OBJECT IVES

T o appreciate the theoretical approaches to pricing provided by economics

T o understand the customer's perception of value

T o learn how to segment a market using pricing

T o become f amiliar with the pricing strategies used by business marketers

T o recognize the importance of price to the buyer

T o identif y the dif f erent types pricing

T o examine leasing in industrial pricing

T o become f amiliar with the process of competitive bidding

T o realize that a great deal of uncertainty surrounds pricing

T he price of a product or service is crucially important to the seller. It determines

whether a product will gain market acceptance, maintain its market position in the

f ace of growing competition, and realize an optimum prof it level. Yet marketing

practitioners and scholars alike agree that pricing is one of the f uzziest and most

dif f icult arcas of decision making.

T his state of af f airs may be attributed to the elements involved in pricing that

are unknown, beyond the f irm's control, or simply clouded by much uncertainty.

In establishing a price, one must estimate the costs involved. But to estimate the

cost, the demand f or the product must be known, which it rarely is. Beyond the

f irm's control are such economic conditions as wars, natural disasters, strikes, tax

changes, and recessions or booms. But even more important to marketers is deter-

mining the value of the product or service to the customer, since prices should be

market oriented. Yet even with extensive marketing research, untii a product is

launched acceptance is uncertain.

We begin this chapter with the theoretical f oundations of price. We then pre-

sent the "real world" considerations used to establish prices in business marketing

MARKET CLASSIFICAT ION AND PRICING

From the perspective of management, one of the most important f actors in pricing

is the market in which the f irm operates. T he type of product and the number and

size of competitors must be considered when setting prices. Pricing behavior that

is rational and consistent with "scientif ic principles in one type of market may be

irrational and unscientif ic in another market. T he appropriate starting point in pric.

ing is to ascertain what type of market the business marketer is attempting to sell

into.HAYRIUSINESS PARINO

Five theoretical f orms of market structure are described here (1) perf ect com

petition. (2) monopolistic competition. (3) pure and dif f erentiated oligopoly (4)

pure and dif f erentiated oligopsony, and (5) monopoly Although there are many

dif f erences among these f ive types of market structure, the major criteria used to

distinguish them are the numbers or buyers and sellers, and the similarity of prod.

Les sold by the sellers in the market Exhibitil-1 classif ies each market structure

f orm according to these two criteria

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in examining the implications f or pricing, there are two ways in which these

market structures may be ranked in terms of degree of certainty and in terms of

degree of control in setting prices of products. Ir the degree of certainty with

which a f irm can estimate the demand f or its products is the criterion, perf ect

competitors and f irms in monopoly markets can estimate their demand more pre

cisely than f irms in other markets. Ir, however, the market f orms are ranked ac

cording to the degree of control that a f irm has in setting the price of its product,

f irms in monopoly markets have the most control and perf ect competitors the

least

In perf ect competition no single f irm has any control over price. T his Jack

of control results f rom the large number of sellers, cach producing exactly the

same product. If a f irm should raise its price above the prevailing market price, its

product would be nonsalable. On the other hand, a perf ectly competitive f irm

would not reduce its price below the prevailing market price because its of f ering

is so small relative to the total supply that it can market its total output at the going

market price Commodities markets and widely held shares in the stock market are

examples of perf ect competition

In a monopoly market there is only one seller. T his f irm has complete con-

trol of the market. It can f ormulate its pricing policy with little f ear of losing sales

to other f irms, since there are none. Public utilities are an example of monopoly

markets,

In the other three f orms of market structure-monopolistic competition, oli

gopoly, and oligopsony-cach industrial f irm has some control over the price of

its products and can alter its sales perf ormance through nonprice competition such

as advertising, sales promotion, product-service variation, channel of distribution

changes, logistics, strategies, and corporate imagery. However, a f irm's f reedom to

change price is tempered by the possibility of competitive repercussions,MARKET CLASSIFICAT ION AND PRICING

419

Monopolistic competitors have the greatest price setting f reedom. Since

there are many f irms in a monopolistic competitive industry, limited action taken

by one f irm is unlikely to make large inroads in the sales of any one rival. Hence,

there is less f ear of retaliation Machine tool marketers are an example.

In an oligopoly structure there are only a f ew sellers. T hus, price changes

initiated by one f irm are likely to invite price retaliation. Marketers of cellular

telephone service f it this category, as do petroleum ref iners, and manuf acturers of

automobiles, steel, and tobacco. Unless it is an acknowledged price leader, an oli-

gopolistic f irm has limited pricing f lexibility due to the uncertainty of competitive

reaction.

Firms in oligopsonistic industries have pricing opportunities similar to

those of monopolistic competitors. For example, a packaged f ood manuf acturer

selling to the central buying units of major corporate chain supermarkets is not

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very concerned about competitors' reactions to its pricing.

Economic theorists have devoted much time to explaining the behavior of

f irms in various market situations. If properly employed, this type of inf ormation

can assist the seller in developing price policies and strategies that capitalize on

market opportunities. For example, in a study of sixty-seven manuf acturers of in-

dustrial goods that market only to industrial users, almost half (thirty-three) saw

themselves as operating under perf ect competition.'

T he disproportionately high number of f irms that perceive their markets

as perf ect competition is open to question f or two reasons. First, f ew markets in

ESS MARKET ING IN PRACT ICE

polist: McCain Foods Risks Price Retaliation

5. French f ry industry, already battered By slicing an average of 6 cents a pound of f

Aggish economy, appears headed f or a its specialty items, McCain hopes to grab a

ar.

much larger share of the f ast-growing U.S.today's economy are perf ectly competitive Second, f if ty-f our of the sixty-seven

respondents identif ied themselves as leading producers of their products in the

market. It theref ore is likely that many of the thirty-three f irms that saw themselves

operating in a perf ectly competitive market actually were participating in a mo

nopolistically competitive market T hus, these f irms could enjoy f ar greater f ree

dom in price setting than they believe possible

RICE-SET T ING T HEORY

Several methods of pricing are practiced by business marketers. T hree. pricing

methods discussed here are (1) supply-demand pricing. (2) cost-plus or markup

pricing, and (3) break even pricing. Prof it considerations are of paramount impor

tance in all those methods. T he methods dif f er in the emphasis placed on prof it

and in the importance of the role played by demand conditions. Since price setting

in perf ect competition requires no price decision by the individual f irms (because

buyers merely accept the market price), only the other market f orms will be

examined

pply-Demand Pricing

Supply-demand pricing places similar emphasis on both supply and demand f ac-

tors. In this pricing method, it is assumed that f irms are attempting to maximize

prof its. T hey accomplish this goal by determining a price where the extra revenue

received f rom selling the last unit of product is equal to the cost of producing it

(marginal revenue = marginal cost).

T his demand-and-supply relationship implies that any increase in price would

reduce both revenue and costs, but that the revenue loss would exceed the reduc-

tion in cost. Similarly, if price were reduced, both revenue and cost would increase

but the increase in cost would exceed the gain in revenue (sce Exhibit 11-2).

