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Todays session

Pricing Strategy & Decisions

Price
Price is unique among the 4 Ps in
that it directly affects the
companys revenues and profits.
Pricing is both a science and an
art.
Diligence and creativity are both
necessary.
Pricing seems to be the one P
that has been dramatically

Characteristics of Industrial
Pricing
Includes more than list or quoted
price
Delivery & Installation
Discounts (quantity, promotion, remit
time)
Training costs
Trade-in allowance
Promotions: 2 for 1
Financing costs

Characteristics of Industrial
Pricing
Not an independent variable. Pricing
interacts with:
product,
promotion, and
distribution strategies

Must consider complementary or


substitute products when
establishing price strategy

Characteristics of Industrial
Pricing
Prices can be changed by:
Changing
Changing
seller
Changing
Changing

price paid by buyer


quantity/quality offered by
premiums or discounts
time and place of payment

Carry
Tax/Cash Flow implications

Changing time and place of transfer


of ownership
Delivery

Characteristics of Industrial
Pricing

Pricing often set through competitive


bidding on a project-by-project basis
Dont know competitors prices
Negotiation may be used instead (some
insist)

Emphasis on fairness
Need to justify price increases
Also justify higher prices

Characteristics of Industrial
Prices
Affected by economic factors outside
companys control:
Inflation
Long-Term contract (escalation clauses)

Interest Rates
Currency Exchange Rates
Affects cost of materials
Affects price of exports

Price = f(Value)
Need to set an initial price that is
neither too high (hurts sales) or too
low (lost profit)
Value has two major dimensions:
Customers subjective estimate of
products capacity to satisfy a set of
goals
Objectively established by the
competitive market: What the market

Economic Value to the


Customer
Purely economic sources of value
Need to compare life-cycle costs of
your product and substitutes
If incremental value is high enough
to justify a higher price, then there is
EVC
Sometimes it takes a convincing
sales effort to help customer see the
value

Whats it worth to the Customer?


How much money can customers
save by using our product?
Can the product help them increase
sales or reach new customers?
Does the product provide a
competitive advantage?
Does the product improve the safety
of the products the customer sells?
How much time can customer save
by buying product vs. making
themselves?

Strategic Pricing Programs Objectives

ROI; Market Share


LT/ST Profit
Sales Growth
Stabilize Market
Convey Desired Image
Desensitize customers to price
Be Price Leader
Discourage entry & push out weak
competitors

Strategic Pricing Programs Objectives


Avoid Government interference
Trust/Regs)

Perceived Fairness
Customers, Distributors, Suppliers

Create interest & excitement


Sell other items in line
Discourage competitors from
dropping price
Recover investment quickly
Generate sales volume

(Anti-

Pricing Program

Strategy, structure, level, and


tactics all work together. They
must be coordinated.
Strategy may be long term
(several years).
May need to modify structure
periodically.
Offer special price deals.

Levels and tactics need to be


monitored closely and changed as
needed.

Strategic Pricing Programs: Strategy


Cost-Based
Fixed and Variable costs/Unit
Markup/ROI

Market-Based
Competitor Prices
Customer Demand

Pricing Decisions: Framework


Most companies use multiple
pricing strategies.
If the firm sells complimentary or
substitute products, they are more
likely to use product line strategies
Objectives
Costs
Demand
Competition

Objectives/Strategies
Differentiation Higher Margins
Fewer competitors are substitutes
Increased brand loyalty

Moving to low price from premiumquality position can hurt sales, not
help
Recover development costs over
longer period of time. Otherwise
run risk of sales numbers that are
too low to ever recover costs.

