Industrial Pricing

Industrial Pricing
Strategies & Policies
Industrial Marketing Faculty of Graduate Studies 1

University of Colombo© Rmst
Special Meaning of Price
When an industrial buying firm buys a product from XYZ
supplier firm which is in competition with several other suppliers
of the similar product, it means that the buying firm perceived
that the supplier offered the highest delivered value. The highest
delivered value is the difference between the overall perception
of the value and total cost to the buying firm.
The overall perception of value (or the benefits) will vary in
degrees of importance to the different individuals within the
buying committee (or the buying centre) of a buying firm. If there
is no agreed formula on the importance to be given to various
benefits, different individuals in the buying centre will have
different perceptions of value provided by various suppliers.

Factors influencing Pricing Decision
An industrial marketing firm has to consider many

factors in its pricing decisions. These factors are,
1. Pricing objectives
2. Demand Analysis
3. Cost analysis
4. Competitive analysis
5. Government regulations
While each of these factors is important, the pricing
objectives represent the most important factor in pricing
decision.
Pricing Objectives
Pricing objectives should be derived from corporate and marketing
objectives. Some companies give more priority to certain objectives and less
priority to others. There are many possible pricing objectives which industrial
firms can pursue.
Survival – A short term objective followed by some companies is survival
if the factory production capacity is underutilised to a large extent, or unsold
finished products have piled up, or due to intense competition, a firm is unable
to sell its products. To keep the factory going and to convert inventory to sales,
as a part of survival objective, an industrial firm reduces prices. Profits are less
important than survival. The prices are set in such a way that they cover
variable costs and part of fixed costs so that the company stays in business.
This is done for a short term. However in the long run the firm must raise its
prices to cover total costs or face losses.

Pricing Objectives
Maximum Short term profits – Some companies try to set

prices with the objective of maximisation of short term profits.
These companies estimate the market demand and costs at
alternative prices and select the price that gives maximum current
profits. However in practice it is difficult to accurately estimate
demand and cost functions. Moreover the emphasis is on short
term profit maximisation rather than long term performance and
customer relationships. The companies following this objective
do not consider competitors’ reactions and legal implications.

Pricing Objectives
Maximum Short term sales – Some companies set

prices with the objective of maximising short term sales
revenue. For doing this, it is required to forecast the
company sales over a period of time. The underline
belief, that these industrial marketers have is , that by
maximising sales revenue the companies will have
growth in market share and also profit maximisation.

Pricing Objectives
Maximum Sales Growth (or Market Penetration) – Some

companies fix the prices of commodities as low as possible with
the objective of maximising sales volume and market share of its
products. The assumption is that the market is price sensitive, and
that the low prices will increase sales. Other assumptions are,
1. Highest volume will reduce the production and distribution
costs, leading to higher long term profits.
2. Low prices will discourage entry of potential competitors

Pricing Objectives
Maximum Market Skimming – If the market penetration price is placed at

one end of pricing alternatives, skimming price would be found at the other
end of the continuum. Some companies set high prices in the initial stages of
the product life cycle when they introduce new and innovative products. The
new product is initially aimed at those market segments where demand is least
sensitive to price, that is, customers in those market segments are willing to
pay high prices for the product. By following the skimming objective, the
company skims maximum revenue and profits. As the time passes and sales
slow down, prices are lowered in stages to attract new customers from price
sensitive segments. The objective in market skimming is to maximise sales
revenue and profits. The assumption made in this strategy is that different
prices can be charged to different segments of customers and also at different
times. The risk involved is that high profits resulting from high prices, will
attract entry of competitors.

Pricing Objectives
Product – Quality Leadership – A company may have an

objective to be product-quality leader in a market. The company
therefore, produces superior quality product (superior to any
other competitor) and charges slightly higher prices than the
competitors’ price. This pricing objective results in higher profits.
Other Pricing Objectives – Between two extremes of market
skimming and market penetration, there is an intermediate range
of moderate pricing alternatives. An intermediate range pricing is
suitable to achieve other pricing objectives like “be regarded fair
by customers” “avoid government intervention”, “try to stabilise
the market” and “meeting the competition”.