T his method of pricing is an "ideal" that should be aimed f or, but it is dif f icult

to use in practice. T he cost of producing and selling additional units of a good or

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taking on a special job is dif f icult to ascertain Even an approximation requires very

detailed cost accounting, which is not usually f ound in small f irms (f or example,

monopolistic competitors). A more important reason f or the dif f iculty that f irms

have in implementing this method of pricing is due to the uncertainty surrounding

the demand f or the f irm's product. It is dif f icult enough to f orecast the demand f or

the product of an industry, especially in manuf acturing But f orecasting is even

more of a problem f or a f irm that must consider the inf luence of price on the

actions of its rivals and other interested parties (including material suppliers, chan-

nel members, and the government), as well as the purchasing plans of its cus-

tomers.CHAPT ER 11 BUSINESS PRICING

pected or standard costs T he level of output (expected demand) used in com

puting cost is usually based on the quantity that is or could be sold at the current

price. T he prof it markup is of ten set quite arbitrarily Although many rationales are

of f ered f or its level, no one prof esses to want more than a "f air" prof it

T he major objection to cost plus pricing is that it is based primarily on supply

conditions and pass little attention to the demand side of the market T his method

of pricing does not attempt to measure the number of units that could be sold at

dif erent prices precluding any possibility of increasing or reducing prices to in

crease prof its In addition, cost plus pricing disregards the actions of competitors

and places inordinate attention on a f irm's historic costs.

T he major advantage of this f orm of pricing is that it is simple. It appeals

especially to f irms that do very little market research Many f irms believe that cost-

plus pricing is the saf est method to f ollow, because attempts to estimate demand

are f rustrated by volatile buyers' pref erences and unpredictable reactions by com

petitors. Indeed, according to one business pricing executive, "Most everyone uses

cost-plus pricing."

Break-Even Pricing

Break-even analysis is of ten used to illustrate the relationship of costs and revenues

to output, but it also can be used as a method of pricing. Break-even pricing is

similar to cost-plus pricing in that it is primarily supply oriented; however, it does

give some weight to demand conditions. Break-even pricing involves estimating a

relationship between cost and output, and computing relationships between rev:

enue and output at various prices. T he points where the various revenues are equal

to the cost are examined, and the f irm selects the point that is determined to be

the most readily attainable (see Exhibit 11-3).

Many of the criticisms that apply to cost-plus pricing apply to break-even pric.

ing as well. For example, too much emphasis is placed on a f irm's historic costs,

and not enough importance is attached to f orecasting demand. Many consider this

pricing approach both crude and conservative.

ricing T heory in Practice

In the study of manuf acturers of industrial goods mentioned earlier, 55 percent of

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the f irms used the cost-plus technique; supply demand analysis was second in pop-

ularity, with 31 percent of f irms using it, and 12 percent used break even analysis.

Use of supply demand pricing increased with the size of the f irm. T his ref lects the

f act that large f irms have cost accounting and marketing research departments that

enable them to employ this more sophisticated and dif f icult method of pricing

Some f irms use dif f erent methods of pricing f or dif f erent products. T he most im

portant price-setting f actors are production costs, competitors' prices, and mar-

keting costs.Although more than one third of the companies saw themselves as price lead.

crs (regardless of the pricing method they used), f our out of every f ive f irms in

the study stated that competition has the f inal say T hat is, af ter calculating what

their price theoretically should be, they adjust their price to meet competitors'

prices!

T o the extent that this adjustment in price is downward, such behavior negates

the value of identif ying market structures and of conceptual pricing models More

importantly, it suggests lack of conf idence in all of the other attributes of the mar

keting mix-unique technical product f eatures, industrial design, quality of sery.

ice, corporate image, and logistical advantages, f or example—that the company

has striven so intensely to achieve

Nonetheless, comparing theory-based price with competitors' prices does rec-

ognize the dynamics of the market, which must be continuously monitored. And

the use of this comparison recognizes that to be customer oriented, the business

marketer must be aware that the buyer's perception of price within the context of

the marketing mix may not be so readily appealed to by the mechanistic ap-

proaches suggested by economic theory.

Pricing Objectives

Because price is a visible aspect of the f irm's operations, it should be consistent

with the organization's overall goals.' A company like IBM, which has spent many

years building a corporate image that communicates reliability and quality, will not

spoil its reputation by competing on the basis of a low price. T hus, pricing objec-

tives must be established by top management to ensure not only that the compa-

ny's prof itability is adequate, but also that pricing is complementary to the total

strategy of the organization.

Among the many pricing objectives that a f irm may adopt are pricing to

achieve rapid cost recovery..

support corporate imagery.

achieve a target return on investment,

maintain stability in industry prices and margins.

maintain or improve market share (maximizing sales volumes or product

adoption throughout the product lif e cycle).

match, lead, or f ollow competitors.

discourage entry of competitors.

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achieve or complement product dif f erentiation

Whatever long range pricing objectives are established by top management,

they set the f ramework within which more specif ic shorter-run pricing policies

can be builtpurchases the buyer is already f amiliar with some product whose price can be

used as a ref erence in evaluating the price of a prospective vendor's product It is

against this commodity" mentality that the business marketer must contend

using all available means to develop a dif f erential competitive advantage Only then

can pricing be f reed f rom the boundaries imposed by ref erence products

Value to the Customer

T he upper limit sct on the supplier's price will be value, or utility, as perceived

by the customer Utility is the satisf action obtained through use of a product or

service No wonder, then that business marketers, af ter establishing their price on

the basis of traditional economic approaches, almost invariably temper that price

by a "look over their shoulders at competitors' prices. T heir customers have a f ixed

perceived value based on the "going market price"

It is not surprising to f ind little dif f erence in competitive prices when products

take on a commodity-like status. T hus, in most purchasing decisions in which the

price spread is small, the f inal choice of vendor's product is generally based on

attributes other than price. T he typical attributes considered when choosing

among suppliers are quality, service, and delivery, f ollowed by price.. In evaluating

vendors of f ive medium-cost (about $5) electrical components, f ourteen industrial

buyers primarily screened vendors on the basis of delivery and quality bef ore re-

questing quotes. In their f inal choice of supplier, these buyers f irst eliminated

vendors on the basis of delivery dates and "signif icantly higher prices. ("Signif i-

cant" being in the range of only 5 to 7 percent above the lowest price.)

On the other hand, it is not suf f icient f or the supplier arbitrarily to build in

additional quality in an attempt to hike the price of an industrial product, or even

to compete at the same price as a competitor. A 5 percent higher ef f iciency in a

200 cf m (cubic f oot per minute) compressor may not be valued at all the cus

tomer, particularly if other components of the process cannot utilize the increased

compressor ef f iciency. Even if , say, this greater ef f iciency led to a demonstrable

saving in electrical power consumption, it may not be of signif icance to the cus-

tomer. T he values of the customer are unlikely to match those attributed to the

purchaser by the industrial supplier

T hus, in the traditional view, the upper limit to price is thought to be set by

competition. T o the extent that business products are viewed with a "commodity"

mentality and compete among the same market segments, this will hold true How

ever, customers will pay more if they think they are getting better value For

example cable T V companies typically use splicing couplers to join home trans

mission wires T his eliminates expensive soldering Installation costs one cent per

coupler plus three cents f or labor. One company dominated the individual coupler

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market until a competitor introduced a new line of couplers plus a special tool

that could attach as many as sixteen at once Although the multicoupler tool was

expensive, the total installed cost of Sixteen couplers was reduced by 28 percent

T hus, the better value induced customers to pay more.Shepler Coda Advertising Agency

Similarly, the value of aluminum's tight weight relative to strength is durity

(plasticity), and its corrosion resistance make unique skin material in the

production of aircran Even as much higher prices than those f or which dominum

currently is sold it would still be in great demand in the airf rame market"

