PRICING STRATEGY FOR

BUSINESS MARKETS
 Take aways…
Understanding how customers value pricing is the essence of the
pricing process.
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 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
 Marketing Mix to Value Proposition

• Progressive marketing oriented firms…

Convert the marketing mix into a Value
Proposition that surpasses customer expectations
while still meeting corporate objectives.
 Meaning of Value
• When a product is selected, the buying center is
buying:

1. A given level of product quality

2. A certain level of technical service
3. Delivery reliability
 What is 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

 Customer Value in Business Markets

Customer Value

Benefits Sacrifices

Core Benefits Add-on Benefits 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.
Benefits

Core Benefit: Basic requirements represented

by performance, quality, expected pre/post
service, value of relationship

Add-on is an attribute not required but

promotes differentiation. Services such as:
a. Joint working relationships
b. Supplier flexibility
c. Commitment to the relationship
 Total Cost in Use
• Broad perspective is needed when
examining the costs that any particular
alternative may present for the buyer.

• Rather than deciding based on price

alone, organizational buyers emphasize
the total cost in use of a particular
product or service.
 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

11
 Value-Based Strategies

• Value-based strategies beg the questions,

1.What is the value of this solution?
2.What is the market willing to pay?
3.Is there a way we can deliver our
product/service better at a lower price?
 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
 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
 Key Components of the
Price-Setting Decision Process

• No easy formula for Set Strategic Pricing Objectives

pricing industrial
product or service
Estimate Demand and the
• Decision is Price Elasticity of Demand
multidimensional
• Each interactive variable
assumes significance Determine Costs and
their Relationship to Volume

Examine Competitors’ Prices and Strategies

Set the Price Level

16
 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.
 Demand Determinants &
Assessing Value
• 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
 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.
 Value Drivers
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
 Value Based approach

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?
 Value Based approach:

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.
 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  Consumers buy more or less
Demand of a product when the
price changes

Inelastic  An increase or decrease in

Demand price will not significantly
affect demand

 An increase in sales exactly offsets

Unitary a decrease in prices,
Elasticity and revenue is unchanged
 Elasticity of Demand
Elastic Demand Curve Inelastic Demand Curve
D
D
Price

Price
D

D
Quantity Quantity
 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.
 Derived Demand

• By 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 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)
 Cost Classification System Goals

 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

• 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.
 Competitive Responses
• 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.
 Followers vs. Pioneers
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
 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
 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.

 Evaluating A Competitive Threat
Competitive price
or “low cost”
product entry

If you
respond, is
Is your competition
No No Is there a response that Yes No
Accommodate position in willing and
would cost less than the Respond
or Ignore other markets able to
preventable sales lost?
at risk? reestablish the
price
difference?
Yes

Does the value

of the markets Yes
No
at risk justify
Will the multiple responses
the cost of No required to match a
response?
competitions cost less than the
preventable sales loss?
Yes Yes

Respond
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.
 Evaluating a Competitive Threat

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 Threat
2.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.

 Evaluating a Competitive Threat

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.
 Competitive Strategy Rules

• Never participate in a
competitive engagement you
cannot win.

• Always participate in
competitive engagement from
an advantageous position.
 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.