Industrial Pricing

• The objective is to help understand : 1. Characteristics of industrial pricing 2. Factors affecting industrial prices 3. Industrial pricing objectives/methods/approaches/policies 4. Leasing 5. New product pricing The Right Price

• Uniqueness of price in the marketing mix is that it is the only element that generates revenue, all other elements incur costs. • Right price is one of the important determinants of business success. • Price has to be consistent with other marketing mix elements and also has to be responsive to the demand. • Demand or competitive conditions sometimes make the absorption of full cost into price impossible. • Companies with specific objectives sometimes use price as a strategic variable to achieve the firm’s objective. Characteristics of Industrial Prices- 1 1. True price an industrial customer pays is different from the list price because of delivery & installation costs, discounts, training costs, trade- in-allowances, financing costs etc. 2. Price is not an independent variable. It is intertwined with product, promotion and distribution strategies. 3. Price of industrial goods cannot be set out without considering other products that are complements or substitutes sold by the company. 4. Industrial prices are established, in many cases, by competitive bidding on a project-by-project basis. Price resolutions through negotiations is very common. Characteristics of Industrial Prices- 2 5. Prices is often a more flexible decision area since it can be altered in numerous ways such as changing ¾ The quantity of goods and services, ¾ Premiums and discounts offered, ¾ Time and place of payment 6. Industrial pricing is often characterised by an emphasis on fairness. Industrial buyers are able to estimate vendors production costs and expect price increases to be justifiable. 7. Industrial prices are affected by a host of economic factors such as inflation, interest rate changes, exchange rate fluctuations etc. Factors Influencing Pricing Company/ Country Image

Competition Exchange Rate

Pricing Costs Decisions Experience Curve

Strategic Government Objectives Factors

Market Characteristics Factors Affecting Pricing-1

• Marketing Objectives – This is very important factor deciding the price. E.g. in case of market penetration, price charged is low. • Competition – Competitive environment affects the price. The severe the competition, lower the pricing freedom. • Firm Size – In many industries, dominant firms often set the price trends. • Product Type – Price competition is common in respect of products which are not amenable to differentiation and which are standardised. • Product Life Cycle – Pricing over PLC is different at different stages. • Price Leadership – It is, in essence, a tacit concurrence by major firms in the industry with the wisdom of leader’s pricing decision. Factors Affecting Pricing-2 • Product Differentiation – If the company’s product is highly differentiated compared to competition, or it has some strong unique features, the company has more freedom to manipulate the price. •Costs– The flexibility a firm can enjoy in pricing depends to a large extent on its cost efficiency. • Market Characteristics – Apart from competition, factors like demand trends, importance of the product to the business and trade margins are relevant to the pricing. • Exchange Rate – Fluctuations in the rate affect the the price of imported equipment and in turn the domestic prices. • Image – The price a firm may charge also depends on the image of the firm and the country. Poor quality image comes in the way of obtaining a better price. Factors Affecting Pricing-3 • Government Factors – Pricing is influenced by government policies and regulations. 1. Regulation of Margins – When these are dictated by government, marketers lose the pricing freedom. 2. Price Floors and Ceilings – These limits sometimes are dictated by government. 3. Subsidies – Enable the sellers to reduce the price without incurring the losses. 4. Taxes, Tax Concessions and Exemptions – Some sectors enjoy certain tax concessions which help them to lower the price. 5. Other Incentives – Like cheap credit, marketing assistance etc. also influence price. 6. Government Competition – Direct competition in the market affects pricing. 7. International Agreements – Prices of international commodities are controlled by quota agreements, buffer stocks etc. Pricing Objectives-1