In another example, very high priced tantum pumps f or extremely comes

chemicals are greatly valued in processing plants where tong production runs are

planned and inf requent downtime f or pump repair can be achieved Wherce un

der similarly corrosive conditions where there are f requent changes in the conhy

ucation of the manutacturing process, cheaper stainless steel pumps are within the

value limit of the buyer but titanium pumps exceed

In the highly competitive trade journal publishing business, rather than trong

to deal with media buyers over rates, publishers remain competitive by 'wweet

ching the deal in the f orm of merchandising incentives, which provide added

value to their advertisers. T he incenuses include paid f ocus group studies, direct

mail, and editorial supportnear the buyere viewpoint the end of purchase includes

Searching Searching as involve the expenses incurred in seekingen

prve suppliers. T he inelude locuing qualif ied suppliers, doing credit

kaming plants inspent the supplier's f acilities and capabilities, and ans

tyring the names and manaw meat strenih of the supplier in the case of large

purchase the preparation of the anion request f or tenders, and analysis of

de Onen, these plus bruyers inertit preclude the consider

ation of potentially valuable new prospective products and suppliers

T ransaction coats T ransaction costs include the expense of negotiation in

surance Englurering and design installation charws and any initial technical train

tarp Costa Blancap costs may either be paid to a dif f erent supplier or be

ached by the buyer but are nevertheless expenses incurred by the purchase

T he customer f acilis may have to be madined (as in the provision of air con

ditioning f or computer instalatom, ditional space may be required or add

ronal purwer provided Dointime may be f os during f acility modif ication product

installation run incintai operation and deping or during raining

Postpurchase Costa Postpurchase costs include continued technical training

maintenance and repair it may be necrecy w have backup equipment or f acil

we Incrementale in an interest on capital invested and depreciation

are likely And operating pin chan encompassing such costs as labor

#manal entory care prate enerwy consumption and

que required by the new product we were ready looking f or lower total cost

De Chemie of Midland Magen that incorporates Vendors service

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lif e (elect like cycle costs include the rate of utilization of the new

produse de produtivity over time the product potential f or technolog

em am the pense of disposal T echnological obsolescence has

beenme apparent in the computers and disposalespeses dated to chemwall products of new and toxic or radioactive materials are of growing

Cuecen

Large utilities are more likely to buy higher priced electrical power distribu

tion transf ormers that of f er lower operating costs over their lif e cycle whereas

local municipalities concerned with capital expenses and their political ramif ica

T ions, f requently buy cheape transf ormers with hucher operating costs, incurring

many times the totalent of the f ormer during their lif e cycle Such pricing

mentation opportunities around

More and more, the buyer's view of new acquisitions encompasses a panoply

of f actors beyond price ranging f rom the total cost evaluation of alternative sup

pliers to the risk of a strike at the supplier's plait" T he customer oriented business

marketer recognizes that in the light of the buyer's extended view of costs, low

price alone may not generate the anticipated sales volume Indeed, a low price

of f ering might be perceived as a high cost noncontender because of its higher lif e-

cycle costs. T hus, it is imperative to understand how the buyer perceives search

ing transaction, start-up postpurchase, and lif e cycle costs relative to the sup

plier's price

T he strategie implications f or industrial pricing based on customers' percep

tions of the upper limit of value and the constraint of customer evaluation of costs

of purchase are clear: it is important f or the business marketer to research the

market caref ully and set prices within the context of a total marketing strategy

CE SEGMENT AT ION

Dulerent target markets can be identif ied based on customers' value expectations

Packaging equipment, f or example, might allow a customer to expand into new

f ields, as in the case of aseptic packaging f or milk and juices winning school and

institutional restaurant and caf eteria business (due to their lack of ref rigerated Stor

age space), or it might extend the customer's market due to lower logistics costs

(because ref rigerated transport is not required)

Similarly, customers' dif f erent cost criteria may permit a seller to use price

segmentation that is, to segment markets and appeal to each segment with dif

f erent prices. T hese prices correspond to the particular segment's view of price

within the f ramework of its own particular costs

T here are f our major ways to segment an industrial market

1 Intensity of product usage lif e cycle costs of a f ront end loader to an eight

hour a day heavy user in a mining operation are more important than to a f our

hour a day light user on a construction site

2 Geographical scope of usage Postpurchase costs of reliability and downtime

are of less concern to a local contractor using carth moving equipment than

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to a multinational company operating extensively in the T hird World, where

maintenance skills, repair service, and replacement parts are not available 430

CHAPT ER 11 * BUSINESS PRICING

3. Growtb in the customer's business. Fast growing customers may be more re

ceptive to cost cutting new generation computers, whereas slow-growing cus-

tomers may be content with their current equipment

+ Nature of the application. A manuf acturer of of f -highway vehicles, which have

the disadvantages of high start-up and lif e cycle costs has a short haul advan

tage in high tonnage slow speed applications such as open pit mining opera

tions, compared to a competitor's vehicles that cost less to operate at cruising

speeds under light or moderate loads."

One of the easiest ways to segment a market using pricing is to require that

buyers purchase a consumable good used in conjunction with a durable good."

IBM leased its early computing equipment with the requirement that they be used

only with IBM cards. Rather than selling its equipment, Xerox leased its machines

so that the company could require customers to use only the paper supplied by

Xerox Needless to say, the price of supplies in both cases carried a hef ty margin

T his approach permitted the companies to appeal to market segments that couldn't

af f ord the initial high purchase cost of the durable equipment

A similar technique is f ound in industrial strapping T he machine that tightens

and locks the metal strapping around a crate is sold at something close to its in-

cremental production cost. Of course, the strapping dimensions are unique to each

manuf acturer so that no other brand of metal strap can be used with the machine

T he supplier's prof it comes f rom the miles and miles of strap that are used in day

to-day operations!

PRICING ST RAT EGIES

Environmental f actors, including the prevailing levels of technology in the industry,

customer perceptions, intensity of competition, and barriers to competitive entry

as well as internal f actors such as ef f iciency of production and the need to recap

ture research expenditures expeditiously, af f ect pricing T hree pricing strategies

experience curve pricing: new product pricing, which includes price skimming

and market penetration pricing and product-line pricing-ref lect the interplay of

these various inf luences

Experience Curve Pricing

It is well known that the direct labor hours required to perf orm a usk decrease by

a constant percentage as the number of times the task is perf ormed doubles T his

phenomenon, which applies across a wide range of industries, is called the learn-

ing curve Purchasing agents have applied the concept in contract negotiations,

both to encourage suppliers to increase their ef f iciency and to f orce them to rePRICING ST RAT EGIES

431

duce their prices. T he Boston Consulting Group (BCG), working f or the electron-

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ics and chemical industries, has shown that increases in productivity improvement

as a result of learning are not limited to labor alone. Rather, they are quite general

and can be f ound in most industrial activities, including administration, R&D, dis-

tribution, manuf acturing, and marketing. BCG coined the term experience curves

to describe this extended concept, showing that prices (in constant dollars) must

be reduced as industry experience is accumulated in order to maintain competi-

tive stability. A graphical representation of an experience curve appears in Exhibit

11. In experience curve pricing, the marketer bases pricing decisions on the

product's current or anticipated position along the experience curve. If prices are

not reduced in parallel with the inevitable cost reduction, instability develops until

competition is attracted, thereby f orcing a return to the experience curve. T hus, a

high-price policy on the introduction of a new industrial product will have a lim-

ited lif etime until competition f orces the f irm to return to the industry experience

curve price f or its product. Alternatively, a low-price policy permits a f irm to build

volume sales, market share, and experience, thereby achieving lower costs than

competitors. If all competitors are pricing their product at roughly the same level,

then the f irm with the most experience likely will achieve the largest market share

and prof its.

