Todays session

Todays sessionPricing Strategy & Decisions

PricePrice 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 affected by the use of the Internet.Characteristics of Industrial PricingIncludes more than list or quoted priceDelivery & InstallationDiscounts (quantity, promotion, remit time)Training costsTrade-in allowancePromotions: 2 for 1Financing costsCharacteristics of Industrial PricingNot an independent variable. Pricing interacts with:product, promotion, and distribution strategiesMust consider complementary or substitute products when establishing price strategyCharacteristics of Industrial PricingPrices can be changed by:Changing price paid by buyerChanging quantity/quality offered by sellerChanging premiums or discountsChanging time and place of paymentCarryTax/Cash Flow implicationsChanging time and place of transfer of ownershipDeliveryCharacteristics of Industrial PricingPricing often set through competitive bidding on a project-by-project basisDont know competitors pricesNegotiation may be used instead (some insist)Emphasis on fairnessNeed to justify price increasesAlso justify higher pricesCharacteristics of Industrial PricesAffected by economic factors outside companys control:InflationLong-Term contract (escalation clauses)Interest RatesCurrency Exchange RatesAffects cost of materialsAffects price of exportsPrice = 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 goalsObjectively established by the competitive market: What the market will bearEconomic Value to the CustomerPurely economic sources of valueNeed to compare life-cycle costs of your product and substitutesIf incremental value is high enough to justify a higher price, then there is EVCSometimes it takes a convincing sales effort to help customer see the valueWhats 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 ShareLT/ST ProfitSales GrowthStabilize MarketConvey Desired ImageDesensitize customers to priceBe Price LeaderDiscourage entry & push out weak competitorsStrategic Pricing Programs Objectives

Avoid Government interference (Anti-Trust/Regs)Perceived FairnessCustomers, Distributors, SuppliersCreate interest & excitementSell other items in lineDiscourage competitors from dropping priceRecover investment quicklyGenerate sales volumeEncourage quick paymentPricing ProgramStrategy, 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.Address competitor changesIn response to cost changesAs demand changesStrategic Pricing Programs: Strategy

Cost-BasedFixed and Variable costs/UnitMarkup/ROI

Market-BasedCompetitor PricesCustomer Demand

Pricing Decisions: FrameworkMost companies use multiple pricing strategies.If the firm sells complimentary or substitute products, they are more likely to use product line strategies ObjectivesCostsDemandCompetitionObjectives/StrategiesDifferentiation Higher MarginsFewer competitors are substitutesIncreased brand loyaltyMoving to low price from premium-quality position can hurt sales, not helpRecover development costs over longer period of time. Otherwise run risk of sales numbers that are too low to ever recover costs.CostsEstablishes the minimum priceSet price based on target margin or returnCan price below cost to:Keep employees and facilities working during downturnSupport other products in the lineLow bid to establish relationship. Make $ in long term, or on extrasExperience or reputationNew skillsStandard Cost ApproachTarget Return PricingNeed accurate sales forecast: standard volumeVariable costs and fixed costs/unit: standard costsP = DVC + FC/Q + rK/Q

P: PriceDVC: Direct Variable Cost/UnitFC: Fixed Costr: Rate of ReturnK: Capital UsedQ: Standard Volume (units)Standard Cost ApproachCan 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 unit fixed costsContribution AnalysisTrade off between price and units soldTotal Revenue Total Variable Cost = Variable Contribution MarginFixed 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)DemandSets the upper limit of priceNeed to understand customers reasons for buying product; how they use itHard BenefitsPhysical Attributes: productivity, durability, error rate, performance tolerances Soft BenefitsWarranty, service, other augmented product Balance benefits to customer against the costs (price +)Industrial Products CharacteristicsTend to have inelastic demandEspecially if technically sophisticated, customized, or crucial to operationsRoutine purchases more elasticSituational elasticity: customer and market circumstancesIncumbents push uniquenessChallengers push substitutabilityElasticity can vary across segmentsCompetitive BiddingMost common withpublic projectsgovernmental agenciescustom, technically complex productslong manufacturing cyclesUsually the low bidder Not always in private sectorConsider bidder qualifications Competitive BiddingInvitation to BidNewspaperPrivate PublicationsOrganisation websiteUsually very precise plans and specifications that become part of the purchase contractMay have to provide a performance bond to ensure that the product/service will be completed. Bid bonds less common.Competitive BiddingSealed/Closed BidsDue at same timeOpen all at onceOne time pricingOpen/Negotiated BidsIterative processCombines bidding and negotiatingWeb bidding has facilitated this processCompetitive BiddingQuestions 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 BiddingBidding StrategyProbabilistic Bidding (Value????)Assumes profit maximization is goalAssumes lowest bid selectedFocus on size of bid, expected profit if win, and probability that bid will winE(X) = P(X)Z(X)

