10.

1 PRICING PRODUCTS AND PRICING DECISIONS

Price is the amount of money charged for a product or service by the seller. Price is the only
element of the marketing mix that produces revenue, all the other elements are cost factors.

Throughout most history, prices were set by negotiation between buyers and sellers. This is also
called dynamic pricing – charging different prices to different customers. Today most prices are
fixed prices i.e. one price is set for all buyers.

Price goes by many names a few of which include:

a) Rent for apartment

b) Fees for tuition
c) Fare for taxi
d) Rates for utilities such as Electricity and water
e) Interest for money borrowed
f) Toll for use of driveway e.g Expressway
g) Salaries for white collar jobs
h) Wages for blue collar jobs
i) Commission for sales persons services

10.4.1 PRICING STRATEGIES

The price strategies often change as a product passes through different stages in the PLC. For
new products, companies normally face an uphill task while coming up with the price for the
first time. Two of the commonly adopted strategies include:

i) Market skimming strategies

ii) Market penetration strategies

Market Skimming Strategies

Market skimming pricing is the setting of a high price for a new product to skim maximum
revenues layer by layer from the segments willing to pay a high price. The company gets few
customers but more profitable sales. An example companies that practice market skimming
strategies are: Nokia and Sony.
Market skimming strategies are workable only if the following conditions hold:

i) The product quality and image must support its higher price. Should be of very high
quality.
ii) Enough buyers must want the product at that price.
iii) The cost of producing the few units must not exceed the target revenue
iv) Competitors should not be able to enter the market easily and undercut the high price

Market Penetration Strategies

Market penetration pricing is the setting of a low price for a new product in order to attract a
large number of buyers and a large market share. Example of firms that have ever practiced
market penetration include Coca-Cola and Dell.

The low price is geared at penetrating the market quickly and deeply. The high sales volume
results in falling costs allowing the company to cut its price even further.

Several conditions must be met for this strategy to work including the following:

i) The market must be highly price sensitive so that a low price generates more market
growth
ii) The production and distribution costs must fall as sales volume increases
iii) The low price must help keep away competition.

10.4.2 Six Step Procedure for Price Setting

1) Selecting price objective

2) Determining demand
3) Estimating costs
4) Analyzing competitors price
5) Selecting price method
6) Selecting the final price
10.4.3 FACTORS TO CONSIDER WHEN SETTING PRICES

There are two factors to consider in pricing:

(i) Internal factors
(ii) External factors

INTERNAL FACTORS

Internal factors include company’s marketing objectives, marketing mix strategy, costs and
organizational consideration.

1. Marketing Objectives

The company’s marketing goal could be survival, current profit maximization (Maximize
market skimming), market share leadership, or product quality leadership.

Companies set survival as their objective if they are troubled by too heavy competition,
and changing consumer needs to keep a plant going in this case, the company sets low
prices hoping to increase demand.

A company with current profit maximization as is objective, will choose a high price that
maximizes current profits, cash flow or return on investment. It uses skimming strategies
in every new market segment that it opens up.

To obtain market share leadership, firms set prices as low as possible e.g Coca-Cola.
Such firms employ rapid penetration strategies to optimize on there representation in the
market.

To attain product quality leadership, a firm charges high prices to cover the high
performance quality and high cost of research and development. The firm differentiates
 its product clearly exemplifying the unique qualities of their product. They position their
products as superior products relative to competition e.g. Safari Park Hotel

2. Marketing Mix Strategy

Companies often position their products on price and then tailor other marketing mix
decisions to the prices they want to charge.

There are five product mix pricing situations including:

a) Product Line Pricing - Is the setting of price steps between various product lines.
The basis of product line pricing could be the difference in cost, customer
evaluation of different features and competitors prices e.g. EABL sets the price of
Alvaro as different from price of Guinness and Pilsner based on consumer
evaluation.
b) Optional Product Pricing – Many companies offer to sell optional or accessory
products along with their main product. They therefore price the optional products
with the main product. e.g. a motor vehicle seller might offer to sell the car with
alloy rims and CD changer as optional products. The seller set optional prices for
the rims and CD changer
c) Captive Product Pricing – Companies may decide to make a separate product
that must be used along with the main product e.g. razor blade and cartridge,
printer and cartridge film and camera etc. HP for instance is said to make very
low margins with its printers but very high margins with its cartridges.
d) By Product Pricing - Is the setting of a price for by products in order to make the
main product’s price more competitive. For example by producing meat,
petroleum and agricultural products, there are often by products. Using by product
pricing the manufacturer will seek a market for these by products and should
accept any price that covers more than the cost of storing and delivering them.
e) Product Bundle Pricing – Is the combination of several products into a bundle
and offering them at a reduced price e.g. fast food restaurants may bundle chips,
chicken and Soda at one reduced price.
3. Costs
Companies always want to charge a price that covers all costs of producing, distributing,
selling and delivering the product at a fair rate of return. The following types of costs
must be remembered:

(a) Fixed cost (overheads) – are costs that do not change with production or
sales levels e.g. rent, interest, salaries etc.
(b) Variable cost – are costs that vary directly with the level of production e.g.
wages, raw materials cost etc.
(c) Total cost - Is the sum of the fixed cost and the variable costs

Marketers make considerations for all the costs (total costs) of making a product after
which a mark up could be used to arrive at the final selling price. Costs must be
minimized for a firm to be competitive in its pricing.
4. Organizational Consideration

- Management must decide who sets the price in the company.

