UNIT IV PRICING

Determinants of Price - Pricing under different objectives and different market structures

- Price discrimination - Pricing methods in practice

Pricing is the process of determining what a company will receive in exchange for its product. Pricing factors are manufacturing cost, market place, competition, market condition, [[brand], ]and quality of product. Pricing is also a key variable in microeconomic price allocation theory. Pricing is a fundamental aspect of financial modeling and is one of the four Ps of the marketing mix. (The other three aspects are product, promotion, and place.) Price is the only revenue generating element amongst the four Ps, the rest being cost centers. However, the other Ps of marketing will contribute to decreasing price elasticity and so enable price increases to drive greater revenue and profits.

Pricing is the manual or automatic process of applying prices to purchase and sales orders, based on factors such as: a fixed amount, quantity break, promotion or sales campaign, specific vendor quote, price prevailing on entry, shipment or invoice date, combination of multiple orders or lines, and many others. Automated systems require more setup and maintenance but may prevent pricing errors. The needs of the consumer can be converted into demand only if the consumer has the willingness and capacity to buy the product. Thus pricing is very important in marketing.

Pricing is different from other marketing activities for a couple of reasons. Firstly, the impacts of pricing decisions are reflected directly in revenue. No other marketing activity has as direct a route to revenue.

Secondly, pricing is unique due to the speed with which pricing plans can be implemented.

Setting Pricing Objectives

In looking to establish objectives for what we wish to accomplish there are several different pricing objectives to consider, these being:

1. Current Profit Maximization

One potential pricing objective would be to simply seek to maximize our current profitability. A concern with this potential approach, however, is that it is short sighted in nature. Real consideration must be given to the potential negative ling-term impacts potentially associated with a going for broke strategy.

2. Current Revenue Maximization

Another potential pricing objective would be to pursue the maximization of current revenue, as opposed to current profits. Under this option there would be little or no attention paid to profit margins. The logic behind this objective is that by increasing market share we will be able to address profitability down the road from an enhanced competitive position.

3. Maximize Quantity

This pricing objective attempts to maximize the total number of units sold or customers served. The thinking behind this particular objective is that by selling large quantities of the product we will eventually put ourselves in the position to decrease long-term costs. Decreased long-term costs serve to ensure our competitiveness and provide a base for increased profitability.

4. Maximize Profit Margin

Maximizing the unit profit margin is another possible pricing objective. In this case there is a need to recognize that the quantities sold will be low.

5. Quality Leadership

By establishing a relatively high price we are signaling to the market that we are a high quality supplier. This pricing objective aids on positioning the product as the quality leader. It must be understood with this approach that we are in all likelihood sacrificing the quantity of units sold in setting this objective

6. Partial Cost Recovery

Partial cost recovery is possible in organizations in which there are other profitable products which would be able to absorb some of the costs associated with the product. In this case the organization may not need to obtain full cost recovery from the one particular product as its costs may be shared with other products.

7. Survival

Establishing a survival pricing objective is a last gasp measure. Survival pricing is not a long-term objective. The intent with this objective is to select a price that covers costs while permitting the firm to remain in the market. Essentially we are trading profits for revenues which cannot continue forever.

8. Status Quo

Price stabilization serves to avoid price wars with competitors while simultaneously maintaining an acceptable degree of profitability.

One final note with respect to pricing objectives. Pricing objectives need to comply with the SMART Objectives structure used in establishing sound objectives. If it’s not a SMART objective it must be…

Pricing issues are also addressed in the Mastering Marketing Plans Seminar by Van Wagner Marketing Solutions.

Determinants of Price:

The final price for a product may be influenced by many factors which can be categorized into two main groups:

  • Internal Factors - When setting price, marketers must take into consideration several factors which are the result of company decisions and actions. To a large extent these factors are controllable by the company and, if necessary, can be altered. However, while the organization may have control over these factors making a quick change is not always realistic. For instance, product pricing may depend heavily on the productivity of a manufacturing facility (e.g., how much can be produced within a certain period of time). The marketer knows that increasing productivity can reduce the cost of producing each product and thus allow the marketer to potentially lower the product’s price. But increasing productivity may require major changes at the manufacturing facility that will take time (not to mention be costly) and will not translate into lower price products for a considerable period of time.
  • External Factors - There are a number of influencing factors which are not controlled by the company but will impact pricing decisions. Understanding these factors requires the marketer conduct research to monitor what is happening in each market the company serves since the effect of these factors can vary by market.

