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Acknowledgement
Our group likes to thank Prof. Vinod Kalia for providing us opportunity to look deeper into B2B pricing
concepts. We would also like to thank our library portals where we find useful research papers and
books. Lastly I would also like to thank makers and providers of Microsoft Word as a wonderful tool to
express your ideas.
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What is pricing?
Pricing is the art of translating into quantitative terms the value of the product to customers at any
given point of time.
In this context- “value” is a quite subjective phenomenon. It is the value that the customer himself
realizes. It includes both tangible as well as intangible benefits. It may be “potential worth” of a product
to the customer. It might be the case that potential worth of a product is much greater than the value
he currently recognizes. He may not realize all the benefits of the product. He may not be
knowledgeable about various ways in which he can use the product.
Hence all the tangible and intangible benefits are part of product package to customer and customer
attach a value to it.
From seller’s point of view, price not only determines profitability of product, but also the cost
associated with product offering such as technical support, after sales service, delivery, credit and so
forth. This suggests that price cannot be taken in isolation. Generally price is directly related to sales
volume, but this mindset should be avoided. Other elements of product offering should be seen in
conjunction with price. Lower price is likely to require lower cost, resulting in subtle changes in product
offerings and a diminution of resource available for promotion and market development.
Also, this price should be derived from product strategy which would be derived from product’s
objectives. If the company’s pricing objective is to only skim the high value customers then it can afford
to price premium on product. However, if the supplier is selling only a commodity product and there is
no opportunity to differentiate the product with competitors then there is no basis to charge a price
premium on that product.
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Key Pricing Strategy Determinants
When designing the product strategy, there are various macro and micro issues. Macro issues consist of
economic condition, government regulations, customer bargaining power and pricing objectives. While
a micro issue consists of various other factors like value of the product to customer, cost, competition,
product type, reseller profit margins etc. In the following diagram we have shown that what are the
factors which affect pricing strategy.
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Value to
the
customer
Pricing Product
Objectives Variables
Customer
Pricing
Bargaining Competition
Strategy
Power
Reseller
Economic
Profit
Conditions
Margins
Governmen
t Policies
Potential Value
It is the value counting all the possible benefits of product to customer. This is highest value to product
to customer. It is the value what the buyer can be educated to recognize in the product. Educating a
buyer is marketing task; it involves advertising, promotion, personal selling and getting the person to try
the product.
Perceived Value
It is the value what the buyer current recognizes. It is less than or equal to potential value. It is the value
that customer recognizes with that product. Sometimes it happens that when a new radical product
comes then it if category perceived value is low then customer would be having low reference price.In
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that case perceived value is much less than potential value. Hence a lot of promotion and advertising is
needed, if a firm wants to charge full value to the customer.
Flexi Pricing
This is a pricing method in which we charge different prices from different customers for the same
product. Generally it depends upon various factors:
Product Usage
Economic condition of the buyer
Importance of item to business/Criticality of the item
Supply/Demand equations
Customization needed
In classroom, we have done Flexi pricing case; I would like to discuss that case:
Signode Industries
The company has started in 1914 as the Seal and Fastener Company, producing and marketing patented
steel strap joints and application tools. The packaging division was supplying 3 kinds of products: Steel
Strapping, Plastic Strapping & Tools and equipment. In steel strapping we have products of 3 grades:
Apex, Box Band, Heavy Duty Magnus. All these products have different uses according to industries.
This was a case when some consumers were costly to serve but paying less, hence we have to device a
policy to charge them appropriately. Also the price of raw material cold rolled steel has increased, Hence
to react to that, company has following 3 options:
Maintain Profitability
Halt market share erosion
Provide cash to the corporation
Bolster sales force morale
Charging high value customers high price- proper segmentation of the target market
Link sales people incentive with $ value rather than unit volumes
Too much flexibility may cause negative brand image in market
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Competition
Generally competitive market puts a cap on pricing. However it depends upon how much differentiated
a product is. A product which is high in quality parameters- functional design, appearance, brand image,
it can charge premium prices.
However it depends upon situation to situation. Even if a product is not highly differentiated it can
charge high prices because it wants to milk the business- let sales decline and they slowly withdraw from
market reaping maximum profits.