EXHIBIT 11-4 An Experience Curve T hat Is Plotted on a Linear

Scale

400

350

ſ 300

250

Cost or price per unit

200

150

100

50

40

160

200

80

120

T otal units

Here we see that as experience (represented by increased quantity of

production) increases, costs are reduced

CHAPT ER 11 BUSINESS PRICING

Dif f erent products and dif f erent industries f ollow dif f erent experience curves

T he experience curve f or silicon transistors stabilized on a 77 percent slope T hat

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is, with every doubling of cumulative production, their unit conts dropped by 25

percent. Integrated circuits have maintained a 73 percent stope. When plotted on

a log-log scale the cost volume, or price volume, slopes produce a straight line (sce

Exhibit 11-5). T he signif icance of this is that price or cost reductions are predict

able

T he existence of the experience cf f ect provides business marketers with an

ef f ective planning and pricing tool Knowledge of a competitor's cumulative ex-

perience with a product can give the pricing executive an indication of the com

petitor's costs. T he experience curve f or a marketer's own industry can provide

goals f or cost reduction. Furthermore, comparison of competitors' prices with the

price levels predicted by the industry experience curve can explain competitors

pricing behavior and help the business marketer to f orecast f uture pricing actions

and reactions

It should be noted, however, that economics of scale and the experience

curve may become less relevant to pricing strategies if manuf acturing f irms adopt

EXHIBIT 11-5 An Experience Curve T hat is Plotted on a

Log-Log Scale

+00

300

200

Cost or price per unit

100

50

20

14

New Product Pricing

It is always dif f icult to price new products because of the uncertainty associated

with their potential f or success. Will customers really consider the new product

of valuc? Will customers be willing to experience the disturbance to and possible

interruption of their manuf acturing operation in order to install a new piece of

equipment? Will the prospect be willing to risk new equipment when things are

going just f ine with the old equipment?

T hese types of questions make new product pricing especially precarious

T hus, it is helpf ul to know that there are some conditions surrounding the adoption

of new products that f avor higher introductory prices, whereas other circum-

stances suggest choosing lower introductory prices. T hese circumstances or con

ditions are best illustrated by describing the extreme pricing strategies of price

skimming (a very high introductory price) and market penetration (a very low

introductory price)."

Price Skimming. In price skimming the new product is priced close to the

upper limit of value or utility as perceived by the industrial customer. T o use such

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an approach, the f ollowing conditions should be present

1. T he buyer is an innovator or carly adopter, a risk taker who welcomes new

products. T he buying company is probably known f or its innovative stance.

2. T he supplier has a patent or hard-to-copy innovation, such as sof tware that is

too dif f icult or time consuming to reverse-engineer, or a technique, such as

the plate glass manuf acturing process, which, although technically easy to un

derstand, requires operational know-how to be workable.

3. Variable costs are a high proportion of total costs. T hus, there are no econo-

mies of scale to be achieved. T his condition exists in marketing of engineering

services.

4. Barriers to competitive entry are high-whether they be f inancial, marketing,

or other types.

5. T he usage of the market is limited,

Because of a higher initial per unit prof it potential, price skimming permits

the business marketer to charge very high prices at the outset to recover heavy

R&D and marketing investment costs quickly But price skimming also acts as an

invitation to competitors, so that eventually the marketer will have to reduce price

to the experience curve norm. With caref ul monitoring of competitors' activities,

this strategy can maximize prof its over the product lif e cycle through price reduc-

tions that anticipate and may ef f ectively prevent competitors' market entline

CHAPT ER 11 BUSINESS PRICING

Market Penetration. In market penetrating pricing, the business marketer

recognizes the f ollowing conditions

1 with heavy f ixed costs and low variable costs, the key to prof itability is build

ing sales volume and economics of scale quickly

2. Many close substitutes are available thus, a low price discourages competitive

entry

3. In this market, the customers are very conservative and traditional, and are

unwilling to take risks

4. T he product is easy to copy and there are f ew barriers to entry by the com

pany's competitors

5. T he market exhibits a high price elasticity of demand

6. T he size of the potential market justif ies the risk of an extended period during

which f ixed costs must be recaptured

A market penetration pricing strategy helps a company build a large share of

the market quickly, with the resulting experience ef f ect providing substantial cost

advantages compared to competitors

Product-Line Pricing

Most f irms sell a range of products within each product line. T hese products are

related to one another, marketed together, used together, and provide variations

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on the same general benef its required by the customer. T hus, product line pric-

ing takes into account, on the demand side, the segments to which these products

and services appeal and their impact on each other (complementarity and substi-

tutability) and, on the cost side, their interactions with one another (joint costs,

bundling possibilities, cannibalization).

T he price of the entire line can support the image the company wishes to

project. Westinghouse ref used to put its corporate name on a f ighting brand when

its market f or vacuum tubes was threatened by low price Japanese imports Alter

natively, the low-end price in the product line might be used to attract marginal

buyers and build total volume.

When a complementary relationship exists within the product line, the de-

mand f or one product may be enhanced by a lower price on another, as in the case

of metal strapping mentioned earlier. T he sale of medical testing equipment to

hospital laboratories generates continuing business in the supplies used with it

And the sale of a crawler tractor generates a continuing demand f or its f ast-wearing

metal treads as well as uniquely f itting accessories and repair parts. When pricing

product lines, the business marketing manager must be aware that the sale of one

item in the line may be inf luenced by, and may inf luence, the sale of other items

in the line

HOW IMPORT ANT IS PRICE T O T HE BUYER?

435

HOW IMPORT ANT IS PRICE T O T HE BUYER?

Despite many studies that rank price f rom f irst to sixth place in importance relative

to other variables in the marketing mix," a more realistic and practical viewpoint

recognizes that the importance of price varies f rom situation to situation

At certain times, price may be the single most important aspect of the mar

keting mix in winning an industrial sale.

2 At other times price may weigh equally in importance with other variables in

the business marketing mix

3. At certain times, such as when a chemical processing operation will have to

be shut down if the necessary raw material, product or service is not received

in time, price may be of little consequence

Exhibit 11-6 lists the f our most important f actors in f our dif f erent buying

situations. Again, it is evident that the importance of price varies widely. Further

more, when decision inf luencers f rom various departments of the organization

(such as engineering, f inance, or production) are involved, price will be viewed

dif f erently by cach individual when evaluating a purchase.

