Pricing Decision

Unit 7
Concept of Price and Pricing
Price is the amount of money and / or other items with
utility needed to acquire a product. – William J. Stanton
Price is the amount charged for a product or service or the
sum of the values that consumers exchange for the benefits
of having or using the product or service. – Philip Kotler
Price is the exchanged value of the product or service
expressed in terms of money. – David J. Schwartz
Pricing is the method a company uses to set the price of its
product.
Pricing means the determination of appropriate value to a
particular good or a service.
Importance of pricing to Economy
Influence on factors of production: Land, labor, capital
and organization are the factors of production. Price
influences the availability and flow of these factors of
production. Increase in the price of these factors
increases supply and vice versa.
Determinant of product demand and supply: Price is the
balancing factor between demand and supply. When
product prices rise, product demand falls and supply
increases. Similarly when product prices fall, product
demand increases and supply decreases.
Optimum utilization of resources: If the resources are
priced rightly, then business organizations use it in
optimum to develop finished goods.
Influences saving and investment: If the price of goods
fall then it increases savings and increases investment.
Hence price helps to plan for investment and
management of fund.
Guides government policy formulation: Government
policies like monetary and fiscal policies are based on
the prevailing price of goods and services in the
market. Similarly government has to formulate
different policies to control and monitor pricing
conditions of different products in the market,
particularly survival goods.
Importance of pricing for Firms
Determination of market share and profitability: Price is
the only instrument that determines market share and
profitability of the firm. Marketer has to make balance
between the price and customers’ expectations to
enhance both market share and profitability.
Determinant of demand: The price of any product
becomes the major determinant of its market demand. If
the price is reasonable, customers will easily accept the
product and it captures the market and vice versa.
Determinants of marketing program: Marketing
programs include development of product, distributing it
in the market, promoting in different ways etc., which
are affected by pricing.
Competitive tools: Price is a tool of competition
among firms. A firm can compete with other firms by
charging lower prices for similar products. Its share of
market depends on its price structure.
Grade of the product: Price is used to grade the
product. High priced product indicates high grade,
quality, status and prestige.
Factors affecting price determination
A. Internal factors: They are controllable internal factors:
1. Pricing objective: The company’s pricing objectives affect
the pricing decisions. If the company adopts profit oriented
objective, the price tend to be little higher; if it adopts
sales-oriented objective, price tend to be little lower; and if
it adopts status-quo objective, price will be competitive and
stable.
2. Level of organizational involvement: A company following
a centralized pricing may have a high level involvement in
pricing to standardize price in various firms. While a
company following a decentralized pricing may have
several prices in various firms even for the same product.
3. Marketing mix: The price of a product is affected by
other elements of the marketing mix such as
distribution strategy, promotion strategy, and the
nature of product.
4. Product differentiation: Generally, the more a firm
differentiates its product the more freedom it has in
setting prices because consumers won’t compare the
prices as the attribute contents widely vary.
5. Costs: The general or traditional principle is that the
price of the product must cover at least the costs
involved in the production, distribution and
marketing support activities.
B. External factors
1. Demand for the product: The general principle is that,
when the level of demand is high, the price is set at higher
limit, and when the demand is low, the price is set at lower
limit in the hope of creating adequate demand in future.
2. Competitive situation: The firms have to set low prices or
at market price when there is intense competition. But if
the company’s competitive position is strong, it has
freedom in setting the price.
3. Supplier’s characteristics: The price of the product is
directly affected by the prices charged by the suppliers on
their raw materials and other inputs. Higher the price of
raw material higher will be the price of finished goods.
4. Distribution system: The price of the product also
depends on whether the firm has direct distribution
channel or indirect. There is no middlemen in direct
channel which saves the cost of middlemen’s margin
and lowers the price. In some cases, direct
distribution may be more expensive, especially when
company has no distribution network and has to
establish.
