Chapter 10 Pricing in Business-to-Business Marketing

Prepared by John T. Drea, Western Illinois University 1

Pricing Basics
Fundamentally, price is an indicator of the worth of a product.
Price needs to be set at a level that indicates that the benefits are worth the price, indicates that the customer can afford the price, the customer cannot obtain more value from some other suppliers offerings.
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Exhibit 10-1 Components of the Offering

Suppliers creatively combinecomponents of the total offering that contributeto value for specificcustomers. Components vary depending specific on customerneedsand the customers cost structure.

Elements of the offering: Product Service Image Availability Quantity Evaluated price

Support activities

Addedvalue

Direct activities

The customerperceives price as a costin its offering. While somecustomers are able to directly fund purchases, othersrequire financingassistance (GECredit Corporation financescustomerpurchases). Other customers may require JIT deliverywhile others may find value in the brand or imageof a particular supplier particularlyif that , imagecan add value to the final product(Intel Inside).
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Cost-Based vs. Value-Based Pricing

CostCost-Based Pricing
Price is set by calculating the cost of an offering, then adding a standard percentage profit. CostCost-Based Price Issues Costs depend on volume. Costs assigned by standard rates may have no relationship to actual costs. Price has no relationship to customers perceptions of the offerings worth.

ValueValue-Based Pricing
Price is set based on perceived customer value.

ValueValue-Based Price Issues More difficult to implement than cost-based pricing. Need to establish the evaluated price (the price of the offering from the customers perspective after all costs associated with the offering are evaluated). 4

Maximum Price Minimum Price

The highest price a supplier can charge for a product or service The price that covers the suppliers relevant costs

Key Points: If there is no competition, maximum price is the point where benefits just barely exceed the evaluated price. To build a relationship, a fair price is needed. Fair is a function of customer perceptions of the offering value. Competitor prices and total benefits delivered constitute a reference points in determining what is a fair price.
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Exhibit 10-3 Customers Perception of Value and Evaluated Price

$ Equivalent value A has more value; customer choosesA though B has more total benefits. Total benefits Total benefits Evaluated price Evaluated price

Value Value

Offering A

Offering B

Value-Cost Model of Pricing

Need to analyze what activities subtract the most from each customers profitability. At the same time, we need to analyze how important a product is to the customers creation of value. This indicates what each buyer can afford and how sensitive the customer is likely to be to price changes.
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Exhibit 10-4a Value-Cost Model for Analyzing Customers

Management and infrastructure. Value score: Technology development Value score: Other overhead. Value score: Delivery & customer service Value score: VC% FC% FC% FC% FC%

Sales Value score: VC% FC%

Marketing Value score: VC% FC%

Operations Value score: VC% FC%

Supply logistics Value score: VC% FC%

Materials Value score: VC% FC%

Value score: Contribution to value for customers customer 1 = Key component, 2 = Significant component, 3 = Minor component
8 Cost percentage = Percentage of fixed costs (FC) or variable costs (VC)

Exhibit 10-4b Value-Cost Model for Analyzing Customers

Management and infrastructure. Value score: 1 Technology development Value score: 3 Other overhead. Value score: 3 Delivery & customer service Value score: 1 VC% 10% FC% 25% FC% 15% FC% 5% FC% 20%

Sales Value score: 3 VC% 0% FC% 10%

Marketing Value score: 3 VC% 0% FC% 5%

Operations Value score: 1 VC% 70% FC% 20%

Supply logistics Value score: 2

Materials Value score: 3

VC% 10% VC% 10% FC% 0% FC% 0%

Value score: Contribution to value for customers customer 1 = Key component, 2 = Significant component, 3 = Minor component
9 Cost percentage = Percentage of fixed costs (FC) or variable costs (VC)

Exhibit 10-5 Maximum and Minimum Price

$ Equivalent value Competitors price for B Cost Acceptable price range Customer view Maximum worth of A

Maximum price per unit for A Minimum price per unit for A

Attributable costper unit offering A

Competitors offering B

Of fering A
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Exhibit 10-6 Effect of Price Reductions on Cost Coverage

$ Original price Original profit New price A

Allocated cost of managers salary Attributable costs Contribution to cover managers salary Price cut A Price cut B Loss New price B

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Exhibit 10-7 Demand and Supply Curves