EXHIBIT 11-6 Importance of Various Factors in Dif f erent Buying Situations

Buying Situation

Four Most Important f actors

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A Frequently ordered product, no signif icant

problems in use

B Product training required

C Doubts about product perf ormance in a

particular application

1. reliability of delivery

2 price

3. f lexibility

4. reputation

1. technical service

2 ease of use

3. training of f ered

4. reliability of delivery

1. reliability of delivery

2. f lexibility

3. technical service

product reliability data

1 price

2 reputation

3 product reliability data

1. reliability of delivery

D Dif f iculty in reaching agreement among all

concerned

Source Lehman Donald R. and O'Shaughnessy John. "Dif f erence in Attribute Importance f or

Dif f erent Industrial Products Journal of Marketing Vol 18 April 19-4) pp 56-12 Reprinted

with permission of the American Marketing Association

T YPES OF PRICES

437

one or more discounts. Such discounts can be changed as f requently as required

without the expense of printing a new set of list prices. T he list prices can help a

supplier camouf lage price changes f rom competitors List prices are also a usef ul

guide to engineers and buyers who are estimating "ballpark" f igures f or proposals

and in preparation of tenders

Net Prices

T he net price is, of course, the key price in the decision whether or not to

buy. In arriving at the net price many types of discounts can be applied to the list

price

T rade Discounts. T rade discounts are reductions f rom list price that are given

to dif f erent groups of intermediaries or customers according to the range of f unc-

tions they perf orm (stocking, advertising), the type of market to which they sell

(OEM, retailers), and the volumes in which they purchase. A manuf acturer of elec-

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trical lamps selling through three classes of domestic intermediaries, to overseas

distributors, and directly to OEMs and government agencies might have the type

of trade discount structure shown in Exhibit 11-7

T rade discounts can be used as a competitive weapon. In most industries there

is an accepted norm f or the discounts of f ered to intermediaries. A business mar-

keter selling through a distributor must recognize that competition includes not

only similar products of f ered by other manuf acturers but also quite dissimilar lines

of items that are competing f or the distributor's time and attention. T hus, the mar-

keter may increase discounts to motivate the distributor to devote more ef f ort on

behalf of the manuf acturer's product

Cash Discounts. Cash discounts of f er the buyer an incentie to pay a slightly

lower price within a short period of being invoiced. A typical payment term would

EXHIBIT 11-7 T ypical T rade Discounts

List Price Less a

Discount of

Class of Customer

154

20

10

30

Industrial distributor

Manuf acturer's agent

Wholesaler selling to retail accounts

Oserseas distributors-hard currency markets

others

OEM accounts

Government accounts

25

35

10

CHAPT ER 11 BUSINESS PRICING

Geogra

be 210 net 30, meaning that if the invoice is paid within ten days, an additional 2

percent can be deducted f rom the price. Beyond the ten days, the payment is the

net price shown on the invoice. Usually a penalty of , say, 18 percent interest is

charged on bills outstanding longer than 30 days. T he cash discount encourages

rapid payment and improves the seller's cash f low position. However, it becomes

a problem when the customer is large and has a slow payment authorization pro-

cedure. T he customer may take the cash discount even though payment stretches

signif icantly beyond the ten-day limit.

Cash discounts can be an important part of the marketer's pricing strategy. In

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the pharmaceutical industry, they are considered as important as stock replenish-

ment f requency and even more important than lead time, consistency of lead time,

and order placement policy' Indeed, business marketers could segment their mar-

kets by of f ering an array of alternative cash discount terms so that the buyer could

choose which one is best f or the buying f irm's Such an innovative pricing ap-

proach might of f er terms of , say, 2/10, 1.7/15, 13:20, 0.825, and net 30. T hus, a

$1,000 purchase could be paid f or with $980 at day 10, 8983 at day 15, 5987 at

day 20, $992 at day 25, and $1,000 at day 30.

Quantity Discounts. Quantity discounts cncourage the customer to order

in larger quantities. Volume price breaks are established, such as those in Exhibit

11-S.

T he break points might represent savings the supplier can achieve in order

processing. palletizing, or transportation For example, a carload quantity is

cheaper to ship than a less-than-carload (LCL) amount. A customer-oriented

supplier might establish break points with such considerations in mind as the

buyer's authorized dollar expenditure limits or annual usage rate.

Quantity discounts may be noncumulative or cumulative. Noncumulative

discounts apply only to the quantity purchased on an invoice, on an order-by-

order basis. Cumulative discounts take into account the volume (measured

either in units or dollars) that has been purchased since the beginning of the cur-

rent discount period. When the current order exceeds a break point, a larger dis-

count is applied to the invoice.

T he rebate system is similar to a cumulative quantity discount with the ex-

ception that no reduction is made on individually invoiced orders. Rather, a rebate

EXHIBIT 11-8 A T ypical Quantity Discount Structure

Volume Purchased

Quantity Discount

Less than 100 units

101-300 units

301-500 units

501-1.000 units

More than 1,000 units

23

3.5%

1.5%

5.25%

T YPES OF PRICES

439

check is issued to the customer at the end of the rebate period, based on the total

volume purchased during that period. In the rebate case, a procedure f or updating

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the customer about the f irm's current cumulative purchase status on a regular basis

throughout the rebate period can provide an extra stimulus f or additional sales.

Geographic Pricing

T he geographical location at which a price is applied can be a competitive pricing

technique Geographic pricing means that the price may be quoted at the f actory

door, at the customer's receiving dock, or at some other location. T he choice of

which location to specif y depends on the location of the competitors' plants, the

bulk and density of the product, location of key customer accounts, industry

norms, gencral competitive conditions, and the proportion of total price that trans-

portation costs contribute.

FOB Factory. FOB stands f or "f ree on board." When goods are shippe FOB

f actory, the buyer pays the invoice price plus the cost of f reight. T his f orm of

pricing is customer oriented in that the customer can choose which carrier will

handic transportation of the goods. T he choice may allow the purchaser to obtain

a better f reight cost than the supplier by consolidating shipments or by negotiating

f reight rates. T he buyer may also choose among various transport modes to obtain

the lowest f reight charge (f or example, rail may be cheaper than truck) or to ob-

tain f aster delivery (f or example, courier or air f reight). A logistically aware cus-

tomer may make arrangements to utilize the buying f irm's empty back-hauls.

FOB Destination. T he FOB destination pricing technique means that the sup

plier assumes the cost of f reight (although this cost is built into the supplier's

invoiced price). T his f rees the buyer f rom expediting arrangements, as the supplier

handles all transportation arrangements.

Freight Equalization. With f reight equalization, the supplier assumes a por.

tion of the cost of f reight and charges only the remaining portion to the customer.

T he amount absorbed by the supplier depends on the distance between the seller's

f actory and the location at which f reight is equalized. For example, because carbon

electrodes used in clectric melting of steel are made by only a f ew manuf acturers

and are extremely dense (theref ore expensive to transport), manuf acturers would

not be able to compete beyond their local areas if they calculated delivered price

based solely on transportation costs. Hence, they calculate delivered prices based

on the transportation cost f rom the supplier's f actory location nearest to the cus-

tomer whether it is their own or a competitor's.

CIF, CIF stands f or "customs, insurance, and f reight" and is the most commonly

used pricing f ormat f or international shipments. T he CIF price includes FOB f ac-

tory price plus all domestic inland charges and all ocean (or air) transportation

440

CHAPT ER 11 BUSINESS PRICING

and ancillary costs. T he total of these costs is called the C&F (cost and f reight)

value. T o the C&F value is added an all risk insurance premium covering 110 per

cent of the C&F value, to arrive at the CIF price. T his price is always quoted at the

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port of destination (f or example, CIF Hamburg). Shipment f rom the dock or airport

to the customer's plant is the buyer's responsibility

LEASING IN INDUST RIAL PRICING

T hus f ar, the pricing decision has centered on the sale of the product or service.

