SITUATION ANALYSIS
Cumberland Metals Industries developed a new type of cushion pad for pile drivers made of curled metal. The 11.5 inch “Cumber-Coil” was tested by two different companies on two different projects and was found to far exceed the performance of the existing market-dominant product, the asbestos pad. The Cumber-Coil weighed half what the asbestos pad did and boasted a 33% faster driving time, 60% reduction in heat generated, and 400% less time wasted changing pads.
The company that performed the first test was ecstatic with the results and has been pressuring CMI to sell them more Cumber-Coils.
Since this is a brand new product unlike anything else available on the market, CMI must quickly settle on an amount to charge that will establish the reference price for their revolutionary product.
PRICING ALTERNATIVES
CMI has a number of options from which to choose when setting the Cumber-Coil’s initial price.
1) COST-PLUS: They could go with a cost-plus pricing method that would take into consideration all the costs involved with producing the product and then adding a fixed amount for gross margin.
SIMPLE COST-PLUS|
| Material Cost/pad| | $ 15.64 |
| Labor Cost/pad| | $ 11.64 |
| Factory Overhead (360%)| | $ 41.90 |
| Total Manuf. Cost/pad| | $ 69.18 |
| Desired GM| | 45%|
| Cost-Plus Price Per Pad| | $ 125.78|
| Unit Cost / (1-GM)=Price| | |
By using the simple cost-plus pricing formula, we arrive at a price of $125.78/pad which translates into $754.68/set of six pads.
This price is not far outside the price range currently required to perform a job using the asbestos pads. To compare apples to apples, the cost of the required number of asbestos pads to drive 10,000 ft.
(based on the results of the Colerick and Fazio tests) ranges from $700-1680. Alternatively, construction companies could spend $755 for a single set of the Cumber-Coil pads and do the same job in less time, more safely and with less potential for health hazards.
This price would likely be appealing to price-sensitive markets and would be easy to communicate and justify to potential customers.
2) GOING-RATE: They could try and determine what the going rate is for such a product in existing and/or similar markets.
In this case, it would be difficult to determine an accurate going-rate since CMI is unaware of any similar products in existence. This is a revolutionary product that is unlike anything previously available and will likely create its own market once it’s launched. The closest data available to a going rate would be the cost of the currently available asbestos pads, which are inferior to these new Cumber-Coils.
3) PERCEIVED VALUE: They could also take into consideration the perceived value of this new product and add premiums for the various benefits to demonstrate its superior quality to customers. PERCEIVED VALUE PRICING| |
Competitor’s cost/set| $50.00| NOTES:|
Premium for Time Savings| $850.00| -> change time savings & 33% faster driving time| Premium for Safety (heat & health)| $200.00| -> never above 250 degrees & eliminates asbestos| Premium for Ease of Handling| $100.00| -> weigh 1/2 as much as asbestos pads| Premium for Cost Savings| $250.00| -> savings in rental, labor and overhead costs| Premium for Potential Additional Revenue| $500.00| -> ~5% of potential revenue from additional jobs| Total Cost Per Set| $1,950.00| |
Discount| -$292.50| 15%|
Your Cost Per Set| $1,657.50| |
When using the perceived value pricing formula, we arrive at a ceiling price of $1,950/set of six pads that can then be discounted to incentivize customers to purchase them.
While more costly per 10,000 ft. than the price established by pure cost-plus pricing, this price is still close to the higher end of the asbestos pads’ price range ($700-1680). By offering a 15% discount, the cost could be comparable to the most expensive asbestos pads. With a smaller discount or with no discount at all, the price sends the message that this is a superior product worth paying more to have.
This price will be more difficult to communicate and will not readily appeal to the unsophisticated price-sensitive buyer.
CRITERIA FOR SELECTING PRICE
When trying to determine the correct price, a number of factors must be considered: the market and its segments, the size of each segment, the ability to reach each segment, what distribution channels to target, whether to vary price by segment, the usefulness of promotional offerings, and whether the goal is to skim or penetrate each market.
1. THE MARKET
There is certainly a market for this product. It is the market that is currently dominated by asbestos pad and micarta slab users, and is comprised of uneducated (about cushion pads) and price-sensitive customers. Prior to CMI’s involvement, “the pile-driving industry had paid very little attention to cushion pads.” There was no dominant manufacturer, little-to-no branding, and ambiguous distribution channels.
CMI estimated that the market amounted to between 290M and 390M feet of piles driven annually by some 19,500-26,000 hammers, some 13,000 of which were privately owned.
