Strategic Marketing

Developing Pricing Strategies Contd.

SMK PGDM Batch 28 Retail & HR Tutorial Eleven
Steps in Setting a Pricing Policy
1. Selecting the Pricing Objective

2. Determining Demand

3. Estimating Costs

4. Analyzing Competitors’ Cost, Prices, and

Offers
5. Selecting a Pricing Method

6. Selecting the Final Price

Step 1: Selecting the Pricing Objective

• Once the positioning of the product is decided upon, a price can

be set based on five major objectives:
• Survival – may be the major objective if the firm is facing
overcapacity, intense competition, or changing consumer demands
– as long as the price covers variable costs and some fixed costs, it
may stay in business. This is just a short-run objective; in the
longer run the firm should learn how to add value or perish.
• Maximum current profit – companies estimate demand and costs
associated with alternate prices and choose the one that generates
maximum current profit, cash flow, or rate of return on investment – but
estimating demand and costs may not be easy and often found difficult and
too much emphasis on current profits may endanger long-run performance
• Maximum market share – firms set lowest prices assuming that the
market is price sensitive and that a higher sales volume would lead to
lower units costs and higher long run profit.
• Texas Instruments famously followed this market-penetration pricing for
many years - The company would build a large plant, set its price as low as
possible, win a large market share, experience falling costs, and cut its
price further as costs fell.
Favorable conditions for market penetration strategy

• The following conditions favor adopting a market-penetration pricing strategy:

• (1) The market is highly price sensitive and a low price stimulates market
growth
• (2) production and distribution costs fall with accumulated production
experience
• (3) a low price discourages actual and potential competition
Maximum market skimming
• Companies (like Sony, Apple) that unveil new technology products, uses
market-skimming pricing. Prices start high and drop over a period of time.
This can prove to be fatal if a worthy competitor decides to price low.
Consumers who buy first may feel disappointed when subsequent buyers
pay much less for the same product.
• This strategy may be desirable if (1) sufficient buyers display high
demand, (2) cost of production is very high for producing small batches,
(3) initial high prices do not invite other competitors to enter the race, and
(4) the high price communicates the superior image of the product
• Product-quality leadership – A company may take the position of
being a price-quality leader. Some brands want to take up the role
of being perceived as ‘affordable luxuries’ offering high levels of
perceived quality, taste, and status with a price just high enough
to be with in the reach of consumers.
• Others like Mercedes Benz, Rolls Royce, BMW, Bosch, Hidesign
position themselves as quality leaders with premium prices.
Step 2: Determining Demand
• Each price will lead to a different level of demand and have a
different impact on a company’s marketing objectives. Normally there
is an inverse relationship between price and demand. The higher the
price, lower will be the demand. The demand curve would show the
market’s probable purchase quantity at alternative prices.
• We need to understand what affects price sensitivity. Firms would
prefer customers who are less price-sensitive.
• The higher the price, the lower the demand.
• For prestige goods, the demand curve sometimes slopes upward.
• Some consumers take the higher price to signify a better
product.
• However, if the price is too high, demand may fall.
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Inelastic and Elastic Demand
PRICE SENSITIVITY

• The demand curve shows the market’s probable purchase quantity at alternative
prices, summing the reactions of many individuals with different price
sensitivities.
• The first step in estimating demand is to understand what affects price
sensitivity. Generally speaking, customers are less price sensitive to low-cost
items or items they buy infrequently.
• They are also less price sensitive when (1) there are few or no substitutes or
competitors; (2) they do not readily notice the higher price; (3) they are slow to
change their buying habits; (4) they think the higher prices are justified; and (5)
price is only a small part of the total cost of obtaining, operating, and servicing
the product over its lifetime.
Factors Leading to Less Price Sensitivity
• The Product is more distinctive
• Buyers are less aware of substitutes
• Buyers cannot easily compare the quality of
substitutes
• The expenditure is a smaller part of the buyer’s
total income
• The expenditure is small compared to the total
cost of the end product
• Part of the cost is borne by another party
• The product is used in conjunction with assets
previously bought
• The is assured to have more quality, prestige, or exclusiveness

