1. 1 2002 Edition Vitale and Giglierano Chapter 10 Pricing in Business-to-Business Marketing Prepared by John T. Drea, Western Illinois University

2. 2 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 supplier’s offerings.

3. 3 Exhibit 10-1 Components of the Offering

4. 4 Cost-Based Pricing Price is set by calculating the cost of an offering, then adding a standard percentage profit. Value-Based Pricing Price is set based on perceived customer value. Cost-Based vs. Value-Based Pricing Cost-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 offering’s worth. Value-Based Price Issues More difficult to implement than cost-based pricing. Need to establish the evaluated price (the price of the offering from the customer’s perspective after all costs associated with the offering are evaluated).

5. 5 Maximum Price The highest price a supplier can charge for a product or service 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. Minimum Price The price that covers the supplier’s relevant costs

6. 6 Exhibit 10-3 Customer’s Perception of Value and Evaluated Price

7. 7 Value-Cost Model of Pricing Need to analyze what activities subtract the most from each customer’s profitability. At the same time, we need to analyze how important a product is to the customer’s creation of value. This indicates what each buyer can afford and how sensitive the customer is likely to be to price changes.

8. 8 Exhibit 10-4a Value-Cost Model for Analyzing Customers Management and infrastructure…. Value score:FC% Technology development………… Value score:FC% Other overhead……………………. Value score:FC% Delivery & customer Supply service SalesMarketing Operations logistics Materials Value Value Value score: score: score: VC% VC% VC% FC% FC% FC% Value score: Contribution to value for customer’s customer 1 = Key component, 2 = Significant component, 3 = Minor component Cost percentage = Percentage of fixed costs (FC) or variable costs (VC)

9. 9 Exhibit 10-4b Value-Cost Model for Analyzing Customers Management and infrastructure…. Value score:1FC% 15% Technology development………… Value score:3FC% 5% Other overhead……………………. Value score:3FC% 20% Delivery & customer Supply service SalesMarketing Operations logistics Materials Value Value Value score: 1 score: 3 score: 3 score: 1 score: 2 score: 3 VC% 10% VC% 0% VC% 0% VC% 70% VC% 10% VC% 10% FC% 25% FC% 10% FC% 5% FC% 20% FC% 0% FC% 0% Value score: Contribution to value for customer’s customer 1 = Key component, 2 = Significant component, 3 = Minor component Cost percentage = Percentage of fixed costs (FC) or variable costs (VC)

10. 10 Exhibit 10-5 Maximum and Minimum Price

11. 11 Exhibit 10-6 Effect of Price Reductions on Cost Coverage

12. 12 Exhibit 10-7 Demand and Supply Curves

13. 13 Relevant Costs must meet the following four criteria ResultantCostsAvoidableCostsForward-lookingIncrementalCostsRealizedCosts

14. 14 Relevant Costs: On-going revenues must pay for on-going costs ResultantCosts Costs that result from the decision RealizedCosts Actual costs incurred Forward-lookingIncrementalCosts Costs that will be incurred for the next units of product sold when the decision is implemented AvoidableCosts Costs that would not be incurred if the decision were not made to launch the offering.

15. 15 Lessons to be learned on the economic fundamentals of price Lesson 1 : D emand 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.

16. 16 Several Marketing Objectives Addressed by Pricing Strategic PurposesStrategic 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 PurposesTactical 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

17. 17 Introductory Pricing Strategies PenetrationPricing 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. PriceSkimming 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.

18. 18 Introductory Pricing Strategies PenetrationPricing 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 PriceSkimming Conditions for penetration: Market must be price sensitive Production and distribution costs must fall as volume increases (economies of scale)

19. 19 Managing Pricing Tactics Bundling Selling several products and/or services together as one Discounts & Allowances Reductions in price for a special reason (but some customers can get hooked on them!) Competitive Bidding Sealed bids involve private bids by potential suppliers. In open bids, competitors see each others bids. Initiating Price Changes Need to react and change marketing activities as events unfold, such as changes by competitors or customers.

20. 20 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

21. 21 Exhibit 10-9 Hypothetical Example of Profit Expectations in a Competitive Bidding Situation CostBidProfit Prob. of Winning Bid Expected Profit $20,000 $0.2$0 $20,000$22,000$2,000.5$1,000 $20,000$24,000$4,000.7$2,800 $20,000$26,000$6,000.5$3,000 $20,000$28,000$8,000.4$3,200 $20,000$30,000$10,000.3$3,000 $20,000$32,000$12,000.2$2,400

22. 22 Exhibit 10-10 Effect of an Industry Increase in Costs

23. 23 Exhibit 10-11 Two Types of Negotiating Situations in B2B Sales Situation Stand-alone Transaction Balanced between Transaction and Relationship Effective bargaining styles Competitive; Problem solving Problem solving; Compromising Effective approach Use of leverage Seek common interests

24. 24 Preparation in negotiation is key Know your customers’ needs and their relative importance. Know the price range anticipated by the customer. Know who has the authority to make a final decision. 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

25. 25 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 on- line auctions – this is good for commodities, but can minimize relationships for other products.