Traditional Approaches for Pricing Based Approach Upside Downside onCost-plus Costs • Focus on profit • Ignores market factors • Ignores customer value • Costs can and will change
Cost Based Pricing• Cost-based approach to pricing combines a calculation of costs with a target profit margin to arrive at a target price Target Price $1.50 / unit Profit margin $0.50 / unit Costs $1 / unitPag
Cost Based Pricing• What happens if production costs decrease?• What if some customers will pay more?• What if sale volume is less than expected?
Cost-based Pricing - Example Total Cost Unit Cost Direct Variable Costs $10,000,000 $10.00 Direct Fixed Costs $20,000,000 $20.00 Administrative Overhead $5,000,000 $5.00 Full Cost $35,000,000 $35.00 14% Revenue $40,000,000 $40.00
Cost-based Pricing - Example +10% -10% $40 $40 Which price change is best?
Traditional Approaches for Pricing Based Approach Upside Downside onCost-plus Costs • Focus on profit • Ignores market factors • Ignores customer value • Costs can and will changeMarket-based Competition • Reality of the market place • Customers will promote competition
What price are you willing to pay? $100 LowerSales CustomerRep $75 Lower $50 Lower
What price wins more market share?Profit Market share
Understanding Price Competition Firm Pricing Strategy & Execution Intensity of Firm Competitive Profitability Rivalry Industry Health Source: Competitive Strategy, Michael Porter, 1980, Free Press
Market Based Pricing• Price competition is a negative sum game.• Competing on value is a positive sum game.
Traditional Approaches for Pricing Based Approach Upside Downside onCost-plus Costs • Focus on profit • Ignores market factors • Ignores customer value • Costs can and will changeMarket-based Competition • Reality of the market place • Customers will promote competitionValue-based Customers • Higher prices for customers • Difficult / expensive to identify who get more value • Difficult to implement • Lower prices for low value customers can expand market size / revenue
Understanding Customer Value Economic Value Non-Economic Value Other Types Quantifiable in Characterized in Societal – benefits / financial terms psychological terms cost reductions for a • Increased revenue • Higher confidence population • Decreased costs • Fewer hassles Clinical value – • Increased margin • More prestige improvements in care or price level process Potential value – enhanced opportunity for value creation
Elements of B2B Customer Value Economic Value Negative Negative Competitor’s Differentiation Differentiation unique valueYour unique value Positive Positive Value Value delivery Customer perspective Differentiation Differentiation delivery Value Value Defined on relative basis Depicted in economic terms Total Economic ValuePrice of Next Best Competitive Competitive Different value for differentCompetitive Alternative Reference Reference customers Source: The Strategy and Tactics of Pricing, Nagle and Hogan, 4th edition, Prentice Hall
What influences the customer’s willingness to pay? Their perception of value
Maintain Relationship between Price and ValueHigh Price High Price P1 Offer1 Offer 2 Offer 3 P2Low Price Low Price Low Value High Value Low Value High Value
Pricing Process• What are some pricing processes in your business?
Pricing Process – a more comprehensive view Price Price Transaction Setting Realization ProfitabilityProduct Market Negotiated On Invoice Promotions Product Cost to ServePricing Pricing Subtractors Cost to Serve & Rebates Cost
Pricing Process – a more comprehensive view Price Price Transaction Setting Realization Profitability Product Market Negotiated On Invoice Promotions Product Cost to Serve Pricing Pricing Subtractors Cost to Serve & Rebates Cost Net Invoice Price Customer Price Invoice Price Pocket Margin Pocket Price Market PriceBase Price List Price
Price Waterfall – Chemical Manufacturer$300,000$250,000$200,000$150,000$100,000 $50,000 $-
Terms for Pricers • Pocket Price – The net price for a transaction after all on-invoice and off-invoice deductions, promotions, and rebates etc. are deducted. – A relative measure of price performance • Pocket Margin – Calculated by subtracting the total direct costs (direct material, direct labor) and any transaction related costs from the pocket price. – A comprehensive measure of transaction attractiveness
Price Waterfall – Better Insight Green Co. Blue Co. $100 $80 Invoice Price Invoice Price
Pricing Processes Span the Organization President BU General R&D Finance Marketing Sales Operations Manager
Price Waterfall• You can’t improve what you can’t measure• Better insight for more informed decision making• A robust source of information on pricing• Is bigger better for price waterfalls?• Start simple, capture improvements, increase sophistication
Two Challenges• Translating better insight into performance• Working in a difficult environment
Tools of the Trade• Policies• Approval• Guidance
The Spend Management Agenda• Assure reliable supply• Negotiate lowest price• Rationalize suppliers• Source low cost-country producers• Eliminate design cost and lead times• Drive internal compliance
What is the Right Model for the Organization? Centralized Decentralized Response vs. Control Elements of each model are required for optimal business performance
Resources to Learn More about Pricing• There are a number of good books on the subject – Pricing and Profitability Management: A Practical Guide for Business Leaders – Contextual Pricing – The Strategy and Tactics of Pricing• Professional Pricing Society – Conferences and workshops• Vendavo University OnDemand