvantage and destroy rival advantages by constantly

disrupting market equilibrium with new products, lowerprices, and strategic relationships.


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In analyzing competitors responses to anystrategic move, a good idea is to considerdirect competitors and substitute their actionsfrom a cost perspective.

For example, one idea is to view competitionas Followers vs. Pioneers. More often, pioneers

face higher entry costs than followers forvarious reasons.


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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?


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Followers vs. Pioneers


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3 Major Pricing Strategies

1. Follow the Crowd

2. Price Skimming

3. Penetration Pricing

Pricing Strategies


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Price Skimming

Price Skimming is charging a high initial price

Price Skimming:

Appropriate for distinctly new products

Provides the firm with opportunity to profitably reachmarket 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 productionand demand capacity.


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Penetration Pricing is charging a very low initialprice.

Penetration Pricing is appropriate when there is: High price elasticity of demand

Strong threat of imminent competition

Opportunity for substantial production costreduction as volume expands


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Price Discrimination

The Robinson-Patman Act of 1936:

holds that it is unlawful to discriminate in

price between different purchasers ofcommodities 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..


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EVALUATINGA 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.

E l ti A C titi Th t


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Evaluating A Competitive ThreatCompetitive price

or low costproduct entry

Accommodateor Ignore

Is yourposition in

othermarkets at

risk?

Is there a responsethat would cost less

than the preventablesales lost?

If yourespond, is

competitionwilling and

able toreestablish

the pricedifference?

Respond

Does thevalue of the

markets atrisk justifythe cost of

response?

Respond

Will the multiple responsesrequired to match a

competitions cost less thanthe 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


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1. Before responding, ask: Do the benefitsjustify the costs?

a. If responding to a price change is less costlythan losing a sale, then do it.

b. If competitor threat only affects a smallsegment, the revenues lost from ignoring itmay be so small that it is not worth it.

c. In other words, Why lower the price to lose

revenue from other segments too?


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Evaluating a Competitive Threat

2.If you respond to the threat, is the competitorwilling to merely reduce price again to restore the

price difference?

Matching a price cut is ineffective if thecompetitor 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?


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EVALUATINGA COMPETITIVE THREAT

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

One consideration is the industry. In high-capital

and labor-intensive industries, it is better to cut theprices only to the point of variable cost levels.

The objective is to try to capture some contributionmargin, if possible.

Strategy: Build into your products high switchingcosts.


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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 pricewar?

Before responding, make sure you understand all of

the ramifications, i.e., lost markets, gained markets,and even bankruptcy.

Evaluating a Competitive Threat


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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


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TYPESOF 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


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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


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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???

Ch12 Pricing Strategy

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