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 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

IMPORTANCE OF PRICING

‡ Andersen Consulting (Accenture) Study of Forest Products Companies in 1998

suggests that:

± over 40% of the differences in forest products company financial performance is driven by
marketing.

± ³strategic pricing management´ emerged as the most important skill in driving bottom line
performance (to the tune of $2 - $18 million dollars annually).

‡ But«Pricing is not a strong basis on which to compete!!!

‡ It doesn¶t create value
‡ It doesn¶t create loyalty
‡ It is easiest to copy

| UNIVERSITY OF MINNESOTA, Department of Bio-based Products © T. M. Smith, 2005 r

 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

COEQUAL ELEMENTS OF MARKETING



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| UNIVERSITY OF MINNESOTA, Department of Bio-based Products © T. M. Smith, 2005 2

 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

INEFFECTIVE PRICING QUESTION

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| UNIVERSITY OF MINNESOTA, Department of Bio-based Products © T. M. Smith, 2005 

 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

STRATEGIC PRICING QUESTION

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| UNIVERSITY OF MINNESOTA, Department of Bio-based Products © T. M. Smith, 2005 `

 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

INEFFECTIVE PRICING QUESTION

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| UNIVERSITY OF MINNESOTA, Department of Bio-based Products © T. M. Smith, 2005 

 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

STRATEGIC PRICING QUESTION

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| UNIVERSITY OF MINNESOTA, Department of Bio-based Products © T. M. Smith, 2005 '

 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

INEFFECTIVE PRICING QUESTION

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| UNIVERSITY OF MINNESOTA, Department of Bio-based Products © T. M. Smith, 2005 

 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

STRATEGIC PRICING QUESTION

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| UNIVERSITY OF MINNESOTA, Department of Bio-based Products © T. M. Smith, 2005 s

 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

A FRAMEWORK FOR PRICING

| UNIVERSITY OF MINNESOTA, Department of Bio-based Products © T. M. Smith, 2005 

 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

A FRAMEWORK FOR PRICING: DATA COLLECTION

1. Cost Measurement: Incremental/Avoidable Costs Only

± What are the incremental costs?

± What are the avoidable fixed costs?
± At what levels of output will additional semi-fixed costs be required?

| UNIVERSITY OF MINNESOTA, Department of Bio-based Products © T. M. Smith, 2005

 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

COST MEASUREMENT

  

   
 
 

Production Capacity 2000
Price $8.00 $6.00 $7.75
Fixed Overhead $4,500 $250 $1,500
Personnel $3,000 $150 $2,000
Variable Costs 1.5 $1.50/unit $1.50/unit $1.50/unit
Units 1200 400 (100) 800 (150)

| UNIVERSITY OF MINNESOTA, Department of Bio-based Products © T. M. Smith, 2005 r

 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

AVERAGE COST MEASUREMENT

  

 

 
 
Capacity 2000
Units 1200 1500 1850
Revenue $9,600 $11,200 $14,600
Total Cost $9,300 $10,150 $13,775
Avg. Cost $7.75 $6.77 $7.45
Price $8.00 $6.00 $7.75



 
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| UNIVERSITY OF MINNESOTA, Department of Bio-based Products © T. M. Smith, 2005 2

 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

INCREMENTAL COST MEASUREMENT

  



 
Price $6.00 $7.75
Unit Sales 400 800
Revenue $2,400 $6,200
Other Foregone Sales ($800) ($1,200)

Revenue Gain $1,600.00 $5,000.00

Personnel $150.00 $1,500.00

Incremental Fixed Costs $250.00 $2,000.00
Variable Material Costs $600.00 $975.00

Total Inc. Costs $1,000.00 $5,100.00

Net Contribution $600.00 ($100.00)

| UNIVERSITY OF MINNESOTA, Department of Bio-based Products © T. M. Smith, 2005 

 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

A FRAMEWORK FOR PRICING: DATA COLLECTION

2. Customer Identification: Who are the potential customers, and why would
they buy your product?

± What is the economic value to customers?