• Market Penetration – A firm may attempt to penetrate market with a low price. • Market Share – Price may be manipulated to increase the market share. • Market Skimming – Product is introduced with high initial price to skim the cream. • Fighting Competition – A price reduction by competitor have to be countered by price cuts. • Preventing New Entry – Low price is set to deter competitors from entering the market. • Shorten Pay-back Period – When the market is uncertain, recouping the investment at the earliest is the objective. Pricing Objectives-2 • Early Cash Recovery – A firm with liquidity problem may give priority to generate a better cash flow. • Meeting Export Obligation – To meet specific export obligations, a company may even imply price lower than the cost. • Disposal of Surplus – Confronted with surplus stock, company may force to dispose surplus at any price. • Optimum Capacity Utilisation – In such case, achieving required quantity of exports is the objective. • Return of Investment – Achieving target rate of return is the most important pricing objective. • Profit Maximisation – Many times profit maximisation is the primary pricing objective. Costs in Industrial Pricing • Types of costs in Industrial Marketing : 1. Production costs – These are two types namely - ¾ Fixed costs – a. costs which remain fixed irrespective of level of production, like investment in land, building and plant and machinery. b. It is the cost which remains same over a range of output. c. As the production increases, the average fixed cost per unit falls. ¾ Variable costs – These are costs which vary with the variation in the level of output and includes labour and material costs. 2. Selling and delivery costs – Includes cost of holding stocks, packing, transport, documentation, inspection, advertising, personal selling etc. Fixed, Variable and Total Costs

Total Cost

Total Variable Cost Total Variable Cost

Costs Fixed Cost

Total FixedTotal FixedCost Cost

Production Pricing Methods/Approaches Cost Based Pricing • Cost based pricing, also known as cost plus pricing, is a common method of pricing. • Price=[fixed cost+variable cost+ overheads +marketing cost] + specified %age of total costs • Advantages of the cost plus pricing are : 1. Covers all the costs 2. Designed to provide target rate of margin 3. Generally, a rational and widely accepted method 4. Easy to comprehend and simple method ƒ Disadvantages are : 1. Cost calculations are based on predetermined level of activity. Variations in the activity will vary the costs rendering this method unrealistic. 2. Ignores the price elasticity of demand. 3. Imparts an in-built inflexibility to pricing decisions 4. Opportunity to charge a high price is foregone. 5. Is not helpful in to tasks like market penetration, fighting competition. Pricing Methods/Approaches Market Oriented Pricing • A very flexible policy in the sense that it allows the prices to be charged in accordance with the changes in the market conditions. • Referred to as what the traffic will bear method. • Advantages are : 1. Very flexible policy 2. Price is based on market conditions 3. When the PLC is expected to be short, this policy will enable the firm to recoup the investment fast. ƒ Disadvantages are : 1. Difficult to estimate what the traffic will bear 2. There is a chance of ignoring elasticity of demand 3. If what traffic can bear in one market is lower than what it is in another, it could lead to development of grey market. Pricing Methods/Approaches Following Competitors Pricing • Important alternative ways of this policy are : 1. Setting the price at same level as of competitor 2. Setting the price below that of competitor 3. Pricing higher than that of competitor’s ƒ Advantage of this method are : 1. It is a very simple method 2. It follows the main market trends 3. It has relevance to competitive standing of the firm ƒ Disadvantage and limitations are : 1. If competitor’s price decisions are unrealistic, the follower will also go wrong on the price 2. Cost factors of follower may not be similar to competitor’s 3. Pricing objective of firm may be different from competitor’s 4. Sometimes competitor may initiate price changes for wrong reasons Pricing Methods/Approaches • Negotiated Prices Method – Deciding price by negotiations between the seller and the buyer is common. – Major advantage of deciding price by negotiation is its great flexibility and the opportunity to put across and understand the points of both the buyer and seller. – Major disadvantage is that getting the good price is dependent on the bargaining power of the seller. • Customer Determined Price Method – In a number of cases, buyer specifies price at which he is prepared to buy the product. – Acceptance of buyer’s quotation will depend upon seller’s cost structure, business conditions, objectives etc. Pricing Methods/Approaches Breakeven Pricing • Breakeven price is the price for a given level of output (known as breakeven point or BEP) at which there is neither any loss nor profit. • If the total costs of production and selling a particular quantity of product is divided by that quantity, the resultant is the breakeven price. • Difference between BEP and the expected capacity utilisation (which is higher than BEP) is the margin of safety. • Lower the BEP, higher is the chance of project making profit lower is the risk of incurring loss. If the BEP is very high, risk also will be very high. Break-even Chart • The break-even chart is the graph portraying the likely profits or losses at different levels of output. 40