Costs

Establishes the minimum price


Set price based on target margin
or return
Can price below cost to:
Keep employees and facilities working
during downturn
Support other products in the line
Low bid to establish relationship.
Make $ in long term, or on extras
Experience or reputation
New skills

Standard Cost Approach


Target Return Pricing
Need accurate sales forecast: standard
volume
Variable costs and fixed costs/unit:
standard costs
P = DVC + FC/Q + rK/Q
P: Price
DVC: Direct Variable
Cost/Unit
FC: Fixed Cost r: Rate of Return
K: Capital Used Q: Standard Volume

Standard Cost Approach


Can include interest rates on debt,
tax rates or inflation factors.
Dont raise prices to counter weak
sales; Dont drop prices too quickly
either
Need reliable standard volume
estimate
Initial low price may increase
volume, which in turn lowers per

Contribution Analysis
Trade off between price and units
sold
Total Revenue Total Variable Cost
= Variable Contribution Margin
Fixed Costs Contribution/Unit =
Break Even Sales Volume (minimum
sales)

Estimate change in volume for


changes in price and compare to
break even (Maximum sales/profit)

Demand
Sets the upper limit of price
Need to understand customers
reasons for buying product; how
they use it
Hard Benefits
Physical Attributes: productivity,
durability, error rate, performance
tolerances

Soft Benefits
Warranty, service, other augmented product

Balance benefits to customer

Industrial Products Characteristics


Tend to have inelastic demand
Especially if technically
sophisticated, customized, or
crucial to operations
Routine purchases more elastic
Situational elasticity: customer and
market circumstances
Incumbents push uniqueness
Challengers push substitutability
Elasticity can vary across

Competitive Bidding
Most common with
public projects
governmental agencies
custom, technically complex products
long manufacturing cycles

Usually the low bidder


Not always in private sector
Consider bidder qualifications

Competitive Bidding
Invitation to Bid
Newspaper
Private Publications
Organisation website

Usually very precise plans and


specifications that become part of the
purchase contract
May have to provide a performance bond
to ensure that the product/service will be
completed. Bid bonds less common.

Competitive Bidding
Sealed/Closed Bids
Due at same time
Open all at once
One time pricing

Open/Negotiated Bids
Iterative process
Combines bidding and negotiating
Web bidding has facilitated this
process

Competitive Bidding
Questions to consider:
Is project large enough to bid?
Are the specs precise enough to do an
accurate bid?
How will successful bid affect our
other jobs, products, and customers?
Who else may bid? How hungry are
they?
Do we have time to put together
quality bid?

Competitive Bidding
Bidding Strategy
Probabilistic Bidding (Value????)
Assumes profit maximization is goal
Assumes lowest bid selected
Focus on size of bid, expected profit if
win, and probability that bid will win
E(X) = P(X)Z(X)
X = Bid Price Z(X) = Actual profit if successful
P(X) = Probability of bid acceptance
E(X) = Expected profit at this bid

Competitive Bidding

Bidding models are only tools


Managerial judgment is critical
Set price to achieve a good win
Bids are not always fixed
Might have an escalation clause
Might have a pass-through clause
(cost+)
Post-Bid negotiation (by customer)
common

Competition
Need to monitor continuously
Anticipate changes
Relatively easy because there are
relatively few suppliers and few
customers
Tends to be oligopolistic
Structure: concentrated
Price Leader
Sets the tone for pricing
Usually the organization with the best
cost structure (competitive

Development of Pricing
Strategy

Pricing strategies
It encompasses three main ways to
improve profits:
1. Cut costs
2. Sell more
3. Find more profit with a better pricing
strategy

The Reality
Merely raising prices is not always the answer,
especially in a poor economy
Too many businesses have been lost because
they priced themselves out of the marketplace
On the other hand, too many business and
sales staff leave "money on the table
One strategy does not fit all, so adopting a
pricing strategy is a learning curve when
studying the needs and behaviours of
customers

Pricing Models- 1
Cost-plus pricing
Cost-plus pricing is the simplest pricing method
The firm calculates the cost of producing the product and adds
on a percentage (profit) to that price to give the selling price
This method although simple has two flaws; it takes no account
of demand and there is no way of determining if potential
customers will purchase the product at the calculated price.
This appears in two forms 1)Full cost pricing which takes into
consideration both variable and fixed costs and adds a% mark up
2) The other is Direct cost pricing which is variable costs plus a%
mark up
This method is only used in periods of high competition as this
method usually leads to a loss in the long run.

