Situation analysis: CMI is looking to diversify its portfolio. It wants to introduce a new high performing cushion pad into the pile-driving market. CMI will initially target small engineering/construction and independent pile-driving contractors. CMI will have the first-to-market advantage, as there are currently no direct competitors for metal pads. In terms of channels, CMI would distribute its pads through manufacturing representative. Main problem: CMI’s primary issue is figuring how price of their new product. Alternative solutions: We studied four different alternatives: cost +, EVC, price differentiation and contingency pricing.
Chosen solution: Following a comparison between all alternatives we concluded that EVC was the best pricing method.
This method takes into account the real value to the customer according to which CMI should price each pad at $2,150. Implementation plan: CMI will focus on 11 1/2” pads and initially target independent construction companies and independent pile-driving contractors. These are most price sensitive and accessible. This move will provide CMI time to learn the market and perfect its production line in preparation for supplying larger project developers in the future.
CMI will position its pads as a new industry standard while stressing their cost-efficiency and superior performance. It will also advertise in magazines and collaborate with professionals and academics to conduct further testing and publish results. Contingencies: plans regarding potential economic distress, product defects, unfavorable market reception, and alternative distribution channels will be discussed.
I. Situation Analysis
Company: CMI specialized in metal equipment production and experienced a decrease in net sales between 2006 and 2007.
The company dominated the exhaust seal market (in auto industry) with its Slip-Seal product capturing 80% market share. Due to shrinking sales and uncertainty regarding market share, management was looking to reduce dependency and diversify its product line. Product: CMI discovered a new application for its curled-metal technology and developed a high-performing cushioning pad for the pile-driving industry. Its innovative pads were far more resilient to heat and lasted longer compared to other available alternatives (micarta slabs and plastic pads). CMI’s pads could potentially shorten the drive-piling process by up to 33% hence reducing expenses. Customers: CMI identified several potential segments that influence the market. Three of these segments – architectural/consulting engineers, soil consultants, and pile hammer manufactures – were not typically direct customers, but were key influencers whose endorsement could bare significant benefits.
The former two were particularly important because they held the ultimate authority and could specifically request for CMI pads. Additional segments included direct customers such as large engineering /construction contractors who offered an opportunity for high revenues but were managerially sophisticated and small price sensitive pile-driving constructors who also held potential for high revenue and were more easily accessible. Pile hammer distributing and renting companies, on the other hand, were interested in long-term rental agreements and were therefore likely to resist CMI’s time-efficient pads (at least as long as curled pads did not become an industry standard). Competitors: At the time there were no other curled-metal pads in the market, and conventional pads produced by smaller manufacturers were sold unbranded.
CMI’s niche-specific high-performing pads were, therefore, first-to-market in what could be considered a new product category. The lack of patent protection and low entry barriers, however, raised concerns regarding potential imitation. Channels: Despite playing a key role in the pile-driving processes, distribution was considered ambiguous with no real promotional effort. This was partially because conventional pads were perceived as a necessity rather than a cost-saving tool and entailed good profit margin that were nonetheless small compared to margins from heavy equipment. Potential channels included: Heavy supply houses and heavy equipment distributors – provided access to a wide market but also absorbed additional profit margins.
More importantly, they were unlikely to hold the enthusiasm needed to actively promote CMI’s pads and educate the market. Manufacturer’s reps – were commission-based transaction-driven salespeople. Reps held strong industry connections and offered access to a wide market without increasing labor costs. On the other hand they held low brand loyalty and could be discouraged by complex time consuming transactions requiring market education. CMI was also considering In-house direct sales force – they would have offered strong brand loyalty, product knowledge and professionalism but also take longer to gain market coverage and demand large expenditure on labor and training. CMI eventually decided to sign manufacturing reps who sold their pads to various distributors and supply houses.
II. Main Problem
CMI faced several challenges. Despite developing a superior new pad, it was far more expensive compared to its alternatives and essentially formed a new product category. Therefore, much information regarding market potential (e.g. size, profits, share) was lacking and CMI needed to establish a marketing strategy that would maximize the potential for a successful penetration. CMI primary concern was determining a price for the pads that would allow it to maximize profits as it penetrated the market. In addition it needed to determine its distribution channels and weather to invest in additional manufacturing equipment or rely on existing capacity.
