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Part 1 (this page):
[Quantity Discount]
[Cash Discount] [Predatory
Pricing] [New Customer Discount]
[Distribution Channel]
[Product Variations]
[Location]
Part 2 (next page): [Time] [Yield Management] [Delivery Mode] [Options] [Bundling] [Be-spoke] [Promotions] [Conclusions]
Case Studies: [EasyInternetCafe] [Tesco vs Levi Jeans Battle]
The previous section, Historic Fixed Pricing, outlined some of the reason why pricing has for many centuries been supply led. As business became more competitive, and products and distribution more varied, suppliers began to be more flexible in their pricing but sought to justify such flexibility from their perspective, keeping the customer subservient.
Quantity
Discounts are justified through economies in order processing and billing,
transportation, and above all, in helping suppliers achieve their break-even
volume in an era of price = cost + margin. This is particularly so in
manufacturing, with its substantial capital investment in manufacturing plant,
but is also thinking that influences the newer services industry. Services
often need significant investment in computer systems (e.g. eCRM systems,
networks), as well as in marketing, employee development (e.g. to meet financial
services regulations), call centres, etc..
Quantity Discounts at first sight seem quite reasonable, especially where distributors have significant inventory costs, but they are based on the false premise of price = cost + margin, and in the inventory situation they are simply shifting costs rather than reducing it. They can lead distributors to over order. Then, when sales fail to materialise, lead to brand erosion when costs are discounted to shift excessive stock or unsuitable products or services are sold to ill-informed customers. This in turn will lead to relationship decline, with both full paying customers and distributors, that will have repercussion on future sales. Not just with existing customers and distributors but with potential new ones that learn through friends and trade networks of the supplier's tactics.
Whilst Quantity Discounts do result in varying prices they are not very dynamic as the percentage rates usually fixed in relation to volume and have often been set many months if not years previously.
Cash
Discounts are prevalent in countries where payment times are excessive (e.g.
typically 3 months for business to business sales in the UK) and in inflationary
times when the cost of capital is high. A purchasing company with a good
A+++ rating may be able to finance a low at very competitive rates and thus
negotiate a cash discount worth more than the cost of borrowing. Equally,
a cash rich company may negotiate a cash discount worth more than investing
their surplus cash with the bank or the money markets.
Cash discounts, if given, should be more dynamic in that they should reflect the cost of working capital. However, when given they tend to reflect the value / cost to the supplier (i.e. the same rate is given to all customers) and the rates may change to reflect the money markets or the suppliers credit standing, rather than the market for the product.
Some suppliers are so aggressive and cash rich that they are heavily discount to below cost. This may be for an introductionary period as a means of grabbing a significant share of a market. When the technique is used for an extended period, often the aim is displace existing players. Many countries have introduced legislation to stop such practices. See the later section on Legislation.
New Customer Discounts are justified to attract new customers
or distributors and may be given under the pretence that the customer or
distributors has switching costs in moving to a new supplier. Often they
are given by suppliers to win market share with the aim of reducing competition
and then allowing a subsequent price hike and excessive profits. Such was
the extent of this practice in some sectors that anti-trust laws had to be
formulated in many industrialised countries.
New Customer Discounts can lead to customer expectations that the product has sufficient margin to justify ongoing discounts even if under a different label. The supplier however, needs to return the prices as soon as possible to "normal". Where switching costs are not significant then New Customer Discounts may be no more than a blatant incentive under an acceptable name. There is the attendant danger that many of these new customers will soon become a new customer for another supplier and another ...... In a retail environment there is also the added danger that your New Customer Discounts are not going to new customers but to existing customers (see promotions on page 2). In fact in many markets, suppliers are chasing new customers with New Customer Discounts and the like, rather than building one to one relationships with customers. If they really knew their customers then they could tell who is new and who is not!
Channel management is one of the biggest challenges for companies today. Traditionally, distributors add value through such activities as breaking down bulk goods into smaller quantities (e.g. oil, chemicals, sand), holding inventory locally for speedy delivery, providing specialist knowledge to help end customers select and use the products, and undertaking local marketing and selling. When manufacturers / suppliers set retail prices then channel negotiation was all about margin management, i.e. how the total margin should be shared by the various parties throughout the distribution chain.
Today, with retail price abolition in the UK and many other countries, the
margins retained by retailers and intermediaries will determine the end price
and this may have a detrimental impact on the brand value. Tesco's bitter
dispute with Levi Strauss jeans is an example.