Pricing Models- 2
Creaming or skimming
Goods are sold at higher prices so that fewer sales are needed to break even
Selling a product at a high price, sacrificing high sales to gain a high profit is
therefore "skimming" the market
Skimming is usually employed to reimburse the cost of investment of the
original research into the product
This strategy is often used to target "early adopters" of a product or service.
Early adopters generally have a relatively lower price-sensitivity
This can be attributed to: their need for the product outweighing their need to
economise; a greater understanding of the product's value; or simply having a
higher disposable income.
This strategy is employed only for a limited duration to recover most of the
investment made to build the product
To gain further market share, a seller must use other pricing tactics such as
economy or penetration
This method can have some setbacks as it could leave the product at a high
price against the competition.

Pricing Models- 3
Limit pricing
A limit price is the price set by a monopolist to discourage
economic entry into a market, and is illegal in many countries
The limit price is the price that the entrant would face upon
entering as long as the incumbent firm did not decrease output
The limit price is often lower than the average cost of
production or just low enough to make entering not profitable
The problem with limit pricing as a strategy is that once the
entrant has entered the market, the quantity used as a threat
to deter entry is no longer the incumbent firm's best response

Pricing Models- 4
Loss leader
A loss leader or leader is a product
sold at a low price (i.e. at cost or
below cost) to stimulate other
profitable sales. This would help the
companies to expand its market
share as a whole.

Pricing Models-5
Market-oriented pricing
Setting a price based upon analysis and
research compiled from the target market
This means that marketers will set prices
depending on the results from the research
Eg if the competitors are pricing their
products at a lower price, then it's up to
them to either price their goods at an above
price or below, depending on what the
company wants to achieve .

Pricing Models-6
Penetration pricing
Setting the price low in order to
attract customers and gain market
share. The price will be raised later
once this market share is gained

Pricing Models-7
Price discrimination
Setting a different price for the
same product in different segments
to the market

Pricing Models-8
Premium pricing
Premium pricing is the practice of keeping the
price of a product or service artificially high in
order to encourage favourable perceptions among
buyers, based solely on the price
The practice is intended to exploit the (not
necessarily justifiable) tendency for buyers to
assume that expensive items enjoy an exceptional
reputation, are more reliable or desirable, or
represent exceptional quality and distinction

Pricing Models-9
Predatory pricing

Aggressive pricing (also known as


"undercutting") intended to drive out
competitors from a market
It is illegal in some countries

Pricing Models -10


Contribution margin-based pricing
Contribution margin-based pricing maximizes the profit
derived from an individual product
It is based on the difference between the product's price
and variable costs (the product's contribution margin per
unit)
It also considers the relationship between the products
price and the number of units that can be sold at that
price
The product's contribution to total firm profit (i.e. to
operating income) is maximized when a price is chosen
that maximizes the following: (contribution margin per
unit)X(number of units sold)

Pricing Models-11
Psychological pricing

Pricing designed to have a positive


psychological impact. For example,
selling a product at Rs 99 rather than
Rs 100

Pricing Models- 12
Dynamic pricing
A flexible pricing mechanism made possible by advances
in information technology, and employed mostly by
Internet based companies
By responding to market fluctuations or large amounts of
data gathered from customers
Dynamic pricing allows online companies to adjust the
prices of identical goods to correspond to a customers
willingness to pay
The airline industry is often cited as a dynamic pricing
success story. In fact, it employs the technique so artfully
that most of the passengers on any given airplane have
paid different ticket prices for the same flight.

Pricing Models-13
Price leadership
An observation made of oligopolistic
business behaviour in which one company,
usually the dominant competitor among
several, leads the way in determining
prices, the others soon following
The context is a state of limited
competition, in which a market is shared
by a small number of producers or sellers.

Pricing Models-14
Target pricing
Pricing method whereby the selling price of a product is
calculated to produce a particular rate of return on investment
for a specific volume of production
The target pricing method is used most often by public
utilities, like electric and gas companies, and companies whose
capital investment is high, like automobile manufacturers.
Target pricing is not useful for companies whose capital
investment is low because, according to this formula, the
selling price will be understated.
Also the target pricing method is not keyed to the demand for
the product, and if the entire volume is not sold, a company
might sustain an overall budgetary loss on the product.

