Pricing Decisions in Industrial Marketing

Product-Mix Pricing

Price- setting logic has to be modified when the product is part of a product  mix. In this case, the firm searches for a set of prices that maximizes profits on  the total product mix. Pricing is difficult because the products have demand and  cost interrelationships and are subject to Product-Line Pricing. Companies  normally develop product lines rather than single products.

  1. Two-Part Pricing. Service firms often charge a fixed fee plus a variable usage fee.  Thus telephone users pay a minimum monthly fee plus charges for calls beyond  the minimum number. Amusement parks charge an admission fee plus fees for  rides over a certain minimum. The service firm faces a problem similar to  adaptive product  pricing, namely, how much to charge for the basic service and how  much for the variable usage. The fixed fee should be low enough to induce  purchase of the service, and the profit can be made on the usage fees.
  2. Byproduct Pricing. In producing processed meats, petroleum products, and other  chemicals, there are often byproducts. If the byproducts have little value and are  in fact costly to dispose of, that will affect the pricing of the main product. The  manufacturer should accept any price that covers more than the cost of  disposing of them. If the byproducts have value to a customer group, then they  should be priced on their value. Any income earned on the byproducts will make  it easier for the company to charge a lower price on its main product if forced to  by competition.
  3. Product-Bundling Pricing. Sellers will often bundle their products at a set  price. Thus an auto manufacturer might offer an option package at less than the  cost of buying all the options separately. A theater company will price a season  subscription at less than the cost of buying all the performances separately. Since customers may not have planned to buy all of the components, the savings on the  price bundle must be substantial enough to induce them to buy the bundle.  Some customers will want less than the whole bundle. Suppose a medical  equipment supplier’s offer includes free delivery and training. A particular  customer might ask to forego the free delivery and training in order to get a  lower price. The customer is asking the seller to “unbundle” its offer. The  seller could actually increase its profit through unbundling if it saves more in  cost than the price reduction that it offers to the customer for the particular  items which are eliminated. Thus, if the supplier saves $100 by not supplying  delivery and it reduces the customer’s price by $80, for example, the supplier has  increased its profit by $20.

Responses  to Price Changes

After developing their pricing strategies, companies will face situations  where they may need to cut or raise prices.

Initiating Price Cuts

Several circumstances might lead a firm to cut its  price. One circumstance is excess capacity. Here the firm needs additional  business and cannot generate it through increased sales effort, product  improvement, or other measures. It may abandon “follow-the-leader” pricing and  resort to “aggressive” pricing to boost its sales. But in initiating a price cut, the  company might trigger a price war, as competitors try to hold on to their market  shares.  Another circumstance is a declining market share.  Companies will also initiate price cuts in a drive to dominate the market  through lower costs. Either the company starts with lower costs than its  competitors or it initiates price cuts in the hope of gaining market share,  which would lead to falling costs through larger volume and more experience.  People Express waged an aggressive low-price strategy and gained a large  market share. But this strategy also involves high risks.

  1. Low-Quality Trap. Consumers will assume that the quality is below that  of the higher-priced competitors.
  2. Fragile-Market-Share Trap. A low price buys market share but not  market loyalty. Customers will shift to another lower-price firm that comes along.
  3. Shallow-Pockets Trap. The higher-priced competitors may cut their  prices and may have longer staying power because of deeper cash reserves.

People Express some years later fell into these traps.. Companies may have to  cut their prices in a period of economic recession. Fewer consumers are  willing to buy higher-price versions of a product.

Initiating Price Increases

Many companies need to raise their prices. A  successful price increase can increase profits considerably.  A major circumstance provoking price increases is cost inflation. Rising  costs unmatched by productivity gains squeeze profit margins and lead  companies to regular rounds of price increases. Companies often raise their  prices by more than the cost increase in anticipation of further inflation or  government price controls; this is called anticipatory pricing. Companies  hesitate to make long-run price commitments to customers, fearing that cost  inflation will erode their profit margins.  Another factor leading to price increases is over demand. When a  company cannot supply all of its customers, it can raise its prices, put customers on  allocation, or both. The “real” price can be increased in several ways, each  with a different impact on buyers.