After a bitter legal battle, Tesco, a major UK food supermarket chain, lost its ability to sell cut price Levi jeans. Levi's maintained they had the right to protect their brand image. Soon after winning their case, Levi's announced a new range of cheaper jeans to be sold through a new distribution channel! Read more in the Tesco vs Levi Jeans Battle
Direct Marketing via the media, call centres or the internet allow suppliers to by-pass distributors. This may allow lower costs or higher margins, thus gaining either a competitive edge or matching the business model of new entrants. Such a move may well be applicable where end users have built up their own skills and knowledge, for example personal computers and standard software packages, such that they feel confident in making their own purchasing decisions.
Direct Marketing is supported by an efficient distribution system that can deliver overnight a parcel across the UK for just £10. Some may argue that the explosion in Direct Marketing has itself fuelled the expansion of effective courier systems. Direct Marketing with its mass market media promotion, backed up with the internet and call centres, perhaps now forms the bulk of consumer and business marketing communications, further reducing the role of the local distributor.
Direct Marketing is also applicable where products have become so reliable
that service calls are infrequent or where on-site repair is no longer possible
or practical, for example with electronic goods and household appliances.
Dell Computers is a classic example where purchasers can use the internet to configure their own computer (see screen shot) which is then manufactured by Dell (known as mass customisation). Dell gains in a number of significant ways:
- it has no inventory of completed computers and with just-in-time supply lines, it has little inventory of components (e.g. hard drives).
- it can quickly capitalise on components from lower cost suppliers.
- it can quickly capitalise on new PC developments (e.g. DVD drives)
- it has a "negative cash conversion cycle" (ie, keep inventory for 5 days, manage receivables to 30 days and push payables to 59 days).
Thanks to ThePriceMan for some of the above information.
A current example of eliminating the distribution chain is by Mercedes Benz
in the UK who are owned by DaimlerChrysler UK Ltd..
Mercedes Benz are proposing to severe links with their existing dealer franchise and instead establish a few wholly owned regional sales centres. Dermot Kelly, the head of DaimlerChrysler UK, is reported as saying that his plan represents 'another step forward in joined up brand management and will provide customers with more' (ref.). In early 2001 the company sent out termination letters to all the dealers. Naturally the dealers are angry and have mounted a PR campaign including a web site. Just as important, how do the customers feel?
The ubiquitous telephone and increased consumer confidence has fueled direct
selling channels, as in insurance:
Within property insurance most general insurers have established direct line operations. Many customers now seek a number of quotes on renewal and will tend to purchase from the lowest cost provider. If and when they do claim, the direct lines tend to offer a speedy, if not instant, claims service available around the clock. For the insurer, direct selling enables quotations (price) to be very specific to the individual customer risk and even to forsake margin to match or beat another quotation or renewal notice.
But before undertaking such significant distribution chain changes suppliers need to assess the consequences. Distributors may decided to switch to other suppliers such that direct sales fail to make up lost sales via distributors. Distributors may decide to reduce customer service levels pushing service calls back to the suppliers who may be ill equipped to deal with the volume or complexity of the calls. Distributors in turn need to reassess where they add value in the light of changing consumer needs or capabilities, changing product attributes and new ways of distributing products. In most industries there is a shift in value from the product to the service elements. In the future, increasing value is likely to be in providing customer experiences and transformations.
Product variations, with their consequential price variations, have become a powerful weapon in the marketing armory, particularly when combined with different distribution channels.
Developing a range of product models at different price points allows suppliers
to address different price points within an overall market. Washing machines
and cars are good examples:
Domestic washing machines are based on 2 standard designs, front or top loading, with the former dominating. Thus all models of a particular design can be manufactured on a single production line for very similar manufacturing cost. Perhaps only the control panel or even just the software is different from model to model. Yet the price range can vary from say £250 for the basic 5 programme model, to £350 for the top of the range model with 12 programmes and other features.
Mixing "model" and channel variations is a more sophisticate pricing structure
that needs to be carefully managed as the following book example
illustrates:
The initial publication is produced in hard-back cover and is heavily promoted at the target audience and sold through book shops. Later this is followed by a paper-backed version at half the cost for more general readership and sold through a wider range of outlets including supermarkets and kiosks. Different versions may be produced exclusively for specific distribution channels: a competitively priced academic version for universities buying in bulk as required reading by students, a cheaper book club version for direct sales, a special luxury edition for collectors, an abridged audio version for busy and mobile readers, and now internet e-books for downloading into PDAs and personal computers.
Product variations is an excellent example of segmenting the market to reflect the different needs and different price points of the market. As such, it is an important development on the road to dynamic pricing.