s le 30 Sa t Profi

20 sts l Co Tota Variable Costs 10 s Costs/Sales Revenue Costs/Sales os L Fixed Costs

0 0 10 20 30 40 50 60 70 80 90 100 Costs/Sales Revenue Marginal Cost Pricing • Marginal cost pricing approach is common in evaluating profitability of new orders in case of firms with excess (i.e. idle) capacity. • The relevant cost considered for pricing is the variable cost, the fixed cost is excluded from the calculation of the product cost. • An order which may appears to be unprofitable by adopting full cost approach (i.e. both fixed and variable cost) may appear to be profitable with marginal cost approach. • Key to marginal costing is to view home sales and export sales as separate compartments and to consider export sales as extra sales. This policy can also apply to different market segments. Creative Pricing • Marginal costing may give scope for creative pricing. • It means taking advantage of the flexibility between the lower limit of break-even price and the upper limit of competitor’s price for similar product. • Advantages : 1. When idle capacity exists, marginal costing is a realistic approach to evaluating an export order. 2. It will make\489 the firm more price competitive and help the firm in market penetration+ 3. When fixed costs are recouped from domestic operation, exporting can increase total profits if price is higher than marginal cost. ƒ Disadvantages are : 1. Normally advisable only when idle capacity exists 2. Has limitations in applying to solely export-oriented units 3. Low price, once established, is difficult to increase later. 4. If the proportion of variable cost is very high, there is not very significant gap between marginal and full cost. Break-Even Points © Full Costing & (E) Marginal Costing

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D 200 sts Co tal To 150 Variable Costs (Domestic Market) 100 E