Demand Analysis
The concepts of demand curve and price elasticity are useful

starting points in the relationship between demand or sales
volume and price. The relationship between price and sales
volume can be measured by an experimental research. In
measuring the price and demand relationship, the market
researcher should control other factors like promotion and
customer service which may also affect demand. The basic
purpose of estimating the demand curve is to find out to what
extent the demand for a product changes with the changes in
prices. The demand curve sums up the price sensitivities of many
buyers. It indicates whether buyers are less price sensitive (in
elastic demand), or more price sensitive (elastic demand)
Demand Analysis
If demand hardly changes with a small change in

price, then the demand is inelastic. However if demand
changes substantially with a small change in price, then
demand is elastic. The price elasticity of the demand is
determined by the following formula.
Price Elasticity of Percentage change in quantity demanded

Demand =
Percentage change in Price

Demand Analysis
Conditions Determining Price Elasticity of Demand
The demand is likely to be less elastic (or inelastic) under the following
conditions
1. There are few competitors
2. No availability of substitute products from other industries
3. The buyers think higher prices are justified by normal inflation or changes
in government policies on excise duty or sales tax and others.
However, the demand for many industrial products is relatively inelastic
or less price sensitive because these industrial products are technically
sophisticated, customised, or important for buyers’ operations. The demand is
also inelastic for those industrial products which are a small percentage of the
item’s total cost.

Cost – Benefit Analysis
When demand analysis carried out, it is useful to undertake

an analysis of benefits received and the cots incurred by the target
consumers in purchasing and using the product. For an
appropriate pricing strategy, an analysis of the benefits and the
costs of the product from the customer’s point of view is
necessary.
Benefits can be categorised into hard and soft benefits. Hard
benefits refer to the physical attributes of the product such as
production rate of a machine, rejection rate of a component, and
price/performance ratio (dividing the price in rupees by the
performance or benefit measured in units)

Soft benefits includes company reputation, customer service,
warranty period, customer training, and are more difficult to
assess.
For industrial customers costs include not only price but
many other expenses that are incurred in purchasing and using
the product such as transportation (freight), installation, energy
usage, repair and maintenance etc. The buyer may be willing to
pay a higher price to reduce the risk of failure. While buying
capital items, the buyer can use the life-cycle costing concept by
estimating the total cost of the product over its life span. Life-
cycle costing includes the price, freight, transit insurance,
maintenance, energy, material and labour costs over the useful
life of the product.
After understanding the important benefits and the

costs to the customers based on the customer’s
perceptions, the industrial marketer should then evaluate
the possible cost/benefit trade-off decisions made by the
industrial buyers. Like, the volume discounts can be
considered by the customer as an incentive to purchase
lager stocks if the quantum of discount is more than the
costs of carrying the inventory. The industrial marketer
can set an appropriate price by understanding how the
customers evaluate the competing offers on cost/benefit
analysis.
Cost Analysis
Company costs set the lowest point on the price

range. Hence, pricing strategy or decisions must
consider the costs involved. Generally, the total costs
consists of the sum of the fixed costs and variable costs
for a given level of production. Some of the cost
elements fluctuate with volume, other cost elements
vary over a period of time, and some are relevant to the
pricing decisions. For making profitable pricing
decisions, the industrial marketer must identify and
classify costs. The production, marketing, and
distribution costs must all be classified.
Classification of Costs/Types of Costs
1. Fixed Costs also known as overheads
2. Variable Costs
3. Total Costs
4. Semi-variable Costs
5. Direct Costs
6. Indirect Costs
7. Allocated Costs or General Costs.
An industrial marketer must understand
• The cost vary at different levels of production, and economies
of scale can be planned.
• Accumulated experience helps in reduction of costs
• The effect of break-even analysis on costs and sales volume.

