Business to Business Pricing
What is Price?
• Strategic element of marketing
mix
• Indication of value or worth of
something
• Without it, transactions could
not take place
•No easy formula
for pricing an
industrial
product.
•Decision is
multidimensional
•Each interactive
variable assumes
significance.
Key Components of the Industrial
Pricing Process
Fig. 15.2
Strategic Purposes of Pricing
• Achieving target level of profitability
• Building good-will or relationships (in a
market with certain customers)
• Penetration of a new market or
segment
• Maximizing profit for a new product
• Keeping competitors out of an existing
customer base
Tactical Purposes of Pricing
• Winning business of new, important
customers
• Penetrating a new account
• Reducing inventory levels
• Keeping business of disgruntled
customers
• Encourage customer trials
• Encourage purchase of complementary
products
Perceived Value and
Evaluated Price
Value Based vs. Cost Based Pricing
 Value Based Pricing
 difficult to establish
 Cost Based Pricing
 easy and often mistakenly used
 Costs important in determining profit
levels
 Beyond this, cost has little to do with
price
The Total Offering
Suppliers creatively
combine components of
total offering that
contribute to value for
specific customers.
Components will vary
depending on specific
customer needs and the
customer’s cost
structure.
Elements of the Offering:
Product
Ancillary Services
Image
Availability
Quantity
Evaluated
Price
Customer perceives price
as a cost in its offering.
Some will be able to
directly fund purchases.
Others will require
financing assistance.
Others may require JIT
delivery.
Others may find value in
the brand or image of a
particular supplier,
particularly if that image
can add value to the final
product (Intel Inside).
Costs Considered in
Evaluated Price:
Consumer Perspective
 Price
paid/value exchanged at
purchase
 Location convenience
 Handling & storage costs for customer
 Inventory financing/holding costs
 Environmental impact/disposal cost
Customer Perception of Value
and Evaluated Price
“A” has more value; customer chooses “A”
$ Equivalent
though “B” has more total benefits
Value
Total
Total
Benefit
Benefit
s
s
Evaluated
Evaluated
Price
Price
Value
Value
Offering A
Offering B
Maximum/Minimum Price
$ Equivalent
Value
Customer view –
Maximum
worth of A
Competitor’s
Price for B
Acceptable
Price Range
Cost
Maximum
Price per
Unit for A
Minimum
Price per
Unit for A
Attributable
cost per unit
Offering A
Competitor’s
Offering B
Offering A
Benefits of a Particular Product
Functional benefits are the design characteristics
that might be attractive to technical personnel.
Operational benefits are durability and
reliability, qualities desirable to production
managers.
Financial benefits are favorable terms and
opportunities for cost savings, important to
purchasing managers and controllers.
Personal benefits are organizational status,
reduced risk, and personal satisfaction.
Customers’ Cost-in-Use Components
•A broad perspective needed in
examining the costs a particular
alternative may present for the buyer.
•Rather than making a decision on the
basis of price alone, organizational
buyers emphasize the total cost in use of
a particular product or service.
Customers’ Cost-in-Use Components
Contribution Margin
• Difference between
– Ongoing attributable costs and
– Ongoing attributable revenues.
• Represents the proportion of the revenues that
contribute to
– Fixed costs
– Indirect costs
– Profit
Price Cut Example
How Low Can You Go?
$
$10,000
Original
Price
$7,000
Original
Profit
$6,000
Allocated
Cost of Mgr’s
Salary—
“unavoidable”
Attributable
Costs
New Price
$6500
Minimum Price –
$6000
Contribution to
Cover
Mgr’s Salary
Price Cut “A” – this is still OK
Price Cut “B”
Below $6000, you lose
more $ with each
additional unit sold
Types of Cost
Costs
Fixed
Costs
Variable Costs
Variable Costs are…
Expenses that are uniform
per unit of output within a
relevant time period
As volume increases, total
variable costs increase
THERE ARE TWO CATEGORIES OF
VARIABLE COSTS
1.Cost of Goods Sold
2.Other Variable Costs
Variable Costs – Cost of Goods
Sold
For Manufacturer or Provider of
Service
 Covers materials, labor and factory
overhead applied directly to
production
For Reseller (Wholesaler or Retailer)
 Covers primarily the cost of
merchandise
Other Variable Costs
Expenses not directly tied to
production but vary directly with
volume
Examples include:
 Sales commissions, discounts,
and delivery expenses
Fixed Costs
Expenses that do not fluctuate with
output volume within a relevant time
period
They become progressively smaller per
unit of output as volume increases
No matter how large volume becomes,
the absolute size of fixed costs remains
unchanged
THERE ARE TWO CATEGORIES OF
FIXED COSTS
1.Programmed costs
2.Committed costs
Fixed Costs – Programmed Costs
• Result from attempts to
generate sales volume
• Examples include:
 Advertising, sales
promotion, and sales
salaries
Fixed Costs – Committed Costs
Costs required to maintain
the organization
Examples include
nonmarketing expenditures,
such as:
 rent, administrative cost,
and clerical salaries
Relevant and
Sunk Costs
Relevant Costs are…
Future expenditures unique to the decision
alternatives under consideration.
