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PRICING

 Price has got various names like rent, fee, tuition, fare, rate, charge, interest, toll,
tax, premium, honorarium, dues, salary, wages, commission, etc

 Price is the amount of money charged for a product or a service. It is the sum of
all the values that consumers exchange for all the benefits of having or using the
product or service

 Price is the only element in the marketing mix that produces revenue. All others
are elements of cost

 Price is the most flexible element in the marketing mix

 Pricing is often the number one problem in marketing

 Some common mistakes made in pricing are :

i) Too much of a cost-orientation rather than customer-value-orientation

ii) Prices not revised often enough to reflect market changes

iii) Pricing that does not match with the other elements of the marketing mix

iv) Pricing that is not differentiated for different products, marketing segments,
etc.

Factors that affect price-setting :

 Internal Factors :

 Company’s marketing objective

 Marketing mix strategies
 Costs
 Organizational considerations
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 External Factors :

 Nature of market & demand

 Competition
 Environmental factors

INTERNAL FACTORS :

Marketing Objectives : Some common marketing objectives are

1) Survival : Applicable if

- Company suffers from over-capacity & paucity of demand

- Heavy competition

- Fast changing consumer wants

- Profits are less important, more important to keep the plant going

- Feasible, as long as variable costs & a part of fixed costs are

covered

- Short-term strategy

2) Current profit maximization : Market Skimming

- Company wants current financial results rather than long- run

performance

- It estimates demand & cost at different levels of price & fixes price
at that level which yields max. Current profit or max. Cash flow or
max. ROI

3) Market share leadership : Market Penetration Pricing

- Company believes that the player with the largest market share will
enjoy lowest costs & highest long-run profits

- Prices are set as low as possible

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4) Product quality leadership :

- High price is charged to cover the high cost of quality & high cost of
R & D.

5) Entry barrier pricing

6) Price to match competition

7) Pricing to win distributor loyalty / co-operation

8) Pricing to create buying enthusiasm

Marketing Mix Strategy :

 Pricing needs to be coordinated with product design, promotion & distribution

decisions to form a consistent & effective marketing programme

 Decisions in the areas of product, promotion & distribution will affect pricing

 Sometimes, companies use price as the pivotal product positioning tool. Other
marketing mix elements are built up to support that positioning

 Price-positioning is supported by a technique called Target Costing

 Target Costing (TC) turns the pricing approach inside out. Traditionally, products
have been designed, costing determined, positioning planned & prices asked.

i) MR is used to establish a new product’s desired functions

ii) Then the price is determined at which the product will sell given its appeal
& competition
iii) Then the desired profit margin is deducted from this to arrive at the target
cost

iv) Then, each of the component activities like design, engg., mfg., sales are
reviewed in order to eliminate functions, substitute parts, reduce supply
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costs, re-engineer components & so on. The objective is to reduce

projected cost to target cost or below

v) If projected cost falls to target cost levels or below, the product is

developed and the company can be more assured about target profits

vi) If projected cost cannot be reduced to target cost, the product will be
dropped

Costs :

 Costs set the floor for the price that the company can charge for its
product/service

 The company needs to charge a price that covers its costs & earns a fair return for
its effort & risk – taking

 Costs can be fixed costs or overheads – that do not vary with production or sales.
For e.g. rent, electricity, interest, executive salaries, etc.

 Costs can be variable, which vary directly, with the level of production, e.g. raw
materials, semi-finished inputs, packaging, etc. Variable costs tend to be the same
for each unit produced

 Total Costs (TC ) are the sum of FC & VC for a given level of production

 Management needs to charge a price that will at least cover the TC at a certain
level of production

 Management needs to know how costs vary with different levels of production
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 SRAC decreases at first because FC is spread over more units

 SRAC increases later as inefficiency increases – more waiting time,

more break-downs, more congestion, etc.