Cost Behaviour at Different Production
Levels – Economies of Scale
To price appropriately, a company should know how its costs
vary with different levels of production. To compete effectively a
company may use economies of scale by building a larger plant
size.
The reason for the fall in the average total costs per unit is
that the fixed costs are reduced per unit by spreading them over
more units with each unit produced being a smaller fixed costs.
Figure below shows the relationship between cost per unit (
average total unit cost) and the quantity produced per year (yearly
production volume). In other words, it reflects economies of
scale)

Economies of Scale
350
300
Cost per Unit (in Rs)
250
200
150
100
50
0
150 200 300 400
Quantity Produced Per Year (in thousand numbers)

In the above figure the plant with the production
capacity of 300,000 units is the most efficient and with
the lowest unit cost. It is the optimum size as the
production capacity of 400,000 units per year increases
the unit cost due to operational reasons. If the market
demand is strong enough to support a plant capacity of
300,000 units per year, the company should take the
advantage of economies of scale to compete effectively
and to make adequate profits.

Break – Even Analysis
It is a financial technique which is used by the

marketer to consider different prices and their possible
effects on sales volume and profits. The break-even
chart given in the figure below is drawn by assuming
fixed cost of Rs. 300,000, variable cost of Rs. 15 per
unit, selling price of Rs. 20, and production capacity of
100,000 units. Break even volume is calculated by the
formula,
Break – Even Fixed Costs
Volume =
Selling Price – Variable Cost

Break - Even Chart
3,500,000
Sales and Costs in Million
3,000,000
2,500,000
Rupees
2,000,000
1,500,000
1,000,000
500,000
-
1 2 3 4 5 6 7 8 9 10
Sales volume in (Thousand) units
Fixed Cost Total Cost Sales Revenue @ 30

Sales Revenue @ 25 Sales Revenue @ 20

Break – Even Analysis
Break – Even 300,000

Volume = = 60,000
20 – 15 Units
If the company chooses trial (or projected) selling prices of

Rs. 20, 25, and 30, the break-even volumes were the sales
revenue line intersect the total costs line are 60,000, 30,000, and
20,000 (which can be also verified by the earlier formula). The
price to be chosen should consider the competitors prices and
price elasticity of demand. The company should also consider
lowering its fixed and/or variable costs by using economies of
scale and learning curve concept. Bringing down the costs will
further lower the break-even volume and improve profits.

Competitive Analysis
Many industrial marketers regard competitive – level pricing as the most
important pricing strategy. An industrial firm should get the information on not
only competitors’ prices and costs but also about the competitors’ product
quality, technical expertise, and delivery performance. This is important
because price is only one factor out of several considered in the buyer’s cost
benefit analysis.
Once the industrial firm gets the information about competitors, it can use
price to position its product against the competition. This means that is a firms
product quality is superior to all its competitors and its service is equally good
it can price its product higher than competitors’. However, if the firm’s product
and service are similar to that of major competitors, then its price should be
close to the major competitors prices (if it decides to price its product higher, it
would lose sales.).

Competitors’ Response to price Changes If an industrial
firm is considering a price change, it has to predict the reactions
of customers and competitors. An industrial marketer must first
study the major competitors financial situations, utilisation of
production capacity, actual sales, costs, corporate objectives, and
strengths and weaknesses. After collecting the information on
competitors the next step is to anticipate the reactions of the
competitors. If the competitor’s corporate objective is to increase
market share, the competitor is most likely to match the price
reduction. If the major objective of the competitor is to maximise
profits, the competitor’s likely response to a price change will be
some other ways, such as improve customer service or product
quality.

Competitors’ Response to price Changes A

competitor’s response depends on its mind-set. To
understand the competitor’s mind-set an industrial
marketer must study the business philosophy, internal
culture, and the past practises of the competing firm.
Some of the common reaction profiles of competitors
are;
1. Some competitors do not react strongly or quickly to
a price change for various reasons like slowness in
noticing the price change, or confident of their customer
loyalty.
Competitors’ Response to price Changes

2. Some competitors react in selective manner. They may not
respond if the price change is small in degree or amount or
initiated by a weak competitor. They may react if the price
change is large and initiated by a major competitor.
3. Some competitors react strongly and quickly to any attack on
their markets. They fight to finish.
4. Some competitors are unpredictable, it is very difficult to
predict their response based on their past behaviour, financial
situations or objectives.

