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Chapter 10

Pricing Industrial Products

And Services

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Price

Price is unique among the 4 Ps in that it

directly affects the companys revenues and

profits. Pricing is both a science and an art.

Diligence and creativity are both necessary.

Pricing seems to be the one P that has

been dramatically affected by the use of the

Internet.

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Characteristics of Industrial Prices I

Includes more than list or quoted price

Delivery & Installation

Discounts (quantity, promotion, remit time)

Training costs

Trade-in allowance

Promotions: 2 for 1

Financing costs

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Characteristics of Industrial Prices II

Not an independent variable. Pricing

interacts with:

product,

promotion, and

distribution strategies

Must consider complementary or substituteproducts when establishing price strategy

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Characteristics of Industrial Prices III

Prices can be changed by:

Changing price paid by buyer

Changing quantity/quality offered by seller

Changing premiums or discounts

Changing time and place of payment

Carry

Tax/Cash Flow implications

Changing time and place of transfer of

ownership

Delivery

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Characteristics of Industrial Prices IV

Pricing often set through competitive

bidding on a project-by-project basis

Dont know competitors prices

Negotiation may be used instead (some insist)

Emphasis on fairness

Need to justify price increases

Also justify higher prices

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Characteristics of Industrial Prices V

Affected by economic factors outside

companys control:

Inflation Long-Term contract (escalation clauses)

Interest Rates

Currency Exchange Rates Affects cost of materials

Affects price of exports

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Price = f(Value)

Need to set an initial price that is neither too

high (hurts sales) or too low (lost profit)

Value has two major dimensions:

Customers subjective estimate of products

capacity to satisfy a set of goals

Objectively established by the competitive

market. What the market will bear.

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Economic Value to the Customer

Purely economic sources of value

Need to compare life-cycle costs of your

product and substitutes

Ifincremental value is high enough to

justify a higher price, then there is EVC

Sometimes it takes a convincing sales effort

to help customer see the value

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Whats it worth to the customer? How much money can customers save by

using our product?

Can the product help them increase sales or

reach new customers?

Does the product provide a competitiveadvantage?

Does the product improve the safety of the

products the customer sells? ( Value)

How much time can customer save by

buying product vs. making themselves?

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Strategic Pricing Programs:

Objectives I ROI; Market Share

Profit

Sales Growth Stabilize Market

Convey Desired Image

Desensitize customers to price Be Price Leader

Discourage entry & push out weak competitors

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Objectives II

Avoid Government interference (Anti-Trust/Regs)

Perceived Fairness

Customers, Distributors, Suppliers

Create interest & excitement

Sell other items in line

Discourage competitors from dropping price Recover investment quickly

Generate sales volume

Encourage quick payment

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Strategy Cost-Based

Fixed and Variable costs/Unit

Markup/ROI

Market-Based

Competitor Prices

Customer Demand

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Market-Based Pricing Strategies Floor: just cover costs

Penetration: lower than market

Parity: match market

Premium: skimming

Price Leadership: everyone plays follow theleader

Stay Out/Keep Out

Bundle: Multiple products/services

Value-Based: Segment pricing

Cross-Benefit: Gotcha (Razors, Ink Jet)

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Structure Basic: One price, no discounts, everyone

pays the same

Lacks flexibility, limits sales

Low Cost competitive advantage in price

Price moves toward costs in PLC, until end

Creative Pricing: empty seats, box filler,

late cancellations, season, demand, advance

purchase, customer loyalty

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Levels/Tactics

Actual price charge w/discounts

Acceptable range that conveys value

Odd ($2,999) vs. Round ($3000) Ensure adequate price gaps between items

Modify for costs, competitors, market s

Timing: not arbitrary, justify to customer Sends signals to customers/competitors

Rebates, 2/1, trade-in, etc.

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Pricing Program

Strategy, structure, level, and tactics allwork together. They must be coordinated.

Strategy may be long lived (several years).

May need to modify structure periodically.Offer special price deals.

Levels and tactics need to be monitored

closely and changed as needed.Address competitor changes

In response to cost changes

As demand changes

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Pricing Decisions: What Lies Beneath?

Most companies use multiple pricingstrategies.

If the firm sells complimentary or substitute

products, they are more likely to use

product line strategies (e.g., bundling).

Objectives

Costs Demand

Competition

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Objectives/Strategies

Differentiation Higher MarginsFewer competitors are substitutes

Increased brand loyalty

Moving to low price from premium-qualityposition can hurt sales, not help

Recoup development costs over longer

period of time. Otherwise run risk of salesnumbers that are too low to ever recoup

costs.

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Costs

Establishes the minimum price

Set price based on target margin or return

Can price below cost to:

Keep employees and facilities working duringdownturn

Support other products in the line

Low bid to establish relationship. Make $ in

long term, or on extras

Experience or reputation

New skills

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Standard Cost Approach

Target Return PricingNeed accurate sales forecast: standard volume

Variable costs and fixed costs/unit: standard

costs

P = DVC + FC/Q + rK/Q

P: Price DVC: Direct Variable Cost/UnitFC: Fixed Cost r: Rate of Return

K: Capital Used Q: Standard Volume (units)

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Standard Cost Approach

Can include interest rates on debt, tax rates(perhaps different countries for mfr and

sales), or inflation factors.

