Pricing Decisions in Industrial Marketing

Price still remains one of the most important elements determining  company market share and profitability. Generally, prices were set by buyers and  sellers negotiating with each other. Setting one price for all buyers is a relatively  modern idea. Price is the only element in the marketing mix that produces  revenue. Price is also one of the most flexible elements of the marketing mix.  At the same time, pricing and price competition are the number-one  problems faced by many marketing executives. Yet many companies do not  handle pricing well. The most common mistakes are these: Pricing is too cost  oriented; price is not revised often enough to capitalize on market changes; price  is set independent of the rest of the marketing mix rather than as an intrinsic  element of market-positioning strategy; and price is not varied enough for  different product items, market segments, and purchase occasions.

pricing decision in industrial markets

Pricing Decisions in Industrial Marketing

Companies handle pricing in a variety of ways. In small companies, prices  are often set by top management rather than by marketing or salespeople. In large  companies, pricing is typically handled by division and production managers. Top  management sets the general pricing objective and policies and often  approves the prices proposed by lower levels of management. In industries  where pricing is a key factor (aerospace, railroads, oil companies), companies will often  establish a pricing department to set prices or assist others in determining appropriate  prices. This department reports either to the marketing department, finance  department, or top management. Others who exert an influence on pricing include  sales managers, production managers, finance managers, and accountants.

Now let us examine three questions:

  1. How should a price be set on a  product or service for the first time?
  2. How should the price be adapted over  time and space to meet varying circumstances and opportunities?
  3. When  should the company initiate a price change, and how should it respond to a  competitor’s price change?

Setting the Price

Pricing is a problem when a firm has to set a price for the first time. This  happens when the firm develops or acquires a new product, when it introduces  its regular product into a new distribution channel or geographical area, and  when it enters bids on new contract work.  The firm must decide where to position its product on quality and price. A  company can position its product in the middle of the market or at three levels  above or three levels below the middle.

Selecting the Pricing Objective

The company first has to decide what it wants to accomplish with the  particular product. If the company has selected its target market and market  positioning carefully, then its marketing-mix strategy, including price, will be  fairly straightforward. For example, if a recreational-vehicle company wants to  produce a luxurious truck camper for affluent customers, this implies charging  a high price. Thus pricing strategy is largely determined by the prior decision  on market positioning.

At the same time, the company might pursue additional objectives. The  clearer a firm’s objectives, the easier it is to set price. Each possible price will have  a different impact on such objectives as profits, sales revenue, and market share.  A company can pursue any of six major objectives through its pricing.

  1. Survival
  2. Maximum Current Profit
  3. Maximum Current Revenue
  4. Maximum Sales Growth
  5. Maximum Market Skimming
  6. Product-Quality Leadership

Factors Affecting Price Sensitivity

The demand curve shows the market’s purchase rate at alternative prices. It  sums the reactions of many individuals who have different price sensitivities. The  first step is to understand the factors that affect buyers’ sensitivity. Nagle has  identified nine factors:

  1. Unique-Value Effect. Buyers are less price sensitive when the product is more  unique.
  2. Substitute-Awareness Effect. Buyers are less price sensitive they are less aware of substitutes.
  3. Difficult-Comparison Effect. Buyers are less price sensitive with they cannot  easily compare the quality of substitutes.
  4. Total-Expenditure Effect. Buyers are less price sensitive the lower the  expenditure is to their income.
  5. End-Benefit Effect. Buyers are less price sensitive the lower the expenditure  is to the total cost of the end product.
  6. Shared-Cost Effect. Buyers are less price sensitive when part of the cost is  borne by another parry.
  7. Sunk-Investment Effect. Buyers are less price sensitive when the product is  used in conjunction with assets previously bought.
  8. Price-Quality Effect. Buyers are Jess price sensitive when the product is assumed  to have more quality, prestige, or exclusiveness.
  9. Inventory Effect. Buyers are less price sensitive when they cannot store the  product.

