Industrial Pricing Strategies and Policies 2014

D.M. Sanath Dasanayaka (sanath.dasanayaka@yahoo.com)

University of Sabaragamuwa, Sri Lanka

Industrial PricingStrategies and Policies

By;

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Abstract

Fundamentally, this comprehensive article examines the significant factors that should be

taken into account before making industrial pricing strategies and policies, such as

pricing objectives, demand analysis, cost analysis and competitive analysis in depth. As

well as pricing strategies in competitive bidding, pricing strategies for new products and

Pricing throughout the product life cycle are expected to be discussed. Furthermore,

industrial pricing policies, such as list price, trade discounts, quantity discounts, cash

discounts and geographical pricing will be elaborated under this article.

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Content

1. Introduction to industrial pricing strategies and policies 03

2. The industrial Pricing Strategies 06

3. The industrial pricing policies 09

4. References 12

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1. Introduction to Industrial Pricing Strategies and Policies

Mainly, pricing in Industrial Marketing is very critical and vital as it is related with market

segmentation strategy, product strategy, distribution strategy, communication strategy and

promotion strategy.

Basically, here, the price is the amount of money that is paid to an industrial seller by an

industrial purchaser. As well as, there is a significant difference between the total costs to the

buying firm and the price. The total cost includes transportation cost of products, transit

insurance cost and installation cost as well as risks, such as product failure, the delays in

supply and lack of technical support other than the product’s price.

Sometimes, the product’s price decreases due to volume discounts (discounts on the volume

of purchase) and cash discounts (discounts upon the total expenses of purchasers).

Before deciding upon pricing strategies and policies, industrial sellers should make decisions

on pricing objectives, demand analysis, cost analysis and competitive analysis. Those

considerable factors are elaborated below.

1. Pricing ObjectivesPricing objectives should go according to the firm’s marketing strategies since the

organization is operating to realize marketing objectives through pricing objectives.

Different pricing objectives have different impacts on sales revenue, profits and

market share. Most basically, below pricing objectives are reviewed before deciding

upon pricing strategies.

Survival: A short-term objective which is taken into the implementation when the

organization is underutilizing its production capacity to a large extent or the firm

has a large unsold stock of products at its stores or there is an intense level of

competition in the market place. Here, the firm decreases product prices in order

to sustain in the market. In this way, they can cover variable cost and a part of

fixed cost. Although this objective ensures the organization’s existence in the

short-run, it makes loses to the firm in the long-term.

Maximum short-term profits: In this case, a firm attempts to maximize its short-

term profits. Companies following this objective select the price that yields the

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maximum current profits. Those organizations usually do not consider of legal

implications and long-term customer relationships.

Maximum short-term sales: Focuses upon maximizing short-term revenue.

Through this, companies expect to acquire growth and market share.

Market penetration: Here, firms fix prices as low as possible with the aim of

getting a high sales volume and market share. In this, organizations believe that

high volume of sales will decrease production and distribution costs, and yield

high profits as well as keep competitors out of the market.

Maximum market skimming: Mainly, here, a firm sets a very high price in the

introduction phase of a new or innovative product aiming the market segments

which are least price sensitive. In this, a company is able to maximize revenue

and profits in a short period of time. But, in the long-term, the prices are brought

down to attract customers from price sensitive market segments. However, this

will attract competitors into the organization’s market.

Product quality leadership: In this, the aim is to produce superior quality

products more than rivals. As well as, a firm following this will charge a price

which is slightly higher than the competitors’ prices. And this objective yields a

high level of returns.

2. Demand Analysis

In this, the relationship between sales volume and the elasticity of demand are taken.

Mainly, the elasticity of demand means the price sensitivity of buyers or the change

in buying volume as a result to a change in the price of a certain product. Basically,

here, pricing strategies are designed depending upon the elasticity of demand. There

are two types of elasticity of demand as,

Inelastic: Small change in demand relatively to the change in the price of the

product.

Elastic: Demand changes substantially with a small change in the product’s

price.

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Basically, the demand is less elastic when there are few rivals; there is an

unavailability of substitute goods and when purchasers think high prices are justified

due to changes in government policies upon duty and taxes.

But, the demand for most industrial products is inelastic since their technically

sophisticated, customized and significant for customers’ operations in their factories.

When developing a successful pricing strategy a firm should consider its products’

costs that are incurred by customers and benefits received in the customers’ point of

view. Product benefits are identified as hard benefits (benefits related to the product’s

physical attributes, such as production rate of a machine, price/performance ratio and

rejection rate of a component), soft benefits (company reputation, customer service

warranty period and customer training).

