Pricing the product or service is one of the most important business decisions you will make.
You must offer your products for a price your target market is willing to pay – and one that produces a profit for your company – or you won’t be in business for long.
According to Prof. K.C. Kite,
“Pricing is a managerial task that involves establishing pricing objectives, identifying the factors governing the price, ascertaining their relevance and significance, determining the product value in monetary terms and formulation of price policies and the strategies, implementing them and controlling them for the best results”.
Pricing is not an end in itself but a means to achieve marketing objectives of the firm.
Therefore, the pricing strategy of a firm should be designed to achieve specific objectives. Like other operating objectives, the objectives of pricing are derived from the overall objectives of the firm. The basic objectives of a firm are survival and growth.
1. Introduction to Pricing 2. Meaning of Pricing 3. Concepts 4. Objectives 5. Importance 6. Kinds
7. Methods 8. Strategy 9. Decision Framework? 10. Difference between Price and Value? 11. Approaches 12. Promotion.
Pricing in Marketing – Meaning, Concepts, Objectives, Importance, Methods, Strategy, Decision Framework and Other Details
Pricing – Introduction
Pricing the product or service is one of the most important business decisions you will make. You must offer your products for a price your target market is willing to pay – and one that produces a profit for your company – or you won’t be in business for long. There are many approaches to pricing, included scientific and unscientific. Here is one framework for making pricing decisions that takes into account your costs, the effects of competition and the customer’s perception of value.
(i) Cost is the total of the fixed and variable expenses (costs to you) to manufacturer or offers your product or service.
(ii) Price is the selling price per unit that customers pay for your product or service.
So, the price you set is the cost to the customer. Ideally, it should be higher than the costs you incurred in producing the product.
Think of your cost as the surface of the ocean. You must set your price above the surface to cover costs or you will quickly drown. Of course, there will be times when you decide to set prices at or below cost for a temporary, specific purpose, such as gaining market entrance or clearing inventory.
How the customer perceives the value of the product determines the maximum price customers will pay. This is sometimes described as “the price the market will bear.” Perceived value is created by an established reputation, marketing messages, packaging, and sales environments. An obvious and important component of perceived value is the comparison customers and prospects make between you and your competition.
Somewhere between your cost and the price “the market will bear” is the right price for your product or service — a price that enables you to make a fair profit and seems fair to your customers. Consequently, once you understand your costs and your maximum price, you can make an informed decision about how to price your product or service.
However, while costs are important in setting your prices, don’t limit your thinking only to cost-based pricing. Value-based pricing makes you think about your business from the customer’s perspective. If the customer doesn’t perceive value worth paying for at a price that offers you a fair profit, you need to re-think your game-plan.
But there are several other key costs that customers may incur in using a service:
(i) Physical efforts may be required to obtain some services, especially if the customer must come to the service factory and delivery entails self-service.
(ii) Sensory costs may include putting up with noise, unpleasant smells, drafts, excessive heat or cold, uncomfortable seating, visually unappealing environments, and even unpleasant tastes (one of the reasons that many children dislike health care).
(iii) For customers, there is an opportunity cost to the time spent in pursuit of service, since that time could, perhaps, be spent in other ways.
(iv) Psychic costs are sometimes attached to the use of a particular service-mental effort, feelings of inadequacy, or even fear.
In short, as the bundle of benefits presented by the product must be traded off against the bundle of costs associated with using it. In any given situation, customers are making judgment about what they get in return for what they give.
Pricing – Meaning of Price and Pricing
Right price is one of the important determinants of business success. Right price, however doesn’t mean a low price. What is the right price? It depends upon a number of factors like the nature of other elements of marketing-mix, nature of market, including demand and competition.
A price policy is a guideline set by the top management to bring about optimum product market integration. It is that sharp weapon by which the marketer can encourage or discourage competition, satisfy or dissatisfy the consumers, helps or hinder the army of salesman in effective selling. Price policies and strategies are important for all the members of channel of distribution.
A price is the amount one pays for a good or a service or an idea. Price is the amount for which a product, a service or an idea is exchanged, or offered for sale regardless of its worth or value, to the potential purchaser. Without price there is no marketing, in the society. To a manufacturer, price represents quantity of money (or goods and services in a barter trade) received by the firm or seller. To a customer, it represents sacrifice and hence his perception of the value of the product.
The term ‘price’ needs not be confused with the term ‘pricing’. Pricing is the art of translating into quantitative terms (say rupees or dollars) the value of the product or a unit of a service to customers at a point in time.
According to Prof. K.C. Kite, “Pricing is a managerial task that involves establishing pricing objectives, identifying the factors governing the price, ascertaining their relevance and significance, determining the product value in monetary terms and formulation of price policies and the strategies, implementing them and controlling them for the best results”.
Thus, pricing refers to the value determination process for a good or service, and encompasses the determination of interest rates for loans, charges for rentals, fees for services, and prices for goods.
Pricing – Buyers’ and Sellers’ View
In general terms price is a component of an exchange or transaction that takes place between two parties and refers to what must be given up by one party (i.e., buyer) in order to obtain something offered by another party (i.e., seller).
Yet this view of price provides a somewhat limited explanation of what price means to participants in the transaction.
In fact, price means different things to different participants in an exchange:
1. Buyers’ View:
For those making a purchase, such as final customers, price refers to what must be given up to obtain benefits. In most cases what is given up is financial consideration (e.g., money) in exchange for acquiring access to a good or service. But financial consideration is not always what the buyer gives up.
Sometimes in a barter situation a buyer may acquire a product by giving up their own product. For instance – two farmers may exchange cattle for crops. Also, as we will discuss below, buyers may also give up other things to acquire the benefits of a product that are not direct financial payments (e.g., time to learn to use the product).
2. Sellers’ View:
To sellers in a transaction, price reflects the revenue generated for each product sold and, thus, is an important factor in determining profit. For marketing organizations price also serves as a marketing tool and is a key element in marketing promotions. For example – most retailers highlight product pricing in their advertising campaigns.
Pricing – Main Objectives of Pricing Followed by Different Firms
Pricing is not an end in itself but a means to achieve marketing objectives of the firm. Therefore, the pricing strategy of a firm should be designed to achieve specific objectives. Like other operating objectives, the objectives of pricing are derived from the overall objectives of the firm. The basic objectives of a firm are survival and growth.