2. MARKET SEGMENTS
The market can be broken down into various segments: pile hammer manufacturers, construction consultants, construction contractors, independent pile-driving contractors and equipment rental companies. Each of these segments has a different level of interest and influence over the purchasing decision.
The first four segments represented groups that are likely to have a positive interest in the new Cumber-Coil pads. Manufacturers and consultants are strong influencers, but are not likely purchasers. Contractors of all sorts are the most likely purchasers, but tend to be the least educated about the pads. The larger contractors were likely to be more savvy purchasers, but would have to be carefully communicated to and handled, while the smaller companies were more likely to be price-sensitive.
The last segment, the rental companies, would likely not have a strong or positive interest in these pads since they make their money from hourly rental rates and the Cumber-Coil pads would significantly reduce the time per job that the contractors would need their equipment.
3. ABILITY TO REACH SEGMENTS
CMI had limited ability in-house to reach any of the segments. They had no direct sales force or distribution outlets of their own via which to sell the new product, so reaching the contractors directly would not be easy. Reaching the supply houses and retail outlets would be similarly challenging without direct contact. This left the manufacturers as the segment they could most easily reach with their available resources.
4. DISTRIBUTION CHANNELS
The existing channels included rental outlets, construction supply houses, manufactures and other miscellaneous outlets. “Everyone used them and took them for granted, but no one attempted to promote pads.” CMI chose to work through manufacturer representatives who would sell the Cumber-Coils to various distributors and supply houses. The feeling was that once end users had tried the new products, their demand would drive the retail outlets and supply houses to continue distribution.
5. PRICE VARIATIONS
The next consideration is whether CMI would benefit from offering different prices to different market segments. Since they had limited ability to reach the various potential market segments, this probably wouldn’t be a good idea upon introduction. Perhaps once the brand developed and the distribution channels solidified, they could consider this as a strategy.
6. PROMOTIONS & DISCOUNTS
Since the Cumber-Coil cushion was such a new and different product, CMI would likely be well served to consider offering some product promotions and discounts to help spread the word, generate hype, introduce the product to skeptical potential customers, and gain initial market share.
Types of promotions and discounts that would probably work well for this product include: first-time customer pricing, a money-back guarantee and volume discounts.
7. SKIM VS. PENETRATE
Finally, in determining the final pricing strategy, CMI should determine whether they want to skim the market or penetrate it. Market skimming typically involves setting a high initial price that will drop over time as the cost of production drops (learning or experience curve). This way, they could skim the maximum amount of revenue initially, and then slowly and steadily drop prices to gain greater percentages of market share. Doing this would result in a lower initial market share, but higher potential initial profits. However, this could backfire if another curled metal manufacturer saw the market potential and entered the market with a competing product at a lower price point.
Market penetration is designed to go after the greatest percentage of market share possible right from the start. The price is set at a lower price point in the expectation that it will attract a greater number of customers and result in more units sold. In this case, the market-penetration strategy could backfire if the demand exceeds their capacity. With such a large potential market (19,500-26,000 hammers) and a capacity for only producing only 250/month, they could easily exceed their capacity and damage their reputation by either making customers wait on orders or disappointing them by being unable to meet demand.
RECOMMENDATION
CMI should go with the perceived-value pricing that puts the price of the Cumber-Coils at the top of the range currently charged for the asbestos pads. This will actually allow them to take a mixed skim/penetration strategy. It will allow them to skim as much profit as possible up front, while giving them flexibility to lower the price later through various discounts. The higher price will discourage some potential customers initially, but will also serve to keep demand in alignment with CMI’s manufacturing capacity. Once the product has been out for a while, CMI could then determine whether the demand is such that it makes sense to add additional manufacturing capacity.
CMI should also consider giving away the first set of pads for free (like they did with the two test companies) to interested early-adopters and potential big customers (like the large international construction companies). This promotional pricing could be rolled into the cost of the remaining units and would serve to build the brand awareness and generate demand for their exceptional product.
CMI should stand behind their product by offering money-back guarantee if the product doesn’t exceed their expectations and work impressively better than their current pads. This would generate goodwill with potential customers and would help to alleviate some of the initial anxiety over changing to a brand new and unknown product.
Finally, the pricing strategy should not include volume discounts until the market demand is more thoroughly assessed and compared to manufacturing capacity. Offering such a discount up front could put CMI in jeopardy of exceeding its capacity and disappointing new customers at a time when their brand is most fragile. They should, however, implement volume discounts once the manufacturing capacity is certain to be able to handle any additional demand.
PRICE RECOMMENDATION: ~ $1600-$1800/set.
Attachments:
* Data and calculations spreadsheet
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