Pricing Industrial Products And Services

1. Chapter 10 Pricing Industrial Products And Services

2. Price Price is unique among the 4 Ps in that it directly affects the company�s 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.

3. Characteristics of Industrial Prices I Includes more than list or quoted price Delivery & Installation Discounts (quantity, promotion, remit time) Training costs Trade-in allowance Promotions: 2 for 1 Financing costs

4. Characteristics of Industrial Prices II Not an independent variable. Pricing interacts with: product, promotion, and distribution strategies Must consider complementary or substitute products when establishing price strategy

5. Characteristics of Industrial Prices III Prices can be changed by: Changing price paid by buyer Changing quantity/quality offered by seller Changing premiums or discounts Changing time and place of payment Carry Tax/Cash Flow implications Changing time and place of transfer of ownership Delivery

6. Characteristics of Industrial Prices IV Pricing often set through competitive bidding on a project-by-project basis Don�t know competitors� prices Negotiation may be used instead (some insist) Emphasis on fairness Need to justify price increases Also justify higher prices

7. Characteristics of Industrial Prices V Affected by economic factors outside company�s control: Inflation Long-Term contract (escalation clauses) Interest Rates Currency Exchange Rates Affects cost of materials Affects price of exports

8. Price = 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: Customer�s subjective estimate of product�s capacity to satisfy a set of goals Objectively established by the competitive market. �What the market will bear.�

9. Economic Value to the Customer Purely economic sources of value Need to compare life-cycle costs of your product and substitutes If incremental value is high enough to justify a higher price, then there is EVC Sometimes it takes a convincing sales effort to help customer see the value

10. What�s 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? ( Value) How much time can customer save by buying product vs. making themselves?

11. Strategic Pricing Programs:Objectives I ROI; Market Share LT/ST Profit Sales Growth Stabilize Market Convey Desired Image Desensitize customers to price Be Price Leader Discourage entry & push out weak competitors

12. Strategic Pricing Programs:Objectives II Avoid Government interference (Anti-Trust/Regs) Perceived Fairness Customers, Distributors, Suppliers Create interest & excitement Sell other items in line Discourage competitors from dropping price Recover investment quickly Generate sales volume Encourage quick payment

13. Strategic Pricing Programs:Strategy Cost-Based Fixed and Variable costs/Unit Markup/ROI Market-Based Competitor Prices Customer Demand

14. Market-Based Pricing Strategies Floor: just cover costs Penetration: lower than market Parity: match market Premium: skimming Price Leadership: everyone plays follow the leader Stay Out/Keep Out Bundle: Multiple products/services Value-Based: Segment pricing Cross-Benefit: �Gotcha� (Razors, Ink Jet)

15. Strategic Pricing Programs:Structure Basic: One price, no discounts, everyone pays the same Lacks flexibility, limits sales Low Cost ? competitive advantage in price Price moves toward costs in PLC, until end Creative Pricing: empty seats, box filler, late cancellations, season, demand, advance purchase, customer loyalty

16. Strategic Pricing Programs:Levels/Tactics Actual price charge w/discounts Acceptable range that conveys value Odd ($2,999) vs. Round ($3000) Ensure adequate price gaps between items Modify for costs, competitors, market ?s Timing: not arbitrary, justify to customer Sends signals to customers/competitors Rebates, 2/1, trade-in, etc.

17. Pricing Program Strategy, structure, level, and tactics all work together. They must be coordinated. Strategy may be long lived (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 changes In response to cost changes As demand changes

18. Pricing Decisions: What Lies Beneath? Most companies use multiple pricing strategies. If the firm sells complimentary or substitute products, they are more likely to use product line strategies (e.g., bundling). Objectives Costs Demand Competition

19. Objectives/Strategies Differentiation ? Higher Margins Fewer competitors are substitutes Increased brand loyalty Moving to low price from premium-quality position can hurt sales, not help Recoup development costs over longer period of time. Otherwise run risk of sales numbers that are too low to ever recoup costs.