The objectives of pricing should be clearly defined because without clear cut objectives a sound price structure cannot be developed. In practice very few firms define their pricing objectives in unambiguous terms. The specific objectives of pricing may vary from firm to firm and even for the same firm at different points of time. Most firms have multiple pricing objectives.
The main objectives of pricing followed by different firms are as follows:
1. To achieve target rate of return on investment;
2. To stabilize prices;
3. To maintain or improve share of the market;
4. To meet or prevent competition;
5. To maximize profits; and
6. To improve public image.
Objective # 1. Target Rate of Return:
Firms following this objective design their pricing strategy in such a way that will yield desired return on total investment (ROI). Rate of return refers to the amount of net profits divided by investment or capital employed. This goal often leads to cost plus pricing. The price of a product or service is determined by adding the expected margin of profit to the cost of production and distribution.
In order to fix the price, the firm estimates the amount of total profit required to earn the expected rate of return. The figure of total profit divided by the average sales volume gives profit margin per unit. Suppose, for instance, that a company wants to earn a return of 20 per cent (before taxes) on its total investment of Rs.50 lakhs. The annual sales volume on an average is anticipated to be 50,000 units and the total cost per unit is Rs.80.
The company can calculate the price as under:
Target rate of return is an important pricing objective and an increasing number of firms follow this goal due to several reasons. Firstly, it ensures a reasonable return to the investors. Secondly, it does not lead to public criticism. Thirdly, the rate of return can be used to evaluate and compare the performance of different products of the firm. Fourthly, it provides a measure of restraint and a guideline for judging improvement in a new product line.
However, target return pricing may not be feasible in all conditions. This goal can be achieved by firms which are industry leaders or which sell in protected markets. Some firms may attempt to achieve target return on sales during the short run. They set a percentage mark-up on sales which is sufficient to cover operating costs and the desired profit.
In such cases, the rate of profit would remain the same, but the amount of profits would vary with the number of units sold. The target rate of return differs from firm to firm depending upon the cost of capital and the actual market conditions in the industry.
Objective # 2. Price Stabilization:
This goal is adopted in industries having a few firms. In an oligopolistic situation where one firm is very big and all others are small, the big firm acts as the price leader and other firms follow it. All the firms try to avoid price wars. No firm is willing to cut its prices for fear of retaliation by other firms.
In order to avoid fluctuations in prices, they may even forgo maximizing profits during the period of scarce supply or prosperity. This objective is followed in case of products which are vulnerable to price wars or which are advertised at the national level. Price stability helps in planned and regular production in the long run. However, it may create rigidity in pricing.
Objective # 3. Target Share of the Market:
In an expanding market, market share is a better indicator of a firm’s success than the target rate of return. When the market has a potential for growth, a firm earning the target rate of return may, in fact, be decaying if its share of the market is decreasing. Therefore, maintenance or improvement in the market share is a more worthwhile objective in growing markets. Market share measures a firm’s sales vis-a-vis the sales of its competitors.
Objective # 4. Facing Competition:
Under conditions of intense competition, a firm may seek to meet or prevent competition. It may fix prices at a very low level (even below cost) to eliminate its competitors or to prevent the entry of new firms in the market. Some firms follow this practice while introducing a new product. This goal is not very popular and cannot be adopted on a regular basis. In the long run, a firm cannot survive if it continues to charge less than the cost of the product or service.
Objective # 5. Profit Maximization:
Traditionally, profit maximization is considered to be the objective of pricing. The classical economic theory suggests the fixation of prices in such a way that the marginal cost is equal to marginal revenue where profits are maximized. Even today some firms are not very conscious of social responsibilities and try to maximize profits. But in recent years there has been a change in the philosophy of business and profit maximization is not considered rational business behaviour. In practice, no firm states explicitly that profit maximization is its pricing objective due to the fear of public criticism and government regulation.
Objective # 6. Improving Public Image:
Another objective of pricing may be to enhance the firm’s public image. The firm may launch a premium product at a high price for this purpose. Alternatively, it may offer the new product at a low price to appeal to the common buyer. The pricing policy should be consistent with the established reputation of the firm.
In addition to the foregoing, business firms may design their pricing policy to achieve the goals of full capacity utilization, market exploration, diversification, etc.
Pricing objectives may be classified into three categories:
(i) Sales volume objectives including sales maximization and improvement in market share.
(ii) Profitability objectives consisting of profit maximization and target rate of return.
(iii) Status quo objectives comprising price stabilization, maintaining market share, facing competition and covering costs.
1. Growth in Sales:
A low price can achieve the objective of increase in sales volume. A low price is not always necessary. Competitive price, if used wisely, can secure faster increase in sales than any other marketing weapon.
2. Market Share:
Price is typically one of those factors that carry the heaviest responsibility for improving or maintaining market share — a sensitive indicator of customer and trade acceptance.
3. Pre-Determined Profit Level:
Return on Investment, say 20 to 25 per cent is a common decision in marketing. Pricing for profit is the most logical of all pricing objectives.
4. Counter Competition:
Many firms follow a flexible pricing policy to counter competition. Prices are to be varied depending upon market condition.
5. Control Cash-flow:
A principal pricing objective is to return cash as much as possible (the funds invested) within a given period. Investment in research and development, market development, promotion, etc., should pay back within a specified period. Capital expenditure on any project must be recovered within 5 to 10 years. Pay-back or cash-flow objectives fit in easily with other corporate objectives.
While determining objectives of a pricing policy, marketers must take into account reactions of number parties such as customers, competition, resellers or dealers, Government, public opinion, and so on. For instance, there may be a conflict between sales maximisation objective and a return on investment or profit objective. However, it should be noted that maximum market penetration in the short-run (in the early phase of the product life-cycle) is the key to maximum ROI in the long run.
6. To Penetrate the Market:
Many firms enter the market by charging a very low price for the product. Example- Low-price Chinese toys have flooded the market.
7. Meet or Follow Competition:
Many firms desire the stabilisation of price levels and operating margins as more important than the maintenance of a certain level of short-run profits. The price leader maintains stable prices in the industry. Follow the leader.
Pricing – Importance
When marketers talk about what they do as part of their responsibilities for marketing products, the tasks associated with setting price are often not at the top of the list.
Marketers are much more likely to discuss their activities related to promotion, product development, market research and other tasks that are viewed as the more interesting and exciting parts of the job.