50 Variable Costs (Export) 0 0 10 20 30 40 50 60 70 80 90 100 UNITS Competitive Bidding Approach • This method covers a large promotion of business marketing and very common with government departments. 1. Closed (sealed) Bidding – In this case, potential supplier submits written proposal in a sealed cover and all the bids are opened at specified date and time, often in the presence of all the bidders. Supplier with the lowest bid is normally selected. 2. Open Bidding – Potential bidders submit open bids within specified time and buyer is free to examine and discuss with the buyers. 3. Informal Bidding – It is characterised by absence of formalities in inviting offers. Price Negotiation Approach • Determining the price by negotiation between buyer and seller is common in business marketing, particularly in complex buying situations. • In this sense, negotiation and open bidding are virtually synonymous. • Gains to the negotiating parties will depend on their negotiating skills. Strategies involved are : 1. Buyer and seller have a close match of strengths and will negotiate price fair to both parties. 2. Dictatorial strategy where buyer is weak relative to seller and price most favourable to seller is attempted. 3. Defensive strategy where seller is weak relative to buyer. 4. Gamesmanship strategy where both parties are weak and will play “hide and seek” to arrive at the price. New Product Pricing • Pricing new product is a very difficult thing and could contribute significantly to success or failure of a new product. 1. Price Skimming – This strategy is a form of price discrimination over time rather than over price and is justified when : ¾ There is sizable demand for the product at the high price. ¾ The aggregate margin on small volume at the high price is higher than those on the large volume at lower price. ¾ There is strong entry barrier that prevents competition. 2. Penetration Policy – This strategy is to tap the whole market quickly with low price and is justified when : ¾ The market is very price elastic-low price generates large demand. ¾ Most of the customers are prepared to adopt new product quickly. ¾ There are substantial economies of scale ¾ No strong entry barriers and high prices will attract competitors Pricing Over the PLC • The pricing strategy may vary over the product life cycle since the supply & demand conditions and competitive situations would be different at different stages of PLC. • Introductory and Market Development stage: Options are price skimming or price penetration. But the market, competition, demand etc. indicate the complexities of introductory pricing. • Rapid growth stage would witness emergence of price segmentation. Scale economies, experience curve benefit facilitate price reduction. • Cumulative Turbulence characterises intense price competition. Price leadership often cause to exist small firms thus increasing market share. • Maturity or Saturation stage witnesses price reductions to the extent of squeezing profits. • Decline stage offers a number of pricing opportunities such as cutting the price to break-even level, use the product as loss leader to sell other complementary products. Pricing Policies-Discount Pricing It refers to difference between list price and the net price. 1. Trade Discounts- This is the discount given to marketing middlemen. Also called as functional discount related to their specific function. 2. Quantity Discounts- These are based on the quantity of purchase and are cumulative discounts based on total purchase or non- cumulative on order-to-order basis. 3. Seasonal Discounts- These aim at increasing sales during off-season and smoothen inventory. 4. Cash Discounts- This is an incentive for early payment. Pricing Policies-Geographic Pricing • Geographic price refers to the location at which the price is applicable i.e. factory gate, customer’s location or some other location. • Important geographic pricing strategies are: 1. FOB factory- When goods are shipped free on board (f.o.b.) factory terms, buyer bears the cost of all transportation to the factory. 2. FOB Destination- In this case the selling price includes all the costs till the goods are delivered to buyer’s place. 3. Freight Equalisation- Here the supplier assumes a part of the freight and charges the balance to the buyer. 4. Basing Point- This is a form of freight equalisation under which price is quoted f.o.b. a basing point. 5. CIF- Under the cost, insurance and freight (c.i.f.) terms, exporter bears the costs and transportation of goods. Transfer Pricing • Transfer pricing or intra-company pricing refers to the pricing of goods transferred from one unit of the company to another one. Objectives are: 1. To maximise the profits of the company 2. To facilitate parent company control 3. To offer management at all levels an adequate basis for maintaining, developing and receiving credit for their own profitability. ƒ Four common arrangements for transfer pricing 1. Sales at the manufacturing cost plus standard markup. 2. Sales at the cost of most efficient producer in the company plus standard markup 3. Sales at the negotiated prices 4. Arm’s length sales using same prices as quoted to independent customers. ƒ Transfer Pricing, however, has become a controversial issue. Leasing-1 • Leasing is an arrangement between the leasing company (lessor) and the user (lessee), the former arranging to buy the equipment for the use of latter. • Lessee has to pay the lessor in the form of rentals and the lessor remains the owner of the equipment during the specified period. • Four types of leasing : 1. Operating lease- refers to short term lease of an asset for an hour, a day etc. 2. Financial lease- is for a basic term, determined by the life of the asset, during which the lease is non-cancelable. 3. Sale and lease back transaction- provides an arrangement by which an entity that owns an asset may sell it to the leasing company, and lease it back. 4. Leveraged lease- is similar to consortium financing where more than one lessors jointly acquire the asset and lease it to the lessee. Leasing-2 • Advantages of leasing : 1. Conserves cash flow by providing 100% finance and enables company to employ funds elsewhere. 2. Lease obligations are not reported as liabilities, whereas loan obligations must be recorded thus a company can report better debt-equity ratio. 3. Leasing facilities provide certainty and cash flow forecasts and budget controls can be accurate. 4. Leasing is a revenue expense and lease rentals are allowable expenditure under the income tax act. 5. Also offers additional cost recovery for contracts which allow rentals but not interest costs. 6. Paper work for leasing is far less than that required for banks or institution finance arrangements 7. Leasing facilities are more flexible. Rental schedules can be adjusted to accommodate special needs of lessee.