An Introduction

Why is Pricing Important?

Charges for your product or service. Profit determinant. long-term strategies are a must for pricing.

The Role of Pricing

To create an image for a product or service:
To create the aura of value Low price perceptions

The Role of Pricing

To generate revenues and income:
Pricing tied to sophisticated demand
Rolex watches or BMW cars

Prices lowered to near-break even to raise cash for operations or other opportunities.
Deccan Airlines Rs 99 offers

Prices raised temporarily to take advantages of market opportunities (demand) and to increase income
Flowers on Mothers Day
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The Role of Pricing

To give customers incentives or disincentives to use a product or a service:
Zero percent financing for cars (incentive) Higher taxes on cigarettes (price driven disincentive)
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The Role of Pricing

To capture market share or squeeze out a rival:
Coke and Pepsi routinely use pricing to capture share units in local markets. Full Airlines squeezed out Low cost carriers by matching prices.

Making All Things Unequal

Marketing is making all things unequal and this can be made by price and or value.

Flexibility
Three of the four Ps in marketing are usually not very flexible:
Products/Services often take years to bring to market. Distribution channels are often costly and take time to set up. Promotion Can be quick but usually takes months to create and use.

Flexibility
Pricing is perhaps the most flexible
Jet Air Price Saver Price created on Thursday for the coming weekend. Negotiation for the purchase of a car.

Methodology
Very sophisticated databases and research models to test pricing options and to track the
(1) impact of price changes (2) the need to change prices.

(3)Others (small, retail) often go by instinct, market knowledge.

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Strategic Pricing
Pricing is a key part of the marketing mix. The strategy of pricing options (competitive position, goals of pricing decisions) are key parts of the overall marketing approach. In other words, pricing is a deliberate decision with specific goals in mind (not limited to profit) to a long-ago set base.
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Profit Maximization
Economic Theory
The quantity demanded is a function of the price that is charged Generally, the higher the price, the lower the quantity demanded

Pricing
Management should set the price that provides the greatest amount of profit
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Determining the Profit-Maximizing Price and Quantity

Rupees per unit

Profit is maximized where marginal cost equals marginal revenue, resulting in price p* and quantity q*.

p* Demand

Marginal cost q*

Marginal revenue

Quantity made and sold per month

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Determining the Profit-Maximizing Price and Quantity Total cost Total revenue

Total profit at the profit-maximizing quantity and price, q* and p*.

Quantity made and sold per month
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q*

Strategic Planning for Price

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2005 McGraw-Hill Companies, Inc., McGraw-Hill/Irwin

Price Perspectives: Price Equals Something of Value

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2005 McGraw-Hill Companies, Inc., McGraw-Hill/Irwin

Objectives Should Guide Strategy Planning for Price

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2005 McGraw-Hill Companies, Inc., McGraw-Hill/Irwin

Objectives Should Guide Strategy Planning for Price

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2005 McGraw-Hill Companies, Inc., McGraw-Hill/Irwin

Objectives Should Guide Strategy Planning for Price

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2005 McGraw-Hill Companies, Inc., McGraw-Hill/Irwin

Most Firms Set Specific Pricing Policies to Reach Objectives

One-Price Policy

Flexible-Price Policy
Different customers, different prices Databases make it easier Salespeople can adjust prices Too much cutting can hurt profits
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The same for everyone

Frequently purchased items Convenient Low cost Maintains goodwill

OR

2005 McGraw-Hill Companies, Inc., McGraw-Hill/Irwin

Responsibility
Finance plays a role in the setting of prices in most industry, but often is NOT the key decision maker.
Factory managers for industrial products Store managers for consumer goods Even hotel front desk clerks under the right circumstances!

