Pricing Business Marketing Dr. Dawne Martin November 29, 2011

Learning Objectives Understand the model for pricing, and how strategy, costs, environment and positioning will affect pricing decisions To understand how market-based, cost- based and value-based prices are determined To understand how to map customer value for determining value-based prices To develop price management policies

Question The XYZ Manufacturing Corporation has experienced a rather large decline in sales for its component parts. Mary Vantage, vice-president of marketing, believes a 10% price cut may get things going again. What factors should Mary consider before reducing the price of the components.?

Managing Pricing To support a target-positioning strategy To achieve target financial goals To fit the realities of the marketplace To pursue both cost and demand based pricing principles and processes.

A MODEL FOR MANAGING PRICE Evaluation and Formation of Prices & policy Demand Factors Elasticity of demand Cross elasticities Customer value perceptions 1 Cost Factors Costs now Anticipated costs Economic objectives 2 Cost Factors Structure of competition Barriers to entry Intent of rivals 3 Strategy Issues Target market selection Product positioning Price objectives Marketing program 4 Trade Factors Power in the channel Traditions and roles Margins 5 Legal Factors Vertical restrictions Price discrimination 6 Exhibit

KEY DECISIONS IN MANAGING PRICE DETERMINE PRICING STRATEGY– Develop specific approach to achieve price objectives DETERMINE CHANNEL INTERMEDIARY PRICES, COSTS AND MARGINS DETERMINE SINGLE PRODUCT AND PRODUCT LINE PRICING Develop pricing structures for substitute and complementary products DETERMINE WHETHER TO PARTICIPATE IN BIDDING AND NEGOTIATION FOR SALES ESTABLISH A PRICING SYSTEM Based on the 4 C’s : Costs, Customers, Competitors, and Channels 14-6

Exhibit 14-5 Types of situations Important dimensions Pure CompetitionOligopoly Monopolistic CompetitionMonopoly Uniqueness of each firm’s product None SomeUnique Number of competitors ManyFewFew to manyNone Size of competitors (compared to size of market SmallLargeLarge to smallNone Elasticity of demand facing firm Completely Elastic Kinked demand curve (elastic and inelastic Either Elasticity of industry demand EitherInelasticEither Control of price by firm NoneSome (with care)SomeComplete ANALYZING MARKET STRUCTURES 14-7

Exhibit 14-9 BREAK-EVEN ANALYSIS BREAK-EVEN IS DONE TO FIND THE LEVEL OF SALES TO COVER ALL FIXED AND VARIABLE COSTS Q is quantity; FC, fixed costs; VC, variable costs; UVC, unit variable costs; Price, average revenue BREAK-EVEN OCCURS WHEN: TOTAL REVENUE=TOTAL COST Given: Price x Q = FC + VC = FC x (UVC x Q) Solve for Q (quantity) (Price × Q) – (UVC × Q) = FC Q(Price – UVC) = FC Q = FC/(Price-UVC) = FC / unit margin Solve for Q (quantity) (Price × Q) – (UVC × Q) = FC Q(Price – UVC) = FC Q = FC/(Price-UVC) = FC / unit margin 14-8

SCENARIO: What sales increase is needed to cover a $1.2 million increase in expenditures? MARGINAL ANALYSIS NR = $1.2 million + COGS NR = $1.2 million +.75 NR.25 NR = $1.2 million NR = $1.2 million /.25 NR = $4.8 million WHERE: COGS = 75% of Net Sales NR = New Revenue 14-9

Exhibit A PRICE INCREASE/DECREASE BY ONE CHANNEL MEMBER WILL IMPACT THE PRICE CHARGED BY SUBSEQUENT CHANNEL MEMBERS CALCULATING MARGIN CHAINS ASSUME: Given a new product selling for $10, what is the maximum factory price allowable? WHOLESALERDEALER Net Sales100%Net Sales100% COGS85%COGS70% Gross Profit15%Gross Profit30% Apply $10 dealer price Net Sales$7.00Net Sales$10.00 COGS5.95COGS7.00 Gross Profit$1.05Gross Profit$

Prices & Policies Strategy -- specific approach to achieve objectives –Attribute bundles and effect on buyer center Product-specific attributes Company-related attributes Salesperson-related attributes –Capitalize on unique strengths & market opportunities Channel Pricing –Intermediary prices, costs and margins –Channel margin management --Promotion, restrictions, push Vs pull