± What other factors influence price sensitivity?
± How can customers be segmented by price?
± Can effective marketing and positioning influence a customer¶s willingness to
pay?

| UNIVERSITY OF MINNESOTA, Department of Bio-based Products © T. M. Smith, 2005 `

 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

A FRAMEWORK FOR PRICING: DATA COLLECTION

3. Competitor Identification: Current or potential competitors affecting your

profitability

± Who are they?

± What are their transactional prices versus list prices?
± What are competitors¶ pricing objectives ± profitability or share?
± What are their strengths/weaknesses ± margins, reputation, products, product
lines, etc«

| UNIVERSITY OF MINNESOTA, Department of Bio-based Products © T. M. Smith, 2005 

 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

A FRAMEWORK FOR PRICING: STRATEGIC ANALYSIS

4. Financial Analysis: What volume trade-offs are needed for potential price
changes to increase profits?

± What is the CM at the baseline price?

± What volume is needed to allow a lower price to generate more contribution?
± What volume can be forfeited at a higher price before contribution declines?
± What volume is needed to cover incremental fixed costs (advertising, regulatory
approval, inc. capital equip., etc.)

| UNIVERSITY OF MINNESOTA, Department of Bio-based Products © T. M. Smith, 2005 '

 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

BREAKEVEN SALES CURVE REQUIRED FOR CONSTANT

PROFITABILITY

| UNIVERSITY OF MINNESOTA, Department of Bio-based Products © T. M. Smith, 2005 

 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

A FRAMEWORK FOR PRICING:

STRATEGIC ANALYSIS
5. Segmentation/Implementation: How can a company price differently to
different segments to reflect differences in price sensitivity or the costs to
serve them?

± Can segments be identified prior to purchase?

± Can ³fences´ between segments be established?
± Are there legal constraints to be addressed?

| UNIVERSITY OF MINNESOTA, Department of Bio-based Products © T. M. Smith, 2005 s

 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

PRICE SEGMENTATION MODEL

| UNIVERSITY OF MINNESOTA, Department of Bio-based Products r

© T. M. Smith, 2005
 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

A FRAMEWORK FOR PRICING:

STRATEGIC ANALYSIS
6. Competitive Analysis: How will competitors actions and reactions affect
profitability and long-term viability?

± What can you realistically achieve, given competitor capabilities and intentions?
± Can you influence competitors¶ behavior?
± Can profitability be insulated by targeting segments where you have competitive
advantage?
± Should you withdraw resources from certain markets when confronted by fierce
competition?

| UNIVERSITY OF MINNESOTA, Department of Bio-based Products r

© T. M. Smith, 2005
 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

A FRAMEWORK FOR PRICING:

STRATEGIC FORMULATION
7. Strategic Formulation: The price-value proposition for conducting future
business.

± No right solution.
± Can¶t superimpose from one situation to another with different cost, customer,
and competitive conditions.

| UNIVERSITY OF MINNESOTA, Department of Bio-based Products rr

© T. M. Smith, 2005
 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

GENERIC PRICING STRATEGIES

| UNIVERSITY OF MINNESOTA, Department of Bio-based Products r2

© T. M. Smith, 2005
 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

PRICE SKIMMING
‡ Customers: Focus on a small segment of price insensitive buyers.
± Usually driven by exceptional value created by product differentiation.
± Also seen in impulse buying situations, when costs can be passed along to others, and
emotionally charged situations.

‡ Costs: Favors situations where incremental costs represent a LARGE share of the
product¶s price.
± If variable costs are 80% of a product¶s price, a 10% price hike would increase profits so
long as sales volume decreases by less than 30%.
± Therefore, a small niche of price insensitive buyers could allow for profitability even in the
most capital intensive industries.