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Legalities (General)
Collusion/Price-Fixing. Pricing below cost/predatory pricing Manufacturer-set pricing

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Pricing
When setting a price, we need to take account of 3 critical points: Market Value What is your product worth to your customers Cost structure What it costs you to provide the product or service

Competition The price your competitors charge

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Market Value
Successful businesses maximise their profit by matching their pricing with the value customers put on their products or services The Cost is the total outlay required to create the product or service
The Value is what the customer thinks the product or service is worth

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Market Value
For a plumber to fix a burst pipe, it may cost: Rs.10 for travel costs Rs.5 for materials Rs.20 for one hours labour However, the value to the customer who has water pouring down the stairway is far greater than the Rs.35 cost. A plumber may, therefore, charge Rs.50+ to fix a burst pipe, more so for an out of hours service Product pricing is often built around the cost plus price model, while service pricing is generally created on a perceived value basis. Both methods, however, do still require a full 25 understanding of costs and the competition

Cost Structure
Your cost structure provides a basis for what you need to charge...however it will not necessarily show what you can or should charge. As long as the price you sell your product or service at is higher than the variable cost then each sale will make a contribution towards covering fixed costs and making profits.

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Competition
Due to deregulation companies face competition in some form. There is a need to benchmark potential pricing. Generally done by: Getting someone to phone or visit your rivals and ask for a price quote. Look at their published annual accounts to analyse their cost base. It is much easier to get prices if it is a ecommerce company.
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Competition
The analysis framework. Too low and you throw away profit, too high you lose customers. Evaluate competitors price along with other factors such as: Where they deliver the product or service How they deliver it The quality of their service provision

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Pricing
Pricing Models:
Cost Plus Pricing Marginal Costing and Contribution Pricing Value Based Pricing A mixture of pricing strategies for differing situations
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Who determines the price?

Once competition enters the market, the price of a product becomes squeezed between the cost of the product and the lowest price of a competitor. Organizations that choose to compete by offering innovative products and services have a more difficult pricing decision because there is no existing price for the new product or service.

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Influences on Price
Customer demand Competitors behavior/prices/actions Costs Regulatory environment legal, political and image related

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Pricing approaches
Cost plus mark-up
Variable contribution margin approach, contribution margin( reflecting mark-up) should cover desired return on investment, all fixed costs Absorption common- mark-up covers all expenses except cost of goods sold plus the desired return on investment

Target costing
price is known, determine the maximum cost per unit

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Cost Plus Pricing

This is the most common method and is based on two elements: The mark-up you must add to your costs to make the desired profit The mark-up used by competitors The mark-up is how much you add to your costs to arrive at your selling price. It is usually expressed as a % of the cost, e.g. Cost plus 50%.

Different products and businesses apply hugely different mark-ups, e.g. Branded clothing: Cost plus 135% Jewellery: Cost plus 250%
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Cost-Plus Pricing
If the final price looks uncompetitive then review the size of the mark-up. Never remove the mark-up altogether to make the price competitive, instead look at reducing costs.
Cost-plus pricing does however have pitfalls: It ignores the image and market position you are looking for It assumes you will achieve a sales target to make break even or better

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Cost-Plus Pricing Example

The costs involved in making a product are:
Direct Materials Direct Labour Direct Expenses Indirect Expenses Rs.3 per unit Rs.11 per unit Rs.2 per unit Rs.4 per unit

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Cost-Plus Pricing Example

If we want a mark up of 30% on each unit, then: Full Cost = Direct Materials Direct Labour Direct Expenses Indirect Expenses Rs. 3 Rs.11 Rs. 2 Rs. 4 Rs.20 Rs. 6 Rs.26

Full Cost= Mark Up= 30% of Rs.20 Selling Price=

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Marginal Costing and Contribution Pricing

The Marginal Cost approach takes a different view from the Cost Plus pricing method Instead of starting from the cost of the product or service, you start from the price that you can charge, and the amount of sales you can make at that price This technique will allow you to see whether you can cover costs and make a profit at a certain price
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Marginal Costing and Contribution Pricing

