Business to Business Pricing
•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
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
Sunk Cost Fallacy
When marketing managers attempt to
incorporate sunk costs into future decisions,
they often fall prey to the Sunk Cost Fallacy
– that is, they attempt to recoup spent dollars
by spending even more dollars in the future.
Example: Continuing to advertise a failing
product heavily in an attempt to recover what
has already been spent on it.
Margins
The difference between the selling price
and the “cost” of a product or service
Margins are expressed in both dollar
terms or as percentages on:
 a total volume basis, or
 an individual unit basis
Gross Margin or Gross Profit
On a total volume basis:
The difference between total sales
revenue and total cost of goods sold
On a per-unit basis:
The difference between unit selling
price and unit cost of goods sold
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
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.
Different Companies,
Different Pricing Objectives
Company
Alcoa
American Can
General Foods
National Steel
U.S. Steel
DuPont
Objective
20% ROI
Maintain market share
33% gross margin
Match the market
8% ROI after taxes
Target ROI, cost-plus
(continued)
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
Factors Impacting Demand
•
•
•
•
•
Ability to buy
Willingness to buy
Benefits vs. Price
Substitutes
Nonprice competition
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?
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