Agriculture Reference
In-Depth Information
some general market average. An agribusiness employing this strategy may simply follow
the price lead of a competitor.
Competitive pricing does not always involve matching the competitors' price; a price
may strategically be held above or below that of competitors. A local lawn and garden store
might choose to hold its price consistently above that of a large chain discount store. Or a small,
independent grain elevator with very low overhead costs may choose to regularly offer two
cents per bushel more than a large cooperative competitor who dominates the local market.
Because competitive pricing is the norm in commodity-based markets, the strategy is
widespread in agribusiness, and is used many times by smaller fi rms whose markets are
dominated by larger fi rms. This works well as long as the smaller fi rm has a favorable cost
structure relative to other fi rms or is small enough not to be a major threat to the larger fi rm.
When one fi rm's value bundle is quite similar to another fi rm in the market, price usually
becomes a major factor in the buying decision. When fi rms struggle to differentiate their
products and services, it is diffi cult to price above the market level. Consequently, most
agribusinesses keep a close eye on the market price and vary from it only in subtle ways. Of
course, this causes major problems for any agribusiness that does not have an effi cient cost
structure. Less effi cient businesses are forced into fi nancial diffi culty because of the neces-
sity of keeping prices competitive. And it is not uncommon for agribusinesses that are in a
low-cost position to intentionally exert pressure on their higher-cost competition in order to
increase market share. While there is nothing clandestine or illegal about this, the effects can
be devastating for the less effi cient agribusiness and benefi cial for the customers.
CTO (contribution-to-overhead) pricing
CTO (contribution-to-overhead) pricing
is a method of encouraging extra sales by selling
additional product above and beyond some base sales projection, at a price slightly greater
than the additional out-of-pocket costs of handling the product. In other words, CTO pricing,
which is also called marginal-cost pricing, ignores the full cost of producing and selling
a product, and focuses on the incremental cost of making the sale. This strategy assumes
the overhead costs will be covered by normal sales as projected, so that if additional products
are sold at any price whatsoever that is above their variable cost, they will make a contribu-
tion to overhead and profi t that would not otherwise exist. (See
Chapter 12
for a detailed
description of volume-cost relationships.)
The logic of this pricing method is quite compelling when viewed in terms of the mar-
ginal or extra sales opportunity. Since many agribusiness sales are made on a negotiated
basis, there is ample opportunity for using CTO pricing methods to increase sales. Whenever
fi xed costs are a major component of total costs, as they are in many agribusiness industries,
there is great temptation to utilize this method of increasing sales, making additional
contributions to overhead, and increasing total profi ts.
The big problem with this strategy is limiting CTO pricing to only marginal or extra sales.
In reality, there is a great tendency for competitors to react to the lower “spot” price, which
causes the average market price to tumble, leaving the market unstable at best or in a sham-
bles at worst. The key is holding CTO pricing to marginal sales.
Value-based pricing
Value-based pricing
is a strategy that prices at a level at or slightly below the estimated
perceived value of the product/service bundle. This idea makes sense—if the product is