- It is important to recognize that a very powerf ul marketing alternative to outright

sale exists—the lease. Roughly 27 percent of all private sector investment in

equipment is f inanced through leasing in the United States, and about 10 percent

in Europe and 5 percent in Japan. Eighty percent of U.S. corporations and 60

percent of U.K companies lease assets cach year. Exhibit 11-9 shows that the

trend toward leasing by business is growing. Worldwide, leases have increased in

value more than sixf old since 1979.2 Leasing has become a very important tech-

nique in marketing industrial equipment, ranging f rom batteries f or f orklif t trucks

to an entire $111 million aluminum reduction mill.24

A lease is a contract through which the owner of the equipment, in return f or

a periodic rental payment, allows the lessee to use the equipment. T here are two

types of leases. Financial (or f ull-payout) leases are intermediate to long-term,

noncancelable contracts and are f ully amortized during the term. T he lessee pays

operating expenses and assumes all liabilities f or the equipment (production ma-

chinery). At the end of the term the lessee usually has the option to buy the equip-

ment. Operating leases are short-term cancelable contracts that are not f ully am.

ortized. T he lessor usually assumes expenses and liabilities of ownership, and a

purchase option typically is not available to the lessee (trencher backhoe).

EXHIBIT 11-9 New Leasing Business Worldwide (billions of US$)

Region

1979

1980

1985

1990

33.9

9.5

5.5

3.6

37.7

13.2

6.3

125.4

1179

North America

Europe

Asia

Australia/N.Z .

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Af rica

Latin America

T otal

775

80.8

2+.

25.9

3.9

1.2

1.6

138.1

5.1

3.8

0.5

1.5

63.6

1.9

53.0

331.7

Sources: T . M. Clark, Chief Executive, Mercantile Group Plc., Basingstoke, England, T M. Clark,

cd.. Leasing Finance, 2nd ed. (London: Euromoncy Books, 1991), p. 4: David J. Porter, "Leasing-

Fighting f or Funding in Recessionary T imes." in World Leasing Yearbook

LEASING IN INDUST RIAL PRICING

141

Economic benef its to the lessce include avoiding the cash purchase cost of

the asset and concurrent f inancing arrangements, improved cash f lows, more avail

able working capital, protection f rom capital equipment obsolescence, and a

better looking balance sheet Other advantages to the lessee include the ability to

enjoy total deductibility of costs, no dilution of ownership or control, ability to

f inance small acquisitions, smaller af ter tax cost compared to equity investment

tax credits f or companies with low carnings or heavily sheltered earnings, and a

greater tax shield than depreciation or interest

T o f acilitate customers' use of its products, an industrial manuf acturer can act

as lessor itself f orming a credit subsidiary to provide leasing (as has been done by

J I Case and John Deere f or f arm equipment and Borg-Warner and Gould f or

pumps), negotiating the lease through a bank, or leasing products through a leasing

company (such as U.S. Industrial T ools or General Finance Corporation).

Why should the business marketer become involved in the complicated

process of leasing? T here are several reasons. Leasing can expand the company's

market to segments that otherwise might not be able to af f ord to buy the f irm's

products. A potential customer unable to invest $15,000 in a new f orklif t truck

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might be quite capable of af f ording to lease one at $300 a month. It also helps the

marketer appeal to potential customers who have avoided outright purchase be-

cause of the risks associated with obsolescence or style change, incorrect selection

of equipment, maintenance, and sporadic use. T he add-on of a service contract

can keep the supplier in continuous contact with the customer, building pref er

ence toward the supplier's total product line and increasing the potential f or f uture

leases and purchases f rom the supplier.

In terms of pricing strategy, the business marketer can set the lease rate and

the purchase price so that either alternative will generate the same return to his

or her company. T he marketer may use low lease rate pricing to encourage more

customers to lease, thus binding lessees to the company's product line, generating

closer contact between the sales and the lessee, increasing sales of the com-

pany's other products, encouraging the lessee to trade up within the lessor's prod-

uct line as the lessee's f irm grows, and perhaps allowing the lessee to apply part of

the lease payments toward purchase of newer or more expensive equipment. A

method f or segmenting markets through price breaks on leasing and payment

schedules has been developed to help the lessor maximize prof its.

A danger in pursuing a leasing strategy is that business salespeople are usually

specialists in the technical f eatures rather than the f inancial aspects of their of f er-

ings. T hus, it might be more prof itable f or larger business marketers to create a

f inancial specialist position in the sales organization.* Xerox Corporation, f or ex-

ample, has a consulting service representative (CSR), a marketing f inancial analyst

who works with the customer's f inancial group in larger multiple-installation ac

counts to analyze the cconomic aspects of lease and rental options. Also at Xerox,

a sold equipment representative (SER) aids customers who pref er purchase rather

than leasing arrangements, providing assistance in analyzing the f inancial aspects

of both installment purchase and outright purchase.

T he pricing alternatives in outright sales of goods, installment payment f or

purchases, and leasing arrangements are extremely complex. Such strategies as

442

CHAPT ER 11 BUSINESS PRICING

those of Xerox recognize the quandary of the customer and creatively combine

pricing with innovations in their total marketing strategy

Pricing is no longer a technical problem that can be solved by applying a rule

or even a complex mathematical procedure. It is a challenge to the creativity of

the business marketer, who must use innovative approaches combined with insight

into buyers' motivations

COMPET IT IVE BIDDING

A very large proportion of business transactions is brought about by the process

of competitive bidding. T his ref ers to situations where the buyer asks two or

more competing suppliers to submit bid prices and associated data on a proposed

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purchase or contract. Af ter evaluating the bids, the buyer decides which of f er best

meets the f irm's needs and places the order. "Best" varies f rom buyer to buyer as

cach weighs of f setting advantages and disadvantages of prospective bidders' prices,

delivery time promises, reputation f or quality, past perf ormance, and other f actors.

Competitive bidding is most f requently used when adequate specif ications describ-

ing the item are available, competition is adequate (enough qualif ying potential

suppliers), the size of the proposed purchase is suf f icient to create competitive

interest, and suf f icient time is available f or carrying out competitive bidding pro-

cedures.29

T he main reason f or the buyer to use competitive bidding is to obtain the

most reasonable prices. For example, when Robert McNamara was U.S. secretary

of def ense, he instituted competitive bidding to replace single sourcing, reducing

ordinance purchase prices by roughly one-quarter. An example of the competitive

bids quoted to McMaster University's Physical Education Department f or the pur-

chase of a whirlpool bath and valves (Exhibit 11-10) illustrates the typical range

of prices.

Price reduction is not the only reason f or seeking competitive bids, however.

Other reasons include the f ollowing:

Institutions spending public f unds cannot be accused of collusion with sup-

pliers to "rig" purchase price.

T he temptation f or a supplier to illicitly inf luence the purchasing of f icial is

eliminated

EXHIBIT 11-10 Competitive Bids f or a Whirlpool Installation

Supplier

Price:

$1,365

$1.11+

$1,200

$952

$9+1

SourcePurchasing Department, McMaster University, Hamilton, Ontario

COMPET IT IVE BIDDING

443

By cost minimization, the purchaser can increase the buying organization's

prof its

In a "straight rcbuy" situation, competitive bids can be used as a check to

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ensure that the "in supplier" is still charging a reasonable price.

