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PowerPoint by:Ray A. DeCormier, Ph.D.Central Ct. State U.
Chapter 12:
Pricing Strategy for Business Markets
Chapter TopicsChapter TopicsUnderstanding 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
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
How do customer’s view value?
Everything costs something (sacrifice)
Everything of value adds something (benefits)
What’s the difference?
Benefits – Sacrifice = Value
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 trust2. Demonstrating commitment3. Being flexible4. Initiating joint ventures5. Working on developing deeper relationships
These efforts enhance customer value & loyalty.
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
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
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
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.
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 “A’s” total offering provides more value than “B”?
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 of features that are unique and different from competitors
Fig 12.3 A Value-Based Approach for Pricing
Define the key market segments
Isolate the most significant drivers of valuein customers’ business
Quantify the impact of your product or serviceon each value driver in customers’ business
Estimate the incremental value created by your productor service, particularly for those features that areunique 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.
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
II. Quantify impact of firms product/service on customer’s business model
a. Does it make or save money? How much?
III. Compare firm’s product/service to next best alternative (competitor’s 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?
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.
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 Elastic Demand Demand Elastic Elastic
Demand Demand
Consumers buy more or lessof a product when the price changes
InelasticInelasticDemandDemand
InelasticInelasticDemandDemand
An increase or decrease in price will not significantly affect demand
UnitaryUnitaryElasticityElasticityUnitaryUnitary
ElasticityElasticity
An increase in sales exactly offsets a decrease in prices, and revenue is unchanged
Elasticity of DemandElastic Demand CurveElastic Demand Curve
D
D
Quantity
Pri
ce
D
D
Quantity
Pri
ce
Inelastic Demand CurveInelastic Demand Curve
Elasticity of Demand
Price Goes...Price Goes...Price Goes...Price Goes... Revenue Goes...Revenue Goes...Revenue Goes...Revenue Goes... Demand is...Demand is...
Down Up Elastic
Down Down Inelastic
Up Up Inelastic
Up Down Elastic
Up or Down Stays the Same Unitary Elasticity
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.
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.
Derived DemandBy 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.
Value-Based Value-Based SegmentationSegmentation
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 Pricing1. It starts by examining and segmenting the market2. Determine what type, quality and attributes each
segment wants at a pre-determined target price3. Understand the perception of value to the target
selling price4. 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)
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.
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?
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.
HYPER-COMPETITIVE SITUATIONS
In some industries rivals are fairly stable and the competitive strategy is “don’t 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.
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.
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?
Followers vs. Pioneers
3 Major Pricing Strategies
1.Follow the Crowd
2.Price Skimming
3.Penetration Pricing
Pricing Strategies
Price SkimmingPrice 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 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
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.
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
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
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?”
Evaluating a Competitive Evaluating a Competitive ThreatThreat2. 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?
EVALUATING A COMPETITIVE THREAT
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.
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
Competitive BiddingCertain groups do bidding
1.Governments2.Large companies (using preferred
suppliers) bid for:a. Non-standard materialb. 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…
On-line sealed bids: on-line auctions
Open bidding: more informal. When it is hard rigidly define
requirementsPrices may be negotiated. Prices may be negotiated
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
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
profitableover the longer term How likely will follow-on business occur???
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