Pricing Industrial Products

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Chapter 10

• Pricing Industrial Products
• And Services

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Price

• Price 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.

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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

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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

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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

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Characteristics of Industrial Prices IV

• Pricing often set through competitive bidding on
  a project-by-project basis
• Dont know competitors prices
• Negotiation may be used instead (some insist)
• Emphasis on fairness
• Need to justify price increases
• Also justify higher prices

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Characteristics of Industrial Prices V

• Affected by economic factors outside companys
  control
• Inflation
• Long-Term contract (escalation clauses)
• Interest Rates
• Currency Exchange Rates
• Affects cost of materials
• Affects price of exports

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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
• Customers subjective estimate of products
  capacity to satisfy a set of goals
• Objectively established by the competitive
  market. What the market will bear.

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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

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Whats 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?

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Strategic Pricing ProgramsObjectives 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

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Strategic Pricing ProgramsObjectives 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

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Strategic Pricing ProgramsStrategy

• Cost-Based
• Fixed and Variable costs/Unit
• Markup/ROI
• Market-Based
• Competitor Prices
• Customer Demand

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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)

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Strategic Pricing ProgramsStructure

• 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

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Strategic Pricing ProgramsLevels/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.

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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

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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

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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.

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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

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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)

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Standard Cost Approach

• Can include interest rates on debt, tax rates
  (perhaps different countries for mfr and sales),
  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 costs

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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

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Demand

• Sets the upper limit of price
• Need to understand customers 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 )

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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

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Elasticity of Demand

• Sensitivity of customers 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

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Elasticity
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Elastic
Inelastic
Quantity Demanded
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Elasticity

• ? Quantity ? Price
• If 1, elastic
• If

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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)

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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

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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

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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)

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Four Strategic Pricing Options

• Pressure Pricing
• Opportunistic Pricing
• Gold-Standard Pricing
• Negotiated Pricing

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Pressure Pricing

• Market leader maintains fairly stable price level
• Price not dictated by demand fluctuations
• Price increases controlled
• Controls market entry

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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

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Gold-Standard Pricing
William Jennings Bryan

Cross of Gold Speech
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Gold-Standard Pricing

• Short run policy
• Quote all customers the same price
• Ignore specific circumstances

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Negotiated Pricing

• Tailor pricing to each customer (or segment)
  based on
• Elasticity
• Competitive Alternatives
• Type of Customers

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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
• Dont try to recoup RD costs too quickly

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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

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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

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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

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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)

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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.

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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

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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)

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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

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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

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Negotiation
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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, wont happen
• Each side has minimums that it wants to win and
  needs to win
• If
• If

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Price Negotiation II

• Need to understand risks and rewards for both
  sides of negotiation
• Estimate settlement ranges for self and other
  party
• Bargaining zone Sellers minimum price to
  Buyers maximum price

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Seller Opens
Buyers Max Price
Buyer Wants
High
Low
Bargaining Zone
Sellers Min Price
Buyer Opens
Seller Wants
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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.

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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?

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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

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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

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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

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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

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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

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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 _at_ end
• Operating Lease
• Shorter, cancelable
• Not amortized
• Lessor (seller) responsible for ownership
  expenses
• No purchase option
• Lease price financial lease price

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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)

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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

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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
• Dont assume customers will not pay more
• Establish electronic exchanges, barter excess
  supplies
• Maximize revenue, not price Yield Management

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