After studying costs and benefits, a firm can make decisions on how customers

perceive its products and competitive offers. So, through this, the firm develops an

appropriate pricing strategy based on cost-benefit analysis.

3. Cost Analysis:

In deciding pricing strategies, a firm should consider about costs incurred in

production. The total costs consist of fixed costs (costs that do not change with the

production or sales, such as rent, interest charges and managerial salaries) and

variable costs (costs that change on the units of production like material and labor

costs) in production, marketing and distribution. To decide on pricing strategies,

firms should have a better understanding on the cost levels at each production level.

As well as, here, an organization should be aware of economies of scale well.

(Economies of scale: the total average cost per unit decreases when the production

volume increases. The logic behind this is the total average cost per unit reduces

since the total fixed costs spread over more units).

As well as, the average unit total cost of products decreases over a period of time

with the firm’s experience of manufacturing and marketing. This is known as the

experience curve.

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4. Competitive Analysis

Many industrial manufacturing and marketing organizations consider competitive-

level pricing a significant method. Here, they gather information on competitors’

prices, product quality, delivery performance and technical expertise through asking

competitors’ customers or marketing surveys on competitors’ actions. By using

collected information on competitors, a firm can design its pricing policy

successfully. As an example, if a firm’s products equal to competitors’ products in

quality and delivery performance, the company is able to charge a superior price as

competitors do.

2. The Industrial Pricing Strategies

After considering the factors affecting the pricing strategies, such as pricing objectives,

demand, cost and market competition, in the next phase, an industrial seller designs

appropriate pricing strategies for its products to be marketed.

Fundamentally, the pricing strategies very based on the product nature and the situation in

market. In this, pricing strategies for following situations are expected to consider.

Competitive bidding in competitive markets.

Pricing new products.

Pricing throughout the product life cycle.

Now, above three situations are discussed in detail.

1. Competitive Bidding

Many industrial sellers do their business through competitive bidding. As examples,

government undertakings, such as Sri Lanka Transportation Board, Ceylon Electricity

Board and Railways Department buy heavy equipment, machineries through

competitive bidding as well as sell used ones in the same way. Furthermore, many

private and public companies do their business in the same way as government

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organizations do. Usually, non-standard materials are bought in bidding. In

government organizations, the lowest price is considered as most favorable but the

commercial enterprises’ decisions in bidding is they finalize decisions based upon

bidders’ quality, design, delivery and price. There are two types of bidding as

closed/sealed bidding and open. In closed bidding, the potential suppliers are invited

through newspaper tender notice to hand over sealed bids in written. All the bids

should be kept in the tender box by a certain date and time. After, all bids are opened

in the presence of representatives of suppliers who submitted bids. Then, all bidders’

commercial terms and prices read out and generally the bidder with the lowest price

will be granted the tender but he should have fulfilled specifications of the product.

Mainly, closed bidding is used by government undertakings.

In open bidding, potential suppliers are asked for submitting bids. After submitting,

the buying organization considers on various offers, negotiates commercial and

technical aspects of products and makes the final decision. This method is normally

utilized by private commercial enterprises. This method consists of bidding and

negotiation.

Strategies for Competitive Bidding

One strategy is probabilistic bidding strategy which has two assumptions; the pricing

objective is profit maximization and the buying organization will put the order on the

lowest price bidder.

There are three variables in this strategy- amount or price of the bid, expected profit if

the bid is expected and probability of acceptance of bid price. An industrial marketer

attempts to find out the optimum trade-off between the bid price and the profit as well

as the probability of winning the contract.

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The basic equation is displayed below.

E (A) =P (A)*T (A)

Where,

A = Bid price

E (A) =Expected profit at bid price A.

P (A) =Probability of acceptance of the bid price.

T (A) =Profit if the bid price A is accepted.

Ability to estimate P (A) depends upon the industrial marketer’s knowledge of

competitors’ costs, strengths, weakness and mind-set.

2. Pricing New Products

There are two strategies that can be used for new products which are in the

introductory phase of its life cycle.

Skimming strategy

This strategy is utilized for distinctive new products for which customers are not

sensitive to initial high prices. In this, the firm has the capability of recovering its

investment in product development by generating high profits. The disadvantage here

is the high profits attract competitors into the market. So, this strategy is appropriate

for products that are distinct, technology focused or capital intensive-the factors

creating entry barriers to rivals. As well as, this strategy is useful when the demand

curve is stable over a period of time and the cost of production declines with the

application of experience curve.