Some reasons of pricing include:
1. Most Flexible Marketing Mix Variable:
For marketers price is the most adjustable of all marketing decisions. Unlike product and distribution decisions, which can take months or years to change, or some forms of promotion which can be time consuming to alter (e.g., television advertisement), price can be changed very rapidly.
The flexibility of pricing decisions is particularly important in times when the marketer seeks to quickly stimulate demand or respond to competitor price actions. For instance, a marketer can agree to a field salesperson’s request to lower price for a potential prospect during a phone conversation. Likewise a marketer in charge of online operations can raise prices on hot selling products with the click of a few website buttons.
2. Setting the Right Price:
Pricing decisions made hastily without sufficient research, analysis, and strategic evaluation can lead to the marketing organization losing revenue. Prices set too low may mean the company is missing out on additional profits that could be earned if the target market is willing to spend more to acquire the product.
Additionally, attempts to raise an initially low priced product to a higher price may be met to customer resistance as they may feel the marketer is attempting to take advantage of their customers.
Prices set too high can also impact revenue as it prevents interested customers from purchasing the product. Setting the right price level often takes considerable market knowledge and, especially with new products, testing of different pricing options.
3. Trigger of First Impressions:
Often times customers’ perception of a product is formed as soon as they learn the price, such as when a product is first seen when walking down the aisle of a store. While the final decision to make a purchase may be based on the value offered by the entire marketing offering (i.e., entire product), it is possible the customer will not evaluate a marketer’s product at all based on price alone.
It is important for marketers to know if customers are more likely to dismiss a product when all they know is its price. If so, pricing may become the most important of all marketing decisions if it can be shown that customers are avoiding learning more about the product because of the price.
4. Important Part of Sales Promotion:
Many times price adjustments are part of sales promotions that lower price for a short term to stimulate interest in the product. However, marketers must guard against the temptation to adjust prices too frequently since continually increasing and decreasing price can lead customers to be conditioned to anticipate price reductions and, consequently, withhold purchase until the price reduction occurs again.
Pricing – Various Kinds of Pricing for their Various Products
Firms may choose various kinds of pricing for their various products these are:
(i) Odd Pricing:
It may be a price ending in an odd number. Bata Shoe Company pricing one of its pair shoes at 299.95 is an example of odd pricing. Such a pricing is adopted by the sellers of specialty or convenient goods.
(ii) Psychological Pricing:
The prices under this method are fixed at a full number. The price settlers feel such a price has an apparent psychological significance from the viewpoint of buyers. This differs from the concept of odd pricing in that the curve doesn’t necessarily have any segments positively inclined.
(iii) Customary Prices:
Such prices are fixed by the custom. Soft drinks are priced by their customary bases, such a pricing is usually adopted by chain stores.
(iv) Pricing at Prevailing Prices:
This kind of pricing is undertaken to meet the competition. It is also called ‘Pricing at the market. Such a strategy presumes a market in elasticity of demand below the current price.
(v) Prestige Pricing:
Many customers judge the quality of a product by its price. In their opinion lower priced product is inferior, and higher priced product is superior. This pricing is applied generally to luxury goods.
(vi) Price Lining:
This policy of pricing is usually found among retailers. Technically it is closely related to both psychological and customary prices. Under this policy the pricing decisions are made only initially and such fixed prices remain constant over long periods of time.
(vii) Geographic Pricing:
The manufacturer sometimes adopts different prices in different markets without creating any ill will among customers, e.g., Petrol is priced depending upon the distance from the storage area to the retail outlet.
(viii) FOB Pricing (Free on Board):
Here the buyer will have to incur the cost of transit and in the later the price quoted is inclusive of transits charges.
(ix) Dual Pricing:
When the manufacture sells the same product at two or more different prices in the same market it is ‘Dual Market Pricing’. This is possible only if different brands are marketed. It is adopted in railways where passengers are charged differently for the same journey and traveling in different classes. This is also referred to as ‘Discriminatory Pricing’.
(x) Administered Pricing:
This applies to the practice of pricing the products for the markets not on the basis of cost, competitive pressures or the laws of supply and demand but purely on the basis of the policy decisions of the sellers. These kinds of price remain unchanged for substantial periods of time.
Pricing – Methods of Pricing the Product: Cost-Oriented Export Pricing Methods and Market-Oriented Export Pricing
The export price structure, like the domestic price structure, begins on the factory floor. But there is no similarity in the costs included in the two structures. The pricing of the products for domestic and export purposes shall be calculated in a somewhat different manner. The export price structure is the basis of all export price quotations, discount and commissions. There are various methods of pricing the product in the foreign markets. The methods may be grouped into two i.e., cost oriented export pricing methods and market oriented export pricing methods.
The pricing of the products for domestic and for the markets abroad is calculated in a somewhat different way. The price structure for export is the basis of all export price quotations, discount and commissions.
The various methods of pricing the product in the foreign markets are grouped into following two methods:
1. Cost-oriented export pricing methods,
2. Market-oriented export pricing methods.
These are based on costs incurred in the production of the articles. As total cost includes fixed costs and variable costs, export pricing may be based on full cost (fixed and variable) or only on variable costs. A reasonable profit will be added to the base cost to arrive at the export pricing.
Thus cost-oriented export pricing methods may be:
(i) Full cost or total cost method, and
(ii) Variable cost or marginal cost method.
(i) Full Cost or Total Cost Method:
This method is also known as cost-plus method and it is the most common method. Under this method for arriving at the export pricing, the total cost of production of the article is considered. In addition to the fixed and variable costs incurred in the production of the item, all direct and indirect expenses needed for the export of the product including cost on transportation, freight, customs duties, risk. To this a reasonable profit allowance is added to the cost. From this amount the value of all assistance received from any source is deducted.
Given below are the various elements of the total cost:
(a) Direct Cost:
It includes variable and other costs directly related to exports:
i. Variable Costs – It includes expenditure on direct materials, direct labour, variable production overheads, and variable administrative overheads.
ii. Other Costs Directly Related to Exports – These are in addition to the variable costs.
Selling costs advertising support to importers in the foreign market. Costs on Special packing, Labelling, Commission to overseas agent, Export credit insurance, Bank charges, Inland freight, Forward charges, Inland insurance, Port charges, Duties on Exports of the product, expenditure on Warehousing at port, Documentation and incidental, expenditure therein, Interest on funds involved or cost of deferred credit. Cost of after sale service, including free supply of spare parts, consular fees, preshipment inspection and loss due to rejection of product.