Expected to occur in the future as a
result of some marketing action
Differ among marketing alternatives
being considered
In general, opportunity costs are
considered relevant costs
Sunk Costs are…
The direct opposite of relevant costs.
Past expenditures for a given
activity
Typically irrelevant in whole or in
part to future decisions
Examples of sunk costs:
Past marketing research and
development expenditures
Last year’s advertising expense
“Landed Cost” of a Product
• Cost of the product at the
source, plus the cost to
transport the product to its
destination.
• If landed cost is lower than that
of other sources, there should
be a demand for that product &
for transportation of that
product.
Landed Cost Examples
Chicago
Production
Cost = $ 3
Chicago
Production
Cost = $ 3
Chicago
Production
Cost = $ 3
Transportation Costs
Chicago to Boston < $ 1
Chicago producer has a
Landed Cost Advantage
Transportation Costs
Chicago to Boston > $ 1
Boston producer has a
Landed Cost Advantage
Transportation Costs
Chicago to Boston = $ 1
Neither producer has a
Landed Cost Advantage
Boston
Production
Cost = $ 4
Boston
Production
Cost = $ 4
Boston
Production
Cost = $ 4
Landed Cost can determine the
Extent of the Market
between 2 competing companies
• Extent of the Market is
– Point at which lowest price (or landed
cost) is equal for products of two firms.
– Market area for a seller is area where
seller has a landed cost advantage over its
competitor (assuming buyer will select
seller with the lowest price).
Extent of Market Illustration
•
•
•
•
•
•
2 producers (A & Z) located 200 miles apart.
A’s production cost = $ 50.00/unit
Z’s production cost = $ 50.00/unit
A’s transportation cost = $ 0.60/unit/mile
Z’s transportation cost = $ 0.50/unit/mile
Extent of Market is point at which
– Landed cost (LC) of A = to LC of Z, or
– Where x is the distance from A’s plant to the limit of the
market area, and
– 200 – x is the distance from Z’s plant to the market area
Continued on next slide
Extent of Market Illustration (continued)
LC (A) = LC (Z)
Production (A) + Transportation (A) = Production (Z) + Transportation (Z)
$ 50 + $ 0.60 (x) = $ 50 + $ 0.50 (200 – x)
$ 50 + $ 0.60 (x) = $ 50 + $ 100 - $ 0.50 (x)
$ 50 + $ 0.60 (x) + $ 0.50 (x) = $ 50 + $ 100
$ 0.60 (x) + $ 0.50 (x) = $ 50 + $ 100 - $ 50
$ 1.10 (x) = $ 100
X = 90.9 miles from A
 Thus,
 A has a market area that extends 90.9 miles from its plant, and
 Z has a market area that extends 109.1 miles from its facility.
 Telling us that,
 The firm with the lower transportation cost (Z) has a greater market area
than the firm with the higher transportation cost (A).
Trade Margin (Markup)
Suppose a retailer pays $10 for an item and
sells it for $15. Markup is thus $5 ($15-$10):
Margin as a percentage of cost:
Margin/Cost x 100 =
($5 / $10) x 100 = 50 %
Margin as a percentage of selling price:
Margin/Price x 100 =
($5 / $15) x 100 = 33.333 %
Break-Even Analysis
Break-even point is the unit or dollar sales
at which an organization neither makes a
profit nor a loss.
At the organization’s break-even sales
volume:
Total Revenue = Total Cost
Break-even Analysis Chart
Dollars
Total Revenue
BE Point
PROFIT
Total Cost
Variable Cost
LOSS
0
Fixed Cost
Unit Volume
Break-even Analysis
Example
Fixed Costs
= $50,000
Price per unit
= $5
Variable Cost
= $3
Contribution
= $5 - $3 = $2
Breakeven Volume
= $50,000  $2
= 25,000 units
Breakeven Dollars
= 25,000 x $5
= $125,000
Problems with Using Price Elasticity to
Set Price
• Fails to consider competitors’ response
• Demand may be inelastic for given
price, but elastic for larger amount
• Measured in sales revenue, not profit
margins
• Fails to consider product line effects
• Ignores low price societal benefits
Pricing Across Product Life Cycle
(Life-Cycle Costing)
• Introduction phase:
– Price skimming: Introductory price set relatively high,
thereby attracting buyers at top of product’s demand
curve.