Penetration strategy

This strategy is commonly used when price elasticity of demand is high or buyers are

highly price sensitive, strong threats from potential customers and opportunities to

decrease the unit cost of production and distribution with increase in production

volume.

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3. Pricing across Product Life Cycle

The pricing strategies in introduction phase of the PLC were discussed in pricing new

products. Other strategies are expected to be elaborated here.

Growth Stage Pricing Strategy

In growth stage, more new customers enter into the market began buying the firm’s

products. Here, industrial marketers lower the product price as well as they focus on

product differentiation, product line extension and building new market segments.

Maturity Stage Pricing Strategy

Here, competitors are aggressive in the market. In this, a company has to cut its

competitors’ market share to increase its sales. The strategy is to lower prices to

match the competitors’ prices

Decline Stage Pricing Strategies

There are three strategies.

- If the company has a reputation on good product quality or dependable service, do

not cut price but reduce costs to earn some profits.

- Cutting prices to increase sales and using a product to help to sell other product.

- Selective increases in prices in markets that are not price sensitive.

3. Industrial Pricing Policies

Mainly, industrial marketers are dealing with different kinds of customers, such as users,

Original Equipment Manufacturers (Caterpillar and Toyota) and dealers. These pricing

policies are to adjust the base (or list price) of a product. Basically, industrial marketers

set a price structure that covers different product items with different sizes and product

specifications.

For instance, electric motors are manufactured in different horse power or kilowatt

ratings, different speeds, and distinctive applications. So, the electric motor manufacturer

has to set a base price for the entire range of products.

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Some common industrial pricing policies are discussed below.

1. List Price

This is called as Price List also. It is a base price of a product consisting various sizes

and specifications. This is a published statement of basic prices and given to the

customers. This statement implies the effective date of its applicability and shows the

extra charges for optional product features, such as the excise duty, freight, sales tax,

or transit insurance (if applicable). The net price is calculated based on list price less

discounts (trade, volume and cash discounts). The net price is very important for

buyers since it is the price that should be paid after deducting discounts.

2. Trade Discounts

Trade discounts are offered to marketing intermediaries, such as dealers and

distributors. The amount of trade discount given depends upon the particular industry

norms and the functions performed by those intermediaries. Further these trade

discounts should be uniform to all industrial intermediaries.

3. Quantity Discounts

A quantity or volume discount is given to customers who buy in large quantities as

well as this is a price reduction given by deducting the quantity discount from the list

price of the product. These discounts can be given either on individual orders (non-

cumulative basis) or on a series of orders over a longer period of time, usually one

year (cumulative basis). The purpose of this is to encourage customers to buy in larger

quantities and maintain customer loyalty. The amount of quantity discounts depends

on demand, costs and competition.

4. Cash Discounts

Commonly, cash discounts are given to encourage customers for prompt payments.

This is applicable on gross amount (basic price plus excise duty plus sales tax) of the

bill and this is granted to customers who pay bills within a stated period from the date

of invoice.

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5. Geographical Pricing

Pricing the company’s products based upon the different geographical locations of

buyers. Mainly, this happens since the company has to undergo different

transportation costs and transit insurance when delivering products to various

locations. Here, there are two methods in geographical pricing.

- Ex-Factory: here, transportation costs and transit insurance costs should be

incurred by the buyer. “ex-factory” means the prices prevailing at factory gate.

- FOR Destination or FOB Destination: this means free on road/free on board

destination. In this transportation (freight) costs are absorbed by the seller or

include in the quoted price. Although the small transit insurance costs are

absorbed by the seller, commonly, average transportation costs and transit

insurance costs are included to the basic product price. In this method, all

customers get the product at the same price irrespective of their location from the

seller’s factory premises. However, in the intense competition sellers can the

whole transportation and transit insurance costs.

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References

Hawaldar, K. Krishna. (2002). Industrial Marketing (1st ed.). TATA McGraw-Hill Publishing

Company Limited, New Delhi.

Laric, M. V. (1980). Pricing strategies in industrial markets, European Journal of

Marketing, 14(5/6), 303-321.

Robert, R.Reeder., Edward, G.Betty & Betty,H.Reeder. (2001). Industrial marketing (2nd ed.).

prentice-Hall of India Private Limited, New Delhi.

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