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