Also while doing competitive pricing, cost should also be considered. No firm will sell product below cost
in normal circumstances. Also under emergency time, opportunistic pricing is done as customers are
ready to pay high price.
Leader Pricing
In this type of pricing, Price leaders initiate price change and expect other players to follow that. Leader
would set its prices higher than of competitors and competitors would derive price w.r.t. leader price
levels. This is also known as “Umbrella pricing”.
The effective exercise of market control by leader depend upon some factors like-
Pros
Constant seek for new product and maintain leadership by leader
High profitability for leader
Cons
Pricing for short term market share gain would result in overall decrease in profitability of that
industry
Low market share
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Parity Pricing
In this type of pricing, we match the price set by overall market or market leader. If a firm has superior
product then it should command a premium price. If a firm has cost advantages then it should become
low price supplier. Only in the case when a firm has high costs, its only option to go in market is through
parity pricing.
Pros
When educating the customer cost is higher if you have superior product, then this strategy
would be cost effective
Cons
Pros
Low cost
Cons
Competitive Bidding
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Product and price information of all products at a single location
Saves time and cost in phoning and faxing potential suppliers
Necessities
Some customizable usage of the site can be that it can provide the procurement manager to request for
special quotes from select few vendors for large quantities.
1. In the first round, mason quoted just in cost price to win the contract. Later we see that it
incurred huge amount of loss.
2. In second round, It was competitive bidding between 2 players. In this case one would get 33%
and other 66% by volume. Mason bidded on 10% profit margin and won the contract for bigger
volumes. However in this contract also we see there is estimated loss.
3. Company now wants to bid for third round. In this case they were 2 competitors and one can be
given whole amount that has been required by customer. Also it can be noted that it would be
highly economical to take volume from just one player.
Important Considerations
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One-on-One Negotiations
The most basic form of trading is one-on-one negotiations where authorized members of the exchange
post expressions of interest to buy or sell goods or services. The price negotiation is one-on-one.
The users are registered and authorized on the exchange before they could post or respond to postings
on the bulletin board. Most systems provide a main screen that lists members’ postings by one or more
categories assigning each posting a unique number. Examples: Catex, Credit Trade, Paper Exchange
The Catastrophe Risk Exchange, Inc (CATEX) is a specialized developer and provider of web based
insurance and reinsurance systems. In the insurance industry, each contract is individually negotiated
because of the unique risks associated with the property, goods that are to be insured. Thus preparing
standard offerings is difficult. To enable negotiation on each B2B every contract Catex has developed a
system where users can post expressions of interest to buy or sell insurance. CATEX develops and
maintains reinsurance software platform that processes over $4 billion annually in premium and claim
activity. CATEX licenses such software to reinsurance brokers, managing general agencies (MGAs) and
reinsurers worldwide.
CreditTrade provides systems to institutional players who wish to trade credit default swaps. The parties
meet anonymously through the post and browse board and then enter into negotiations.
PaperExchange enables a buyer to respond to a price posted on the system by a seller. The buyer can
either accept the proposal or post a counterbid. The seller either accepts the counteroffer or posts a
revised price.
The exchange must provide certain basic functionalities to attract and support existing users:
Above all, many users of an exchange want to retain anonymity, in the early stages of negotiation, to
avoid showing their hands too early. B2B exchanges provide the same through anonymous e-mail.
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However, the exchanges tend not to get involved in the settlement and clearing. Because each trade is
individually negotiated, the exchange usually requires members to sort out payments and deliveries.
The exchange can add to its value offering by providing the back office operations like accounting,
settlement and invoicing.
Post and browse exchanges are relatively easy to implement making them vulnerable to competition.
They must evolve them with time and come up with more sophisticated models to enhance the value
proposition.
Auctions
Auction is a method in which the liquidity from all the buy and sell orders is considered at the time of
auction. Dynamic pricing is created by collection of multiple sellers or buyers to set a price for a wide
range of goods and services.
Benefits to buyers
Increased selection
More convenience
Opportunity to pay less
Benefits to suppliers
Larger market
Opportunity to charge more
Seller Driven
In this type of auction a person lists item for sale and the various bidders submit upward price for it. This
increases the price till equilibrium is reached. This facilitates efficient market pricing while increasing the
reach. Its most effective when the product is unique and differentiated. Seller driven auctions are good
in liquidating surplus goods.