Industrial Marketer's Response to price Changes

How an industrial marketing firm would respond to a price
change initiated by a competitor? The answer is that an industrial
marketer should respond only after getting answers to the
following questions;
1. Why the competitor has changed the price? Is it to increase the
market share, to meet changes in the cost, or to utilise excess
production capacity?
2.Is the price change temporary or permanent? If it is temporary
and directed at reducing accumulated stocks, and there is no need
to respond.

3. What will be the impact of the price change on the

company’s sales and profits if the company does not
respond?
4. What would be the reaction of other competitors? If
some competitors match the price change there is a high
probability that other competitors will also match it.
The competitors are likely to respond when the number
of industrial buyers are less, the buyers are aware of
price change, and the products are similar or
homogeneous.

Government regulations
Business marketers must be aware of the effect of government
regulations on pricing decisions. Though we have a “free market”
economy, there are some necessary restrictions that must be
placed on business to ensure fair play, and to protect consumers
and smaller companies.
Price Discrimination
The price discrimination to be effective the two markets or
buyers need to be geographically or otherwise distant. Goods
from cheaper market should not cross over to the expensive
market. Goods transfer need to be economically not viable or else
need to restrict such transfers through the legal system.

Predatory Pricing
This mode of pricing is not permitted, because it takes
place when a company with dominant position lowers
its pricing structure so that new or smaller firms cannot
operate in a profitable manner. The pricing strategy of
the dominant firm aims to kill or drive out competitors.

Pricing Strategies
After an industrial marketer has analysed the five

factors (pricing objectives, demand, costs, competition
and government regulations) which influence the
pricing decisions, the next step is to decide the
appropriate pricing strategy. The pricing strategies
would be different depending on product and market
situations. We will consider the pricing strategies for the
following situations.
1. Competitive bidding in competitive markets
2. Pricing new products
3. Pricing across the product life-cycle

Pricing Strategies
1. Competitive bidding in competitive markets

A large volume of business in the industrial market is decided
through competitive bidding. This method is mostly used by the
state sector enterprises. Even in the private sector large projects
or purchases are decided through competitive bidding. In
competitive bidding to government buyers generally the orders
or contracts are decided in favour of the lowest price bidders.
However in case of commercial enterprises, the orders are
finalised based on the evaluation of bidders quality, design,
delivery, and price factors. Competitive bidding can be either
closed or open.

Pricing Strategies
Strategy for competitive bidding

One of the commonly used strategies is probabilistic bidding.
This technique makes two assumptions
1. Pricing objective is profit maximisation
2. The buying organisation will decide the
order on the lowest price bidder.
Three variables are used in this technique
(a) amount or price of the bid
(b) expected profit if the bid price is accepted
(c) the probability of acceptance of this bid price.

Pricing Strategies
Strategy for competitive bidding
An industrial marketer tries to seek an optimum trade-off between the bid price
or profit on one hand and the probability of winning the contract on the other.
The basic equation used here is as follows;
E(A) = P(A) x T(A)
Where,
A = Bid price
E(A) = Expected profit at bid price A
P(A) = Probability of acceptance of the bid price A
T(A) = Profit if the bid price A is accepted.
For the industrial marketer the most difficult task is to estimate the probability
of acceptance of its bid price as being the lowest i.e. the variable P(A). The
ability to estimate P(A) correctly depends on an industrial marketers
knowledge of the competitors costs, strengths and weaknesses, and the mind-
set.

Pricing Strategies
Pricing New Products

There are two pricing strategies available for a new product
which is in the introductory stage of its life cycle
(1)Skimming (high initial price) strategy
(2)Penetration (low initial price) strategy
While persuading these strategies the industrial marketer must
study the price from the industrial buyers perceptions. Another
factor to be considered by a marketer is how soon the company
should try to recover the investment on the new product.

Pricing Strategies
(1)Skimming (high initial price) strategy
This strategy is used for a distinctly new product which is to be purchased by a
market segment that is not sensitive to the initial high price. It has an
advantage of recovering the investment in the development of the new product
sooner by generating larger profits. An industrial marketer thereafter reduces
the price to reach the other market segments that are more price sensitive. The
disadvantage of the skimming strategy is that it attract competition due to high
profits. Hence this strategy is appropriate for a new product which is distinct,
high on technology, or capital intensive, the factors which would create a
strong barrier to market entry for the competitors. The skimming strategy is
also appropriate if the demand curve is stable over a period of time and the
production costs decline with accumulated production volume.

