Pricing Decisions in Industrial Marketing - Page 3 of 3

Product-Mix Pricing

Price- setting logic has to be modified when the product is part of a product mix. In this case, the firm searches for a set of prices that maximizes profits on the total product mix. Pricing is difficult because the products have demand and cost interrelationships and are subject to Product-Line Pricing. Companies normally develop product lines rather than single products.

Two-Part Pricing. Service firms often charge a fixed fee plus a variable usage fee. Thus telephone users pay a minimum monthly fee plus charges for calls beyond the minimum number. Amusement parks charge an admission fee plus fees for rides over a certain minimum. The service firm faces a problem similar to adaptive product pricing, namely, how much to charge for the basic service and how much for the variable usage. The fixed fee should be low enough to induce purchase of the service, and the profit can be made on the usage fees.
Byproduct Pricing. In producing processed meats, petroleum products, and other chemicals, there are often byproducts. If the byproducts have little value and are in fact costly to dispose of, that will affect the pricing of the main product. The manufacturer should accept any price that covers more than the cost of disposing of them. If the byproducts have value to a customer group, then they should be priced on their value. Any income earned on the byproducts will make it easier for the company to charge a lower price on its main product if forced to by competition.
Product-Bundling Pricing. Sellers will often bundle their products at a set price. Thus an auto manufacturer might offer an option package at less than the cost of buying all the options separately. A theater company will price a season subscription at less than the cost of buying all the performances separately. Since customers may not have planned to buy all of the components, the savings on the price bundle must be substantial enough to induce them to buy the bundle. Some customers will want less than the whole bundle. Suppose a medical equipment supplier’s offer includes free delivery and training. A particular customer might ask to forego the free delivery and training in order to get a lower price. The customer is asking the seller to “unbundle” its offer. The seller could actually increase its profit through unbundling if it saves more in cost than the price reduction that it offers to the customer for the particular items which are eliminated. Thus, if the supplier saves $100 by not supplying delivery and it reduces the customer’s price by $80, for example, the supplier has increased its profit by $20.

Responses to Price Changes

After developing their pricing strategies, companies will face situations where they may need to cut or raise prices.

Initiating Price Cuts

Several circumstances might lead a firm to cut its price. One circumstance is excess capacity. Here the firm needs additional business and cannot generate it through increased sales effort, product improvement, or other measures. It may abandon “follow-the-leader” pricing and resort to “aggressive” pricing to boost its sales. But in initiating a price cut, the company might trigger a price war, as competitors try to hold on to their market shares. Another circumstance is a declining market share. Companies will also initiate price cuts in a drive to dominate the market through lower costs. Either the company starts with lower costs than its competitors or it initiates price cuts in the hope of gaining market share, which would lead to falling costs through larger volume and more experience. People Express waged an aggressive low-price strategy and gained a large market share. But this strategy also involves high risks.

Low-Quality Trap. Consumers will assume that the quality is below that of the higher-priced competitors.
Fragile-Market-Share Trap. A low price buys market share but not market loyalty. Customers will shift to another lower-price firm that comes along.
Shallow-Pockets Trap. The higher-priced competitors may cut their prices and may have longer staying power because of deeper cash reserves.

People Express some years later fell into these traps.. Companies may have to cut their prices in a period of economic recession. Fewer consumers are willing to buy higher-price versions of a product.

Initiating Price Increases

Many companies need to raise their prices. A successful price increase can increase profits considerably. A major circumstance provoking price increases is cost inflation. Rising costs unmatched by productivity gains squeeze profit margins and lead companies to regular rounds of price increases. Companies often raise their prices by more than the cost increase in anticipation of further inflation or government price controls; this is called anticipatory pricing. Companies hesitate to make long-run price commitments to customers, fearing that cost inflation will erode their profit margins. Another factor leading to price increases is over demand. When a company cannot supply all of its customers, it can raise its prices, put customers on allocation, or both. The “real” price can be increased in several ways, each with a different impact on buyers.

The price increase should be accompanied by company communications explaining why price are being increased. The company’s sales force should help customers find ways to economize. There are other ways that the company can respond to high costs demand without raising prices. The possibilities include the following:

Shrinking the amount of product instead of raising the price.
Substituting less-expensive materials or ingredients.
Reducing or removing product features to reduce cost.
Removing or reducing product services, such as installation, free delivery, or long warranties.
Using less-expensive packaging material or reducing larger package sizes to keep down packaging cost.
Reducing the number of sizes and models offered.
Creating new economy brands.

The best action to take is not always obvious. Quaker Oats produces the successful cereal/called Quaker Oats Natural, which contains several ingredients, such as almonds and raisins, whose prices jumped during the recent inflation. Quaker Oats saw two choices, namely, raising the price, or cost reducing the ingredients by including fewer almonds and raisins, or finding cheaper substitutes. It decided against changing the ingredients and raised the price. But the price elasticity was high, and sales fell. This forced the company to reconsider ways to cost-reduce the ingredients, knowing that such a move also involves a risk.

Customers Reactions to Price Changes

Any price change can affect customers, competitors, distributors, and suppliers and may provoke government reaction as well. Here we will consider customers reactions. Customers do not always put a straightforward interpretation on price changes.

A price cut can be interpreted in the following ways:

The item is about to be replaced by a new model;
The item is faulty and is not selling well;
The firm is in financial trouble and may not stay in business to supply future pacts;
The price will come down even further, and it pays to wait; or
The quality has been reduced.

A price increase, which would normally deter sales, may carry some positive meanings to customer :

The item is “hot” and might be unobtainable unless it is bought soon;
The item represents an unusually good value; or
The seller is greedy and is taking advantage of customers.

Customers are most price sensitive to products that cost a lot and/or are fought frequently, whereas they hardly notice higher prices on low-cost items that they buy infrequently. In addition, some buyers are less concerned with the product’s price than the total costs of obtaining, operating, and servicing the product over lifetime. A seller can charge more than competitors and still get the business if the customer can be convinced that the total lifetime costs are lower.

Competitors Reactions to Price Changes

A firm contemplating a price change has to worry about competitors as well as customers reactions. Competitors are most likely to react where the number of firms is small, the product is homogeneous, and the buyers are highly informed. How can the firm anticipate the likely reactions of its competitors? Assume that the firm faces one large competitor. The competitor’s reaction can be estimated from two vantage points. One is to assume that the competitor reacts in a set way to price changes. In this case, its reaction can be anticipate. The other is to assume that the competitor treats each price change as a fresh challenge and reacts according to self-interest at the time. In this case, the company will have to figure out what lies in the competitor’s self-interest. The competitor’s current financial situation should be researched, along with recent sales and capacity, customer loyalty, and corporate objectives. If the competitor has a market-share objective, it is likely to match the price change. If it has a profit-maximization objective, it may react on some other strategy front, such as increasing; the advertising budget or improving the product quality.

The challenge is to read the competitor’s mind by using inside and outside sources of information. The problem is complicated because the competitor can put different interpretations on, say, a company price cut. The competitor can surmise that the company is trying to steal the market, that the company is doing poorly and trying to boost its sales, or that the company wants the whole industry to reduce prices to stimulate total demand. When there are several competitors, the company must estimate each close competitor’s likely reaction. If all competitors behave alike, this estimate amounts to an analysis of atypical competitor. If the competitors do not react uniformly because of critical differences in size, market shares, or policies, then separate analyses are necessary. If some competitors will match the price change, there is good reason to expect that the rest will also match it.

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