(b) Fixed Costs:
It includes overheads on production and administration, publicity and advertising, travel abroad, after sale service.
From this amount following are deducted:
i. Compensatory assistance,
ii. Import replenishment benefits,
iii. Duty drawback,
iv. Expenditure on Freight and Insurance.
(a) Its main advantage is that through this method exporter becomes aware of the full cost in marketing the product in a market abroad.
(b) It is a very simple method.
When smaller number of units are to be exported it would be difficult for the exporter to supply the product at the same price because of its high cost of production per unit due to fixed costs. This method is justified only when the cost of information about demand and the administrative cost of applying a demand based pricing policy exceed the profit contribution arrived at when this approach is applied.
In this method the price is determined on the basis of variable cost or direct cost, while fixed cost element in the total cost of production is totally ignored. The firm is concerned here only with the marginal incremental cost of producing the goods which are sold in foreign markets.
Now, the fixed cost remains fixed up to a certain level of output irrespective of the volume of output. On the other hand, variable costs vary in proportion to the volume of production. Thus, the variable or direct or marginal costs set the price after output at Break-Even Point (BEP).
This method is based on the following assumptions:
(a) The export sales are bonus sales and any return over the variable costs contributes to the net profit.
(b) The firm has been producing the goods for home consumption and the fixed costs have already been meet or in other words, breakeven point has been achieved. Thus, if the manufacturers are able to realize the direct costs, including those involved in export operations specifically, they would not affect the profitability of their firms. However, the profitability of firms should be assessed with reference to marginal cost which should normally constitute the basis for export pricing. Direct costs and other elements in calculating price will remain the same.
(i) No Overhead Costs – Export sales are additional sales. Hence these should not be burdened with overhead costs which are ordinarily met from the domestic trade.
(ii) Large Market – Since the buyers of products from developing countries are usually in countries with low national income, it is advisable for the firm to serve a large segment of the market at low prices. Low prices may serve to widen and create markets. In such countries price is still the decisive factor and quality is comparatively less important.
(iii) Firms from Developing Countries – This approach is advocated for firms from developing countries who are not well-known in foreign markets as compared to their competitors from developed countries. Therefore, lower prices based on variable costs may help them enter a market. Price may be used as a technique for securing market acceptance for products newly introduced into the market.
(i) Attracts Anti-Dumping Process – Developing countries might be charged of dumping their products in foreign markets because they would be selling their products below net prices and attract antidumping provisions which take away their competitive advantage.
(ii) Cut-throat Competition – The use of this approach may give rise to cut-throat competition among exporting firms from developing countries resulting in loss in valuable foreign exchange to the exporting countries.
(iii) Marginal Cost Pricing is Not Advisable in the following cases-
a. If the importers are regularly purchasing the product at a low price, it will be difficult for exporters to increase the price of the commodities later on. It may lose their market.
b. This policy is not useful or of limited use to industries which are mainly dependent upon export markets and where over-heads or fixed costs are insignificant.
(i) Large Domestic Market – There must be a large domestic market of the product so that the overheads may be charged from products manufactured for domestic market.
(ii) Mass Production – Mass production techniques must have been adopted so that the gap between the full and marginal costs may be reduced.
(iii) Higher Prices in Home Market – The home market has a capacity to bear the higher prices.
(iv) No Overhead Costs – Additional production for exports is possible without increasing overhead costs and within permissible production capacity.
The costs are no doubt, important but the competitive prices should also be considered before fixing the export price, competitive prices mean the prices that are charged by the competitions for the same product or for the substitute of the product in the target market. Once this price level is established, the base price, or what the buyer can afford, should be determined.
The base price can be determined by following the three basic steps:
(i) First, relevant demand schedules (quantities to be bought) at various prices should be estimated over the planning period;
(ii) Then, relevant costs (total and incremental) of production and marketing costs should be estimated to achieve the target sales volume as per demand schedules prepared; and
(iii) Lastly, the price that offers the highest profit contribution, i.e., sales revenues minus all fixed and variable costs.
The final determination of base price should be made after considering all other elements of marketing mix within these elements, the nature and length of channel of distribution is the most important factor affecting the final cost of the product. Besides, product adaptation costs should also be considered in fixing the base price.
The above three steps; though appear to be very simple, but it is not so because there are various other factors that should be looked into. The most appropriate method to estimate the demand of the product shall be the judgmental analysis of company and trade executives. One other way may be the extrapolation of demand estimates for target markets from actual sales in identical markets in terms of basic factors.
The following information gives the nature of analysis for market-oriented export pricing:
Analysis for Market-Oriented Export Pricing:
Having found out what the market can bear, the firm has to determine whether it can sell the product at that price profitably or not by working back from the market price as shown above.
This analysis gives an idea of the upper limit of what the firm can charge. The price of the product in the foreign market may be then fixed between these two limits. As the firm gathers experience, it would be able to set the price that gives the highest profitability. However, in many cases, it happens that the market realization is very low.
In such circumstances, the exporter may compare his f.o.b. realization (under market-oriented export pricing) with the direct cost or full cost as calculated under cost- oriented export pricing. He can then determine whether he should export the goods or not. He can decide to export the goods even at a loss if he thinks that market prospectus are better in future and the loss is only a short-term phenomenon and he feels a better realization in future.
Whatever be the price determined by the firm for its product, it must consider the prices and non-price factors before taking a final decision.
Pricing – Strategy: Traditional Pricing Strategies and Pricing Strategy for New Products
Are you pricing too high or too low? Do you have the right pricing process to help you capture the value you have created in the marketplace?
Studies have shown that pricing is the most critical profit driver in today’s competitive business environment. After a goods or service has been developed, identified, and packaged, it must be priced. This is the second aspect of the marketing mix. Price is the exchange value of a good or service. Pricing strategy has become one of the most important features of modern marketing.
All goods and services offer some utility or want-satisfying power. Individual preferences determine how much utility a consumer will associate with a particular good or service. One person may value leisure-time pursuits, while another assigns a higher priority to acquiring property, automobiles, and household furnishings.
Consumers face an allocation problem; their scarce resource of a limited amount of money and a variety of possible uses for it. The price system helps them make allocation decisions. A person may prefer a new personal computer to a vacation, but if the price of the computer rises, they may reconsider and allocate funds to the vacation instead.