III. Alternative Pricing Methods
In our calculations we focused only on 11½” pad since this size was most popular and cheapest to produce. Alternative 1: Cost+ method. We first calculated CMI’s costs to produce one pad with and without investing in new equipment and then added 40% to 50% for CMI’s margin and 30% to 40% for distributor margin. This analysis resulted in 8 price options (4 with and 4 without investing in new equipment, see Appendix 1). If CMI remains with the existing equipment, the price per pad ranges between $808.74 and $933.16. If CMI invests in new equipment, however, prices fall down and range between $377.72 and $435.83. One problem with this method is that the more CMI invested in new equipment, the more they would have to lower their price, when in effect they could charge more. In addition, this method doesn’t take in consideration the values of the new pads compared to conventional ones.
Alternative 2: EVC. The second alternative is to measure the real value to the customer by using the EVC method. We first determined the added values of CMI’s pad compared to a conventional one, then we monetized it, and finally decided the amount we were willing to leave on the table in order to make our product more attractive to the customer. We measured the EVC based on both Kendrick and Corey data (see Appendix 2). Looking at Kendrick first we found that the EVC was $3,584.48 and after leaving 40% to the customer we priced the pad at $2,150.67. Based on Corey’s numbers the EVC was $5,712.58 and after leaving 40% to the customer the price was $3,427.49 per pad. The value to the customer for the 11½” pads ranged between $2,150.67 to $3,427.49 representing the maximum a customer would be willing to pay. Since it is difficult to determine the real true value (more tests needed to narrow this range) we selected the lower of the two options, i.e. $2,150 per pad.
Alternative 3: Price differentiation. The third alternative is to use the results we got from the previous alternative but to set different prices based on customer segmentation. Setting the price according to the perceived value to the customer is the most efficient way to generate higher profits since CMI could get the maximum price the customer was willing to pay from each segment. CMI should set different prices for direct users and third party users. The first segment includes engineering/construction contractors and independent pile-driving contractors who directly use the pads. This segment would have a higher willingness to pay since pads could reduce costs and improve safety. Thus, CMI should charge a higher price (closer to the EVC) by leaving only 30% on the table, ranging from $2,509.14 (70% x $3,584.48) to $3,998.81 (70% x $5,712.58).
The second segment, third party users, refers to pile hammers manufacturers and pile hammers distributing / renting companies who would not use the pads directly. This segment would have a lower willingness to pay since they would be looking for pads that most benefit their interest and not necessary their clients. Thus, CMI should settle for lower prices in return for exclusivity. CMI should leave up to 50% on the table, setting a price ranging from $1,792.24 (50% x $3,584.48) to $2,856.29 (50% x $5,712.58).
Alternative 4: Contingency pricing. The fourth alternative is to estimate a price based on minimal and maximal evaluations. We need to calculate the real cost per hour and then factor in the estimated 20% performance increase of the CMI pads (see Appendix 3). From the results, we found that in the minimal evaluation CMI would save $27,434.48 per pad whereas in the maximal evaluation it would save $27,191.45 per pad. CMI would set a price that covers their costs of $444.36 or $207.54 and then add 10% to 20% of the savings amount. Therefore, the price ranges from $2926.69 to $5,931.26 depending on relevant costs (with or without new equipment) and on the percentage of the added savings.
We compared alternatives (see Appendix 4) based on the assumptions that 1) 11½” pads constituted 50% of the overall market and 2) CMI could gain 10% market share in the first year following product introduction. While Cost + seems like a fair price system for the customer it is inherently contradictory. The more CMI improves manufacturing technology, the lower the costs, prices, and profits, diminishing its inventive to improve equipment in reality. EVC in comparison to Cost+ does take into consideration more than just the costs basing price upon customer’s perceived value of the product. Setting a higher price, however, might be problematic because it requires educating the customers about the added values. The price differentiation method seems to offer the high profit potential however it requires a lot of market research before adapting each price and it runs there is considerable risk customers find out about differentiation in what seems to be a close-knit industry.