Below we provide a detailed discussion of both internal and external factors.

Marketing decisions are guided by the overall objectives of the company. While we will discuss this in more detail when we cover marketing strategy in a later tutorial, for now it is important to understand that all marketing decisions, including price, work to help achieve company objectives.

Corporate objectives can be wide-ranging and include different objectives for different functional areas (e.g., objectives for production, human resources, etc). While pricing decisions are influenced by many types of objectives set up for the marketing functional area, there are four key objectives in which price plays a central role. In most situations only one of these objectives will be followed, though the marketer may have different objectives for different products. The four main marketing objectives affecting price include:

  • Return on Investment (ROI) – A firm may set as a marketing objective the requirement that all products attain a certain percentage return on the organization’s spending on marketing the product. This level of return along with an estimate of sales will help determine appropriate pricing levels needed to meet the ROI objective.
  • Cash Flow – Firms may seek to set prices at a level that will insure that sales revenue will at least cover product production and marketing costs. This is most likely to occur with new products where the organizational objectives allow a new product to simply meet its expenses while efforts are made to establish the product in the market. This objective allows the marketer to worry less about product profitability and instead directs energies to building a market for the product.
  • Market Share – The pricing decision may be important when the firm has an objective of gaining a hold in a new market or retaining a certain percent of an existing market. For new products under this objective the price is set artificially low in order to capture a sizeable portion of the market and will be increased as the product becomes more accepted by the target market (we will discuss this marketing strategy in further detail in our next tutorial). For existing products, firms may use price decisions to insure they retain market share in instances where there is a high level of market competition and competitors who are willing to compete on price.
  • Maximize Profits – Older products that appeal to a market that is no longer growing may have a company objective requiring the price be set at a level that optimizes profits. This is often the case when the marketer has little incentive to introduce improvements to the product (e.g., demand for product is declining) and will continue to sell the same product at a price premium for as long as some in the market is willing to buy.

Market:

Market is an arrangement that facilitates the buying and selling of a product, service, factor of production etc., In other words a market is a place where the buyers and sellers meet one another to transact business.

Market structure:

Market structure refers to the number and distribution size of buyers and sellers in the market of particular goods and services.

The interconnected characteristics of a market, such as the number and relative strength of buyers and sellers , level and forms of competition, extent of product differentiation, and ease of entry into and exit from the market.

External Factors: Customer Expectations

Possibly the most obvious external factors that influence price setting are the expectations of customers and channel partners. As we discussed, when it comes to making a purchase decision customers assess the overall “value” of a product much more than they assess the price. When deciding on a price marketers need to conduct customer research to determine what “price points” are acceptable. Pricing beyond these price points could discourage customers from purchasing.

Firms within the marketer’s channels of distribution also must be considered when determining price. Distribution partners expect to receive financial compensation for their efforts, which usually means they will receive a percentage of the final selling price. This percentage or margin between what they pay the marketer to acquire the product and the price they charge their customers must be sufficient for the distributor to cover their costs and also earn a desired profit.

Marketers will undoubtedly look to market competitors for indications of how price should be set. For many marketers of consumer products researching competitive pricing is relatively easy, particularly when Internet search tools are used. Price analysis can be somewhat more complicated for products sold to the business market since final price may be affected by a number of factors including if competitors allow customers to negotiate their final price.

Analysis of competition will include pricing by direct competitors, related products and primary products.

