Business to Business Pricing

•No easy formula Key Components of the Industrial

Pricing Process
for pricing an
industrial
product.
•Decision is
multidimensional Fig. 15.2

•Each interactive
variable assumes
significance.
 Types of Cost

Costs

Fixed
Variable Costs
Costs
 Variable Costs are…

Expenses that are uniform

per unit of output within a
relevant time period

As volume increases, total

variable costs increase
 THERE ARE TWO CATEGORIES OF
VARIABLE COSTS

1.Cost of Goods Sold

2.Other Variable Costs

Variable Costs – Cost of Goods
Sold
For Manufacturer or Provider of
Service

 Covers materials, labor and factory

overhead applied directly to
production

For Reseller (Wholesaler or Retailer)

 Covers primarily the cost of

merchandise
 Other Variable Costs

Expenses not directly tied to

production but vary directly with
volume

Examples include:

 Sales commissions, discounts,

and delivery expenses
 Fixed Costs

Expenses that do not fluctuate with

output volume within a relevant time
period

They become progressively smaller per

unit of output as volume increases

No matter how large volume becomes,

the absolute size of fixed costs remains
unchanged
 THERE ARE TWO CATEGORIES OF
FIXED COSTS

1.Programmed costs
2.Committed costs
Fixed Costs – Programmed Costs

• Result from attempts to

generate sales volume

• Examples include:

 Advertising, sales
promotion, and sales
salaries
Fixed Costs – Committed Costs

Costs required to maintain

the organization

Examples include
nonmarketing expenditures,
such as:

 rent, administrative cost,

and clerical salaries
Relevant and
Sunk Costs
 Relevant Costs are…

Future expenditures unique to the decision

alternatives under consideration.

Expected to occur in the future as a

result of some marketing action

Differ among marketing alternatives

being considered

In general, opportunity costs are

considered relevant costs
 Sunk Costs are…
The direct opposite of relevant costs.

Past expenditures for a given

activity
Typically irrelevant in whole or in
part to future decisions

Examples of sunk costs:

Past marketing research and
development expenditures
Last year’s advertising expense
 Sunk Cost Fallacy

When marketing managers attempt to

incorporate sunk costs into future decisions,
they often fall prey to the Sunk Cost Fallacy
– that is, they attempt to recoup spent dollars
by spending even more dollars in the future.

Example: Continuing to advertise a failing

product heavily in an attempt to recover what
has already been spent on it.
 Margins

The difference between the selling price

and the “cost” of a product or service

Margins are expressed in both dollar

terms or as percentages on:

 a total volume basis, or

 an individual unit basis

 Gross Margin or Gross Profit

On a total volume basis:

The difference between total sales

revenue and total cost of goods sold

On a per-unit basis:

The difference between unit selling

price and unit cost of goods sold
 Trade Margin (Markup)
Suppose a retailer pays $10 for an item and
sells it for $15. Markup is thus $5 ($15-$10):

Margin as a percentage of cost:

Margin/Cost x 100 =
($5 / $10) x 100 = 50 %

Margin as a percentage of selling price:

Margin/Price x 100 =
($5 / $15) x 100 = 33.333 %
 Break-Even Analysis

Break-even point is the unit or dollar sales

at which an organization neither makes a

profit nor a loss.

At the organization’s break-even sales

volume:

Total Revenue = Total Cost

Break-even Analysis Chart

Dollars
Total Revenue

BE Point
Total Cost
PROFIT

Variable Cost

LOSS Fixed Cost

0 Unit Volume
 Break-even Analysis
Example

Fixed Costs = $50,000

Price per unit = $5
Variable Cost = $3
Contribution = $5 - $3 = $2
Breakeven Volume = $50,000  $2
= 25,000 units
Breakeven Dollars = 25,000 x $5
= $125,000
 Operating Leverage
Extent to which fixed costs and variable
costs are used in the production and
marketing of products and services.

Firms with high total fixed costs relative

to total variable costs are defined as having
high operating leverage.

