Pricing Business Marketing

Dr. Dawne Martin

November 29, 2011

Learning Objectives

• Understand the model for pricing, and how strategy, costs, environment and positioning will affect pricing decisions

• To understand how market-based, cost-based and value-based prices are determined

• To understand how to map customer value for determining value-based prices

• To develop price management policies

Question

• The XYZ Manufacturing Corporation has experienced a rather large decline in sales for its component parts. Mary Vantage, vice-president of marketing, believes a 10% price cut may get things going again.

• What factors should Mary consider before reducing the price of the components.?

Managing Pricing

• To support a target-positioning strategy

• To achieve target financial goals

• To fit the realities of the marketplace

• To pursue both cost and demand based pricing principles and processes.

A MODEL FOR MANAGING PRICE

Evaluation and Formation of

Prices & policy

Demand Factors• Elasticity of demand

• Cross elasticities

• Customer value

perceptions

1

Cost Factors

• Costs now

• Anticipated costs

• Economic objectives

2

Cost Factors• Structure of competition• Barriers to entry• Intent of rivals

3

Strategy Issues• Target market selection• Product positioning• Price objectives• Marketing program

4

Trade Factors• Power in the channel• Traditions and roles• Margins

5

Legal Factors• Vertical restrictions• Price discrimination

6

Exhibit 14-2

14-5

KEY DECISIONS IN MANAGING PRICE

• DETERMINE PRICING STRATEGY– Develop specific approach to achieve price objectives

• DETERMINE CHANNEL INTERMEDIARY PRICES, COSTS AND MARGINS

• DETERMINE SINGLE PRODUCT AND PRODUCT LINE PRICING

• Develop pricing structures for substitute and complementary products

• DETERMINE WHETHER TO PARTICIPATE IN BIDDING AND NEGOTIATION FOR SALES

• ESTABLISH A PRICING SYSTEM

• Based on the 4 C’s : Costs, Customers, Competitors, and Channels 14-6

Exhibit 14-5

Types ofsituations

Importantdimensions

Pure Competition Oligopoly

MonopolisticCompetition Monopoly

Uniqueness of each firm’s product None None Some Unique

Number of competitors Many Few Few to many None

Size of competitors (compared to size of market

Small Large Large to small None

Elasticity of demand facing firm

Completely Elastic

Kinked demand curve (elastic and inelastic

Either Either

Elasticity of industry demand Either Inelastic Either Either

Control of price by firm None Some (with care) Some Complete

ANALYZING MARKET STRUCTURES

14-7

Exhibit 14-9

BREAK-EVEN ANALYSIS

BREAK-EVEN IS DONE TO FIND THE LEVEL OF SALES TO COVER ALL FIXED AND VARIABLE COSTS

Q is quantity; FC, fixed costs; VC, variable costs;UVC, unit variable costs; Price, average revenue

BREAK-EVEN OCCURS WHEN: TOTAL REVENUE=TOTAL COSTBREAK-EVEN OCCURS WHEN: TOTAL REVENUE=TOTAL COST

Given: Price x Q = FC + VC = FC x (UVC x Q)Given: Price x Q = FC + VC = FC x (UVC x Q)

Solve for Q (quantity) (Price × Q) – (UVC × Q) = FC Q(Price – UVC) = FC Q = FC/(Price-UVC) = FC / unit margin

Solve for Q (quantity) (Price × Q) – (UVC × Q) = FC Q(Price – UVC) = FC Q = FC/(Price-UVC) = FC / unit margin

Solve for Q (quantity) (Price × Q) – (UVC × Q) = FC Q(Price – UVC) = FC Q = FC/(Price-UVC) = FC / unit margin

Solve for Q (quantity) (Price × Q) – (UVC × Q) = FC Q(Price – UVC) = FC Q = FC/(Price-UVC) = FC / unit margin

14-8

SCENARIO: What sales increase is needed to cover a $1.2 million increase in expenditures?

MARGINAL ANALYSIS

NR = $1.2 million + COGS

NR = $1.2 million + .75 NR

.25 NR = $1.2 million

NR = $1.2 million / .25

NR = $4.8 million

WHERE: COGS = 75% of Net Sales NR = New Revenue

14-9

Exhibit 14-11

A PRICE INCREASE/DECREASE BY ONE CHANNEL MEMBER WILLIMPACT THE PRICE CHARGED BY SUBSEQUENT CHANNEL MEMBERS

CALCULATING MARGIN CHAINS

ASSUME: Given a new product selling for $10,what is the maximum factory price allowable?