  • Direct Competitor Pricing – Almost all marketing decisions, including pricing, will include an evaluation of competitors’ offerings. The impact of this information on the actual setting of price will depend on the competitive nature of the market. For instance, products that dominate markets and are viewed as market leaders may not be heavily influenced by competitor pricing since they are in a commanding position to set prices as they see fit. On the other hand in markets where a clear leader does not exist, the pricing of competitive products will be carefully considered. Marketers must not only research competitive prices but must also pay close attention to how these companies will respond to the marketer’s pricing decisions. For instance, in highly competitive industries, such as gasoline or airline travel, competitors may respond quickly to competitors’ price adjustments thus reducing the effect of such changes.
  • Related Product Pricing - Products that offer new ways for solving customer needs may look to pricing of products that customers are currently using even though these other products may not appear to be direct competitors. For example, a marketer of a new online golf instruction service that allows customers to access golf instruction via their computer may look at prices charged by local golf professionals for in-person instruction to gauge where to set their price. While on the surface online golf instruction may not be a direct competitor to a golf instructor, marketers for the online service can use the cost of in-person instruction as a reference point for setting price.
  • Primary Product Pricing - As we discussed in the Product Decisions tutorial, marketers may sell products viewed as complementary to a primary product. For example, Bluetooth headsets are considered complementary to the primary product cellphones. The pricing of complementary products may be affected by pricing changes made to the primary product since customers may compare the price for complementary products based on the primary product price. For example, companies that sell accessory products for the Apple iPod may do so at a cost that is only 10% of the purchase price of the iPod. However, if Apple were to dramatically drop the price, for instance by 50%, the accessory at its present price would now be 20% of the of iPod price. This may be perceived by the market as a doubling of the accessory’s price. To maintain its perceived value the accessory marketer may need to respond to the iPod price drop by also lowering the price of the accessory.

Government Regulation:

Marketers must be aware of regulations that impact how price is set in the markets in which their products are sold. These regulations are primarily government enacted meaning that there may be legal ramifications if the rules are not followed. Price regulations can come from any level of government and vary widely in their requirements. For instance, in some industries, government regulation may set price ceilings (how high price may be set) while in other industries there may be price floors (how low price may be set). Additional areas of potential regulation include: deceptive pricing, price discrimination, predatory pricing and price fixing.

Finally, when selling beyond their home market, marketers must recognize that local regulations may make pricing decisions different for each market. This is particularly a concern when selling to international markets where failure to consider regulations can lead to severe penalties. Consequently marketers must have a clear understanding of regulations in each market they serve.

Different types of Pricing under different objectives

Here are four ways to calculate prices:

  • Cost-plus pricing - Set the price at your production cost, including both cost of goods and fixed costs at your current volume, plus a certain profit margin. For example, your widgets cost $20 in raw materials and production costs, and at current sales volume (or anticipated initial sales volume), your fixed costs come to $30 per unit. Your total cost is $50 per unit. You decide that you want to operate at a 20% markup, so you add $10 (20% x $50) to the cost and come up with a price of $60 per unit. So long as you have your costs calculated correctly and have accurately predicted your sales volume, you will always be operating at a profit.
  • Target return pricing - Set your price to achieve a target return-on-investment (ROI). For example, let's use the same situation as above, and assume that you have $10,000 invested in the company. Your expected sales volume is 1,000 units in the first year. You want to recoup all your investment in the first year, so you need to make $10,000 profit on 1,000 units, or $10 profit per unit, giving you again a price of $60 per unit.
  • Value-based pricing - Price your product based on the value it creates for the customer. This is usually the most profitable form of pricing, if you can achieve it. The most extreme variation on this is "pay for performance" pricing for services, in which you charge on a variable scale according to the results you achieve. Let's say that your widget above saves the typical customer $1,000 a year in, say, energy costs. In that case, $60 seems like a bargain - maybe even too cheap. If your product reliably produced that kind of cost savings, you could easily charge $200, $300 or more for it, and customers would gladly pay it, since they would get their money back in a matter of months. However, there is one more major factor that must be considered.
  • Psychological pricing - Ultimately, you must take into consideration the consumer's perception of your price, figuring things like:
  • Positioning - If you want to be the "low-cost leader", you must be priced lower than your competition. If you want to signal high quality, you should probably be priced higher than most of your competition.
  • Popular price points - There are certain "price points" (specific prices) at which people become much more willing to buy a certain type of product. For example, "under $100" is a popular price point. "Enough under $20 to be under $20 with sales tax" is another popular price point, because it's "one bill" that people commonly carry. Meals under $5 are still a popular price point, as are entree or snack items under $1 (notice how many fast-food places have a $0.99 "value menu"). Dropping your price to a popular price point might mean a lower margin, but more than enough increase in sales to offset it.
  • Fair pricing - Sometimes it simply doesn't matter what the value of the product is, even if you don't have any direct competition. There is simply a limit to what consumers perceive as "fair". If it's obvious that your product only cost $20 to manufacture, even if it delivered $10,000 in value, you'd have a hard time charging two or three thousand dollars for it -- people would just feel like they were being gouged. A little market testing will help you determine the maximum price consumers will perceive as fair.

Refer your Material also