Finally, contingency pricing (CMI’s real costs per hour) generates the highest profits yet the associated price is drastically higher compared to both conventional pads and the other pricing methods making it particularly difficult to convince customers to pay such price. Chosen solution: After evaluating the four methods we concluded that taking into account all additional values makes CMI’s product much more attractive and allows for a significant price increase. CMI should opt for the EVC method at least for the market penetration period since this is the method would secure most profits. It should also invest in new equipment in order to reduce their costs.
V. Implementation Plan
Introducing a new niche product requires investment in direct activity and market education. While CMI products function as cost saving tool, the impression would be they are significantly more expensive compared to existing alternative pads. CMI will need to educate the customers and help them perceive the real economic value the pads product. Market segment: 50% of the market is handled by companies directly owning their hammers. Companies could be divided into 3 groups, including 1) Large international construction companies, 2) Small independent construction companies, and 3) Independent pile- driving contractors.
Primary targets: Small independent construction companies and independent pile-driving contractors are less bureaucratic, more price sensitive, more accessible and will allow quick access to sales and jobs on the field. This will also provide CMI the necessary time to learn about the market, perfect its production line, learn from mistakes, improve quality assurance and better determine their real capacity. Secondary targets: Once quality and production consistency are established and pads are protected by patent, CMI could approach international contractors and commit to steady supply for large-scale projects.
At this stage product awareness will be higher and wholesalers and stocking distributors segments will be also be targeted. Positioning: CMI will position its pads as game changing product and the new gold standard. In order to justify its higher price, it must advocate its cost and time saving properties along with its superior performance and safety benefits. This will require additional research and data collection. CMI will establish evidence-based marketing by approaching opinion leaders and industry authorities and encourage them to examine their pads. Influencing figures such as top architectural, engineering and soil consultants would be solicited along with Professor McCormack and would be encouraged to publish their results. Product: CMI will initially focus its manufacturing on 11½” inch pads which are the most popular in the pile-driving market and are cheapest to produce per unit.
Larger sizes will be introduced later on, as CMI learns the market, its customers, trends, demand and opportunities. The price, before the patent was validated, should reflect the real value to the customer while leaving 40% on the customer’s end, i.e. $2,150 per pad. Once a patent is retained CMI could consider rising the price by an additional 10-15%. Promotion: will include advertisements in industry magazines and presence in professional seminars (Piletalk) were free samples would be distributed. CMI will also continue to collaborate with smaller pile-driving contractors and academics in order to collect data from the field and publish it in newsletters.
This step will be critical in help building the product’s reputation while creating word-of-mouth buzz. Place: Most of the initial sales burden will fall on independent reprasentative which will cover large territories and facilitate deals with large customers they have direct access to. Distribution channels should be developed as a secondary step, selling the product once the market has been educated. As a final step, equipment rental companies should be approached, as the market needs for time saving efficient pads will force them to place them in the shelves for hire.
VII. Contingency Plan
Problems might stem from economic recession. In such condition beginning of new builds reduces dramatically, which might reduce demand dramatically. CMI must plan for the increase costs of idle inventory, raw material, and unused equipment. In addition problems might appear with product itself or market reception. A lot is at stake because of our decision to penetrate the market while focusing on 11 1/2” pads. CMI should be ready to adapt its production line in the event demand is significantly higher for bigger sizes, or shut down production if product quality is found defective or insufficient.
In the event sales do not rise as expected, CMI must be ready to leave a larger portion of value (up to 50%) on the customer’s side as a first step. If sales further decline, new pricing methods must be considered. CMI is also highly dependent on its distribution channels. Smaller pile driving companies might fail to pay in time and are particularly susceptible to economic conditions. CMI should be prepared to enter a joint venture with a hammer manufacturer or an international construction company that will provide both financing and access to a large customer base. Finally, CMI must prepare a plan for the event that customers fail to perceive the superiority of its products. This will entail further testing and more pads being handed for free or for promotional prices.