PRICING STRATEGIES FOR BUSINESS MARKETS

(Chapter 12)

PIYUSA DAS, ASST PROFESSOR (KSOM)

Chapter Sections
 Key Determinants of Industrial Pricing Process
 Pricing Strategies for new and existing products
 Framework to guide strategy when competitor cuts prices
 Competitive Bidding
A model for Managing Price
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

Set Strategic Pricing Objectives

 No easy formula for
pricing industrial Estimate Demand and the
product or service Price Elasticity of Demand

 Decision is
multidimensional Determine Costs and
their Relationship to Volume
 Each interactive
variable assumes
significance Examine Competitors’ Prices and
Strategies

Set the Price Level

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
 Commodity Value:Value customers assign
to features that resembles competitive
offerings (Point of Parity)

 Differentiation Value: Represents the value

of features that are unique and different
from competitors (Point of Difference)

 Economic Value: Represents cost saving

and/or revenue gains when purchasing a
product (instead of next best alternative)
 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

Value Based Approach
I. Goal is to identify significant drivers III. Compare firm’s product/service to next best
of value alternative (competitor’s product/service)
a. Cost Drivers: Create value by economic a. Isolate unique features that differ from
savings competitor
b. Revenue Drivers: Add incremental value b. Do those features provide value that
by facilitating revenue or margin customer cannot get elsewhere?
requirements
Example: Cisco’s virtual specialist c. How much value does it create?
II. Quantify impact of firms
product/service on customer’s IV. Understand how customer uses the product
business model and how much value will s/he realize
1. Does it make or save money? How much?
2. Example: Cisco’s virtual specialist helped
the company reducing travel costs for its V. Set the price & develop a responsive marketing
sales specialists by 50% and increased the strategy
time its sales representative spent with
customers by 40%
Value Based approach
Value Based APPROACH- EXAMPLE

Improved Ventilation
and reduced noise of Increase in space
operation requirement for Air Handling
= INR 2,00,000 Unit= INR 2,50,000 Differential Value
Due to remote = INR 2,50,000
monitoring fewer
shutdowns and
maintenance issues=
INR 3,00,000

HVAC System 250 Ton:

Next Best Competitive
Alternative

INR 50,00,000
Elasticity of Demand

Elastic  Consumers buy more or less

of a product when the price
Demand changes
 Price elasticity measures how
sensitive customers are to price
changes.
Inelastic  An increase or decrease in
price will not significantly
Demand affect demand  Price elasticity of demand refers
to rate of percentage change in
quantity demanded to percentage
 An increase in sales exactly change in price.
Unitary offsets a decrease in prices,
Elasticity and revenue is unchanged
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.

 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.
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)
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?
 Impact of Competition on Pricing
 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.
Followers vs. Pioneers
Pricing across the Product Life Cycle
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
Legal Considerations on Pricing
 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
Is there a response competition
No position in No Yes No
Accommodate that would cost less willing and
other Respond
or Ignore than the preventable able to
markets at
sales lost? reestablish the
risk?
price
difference?
Yes

Does the Yes

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

Yes Yes

Respond Respond
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.

Competitive 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: E-procurement

 Open bidding: more informal.

 When it is hard rigidly define requirements
 Prices may be negotiated.

 Online Open Bid: Online Auctions

Strategies of Competitive Bidding
 Class Exercise(2.5 marks)
 VALUE-BASED PRICING for
Cisco’s WebEx (Video
conferencing tool) vis-à-vis
Business class air travel (Next
Best Competitive Alternative)
 Follow the step by step approach
of Value-based pricing and for
calculation of cost and revenue
drivers clearly indicate your
assumptions
Cost and revenue Drivers
Q & As