• Buyers cannot store the product

Step 3: Estimating Costs
• Demand sets a ceiling on the price the company can charge for
its products; costs set the floor. A company has to charge a price
that covers its production, distribution, and sales including a
fair return for its effort and risk.
• A company’s costs take two forms; fixed, also known as
overheads that do not vary with production level or sales
revenue. Variable costs vary directly with the level of
production. Total costs consist of the fixed and variable costs
for any given of production; average cost is the cost per unit at
that level of production
• Average cost is the cost per unit at that level of production; it equals total costs
divided by production. A firm has to charge a price that will at least cover the total
production costs at a given level of production. The management needs to know
how its costs vary with different levels of production
• Samsung has built a fixed-size plant to produce 1,000 tablet computers a day. The
cost per unit is high if few units are produced - As production approaches 1,000
units per day, the average cost falls because the fixed costs are spread over more
units.
• Short-run average cost (SRAC) Curve
• Short-run average cost (SRAC)increases after 1,000 units, however, because the
plant becomes inefficient:
Long-run average cost (LRAC) curve

• If Samsung believes it can sell 2,000 units per day, it should consider
building a larger plant
• The plant will use more efficient machinery and work arrangements, and
the unit cost of producing 2,000 tablets per day will be lower than the unit
cost of producing 1,000 per day
• This is shown in the long-run average cost (LRAC) curve
Cost per Unit as a Function of Accumulated Production: The Experience Curve

• There are more costs than those associated with manufacturing. To estimate the real
profitability of selling to different types of retailers or customers, the manufacturer
needs to use activity-based cost (ABC) accounting instead of standard cost accounting
• ACCUMULATED PRODUCTION Suppose Samsung runs a plant that produces 3,000
tablet computers per day.
• As the company gains experience producing tablets, its methods improve.
• Workers learn shortcuts, materials flow more smoothly, and procurement costs fall
• Thus the average cost of producing the first 100,000 tablets is $ 100 per
tablet. When the company has produced the first 200,000 tablets, the average
cost has fallen to $ 90.
• After its accumulated production experience doubles again to 400,000, the
average cost is $ 80.
• This decline in the average cost with accumulated production experience is
called the experience curve or learning curve
• Target Costing – costs change with production and experience.
They may also change due to concentrated effort by designers,
engineers, and purchasing agents to reduce them through target
costing.
Step 4: Analyzing Competitors’ Costs, Prices, and Offers

• Within the range of possible prices determined by market demand and company
costs, the firm must take competitors’ costs, prices, and possible price reactions
into account. Depending upon the features the firm’s products possess or do not in
relation to the competitors’ products, the firm should add or subtract values from
its prices.
• Changes in prices can provoke a response from the customers, competitors, and
even the government.
• Competitors are most likely to react when producers are only few, the product is
homogenous, and buyers are highly informed.
• The firm should be able to anticipate the reactions from the
competitors. The problem can get really complicated if the
competitors interpret differently the lowering of prices or price cuts:
• Whether the company is trying to steal the market?
• It is doing badly and want to boost sales?
• It wants the whole industry to reduce the prices to stimulate total
demand?
VALUE-PRICED COMPETITORS
• Companies offering the powerful combination of low price and high quality
are capturing the hearts and wallets of consumers all over the world.
• Value players, such as Aldi, E* TRADE Financial, JetBlue Airways, Southwest
Airlines, Target, and Walmart, are transforming the way consumers of nearly
every age and income level purchase groceries, apparel, airline tickets,
financial services, and other goods and services.
• Traditional players - feel threatened. Upstart firms rely on serving one or a few
consumer segments, providing better delivery or just one additional benefit,
and matching low prices with highly efficient operations to keep costs down.
Step 5: Selecting a Pricing Method

• Given the customers’ demand schedule, the cost function, and competitors’
prices, the company must select a price.
• The Three Cs Model for Price Setting:
• Costs set a floor to the price
• Competitors’ prices and the price of substitutes provide an orienting point
• Customers’ assessment of unique features establishes the price ceiling