This approach to costs and pricing takes cost behaviour as the basis for allocating costs The categories of costs considered for this method are the variable and fixed costs This method also introduces the concept of contribution the amount remaining after deducting the variable costs from the selling price This goes towards covering the fixed costs and any remainder goes to profit
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Marginal Costing and Contribution Pricing

Example Sales Price of a Product: Rs.7.50 per item Variable Costs: Rs.4.50 per item Fixed Costs: Rs.2.90 per item

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Marginal Costing and Contribution Pricing

Example Contribution = Sales less Variable Costs = Rs.7.50 Rs.4.50 Contribution = Rs.3.00 per item Fixed Cost = Rs.2.90 per item

Profit

= Rs.0.10

So, selling 100 items, a profit of Rs.10 would be generated.

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Value Based Pricing

States that the price should reflect the value of a product as customers perceive it (the willingness-to-pay) Value-based pricing is an effort to extract this perceived value from the market This involves quantifying perceived value and increasing it whenever possiblei.e., when the customers willingness to pay for the increased value exceeds the cost of delivering it
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Value Based Pricing

This perceived-value pricing takes a number of forms: Convenience: A convenient, local service will normally be able to charge more Brand: Many customers will pay more for a well marketed brand Competition: The less competition there is then the less choice the customer has Supply & Demand: More customer demand than there is supply will lead to the ability to charge higher prices Overcharging could alienate customers and could 42 draw in competitors

Cost-based vs. Value-based

Cost-based most common pricing method easiest pricing method considered fair difficult to allocate fixed costs sub-optimal profits Value-based optimal profits requires research complicated to administer can be considered unfair

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Margins
Margins indicate the % profit a business makes after applying a mark-up If an enterprise, for example, costs its product or service at Rs.100 and marks it up by 50% to sell it for Rs150 then its profit margin is 33.3% (Rs.50), i.e. the value of the mark-up (Rs.50), divided by the selling price (Rs.150) x 100 Margins are good barometers of how important particular products or services are to the profitability of your business.
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Opportunity cost
Opportunity cost is the most fundamental cost concept.
The opportunity cost of doing or getting something is:

what you could have done or gotten instead

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Price

The price of a chocolate bar is the amount of money that I have to give up to buy. In paying the price, The customer is sacrificing what else these coins could have bought.

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Opportunity cost is what you forgo.

Example: Your opportunity cost for taking this class includes: Whatever else you could have bought with your tuition and fee money

Plus
the work, family participation, and recreation that you are not doing because you are here.

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Opportunity cost is not resources used

Strictly speaking, the cost of something is not the resources used up to get it. Instead, the cost is what else you could have done with those resources. Resources have value only because you can use them to make goods and services that have value.

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Using prices for costs

Opportunity cost can be hard to use in practice.

Rupee costs (prices) are easier to determine And easier to add up.

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But one should not lose sight of opportunity cost.

For example: saving medical institutional costs by discharging patients early adds opportunity costs for family members drafted into being home caregivers (one of the ways that the percentage of national health expenditure in the GDP understates the cost of our health care system)

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Opportunity cost = price?

Prices can reflect society's opportunity cost Means that the ratio of prices of any two goods or services is the opportunity cost of the one in terms of the other. If the market system works properly then the price ratio of any two goods or services tells you how many of good X you give up to get each unit of good Y. For this to work properly, you have to have strong competition and savvy consumers. Competition will then force the sellers to be efficient, and provide goods and services at prices in line with costs.
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Inefficiency
To know that the resources that could be used to make more of the product instead being used to make something less valuable? Because the price of a resource depends on what it can be used for. If there are some resources that are not being used in the most valuable way, that is the definition of inefficiency and loss of opportunity.
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Hospital day price example

Prices for hospital days late in a patients stay.

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Functional-Based Management Model

Cost View

Resources

Operational View

Efficiency Analysis

Functions

Performance Analysis

Products
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Activity-Based Management Model

Cost View

Resources

Process View

Driver Analysis Why?