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Price bids in a seller driven auction
As this method is most often used to move surplus goods sellers benefit the most because
Buyer Driven
In this type of format buyer species the product to buy and seller competes with downward price
auction. This is in much favor of buyers. The price tends to fall as auction reaches its end. Some online
portals hold real time B2B buyer driven auction sometimes for commodities like coal and steel.
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Bidders remain anonymous of competitors but bid price is available
Reasons of popularity
Reach
Scale
Interactive
Real time
Affordability due to use of internet
If there is little liquidity in the product, member’s limit order will take some time to find a match in the
system and hence it will be in the order book. For every second that the limit order sits out in the order
book, the buyer or seller may be exposed to changes in fair market price for the item because that order
can be automatically executed against at any time until he or she cancels it. This make traders use a ‘kill
or fill’ (FOK) approach, whereby they enter an order at a limit price but remove it immediately if it is not
instantly matched in the order book. Many systems provide special FOK order that automatically flushes
the order if it is not matched.
Product Variables
Product Cost
When setting the price for a product, a very important consideration is cost of the product. Rarely is the
case when you want to sell product below cost. Costs can be classified into 3 parts:
Fixed
Variable
Semi variable
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Fixed costs don’t vary with the level of activity. Variables cost vary directly with the level of activity. Semi
Variable costs go up and down depending on the operating level.
If fixed and semi variable cost is large portion of total costs as case with the railways, then pricing for
maximum capacity utilization is crucial. After you cover the fixed cost, you get higher amount of profits.
However, if variables costs are high percentage of total costs then pricing to maximizing unit
contribution (Difference between price and variable cost) is paramount.
Pros
Very simple method of pricing
Give a sense of “fairness”
Justifiable to customers who want to know how prices are determined
Cons
Calculation of all costs parameters is difficult to gauge- often results in a lot of discussions
It is difficult to obtain a certain profit margin
No relation of product pricing w.r.t. demand
False sense of security
Product type
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Complementary Product Pricing
If two or more products are complementary in nature then a lesser profit on one product can be
compensated by higher profits on other products. Here we can take classic example of Gillette’s strategy
of selling razors cheaply but blades costly.
Also in many Industrial products, we know that if a firm offers wide range of supplies, spare parts and
all, firm would make high profits on spare parts and related accessories. It might be the case that
complementary product would generate greater sales in comparison to main product during customer
life time value. E.g. for a life time of razor – blades may yield higher business than razor itself. Also, the
markup on spare parts for bulldozers can be as high as 200% which would be much higher than the
margin on main product.
Generally, In this kind of scenario, customers generally have high switching costs.
Pros
Market penetration for main product
High profitability for complementary product
Focus would be on more quality rather than cost
Cons
If customer switching cost becomes lower than this strategy will not work
Price Bundling
In this type of pricing, product is sold as a part of total system. This system is a bundle of several
products. In these cases, customers generally achieve a great amount of saving if he buys overall system
rather than individual items. To adapt this type of strategy it is required that the firm provides complete
solution to customers rather than in parts. For example, if you take a window OS and all the windows
software together you can save a lot of money. However if you buy each software individually, it costs
you more.
But this is possible as Windows offers complete system solution rather than specializing in a particular
domain.
Pros
Achieves high volume sales
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Incentivizes customers to buy firm’s products only
Generates loyal customers
Cons
Some loss of profitability if firm can sell all individual components without additional efforts
May have to bear substantial integration cost
Also this value-price product concept varies by intensity of product usage and geographical scope of
usage. Low intensity users would be more sensitive to initial price than heavy users.
However this strategy works when price changes are difficult to detect. As company is providing basic
product at cheap price, it can cannibalize its high priced products. It becomes more powerful when
there is good amount of brand loyalty among users.
Pros
Low growth market penetration
Generates loyal customers
“Product for everybody” concept
Cons
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Reseller Profit Margins
While making any pricing strategy distributor, retailer or any kind of reseller’s profit margin has to be
considered. If the influencing power of retailer is very high, we want to give him more margins so that
he will attain higher return on investment compared to competitors’ products.
