Cost-Benefit Analysis in Industrial Pricing

To formulate an appropriate industrial pricing strategy it is very essential to have an analysis of the costs and benefits of the industrial product from the customer’s point of view.

The benefits can be grouped into soft and hard benefits. Soft benefits includes those benefits which are very difficult to assess, such as customer training, warranty period, customer services, company reputation etc. Hard benefits are the physical attributes of the products such as production rate of machine, rejection rate of component and price/performance ratio.

The costs for an industrial customer mean price plus other expenses that are incurred in purchasing and using the product. For example, the cost of a new oil refinery machine purchased by oil mill includes price, freight, installation, energy usage, repair and maintenance. The cost of production stoppage due to failure of machine may also be included while calculating the machine cost though it is difficult to estimate such cost accurately. The life cycle costing concept can be used by the industrial buyer at the time of purchasing the capital items and estimate the total cost of the product over its life span. Life cycle costing takes into consideration the price, freight, transit insurance, maintenance’s, energy, material and labor costs over the useful life of the product.

The industrial marketer should evaluate the possible cost/benefit trade-off decisions made by the industrial buyer. If the quantum of discount offered by industrial marketer as an incentive for purchase of large stock can be considered by the industrial buyer if the quantum of discount is more then the cost of carrying the inventory. The understanding of cost-benefit analysis in industrial pricing will enable the marketer to set an appropriate price.

Cost Analysis in Industrial Pricing

Pricing strategy or decision of a company must consider the costs involved. Generally the total cost consists of the variable cost and fixed costs for a given level of out put. Some of the cost elements vary over a period of time; other cost elements fluctuate with volume. The cost data are relevant to the pricing decisions. The industrial marketer must identify and classify the cost for making profitable pricing decisions. The classification of costs and their description is given in the following table for the better understanding of the cost concept.

Classification of Costs/Types of Costs

  1. Fixed costs: Costs that do not vary with production or sales. Examples are rent, interest charges, and managerial salaries. Fixed costs or overheads are incurred irrespective of production levels or sales volume.
  2. Variable costs: Costs that vary in direct proportion to the levels of production. Examples are raw materials and direct labour costs. They are called variable because the total variable cost varies with the number of units produced.
  3. Total costs: Sum of the fixed and variable costs for any given level of production are called fixed costs.
  4. Semi variable costs: Costs that vary with changes in output but not in direct proportion to quantities produced. Examples are equipment repair and  maintenance costs. Semi variable costs have components of both fixed and variable costs.
  5. Direct costs: Fixed or variable costs that are incurred directly for a specific product or sales territory. Examples are selling expenses, freight and raw material.
  6. Indirect costs: Fixed or variable costs that can be traced indirectly to sales territory or a product. Examples are production overhead and quality control that are indirectly assigned to a product.
  7. Allocated costs: Costs that support a number of activities but cannot be objectively assigned to a specific product or a market. Theses costs are usually allocated across business groups or divisions by some arbitrary criterion. Examples are administrative overhead and corporate advertising.

About Abey Francis

Abey Francis is the founder of MBAKnol - A Blog about Management Theories and Practices - and he's always happy to share his passion for innovative management practices. You can found him on Google+ and Facebook. If you’d like to reach him, send him an email to: [email protected]
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