Business to Business Pricing

1. Business to Business Pricing

2. Key Components of the Industrial Pricing Process • No easy formula for pricing an industrial product. • Decision is multidimensional • Each interactive variable assumes significance. Fig. 15.2

3. Types of Cost Costs Fixed Costs Variable Costs

5. Variable Costs are… • Expenses that are uniform per unit of output within a relevant time period • As volume increases, total variable costs increase

6. THERE ARE TWO CATEGORIES OF VARIABLE COSTS • Cost of Goods Sold • Other Variable Costs

7. 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

8. Other Variable Costs • Expenses not directly tied to production but vary directly with volume • Examples include: • Sales commissions, discounts, and delivery expenses

9. 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

10. THERE ARE TWO CATEGORIES OF FIXED COSTS • Programmed costs • Committed costs

11. Fixed Costs – Programmed Costs • Result from attempts to generate sales volume • Examples include: • Advertising, sales promotion, and sales salaries

12. Fixed Costs – Committed Costs • Costs required to maintain the organization • Examples include nonmarketing expenditures, such as: • rent, administrative cost, and clerical salaries

13. Relevant and Sunk Costs

14. 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

15. 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

16. 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.

17. 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

18. 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

19. Trade Margin (Markup) Suppose a retailer purchases an item for $10 and sells it at $20. Retailer Margin as a percentage of cost is: Margin/Cost x 100 = ($10 / $10) x 100 = 100 % Retailer Margin as a percentage of selling price is: Margin/Price x 100 = ($10 / $20) x 100 = 50 %

20. Contribution Analysis • Contribution is… • The difference between total sales revenue and total variable costs • OR on a per-unit basis • The difference between unit selling price and unit variable cost

21. 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

22. Break-even Analysis Chart Dollars Total Revenue BE Point Total Cost PROFIT Variable Cost Fixed Cost LOSS 0 Unit Volume

23. 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

24. 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 break-even volume. The same happens with losses when sales fall below break-even volume.

25. Preparing a pro formaIncome Statement A pro forma income statement is a projected income statement Includes: • Projected Revenues • Budgeted Expenses • Estimated Net Profit

26. Pro Forma Income Statement – Example Sales $1,000,000 Cost of goods sold 500,000 Gross margin 500,000 Marketing expenses Sales expenses $170,000 Advertising expenses 90,000 Freight or delivery expenses 40,000300,000 General and administrative expenses Administrative salaries $120,000 Depreciation on buildings and equipment 20,000 Interest expense 5,000 Property taxes and insurance 5,000 Other administrative expenses 5,000155,000 Net profit before (income) tax$45,000

27. Preparing a pro formaIncome Statement • Sales– forecasted unit volume times selling price • Cost of goods sold– costs incurred in buying or producing products and services • Gross margin– represents the remainder after cost of goods sold has been subtracted from sales

28. Preparing a pro formaIncome Statement • Marketing Expenses– programmed expenses to be spent on increasing sales • General & Administrative Expenses– fixed costs (often referred to as overheads) • Net Income before Taxes– sales revenues minus all costs

29. Different Companies,Different Pricing Objectives CompanyObjective Alcoa 20% ROI American Can Maintain market share General Foods 33% gross margin National Steel Match the market U.S. Steel 8% ROI after taxes DuPont Target ROI, cost-plus (continued)

30. 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.

31. 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.

32. Customers’ Cost-in-Use Components

33. Factors Impacting Demand • Ability to buy • Willingness to buy • Benefits vs. Price • Substitutes • Unfulfilled demand • Nonprice competition • Market segments

34. 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

35. 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

36. 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

37. 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

38. 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

39. 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

40. 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.

41. 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

42. 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.

43. 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.

44. 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?

45. 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

46. 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