Prices help direct the overall economic system – A firm uses various factors of production, such as natural resources, labour, and capital, based on their relative prices. High wage rates may cause a firm to install labour-saving machinery. Similarly, high interest rates may lead management to decide against a new capital expenditure. Prices and volume sold determine the revenue received by the firm and influence its profits.
Yet few firms think systematically about their pricing strategies or acquire the confidence to leverage their pricing strategies to capture maximum value. An ad-hoc pricing strategy or a trial-and- error approach to pricing can significantly reduce a firm’s bottom line. Pricing Strategies will give you a powerful set of tools and frameworks for developing your pricing strategies. The fundamental underlying pricing strategy can be described with the three elements being named costs, competition, and value to the customer.
The costs to be recovered set a floor to the price that may be charged for a specific product; the value of the product to the customer sets a ceiling; whereas the price charged by competitors for similar or substitute products may determine where, within the ceiling-to-floor range, the price level should actually be set. Companies seeking to make a profit must recover the full costs associated with producing and marketing a service, and then add a sufficient margin to yield satisfactory profit.
An exception occurs in the case of “loss leaders,” designed to attract customers who will also buy profitable products from the same organisation. But even with such loss leaders, managers need to know the full costs associated with these products, so that the amount of promotional subsidy is fully understood. Price may also play a role in communicating the quality of a service. In the absence of tangible clues, customers may associate higher prices with higher levels of performance on service attributes.
Traditional Pricing Strategies:
Many executives and economists argue that not cost but the market fix the prices. While true in theory, this is rarely the case in practice. Almost all companies set prices on a cost-plus-basis. They rely on the traditional labour based cost accounting system to establish a cost- based price.
Since product costs are calculated according to volume and product-mix, prices are set to an acceptable profit margin above the product costs. Therefore, each company has its costs systematically decided in the same direction – underpricing low-volume, customized products; and over-costing high-volume, standardized products. This distortion, no doubt, influences pricing.
Traditional cost systems ignore the so-called “below-the-line” expenses, like sales, distribution, R&D and administration. At many companies, those costs are not assigned to different markets, customers, channels of distribution or even products. Many managers believe these costs are fixed.
Therefore, these “below-the-line” costs are treated as though they are equally distributed across all customers. Yet, some customers are much more expensive to serve than others. Using one price to all customers may either underprice or over-cost to the disadvantage of some customers.
A company cannot set up a right pricing strategy unless it changes from the traditional labour-based costing method to “activity-based” costing method. Activity-based costing splits costs into two different groups – one that is product-driven and another that is customer-driven.
Product-driven costs are the costs of designing and manufacturing products. These costs include procurement, warehousing and transport, production planning, quality control, engineering etc.
Customer-driven costs are the costs of delivery, servicing, and supporting customers and markets. These costs include order entry, distribution sales, R&D, advertising, marketing, etc.
Activity-based costing (ABC) assigns costs to products or customer bands on the resources they consume. The system identifies the costs of activities such as order entry, shipping, billing and freight. These costs vary with the frequency of the activities and can be modified at different levels.
Another traditional method of pricing is the demand-oriented pricing. The classic optimization model of microeconomics theory assumes that the firm’s pricing objective is to maximize short-term profits. To maximize profit, a company chooses a price at the intersection point of the marginal cost and marginal revenue curves. A major limitation of the marginal analysis is the assumption that cost data and demand schedule information are readily available.
However, we can easily estimate the cost impact of a volume change on a product’s production cost. Few companies know precisely what their products’ price elasticity is; that is, what the demand curves look like. The company does not know how much sales volume it will lose by increasing the product’s price, or vice versa. Therefore, it is only possible to estimate the optimal price for the highest cash flow; but it is difficult to determine the profitability of a company.
Some other traditional methods of pricing are as follows:
(i) Rate of return pricing, whereby prices are set to achieve a preset rate of return on investments or assets.
(ii) Competitive parity pricing, where prices are set on the basis of following those set by the market leader.
(iii) Loss leading pricing, usually applied on a short-term basis, to establish a position in the market, gain market shares, or to provide an opportunity to cross-sell other products.
(iv) Bundle pricing, where a set of products or services are combined and a low, single price is charged for the whole package.
(v) Cross-benefit pricing, where price is set at or below cost for one product in a product line, but relatively high price is set for another item in the line which serves as a direct complement.
(vi) Stay-out pricing, where the firms set prices lower than the demand conditions so as to discourage market entry by new competitors.
The problems with most of the traditional pricing methods are as follows:
(i) They consider only one party (the customer) in price setting. In the real world, the firm must consider all channel members such as competitors, suppliers, public policy makers, officials in non-marketing functional areas, and others.
(ii) They put strong emphasis on price to set the marketing strategy. Actually, many other controllable and uncontrollable variables are involved. The marketing manager must consider the role of each of the other elements in the marketing mix and the relationships among them.
(iii) Almost all pricing decisions remain largely the domain of economic theory, as in the case of cost-plus, demand-oriented or imitative pricing. However, a pricing policy or strategy may be formulated to take advantage of an impending market opportunity or in response to customer value.
(iv) Most of the pricing decisions are based on a simple assumption—to increase the sale volume in the short-run— without considering the activity costing information and the outcome of the price changes.
(v) Traditionally, price setters have considered a very limited number of alternatives when faced with pricing difficulties. If their prices seemed high, they would lower it, and if it was too low, they would simply raise it. Much more complex behaviours should be considered which provide opportunities for novel approaches. For example, price setters might change the product’s package, advertising, quality design, or the after-sale customer service.
Pricing of new product is a critical task for the firms. As we know new products can be developed out of technological innovations or modifications to the existing product. In case where new products are through marketing modifi-cations, pricing is not as such a big issue; but altogether new products through technological innovations, pricing becomes a critical issue. Firm here has no base on which it can work out the price.
Such type of the new products, do not have any demand in the market nor any competitors, or any leader. Thus, demand based pricing, competition based pricing and leader based pricing do not provide a solution. Further, the estimation of cost also cannot be done accurately as many costs such as research and development cannot be easily allocated. Thus, cost plus pricing is also not very feasible.
