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Pricing Strategies

Price Determinants Factors influencing pricing strategies Concept of learning curve Pricing strategies Competitive bidding Leasing

Pricing is an indispensable part of the industrial marketing strategy. It must be carefully interrelated to the firms product, distribution, and communication strategy. The IM manger has the challenging responsibility of blending the various elements of the marketing mix to ensure that the needs of the market, but also provides a return consistent with the firms profit objectives.

Price constraints

Market demand Customer values Manufacturing cost Competition Economic conditions Government regulations Reseller profit margins

Price: A crucial element in product strategy

For two reasons, price must be viewed as a part of the product offering as well as a separate element in the marketing mix First, from the buying perspective :cost against product quality, delivery, and supplier service Second, from sellers point of view, which includes profitability, post purchase, service and technical assistance. In Industrial buyer, price is only one determinant of the economic impact that a product will have on the firm.

Factors Influencing Pricing Strategy


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Customer Demand The nature of the derived demand Competition Cost and Profit relationship The markets reaction to and perception of price, and Government regulation

1.Customer demand

The demand for virtually all industrial products is derived from the demand and production of some consumer end product. Since a single product may be used in many different applications and varying usage levels across individual firms and market segments. importance of the end product may also vary For these reasons, potential demand, sensitivity to price, potential profitability differ across market segment.

Determining product values from the customers perspective

Analyzing Customer Benefits

Analysis of the potential customer benefits begins by focusing on the attributes of physical products as well as the elements of the augmented product.( delivery, financing, or technical support)

Analyzing Customer costs:

In addition to weighing benefits, organizational customers assess the costs associated with owning and using the product, by applying life-cycle costing.

Product value is related to the buyers sensitivity to price. Price Sensitivity varies with purchases, over time, and from one set of circumstances to another

Price Sensitivity:

2 The Nature of Derived Demand

Derived demand means that sales original equipment manufacturer (OEM) ultimately depend on the level of customer demand for the products that the OEM makes. Because of the relatively distant relationship between an industrial supplier and ultimate consumer. what was the direct relationship between price and quantity demand in the consumer market becomes an indirect and often reversed relation

3 Competition
Existing and potential competition inevitably affects pricing strategy by setting an upper limit. Research indicates that competitive-level pricing is regarded By the majority of firms as the most important pricing strategy

Price Leadership:

When initiating price increases, the marketer must predict how competitors will react. A price increase that is not followed by competitors will must likely lead to a loss of market share. The competitors to follow as price increase 1. Total demand will not be reduced by increase 2. Other major suppliers will also follow the increase 3. The initiator of the price increase is acting intelligently and in the best interest of all suppliers

4 Cost and profit relationship


While competition sets the upper limit on price, costs set the lower limits. Therefore, it makes little sense to develop pricing strategy without considering the costs involved . The various costs may include fixed cost, variable cost , direct cost, indirect cost, Allocated costs, semivariable cost . Many organization tend to follow Price= total cost + profit Advantages 1. It is relatively simple to calculate 2. For low-cost producer cost plus pricing can be very competitive strategy.

Estimating Cost

Price setters can use two different sources of information in estimating costs: accounting records plus engineering and manufacturing estimates . Marginal Cost and Revenue To develop a profitable pricing strategy, the price setter must also understand the concept of marginal revenue and cost. Theoretically, the firm should continue to increase sales and production volume as long as the total cost of producing the last unit does not exceed its selling price

Cost Analysis

The cost of producing and distributing a product establishes the floor floor for the contemplated price. If these costs are not atleast covered, losses will be incurred. But which costs should the price setter consider. Fixed cost and variable costs are the major concerns, but the specific type and level of cost to be used as the basis for unit price is to be determined.

Difficulties in encountering in determining relevant cost for pricing

Predicting the sales volume The estimation of variable and semivariable costs In attempting to determine relevant cost involves the inclusion or exclusion of certain cost items.

5.Cost behavior over time: Learning Curve

Basic Concepts: Learning Curve was first recognized in the early 1950s by Boeing. They discovered that the no of hours required to build aircraft decreased about 20% each time cumulative production doubled. Many other firms that have actively employed the L-C concept found that Labor hours decreased and volume related cost also decreased.

Important Distinction

The Learning curve is a volumedependent, not time-dependent. The cost savings are not limited to the production process. L-C concept is not the same as economics of scale.