X = Bid PriceZ(X) = Actual profit if successfulP(X) = Probability of bid acceptanceE(X) = Expected profit at this bidCompetitive BiddingBidding models are only toolsManagerial judgment is criticalSet price to achieve a good winBids are not always fixedMight have an escalation clauseMight have a pass-through clause (cost+)Post-Bid negotiation (by customer) common

CompetitionNeed to monitor continuouslyAnticipate changesRelatively easy because there are relatively few suppliers and few customersTends to be oligopolisticStructure: concentratedPrice LeaderSets the tone for pricingUsually the organization with the best cost structure (competitive advantage)Development of Pricing Strategy

Pricing strategies

It encompasses three main ways to improve profits:Cut costs

2. Sell more

3. Find more profit with a better pricing strategyThe RealityMerely raising prices is not always the answer, especially in a poor economyToo many businesses have been lost because they priced themselves out of the marketplaceOn the other hand, too many business and sales staff leave "money on the tableOne strategy does not fit all, so adopting a pricing strategy is a learning curve when studying the needs and behaviours of customers Pricing Models- 1Cost-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 up2) The other is Direct cost pricing which is variable costs plus a% mark upThis method is only used in periods of high competition as this method usually leads to a loss in the long run.

Pricing Models- 2Creaming or skimmingGoods are sold at higher prices so that fewer sales are needed to break evenSelling a product at a high price, sacrificing high sales to gain a high profit is therefore "skimming" the marketSkimming is usually employed to reimburse the cost of investment of the original research into the productThis 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 penetrationThis method can have some setbacks as it could leave the product at a high price against the competition.

Pricing Models- 3Limit pricingA 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- 4Loss 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-5Market-oriented pricing Setting a price based upon analysis and research compiled from the target marketThis means that marketers will set prices depending on the results from the researchEg 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-6Penetration 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-7Price discrimination

Setting a different price for the same product in different segments to the marketPricing Models-8Premium 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-9Predatory pricing Aggressive pricing (also known as "undercutting") intended to drive out competitors from a market It is illegal in some countries

Pricing Models -10Contribution margin-based pricingContribution margin-based pricing maximizes the profit derived from an individual productIt 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 priceThe 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-11Psychological pricing

Pricing designed to have a positive psychological impact. For example, selling a product at Rs 99 rather than Rs 100

Pricing Models- 12Dynamic pricingA 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-13Price leadershipAn 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 followingThe context is a state of limited competition, in which a market is shared by a small number of producers or sellers.

Pricing Models-14Target pricingPricing 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-15Absorption pricing

Method of pricing in which all costs are recoveredThe 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-16High-low pricingMethod 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 itemsThe 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-18Marginal-cost pricingIn 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-19Value-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-20Pay what you wantPay 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-21FreemiumFreemium 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-22Odd pricingIn 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 99This pricing policy is common in economies using the free market policy.

Discounts and IncentivesCommon point of negotiationCan use to attract new customers, or keep existing onesCan offer on select products, and to select customersPrepaid freight, drop-shipping, financing, post-dating, returns, rebateDiscounts:CashQuantityTradeCash DiscountsIncentive to pay quicklyHelps cash flow2/10, n30: 2% off if paid w/in 10 days, otherwise, full amount due in 30 daysMight offer discount for prepaying, prior to delivery, or even prior to productionMany companies need cash, and will discount for up-front $ (+ no risk)Prepaid expenses can provide payer tax benefits in addition to discounts offeredQuantity DiscountsCheaper by the dozen theorySeller gets guaranteed salesCan plan production betterSmoothes out production, inventory, deliveryHelps with financing, & getting other businessCan offer discounts on $ or unit levelMight spread out large purchases over a period of time, but commit up frontTrade DiscountsAlso called functional discountsUsually given to distributors for performing certain functions for the manufacturerStorage, warehousingSalesTransportationPromotionCommon with automobile dealersLeasingContract to use an asset that is owned by someone else (renting) for a period of timeAvoid cash payment up frontSometimes avoid maintenance and ops costsCan expense for taxes (not amortize)Does not reduce debt capacityHedge against technology obsolescenceLeasing Financial LeaseLonger termLessee (buyer) responsible for maintenance & operating expensesCan apply some of lease pmt to purchase @ endOperating LeaseShorter, cancelableNot amortizedLessor (seller) responsible for ownership expensesNo purchase option

Transfer PricingInternal sales price from one division to another within the same companyNeed to cover costsNeed to be cheaper than marketExact price subject to negotiationBoth sides usually profit centersMay need to be determined by higher-up

Commercial Terms & ConditionsDirect paymentPayment through Bank95/5 % or 98/2% payment termsBank guaranteeFirm Price PVC- Price Variation ClausePRD- Price ruling at time of deliveryLD/Penalty Any Questions Please?