Dont raise prices to counter weak sales;

Dont drop prices too quickly either

Need reliable standard volume estimate

Initial low price may increase volume,

which in turn lowers per unit fixed costs

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Contribution Analysis

Trade off between price and units sold

Total RevenueTotal Variable Cost =

Variable Contribution Margin

Fixed Costs Contribution/Unit = Break

Even Sales Volume (minimum sales)

Estimate change in volume for changes inprice and compare to break even (Maximumsales/profit

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Demand

Sets the upper limit of price

Need to understand customers reasons forbuying product; how they use it

Hard BenefitsPhysical Attributes: hp, productivity, durability,

error rate, performance tolerances

Soft Benefits Warranty, service, other augmented product

Balance benefits to customer against thecosts (price +)

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Costs Price + (delivery, modifications, financing,

maintenance, operation, less salvage) CT machine $500K-$1MM to purchase

Also costs ~ $100K/year to operate andmaintain

Cost to prepare facilities to house

Risk (defect, poor performance) Cost

What trade offs are the customers willing to

accept?Slower delivery; Low service priority

Higher, chunkier inventory

Larger purchase commitment

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Elasticity of Demand

Sensitivity of customers quantity demand

to changes in price

Usually demand has a negative slope(higher price lower demand)

Issue is how steep

Sometimes must hit a threshold level beforethere is a change in elasticity Substitutes

become more palatable as prices rise

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Elasticity

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$

Quantity Demanded

Inelastic

Elastic

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Elasticity

% Quantity % Price

If > 1, elastic

If < 1, inelastic

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Determinants of Elasticity

Available substitutes Necessity of product

Relative size of purchase $$$

Differentiation of product/Standardization Customer switching costs

Ease/Difficulty of comparison (Complexity)

Third-Party Payer (Pass-Through)

Price/Quality Association

Time (Payment due, need for product)

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Industrial Products

Tend to have inelastic demand Especially if technically sophisticated,

customized, or crucial to operations

Routine purchases more elastic Situational elasticity: customer and market

circumstances

Incumbents push uniqueness Challengers push substitutability

Elasticity can vary across segments

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Cross Elasticity

Compliments

Lumber and nails, drill presses and bits

Negative cross elasticity

Substitutes

Shipping by train vs. truck, Company B vs. A

Positive cross elasticity

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Competition

Need to monitor continuously

Anticipate changes

Relatively easy because there are relatively

few suppliers and few customers

Tends to be oligopolistic

Structure: concentrated

Price LeaderSets the tone for pricing

Usually the organization with the best cost

structure (competitive advantage)

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Four Strategic Pricing Options

Pressure Pricing

Opportunistic Pricing Gold-Standard Pricing

Negotiated Pricing

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Pressure Pricing

Market leader maintains fairly stable price

level

Price not dictated by demand fluctuations

Price increases controlled

Controls market entry

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Opportunistic Pricing

Follow the swings of the market

Raise prices as high as elasticity will allow

Raise prices as high as customer goodwill

or loyalty will allow

Lower prices as demand drops

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Gold-Standard Pricing

William Jennings Bryan

Cross of Gold Speech

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Gold-Standard Pricing

Short run policy

Quote all customers the same price

Ignore specific circumstances

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Negotiated Pricing

Tailor pricing to each customer (or

segment) based on

ElasticityCompetitive Alternatives

Type of Customers

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PLC Pricing I Critical at Introductory Stage

Sets the tone for future pricing decisions Penetration pricing (low)

Higher sales, lower margins

Can leave too much on the table Parity pricing (match)

Premium/Skimming pricing (high)

Can get highest marginsRisk competitive entry

Always easier to lower prices than to raise

Dont try to recoup R&D costs too quickly

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PLC Pricing II

Growth: New competition

More specialized need segments develop

Product extensions developed

Scale economies and experience curve start

to come into play

Price ranges narrow; convergence on

market price

Downward pressure on pricing

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PLC Pricing III

Maturity: Market more saturated

Competition aggressive and entrenched

Product may be cash generator (Cash Cow)

Focus is on repeat sales/internal costefficiency

Competition more heavily priced based; but

stop short of price war Maximize short-term direct product

contribution to profit

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PLC Pricing IV

Decline

May raise price to capitalize on remaining,

inelastic demand, or

Leave prices stable, cut expenditures, let

product die, or

Cut price, toward break-even, use as lossleader to sell complimentary products

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Competitive Bidding I

Most common with

public projects

governmental agenciescustom, technically complex products

long manufacturing cycles

Usually the low bidder Not always in private sector

Consider bidder qualifications (See AGC form)

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Competitive Bidding II

Invitation to Bid: RFP publishedNewspaper

Private Publications: Dodge Reports

Usually very precise plans andspecifications that become part of the

purchase contract

May have to provide a performance bond toensure that the product/service will be

completed. Bid bonds less common.

