Pricing

Once you have completed this section, your next step would be to move to the Improve Pricing section.

Throughout the text, you will find links to information that offer further insight on the topic. The green links are glossary pop-up boxes. In addition, at the end of each section, you will find questions and links to analyses that will guide you through your diagnosis.

SUMMARY POINTS

Pricing: Introduction

Industry Price Outlook
Capsule: Depending on the value added in the industry, the Company will develop either a detailed or rough forecast of the direction of prices and margins over the next three to five years. In either type of forecast, the key driver of future margins is the growth of capacity expansion compared to the growth of demand.

Type of Industry and Its Profitability
Capsule: If future demand exceeds capacity, prices should rise. Prices should fall if future capacity exceeds demand. This rule holds most readily in industries with low marketing and sales expenses as a percentage of sales. If you are in a low marketing and sales expense industry, one with commodity-like characteristics, spend the time to develop detailed forecasts of demand and supply. Otherwise, don't bother. In high marketing and sales industries, expect prices to come under pressure if industry returns are high or if the industry has had several years of price increases at a rate greater than inflation.

Demand Growth
Capsule: As in politics, all demand growth is local. You start by forecasting local demand growth and extend beyond the local service area only where necessary.

Future Capacity from Current Competition
Capsule: The current industry has many different forms of capacity that it can make available or withdraw from the market. Each of these forms has a separate cost that affects market prices. The various forms of capacity enter, or withdraw from, the market depending on the price.

Future Prices
Capsule: The economic effect of every price is the discouragement of a competitor from operating some or all of its capacity. In low marketing and sales expense industries, the price falls just short of the cash costs of the next increment of capacity that the industry could supply the market. In other industries, prices and margins tend to rise until they attract low-priced competitio

Assumption Sensitivity
Capsule: The best guess pricing scenario may be okay. But, check out the best and the worst case scenarios just in case.

Company Price Environment
Capsule: The Company Price Environment section examines the pricing opportunities the company has in the next twelve to eighteen months. This section adopts a short-term focus on the company's pricing and develops specific pricing objectives and guidelines for each key customer.

Price Sensitivity Among Customers
Capsule: There is opportunity to use price to improve profits as long as customers do not become price sensitive. The industry's competitors teach a market to become price sensitive. As customers become price sensitive, they begin to use the "Last Look" tactic in order to extract even lower prices from their best suppliers. Ironically, "Last Look" drastically reduces price-based competition.

Competition and Their Knowledge, Capacity and Will
Capsule: Competition may have the power block our attempts to change prices. Whether they will do so depends on their knowledge of our actions, on their ability to change their capacity in response to our move, and on their will to risk their profits.

Pricing Objectives and Guidelines
Capsule: The basic rule is to raise the price until it attracts a competitor or chases away a customer. Usually the competitor, rather than the customer, sets the upper limit on the price. Company guidelines follow these objectives by adopting primarily Defensive or Offensive tactics in pricing.

Price Change Opportunities
Capsule: Most price change opportunities, of course, will mirror those of the broader industry. As industry prices rise, so will those of the Company. As they fall, the Company's prices will tumble as well.

Price Discount Opportunities
Capsule: The Company may discount to gain share where a customer does not use "Last Look," or where it finds a competitor in a Leader's Trap. The preservation of market share drives most price discounts.

Price Increase Opportunities
Capsule: The Company cannot increase its prices if competitors don't follow, so most price increases begin as short term events, pending competitive reaction. Long-term price increases depend on a unique competitive position or on an unusually un-competitive market.

Pricing Process
Capsule: The process of setting the price considers the rate of change in product availability compared to customer demand, the amount by which price should change, the potential for cost savings to the Company and the trade-offs between administrative efficiency and revenue maximization.

Frequency of Price Changes
Capsule: The industry changes prices more frequently as the industry's product availability changes rapidly relative to changes in customer demand.

Amount of Movement
Capsule: No traditional movement in price is sacrosanct. Price should move in the increment that suits the Company's objectives.

Non-Price Benefits to the Company
Capsule: While the Company may not be able to command a price premium, there are two major types of non-price benefits that customers may grant to improve the Company's profits.

Level of Application
Capsule: Apply the price at a low level in a falling price market and at a high level when prices rise.

Price Components
Capsule: The Company implements its pricing policy and changes the level at which it prices its products by using the five major components of a price.

Performance Benefits
Capsule: The performance of a product includes four basic types of benefits: primary, support, related option and unrelated option. A change in any one of these components with out a change in price still changes the effective value and price of the product for the customer.

Optional Price Components
Capsule: The industry may change effective price by including fees, penalties, bonuses or extended payment terms in the product price.

Discounts and Premiums
Capsule: The industry might use several different types of discounts or premiums to appeal to specific segments of customers. The discounts usually reflect savings for the industry in serving those segments compared to the average customer. The premiums reflect the industry's higher costs.

Basis of Charge
Capsule: The industry may change the basis of charge it uses for the product or for any other component of price in order to change the effective price for some or all customers.

Period of Price Effectiveness
Capsule: The industry may shorten or lengthen the period during which it promises to hold prices constant for the customer. A short period helps the industry. A long period may help either the industry or the customer.

Next: Introduction

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This section covers most of the questions you must answer to develop a successful pricing policy. Turn next to the Improve Pricing to develop new ideas for your future pricing policy.