PRICING METHODS AND STRATEGIES

ASPECTS OF PRICING DECISIONS

Pricing

• “money charged for a product or service”

• It is everything that a “customer has to give up” in order to acquire a product or service.
• Pricing is “one of the most important business decisions” management take.
• The term used in economics and finance which refers to the act of establishing a value for a product or service.
• It occurs when a business decides how much a customer must pay for a product or service.

Pricing is the process whereby a business sets the price at which it will sell its product and services, and may be part
of the business’s marketing plan. In setting prices, the business will take into account the price at which it could
acquire the goods, the manufacturing cost, the market place, competition, market condition, brand, and quality of
product.

Factors Influencing Pricing Decisions

Internal Factors External Factors
Cost Competition
Company Objectives Demand
Organizational factors Suppliers
Marketing Mix Economic Conditions
Product Differentiation Consumers
Government

Internal Factors

• The internal factors are factors that can be control, determine and process by the organization.
• These factors are mostly in relation with the organization business level strategy and greatly influenced by
the nature of the business.

Cost

• Major factor that determines the price.

• This is the total cost incurred by the organization in the production of goods or services
• The cost of production is largely influence by the supplier cost, macroeconomic trends and the nature of
the business

Company Objectives
• In such a case, a percentage is added to the cost of production in order to arrive at the price
• The argue here is that, the company’s objective is profit maximization and therefore a pricing decision
must be that will consider that profit maximization objective.
• When pricing decisions are made, they must be in line with the overall company objectives, as this is what
will inform what the pricing objective really is, so that the pricing decisions made will not be against the
company objective.
Organizational factors
• Pricing decisions occur on the two levels in the organization. Over-all price strategy is dealt with top
executives. They determine the basic ranges that the product falls into in terms of market segments.
• The actual mechanics of pricing are dealt with at lower levels in the firm and focus on individual product
strategies. Usually, some combination of production and marketing specialist are involved in choosing the
price.

Marketing Mix
• Price is the important element in marketing mix.
• A shift in any one of the elements has an immediate effect on the other three- Production, Promotion, and
Distribution.
• The effort for implementing strategies will not succeed unless the price change is combined with a total
marketing strategy that supports it.

Product Differentiation
• The price of the product also depends upon the characteristics of the product.
• In order to attract the customers, different characteristics are added to the product, such as quality, size,
color, attractive package, alternative uses etc.
• Generally, customers pay more prices for the product which is the new style, fashion, better package etc.

External Factors
• The external factors are those that are not within reach of the organization. They are external because
there are many parties that determine and control these factors.
• The business organization is a party o the external factor and cannot control or determine the aggregate
indicators of these factor.

Competition

• Competition is a crucial factor in price determination.

• A firm can fix the price equal to or lower than that of the competitors, provide the quality of product, in
no case, be lower than that of the competitors.
Demand
• For a new product, there is need to price such product strategically in such a way that it penetrates the
market, even if it will be at the total cost, while for a highly demanded product, an increase in price may
not really have a high effect on the demand for such products, so is the need for management when
making pricing decisions to consider the demand for the product.
• Some companies who receive order from customers may decide to reduce their price per unit or increase
their discounts, when it is noted that demand from a customer is high, and this may be on the other way
around, depending on other factors considered by the management.

Suppliers
• Suppliers of raw materials and other goods can have a significant effect on the price of a product.
• The price of a finished product is intimately link up with the price of the raw materials.
• Scarcity or abundance of the raw materials also determines pricing.
Economic Conditions
• The inflationary or deflationary tendency affects pricing.
• The prices are increased in boom period to cover the increasing cost of production and distribution. To
meet the changes in demand, price etc.

Consumers
• The various consumers and businesses that buy a company’s product or services may have an influence in
the pricing decisions.
• Their nature and behavior for the purchase of a particular product, brand or services etc.
affect pricing when their number is large.

Government
• Price discretion is also affected by the price-control by the government through enactment of legislation,
when it is thought proper to arrest the inflationary trend in prices of certain products.
• The prices cannot be fixed higher, as government keeps a close watch on pricing in the private sector. The
marketers obviously can exercise substantial control over the internal factors, while they have little, if any,
control over the external one

CONCLUSION
• Price is the sum of value that the customer exchange for benefit.
• Pricing includes all that firm is offering along with the product.
• There are certain factors that include pricing decisions. They are broadly classified into internal and
external factors.
• Internal factors include cost, objectives, factors of organization marketing mix and product differentiation.
External factors include demand, supplies, polices by government, competition, economic conditions and
consumers.

PRICING METHODS AND PRICING STRATEGIES

Pricing methods generates the development of pricing strategy that were determined by the product or service
offered, while pricing strategy is directed toward attaining the company’s goals.