 By enhancing the production capacity from 1K units/day to 2K units/day, it can

lower average cost/unit as a result of more efficient machines & manpower &
workplace arrangements

 But after further increases in the daily production capacity, the average cost /unit
will go up at a point because of increasing diseconomies of scale – too many
workers to manage, too much paperwork, too many schedules & so on

 This should decide the optimum capacity of the plant to take advantage of the
LRAC Curve

 The other aspect of cost is as a function of the production experience. As the

company gains experience of production, it learns to do things better. It develops
better work methods, improved technology & processes. As a result, AC falls
with accumulated production experience. Thus, the AC of producing the 1st 100k
units may be Rs.10 per unit but when the company produces 200k units the AC
per unit might drop to Rs.9 & when the company doubles that production to
400k units, the AC per unit might further drop to Rs.7. This drop in the AC per
unit with accumulated production experience is called the Experience Curve or
the Learning Curve.

 To take advantage of falling AC per unit, the company must try to grab max market
share early in the PLC by offering very low prices to increase sales. As its unit cost
falls through gaining experience, it can cut prices further
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 This strategy of cutting costs entails risks. Price cutting gives the product a cheap
image

 It assumes that competition is weak & won’t be able to match price cuts

 When the company builds volumes by concentrating & improving on one

technology, an alert competitor may come up with a lower-cost technology that
enables it to manufacture at lower costs

Organizational Considerations :

 In small companies, prices are often set by top management

 In large companies, pricing is handled by divisional managers or product line

managers

 Generally, top management sets the pricing objectives & often approves prices
proposed by lower level management

 In large companies, where prices are relatively stable (e.g. oil companies), there
is a pricing department which reports to top management

 Sales, Production, Finance, Promotions also influence pricing

EXTERNAL FACTORS :

Market & Demand

 While costs set the floor for pricing, the market & demand set the ceiling

 From the pt. of view of economics, there are 4 types of markets

 In pure or perfect competition, there are several sellers & buyers who are
trading in commodity type products. Prices are determined solely on the basis
of the market forces : demand & supply
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 In such a market the seller has to accept the going price. No seller can charge
a higher price because he will lose out to the other sellers. He cannot charge a
lower price because it will be matched by the others, thus neutralizing the
advantage. In such markets, MR, Advertising, Pricing, Sales Promotion play
insignificant roles

 In a pure monopoly, there is one seller & many buyers. The monopolist could
be a govt. company, a private regulated company or a Pvt unregulated
company

 A govt. monopolist might let a price below cost if the product is important &
the consumers cannot pay for the full cost (e.g. transport, education). The
price may even be set quite high to discourage consumption (Indian Railways,
Indian Airlines, long distance telephony)

 In case of a Pvt. regulated monopolist, the govt. permits the setting of a price
that yields a “fair rate of return” (e.g. Hind Motors)

 Non- regulated Pvt. monopolists are free to charge what the market will
bear(e.g. Coke)

 In oligopoly, there are a few sellers & many buyers. Each seller is alert &
sensitive to the others’ pricing & others’ strategies (e.g. Steel, Oil, Cement,
etc)

 A price cut by an oligopoly & will normally be matched by the other sellers
resulting in less revenues for all. A price increase may not be followed by the
others leading to quick erosion of market share. This leads to formation of
cartels (e.g. Pvt telecom network operators, Pvt. airlines)

 In monopolistic competition, there are many sellers. Sellers seek out different
market segments within which they compete by differentiating their offers by
using branding, advertising, personal selling, pricing, etc. Buyers perceive
offers as different & pay different prices. So, price becomes one of the many
strategic tools rather than the defining one.
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Price-Demand Relationship :

 The relationship between price charged & the resulting demand is shown by
the Demand Curve (DC)

 Normally, price & demand are inversely related. But in case of prestige goods,
the DC slopes upward (e.g. perfumes, expensive cars, etc.)

 Marketers need to know the Price Elasticity of their Demand. If demand

hardly changes for a small change in price, the demand is said to be price
inelastic. If demand changes significantly for a small change in price, demand
is elastic.