Price inf ormation can be obtained in the "new task purchase situation where

there are no known norms f or prices

T he buyer can assess the range of prices in a market

T he buyer can learn f rom whom and under what conditions lowest price is

provided

T he buyer can choose among various alternatives when design and manuf ac-

turing methods f or complex cquipment vary considerably

When the buyer doesn't want to repeat the entire purchasing process on each

reorder of f abricated parts or materials but still wants some price leverage,

competitive bidding can be used f or, say, a year's requirements in a term con-

tract purchase

Since there are more reasons f or conducting competitive bidding than price

alone, the lowest price does not necessarily guarantee that a bidder will be

awarded the contract. Indeed, it is a practice in some f irms when evaluating the

bid of f ers to eliminate the highest and the lowest bidder f rom consideration prior

to beginning thorough bid evaluation. T his eliminates bidders who (at the high

end) may not really want the business anyway and who (at the low end) may have

made an error in their submission

T here are three f orms of competitive bidding procedures, ranging f rom the

loosest or the least f ormal to the most f ormalized inf ormal bidding, open bidding.

and closed bidding

Inf ormal Bidding

In inf ormal bidding, the buyer may ask several salespeople to stop by the of f ice.

T hey are shown the requirements of the purchase, which they take away and use

to estimate their price. If the job is simple enough the buyer may describe its

requirements to suppliers by telephone. T he salespeople then telephone their

price to the buyer and subsequently submit their quotation by mail. T he buyer

already may have awarded the job to one of them bef ore the mail delivery of

quotes arrives. T his process is typical in printing of catalogs and other relatively

uncomplicated purchases of no more than a f ew thousand dollars.

Open Bidding

In open bidding, a somewhat more f ormal process is f ollowed. Specif ications are

drawn up, suppliers are contacted, and a f inal date f or written tender submission.444

CHAPT ER 11 BUSINESS PRICING

is established. However, when an of f er is received bef ore the f inal date, the buyer

is f ree to examine it, discuss it with the supplier, and even suggest changes and

resubmission bef ore the f inal due date. T he danger in open bidding is that the

contents of one supplier's proposal may be divulged to competing suppliers, as in

"If you can just shave another $350 of f your quote, I'll be able to give you the job.

Yes, that's how much Acme Fasteners' price was below yours." Or, "Gee Charlie,

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Apex Company came up with a great idea in their bid that cut the cost of this job

by 10 percent. Here's what they did. Can you match that?" Such disclosure of

competitors' quotes is uncthical and should be avoided.

Closed Bidding

In closed bidding, the supplier submits a written proposal in a sealed envelope

by a specif ied deadline. Late submissions are not accepted. At a presct time and

location all bids are opened and examined. T hus, there is no opportunity f or their

contents to be revealed to anyone bef ore the bid-opening ceremony. Of ten this

occasion is an open public meeting to which all bidders have been invited. T ypi.

cally in this situation the supplier who wins the contract is the lowest "responsible

bidder"-that is, the one whose bid meets all specif ications.

Formal Bidding Procedures

Most private organizations and government agencies maintain a record of accept-

able vendors, generally based on past dealings. T hey have been qualif ied on the

basis of product quality, service and guarantee policies, prices, technical capability,

overall reputation, and other criteria. It is most important f or the potential sup-

plier's organization to qualif y f or and get on the approved list if the marketer

wishes to receive invitations to tender bids.

From this list, the buyer will select some or all of the vendors that match the

f irm's needs and send them a request f or quotation (RFQ), which is also called

a request f or proposal (RFP) or an invitation to bid. T his f orm states all the

requirements of the project, including specif ications, quantity, weights, shipping

specif ications, terms and conditions of purchase, and date f or f ormal opening of

bids.

In proposals f or building contracts ard large projects, especially f or govern

ments, the bidder may be required to f urnish a bid bond or certif ied check (say.

10 percent of the bid price) as a guarantee of good f aith, and sometimes a labor

and material perf ormance bond (as much as 50 percent of the bid price), and

insurance certif icates. T hese protect the buyer f rom f ailure to complete the job

and f rom lien claims against labor and materials. Since the bid is a legal of f er, if

accepted it becomes a legally binding contract.

Competitive bidding is a costly process. It involves a great deal of marketing re-

search to assess the customer's unwritten pref erences and requirements (as well

as those explicitly stated in the RFP). T he potential f or f ollow on business must be

assessed. Research is required to determine who the competitors on the bid are

likely to be, including their perf ormance on previous bids, their current plant uti

lization, and their expected bid price. Environmental appraisals are necessary to

determine how current labor, economic political, and f inancial conditions will

inf luence the bid and the company's ability to f ulf ill its requirements throughout

the duration of the contract f or these reasons, the development of a proposal

resembles the process of preparing a caref ully developed business plan.

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Bidding Objectives

Objectives governing the development of bids should be established. Some of

these will be derived f rom overall pricing objectives, whereas some will be specif ic

to bidding. For example: Does the company wish to maintain its presence as a

prospective supplier, even when the shop is working to capacity? If so, then it will

be necessary to continue bidding on new jobs even though there is no intention

to win the contracts. T hus, a high bid price would be indicated. Alternatively, to

keep the shop f ully utilized, it might be necessary to submit "low ball" prices on

bids f rom time to time. Other objectives might include being unif ormly competi-

tive in all the company's markets, maintaining price stability, and using price to

help maintain a particular corporate image. Part of the development of the pro-

posat also will involve assessing the objectives of all competitors who are likely to

bid.

Organizing f or Bidding

T he f irm should be organized to bid ef f ectively. T he cost of preparing a bid is

directly proportional to the job's total cost. Hence, a substantial budget should be

allocated to support bid preparation. In some cases, such as bidding on architec

tural design work, the customer will provide f unds to cover proposal costs of a

limited number of bidders.) Usually a multiple buying inf luence (MBI) is in

volved in developing the buyer's request f or proposal. If the business marketer

learns the "who's who" of the MBI early enough, valuable inf ormation can be pro-

vided to those people in the customer f irm to help them design the specif ications.

It is common f or an astute marketer to help the buyer write specif ications that will

qualif y the marketer's own products and exclude those of competitors. At the same

time, the marketer acquires greater insight into both the customer's "hard" (spec.446

CHAPT ER 11 BUSINESS PRICING

if icd) and "sof t" (or unstated) needs, and also builds some creeping commitment

toward his or her f irm in the process,

A signif icant organizational f ault among contracting f irms in civil engineering

building, and construction engineering is the employment of too f ew people as

estimators. T he number of estimators can be as important to the bidding f irm as

the number of salespeople to a company selling goods at standard prices. In bid.

ding, the higher the markup over costs, the greater the potential prof it but the less

the probability of success in winning the bid. T o maintain shop volume, many

companies choose to bid a low price at least occasionally. T hus, they may not

maximize their prof it. T o optimize prof its, it pays to increase the number of esti

mators and bid at a higher markup, as long as marginal estimating and sales costs

of additional bids are more than of f set. A study of six f irms' actual and optimal

numbers of estimators summarized in Exhibit 11-11 demonstrates this point. It

can be seen that, grouped together, these six f irms, by hiring a bit more than twice

as many estimators, and incurring two and a third more estimating and selling

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costs, even with half the chance of winning bids at a higher markup, would earn

an average of 58 percent more prof it.

Last, an important organizational aspect is the assignment of people to f ollow

up af ter the contract has been awarded to a competitor to f ind out why the job

was lost. T his provides valuable input about both the customer's priorities and the

competitors' behavior, which can be used in preparation of f uture bidding propos-

als. IBM has f ormalized this process, holding monthly "joint loss reviews" (lost

account discussions) with regional and branch personnel to analyze why business

was lost and what corrective action can be taken."