20. Costs Establishes the minimum price Set price based on target margin or return Can price below cost to: Keep employees and facilities working during downturn Support other products in the line Low bid to establish relationship. Make $ in long term, or on extras Experience or reputation New skills

21. Standard Cost Approach Target Return Pricing Need accurate sales forecast: standard volume Variable costs and fixed costs/unit: standard costs P = DVC + FC/Q + rK/Q P: Price DVC: Direct Variable Cost/Unit FC: Fixed Cost r: Rate of Return K: Capital Used Q: Standard Volume (units)

22. Standard Cost Approach Can include interest rates on debt, tax rates (perhaps different countries for mfr and sales), or inflation factors. Don�t raise prices to counter weak sales; Don�t drop prices too quickly either Need reliable standard volume estimate Initial low price may increase volume, which in turn lowers per unit fixed costs

23. Contribution Analysis Trade off between price and units sold Total Revenue � Total Variable Cost = Variable Contribution Margin Fixed 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

24. Demand Sets the upper limit of price Need to understand customer�s reasons for buying product; how they use it Hard Benefits Physical Attributes: hp, productivity, durability, error rate, performance tolerances Soft Benefits Warranty, service, other augmented product Balance benefits to customer against the costs (price +)

25. Costs Price + (delivery, modifications, financing, maintenance, operation, less salvage) CT machine $500K-$1MM to purchase Also costs ~ $100K/year to operate and maintain Cost to prepare facilities to house Risk (defect, poor performance) ? Cost What trade offs are the customers willing to accept? Slower delivery; Low service priority Higher, chunkier inventory Larger purchase commitment

26. Elasticity of Demand Sensitivity of customer�s quantity demand to changes in price Usually demand has a negative slope (higher price ? lower demand) Issue is how steep Sometimes must hit a threshold level before there is a change in elasticity ? Substitutes become more palatable as prices rise

29. Elasticity % ? Quantity � % ? Price If > 1, elastic If < 1, inelastic

30. Determinants of Elasticity Available substitutes Necessity of product Relative size of purchase $$$ Differentiation of product/Standardization Customer switching costs Ease/Difficulty of comparison (Complexity) Third-Party Payer (Pass-Through) Price/Quality Association Time (Payment due, need for product)

31. Industrial Products Tend to have inelastic demand Especially if technically sophisticated, customized, or crucial to operations Routine purchases more elastic Situational elasticity: customer and market circumstances Incumbents push uniqueness Challengers push substitutability Elasticity can vary across segments

32. Cross Elasticity Compliments Lumber and nails, drill presses and bits Negative cross elasticity Substitutes Shipping by train vs. truck, Company B vs. A Positive cross elasticity

33. Competition Need to monitor continuously Anticipate changes Relatively easy because there are relatively few suppliers and few customers Tends to be oligopolistic Structure: concentrated Price Leader Sets the tone for pricing Usually the organization with the best cost structure (competitive advantage)

34. Four Strategic Pricing Options Pressure Pricing Opportunistic Pricing Gold-Standard Pricing Negotiated Pricing

35. Pressure Pricing Market leader maintains fairly stable price level Price not dictated by demand fluctuations Price increases controlled Controls market entry

36. Opportunistic Pricing Follow the swings of the market Raise prices as high as elasticity will allow Raise prices as high as customer goodwill or loyalty will allow Lower prices as demand drops

37. Gold-Standard Pricing

38. Gold-Standard Pricing Short run policy Quote all customers the same price Ignore specific circumstances

39. Negotiated Pricing Tailor pricing to each customer (or segment) based on Elasticity Competitive Alternatives Type of Customers

40. PLC Pricing I Critical at Introductory Stage Sets the tone for future pricing decisions Penetration pricing (low) Higher sales, lower margins Can leave too much on the table Parity pricing (match) Premium/Skimming pricing (high) Can get highest margins Risk competitive entry Always easier to lower prices than to raise Don�t try to recoup R&D costs too quickly

41. PLC Pricing II Growth: New competition More specialized need segments develop Product extensions developed Scale economies and experience curve start to come into play Price ranges narrow; convergence on market price Downward pressure on pricing

42. PLC Pricing III Maturity: Market more saturated Competition aggressive and entrenched Product may be cash generator (Cash Cow) Focus is on repeat sales/internal cost efficiency Competition more heavily priced based; but stop short of price war Maximize short-term direct product contribution to profit

43. PLC Pricing IV Decline May raise price to capitalize on remaining, inelastic demand, or Leave prices stable, cut expenditures, let product die, or Cut price, toward break-even, use as loss leader to sell complimentary products

44. Competitive Bidding I Most common with public projects governmental agencies custom, technically complex products long manufacturing cycles Usually the low bidder Not always in private sector Consider bidder qualifications (See AGC form)

45. Competitive Bidding II Invitation to Bid: RFP published Newspaper Private Publications: Dodge Reports Usually very precise plans and specifications that become part of the purchase contract May have to provide a performance bond to ensure that the product/service will be completed. Bid bonds less common.