Price Demand Supply

Elasticity PQ at (slope of demand curve)

12 Quantity

Relevant Costs
must meet the following four criteria

Resultant Costs

Realized Costs

ForwardForwardlooking Incremental Costs

Avoidable Costs

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Relevant Costs:
On-going revenues must pay for on-going costs
Resultant Costs Costs that result from the decision Costs that will be incurred for the next units of product sold when the decision is implemented Realized Costs ForwardForwardlooking Incremental Costs

Actual costs incurred Costs that would not be incurred if the decision were not made to launch the offering. Avoidable Costs
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Lessons to be learned on the economic fundamentals of price

Lesson 1: Demand levels differ at different price levels. Each segment will have a different degree of price sensitivity. Lesson 2: Price changes trigger customer reactions. In the short-term, these reactions may be constrained by customers situations. Lesson 3. Price changes trigger reactions from competitors.
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Several Marketing Objectives Addressed by Pricing Strategic Purposes

Achieve a target level of profitability Build goodwill in a market Penetrate of a new market or segment Maximize profit for a new product Keep competitors out of an existing customer base

Tactical Purposes
Win new and important customer business Penetrate a new account Reduce inventory levels Keep business of disgruntled customers Encourage product trial Encourage sales of complementary products 16

Introductory Pricing Strategies

Penetration Pricing
Charging relatively low prices to entice as many buyers as possible into the early market. Penetration pricing can assist in obtaining a dominant market share an excellent defense to future competition. Charging relatively high prices that take advantage of early adopters strong desire for the product. Skimming is most effective when an offering has significant patent protection and offers significant value at the skim price.

Price Skimming

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Introductory Pricing Strategies

Penetration Pricing
Conditions for skimming: Offering quality and image support the higher price Small volume production costs allow profits at low sales volume Sufficient number of adopters at skim price to justify effort Conditions for penetration: Market must be price sensitive Production and distribution costs must fall as volume increases (economies of scale)
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Price Skimming

Managing Pricing Tactics

Bundling Selling several products and/or services together as one Reductions in price for a special reason (but some customers can get hooked on them!) Sealed bids involve private bids by potential suppliers. In open bids, competitors see each others bids. Need to react and change marketing activities as events unfold, such as changes by competitors or customers.
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Discounts & Allowances Competitive Bidding Initiating Price Changes

Determining a Bid Price

Expected profit at a given price is calculated as

E(PF) = PW(Pr) x PF(Pr)

Where: E(PF) = Expected profit PW(Pr) = Probability of winning the bid at price Pr PF(Pr) = Profit at price Pr
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Exhibit 10-9 Hypothetical Example of Profit Expectations in a Competitive Bidding Situation

Cost Bid Profit $0 $2,000 $4,000 $6,000 $8,000 Prob. of Winning Bid .2 .5 .7 .5 .4 .3 .2 Expected Profit $0 $1,000 $2,800 $3,000 $3,200 $3,000 $2,400
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$20,000 $20,000 $20,000 $22,000 $20,000 $24,000 $20,000 $26,000 $20,000 $28,000

$20,000 $30,000 $10,000 $20,000 $32,000 $12,000

Exhibit 10-10 Effect of an Industry Increase in Costs

S2 S1

P2 P1

Price

Q2

Q1

Quantity
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Exhibit 10-11 Two Types of Negotiating Situations in B2B Sales Situation Stand-alone Transaction Effective bargaining styles Effective approach Balanced between Transaction and Relationship
Problem solving; Compromising Seek common interests
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Competitive; Problem solving

Use of leverage

Know your customers needs and their relative importance. Know who has the authority to make a final decision.

Preparation in negotiation is key

Know the bargaining styles of the individuals involved in the bargaining decision process. Know whether the situation is perceived as: A transaction, Part of a relationship, or A combination of the two Know the price range anticipated by the customer. 24

Pricing and the Changing Business Environment

As time pressures increase, marketers must react quickly to changes in customer needs or competitor actions. Two examples are hypercompetition and the Internet. Hypercompetition: requires constant collection of information on customer value-cost models and paying attention to your customers customers and their perceptions of value. The Internet: Improves communication, increases both buyers and marketers preparation. The Internet also facilitates online auctions this is good for commodities, but can minimize relationships for other products. 25