The pricing strategy for new products will depend to a large extent on the degree of newness of the product and how firm considers the concept of new product. The need to introduce a new product may be different for different companies. For some companies it may be simply to enlarge their product mix and for others it may be the desire to fulfil an unsatisfied need of the market. There may be companies which go for new products because they want to provide something entirely new to the market.
Pricing strategy is also influenced by the fact that how new the product is to the market. The degree of newness of the product will attract the market and accordingly the price may be set.
In general, the pricing strategy options available for the companies are:
1. Market Skimming Pricing.
2. Market Penetration Pricing.
Market skimming pricing strategy is a one where the firm initially charge high prices and skims the cream of market by concentrating on those segments of the market which are not price sensitive. The high initial price of the product helps in bringing back the revenues for the firm which can be further used by the firm. Later, on as product gets accepted and firm wants to enter mass market; it may lower down the price. For skimming strategy it is necessary that firm offers something distinctive in the product, worthy of its price, only then the product will be acceptable.
The market penetration pricing strategy is one where firm initially charges a low price for the product with the objective of the penetrating the market. When the firm sees that market available for the product is price sensitive, it has to fix a low price of the product. Low price brings changes in volume of sales and thereby more profits.
Penetration pricing is thus used when there is no segment in the market which is willing to pay any price for the product. At the same time, the product is such that it will face intense competition immediately when it is introduced in the market.
Pricing – Steps of Setting Prices
Pricing decision means decision of determining price of a product. A concern has to take a number of factors like cost of production, cost of distribution, cost of transportation, cost of advertisement and personal selling, competitive forces, purchasing power of the consumer etc., other than the demand and supply position of the product in the market. Decision concerning price to be followed for a period of time may be called as “Price Decision”.
The price of a product must be determined in such a manner as to offer a reasonable amount of profit to the manufacturer, a reasonable remuneration to middleman and the maximum satisfaction to consumers.
Every marketer faces a problem of setting the prices of products. The main aim of marketing strategy of an organization is to attain marketing objectives and satisfy the targeted market. The marketing decisions affect the prices of products to a great extent.
Now, let us discuss the steps of setting prices in detail:
1. Setting Price Objectives:
It refers to set the goals of the pricing policy. An organization can have multiple pricing objectives.
Some of the price objectives are discussed as follows:
It involves the formulation of a short-term price objective to face the fierce competition. The price of a product is reduced to increase sales volume. However, this strategy does not work in the long term as an organization would not be able to cover its costs, thus, profit margin may decrease in future.
ii. Quality of a Product:
It affects the price of products. An organization incurs high cost in research and development to improve the quality of a product. Therefore, it covers the research and development cost in the price of the product. Sometimes, the organization raises prices to make customers aware about the improved quality of its products.
2. Estimating the Product Demand:
It helps in knowing the factors that affect the demand of a product. Some of the important factors can be the prices of products, environmental factors, and income and expectations of customers. There are three things that are studied by the marketers for estimating the demand.
These are discussed as follows:
i. Price Sensitivity:
It affects the demand of a product. If the price of the product rises then the demand falls and vice versa. In this case, the demand may shift to the substitute of the product. A marketer tries to study the price sensitivity of the product for making decisions about the price of the product.
ii. Demand Curve:
It implies a statistical tool that shows a relationship between the demand and price of a product. It helps in knowing the demand and price fluctuations of the product.
iii. Price Elasticity of Demand:
It refers to a percentage change in the demanded quantity of the product with respect to the percentage change in the price of the product. If the demand of a product changes with the change in price then the demand is said to be elastic. On the other hand, if the demand of a product does not change with the change in price then the demand is said to be inelastic.
3. Analysing the Competitor’s Prices:
It influences the decisions of setting the prices of products. The pricing strategies of competitors affect the demand of the product and lead to a loss of market share. Thus, it is clear that the marketers should be careful about the future competition.
Following are the three ways by which an organization reacts to price changes:
i. Maintaining the status quo and not reacting to any price change.
ii. Setting the prices equal to the organization’s prices.
iii. Setting the prices less than the organization’s prices.
The process of analysing the prices of competitors is difficult. Therefore, the organizations depend on the publicly available data or public statements to know the price strategies of competitors.
4. Selecting the Pricing Method:
It involves the selection of a technique for setting the price. There are various types of pricing methods used by organizations.
5. Selecting the Pricing Policy:
It involves a strategy or practice used by an organization to achieve its pricing objectives.
Pricing – Difference between Price and Value
For most customers price by itself is not the key factor when a purchase is being considered. This is because most customers compare the entire marketing offering and do not simply make their purchase decision based solely on a product’s price.
In essence when a purchase situation arises price is one of several variables customers evaluate when they mentally assess a product’s overall value.
Value refers to the perception of benefits received for what someone must give up. Since price often reflects an important part of what someone gives up, a customer’s perceived value of a product will be affected by a marketer’s pricing decision.
Any easy way to see this is to view value as a calculation:
Value = Perceived benefits received
Perceived price paid
For the buyer value of a product will change as perceived price paid and/or perceived benefits received change. But the price paid in a transaction is not only financial it can also involve other things that a buyer may be giving up.
For Example – In addition to paying money a customer may have to spend time learning to use a product, pay to have an old product removed, and close down current operations while a product is installed or incur other expenses. However, for the purpose of this tutorial we will limit our discussion to how the marketer sets the financial price of a transaction.
Pricing – 2 Types of Pricing Orientations Followed by Multinational Companies (With Examples)
The international pricing decision depends on the number of factors, such as pricing objectives, cost, competition, customers and the government laws etc. The total cost method is considered to be the most important factor in setting price in the international market.
Mainly the following two types of pricing orientations are followed by the multinational companies:
(1) The Cost Approach:
In the cost approach all the relevant costs are computed first and then after a desired markup profit is added as to arrive at the price. The cost approach is very simple to comprehend and use, therefore it is very popular approach in practice. The other benefit of using this approach is that it leads to fairly stable prices.
(i) It is very simple to comprehend and use.
(ii) It leads to fairly stable prices.
(iii) It is helpful to remain competitive in the market.
(iv) It is used as a promotional tool.
(v) It is helpful to win confidence of the buyers.
(vi) It can be used as an important tool as to convince and motivate buyers.
(i) Sometimes computation of costs can be troublesome.
(ii) It brings inflexibility into the pricing decisions.