Activities What? Products and Customers

Performance Analysis How Well?

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Comparison of FBM and ABM Accounting Systems

Functional-Based Activity-Based

1. Unit-based drivers
2. Allocation-intensive 3. Focus on managing cost 4. Sparse activity information 5. Maximization of individual unit performance 6. Use of financial measures of performance

1. Unit- and nonunit-based drivers

2. Tracing-intensive 3. Focus on managing activities 4. Detailed activity information 5. Systemwide performance maximization 6. Use of both financial and nonfinancial measures of performance

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Customer perception of product

Price is the amount of money you pay to buy the equipment.

Cost is the amount of money you pay to operate the equipment over the lifetime. This is called the Total Cost of Ownership. There are five key points that affect the Total Cost of Ownership (TCO).
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The five key points that affect the Total Cost of Ownership (TCO)
Labor Cost If your laundry runs 10 loads per day, a washer with 34 water valves versus 12 water valves could save you 30 minutes of operating time. Lower priced machines generally have lower extraction speeds. To get the lowest TCO, you should invest in higher extraction speeds to remove more water from linens. This allows the linen to dry faster. If extraction efficiency is measured by G-force, a 300 G-force washer will remove significantly more water than a 90 G-force washer. The dry time difference in a 60 lb load of terry towels can be almost ten minutes! How much labor can you save in your operation by cutting ten minutes on every load of towels?

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Cost of Power
Utilities are a controllable cost that is often overlooked when considering which laundry equipment to buy. Using the above scenario, you might save more than Rs.1500 per year by reducing the time in your save in your utility bill by cutting ten minutes of drying time on every load of towels?

Value for Your Money

Look at the total weight of the machine. Weight generally indicates if the frame or bearings are built to a higher standard and are more likely to give you extended years of service. This may even lower maintenance costs over the life of the product. Stainless steel panels versus painted panels are worth 59 spending a little extra money for.

Past Performance It is the best indicator of future performance! What do you know about the machine you are considering? Do you know anyone that has used this brand of machine for 5+ years?

What do you know about the company you are buying from?
How will they perform service for you in the future?

Service support
How many service technicians do they have? How many hours does it take to respond to your future service needs? It is worth paying a little more for good service support for the 60 equipment.

Warranty? The industry warranty period varies from one year to three years. Having the longest and most comprehensive warranty should lower your TCO. Is there a labor warranty? You may even consider an extended labor warranty. So when buying laundry equipment customer looks for the products that will lower Total Cost of Ownership (TCO)! The marketer must make sure you determine the under lying difference between price and cost.

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Defining business and value

The horse carriage makers mistakenly thought they were in the horse carriage business (product) rather than the transportation market (benefit). The best way to succeed is not to focus on the product, but the benefit you're providing your customers:

It is important to bear in mind that people value benefits and not necessarily forms.

The key benefit that journalists and news organizations have provided has been relevant, timely, accurate information that helps people make decisions, take action, and form opinions.
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Pricing Strategies
According to McKinsey, 80 to 90 percent of all poorly chosen prices are too low Companies habitually charge less than they could for new offerings. Its a terrible habit. Glenn Voss

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Target costing vs traditional cost based pricing

a. traditional cost based pricing is designed to appeal to any customers, but target costing target specific customers.
b. traditional cost based pricing consider the market that is available for the product at the end of the process, whereas target costing considers the market at the beginning of the process.

c. product costs are irrelevant under target costing, but are very important under traditional cost based pricing.
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Distribution Wide Low Low-mid quality quality product product Low price Heavy Cost Leadership X Exclusive

Low-mid Highest quality quality product product

X X

Promotion

Low-mid price

Brand-centric Differentiation

Light

Low-mid price Highest price

Customercentric Differentiation X

Product Differentiation
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