An effective pricing strategy is one that accurately connects the value your products or service provides with your
target customers willingness to pay. Setting and effective price for your business requires understanding of the
optimal pricing method to support not only the goals of your business but your acquisition strategy as well.

Main Methods of Pricing

1. Demand –based pricing is a pricing method that uses consumer demand, based on perceive value needs to
be at the core of every pricing decision your company makes. Any price you choose always has to connect
directly to the value customers derive from it. These include: price skimming, price discrimination and
yield management, price points, psychological pricing, bundle pricing, penetration pricing, price lining,
value-based pricing. Pricing factors are manufacturing cost, market location, competition, market
condition and the quality of the product.
Take note: A customer perception value. Setting your prices according to what consumers think your
product is worth.
 Figure 1: Demand-based Pricing Illustration
Price points on the demand curve: P is price; Q is quantity demanded; A, B and C are the price points. Price points
are prices at which demand for a given product is supposed to stay relatively high.

2. Cost -plus pricing is a method used by companies to maximize their profits. Basically, this approach set
prices that cover the cost of production and provide enough margin to the firm to earn its target rate of
return. The firm accomplish their objective of profit maximization by increasing their production until
marginal revenue equals marginal cost, and then charging a price which is determined by the demand
curve.
It is important to know the true costs of running your business. The price you set has to cover your costs,
as well as provide a margin for profit and unseen circumstances. Look at not only the production and
development costs but your customer acquisition, marketing, operational cost as well.
Take note: Cost of running your business. Calculating your costs and adding a markup.

Figure 2: Cost-based pricing model

3. Competitor-based pricing or market-oriented pricing

Knowledge of the market landscape helps you predict how potential customers will react to your price
structure.
For example, if the competitors are pricing their products at a lower price, then it’s up to them to either
price their goods at a higher or lower price, all depending on what the company wants to achieve.
Whether you have one main competitor or hundreds, having a clear picture of what the other players in
your market are charging for their service helps position your price more effectively.
Take note: Competitors in your market. Setting and maintaining existing prices based on what the
competition charges and or analysis and research compiled from the target market.
The advantages of this method is to avoid price competition that can damage the company while the
disadvantages include that businesses have to attract customers in other ways, since the price will not
grab the customer’s interest. The price may also barely cover production costs, resulting in low profits.
 4. Target pricing the most effective way to conceptualize what different types of customers you need to
reach certain revenue and growth goals. Building out a set of qualified buyer personas ensures that you’re
not pricing your products or service outside the reach of your target customers.
Take note: Target customer personas. Setting a price to achieve a desired return on investment.

5. Psychological pricing or price ending is a marketing practice based on the theory that certain prices have
psychological impact.
Take note: The price is based on attributes the customers consider to be fair, the quality, positioning, and
similar factors.

Pricing Strategies shape the overall profitability in the future. It is an important factor in the struggle of a company
to achieve competitive advantage in an industry.

Pricing strategy – the policy a firm adopts to determine what it will charge for its products and services.

Pricing strategy is important since it defines the value that your products are worth for you to make and for your
customers to use.

Pricing strategy is not fixed, but it changes a product moves in its life cycle. The objectives of the pricing strategy is
to set a competitive price in the market that will give a fair return on investment.

1. New Product Pricing Strategies Introducing new products to the market that means to set their prices for
the first time. The pricing strategies for new products are as follows:

a. Skim pricing strategy –this strategy allows a company to set a high initial price for its product to
obtain the highest possible revenue. This pricing strategy works effectively when competitors can
hardly enter the market to offer a lower price for its product. The objective of the price skimming
strategy is to capture the consumer surplus. Theoretically, no customer will pay less for the
product than the maximum they are willing to pay if it is done successfully.

Example: Setting high prices when a product is introduced and then gradually lowering the price as
more competitors enter the market.
b. Penetration pricing strategy - In this strategy, a company set a low initial entry price for its
product often lower than the eventual market price so that it can easily penetrate to attract new
customers and gain considerable share in the market.

2. Product –Mix Pricing Strategy

Product-mix or product portfolio is a set of product lines or items offered by a seller for a single price. The
different variations of product-mix pricing strategies are as follows:

a. Product line pricing strategy the product price in this pricing strategy is set across an entire product
line. The price between various products in a product line is set based on cost difference, costumer
evaluation, and competitors price.
b. Optional product line pricing strategy this pricing strategy is adopted when there are accessories that
can be added to the main product. It is the primordial task of a company to determine which items
are included in the based price and which are to be added as accessories with separate prices.
c. Captive product pricing strategy it is the pricing strategy that is employed when a
 certain product must be used with other products. Example, a razor cannot function without a blade.
Setting the price of the blade, whether high or low, illustrates captive product pricing.
d. By-product pricing strategy this pricing strategy can be adopted when producing the main product
results in a by-product with a sealable value. Setting prices to byproducts reduces product cost and
makes product competitive in the market.
e. Product bundle pricing strategy it is the pricing strategy used when products are offered to the
market as a bundle with one collective price. This strategy is very common in the software business
(e.g. bundle a word processor, a spreadsheet, and a database into a single office suite.)