Under this approach tentative price charged is calculated on the basis of its costs. The final price emerges by considering government regulations, demand for the products, competition in the market, objectives of the company and others. The main emphasize is given to the costs of the product.
It forces inflexibility also. The main problem in this regard is the meaning of costs, what should be included in the total cost, should it be both fixed as well as variable costs. Should the total cost also consist of research and development costs as well as administrative cost of present company? The exact answer and other classification of all these questions is very difficult.
While determining the total cost as the basis of pricing a full cost or an incremental cost pricing method can be applied. A full cost pricing is a conservative approach, whereas an incremental cost pricing can allow for seeking business otherwise lost.
It can be explained with the help of following illustration:
The Duke Overseas Pvt. Ltd. has a production capacity of 20,00,000 units per year. At present the company is producing and selling 15,00,000 units per year. The regular market price of its unit is $15.00 per unit.
Now suppose the company do have an opportunity of selling an additional 3,00,000 units $10.00 per unit in the overseas market. This particular order does not have any adverse effect on the prices of the products in the regular market.
Further if Duke Overseas Ltd. would have used full costing method to reach up till the decision on pricing for the particular product, the offer would have been rejected. Because the full cost method does not justify the price quoted for the said offer.
Thus there will not be any other option with the company except to give up this order. The company will be losing revenue worth $ 300000. On the other hand if company is using incremental cost method, the offer for said order shall be accepted and thus company will be earning additional revenue of $ 300000.
Thus the treatment of fixed cost plays an important role in both the cases. While calculating price and cost on the basis of full cost method, the cost per unit is calculated by considering the fixed cost in the total cost. On the other hand in incremental cost method it is considered that no additional fixed costs shall be incurred if additional units are produced.
Thus fixed costs are not considered in the process of decision making for additional overseas order. It is pertinent to mention here that an important factor which is always considered and kept in the mind is the negative effect of such offers on regular market price. If such an offer is from the regular market, in that case it should not be accepted. Because by doing this, it can severely hamper the market operations in future course of time in the regular market.
For example, if the total investment in the present business is $ 10,00,00,000 and the total standard cost of annual output is $ 15 crore, the capital turnover ratio would be $ 10 crore/ $ 15 crore, or say 0.67. While multiplying it with desired percentage return on investment, it will give percentage mark up on cost. For example if the desired percentage return on investment is 25 percentage, the percentage markup on cost will be (0.67 x 25 = 16.67 percent).
This method is considered to be more scientific and is an improvement over the cost plus method. The determination of fair rate of return may be a problem with the company. Generally a fair return on investment should be equal to or more than the current cost of capital. But in actual practice some time a certain amount is to be considered as a fair return. In this particular method the mark up is linked with total investment and do not consider any change in price of cost elements.
In the market approach, pricing starts in a reverse way.
The pricing is to be determined in the following steps:
(i) An estimate of acceptable price is made in the target market.
(ii) In the second stage an analysis is carried out as to determine whether the price would meet the objectives of the company.
If not the alternatives shall be either to increase the price or to give up that business.
(iii) An additional adjustments can be required as to cope with other factors like, competitors price, laws of host country, costs and other environmental factors. These factors are considered essentially in both the approaches i.e. cost plus and market approach. The market approach focuses on the price at customers’ requirements or view point.
The major drawback and leakage of this approach is lack of price and demand relationship in many countries which is not possible to develop there. Therefore it is not possible to implement market approach for pricing in those countries. This uncertainty emphasizes to pursue for the cost approach.
Pricing – Types of Promo-tional Discounts
One of the most frequently used sales promotion techniques is offering promo-tional discounts to buy extra sales—albeit only in the short term.
These can be grouped into a number of main categories:
1. Price Reductions:
The simple money-off promotion imprinted on the packaging is the most direct method and may have the most immediate impact on sales levels. Because it is shown on the package, it is nearly impossible for any retailer to avoid passing it on to the consumer. It is the most expensive technique, because to be effective it usually needs to represent 15 to 20 percent off the regu-lar retail price.
It may also prove difficult to restore the price to its original level at the end of the promotion, as consumers may decide to stockpile in order to hold off on additional purchases until the next promotion. It may also do consid-erable damage to the image of quality products or services, especially where the price-off sticker visually dominates the label.
Even though there are many draw-backs to price reductions, researchers have found that in spite of the success of the everyday low pricing scheme of Wal-Mart and other retailers, a high-low pricing scheme works more profitably for most firms. At the same time, however, they concluded that price is not a defensible point of differentiation for a firm unless it is driven by an existing advantageous operating cost structure.
2. Free Goods:
The offer of more products for the same price (e.g., two for the price of one) has several advantages. It forces the customer to buy more than usual for the same price during the sale. However, it clearly signals what a nor-mal price is and that such a discount is temporary. Therefore, it has less impact on the image of the product and its established price.
3. Tied Offers:
Two or more kinds of products, often shrink-wrapped together and offered at a lower price (e.g., a Microsoft Windows 2000 manual that comes with a Rand McNally’s Trip Routing Software on a CD-ROM and its instruction brochure). This packaging requires retooling of the assembly process and changes to the production and assembly lines with considerable reductions in productiv-ity. In addition, larger or different shelf space may be required at the retail store. It could be a dangerous promotional campaign if cooperation was not assured in advance from the retailer.
4. Coupons and Virtual Coupons:
Coupons are often used when the aim is to extend the penetration or trial of the product to new customers. These are most effectively delivered door-to-door, where they achieve high redemption rates. Increasingly, coupons are also delivered via freestanding inserts, which are books full of coupons. Coupons can also be incorporated in press advertisements, which are cheaper to run but have a considerably lower redemption rate.
Depend-ing on the generosity of the offer, the coupon is supposed to tempt consumers away from the brands they use to try a new one. This can be a very effective type of promotion if coupon redemption levels are high enough and may be more cost effective than sampling.
The use of traditional coupons, along with other forms of sales promotion, has not been without controversy. Procter & Gamble, probably the most success-ful package goods marketer with a wide array of sales promotions in the United States, came to realize how difficult the company had made it for consumers over the years to make a purchase decision.
In 1996, the company began stan-dardizing product formulas, eliminating marginal brands, cutting product lines, and reducing complex deals and coupons. Gone are 27 types of promotions, including such outlandish tactics as goldfish giveaways to buyers of Spic & Span (unfortunately, many froze to death during midwinter shipping). Although it is not possible to attribute the results solely to reduced use of coupons, the company has increased its business by a third. P&G executives attribute it to the power of simplicity. Obviously, the reduced use of coupons has not hurt sales at all.