Quantity Discounts
It is a common trend that for large quantity you offer lower prices than low quantities. The lower unit
price reflects the economies of scale possible with the product. If quantity discounts have been given
then marketing costs should be emphasized rather than production cost.
Large customers have much bargaining power if supplier has excess capacity in a plant that has high
fixed costs.
Functional Discounts
For the functions middlemen perform, they are given reductions from prices for their services or
functions. Discount offered to channel members are called trade discount.
Competitive Discounts
List prices can be reduced to meet competition. Such price reductions may take several forms- outright
price cutting, variations in the term of payment, elimination of charges for certain extras such as product
modifications and transportation charges, substitution of one quality of product for another. If
customers can show the low prices for similar specifications then to remain competitive company offers
discounts.
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Economic Conditions
Pricing also depends upon economic conditions of the market. During a recession period, company may
charge lesser price for the same product because consumer spending power has decreased. Vice versa
in a growing economy you can increase price without any increase in product quality.
Government Policies
Some basic products are subsidized by government. The government may set import quotas on specific
product categories to protect domestic producers, eliminating foreign competition and restricting
supply to domestic production.
Government agencies also strongly influence price level in various specific ways. In various regulated
industry such as public utilities and communications, state and federal commissions have the authority
to approve or reject proposed price changes.
Also, there are some antitrust laws enforced by regulations such as:
Sherman Antitrust Act- It seeks to preserve competition by proscribing predatory pricing- pricing
that has the intent or effect of driving firms out of business.
Robinson- Patman Act- It makes it illegal to sell the same product at different prices to customer
who competes with each other. It is permissible under certain conditions:
o If a low price to one consumer meets the equally low price being offered to that
customer by a competitor
o If the reduced price pass on a cost saving that may result from lowered manufacturing,
transportation or marketing costs associated with the sale
Pricing Objectives
Pricing strategy of any firm would depend upon pricing objective of the firm. E.g. for a new product, firm
wants to gain an entry in this segment hence it could adapt different position depending upon the
situation. Pricing objective can be profit maximization, revenue maximization or just to have a presence
in one market etc. Now we will see depending upon situation how pricing strategy would differ:
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New Product Introduction
When an organization introduces a new product, it will adopt pricing according to the situation like
product life cycle, product line etc.
Price Skimming
It is about setting initial price high which would be discounted w.r.t. time. Initially high value
markets/customers are identified and then other less valuable markets are included as these markets
become saturated. The purpose of the skimming pricing is to identify the customers which are having
special needs and who are insensitive to initial high price. Also it is noted that timing should be right
while setting this strategy. Initially it will be enjoying monopoly position.
After some time, when competitors come and reduce the category prices, price reduction becomes a
necessity. To apply this kind of pricing, there should be following conditions fulfilled:
Pros
High profitable line
Less effort required as customers are less
More investment in R&D and hence developing newer products
Cons
Penetration Pricing
It is about setting a very low initial price for a new product. This strategy is particularly used when the
company wants to speed up adoption of new market. Here cost would be an important factor that
would determine profitability of the business. Market domination would be carried out at price level
hence each firm would try to be cost leader and try to penetrate as much market as possible. This
strategy required demand to be elastic.
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Pros
High market share approach
Market domination- leaves very short part of cake for competitors
Cons
Profitability is an issue
High sales & administration effort is required as it has to cater to mass market
Efforts are concentrated on cost rather than quality
Experience curve has a different focus and advantage than penetration pricing. It seeks volume by
passing on the experience curve price advantage to the customers. Also it should be noted that this kind
of experiential cost savings should be possible for that product.
Pros
Volume maximization
Maximum capacity utilization
Market domination- leaves very short part of cake for competitors
Cons
Profitability is an issue
Efforts are concentrated on cost rather than quality
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References
PETER M. NOBLE AND THOMAS S. GRUCA, “Industrial Pricing: Theory and managerial practice”,
Marketing science@1999 INFORMS, Vol. 18, No.3
KENT B. MONROE and ALBERT J. DELLA, “Models for Pricing Decision”, Journal of marketing research,
Vol XV ( August 1978)
ROBERT R. REEDER, EDWARD G. BRIERTY, BETTY H. REDDER, “Industrial marketing: Analysis, Planning
and control” Second edition, Prentice hall, Inc.
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