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Competitive Bidding III

Sealed/Closed Bids

Due at same time

Open all at onceOne time pricing

Open/Negotiated Bids

Iterative processCombines bidding and negotiating

Web bidding has facilitated this process

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Competitive Bidding IV

Questions to consider:

Is project large enough to bid?

Are the specs precise enough to do an accuratebid?

How will successful bid affect our other jobs,

products, and customers?

Who else may bid? How hungry are they?

Do we have time to put together quality bid?

(Courtesy Bid)

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Competitive Bidding V

Bidding Strategy Probabilistic Bidding (Value????)

Assumes profit maximization is goal

Assumes lowest bid selectedFocus on size of bid, expected profit if win, and

probability that bid will win

E(X) = P(X)Z(X)

X = Bid Price Z(X) = Actual profit if successful

P(X) = Probability of bid acceptance

E(X) = Expected profit at this bid

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Competitive Bidding VI

Bidding models are only tools

Managerial judgment is critical

Set price to achieve a goodwin

Bids are not always fixed

Might have an escalation clause

Might have a pass-through clause (cost+)

Post-Bid negotiation (by customer) common

Extras (not addressed by bid) PROFITABLE

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Negotiation

P i N ti ti I

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Price Negotiation I

Need good interpersonal skills, persuasion

skills, judgment, conflict resolution skills

Negotiation is the result of two sides

coming together to decide how much gain

each will have by working together If not win-win, wont happen

Each side has minimums that it wants to

win and needs to win

If < need No deal

If

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Price Negotiation II

Need to understand risks and rewards for

both sides of negotiation

Estimate settlement ranges for self and

other party

Bargaining zone: Sellers minimum price toBuyers maximum price

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High Low

Buyers

Max Price

Sellers

Min Price

Bargaining

Zone

Seller

Wants

Seller

Opens

Buyer

Opens

Buyer

Wants

N i i S l

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Negotiation Styles Avoidant: Relatively rare

Avoid confrontation. Out for self.

Collaborative: Good long-term strategy

Win-Win. Try to satisfy self and other party.

Competitive: Short-sighted

Win-Lose. Get all you can from other party.

Sharing: Common

Both partiespartially satisfied.

Accommodative: Rare

Satisfy other party, at own expense.

O h I N i i

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Other Issues on Negotiation

One time deal, or repeated negotiation? Repeat more cooperation

Have longer term view

What else besides price is important?

Guarantees

Return Policies

Volume

Quality

Financing

Service

Time constraints?

Di d I i

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Discounts and Incentives Common point of negotiation

Can use to attract new customers, or keepexisting ones

Can offer on select products, and to select

customers Prepaid freight, drop-shipping, financing,

post-dating, returns, rebate

Discounts:CashQuantity

Trade

C h Di

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Cash Discounts

Incentive to pay quickly Helps cash flow

2/10, n30: 2% off if paid w/in 10 days,otherwise, full amount due in 30 days

Might offer discount for prepaying, prior todelivery, or even prior to production

Many companies need cash, and will

discount for up-front $ (+ no risk) Prepaid expenses can provide payer tax

benefits in addition to discounts offered

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Quantity Discounts

Cheaper by the dozen theory

Seller gets guaranteed sales

Can plan production betterSmoothes out production, inventory, delivery

Helps with financing, & getting other business

Can offer discounts on $ or unit level Might spread out large purchases over a

period of time, but commit up front

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Trade Discounts

Also called functional discounts

Usually given to distributors for performing

certain functions for the manufacturerStorage, warehousing

Sales

TransportationPromotion

Common with automobile dealers

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Leasing I

Contract to use an asset that is owned by

someone else (renting) for a period of time

Avoid cash payment up front Sometimes avoid maintenance and ops costs

Can expense for taxes (not amortize)

Does not reduce debt capacity

Hedge against technology obsolescence

Leasing II

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Leasing II Financial Lease

Longer term

lease pmts > Purchase price of asset

Lessee (buyer) responsible for maintenance &

operating expenses

Can apply some of lease pmt to purchase @ end

Operating Lease

Shorter, cancelable

Not amortized

Lessor (seller) responsible for ownership expenses

No purchase option

Lease price > financial lease price

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Transfer Pricing

Internal sales price from one division to

another within the same company

Need to cover costs Need to be cheaper than market

Exact price subject to negotiation

Both sides usually profit centers

May need to be determined by higher-up

Set formula (cost + 2/3 of margin to market)

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WWW & Pricing

Facilitates information search by customers

Auctions: buyers set prices, not sellers

Buyers control transaction, on-line bidding

Can get spot pricing on everything and can

take competitive bids on lots of purchases

Forces even strong brands to be treated like

commodities

What to do about WWW

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What to do about WWW Use differential pricing

Optimize pricing by using customer data:increases customer switching costs

De-Menu pricing; can adjust pricing almostinstantly as needed; remove lumpiness

Push differentiation even more: can use web toprovide pleasing aesthetics, entertainment,education, or escapism

Dont assume customers will not pay more Establish electronic exchanges, barter excess

supplies

Maximize revenue, not price: Yield Management

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Documents

B2B Chapter 10