B2B Pricing Basics
Traditional Approaches for Pricing
ApproachBased
onUpside Downside
Cost-plus Costs • Focus on profit • Ignores market factors• Ignores customer value• Costs can and will change
Page 3
Cost Based Pricing
• Cost-based approach to pricing combines a calculation of costs with a target profit margin to arrive at a target price
Costs$1 / unit
Profit margin$0.50 / unit
Target Price$1.50 / unit
Cost Based Pricing
• What if some customers will pay more?
• What happens if production costs decrease?
• What if sale volume is less than expected?
Direct Variable Costs
Unit Cost
$10.00
Total Cost
$10,000,000
Direct Fixed Costs $20.00$20,000,000
Administrative Overhead $5.00$5,000,000
Full Cost $35.00$35,000,000
Revenue $40.00$40,000,000
14%14%
Cost-based Pricing - Example
$40$40 $40$40
+10%
$44$44 $36$36
-10%
Which price change is best?
Cost-based Pricing - Example
Incremental Marginal Analysis
-30%
-20%
-10%
0%
10%
20%
30%
-30% -20% -10% 0% 10% 20% 30% 40% 50%
Pri
ce C
han
ge (
%)
50%
Price / Volume Relationship
17%
Breakeven Sales Change (%)
Legend
30% CM
70% CM
Traditional Approaches for Pricing
ApproachBased
onUpside Downside
Cost-plus Costs • Focus on profit • Ignores market factors• Ignores customer value• Costs can and will change
Market-based Competition • Reality of the market place • Customers will promote competition
What price are you willing to pay?
$100
$75
Lower
Lower
$50
Sales Rep
Customer
Lower
What price wins more market share?
Profit
Market share
Understanding Price Competition
Understanding Price Competition
FirmPricing Strategy
& Execution
IndustryHealth
Intensity of Competitive
Rivalry
FirmProfitability
Source: Competitive Strategy, Michael Porter, 1980, Free Press
Market Based Pricing
• Competing on value is a positive sum game.
• Price competition is a negative sum game.
Traditional Approaches for Pricing
ApproachBased
onUpside Downside
Cost-plus Costs • Focus on profit • Ignores market factors• Ignores customer value• Costs can and will change
Market-based Competition • Reality of the market place • Customers will promote competition
Value-based Customers • Higher prices for customers who get more value
• Lower prices for low value customers can expand market size / revenue
• Difficult / expensive to identify• Difficult to implement
Understanding Customer Value
Economic Value Non-Economic Value Other Types
Quantifiable in financial terms• Increased revenue • Decreased costs• Increased margin
or price level
Characterized in psychological terms• Higher confidence• Fewer hassles• More prestige
Societal – benefits / cost reductions for a population
Clinical value – improvements in care process
Potential value – enhanced opportunity for value creation
Elements of B2B Customer Value
Source: The Strategy and Tactics of Pricing, Nagle and Hogan, 4th edition, Prentice Hall
PositiveDifferentiation
Value
PositiveDifferentiation
Value
Your uniquevalue
delivery
Competitive Reference
Competitive Reference
Price of Next Best
CompetitiveAlternative
Negative Differentiation
Value
Negative Differentiation
Value
Competitor’s unique value
delivery
Total Economic Value
Customer perspective
Defined on relative basis
Depicted in economic terms
Different value for different customers
Economic Value
What influences the customer’s willingness to pay?
Their perception of value
High Price
Low Price
Low Value High Value
P1
P2
High Price
Low Price
Low Value High Value
Offer1
Offer 2
Offer 3
Maintain Relationship between Price and Value
Pricing Process
• What are some pricing processes in your business?
Pricing Process – a more comprehensive view
Price Setting
PriceRealization
TransactionProfitability
ProductPricing
MarketPricing
ProductCost
Negotiated Subtractors
Promotions & Rebates
Cost to ServeOn Invoice
Cost to Serve
Pricing Process – a more comprehensive view
Price Setting
PriceRealization
TransactionProfitability
List
Pric
e
Base
Pric
e
Mar
ket P
rice
Cust
omer
Pric
e
Net I
nvoi
ce P
rice
Pock
et P
rice
Pock
et M
argi
n
Invo
ice P
rice
ProductPricing
MarketPricing
ProductCost
Negotiated Subtractors
Promotions & Rebates
Cost to ServeOn Invoice
Cost to Serve
Price Waterfall – Industrial Manufacturer
$- $50,000
$100,000 $150,000 $200,000 $250,000 $300,000 $350,000 $400,000
Price Waterfall – Chemical Manufacturer
$-
$50,000
$100,000
$150,000
$200,000
$250,000
$300,000
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
Blue Co.Green Co.
Invo
ice P
rice
Invo
ice P
rice
$100
$80
Price Waterfall – Better Insight
Blue Co.’s WaterfallGreen Co.’s WaterfallCu
stom
er P
rice
Pock
et P
rice
Frei
ght C
harg
e
Invo
ice P
rice Frei
ght C
ost
Cust
omer
Pric
e
Pock
et P
rice
Frei
ght C
harg
e
Invo
ice P
rice
Frei
ght C
ost
$100
$80 $80$80
$70
$80
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Blue Co.’s Waterfall
Price Waterfall – Better Insight
Page 27
Cust
omer
Pric
e
Net
Price
Pock
et P
rice
Volu
me
Reba
te
Frei
ght
Char
ge
Frei
ght C
ost
Green Co.’s Waterfall
Cust
omer
Pric
e
Net I
nvoi
ce P
rice
Pock
et P
rice
Volu
me
Reba
te
Frei
ght C
harg
e
Invo
ice P
rice
Frei
ght C
ost
PresidentPresident
MarketingMarketingFinanceFinanceR&DR&D SalesSales BU General Manager
BU General Manager OperationsOperations
Pricing Processes Span the Organization
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?
DecentralizedCentralized
Elements of each model are required for optimal business performance
Response vs. Control
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
THANK YOU