46. Competitive Bidding III Sealed/Closed Bids Due at same time Open all at once One time pricing Open/Negotiated Bids Iterative process Combines bidding and negotiating Web bidding has facilitated this process

47. Competitive Bidding IV Questions 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? (Courtesy Bid)

48. Competitive Bidding V Bidding Strategy Probabilistic Bidding (Value????) Assumes profit maximization is goal Assumes lowest bid selected Focus on size of bid, expected profit if win, and probability that bid will win E(X) = P(X)Z(X) X = Bid Price Z(X) = Actual profit if successful P(X) = Probability of bid acceptance E(X) = Expected profit at this bid

49. Competitive Bidding VI Bidding models are only tools Managerial judgment is critical Set price to achieve a good win Bids are not always fixed Might have an escalation clause Might have a pass-through clause (cost+) Post-Bid negotiation (by customer) common Extras (not addressed by bid) PROFITABLE

50. Negotiation

51. Price Negotiation I Need good interpersonal skills, persuasion skills, judgment, conflict resolution skills Negotiation is the result of two sides coming together to decide how much gain each will have by working together If not win-win, won�t happen Each side has minimums that it wants to �win� and needs to �win� If < �need� ? No deal If << �want� ? No repeat deal

52. Price Negotiation II Need to understand risks and rewards for both sides of negotiation Estimate settlement ranges for self and other party Bargaining zone: Seller�s minimum price to Buyer�s maximum price

54. Negotiation Styles Avoidant: Relatively rare Avoid confrontation. Out for self. Collaborative: Good long-term strategy Win-Win. Try to satisfy self and other party. Competitive: Short-sighted Win-Lose. Get all you can from other party. Sharing: Common Both parties partially satisfied. Accommodative: Rare Satisfy other party, at own expense.

55. Other Issues on Negotiation One time deal, or repeated negotiation? Repeat ? more cooperation Have longer term view What else besides price is important? Guarantees Return Policies Volume Quality Financing Service Time constraints?

56. Discounts and Incentives Common point of negotiation Can use to attract new customers, or keep existing ones Can offer on select products, and to select customers Prepaid freight, drop-shipping, financing, post-dating, returns, rebate Discounts: Cash Quantity Trade

57. Cash Discounts Incentive to pay quickly Helps cash flow 2/10, n30: 2% off if paid w/in 10 days, otherwise, full amount due in 30 days Might offer discount for prepaying, prior to delivery, or even prior to production Many companies need cash, and will discount for up-front $ (+ no risk) Prepaid expenses can provide payer tax benefits in addition to discounts offered

58. Quantity Discounts Cheaper by the dozen theory Seller gets guaranteed sales Can plan production better Smoothes out production, inventory, delivery Helps with financing, & getting other business Can offer discounts on $ or unit level Might spread out large purchases over a period of time, but commit up front

59. Trade Discounts Also called functional discounts Usually given to distributors for performing certain functions for the manufacturer Storage, warehousing Sales Transportation Promotion Common with automobile dealers

60. Leasing I Contract to use an asset that is owned by someone else (renting) for a period of time Avoid cash payment up front Sometimes avoid maintenance and ops costs Can expense for taxes (not amortize) Does not reduce debt capacity Hedge against technology obsolescence

61. Leasing II Financial Lease Longer term S lease pmts > Purchase price of asset Lessee (buyer) responsible for maintenance & operating expenses Can apply some of lease pmt to purchase @ end Operating Lease Shorter, cancelable Not amortized Lessor (seller) responsible for ownership expenses No purchase option Lease price > financial lease price

62. Transfer Pricing Internal sales price from one division to another within the same company Need to cover costs Need to be cheaper than market Exact price subject to negotiation Both sides usually profit centers May need to be determined by higher-up Set formula (cost + 2/3 of margin to market)

63. WWW & Pricing Facilitates information search by customers Auctions: buyers set prices, not sellers Buyers control transaction, on-line bidding Can get spot pricing on everything and can take competitive bids on lots of purchases Forces even strong brands to be treated like commodities

64. What to do about WWW Use differential pricing Optimize pricing by using customer data: increases customer switching costs De-Menu pricing; can adjust pricing almost instantly as needed; remove lumpiness Push differentiation even more: can use web to provide pleasing aesthetics, entertainment, education, or escapism Don�t assume customers will not pay more Establish electronic exchanges, barter excess supplies Maximize revenue, not price: Yield Management