- In smaller companies, top management sets the price rather than marketing and
sales departments.
- In larger companies, prices are set by product or brand managers and approved by
top management.
- In industrial markets, sales people are allowed to negotiate with customers within
certain price range. Even so, management sets the pricing objectives and policies.
EXTERNAL FACTORS

These are factors often out of control of the company and may include; Estimated demand, type
of competitive markets and other environmental elements.

1. Estimated Demand

Demand is the quantity of commodity that consumers are willing and able to buy at a given price
over a given time period.

Price elasticity of demand refers to how responsive demand is to a change in price. Some
products are price elastic others are price inelastic.

In markets with elastic demand the marketer must be aware that a slight increase in price is
followed by a big drop in quantity demanded. While in markets with inelastic demand, the
marketer charges high prices to optimize profitability.

2. Type of Market
Sellers pricing freedom varies with the type of markets as follows:

(a) Pure competition – under this structure, the price is given by the market forces of
demand and supply and sellers take it as the market decides. Marketers efforts of
sales promotion, prices change and advertising play no role in influencing
demand, they only create awareness.

(b) Monopolist – The firm in this market is the largest single seller. The firm sets the
price and is in full control of its demand curve. It can set a high price to maximize
profits or set a low price to maximize on sales revenue.

(c) Monopolistic competition – The firms in this market are the price setters; however
each firm is keen to watch the competitors prices and set theirs as close as
 possible to that of competitors. Aggressive marketing campaigns i.e. advertising
and strong branding reduces the impact of any price difference between firms.

(d) Oligopolistic competition – Each seller is free to set prices on the similar but
differentiated products. A price increase by one firm is not necessarily followed
by a rival firm.

3. Other External Factors

a) Competitors Costs, Prices and Offers

Firms must benchmark their products, costs and prices with those of competitors in order
to know if they are operating at a cost advantage or disadvantage. A firm then decides
what price to offer to counter competition.

b) Economic Conditions

Economic trends such as recession and boom would affect the price charged. Economic
variables like interest rate would equally impact on prices.

Pricing Approaches/Methods

1. Cost based pricing – Adding a standard mark up to the cost of the product to get the final
selling price. Also called mark up pricing.

Mark up pricing = Unit cost

(1-Desired % return on sales)

2. Perceived value pricing – Also called positioning above competition. Price based on the
perceived value of the product by the customer and company. Mostly used in product
 positioning e.g. for upper markets, marketers charge higher prices and for low markets
lower prices.
3. Competition based pricing – Also called positioning below competition Setting prices
based on the prices that competitors charge for similar products.
4. Breakeven analysis pricing – Setting price to break-even on the costs of marketing the
product.

Break even point in units = Total fixed Cost

(Selling Price-Average variable cost)

5. Sealed bidding price: Based on customers proposals.

6. Target return pricing - This is a price that would help yield a target return on
Investment. Formulation for getting this is given as

TRP = unit costs + Desired returns %  capital invested

Unit sales

10.4.4 OTHER FACTORS CONSIDERED BEFORE ADOPTING A PRICE

There are a number of considerations to be made when charging customers after determining the
base price of a product.

1) Price discounting

i) Cash discount
ii) Quantity discount
iii) Functional discount/trade
iv) Seasonal discount

2) Promotional pricing
 i) Loss leader pricing
ii) Cash rebates
iii) Low interest financing for purchase of products

3) Discriminatory pricing

i) Resident or non-resident
ii) Geographical location of customer
iii) Age or gender
iv) Time pricing i.e. day or night rate
v) Product image pricing

4) Psychological pricing strategy

i) Quality and brand value consideration

ii) Impact of price or other parties i.e. dealers and distributors, sales people, suppliers
iii) Competitor’s price

10.2 ACTIVITY

A manufacturer of metal containers has the following costs and sales expectations

Vrriable cost per unit Ksh 20

Fixed costs Ksh 2 Million
Expected unit sales 50,000
Invested capital Ksh 10 Million
Mark-up 20%
Expected return on investment 40%
Required
(i) Determine two alternative prices for each unit produced and sold

Which pricing method would yield greater results?