The price increase should be accompanied by company communications  explaining why price are being increased. The company’s sales force should  help customers find ways to economize.  There are other ways that the company can respond to high costs  demand without raising prices. The possibilities include the following:

  1. Shrinking the amount of product instead of raising the price.
  2. Substituting less-expensive materials or ingredients.
  3. Reducing or removing product features to reduce cost.
  4. Removing or reducing product services, such as installation, free  delivery, or long warranties.
  5. Using less-expensive packaging material or reducing larger  package sizes to keep down packaging cost.
  6. Reducing the number of sizes and models offered.
  7. Creating new economy brands.

The best action to take is not always obvious. Quaker Oats produces the  successful cereal/called Quaker Oats Natural, which contains several  ingredients, such as almonds and raisins, whose prices jumped during the recent  inflation. Quaker Oats saw two choices, namely, raising the price, or cost reducing  the ingredients by including fewer almonds and raisins, or finding  cheaper substitutes. It decided against changing the ingredients and raised the  price. But the price elasticity was high, and sales fell. This forced the company  to reconsider ways to cost-reduce the ingredients, knowing that such a move  also involves a risk.

Customers Reactions to Price Changes

Any price change can affect customers, competitors, distributors, and  suppliers and may provoke government reaction as well. Here we will consider  customers reactions.  Customers do not always put a straightforward interpretation on price  changes.

A price cut can be interpreted in the following ways:

  • The item is  about to be replaced by a new model;
  • The item is faulty and is not selling well;
  • The firm is in financial trouble and may not stay in business to supply future  pacts;
  • The price will come down even further, and it pays to wait; or
  • The quality  has been reduced.

A price increase, which would normally deter sales, may carry some positive  meanings to customer :

  • The item is “hot” and might be unobtainable unless it is  bought soon;
  • The item represents an unusually good value; or
  • The seller is greedy  and is taking advantage of customers.

Customers are most price sensitive to products that cost a lot and/or are  fought frequently, whereas they hardly notice higher prices on low-cost items that  they buy infrequently. In addition, some buyers are less concerned with  the product’s price than the total costs of obtaining, operating, and servicing the  product over lifetime. A seller can charge more than competitors and still get the  business if the customer can be convinced that the total lifetime  costs are lower.

Competitors Reactions to Price Changes

A firm contemplating a price change has to worry about competitors as  well as customers reactions. Competitors are most likely to react where the  number of firms is small, the product is homogeneous, and the buyers are highly  informed. How can the firm anticipate the likely reactions of its competitors?  Assume that the firm faces one large competitor. The competitor’s reaction can  be estimated from two vantage points. One is to assume that the competitor reacts  in a set way to price changes. In this case, its reaction can be anticipate. The other  is to assume that the competitor treats each price change as a fresh challenge  and reacts according to self-interest at the time. In this case, the company  will have to figure out what lies in the competitor’s self-interest. The  competitor’s current financial situation should be researched, along with recent  sales and capacity, customer loyalty, and corporate objectives. If the  competitor has a market-share objective, it is likely to match the price change. If  it has a profit-maximization objective, it may react on some other strategy front,  such as increasing; the advertising budget or improving the product quality.

The challenge is to read the competitor’s mind by using inside and outside  sources of information.  The problem is complicated because the competitor can put different  interpretations on, say, a company price cut. The competitor can surmise that  the company is trying to steal the market, that the company is doing poorly  and trying to boost its sales, or that the company wants the whole industry to  reduce prices to stimulate total demand.  When there are several competitors, the company must estimate each close  competitor’s likely reaction. If all competitors behave alike, this estimate amounts  to an analysis of atypical competitor. If the competitors do not react uniformly  because of critical differences in size, market shares, or policies, then separate  analyses are necessary. If some competitors will match the price change, there is  good reason to expect that the rest will also match it.

Leave a Reply

Your email address will not be published. Required fields are marked *