Pricing Models-15
Absorption pricing
Method of pricing in which all costs
are recovered
The price of the product includes
thevariable cost of each item plus a
proportionate amount of thefixed
costsand is a form of cost-plus
pricing

Pricing Models-16
High-low pricing
Method of pricing for an organization where the
goods or services offered by the organization
are regularly priced higher than competitors,
but through promotions, advertisements, and
or coupons, lower prices are offered on key
items
The lower promotional prices are designed to
bring customers to the organization where the
customer is offered the promotional product as
well as the regular higher priced products

Pricing Models-17
Premium decoy pricing
Method of pricing where an
organization artificially sets one
product price high, in order to boost
sales of a lower priced product

Pricing Models-18
Marginal-cost pricing
In business, the practice of setting the price
of a product to equal the extra cost of
producing an extra unit of output
By this policy, a producer charges, for each
product unit sold, only the addition to total
cost resulting from materials and direct
labour
Businesses often set prices close to
marginal cost during periods of poor sales

Pricing Models-19
Value-based pricing

Pricing a product based on the value


the product has for the customer and
not on its costs of production or any
other factor

Pricing Models-20
Pay what you want
Pay what you want is a pricing system where buyers pay any
desired amount for a given commodity, sometimes including
zero
In some cases, a minimum (floor) price may be set, and/or a
suggested price may be indicated as guidance for the buyer.
The buyer can also select an amount higher than the standard
price for the commodity.
Giving buyers the freedom to pay what they want may seem to
not make much sense for a seller, but in some situations it can
be very successful.
While most uses of pay what you want have been at the margins
of the economy, or for special promotions, there are emerging
efforts to expand its utility to broader and more regular use.

Pricing Models-21
Freemium
Freemium is a business model that works by
offering a product or service free of charge
(typically digital offerings such as software,
content, games, web services or other) while
charging a premium for advanced features,
functionality, or related products and services
The word "freemium" combines the two
aspects of the business model: "free" and
"premium
It has become a highly popular model

Pricing Models-22
Odd pricing
In this type of pricing, the seller tends to fix a
price whose last digits are odd numbers.
This is done so as to give the buyers/consumers
no gap for bargaining as the prices seem to be
less and yet in an actual sense are too high
A good example of this can be noticed in most
supermarkets where instead of pricing at Rs100,
it would be written as Rs 99
This pricing policy is common in economies using
the free market policy.

Discounts and Incentives


Common point of negotiation
Can use to attract new customers,
or keep existing ones
Can offer on select products, and
to select customers
Prepaid freight, drop-shipping,
financing, post-dating, returns,
rebate
Discounts:
Cash
Quantity
Trade

Cash Discounts
Incentive to pay quickly
Helps cash flow
2/10, n30: 2% off if paid w/in 10
days, otherwise, full amount due in
30 days
Might offer discount for prepaying,
prior to delivery, or even prior to
production
Many companies need cash, and
will discount for up-front $ (+ no
risk)

Quantity Discounts
Cheaper by the dozen theory
Seller gets guaranteed sales
Can plan production better
Smoothes out production, inventory,
delivery
Helps with financing, & getting other
business

Can offer discounts on $ or unit


level

Trade Discounts
Also called functional discounts
Usually given to distributors for
performing certain functions for
the manufacturer
Storage, warehousing
Sales
Transportation
Promotion

Common with automobile dealers

Leasing
Contract to use an asset that is
owned by someone else (renting) for
a period of time
Avoid cash payment up front
Sometimes avoid maintenance and
ops costs
Can expense for taxes (not amortize)
Does not reduce debt capacity
Hedge against technology
obsolescence

Leasing
Financial Lease
Longer term
Lessee (buyer) responsible for
maintenance & operating expenses
Can apply some of lease pmt to purchase
@ end

Operating Lease
Shorter, cancelable
Not amortized
Lessor (seller) responsible for ownership
expenses
No purchase option

Transfer Pricing
Internal sales price from one division
to another within the same company
Need to cover costs
Need to be cheaper than market
Exact price subject to negotiation
Both sides usually profit centers
May need to be determined by
higher-up

Commercial Terms &


Conditions

Direct payment
Payment through Bank
95/5 % or 98/2% payment terms
Bank guarantee
Firm Price
PVC- Price Variation Clause
PRD- Price ruling at time of delivery
LD/Penalty

Any Questions Please?