5. Economic condition: Economic conditions may be
either favorable or unfavorable for a business
depending upon the business cycle. When the
business cycle is in a favorable stage, the demand for
a product may increase.
Pricing Approaches
1. Cost-based pricing: Pricing is generally bases on the costs.
Most of the companies set their prices on the basis of costs
because price of the particular product should cover at least
costs incurred for product development.
a. Cost-plus pricing: This is mark-up pricing and is a cost-
based method for pricing. We need to add all the costs such
as direct material cost, direct labor cost, and overhead costs
for a product and add to it a markup percentage.
b. Target return pricing: It is a pricing method in which a
formula is used to calculate the price to be set for a product
to return a desired profit or rate of return on investment
assuming that a particular quantity of the product is sold.
This pricing method is used almost exclusively by market
leaders.
c. Breakeven pricing: It is the practice of setting a price
point at which a company will earn zero profits on a
sale. The objective of breakeven pricing is to use low
prices as a tool to gain market share and drive
competitors from the market place. This method is
most useful for those companies with sufficient
resources to lower prices and fight off attempts by
competitors to undercut them.
2. Demand based or value based pricing
a. Perceived value pricing: In this method of pricing, first, the
producer collects buyers’ views, experiences, feelings, and
perception of the value and fixes the price around the
average perceived value of the product. Costs and demand
of product are secondary factors.
b. Customer value pricing: Low price is charged for quality
products to attract a large number of value-conscious
customers. It is providing high value at low price. Some
organizations feature one or two items for value pricing to
attract customers and others at premium price.
c. Demand differential pricing: In this method a product is sold
at two or more prices that do not reflect a proportional
differences in marginal costs. This is also known as price
discrimination.
3. Competition-based pricing:
a. Going rate pricing: It is also known as meet
competition pricing which involves pricing a product
at the same rate as the rest of the competitors’ prices.
Small companies fix price only after the big
companies fix prices of their products.
b. Pricing below competition: It is a competitive pricing
method in which initial price is set at levels intended
to be below competitors’ prices. The main purpose of
this method is to attract price sensitive customers by
sweeping market competitors aside.
c. Pricing above competition: It is a competitive pricing
method in which initial price is set at levels intended
to be above competitors’ prices. Generally such
pricing method may be applied for quality products
or reputed brands.
d. Sealed bid pricing: It is mainly used for pricing the
tender transaction. Sealed bid price is determined
confidentially. A bidder tries to bid at lower price
than other bidders/competitors to win the contract.
New Product Pricing Decisions
a. Market skimming pricing: It is the setting a high price for
new product to skim maximum revenues layer by layer from
the segments willing to pay the high price. Customers pay
more to have product sooner. This type of pricing strategy
may be suitable in the following situations:
- If the company is going to launch a new product for the
market
- If the new product has distinct feature strongly desired by
the customers
- Of the demand for the product is fairly inelastic
- If the new product is protected by patent right or other rights
- If the product is very innovative
b. Market penetration pricing: Market penetration
pricing is the setting a low price for a new product in
order to attract a large number of buyers and a large
market share. The price of new products is fixed
lower than the expectation of the target market. This
pricing strategy may be suitable in the following
situations:
- When a mass market exists for the product
- When the demand for the product is highly elastic
- When economies of scale are possible
- When fierce competition already exists in the market
for the product
Price Lining and Price Adjustment Decisions
Price lining refers to selecting a limited number of
prices at which a business will sell related products. It
helps customers in simplifying buying decisions; while
for the retailers, price lining helps planning purchases
of required goods.
There are several strategies to adjust price of the
product to the changed market situations. They are:
1. Product-mix pricing strategies:
a. Product line pricing: It is the setting a single price for all products
in a product line.
b. Optional-product pricing: It is the pricing of optional or accessory
products along with a main product. For e.g. the car is main
product and air conditioned, power window, CD player, air bag
etc are optional products.
c. Captive-product pricing: A captive product is an item that is
produced for use only with another specific product. For e.g. refill
cartridges for pen, blades for razor, films for camera. The pricing
for these items is often planned with the primary item in mind.
d. By-product pricing: It is the pricing strategy for by-products
created during the production of a main product in order to make
the main product’s price more competitive.
e. Product bundle pricing: Product bundle pricing is the combining
several products and offering the bundle at a reduced price. It is a
package deal.
