Pricing in Business Markets

Chapter Topics
Understanding 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

 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
 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 trust
2. Demonstrating commitment
3. Being flexible
4. Initiating joint ventures
5. 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
 Key Components of the
Price-Setting Decision Process Fig. 12.1

 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 Determine Costs and
assumes significance their Relationship to Volume

Examine Competitors’ Prices and Strategies

Set the Price Level

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

Inelastic
 An increase or decrease in
Inelastic price will not significantly
Demand
Demand affect demand

 An increase in sales exactly

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

Price
D

D
Quantity Quantity
Elasticity of Demand
Price
Price Goes...
Goes... Revenue
Revenue Goes...
Goes... 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 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)
 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
 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 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

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

Does the
value of the Yes
No markets 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.
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 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…

 On-line sealed bids: on-line auctions

 Open bidding: more informal.

 When it is hard rigidly define requirements
 Prices 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 profitable
over the longer term
 How likely will follow-on business occur???

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