Price Elasticity of Demand = % change in Qty demanded

% change in Price

 If demand in elastic, marketers will consider lowering price to increase sales but
this can turn products into commodities

 The less elastic the demand, the more it pays for the marketer to raise price

 Buyers are less sensitive to price when

1) The product is unique or distinctive – monopoly/Monopolistic competition

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2) It is of high quality, high prestige or exclusive

3) No substitutes available –monopoly
4) Comparisons are difficult – monopolistic comp.
5) The price of the product is low compared to income
6) Part of the price is borne by someone else (many users)
7) The Product is used with existing assets – Spares
8) Product cannot be stored – Perishable

 Buyers are most price-sensitive to products that

i. Cost a lot or
ii. Are bought frequently

 They are less price-sensitive to low-cost items or infrequently purchased items

 They are less price-sensitive when the price is only a small part of the total cost
of procuring, operating & servicing the product over its lifetime, i.e. if the total
cost of ownership (TCO) is lower – Cost Benefit Analysis

Competitors’ Costs, Prices & Offers :

 The company needs to benchmark its costs against those of competitors to learn
whether it is operating at a cost advantage or disadvantage

 It needs to learn the prices & qualities of competitors’ offers & use them as a
starting point for its own pricing

 It also needs to forecast how competitors will react to its pricing

Environmental Factors :

 Economic conditions : boom, recession, inflation, interest rates,etc

 Distributors’ perceptions

 Government intervention

 Social concerns
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PRICING APPROACHES

A) Cost based Approach

 Cost Plus Pricing

 Break-Even Analysis’

B) Market-based or Buyer-based Approach

 Value – based Pricing

 Going-rate Pricing
 Sealed-bid Pricing

Cost-Plus Pricing : Mark-up Pricing

Expected Sales : 50,000 units

Variable Cost : Rs. 10 per unit
Fixed Cost : Rs. 3,00,000
.
. . Unit Cost = 10 + 3,00,000 = Rs. 16
50,000

Now if the marketer wants a 20% mark-up on sales,

Mark-up Price = Unit Cost / (1- 0.2) = 16/0.8 = Rs. 20
.
. . His profit =Rs 20 – Rs 16 = Rs. 4.00 per unit

Now, if dealers want a mark-up of 50%, their MU Price = 20/ (1-0.5) =20/0.5
= Rs. 40 per unit.

 MU Pricing works if expected sales are achieved

 Sellers feel more confident as they are more certain about costs

 Prices are more stable & price competition is minimized

 Leads to “fair” pricing

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Break-Even Pricing :

At BEP, TR = TC

If BEV = X units, then

XP = VC + FC
XP – VC = FC
X(P – VC) = FC
So, X = F C = 3,00,000 = 30,000 units
P-VC 20 – 10

 Higher the price charged, lower the BEV

 As price is increased, demand may fall
 The manufacturer has to estimate demand at different prices & total
profits to be earned

Value –Based Pricing :

 Cost-based pricing in product-driven but value-based pricing reverses this

approach

 It begins with analyzing customer needs & value perceptions to set a price

 The Company will ask consumers how much they will pay for a basic product &
& for each benefit added
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 It might conduct test marketing to assess perceived value

 Companies adopting this approach seldom cut prices. Instead, they add value to
differentiate their offer to support higher prices, thereby trying to shift customer
focus from price to value

 This is difficult for companies selling commodity type products. They still
differentiate their offers by charging EDLP (Every Day Low Prices) or High Low
Pricing

PRICING STRATEGIES :

 Market – Skimming Pricing

 Market – Penetration Pricing

 Product Line Pricing : Setting price steps between product line items

 Optional Product Pricing : Starts with a low price for the basic stripped – down
product to build consumer traffic & often add-on features at additional prices

 Captive-Product Pricing: Used by companies selling complementary products.

The basic (re-usable) product is priced low but the consumables are priced high
(e.g. camera-film, computer-software; machine- spares )

 Two-Part Pricing : A fixed fee + a variable usage rate (e.g. tel.bills, amusement
park tickets)

 By Product Pricing: If by-products can be sold, a more competitive price can be

charged for the main product. Practiced by petroleum refining companies,
chemical companies, Meat- sellers, etc.

 Product – Bundle Pricing