Approaches to pricing

You have completed the formal costing exercise and you now know what your costs are. The next step is to decide on an export price. This decision is divided into to parts; the first is to decide on the broad pricing approach you intend to follow (which we discuss below) and the second is to decide on a specific pricing strategy. As far as the broad approaches to price setting are concerned, there are essentially three ways in which you can approach your pricing in foreign markets. These are discussed below:

1. Competitor-oriented pricing: In terms of this approach, your pricing decisions would depend on what the competition does. Competitororiented pricing is the approach to follow when you are dealing with a market where prices are openly set through the process of supply and demand as in the case of most commodity markets such as coal, coffee, wheat and gold. It is also common in markets where there are one or two powerful competitors that set the price levels, for smaller suppliers to follow it can also be termed as method of pricing in which a manufacturer's price is determined more by the price of a similar product sold by a powerful competitor than by considerations of consumer demand and cost of production. In an industry where there is only one competitor, competitive activity is absent and the firm is free to set any price, subject to constraints imposed by law. Conversely, in an industry comprised of a large number of active firms there is fierce competition, which limits the discretion of a firm in setting its prices. Where there are a few firms manufacturing an undifferentiated product, only the industry leader may have the discretion to change prices. Other industry members will tend to follow the leader in setting their prices.

The firm with a large market share in an industry will be in a position to initiate price changes without worrying about competitors' reactions. Presumably, a competitor with a large market share will have the lowest costs. The firm can, therefore, keep its prices low, thus discouraging other members of the industry from adding capacity and further improving its cost advantage in a growing market. If a firm operates in an industry where there are opportunities for product differentiation, it can have some control over pricing even if the size of the firm is small and there are many competitors in the industry. This may occur if customers consider one brand to be different from other competing brands; whether the difference is real or imaginary, they will not object to paying a higher price for their preferred brand. To establish product differentiation of their brand in the minds of consumers, companies spend heavily for promotion. Product differentiation, however, offers an opportunity to control prices only within a certain range 2. Cost-oriented pricing: In the case of cost-orientated pricing, you would calculating your total unit cost and add on a profit margin to arrive at an export price. Consumer demand or competitor actions thus have little bearing on your decision-making. This approach is commonly used in the case of industrial goods where it is often difficult to differentiate between products in terms of their perceived value to the customer. Many firms set product prices largely on the basis of product cost. The price to the distributor of an item will therefore be the units total cost plus an amount to cover a targeted profit on the unit. Simple cost plus methods of pricing can be used most effectively in well-established businesses in a stable market environment.

3. Demand-oriented pricing: Also referred to as market-orientated pricing, the demand-oriented company sets prices according to the intensity of demand for the product. Where demand is strong high prices are normally set, and where demand is weak lower prices are the norm. The unit cost is not a major determinant of pricing in this case, although it is obviously taken into consideration when the lower limit on a price is considered. Demand-oriented prices are usually applied to branded consumer goods but they may also be app One obvious disadvantage of at least the target-pricing component of cost-based pricing is that sales volume is affected by price. What is missing is a demand function showing how many units the firm could expect to sell at different prices. It is very difficult to quantify how much a price increase or decrease will affect demand. This relationship is called the price elasticity of demand and differs between products. Another approach to pricing is to work backwards from the products perceived value to the buyer, rather than forward from costs. A company develops a product for a particular target market with price, quality and service to match the competition for that segment of the market. Having determined this demand oriented price, the manufacturer then works out whether, allowing for costs, there is sufficient profit on the item to make it worthwhile. There is no formula for working out sales volume at the demand price. This figure has to be arrived at on the basis of experience and a conservative estimate of the market share the product will receive.

Approach to pricing:
Competitor-orientated In the case of commodity markets, e.g. wheat, tea, coffee, grain, prices are established through the interaction of a large number of buyers and sellers. There are usually publicized world prices that set the pricing levels in these types of markets. As an exporter competing in such markets, you will need to keep to these prices - this is known as commodity-based pricing. Any exporter quoting prices in excess of the price prevailing in the marketplace would effectively cut themselves out of the market - they would, of course, be equally foolish to quote below the prevailing rate. If you operate in commodity-type markets your primary function would be to keep production costs and overheads as low as possible in order to increase profits.

What to make when, for whom and at what price?

How does your consumer products business respond to changes in commodity prices? Whether you re producing grains, meat or produce, many factors can affect commodity pricing in a hyper connected market escalating feed or fertilizer costs, weather, oil prices, natural disasters and even geopolitics. In the past, processes assumed stable commodity prices, but this is no longer suited to today s environment. Consumer products companies may find it more difficult than ever to determine optimal price, mix and supply plans. The commodity price optimization solution from IBM allows organizations to turn commodity market volatility into opportunity. It is designed for clients who want to maximize margins, improve account- or channel-level visibility, and proactively manage price fluctuations.

Competition-based pricing Of course, commodity markets are not the only markets in which this type of competitor-orientated pricing takes place. There may be industries in which many participants compete with one another, and, although there is no publicised world price for the products in question, there is an accepted narrow range of prices within which you will need to compete.The price range set by your competition is the range your customers will expect. You can get this information by preparing a profile of your competition and determining the prices they charge for products similar to yours. You can use this as a guide to set your prices. You can set your price the same as your competitors or you can set a price that is lower to lure customers away, but make sure you are still covering your costs of production and overhead The worst risk is that competition-based pricing lulls the price setter into passivity. Managers can be so taken by this pricing approach that they lose sight of their own pricing responsibilities. To them, pricing involves nothing more than monitoring competitors' prices and making some timely adjustments on their own price based on the competition's price. Maybe this is what managers mean when they say the invisible hand sets their prices. This might seem like a low-risk strategy, but unfortunately sometimes the competition decides to set its prices the same way. When this kind of double-mirroring occurs, prices not just for the company but for the entire industry can easily fall out of sync with current demand. Other times, price-matching can lead to a game of chicken. Everyone knows that setting a low price is the easiest, fastest way to gain market share. The trouble is that one rarely encounters a company that does not want a larger market share: In any given industry, if you added up all the market share targets of each company, the sum would most likely far exceed 100%. Obviously, something has to give. If all the firms in an industry become overzealous about meeting their market share targets, prices can easily slip into a downward spiral that can hurt not just the company but the industry as a whole. The competition for market share between the two aerospace giants Boeing and Airbus in the mid- and late 1990s offers an example of this risk. At the time, Airbus was consistently gaining market share and had surpassed its self-determined "survival threshold" of 30% of new global commercial airplane orders. Boeing decided to respond. It would

"beat back Airbus and retain supremacy in the commercial-jetliner industry,"3 and fearlessly guard its 60% market share. Boeing and Airbus began competing vigorously, "making every bid a battleground." Each would slash its price by at least 20% off the list price to grab an order. For example, to bid for ValueJet's order of 50 100-passenger airplanes in 1995, Boeing reportedly brought its price for Boeing 737s down from the list of $35 million, below its rock-bottom price of $22 million, all the way to $19 million.4

Follow-the-leader pricing:
Another form of competitor-orientated pricing occurs in markets where there is an extremely dominant supplier (or perhaps two) that has the largest market share and that essentially sets the price levels for that particular market. The other, usually smaller, producers play a follow-the-leader approach to pricing and keep to the pricing set by the market leader (although they may offer a small discount compared with the market leader's price to entice buyers to purchase their goods).