WHOLESALER DEALERNet Sales 100% Net Sales 100%

COGS 85% COGS 70%

Gross Profit 15% Gross Profit 30%

Apply $10 dealer priceNet Sales $7.00 Net Sales $10.00

COGS 5.95 COGS 7.00

Gross Profit $1.05 Gross Profit $ 3.0014-10

Prices & Policies• Strategy -- specific approach to achieve

objectives– Attribute bundles and effect on buyer center

• Product-specific attributes• Company-related attributes• Salesperson-related attributes

– Capitalize on unique strengths & market opportunities

• Channel Pricing– Intermediary prices, costs and margins– Channel margin management --Promotion,

restrictions, push Vs pull

KEY DECISIONS IN MANAGING PRICE

• DETERMINE PRICING STRATEGY– Develop specific approach to achieve price objectives

• DETERMINE CHANNEL INTERMEDIARY PRICES, COSTS AND MARGINS

• DETERMINE SINGLE PRODUCT AND PRODUCT LINE PRICING

• Develop pricing structures for substitute and complementary products

• DETERMINE WHETHER TO PARTICIPATE IN BIDDING AND NEGOTIATION FOR SALES

• ESTABLISH A PRICING SYSTEM

• Based on the 4 C’s : Costs, Customers, Competitors, and Channels 14-12

Pricing Policies

• Product Line Pricing– Substitute product – based on relative benefits

and price sensitivity of each target market– Complementary products – Price driver product

low in order the penetrate market – negotiate on-going price contracts

– Segmentation Pricing – Based on relative customer value

– Product Life Cycle Issues – pricing new vs. old products

Other Issues• Discounts

– Cumulative vs. Non-cumulative

• Return or Breakage Allowance Leasing• Co-op payments• Trade show support• Legal Issues

– Robinson-Patman Act– Clayton and Sherman Antitrust Acts– Functional discounts – based on purchaser’s role in the

supplier’s distribution system reflecting services performed for the supplier.

What Do You Need to Know

• Customer Price Sensitivity– Customer product perceptions & value– Value Mapping

• Criteria customers use to make purchase decision

• Weight of features in terms of importance

• List of competitors in market (customer perceptions)

• Rating of competitor products on features

• List actual prices for each competitor

• Calculate value position for each

• Plot each on value map

George E. Cressman, Jr. “Snatching Defeat from the Jaws of Victory”, Marketing Management, Summer 1997.

What Do You Need to Know

• Firms Cost Structure– More fixed/less variable costs = lower prices– More variable/less fixed = raise price

• Competitor Strategies & Costs– Strategic Intent

• Which customer groups are “must win”

• Support for positioning and targeting

• How is price used

– Capabilities & barriers

What Do You Need to Know– Likely Outcome -- compare strategic intent with

capabilities & barriers

– Impact on your firm

• Issues in Strategies and Costs– High-fixed cost industries

• Focus on capacity utilization

• Price cuts will generate retaliation

– Price insensitive markets• Price is an estimator of value -- when customer finds it

difficult to forecast quality

Adjustments to Base Price

• Many pricing decisions involve an adjustment to the price of an existing product or service.

• A change in price should be judged in terms of its effects on short or long-term profits rather than sales volume (an outdated decision production rule).

Dol

lars

per

sq

uar

e ya

rd

Linoleum Price to Retailer

How Pricing Tactics Create a Price Range

Price Range

Dealer list

price

Order size

discount

Competitive discount

Invoice price

Payment terms

discount

Annual volume bonus

Off-invoice promotions

Co-op advertising

Freight Pocket price

Source: Robert L. Rosielli, “Managing Price, Gaining Profit,” Harvard Business Review, September/October 1992, 86.

$0.10$0.12

$5.78

$0.30

$0.37$0.35

$0.20$0.09

$4.47

22.7% off invoice

$6.00

Price Tactics that Create a Price Schedule/Range

• Price discriminate against slow payers.

• Price discriminate for volume purchases

• Price discriminate by tying purchases

• Price discriminate to different usage/benefit segments

• Price discriminate against a usage time

• Price discriminate against distant user

ROBINSON-PATMAN ACT

VIOLATIONS OCCUR:

1. When different prices are charged to competitors;

2. The differences are not attributable to cost differences;

3. The product is essentially the same for each competitor;

4. The effects are damaging to competition14-21

LEVERAGE FOR A GLOBAL PRICING CONTRACT

These products or services are a significant portion of customer’s purchases.

Local markets are reasonably homogeneous.

Customer’s top management is omitted.

Customer seeks value enhancement more than cost cutting.

Supplier has good working relationships not just at HQ, but with the company’s country managers.

Customer and supplier have some implementation experience with global strategies played out at local levels.

Exhibit 14-1614-22

Medicus Major• Sells small medical instruments & supplies• Uses national distributor -- Galax

– 50% of sales to large hospitals– 50% to dealers who sell to small hospitals and clinics

• Discount structure– Small hospitals & clinics -- pay list price– Large hospitals -- 12% discount off list– Wholesalers -- 40% discount– Dealers -- 20% discount

Questions

• If Medicus’s price is $4 what is the COGS for Glaxa• What increase in sales must Galax produce to cover

new debt service costs of $185, 000 per year for its truck fleet expansion?

• To enhance coverage of the Southern states, Medicus is considering adding a wholesaler, Dixie Supply, who has made acquisitions to establish a national presence– What are the possible consequences on

• Prices - Channel functions• Channel margins