Selection of Pricing  Method

Given the three Cs–the customers demand schedule, the cost function,  and competitors prices–the company is now ready to select a price. The price  will be somewhere between one that is too low to produce a profit and one that is  too high to produce any demand. Customers’ assessment of unique product  features in the company’s offer establishes the ceiling price.  Companies resolve the pricing issue by selecting a pricing method that  includes one or more of these three considerations. The pricing methods will then lead to a specific price. We will examine the following price-setting methods: markup pricing, target-return pricing, perceived-value pricing, value  pricing, going-rate pricing, and sealed-bid pricing.

  1. Markup Pricing. The most elementary pricing method is to add a standard  markup to the product’s cost. Construction companies submit job bids by  estimating the total project cost and adding a standard markup for profit.  Lawyers, accountants, and other professionals typically price by adding a standard  markup to their costs. Some sellers tell their customers they will charge their  cost plus a specified markup; for example, aerospace companies price this way  to the government. Markups are generally higher on seasonal items (to cover  the risk of not selling), specialty items, slower moving items, items with high  storage and handling costs, and demand-inelastic items. Does the use of standard  markups to set prices make logical sense? Generally, no. Any pricing method  that ignores current demand, perceived value, and competition is not likely to  lead to the optimal price.
  2. Target-Return Pricing. The firm determines the price that would yield its  target rate of return on investment (ROI). This pricing  method is  used by public utilities that are constrained to make a fair return on their  investment.
  3. Perceived-Value Pricing. Companies are basing their price on the  product’s perceived value. They see the buyers’ perceptions of value, not the  seller’s cost, as the key to pricing. They use the non price variables in the  marketing mix to build up perceived value in the buyers’ minds. Price is set to  capture the perceived value.  The key to perceived-value pricing is to accurately determine the  market’s perception of the offer’s value. Sellers with an inflated view of their  offer’s value will overprice their product. Sellers with an underestimated view  will charge less than they could. Market research is needed to establish the  market’s perception of value as a guide to effective pricing.
  4. Value Pricing. In recent years, several companies have adopted value  pricing by which they charge a low price for a high-quality offering. Value  pricing is not the same as perceived-value pricing. The latter is really a “more  for more” pricing philosophy. It says that the company should price at a level  that captures what the buyer thinks the product is worth. Value pricing, on the  other hand, says that the price should represent an extraordinary bargain for  consumers. Value pricing is not a matter of simply setting lower prices on one’s  products compared to competitors. It is a matter of re-engineering the  company’s operations to truly become the low-cost producer without sacrificing  quality, and to lower one’s prices significantly in order to attract a large  number of value-conscious customers.
  5. Going Rate Pricing.  In going-rate pricing, the firm bases its price largely on competitors  prices with less attention paid to its own cost or demand. The firm might  charge the same, more, or less than its major competitor(s). In oligopolistic  industries that sell a commodity such as steel, paper, or fertilizer, firms normally  charge the same price. The smaller firms “follow the leader.” They change their  prices when the market leader’s prices change rather than when their own  demand or cost changes. Some firms may charge a slight premium or slight  discount, but they preserve the amount of difference. Going-rate pricing is quite popular. Where costs are difficult to measure or  competitive response is uncertain, firms feel that the going price represents a  good solution. The going price is thought to reflect the industry’s collective  wisdom as to the price that would yield a fair return and not jeopardize  industrial harmony.
  6. Sealed Bid Pricing.  Competitive-oriented pricing is common where firms bid for jobs. The firm  bases its price on expectations of how competitors will price rather than on a  rigid relation to the firm’s costs or demand. The firm wants to win the contract,  and winning normally requires submitting a lower price than competitors.  Yet the firm cannot set its price below a certain level. It cannot price  below cost without worsening its position. On the other hand, the higher it sets  its price above its costs, the lower its chance of getting the contract.

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