3. Product Adjustment Strategies When a market situation changes as the demand, taste, preferences, and
other variables change, the price in the market also changes. In other words, the market price of goods
rise and falls. This requires adjustments. The different price adjustment strategies are as follows:

a. Discount and allowance pricing strategy reducing prices to reward customer responses such as paying
early or promoting the product.
Example: In payment terms,”2/10, n30”.Meaning the payment is due within 30days, but buyer can
deduct 2 percent if the bill is paid within 10 days.

b. Segmented pricing strategy Adjusting prices to allow for differences in customers, products or
locations. Different customers pay different prices for the same product or services
Example: Museums and theatres may charge a lower admission for students and senior citizens.

c. Psychological pricing strategy. Adjusting prices for psychological effect. It refers to pricing that
considers the psychology of prices, not simply the economics. Indeed, the price says something about
the product.
 Example: Many customers use price to judge quality. A worth of P100 bottle of perfume may contain only
P50 worth of scents, but people willing to pay the P100 because the high price indicates that product is
something special. However, this does not work forever when consumers can judge the quality of product
by examining it or by calling someone with past experience with it.

d. Promotional pricing strategy. Temporarily reducing prices to increase short-run sales. Even low
interest financing, longer warranties or free maintenance are part of promotional pricing.
However, if it is used too frequently and copied by competitors, price promotions can create
customers who will wait brands go on sale before buying them or the brands value and credibility can
be reduced in the eyes of the customers.
Example: VTC groceries offers buy1 take one or pay half the price of the goods knowing that the
reason for its lowering the price is due to forthcoming expiration of the product.

e. Geographical pricing strategy. Adjusting prices to account for the geographic location of customers.
There are five geographical pricing strategies: FOB- origin pricing, Uniform-delivered pricing, Zone
pricing, Based-point pricing, and Freight –absorption pricing.
Example: FOB-origin pricing, goods are placed free on board a carrier, the customer thus pays the
freight from the factory to the destination. Price differences are the consequence.

f. Dynamic pricing strategy Adjusting prices continually to meet the characteristics and needs of
individual customers and situations. Prices were adjusted to the specific customers or situation.
Example: In online auction sites such as eBay, between buyers and sellers wherein the consumers can
negotiate prices.

g. International pricing strategy. Adjusting prices for international markets. Costs play important role in
setting international prices. Thus, a higher cost of selling in another country is expected. The following
may create a need to charge different markets: Additional cost of operations, product modifications,
shipping and insurance, import tariffs and taxes, and even exchange rates fluctuation.

The price adjustment strategies will lead to a short and long-term increase in sales and continuous success.
However, all of the price adjustment strategies can also do harm and damage if executed in the wrong way. Thus,
careful preparation, analysis and execution is an absolute prerequisite.
CVP ANALYSIS AND LINEAR PROGRAMMING IN THE PRICING AREA
Cost Volume Profit Analysis – a strategic method of examining the effects of changes in an organization's volume
of activity on its costs, revenue and profit. It helps in analyzing the effects of change in Sales Volume or sales mix or
fixed costs in the profit of the firm.

- A technique that examines changes in profits, sales volume, costs, and prices.

Usage of CVP

• Product pricing
• Accepting/ rejecting sales orders
• What product lines to promote
• What level of output is required to achieve a set level of net profit
Techniques of CVP

1. Contribution margin analysis

Contribution margin is needed in CVP analysis and with this companies can determine and solve for their
desired profit and determine product prices

Key calculations when using CVP analysis are the contribution margin and the contribution margin ratio.
The contribution margin represents the amount of income or profit the company made before deducting
its fixed costs. Said another way, it is the amount of sales dollars available to cover (or contribute to) fixed
costs. When calculated as a ratio, it is the percent of sales dollars available to cover fixed costs. Once fixed
costs are covered, the next dollar of sales results in the company having income.

2. Break even analysis

The break‐even point represents the level of sales where net income equals zero. In other words, the
point where sales revenue equals total variable costs plus total fixed costs, and contribution margin
equals fixed costs.

Limitations of CVP

• It does not include adjustments for risks and uncertainties.

• Contribution itself is not a guide if there is some key or limiting factors
• Decisions by sales staff and marketing personnel may lead to low Profit or loss.
Linear Programming in Pricing Areas

Linear programming – is used for obtaining the most optimal solution for a problem with given constraints. In
linear programming, we formulate our real-life problem into a mathematical model. It involves an objective
function, linear inequalities with subject to constraints.