Higher operating leverage results in a faster

increase in profit once sales exceed break-
even volume. The same happens with losses
when sales fall below break-even volume.
 Different Companies,
Different Pricing Objectives

Company Objective
Alcoa 20% ROI
American Can Maintain market share
General Foods 33% gross margin
National Steel Match the market
U.S. Steel 8% ROI after taxes
DuPont Target ROI, cost-plus

(continued)
 Benefits of a Particular Product
Functional benefits are the design characteristics
that might be attractive to technical personnel.
Operational benefits are durability and
reliability, qualities desirable to production
managers.
Financial benefits are favorable terms and
opportunities for cost savings, important to
purchasing managers and controllers.
Personal benefits are organizational status,
reduced risk, and personal satisfaction.
Customers’ Cost-in-Use Components

•A broad perspective needed in

examining the costs a particular
alternative may present for the buyer.
•Rather than making a decision on the
basis of price alone, organizational
buyers emphasize the total cost in use of
a particular product or service.
Customers’ Cost-in-Use Components
 Factors Impacting Demand
• Ability to buy
• Willingness to buy
• Benefits vs. Price
• Substitutes
• Nonprice competition
 Problems with Using Price Elasticity to
Set Price
• Fails to consider competitors’ response
• Demand may be inelastic for given
price, but elastic for larger amount
• Measured in sales revenue, not profit
margins
• Fails to consider product line effects
• Ignores low price societal benefits
 Pricing Across Product Life Cycle
(Life-Cycle Costing)

• Introduction phase:
– Price skimming: Introductory price set relatively high,
thereby attracting buyers at top of product’s demand
curve.
– Market penetration pricing: Low price is used as an
entering wedge.
• Growth phase
• Maturity phase
• Decline stage
 Strategies in the Introduction Stage of
the PLC
• Rapid-skimming strategy
– Launch new product at high price
– High promotion level
– Makes sense if:
• large part of potential market is unaware of the
product
• those who become aware are eager & willing to pay
• need to build brand preference quickly due to
potential competition
 Strategies in the Introduction Stage of
the PLC
• Slow-skimming strategy
– launch new product at high price
– low promotion
– helps maintain high profit per unit
– makes sense if:
• market size is limited
• most of market is aware of product
• buyer willing to pay high price
• no significant potential competition
 Strategies in the Introduction Stage of
the PLC
• Rapid-penetration strategy
– launch new product at low price
– spend heavily on promotion
– allows fastest market penetration & share
– makes sense if:
• large market that is unaware of product
• buyers are price-sensitive
• strong potential competition exists
• can rapidly enjoy economies of scale
 Strategies in the Introduction Stage of
the PLC
• Slow-penetration strategy
– launch new product at low price
– low level of promotion
– encourages rapid product acceptance
– allow slightly higher profits than rapid-penetration
– makes sense if:
• market is price-sensitive
• market is not promotion-sensitive
• large market that is aware of the product
• some potential competition
 Price-Leadership Strategy
• One (or a very few) firm(s) initiate price
changes, with most or all the other firms in
the industry following suit.
• When price leadership prevails,
– price competition does not exist.
– burden of making critical pricing decisions is
placed on leading firm(s) and
– others simply follow the leader.
 Characteristics of Successful Price Leaders
• Large share of industry’s production capacity
• Large market share
• Commitment to particular product class/grade
• New, cost-efficient plants
• Strong distribution systems
• Good customer relations
• Effective market information systems
• Sensitivity to price/profit needs of industry
• Sense of timing as to when make price changes
• Sound management organization for pricing
• Effective product-line financial controls
 Competitive Bidding
• Buyer sends inquiries (requests for quotations or
RFQs) to firms able to produce in conformity
with requested requirements.
• Requests for proposals (RFPs) involve the same
process, but
– here buyer is signaling that everything is preliminary
and
– that a future RFQ will be sent once specifics are
determined from the best proposals.
 Competitive Bidding

• Closed bidding
– often used by business and governmental
buyers
– involves a formal invitation to potential
suppliers to submit written, sealed bids for a
particular business opportunity.
• Open bidding
– more informal and allows suppliers to make
offers (oral and written) up to a certain date.
 Whether or Not to Bid
• Is the dollar value of the contract large enough to
warrant the expense involved in making the bid?
• Are the product specs precise enough to allow
the cost of production to be accurately estimated?
• Will acceptance of the bid adversely affect
production and/or ability to serve other
customers?
• How much time is available to prepare the bid?
• What is the likelihood of winning the bid given
the presence and strength of other bidders?
 Types of Leases
• Operating Lease
– short-term and cancelable
– lessor generally provides maintenance/service
– rarely contains purchase option
• Direct-financing Lease
– long-term and non-cancelable
– lessee responsible for operating expenses
– lessee has option of purchasing the asset
 Leasing in the Business Market
• Advantages to buyer
– No down payment
– No risk of ownership
• Advantages to seller
– Increased sales
– Ongoing business relationship with
lessee
– Residual value retained