Download Pricing Strategy for Business Markets Chapter Topics

Chapter 14:
Pricing Strategy for
Business Markets
PowerPoint by:
Ray A. DeCormier, Ph.D.
Central Ct. State U.
Chapter Topics
Understanding 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
Benefits
Core Benefits
Add-on Benefits
Sacrifices
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.
Sacrifices = Total Costs
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
Customers’ Total Cost-in-Use Components
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:
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.
Differentiating through Value-creation
• 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 customer’s time to market
• Moderate differentiating factors include:
1. Product quality
2. Delivery
3. Acquisition and operation costs
Key Components of the
Price-Setting Decision Process
• No easy formula for
pricing industrial product
or service
• Decision is
multidimensional
• Each interactive variable
assumes significance
Fig. 14.2
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
Demand Determinants &
Assessing Value
• There are a number of issues when considering demand:
1.
2.
3.
Usage and importance of the product/service by various segments
Price Sensitivity (elasticity of demand)
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 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. 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
Demand
Inelastic
Demand
Unitary
Elasticity

Consumers buy more or less
of a product when the
price changes

An increase or decrease in
price will not significantly
affect demand

An increase in sales exactly
offsets a decrease in prices,
and revenue is unchanged
Elasticity of Demand
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
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 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
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
Pricing Strategies
• 3 Major Pricing Strategies
1. Follow the Crowd
2. Price Skimming
3. Penetration Pricing
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.
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 Threat
Competitive price
or “low cost”
product entry
Accommodate
or Ignore
No
Is your
position in
other markets
at risk?
No
Is there a response that Yes
would cost less than the
preventable sales lost?
Yes
No
Does the value
of the markets
at risk justify
the cost of
response?
Yes
Respond
If you
respond, is
competition
willing and
able to
reestablish the
price
difference?
No
Yes
No
Will the multiple responses
required to match a
competitions cost less than the
preventable sales loss?
Yes
Respond
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.
Respond
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
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 Bidding
Bidding 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 price
2. 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 project
2. Include costs associated with special terms:
1. Technical
2. Marketing
3. 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.