KEY DECISIONS IN MANAGING PRICE DETERMINE PRICING STRATEGY– Develop specific approach to achieve price objectives DETERMINE CHANNEL INTERMEDIARY PRICES, COSTS AND MARGINS DETERMINE SINGLE PRODUCT AND PRODUCT LINE PRICING Develop pricing structures for substitute and complementary products DETERMINE WHETHER TO PARTICIPATE IN BIDDING AND NEGOTIATION FOR SALES ESTABLISH A PRICING SYSTEM Based on the 4 C’s : Costs, Customers, Competitors, and Channels 14-12

Pricing Policies Product Line Pricing –Substitute product – based on relative benefits and price sensitivity of each target market –Complementary products – Price driver product low in order the penetrate market – negotiate on-going price contracts –Segmentation Pricing – Based on relative customer value –Product Life Cycle Issues – pricing new vs. old products

Other Issues Discounts –Cumulative vs. Non-cumulative Return or Breakage Allowance Leasing Co-op payments Trade show support Legal Issues –Robinson-Patman Act –Clayton and Sherman Antitrust Acts –Functional discounts – based on purchaser’s role in the supplier’s distribution system reflecting services performed for the supplier.

What Do You Need to Know Customer Price Sensitivity –Customer product perceptions & value –Value Mapping Criteria customers use to make purchase decision Weight of features in terms of importance List of competitors in market (customer perceptions) Rating of competitor products on features List actual prices for each competitor Calculate value position for each Plot each on value map George E. Cressman, Jr. “Snatching Defeat from the Jaws of Victory”, Marketing Management, Summer 1997.

What Do You Need to Know Firms Cost Structure –More fixed/less variable costs = lower prices –More variable/less fixed = raise price Competitor Strategies & Costs –Strategic Intent Which customer groups are “must win” Support for positioning and targeting How is price used –Capabilities & barriers

What Do You Need to Know –Likely Outcome -- compare strategic intent with capabilities & barriers –Impact on your firm Issues in Strategies and Costs –High-fixed cost industries Focus on capacity utilization Price cuts will generate retaliation –Price insensitive markets Price is an estimator of value -- when customer finds it difficult to forecast quality

Adjustments to Base Price Many pricing decisions involve an adjustment to the price of an existing product or service. A change in price should be judged in terms of its effects on short or long-term profits rather than sales volume (an outdated decision production rule).

Dollars per square yard Linoleum Price to Retailer How Pricing Tactics Create a Price Range Price Range Dealer list price Order size discount Competitive discount Invoice price Payment terms discount Annual volume bonus Off-invoice promotions Co-op advertising FreightPocket price Source: Robert L. Rosielli, “Managing Price, Gaining Profit,” Harvard Business Review, September/October 1992, 86. $0.10 $0.12 $5.78 $0.30 $0.37 $0.35 $0.20 $0.09 $ % off invoice $6.00

Price Tactics that Create a Price Schedule/Range Price discriminate against slow payers. Price discriminate for volume purchases Price discriminate by tying purchases Price discriminate to different usage/benefit segments Price discriminate against a usage time Price discriminate against distant user

ROBINSON-PATMAN ACT VIOLATIONS OCCUR: 1.When different prices are charged to competitors; 2.The differences are not attributable to cost differences; 3.The product is essentially the same for each competitor; 4.The effects are damaging to competition 14-21

LEVERAGE FOR A GLOBAL PRICING CONTRACT These products or services are a significant portion of customer’s purchases. Local markets are reasonably homogeneous. Customer’s top management is omitted. Customer seeks value enhancement more than cost cutting. Supplier has good working relationships not just at HQ, but with the company’s country managers. Customer and supplier have some implementation experience with global strategies played out at local levels. Exhibit

Medicus Major Sells small medical instruments & supplies Uses national distributor -- Galax –50% of sales to large hospitals –50% to dealers who sell to small hospitals and clinics Discount structure –Small hospitals & clinics -- pay list price –Large hospitals -- 12% discount off list –Wholesalers -- 40% discount –Dealers -- 20% discount

Questions If Medicus’s price is $4 what is the COGS for Glaxa What increase in sales must Galax produce to cover new debt service costs of $185, 000 per year for its truck fleet expansion? To enhance coverage of the Southern states, Medicus is considering adding a wholesaler, Dixie Supply, who has made acquisitions to establish a national presence –What are the possible consequences on Prices- Channel functions Channel margins