Pricing Strategies
(2) Penetration Strategy
This strategy is effective when
•Price elasticity of demand is high or the buyers are highly price sensitive
•Strong threat exists from potential competitors
•Opportunity exists to reduce the unit cost of production and distribution
with increase in volume.
The company can draw on the experience curve effect and also achieve the
economies of scale. This would give the company a strategic advantage of
cost leadership over the competitors. Instead of short term profit objective,
the company can adopt the pricing objective of long term profits through
large market share.

Pricing Strategies
Pricing Across Product Life-cycle
The pricing strategy is a key factor in each of the four stages of
the PLC.
Growth Stage Strategy
During the growth stage of the product, new competitors enter the
market and more customers start using the product. Industrial
marketers therefore face a pressure of lowering the prices below
the introduction stage. In the growing market the industrial
marketer tends to focus on product differentiation, product line
extension, and building new market segments. Industrial buyers
follow the purchasing policy of developing more than one
supplier as more than one supplier enter the market. This put
pressure on the innovator firm to lower the price.

Pricing Strategies
Maturity Stage Pricing Strategy

In the maturity stage of the product, the competitors are
well entrenched and aggressive. To increase sales
volume the marketer has to cut into the competitors
market share. This can be achieved by adopting the
pricing strategy of lowering the price to match the
competitors prices. Besides industrial customers buying
behaviour will take full advantage of the cost-benefit
analysis of various suppliers.

Pricing Strategies
Decline Stage Pricing Strategy

There are a number of pricing strategies open to the industrial
marketer during the decline stage, depending on certain
conditions. If the company has built a reputation of good product
quality and dependable service, it need not cut price but reduce
costs to earn some profits. Another strategy is to cut the prices to
increase sales volume above break-even volume and use the
product to help sell other products in the product mix. If some of
the competitors have withdrawn from the market, industrial
market can even consider selective increase in prices for some
segments of the market which are not price sensitive.

Pricing Strategies
Key Terms Associated with Pricing
•List Price (price list) ++
•Net Price
•Trade Discounts – for intermediaries
•Quantity Discounts (Volume) because of reduce cost of selling,
inventory carrying, and transportation.
•Cash Discounts – for prompt payments/no credit
•Geographical Pricing- Transportation & Insurance
•Ex-Factory – at the factory gate
•FOR Destination or FOB Destination- Free on Road / Free on
Board destination
•CIF – Cost Insurance and Freight included up to the port of destination
•Taxes and levies – VAT, PAL, etc.

Commercial Terms and Conditions in
Industrial Markets
Terms of Payment (TOP)
1. Direct Payment – Credit is normally offered to a
customer who is a good paymaster or creditworthy.
2. Payment through Bank –
(i) LC – Letter of credit
(ii) DA – Documents on acceptance
(iii) DP – Documents against Payments
(iv) PAC – Partial Acceptance Certificate
(v) BG – Bank Guarantees
(vi) PG – Performance Guarantee
(vii) LD/Penalty – for performance

Industrial Markets
Role of Leasing
Industrial buyers have an option of either buying or leasing
capital items. A lease is a contract through which the asset owner
(lessor) extends the right to use the asset to another party (lessee)
in return for periodic payment of rent over a specified period.
Lease versus Purchase
Industrial buyers examine the cost benefit trade off of alternatives
of buying versus leasing. If the benefits of leasing are more than
the benefit of owning the capital item, industrial buyer will lease
instead of purchasing the product. The benefits of the leasing are
(a) conserving capital (b) gaining tax advantages (c) getting the
latest products. The cost of leasing includes the lease payment
and sacrifice of assets salvage value.