Strategic use of the learning curve:


It is frequently considered with market penetration strategy. L-C cost reduction is used for following purposes: 1. To cover sunk cost more quickly 2. To enhance marketing efforts in this market 3. To develop new market opportunities

4.To increase R&D expenditures


5.To raise needed working capital 6.To expand production capacity

Pricing Strategies
Pricing: pricing is indispensable part of industrial marketing strategy. It must be carefully interrelated to the firms product, distribution and communication strategies

Pricing strategies must be conceived in relation to overall objectives and marketing strategy. The success of any business depends on a blend of long term profit, growth, and survival objective. Prices influences of unit sales volume, profit margin, affects long term profit objective and finance growth objectives. Maintaining profitability through sound pricing practices is necessary to insure the firms survival over a time

Types of pricing strategies

New product introduction Product life cycle consideration Flexible pricing strategy

Pricing for new product introduction

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Activities associated with the development and marketing of a new product RESEARCH , PLANNING , TESTING AND MARKET INTRODUCTION. There are two pricing strategies Market skimming strategies Market penetration strategies

1.Marketing skimming strategy


A Market skimming strategy, charging an artificially high price and then gradually reducing it over time, has the advantage of generating greater profits per unit earlier than would be possible with a lower price. If developing and marketing costs can be used recovered before competitors enter, surplus earning can be used for product improvement and expansion into large-volume markets, thus reducing the average cost of producing. The greatest disadvantages to market skimming is that the high margins attract

Conditions favoring price skimming


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Product has a strong patent protection or other barriers to market entry. Genuine product innovation that is likely to represent substantial value to potential users. Buyers who are willing to pay a premium to enjoy the products benefits . A relatively short life span, so that a quick recovery of investment is essential. Potential competitors are relatively weak or distant in time Uncertainty concerning the markets price sensitivity. Should the initial price prove to be in error, the firm can always lower price, whereas a low price may be difficult to raise.

2.Market penetration strategy


Penetration pricing is based on the assumption that demand for the product is highly elastic. By setting a relatively low price, the firm hopes to stimulate market growth and capture a large share of it. The advantage is that penetration pricing tends to discourage competition, because there is less opportunity to reap an unusually high return on investment. Penetration pricing may also be

Conditions favorable to penetration pricing


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The market appears to be highly price sensitive. Unit cost of production and distribution fall with accumulated output. Strong potential competitors exist who are seeking new profitable ventures. The firms primary goal is significant market share rather than maximized short-term profits. The product has hidden or subtle benefits that will become obvious only after use. The sale of complementary products will also

Conditions favoring price skimming


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Product has a strong patent protection or other barriers to market entry. Genuine product innovation that is likely to represent substantial value to potential users. Buyers who are willing to pay a premium to enjoy the products benefits . A relatively short life span, so that a quick recovery of investment is essential. Potential competitors are relatively weak or distant in time Uncertainty concerning the markets price sensitivity. Should the initial price prove to be in error, the firm can always lower price, whereas a low price may be difficult to raise.

2.Market penetration strategy


Penetration pricing is based on the assumption that demand for the product is highly elastic. By setting a relatively low price, the firm hopes to stimulate market growth and capture a large share of it. The advantage is that penetration pricing tends to discourage competition, because there is less opportunity to reap an unusually high return on investment. Penetration pricing may also be

Conditions favorable to penetration pricing


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2.

3.

4.

5.

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The market appears to be highly price sensitive. Unit cost of production and distribution fall with accumulated output. Strong potential competitors exist who are seeking new profitable ventures. The firms primary goal is significant market share rather than maximized short-term profits. The product has hidden or subtle benefits that will become obvious only after use. The sale of complementary products will also

During the course of an individual products life cycle, the competitive situation and market demand level will very greatly. The product itself, along with promotion and distribution, must change accordingly. In like manner, for price to remain an effective marketing tool, it must be constantly monitored and adjusted when appropriate. Growth Maturity Decline

Product life-cycle consideration

Growth : during the product growth

stage, when more customers develop a use for the product and competitors are able to offer substitutes, price will take on more importance in the purchasing decision. However, in an expanding market, suppliers tends to emphasize nonprice factors as their primary selling points. In general, the price in this stage falls below the introductory level.

Maturity:

by the time a product enter the maturity stage, the levels of competition has peaked, and product differentiation is minimal. Consequently, although buyers will still insist on product quality and service dependability, price considerations will heavily influence their buying decisions. And since a supplier can increase volume in a flat market only by cutting into the market share of competitions. Price wars become commonplace.

already left the market, particularly those with heavy emphasis on growth strategies, the decline stage can be a fairly profitable one for the remaining suppliers. Assuming a firms has developed a very positive image by providing a quality product, competitively priced, dependably shipped, and consistently serviced. And industrial firms, both sellers and buyers realize the necessary relationship between production volumes and incurred costs. With this reason the well accepted firm can increase prices during the decline stage and maintain an acceptable profit level.

Decline: since many competitors will have

COMPETITIVE BIDDING

Competitive bidding may be either closed or open. Closed bidding; Closed bidding starts with a formal invitation to potential suppliers to submit written, sealed bids. Open bidding; It is more informal that suppliers may make a series of oral or written offers up to a specified date.