Even within the same distribution channel, price may vary according to the
location of the outlet. Users of airport shops will appreciate that their
prices can be much higher than the same retail outlet on the High Street.
Shops in tourist venues will also charge significantly more for goods, often
with little more than the application of a transfer to a plain object to
turn it into a souvenir.
Are First Great Western "ripping off travellers"?
Read the First Great Western Case Study
where one commuter found it was costing him twice the price to commute to his place of work compared to purchasing 2 tickets covering exactly the same journey.
Location also of course impacts transport costs and therefore final price. Offshore islands usually have a delivery surcharge and free delivery is usually restricted to a certain distance. Outside these extremes, companies tend to use an average price even though delivery costs will vary significantly due to congestion, rural and difficult to find locations, difficulties in unloading, or the need to negotiate flights of stairs.
UK Postal Service Under Strain
- Will the universal service be maintained to all locations?
Many people in rural areas and off-shore islands in the UK
are worried about the continuing viability of their daily postal service. The UK postal market is being opened up and new entrants are likely to concentrate on the volume urban market. Today, the UK state Post Office is losing £1m (1.4m Euro) every day. Fixed postal collection times have been abandoned along with 2nd deliveries and fixed delivery times. With competition, the Post Office is likely to demand its statutory universal service requirements are suspended. For example, the requirement to deliver to every household on a daily basis and a minimum number and density of post boxes. For the people living in remote areas it's a "double wammy", as they will be the last to get broadband, if they ever do get it.
Insurance premiums are usually location dependent.
The base price for house insurance is usually set by the owners post (zip)
code based on crime levels and the meeting of minimum levels of security
for that area. Holiday insurance is based on the destination, with the USA
attracting high premiums because of the high cost of medical care.
Motor insurance also factors in location, usually the home address. But with many drivers commuting into major towns, some motor insurance companies are more concerned with the owner's place of work and the likely traffic densities.
Some insurance industry analysts are predicting that insurance premiums could be dynamically based on where, when, how and by whom a motor car is driven. This would be achieved using technologies such as Global Positioning Satellites, on-board car computers and personal body sensors. City centres in the rush hours with a driver with high blood pressure and high pulse rate would attract a high premium.
These examples illustrate that location often has an impact on the service
element of the product. In many industries, whilst automation has significantly
reduced manufacturing costs, the costs of the service elements have increased
considerably. Companies now need to give more consideration to factors like
location that have an impact on service cost.
One Italian tyre manufacturer has developed a compact machine that can produce a tyre in hours rather than days. Additionally, rather than a single manufacturing plant, these smaller units can be located in many places and operated by semi-skilled workers. Production can now reflect local demand patterns and inventory costs are significantly reduced.
In other instances, companies have found it more economical to centralised support to a single location. In Europe many computer vendors and airlines now have one call centre. Using multi-language employees they are able to load-balance calls from many countries, and by extending the working day or operating 24 by 7, they are able to handle customers throughout the world. Where service engineers need to be deployed, many of them will now work from home or their car rather than a regional offices.
The significant reduction in telecommunications
costs, as well as a significant increase in switching and call handling
functionality, has made this possible. The same technology has allowed companies
to handle service calls using remote diagnostics. Currently most applicable
to commercial equipment, before long many domestic appliances will be similarly
serviced. In fact there is already a washing machine that is internet enabled.
Beyond problem calls the technology opens the way for additional value added
services. A printer company foresees it's printers automatically reordering
ink, toner and paper based on print volumes and a household appliance company
is working on an internet enabled toaster that will burn advertising into
the toast!
Distance can impact non
tangibles. In June 2003 the Government turned down the electricity regulator's
(Ofgem) proposal to charge consumers differing prices according to how far
they live from the generating plant (known as "cost reflective charging"
or "average zonal charging"). This differential charging was to reflect the
loss of energy along the distribution lines and was promoted as an environmental
benefit. Had the proposals been accepted then it was estimated that consumers
in Scotland would see annual bills reduce by £7 and those in London
and the South East of England increase by £1.
The Government said that would be too disruptive to introduce the change at the same time as new [wholesale] electricity trading arrangements are being introduced. It was also apparently unconvinced by the reasoning but it didn't rule out the idea for the future. Maybe the real reason was that such a scheme would create a demand for power stations in the South East - not something that would go down very well with affluent SE consumers ("not in my back yard" brigade or NIMBYs - pronounced nimbies).
to part 2:
[Time][Yield Management] [Delivery Mode] [Options] [Bundling] [Be-spoke] [Promotions] [Conclusions]
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