Bidding to Win Follow-on Contracts

Special pricing strategies may be implemented in situations where equipment con

tracts are large, component parts f or the equipment are expected to be ordered

EXHIBIT 11-11 Analysis of Estimator Usage in Bidding

T otal Volume

of Bidding

(5 million)

T otal Number

of Estimators

Average of

6 Mean

Markups

Average of

6 Mean

Success

Probabilities

T otal Prof its

Expected

Af ter

Estimated

Sales Costs

(5 million)

T otal

Estimating and

Sales Costs

(5 million)

8,0

Actual

Optimal

215

34

2,449

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5,322

0.165

0.085

12.7

6.45

15.10

21.01

33.20

Source: From "T he Number of Estimators: A Critical Decision f or Marketing Under Competitive Bidding," by

Kenneth Simmonds and Stuart Slatter f rom Journal of Marketing Researcb, vol. 15 (May 1978). Reprinted by

permission of the American Marketing AssociationPRICING UNCERT AINT Y

447

f or several years, some customization is required, and there is the chance of a

f ollow on contract A f ollow on contract is a repeat order f rom the customer f or

example, if an injection molder wins the contract on the dies and the f irst run of

a product, this f irm has an excellent opportunity to obtain f urther runs, particu-

larly if the mokler retains possession of the dies

T he pricing strategy in such a situation might dictate sacrif icing some probit

with a low bid on the f irst contract in the expectation of winning f ollow on bust

ness with a higher bid and a corresponding higher prof itability in subsequent con

tracts. Determining the best combination or prices f or the initial bid and the f ol

lowon bid can be quite dif f icult

Negotiation

Af ter a competitive bidding process has resulted in a f irm being awarded a con

tract, the buyer may decide to change the specif ications or integrate some newly

developed technology into the equipment. In other situations the job may be so

complex, and have so many alternative solutions, that bidding is not f easible. Or it

may take such a long time to complete that neither buyer nor seller can be sure

of the amount or type of work involved

En such an instance, price is arrived at through negotiation: the buyer and

chosen supplier spend considerable time together working over the details of the

job and eventually arrive at a mutually agreeable pricing arrangement. In one ex-

ample of this, an Af rican nation contracted a North American supplier to install a

turnkey power distribution system in the country. T wo years af ter work on the

project had begun, negotiations were still under way!

In negotiation, any aspect of the marketing mix may be up f or grabs." T hus,

the marketing manager must be thoroughly prepared and have not only technical

Inf ormation and costs but also negotiating skills, knowing when to concede an

issue and when to draw the line.

PRICING UNCERT AINT Y

At all times there is some degree of uncertainty in the determination of prices,

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especially the uncertainty of demand. However, this is a risk the entrepreneur ac

cepts. A more troublesome risk is uncertainty about the availability of resources

and their costs

Until this point, our discussion of pricing has tacitly assumed that the labor,

materials, and component supplies that are required to produce industrial goods

and provide business services were available in adequate quantities and could be

purchased at relatively stable prices. T his prices could be set and contracts could

be bid f or or negotiated with some conf idence that the principal problems wouldCHAPT ER 11 BUSINESS PRICING

center on customer and competitive reactions. Increasingly, however, this is not

the case

Westinghouse Large Power T ransf ormer Division lost millions of dollars on an

order that had been contracted two years earlier At that time the f ixed price

contract had been estimated using an annual inf lation f actor of 6 percent f or

both materials and labor. By the time the transf ormer equipment was deliv.

cred, materials (which accounted f or more than one-third of the quoted price)

Iuad skyrocketed by 435 percent."

Electrical capacitor manuf acturers f linched as the price of tantalum powder

increased 300 percent in a twelve-month period.

Manuf acturers of high-tech electronic components have f aced periodic pro-

duction-stopping shortages of microprocessors.

All such instances af f ect costs, and thus the company's vulnerability in pub-

lishing f irm prices and quoting on contracts. T he f ollowing are some of the alter-

natives in dealing with these uncertainties:

Building and holding costly inventories of the items that might be af f ected.

Hedging, by buying f utures on commodity exchanges.

Backward integration toward the source of supply (purchasing supplier f irms).

Materials substitution. One manuf acturer now uses tin alloy plating rather than

gold plating f or electrical terminals.4

Elimination of low margin products.

Investing in R&D. One manuf acturer developed a new process to spot gold

accurately on electrical contact points rather than spreading it."

Unbundling of services. Manuf acturers are increasingly charging f or services

separately rather than building them into product costs.

Writing f ixed-price contracts valid f or a limited time.

Delaying submission of quotations until the last minute.

Selling on a price-in-ef f ect-at-time-of -shipment (PET S) basis. In a study of 153

purchasing agents, half of them stated that 80 percent or more of their vendors

were selling on a PET S basis. %6

Quoting on individual orders rather than publishing a price list.

Setting prices in anticipation of f uture costs,

Quoting current prices but including an escalator clause, which allows the

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buyer to compare base.prices among competitors. T he escalator clause ties

specif ic costs to a widely available published government or industry as-

sociation index. If the index rises, then the prespecif ied portion of costs

in the original price that was quoted is increased proportionately (See the

Business Marketing in practice box "Price Escalation-Coping with Cost In-

f lation.")150

CHAPT ER 11 BUSINESS PRICING

Issuing new price lists or circulating surcharge notices as costs change

Maintaining prices but reallocating scarce resources. Here, the volume of var:

ious products in the line will be adjusted to optimize total prof its.

PRICING FOR EXPORT

Exportation of products of f ers new markets to previously domestically oriented

f irms. One advantage business marketers have over consumer marketers in ex.

porting is that f oreign customers' product evaluations are f ar more economically

oriented and less subject to cultural peculiarities that may hinder market accep

tance. A f our nation study by three coauthors of this text showed that the similar.

itics in purchasing inf luences are quite strong."

But the dif f erences still exist! In pricing, however, they are not so serious. It

is generally advisable to quote prices CIF the buyer's country in the f oreign coun-

try's own currency, though this poses risks. Rolls Royce in the United Kingdom

was stung to the extent of $66 million on jet engine export contracts that had

been quoted in U.S. dollars. T he pound sterling strengthened, and the dollar weak-

ened in international currency markets.58 T he saf est approach in selling export is

to lock in the price quoted by short selling the f oreign currency f or the amount

and date that the payment will be received."

Unless export sales represent a large proportion of the f irm's business, or the

production f acilities are strained, any revenue over the marginal costs of produc-

tion and export will provide a contribution to overhead. Consequently, the busi-

ness marketer has a wide range of f lexibility in setting export prices.

SUMMARY

Knowledge of the f orms of market structure perf ect competition, monopolistic

competition, oligopoly, oligopsony, and monopoly-is helpf ul an understanding

competitive pricing behavior. T he traditional "economics" approaches of supply-

demand pricing, cost-plus pricing, and break-even pricing provide f urther insight

but have numerous limitations.

In practice, companies set pricing objectives that f ollow f rom and comple-

ment the total corporate strategy and objectives of the organization. Price objec

tives may seek to achieve other goals than simple prof it maximization. From pric-

ing objectives, shorter-run pricing policies are derived.

Despite a high degree of standardization in many business products, business

marketers attempt to avoid commodity like pricing by seeking nonprice dif f eren-

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tial advantages relative to their competitors. If successf ul, they are able to sell their

of f ering at prices higher than their competitors. T he upper limit on price now

becomes the customer's perception of value. Similarly, the marketer's costs be-

come irrelevant to price determination (as long as they are recovered).

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