Part 2: Company Price Environment
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.
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Symptoms and Implications:
The Company's pricing policy serves as a bridge between the Company's value proposition and its cost management task. The pricing policy first ensures the Company's performance and Price Points present an attractive value proposition to customers. This requirement demands that the Company allow competitive prices and customer net cost savings on the use of the product to guide its own pricing. At the same time, pricing policy helps the Company make an attractive return on investment. Cost and return management goals may seek higher prices for the Company's products.
These two demands on the price conflict with one another. In practice, the Company makes trade-offs by emphasizing one objective or another, depending on the near-term pricing environment. Where prices are likely to fall, the Company adopts defensive pricing guidelines to protect and raise sales volume. Where prices are increasing, the Company adopts offensive pricing guidelines to raise margins. The Company applies these guidelines to each customer relationship.
Two Basic Price Objectives
The objective of a Company's pricing policy is to set the Company's product price at the highest level that a customer will pay and at a level low enough to prevent a competitor from gaining attractive sales volume in price competition with the Company. The Company must find a balance between two potentially conflicting actions:
The competitors' capacity and will to underprice the Company usually sets the upper limit on the Company's price for the product. Customers may be willing to pay higher prices than they pay today. But, those higher prices would, in many markets, attract competitors who would attempt to gain the customer relationship with a lower price.
The Company's view of price and margin direction comes into play here. If the Company foresees a falling price and margin environment, it follows pricing rules that are defensive, meant to protect current customer sales volumes. If, on the other hand, the Company expects a rising price and margin environment, it adopts more offensive pricing tactics, meant to raise prices while protecting Core customer relationships.
For Falling Price Environments
The balance between the market's demand and capacity informs a company's pricing actions against competitors. In a market where both the Company and the industry are in overcapacity, the Company sets its pricing policy by following three basic rules:
|These rules lead to defensive pricing guidelines for the Company to implement in the near term. With defensive guidelines, the Company stresses the actions to increase or protect sales volumes and emphasizes the second of the two basic price objectives. The guidelines address Company actions with each customer:
For Rising Price Environments
In the more fortunate circumstance where capacity falls short of demand, industry prices will be high or rising. In this situation, the Company would raise its prices as fast as market demand management allows. The Company has no incentive to set prices below those of competition since it is likely to be sold out of its current capacity. Rather, its primary incentive is to match, or perhaps even exceed, average industry pricing based on its objectives for each customer. It may, in these circumstances, keep some customers at industry pricing and others above industry pricing, depending on how valuable the customer relationship is to the Company in the long term. The more valuable the customer relationship is to the Company, the more likely the Company would hold its prices at industry average for the customer.
In these markets, where demand exceeds capacity, the Company may be short of capacity. It may have to allocate its product output. In doing so, its first priority is to support its Core customers. In such a market, the Company should use its pricing policy for its support of Core customers. This objective implies that the Company would raise its prices to its Non-core and Near-core customers by enough that they will either become long term Core customers or will seek other sources of supply for the product.
Using the common practice of putting all customers on the same allocation based on a percentage of last period's purchases is ill-advised. This policy creates a "failure" with Core customers. Good Core customers will forgive rising prices in a product-short market. Their memories are much longer, and their understanding much lower, if we fail to deliver the product they need to exploit their own markets. Far better to let Non-core customers wait for product.
In a Reprieve market, industry demand exceeds current industry capacity. Times are very good for industry profits. In this type of market, the Company follows five pricing rules. These are offensive pricing guidelines:
Guideline Application to Customers
These guidelines apply to each customer relationship the Company has or plans to have over the next 12 – 18 months.
In a falling price environment, the Company would develop specific pricing plans for each Large and Very Large customer it serves or plans to serve. Each of these customers is important enough to warrant specific individual consideration. The Company would issue broader directives to the sales force and marketing staffs to cover the implementation of these guidelines with the smaller, and far more numerous, Medium and Small customers.
In a rising price environment, the company would also develop specific individual plans for each Very Large and Large customer. With Core customers, the Company would plan to provide the appropriate level of capacity support for these customers' growth needs. With Non-core customers, the Company would plan the timing for specific price increases over and above normal industry price increases to free the capacity these customers use. Finally, with Near-core customers, the Company would plan the order in which these customers will receive prices above industry standard price increases, again to free capacity in support of Core customers.
With Small and Medium customers, the Company would develop specific plans only for the Core customers. The remaining Near-core and Non-core customers would be subject to broader guidelines issued by the Company for implementation in the field.
With specific objectives and pricing guidelines established, the Company next turns to the task of defining where the specific opportunities to change its price to gain margin or share might lie.