Bidding strategy consists of two stages, .Prebid Analysis .Bid Determination

In the industrial market, a significant volume of purchasing is transacted through competitive bidding rather than on the basis of a price list. Government agencies and most public institutions are required to purchase through the bi dding system. Industrial buyers also use competitive bidding as a means of exploring and determining price levels when purchasing nonstandardized materials, complex fabricated products on which design and manufacturing methods vary and items made to their specification that do not have an establishment market price.

Prebid analysisPrebid analysis requires a precise definition of company objectives, an analytical approach for screening alternative bid opportunities, and a method for assessing the probability of success for a particular bidding strategy.

Company objectivesfocus on: - Profit maximization. -gaining market entry -keeping the plant operating and Labour force intact. Screening bid opportunitiesThree stages involved in screening process. 1) An identification of criteria deemed important in evaluating contracts. 2) A measure of their relative importance. 3) An evaluation of the bid opportunity.

Bid Determination
A bid with a large expected profit has a low probability of being accepted. Conversely a low bid that offers little or no profit has a high probability of being accepted. An optimum bid is on that offers the highest expected pay off. It would maximize E(X) as expressed in the equation. E(X)= P(X)Z(X) where X= amount of the bid. Z(X)= profit of bid if accepted. P(X)= probability of a bid of X being accepted. E(X)= expected profit of a bid.

LEASING

Lease is a contract under which a leassor, the owner of the assets, gives right to use the asset to a lessee, the user of the assets, for an agreed period of time for a consideration called the lease rentals. In up-fronted leases, more rentals are charged in the initial years and less in the later years of the contract. The opposite happens in back ended leases. Primary lease provides for the recovery of the cost of the assets and profit through lease rentals during a period of about 4 or 5 years. It may be followed by a perpetual, secondary lease on nominal lease rentals.

Lease Defined

Types of Leases

Operating Lease Financing Lease Sale and Lease Back

Operating Lease

Shot-term, cancelable lease agreements are called operating lease. Tourist renting a car, lease contracts for computers, office equipments and hotel rooms. The Lessor is generally responsible for maintenance and insurance. Risk of obsolescence remains with the lessor.

Financial Lease

Long-term, non-cancelable lease contracts are known as financial lease. Examples are plant, machinery, land, building, ships and aircrafts. Amortise the cost of the asset over the terms of the leaseCapital or Full pay-out leases.

Cash Flow Consequences of a Financial Lease

Avoidance of the purchase price. Loss of depreciation tax shield. Aftertax payments of lease rentals.

Sale and Lease Back

Sometimes, a user may sell an (existing) asset owned by him to the lessor (leasing company) and lease it back from him. Such sale and lease back arrangements may provide substantial tax benefits. In April 1989, Shipping Credit and Investment Corporation of India purchased Great Eastern Shipping Company bulk carrier, Jag Lata, for Rs 12.5 Cr and then leased it back to GESC on a 5 years lease, the rentals being Rs 28.13 Lakh per month. The ships WDV was Rs 2.5 Cr.

Commonly Used Lease Terminology


Leveraged Lease. Cross-border lease. Closed and open ended lease. Direct lease. Master lease. Percentage lease. Wet and dry lease. Net net net lease. Update lease.

Myths about Leasing

Leasing Provides 100% Financing Leasing Provides Off-the-BalanceSheet Financing. Leasing Improves Performance. Leasing Avoids Control of Capital Spending.

Advantages of Leasing

Convenience and Flexibility. Shifting of Risk of Obsolescence. Maintenance and Specialized Services.

Evaluating a Lease

Equivalent Loan Method. Net Advantage of a Lease Method. IRR Approach.

Equivalent Loan Method


EL is that amount of loan which commits a firm to exactly the same stream of fixed obligations as does the lease liability. Method

Find out incremental cash flows from leasing. 2. Determine the amount of equivalent loan such cash flow can service. 3. Compare the equivalent loan so found with lease finance.
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Net Advantage of a Lease Method

The direct cash flow consequences are:


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purchase price of the asset is avoided. 2. The depreciation tax shield Is lost. 3. The after tax lease rentals are paid.

The net present value of these cash flows at after tax cost of debt should be calculated. If it is positive lease is beneficial.

Lease Benefits to Lessor and Lessee


A lease can benefit both when their tax rate differs. Leasing pays if the lessees marginal tax rate is less than that of the lessor. In fact in a lease, the lessee sells his depreciation tax shield to the lessor. In the absence of taxes it is hard to believe that leasing would be advantageous if the capital markets are reasonably well functioning. Gain of both is loss to the government in form of taxes.

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