2. Price adjustment strategies
a. Discount and allowance pricing: Discounts are reductions
to the selling price of goods or service. It can be trade
discount and cash discount. Trade discount is direct
reduction from list price for middlemen and cash discount
is price reduction to buyer to pay their bills promptly.
Allowance is promotional money paid by manufacturer to
retailers in return for an agreement to feature the
manufacturer’s products in some way. It can be
promotional and trade.
b. Segmented pricing: Segmented pricing strategy is the
selling a product or service at two or more prices, where
the difference in prices is not based on differences in costs.
c. Psychological pricing: It is a pricing strategy based on the
theory that certain prices have psychological impact to the
customers. The prices are often expressed as odd prices for
e.g. Rs. 19,999 rather than Rs. 20,000.
d. Promotional pricing: It is the act of offering a lower price
(below the list price and sometimes even below the cost)
temporarily in order to increase short-run sales.
e. Geographical pricing: It is the practice of modifying a basic
list price based on the geographical regions of the buyer. It is
intended to reflect the costs of transportation to different
locations.
f. International pricing: It is the equilibrium product price that
results from international trade. The price setter has to
consider currency exchange rates, economic conditions,
production expenses, competitors etc. while setting the price.
For e.g. Boeing sells jetliners at about the same price
everywhere.
3. Price change strategies
a. Price increase: Price setter increase the price of the
product because of inflation, taxes, shortages,
competitor’s price etc.
b. Price decrease: Company decrease its product price
to capture the market share, to sweep the
competitors, to win price war, and so on.
c. Price maintain: The company try to maintain its
product price by adjusting the value to the product
by increasing or decreasing the benefits of product.
 Initiating and Responding to Price Change
1. Initiating price cuts: Several circumstances may lead a
firm to consider cutting its price even though such a
move may threaten industrial harmony and provoke a
price war. They are:
• Excess capacity
• Vigorous price competition triggering a price war
• Drive for dominance through lower costs
• Demand for product is price-elastic
• Consumers assume low quality of product
• Reduction in service level
2. Initiating price increases: For several circumstances a
firm has to increase its prices. They are:
• Cost inflation
• Over demand of the product
• Adding free service delivery or installation facility to
the customer
• Reduction in discounts
• Scarcity of the product
3. Responding to competitor’s price change: Price
changes may be initiated due to the competitors
reactions in price changes. Competitor’s reactions are
particularly important where the number of firms is
small, the product offering is homogeneous, and the
buyers are discriminating and informal. There may be
one or more competitors reacting similar or different
responses. In such case, a question may arise as how
to estimate the likely reaction of its competitors?
a. When there is only one large competitor
b. When there are more than one competitor
Responding to Price Changes by the Firm
Maintaining the price: The first strategy is that the
company may maintain its price as it is because the
company may think that the reduction of price may
loose too much profit, or reduction of price does not
affect on market share of the company, or by
maintaining its price the company may regain market
share in future.
Price maintaining with non-price counter attack: The
second strategy is that the company may maintain its
price by providing non-price services such as warranty,
quality service or product, good communication etc.
Price reduction: The third strategy is that the company
may reduce its price because the company may think
that the market is price-sensitive, or its costs fall with
volume, or it would be difficult to rebuild its market
share one it is lost.
Price increase with product counter-attack: The fourth
strategy is that, instead of maintaining or lowering its
price, the company might raise its price along with
introducing some brands, or redesigning the product,
or adding new utilities in the product, or providing
quality services such as free repair and maintenance,
etc.