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Seller Pricing Strategies: a Buyer's Perspective Seller Pricing Strategies: A Buyer’s Perspective By David V. Lamm and Lawrence C. Vose David V. Lamm is Associate Understanding pricing strategies used by sellers is Professor of Administrative extremely important to a successful buyer. Several key Sciences at the Naval variables can be identified and evaluated in determining Postgraduate School in the seller’s pricing strategy and the conditions under which Monterey, California. He it was developed. Knowing how to recognize these specializes in the fields of variables and integrate them into the buying process Is a acquisition, contracting, challenging and demanding effort. The motivated buyer project management, and constantly hones his or her skills In this area, attempting to logistics. Dr. Lamm earned obtain the most advantageous business arrangement for the his D.B.A. degree at the organization. George Washington This article Identifies various seller pricing strategies University. and the principal variables involved in their analysis. The strategies and variables examined should significantly Lawrence C. Vose is assist buyers in preparing for the buying task. currently on active duty in the Coast Guard. He holds In the institutional, industrial, and governmental buying an M.S. degree in process, successful contract negotiation requires management from the Naval knowledge and understanding of several key elements. Postgraduate School. The seller’s pricing strategy is one of these. A perceptive Lieutenant Vose’s principal buyer continually explores the factors that contribute to the specialty is acquisition and development of a seller’s pricing strategy, in an effort to contracting management. determine what he or she might do differently by understanding the strategy. In preparing for contract negotiations, many buyers typically devote only modest attention to this area because it is one of the most difficult in which to obtain valid data. It involves confidential and proprietary management information. Regardless of the difficulty, effective buyers must be aware of the types of pricing strategies sellers are likely to employ, the conditions under which these strategies generally surface, and the significance of this knowledge in the buying process. This article identifies some of the more common pricing strategies and the principal variables that contribute to the development of the strategy. It concludes with an analysis of the usefulness of this information to the buyer. PRICING STRATEGIES Copyright November 1988 by thew National Association of Pricing strategies exist because, for many hidden as well Purchasing Management, Inc. as obvious reasons, a seller’s quoted prices are often very dif- ferent from the prices it actually gets. The following a seller cuffing a deal with a buyer at a “certain” price approaches are commonly used in determining price: because of “certain” conditions. If it became public, other buyers would want deals similar to this most favored Cost-Plus (Penetration) Pricing customer regardless of the economic or financial health of Demand (Skimming) Pricing the seller. The relationship between cost data and pricing Rule-of-Thumb (Myopic) Pricing decisions on a pragmatic level has received very little Buy-in (Foot-in-the-Door) Pricing attention as far as empirical research is concerned. This is not surprising in that it concerns very sensitive questions 7 Cost-Plus pricing has appeal because it is a logical way that firms are generally unwilling to answer. to determine a minimum acceptable price. Although cost is not always a good direct determinant of price, firms PRICING VARIABLES must price their products at a level that at least recovers operating costs over time.’ This takes on special Sellers consider many factors in determining a pricing significance in new product pricing where a variation strategy. One useful approach categorizes these as 8 known as “penetration pricing strategy” is used. Greer intrinsic and extrinsic factors. Intrinsic factors are the defines penetration pricing as a method to diffuse the baseline needs, such as costs, product characteristics, and appeal of the product rapidly through low initial pricing; soon, and the regulatory system which places limitations 9 then, once the market is “penetrated” to take ad-vantage on how those needs can be met. Extrinsic factors are of cost reductions and/or price increases to generate related to the economic and operating environment of a profits.2 This strategy is also aimed at discouraging procurement, including product differentiation, demand, 10 would-be competitors from entering the market due to and the number of firms involved. apparently low profit margins. The buyer’s problem The following discussion explores what are considered becomes one of determining what cost the seller is using to be the most identifiable and significant variables that to price the product. contribute to a seller’s pricing strategy in terms of both Demand pricing can be viewed as “charging as much external and internal variables. as the market will bear.” It is based on economic theory which focuses on the concept of the industry and the External Variables finn’s demand curves. A variation of this strategy, Variables in this category can be grouped as: (1) the applicable to the introduction of new technology or nature of the product, (2) market characteristics, and (3) innovation in the marketplace, is known as “skimming the the buyer’s control variables. cream.”3 The “skimming” strategy involves high initial Nature of the product. The most significant aspects of pricing in an attempt to achieve an almost instantaneous this element of pricing strategy are the maturity, or stage return on investment.4 The obvious risks are that the seller of the product in its life cycle, and the degree of invites competition, that it may not be able to sell as much differentiation inherent in the product. Pioneering as it would like at a high price, and that it may alienate products offer a much greater flexibility in pricing potential buyers by the apparent profiteering. strategy than do products in their prime or beyond. The Rule-of-Thumb pricing is a middle of the road pricing implications are that a buyer can expect a higher strategy. Two general approaches to this strategy include: probability of the existence of a demand (skimming) (1) a leader-follower concept, allowing competitors to set pricing strategy because of the lack of competition, the prices and then following suit, and (2) a more traditional lack of product cost history, and other similar factors that pricing formula such as direct material and labor costs accompany new product introduction. plus 40 percent. It is generally considered conservative The degree of innovativeness or differentiation can be and safe by those who use it, often because it has worked very significant, assuming that a seller in fact is in the past. The Rule-of-Thumb approach greatly distinguished from competitors and that this simplifies the pricing problem. It is a way of coping with differentiation is aligned with a buyer’s desires. (by essentially ignoring) uncertainties in the estimation of Technological innovation may lead to significant cost demand function shapes and elasticities.5 For the buyer, it advantages and the opportunity for a penetration strategy may be much easier to understand and to apply. in cases where a seller capitalizes on the opportunity to The “Buy-In” strategy is a short-term approach based deter the entry of competitors. On the other hand, a buyer on other than normal cost recovery or profit motives. It might anticipate a skimming strategy if a particular involves pricing to recover variable costs and perhaps product attribute is able to command a premium price some fixed costs to the extent that a low enough price is well above the marginal cost of providing it. Other offered to beat the competition. In a different form, this controlling elements are differential advantages in (1) strategy meets the conditions of a depressed market. One quality and superiority—the degree to which a seller analyst states that “companies neither record nor markets products that meet customer needs better than generally talk about all the ‘under the table’ prices and competing products; (2) customer impact and features— other valuable concessions they make when the market is products that have a major impact on buyer sluggish.”6 Normal business practice finds behavior, allow buyer cost reductions, and offer unique “fair” profit return determination. Market newness features; and (3) product fit and focus—the degree to exploits the differences between fresh and existing which a seller’s products are similar to existing products markets, frequently creating distinctly different pricing in use, have similar end uses, fit in an existing product strategies. The effect of market segmentation is the line, and are closely related to each other. ability to sell to buyers in different markets at different The scarcity of a needed product or material may also prices, with no significant repercussions. What really influence pricing strategy significantly. For example, a determines segmentation sensitivity is not the number and buyer might require a product using a scarce material similarity of available substitutes but individual buyer’s that is subject to fluctuations in price and availability. perceptions about these things.14 If a selling firm believes The buyer should be very cautious if he or she detects a that a buyer may not be aware of competing products
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