‡ Competition: Must have some source of competitive protection to maintain this

strategy long-term.
± Patents/Copyrights, brand, access to scarce resource, access to exclusive distribution,
etc«
± Doesn¶t mean you can¶t skim while you can, then re-position when required by competition
(sequential skimming)

| UNIVERSITY OF MINNESOTA, Department of Bio-based Products r

© T. M. Smith, 2005
 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

PENETRATION PRICING
‡ Customers: Price must be low enough to attract a large share of the
market.
± Need a large portion of customers to be at least somewhat price sensitive.

‡ Costs: Favors situations where incremental costs represent a SMALL

share of the product¶s price.
± In this case each additional unit of sales provides a large contribution to profit.
± Can also work if increased volume leads to sufficient variable cost economies.

‡ Competition: Beware of the price war.

± Only if you have a significant cost advantage, or are so small your gain in sales
won¶t prompt a response.

| UNIVERSITY OF MINNESOTA, Department of Bio-based Products r`

© T. M. Smith, 2005
 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

EFFECT OF CONTRIBUTION MARGIN

ON BREAK-EVEN VOLUME
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| UNIVERSITY OF MINNESOTA, Department of Bio-based Products r

© T. M. Smith, 2005
 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

EXAMPLE: PENETRATION PRICING & MARKET SHARE



| 

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Price: 3.50 3.25

Unit Variab e Costs: .00 .35
Mar et Share: 5 5
Voume: 50,000,000 50,000,000
Re enue: 2, 5,000,000 ,500,000
Fi ed Costs: ,500,000,000 500,000,000
Variab e Costs: 50,000,000 202,500,000
Profit Mar in 0.2 0.

| UNIVERSITY OF MINNESOTA, Department of Bio-based Products r'

© T. M. Smith, 2005
 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

EXAMPLE: PENETRATION PRICING & MARKET SHARE


  


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Price: $3.50 $3.25

Unit Variable Costs: $1.05 $1.15
Market Share: 70% 30%
Voume: 700,000,000 300,000,000
Revenue: 2,450,000,000 975,000,000
Fixed Costs: 1,500,000,000 500,000,000
Variable Costs: 735,000,000 345,000,000
Profit Margin 0.09 0.13

| UNIVERSITY OF MINNESOTA, Department of Bio-based Products r

© T. M. Smith, 2005
 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

NEUTRAL PRICING

‡ A strategic decision not to use price as a significant marketing tool.

± Usually a default strategy, because conditions are not favorable for either of the
other two strategies.
± Also used to maintain a coherent product line pricing strategy.
± DOES NOT IMPLY A LOW PRICE IN THE MARKET.
± A high price is a neutral price when the product value seems to justify the price to
most potential buyers.

| UNIVERSITY OF MINNESOTA, Department of Bio-based Products rs

© T. M. Smith, 2005
 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

Pricing in Mature/Commodity Markets

‡ Pricing latitude reduced by severe price competition:

± Accumulated purchase experience of repeat buyers 6 improves their ability to

evaluate competing products 6 reduces loyalty.

± Increased imitation of successful products (i.e. product/performance/ grading

standards) 6 reduced differentiation.

± Increased price sensitivity attract competitors whose distinct competence is efficient

production/distribution 6 further price erosion.

| UNIVERSITY OF MINNESOTA, Department of Bio-based Products 2

© T. M. Smith, 2005
 BP 3503-5503: MARKETING BIO-BASED PRODUCTS

SOME SUGGESTIONS«

± Improve control and utilization of costs ± identify unprofitable products or

customers.

± Improve estimation of price sensitivity ± when demand is primarily from repeat

buyers and competition is relatively stable, a little fine tuning can significantly
improve profits.

± Unbundle related products/services ± Dominate what you are best at and own that
business (high volume in one area, rather than seller everything to an ever fewer
number of customers).

± Expand the product line ± accessorize, accessorize, accessorize.

± Reevaluate distribution ± less need to pay channel to promote to new buyers, less
need to restrict distribution.

| UNIVERSITY OF MINNESOTA, Department of Bio-based Products 2

© T. M. Smith, 2005