– Market penetration pricing: Low price is used as an
entering wedge.
• Growth phase
• Maturity phase
• Decline stage
Strategies in the Introduction Stage of
the PLC
• Rapid-skimming strategy
– Launch new product at high price
– High promotion level
– Makes sense if:
• large part of potential market is unaware of the
product
• those who become aware are eager & willing to pay
• need to build brand preference quickly due to
potential competition
Strategies in the Introduction Stage of
the PLC
• Slow-skimming strategy
– launch new product at high price
– low promotion
– helps maintain high profit per unit
– makes sense if:
• market size is limited
• most of market is aware of product
• buyer willing to pay high price
• no significant potential competition
Strategies in the Introduction Stage of
the PLC
• Rapid-penetration strategy
– launch new product at low price
– spend heavily on promotion
– allows fastest market penetration & share
– makes sense if:
• large market that is unaware of product
• buyers are price-sensitive
• strong potential competition exists
• can rapidly enjoy economies of scale
Strategies in the Introduction Stage of
the PLC
• Slow-penetration strategy
–
–
–
–
–
launch new product at low price
low level of promotion
encourages rapid product acceptance
allow slightly higher profits than rapid-penetration
makes sense if:
•
•
•
•
market is price-sensitive
market is not promotion-sensitive
large market that is aware of the product
some potential competition
Price-Leadership Strategy
• One (or a very few) firm(s) initiate price
changes, with most or all the other firms in
the industry following suit.
• When price leadership prevails,
– price competition does not exist.
– burden of making critical pricing decisions is
placed on leading firm(s) and
– others simply follow the leader.
Characteristics of Successful Price Leaders
•
•
•
•
•
•
•
•
•
•
•
Large share of industry’s production capacity
Large market share
Commitment to particular product class/grade
New, cost-efficient plants
Strong distribution systems
Good customer relations
Effective market information systems
Sensitivity to price/profit needs of industry
Sense of timing as to when make price changes
Sound management organization for pricing
Effective product-line financial controls
Competitive Bidding
• Buyer sends inquiries (requests for quotations or
RFQs) to firms able to produce in conformity
with requested requirements.
• Requests for proposals (RFPs) involve the same
process, but
– here buyer is signaling that everything is preliminary
and
– that a future RFQ will be sent once specifics are
determined from the best proposals.
Competitive Bidding
• Closed bidding
– often used by business and governmental
buyers
– involves a formal invitation to potential
suppliers to submit written, sealed bids for a
particular business opportunity.
• Open bidding
– more informal and allows suppliers to make
offers (oral and written) up to a certain date.
Whether or Not to Bid
• Is the dollar value of the contract large enough to
warrant the expense involved in making the bid?
• Are the product specs precise enough to allow
the cost of production to be accurately estimated?
• Will acceptance of the bid adversely affect
production and/or ability to serve other
customers?
• How much time is available to prepare the bid?
• What is the likelihood of winning the bid given
the presence and strength of other bidders?
Negotiating Situations in B2B Sales
Situation:
Stand Alone Transaction
Balanced Between
Transaction and
Relationship
Effective Bargaining Styles Competitive;
Problem Solving
Problem Solving;
Compromising
Effective Approach
Seek Common Interest
Use of Leverage
Stages of Negotiation Process in
B2B Sales
• Preparation
– Data Collection and Analysis
– Determination of Negotiation Strategy
• Information Exchange
– Elicit Information not yet obtained
– Test Hypothesis about nature of situation
• Engage in Negotiation
– Opening
– Discussion positions
– Concessions
– Closing
• Obtain Commitment
Final Negotiation Considerations
• Who has the authority to make final
decisions?
• What are the bargaining styles of
participants in bargain decision?
• Is bargain perceived as transaction,
relationship or both?
• What evaluated price range is the
customer expecting?
Types of Leases
• Operating Lease
– short-term and cancelable
– lessor generally provides maintenance/service
– rarely contains purchase option
• Direct-financing Lease
– long-term and non-cancelable
– lessee responsible for operating expenses
– lessee has option of purchasing the asset
Leasing in the Business Market
• Advantages to buyer
– No down payment
– No risk of ownership
• Advantages to seller
– Increased sales
– Ongoing business relationship with
lessee
– Residual value retained
Operating Leverage
Extent to which fixed costs and variable
costs are used in the production and
marketing of products and services.
Firms with high total fixed costs relative
to total variable costs are defined as having
high operating leverage.
Higher operating leverage results in a faster
increase in profit once sales exceed breakeven volume. The same happens with losses
when sales fall below break-even volume.