0 Chapter 12: Pricing Strategy for Business Markets
Pricing decision is multidimensional • Demand • Cost • Competition • Profit • Customer usage patterns
Key Components of the Price-Setting Decision Process 0 Fig. 12.1 Set Strategic Pricing Objectives Estimate Demand and the Price Elasticity of Demand Determine Costs and their Relationship to Volume Examine Competitors’ Prices and Strategies Set the Price Level
Class exercise http://www.smh.com.au/business/qantas-to-raise-fares-blaming-higher-fuel-costs-and-fall-in-aussie-dollar-20130730-2qxb4.html Explain how change in pricing by Qantas relate to the Figure 12.1 ‘The key components of price-setting decision process’.
Three Principles of Successful Pricing Strategies Value based and reflect a clear understanding of how a firm’s products or services create value for customers Proactive and anticipate disruptive events such as a competitive threat, negotiations with customers or a technological change Profit driven and judge success based on bottom-line performance, rather than the level of revenue generated
Class Exercise Question: When Apple launched its iPhone or iPad, critics claimed that the price of each was far too high. Identify the pricing principle(s) used by Apple from the three principles listed on the previous slide. Question: Identify the pricing principle (s) used by Australian supermarkets.
Price Objectives 0 • 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 0 • There are a number of issues when considering demand: • Usage and importance of the product/service by various segments • Price Sensitivity (elasticity of demand) • 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”?
Business Purchasing and Price • The price of a purchased business product is only one of the various costs evaluated by business buyers. A customer when buying a manufacturing machine must consider the lifetime costs and benefits of the purchase. • These might include factors like faster machining speeds, higher output, lower energy consumption, lower maintenance costs, lower repair costs, lower downtime for setup, greater functional flexibility, higher resale price as used equipment, or lower disposal costs.
Fig 12.2 A Value-Based Approach for Pricing 0 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 ref. Fig. 12.2 0 • Goal is to identify significant drivers of value • Two categories of value drivers: • Cost Drivers: Create value by economic savings • Example: Machine can process more widgets/hr. with less electricity and labor costs • Revenue Drivers: Add incremental value by facilitating revenue or margin requirements • Example: Packaging is more attractive thus increasing sales
Value Based approach ref. fig. 12.2 0 • Quantify impact of firms product/service on customer’s business model • Does it make or save money? How much? • Compare firm’s product/service to next best alternative (competitor’s product/service) • Isolate unique features that differ from competitor • Do those features provide value that customer cannot get elsewhere? • How much value does it create?
Value Based approach: ref. fig. 12.2 0 • Understand how customer uses the product and how much value will s/he realize • 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.
Other Important factors determining price 0 • End Use: How important is the product as 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. • A two-tiered market focus- on organisational customers and on final-product customers is a better strategy. Thus, business marketers will have more success in raising prices to customers who are prospering than to customers who are hard pressed.
http://www.dhl.com.au/en/logistics/industry_sector_solutions/life_sciences_and_healthcare_logistics.htmlhttp://www.dhl.com.au/en/logistics/industry_sector_solutions/life_sciences_and_healthcare_logistics.html Describe how DHL’s provides value to its customers in the healthcare industry.
Value-Based Segmentation 0 • 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 Costing • The firm identifies and targets the most attractive market segments. • Then determines what level of quality and types of attributes are required to succeed in each segment, given a predetermined target price (based on customer value perceptions) and volume. • Once the target selling price and target profit margins have been established, the firm calculates the allowable cost. • 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. • Companies that used target costing: Toyota, Cannon
Class Exercise on Target Costing Handy Appliance Company feels that there is a market niche for a hand mixer with certain new features. Surveying the features and prices of hand mixers already in the market, the marketing department believes that a price of $30 would be about right for the new mixer. At that price, marketing estimates that 40,000 of new mixers could be sold annually. To design, develop, and produce these new mixers, an investment of $2,000,000 would be required. The company desires a 15% return on investment (ROI). Compute the cost of one hand mixer.
Advantages of Target Costing • Proactive approach to cost management. • Orients organizations towards customers. • Breaks down barriers between departments. • Implementation enhances employee awareness and empowerment. • Foster partnerships with suppliers. • Minimize non value-added activities. • Encourages selection of lowest cost value added activities. • Reduced time to market.
Disadvantages of Target Costing • Effective implementation and use requires the development of detailed cost data. • its implementation requires willingness to cooperate • Requires many meetings for coordination • May reduce the quality of products due to the use of cheep components which may be of inferior quality.
Cost Concept Analysis 0 • 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)
Competition 0 • 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 0 • 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 0 • 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. • Failing to recognize potential cost advantages of late entrants, the firm can dramatically overstate cost differences.
Pricing Strategies 0 • 3 Major Pricing Strategies • Follow the Crowd • Price Skimming • Penetration Pricing
Price Skimming 0 • 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 0 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 0 • Before responding, ask: “Do the benefits justify the costs?” • If responding to a price change is less costly than losing a sale, then do it. • If competitor threat only affects a small segment, the revenues lost from ignoring it may be so small that it is not worth it. • In other words, “Why lower the price to lose revenue from other segments too?”
Evaluating a Competitive Threat 0 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. • Do they want % share of market? • Do they just want to clear inventory? • Do they just want to recoup some of their investment quickly?
Evaluating a Competitive Threat 0 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.
0 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.