Coupons can also meet with cultural resistance. When ACNielsen tried to introduce money-off coupons in Chile, the firm ran into trouble with the nation’s supermarket union, which notified its members that it opposed the project and recommended that coupons not be accepted. The main complaint was that an intermediary such as Nielsen would unnecessarily raise costs and thus the prices charged to consumers. Also, some critics felt that coupons would limit individual negotiations, because Chileans often bargain for their purchases.
However, emerging forms of coupons permit more precise targeting and therefore result in less waste. Advanced Promotions Technologies, for example, has developed a unit with a small colour touch screen and a printer that sits on the check-writing stand in supermarkets. The customer can watch the screen to see coupons that are applicable to the purchases made and touch the screen to request a printout.
Other technology prints out coupons at the checkout counter that either highlight complementary products that the customer has not bought or products competitive with ones that have been purchased. Similarly, consumers can sign up on various Internet-based coupon offering Web sites by providing their residential and other personal information so that the Web-based companies can show on the screen various coupons on goods and services that they may be interested in purchasing.
A study by NPD Online Research shows that 46 percent of Internet users who have downloaded coupons have used coolsavings(dot)com, 41 percent have used valupage(dot)com, 12 percent have used valpak(dot)com, 12 percent have used hotcoupons(dot)com, and 10 percent have used directcoupons(dot)com. Obvi-ously, coupons are alive and well on the Internet. With such greater precision, the coupon tool becomes less expensive and more efficient and is therefore likely to be used more. It can be problematic, however, for some industries.
5. Cash Refund:
A cash refund (from the retailer or by mail), usually on the basis of a coupon that is part of the packaging, is another way of offering a con-trolled price reduction. However, the redemption procedures may be complex and unwelcome to the trade, because proper monitoring is required to ensure that cash refunds are issued only for sales that have actually been made.
Unless there is a matching of inventory held, products sold, and refunds issued, manufactur-ers may expose themselves to the possibility of retailers claiming cash refund reimbursements without having sold the merchandise. Cash refunds can also be expensive. Sometimes the refund may be as much as the whole purchase price.
6. Money Off Next Purchase:
This method may be used to extend buying patterns and build customer loyalty. Such offers are often part of the product label and require some effort to use. For example, the label may have to be soaked off the bottle, or the packaging may have to be preserved. Sometimes, the hassle of such requirements can result in customer dissatisfaction rather than promotion.
7. Loss Leader Pricing:
A product may actually be priced below cost in order to attract customers into a store, in the hope that they will buy other prod-ucts or services that are profitable.
8. Cheap Credit:
If credit is offered, lower-priced or even free credit may be used instead of a simple price reduction. This may be cheaper to the vendor who has access to lower-cost credit, although the cost of bad debts must also be cov-ered. Such offers are often seen in the furniture business (e.g., 90 days same as cash; pay nothing until January 2001), where financing rates low are advertised.
Low-cost credit and delayed invoicing can also be used as important tools to get retailers to carry a new product. By offering payment terms of 120 days, for exam-ple, many Japanese manufacturers and wholesalers achieve high acceptance lev-els from their retailers, who can keep the funds for some time after the sale and earn interest. Low-cost credit may also introduce the consumer to the use of the supplier’s credit facilities.
Other forms of promotion offer added value but are not directly price related.
In this case the purchaser receives the right to one or more entries in a competition. Because the size of the top prize reportedly determines the inter-est of the customer, a large prize can be a very attention-getting form of promo-tion. Contests can be easy and cheap to mount and have a guaranteed fixed max-imum cost. They can also be used as incentives for retailers for the sales force in the form of bonuses or prizes, such as participation in special top-production meetings in a desirable resort area.
2. Free Gifts:
Such offers can be designed to lure customers and channel mem-bers from the competition or to build loyalty. Banks, for example, offer home equity loans without charging financing points or advertise that they will pay for any legal expenses of the closing costs. Customers are thus encouraged to change banks. The use of frequent flyer miles by airlines is an example of a customer loy-alty builder.
Here customers are encouraged to fly regularly on a specific airline in order to receive, after a number of flights, a free ticket. On the Internet, there is now a ubiquitous virtual gift. For example, Internet Perks’ Incentive Ware is an Internet promotional piece that companies can use to keep their names in front of customers while giving them free desktop applications.
As the use of sales forces declines, the Internet becomes a valuable tool with which to reach cus-tomers. Incentive Ware consists of applications for the desktop called droplets that can be sent as virtual gifts attached to e-mail, downloaded free from a Web site, or put on disks to be handed out at trade shows and sales calls. Incentive- Ware is meant to replace promotional gifts, such as hats, coffee mugs, and T-shirts bearing the corporate logo that companies frequently use.
3. Self-Supporting Offers:
In this case, the offer is not free, which is why it is also called a premium offer. The impression is usually given that the supplier is subsidizing the offer so, that the customer will obtain a good deal on the item. In practice, the intention is usually to cover the cost with the amount paid by the customer, in effect offering the customer only the benefit of the supplier’s buying power. Marlboro sweatshirts is one example. Such offers can be difficult to admin-ister, and the forecasting of inventory levels can be problematic.
4. Multi Brand Promotions:
In this case a number of brands, typically from one supplier, share a single promotion in order to maximize impact for given costs. This technique can be used to recruit new users to these brands. For exam-ple, Taco Bell promotes Six Flags amusement parks with a “Buy One Get One Free” discount ticket. Taco Bell has booths and restaurants at Six Flags parks to boost its sales as well.
5. Guarantees and Services:
Trade promotion can also take the form of special guarantees or services, either to consumers or to channel members. For example, in order to increase sales for online retailers, much emphasis has been placed on network and referral programs. Consumers can also be offered a 30-day trial period. Frequently such promotions are used for magazine subscriptions, allowing customers to cancel the subscrip-tion after trying out one or more issues.
However, similar guarantees are emerg-ing in many other sectors, where customers can return merchandise liberally. The same tool is also applied to channel members, where manufacturers may desire that retailers stock up in expectation of large demand. Liberal return priv-ileges facilitate such over ordering. Offering special services, such as restocking assistance, cooperative advertising, or providing display stands can also be used as enticements.