Industrial Markets
Role of Leasing – Types of Leases
Financial Leases, these are non cancellable long term
agreements or contracts and are fully amortised. The
sum of the lease payments over the contract period
equal or exceed the original purchase price of the capital
item. The buyer is generally responsible for operating
and maintenance expenses. The buyer is usually given
the option of purchasing the asset at the end of the
contract period, on the basis of the assets’ fair market
value.
Industrial Markets
Role of Leasing – Types of Leases
Operating Leases, in contrast these are cancellable short-term agreements or
contracts and not fully amortised. Because the asset is provided for a short
period the purchase option is not included. The rates for operating lease are
usually higher than the rates for financial lease because the responsibility of
the operating expenses and the risk of obsolescence are that of the marketer
(the lessor).
Depending on the marketing objectives of the firm, the pricing strategy could
be decided out of the possible three alternatives
(a) Decide lease rate to favour leasing
(b) Decide the lease rate to favour outright purchase
(c) Achieve the balance between lease rate and sale rate.
To stimulate the demand for new capital items the firm may decide to
offer alternative lease rates so that the potential adaptors (customers) can try
the new product on a limited basis.

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Strategies & Policies

Industrial Marketing Faculty of Graduate Studies 1

Industrial Marketing Faculty of Graduate Studies 2

An industrial marketing firm has to consider many

Industrial Marketing Faculty of Graduate Studies 5

Maximum Short term profits – Some companies try to set

Industrial Marketing Faculty of Graduate Studies 6

Maximum Short term sales – Some companies set

Industrial Marketing Faculty of Graduate Studies 7

Maximum Sales Growth (or Market Penetration) – Some

Industrial Marketing Faculty of Graduate Studies 8

Maximum Market Skimming – If the market penetration price is placed at

Industrial Marketing Faculty of Graduate Studies 10

Product – Quality Leadership – A company may have an

Industrial Marketing Faculty of Graduate Studies 12

The concepts of demand curve and price elasticity are useful

If demand hardly changes with a small change in

Price Elasticity of Percentage change in quantity demanded

Industrial Marketing Faculty of Graduate Studies 14

Industrial Marketing Faculty of Graduate Studies 15

When demand analysis carried out, it is useful to undertake

Industrial Marketing Faculty of Graduate Studies 17

After understanding the important benefits and the

Company costs set the lowest point on the price

Industrial Marketing Faculty of Graduate Studies 21

Industrial Marketing Faculty of Graduate Studies 22

Industrial Marketing Faculty of Graduate Studies 23

Industrial Marketing Faculty of Graduate Studies 24

It is a financial technique which is used by the

Industrial Marketing Faculty of Graduate Studies 26

Fixed Cost Total Cost Sales Revenue @ 30

Industrial Marketing Faculty of Graduate Studies 27

Break – Even 300,000

If the company chooses trial (or projected) selling prices of

Industrial Marketing Faculty of Graduate Studies 28

Industrial Marketing Faculty of Graduate Studies 29

Industrial Marketing Faculty of Graduate Studies 30

Competitors’ Response to price Changes A

Competitors’ Response to price Changes

Industrial Marketing Faculty of Graduate Studies 32

Industrial Marketer's Response to price Changes

Industrial Marketing Faculty of Graduate Studies 33

3. What will be the impact of the price change on the

Industrial Marketing Faculty of Graduate Studies 34

Industrial Marketing Faculty of Graduate Studies 35

Industrial Marketing Faculty of Graduate Studies 36

After an industrial marketer has analysed the five

Industrial Marketing Faculty of Graduate Studies 38

1. Competitive bidding in competitive markets

Industrial Marketing Faculty of Graduate Studies 39

Strategy for competitive bidding

Industrial Marketing Faculty of Graduate Studies 40

Industrial Marketing Faculty of Graduate Studies 41

Pricing New Products

Industrial Marketing Faculty of Graduate Studies 42

Industrial Marketing Faculty of Graduate Studies 43

Industrial Marketing Faculty of Graduate Studies 45

Industrial Marketing Faculty of Graduate Studies 47

Maturity Stage Pricing Strategy

Industrial Marketing Faculty of Graduate Studies 48

Decline Stage Pricing Strategy

Industrial Marketing Faculty of Graduate Studies 49

Industrial Marketing Faculty of Graduate Studies 51

Industrial Pricing - Strategies & Policies L4

Industrial Pricing - Strategies & Policies L4