Pricing - Lecture notes 10 PDF

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PRICING INTRODUCTION Price is the value that is put to a product or service and is the result of a complex set of calculations, research and understanding and risk taking ability. A pricing strategy takes into account segments, ability to pay, market conditions, competitor actions, trade margins and input costs, amongst others. Price is a significant element in the marketing mix. ‘Marketing mix’ is referred to as the controllable marketing tools through which a firm is able to produce a response for the targeted market. In the marketing mix, price has its own place which determines a customer’s payment to acquire a product (Riaz & Tanveer, n.d.). The underlying factors that determine a company’s price decisions can be categorized as internal factors and external factors. Internal factors include company’s marketing objectives, marketing mix strategy, and costs; whereas external factors consist of market environment, demand, competition (Khoso, Ahmed, & Ahmed, 2014). 99.

PRICING STRATEGIES A business can use a variety of pricing strategies when selling a product or service. The price can be set to maximize profitability for each unit sold or from the market overall. It can be used to defend an existing market from new entrants, to increase market share within a market or to enter a new market. Pricing strategy is beneficial in terms of diverse purchasing behavior of various customers. Secondly, high degree of demand and uncertainty create more revenue. On the other hand, rigidity of production boosts the organization to play with prices (Dolgui & Proth, 2010). The effectiveness and relevance of different pricing strategies such as penetration strategy and price differentiation strategy can be determined by its outcome in terms of sales and customer satisfaction. Organizations can apply strategies to achieve their pricing objective. The elements of pricing objective include profit maximization, revenue maximization, quality leadership, quantity maximization and survival (Roth, 2007). Pricing objective is focused on three factors, i.e.

nature, the desired level of attainment and the associated time horizon. Pricing objectives of service organizations are profit maximization, sales maximization, market share maximization, market share increase, return on investment (ROI), price differentiation, price stability in the market, sales stability in the market, discouragement of new competitors, maintenance of existing customers, long term survival (Avlonitis & Indounas, 2005). TYPES OF PRICING STRATEGIES 1. Pricing at a Premium With premium pricing, businesses set costs higher than their competitors. Premium pricing is often most effective in the early days of a product’s life cycle, and ideal for small businesses that sell unique goods. Because customers need to perceive products as being worth the higher price tag, a business must work hard to create a value perception. Along with creating a high-quality product, owners should ensure their marketing efforts, the product’s packaging and the store’s décor all combine to support the premium price. 2. Pricing for Market Penetration Penetration strategies aim to attract buyers by offering lower prices on goods and services. While many new companies use this technique to draw attention away from their competition, penetration pricing does tend to result in an initial loss of income for the business. Over time, however, the increase in awareness can drive profits and help small businesses to stand out from the crowd. In the long run, after sufficiently penetrating a market, companies often wind up raising their prices to better reflect the state of their position within the market. 3. Economy Pricing Used by a wide range of businesses including generic food suppliers and discount retailers, economy pricing aims to attract the most price-conscious of consumers. With this strategy, businesses minimize the costs associated with marketing and production in order to keep product prices down. As a result, customers can purchase the products they need without frills.

While economy pricing is incredibly effective for large companies like Wal-Mart and Target, the technique can be dangerous for small businesses. Because small businesses lack the sales volume of larger companies, they may struggle to generate a sufficient profit when prices are too low. Still, selectively tailoring discounts to your most loyal customers can be a great way to guarantee their patronage for years to come. 4. Price Skimming This is designed to help businesses maximize sales on new products and services. Price skimming involves setting rates high during the introductory phase. The company then lowers prices gradually as competitor goods appear on the market. One of the benefits of price skimming is that it allows businesses to maximize profits on early adopters before dropping prices to attract more price-sensitive consumers. Not only does price skimming help a small business recoup its development costs, but it also creates an illusion of quality and exclusivity when your item is first introduced to the marketplace. 5. Psychology Pricing Psychology pricing refers to techniques that marketers use to encourage customers to respond on emotional levels rather than logical ones. For example, setting the price of a watch at $199 is proven to attract more consumers than setting it at $200, even though the true difference here is quite small. One explanation for this trend is that consumers tend to put more attention on the first number on a price tag than the last. The goal of psychology pricing is to increase demand by creating an illusion of enhanced value for the consumer. 6. Bundle Pricing With bundle pricing, small businesses sell multiple products for a lower rate than consumers would face if they purchased each item individually. Not only is bundling goods an effective way of moving unsold items that are taking up space in your facility, but it can also increase the value perception in the eyes of your customers, since you’re essentially giving them something for free. Bundle pricing is more effective for companies that sell complimentary products. For example, a restaurant can take advantage of bundle pricing by including dessert with every entrée sold on a particular day of the week. Small businesses should keep in mind that the

profits they earn on the higher-value items must make up for the losses they take on the lower-value product.

SIGNIFICANCE OF PRICING Pricing strategies are important, but it’s also important to not lose sight of the price itself. Here are five things to consider, alongside your strategy, when pricing your products. 1. Effect of Price on Profit Margins The price you set affects your profit margin per unit sold, with higher prices giving you a higher profit per item if you don’t lose sales. However, higher prices that lead to lower sales volumes can decrease, or wipe out, your profits, because your overhead costs per unit increase as you sell fewer units. 2. Effect of Price on Sales Volumes One of the most obvious affects pricing will have on your business is an increase or decrease in sales volume. Economists study price elasticity, or the response of consumer purchasing to a price change. Increasing your prices might lower your sales volume only slightly, helping you make up for decreased volume with higher total profits generated by higher margins. Lowering your prices can increase your profits if your sales jump significantly, decreasing your overhead expense per unit. Test the market’s response to price increases by changing prices in targeted areas before instituting an across-the-board price increase. 3. Price and Business Positioning The price you set sends a message to some consumers about your business, product or service, creating a perceived value. This affects your brand, image or position in the marketplace. For example, higher prices tell some consumers that you have higher quality, or you wouldn’t be able to charge those prices. Other consumers look for low-priced products and services, believing they’ll get the quality they need at a low price. Offering sales, discounts, rebates and closeouts can send the message you can’t sell your products or services at your regular price, or tell buyers they have a short-term opportunity to get a bargain.

4. Market Share and Competition The price you set makes you more or less competitive in the marketplace, affecting your share of the market’s volume. Some businesses lower prices temporarily to gain market share from competitors, who can’t respond to and meet a price decrease. After consumers have had time to try your product and develop a brand preference or loyalty, you can raise your prices again to a level that won’t cause them to leave you. Predatory pricing is the practice of selling a product or service below cost for the specific purpose of taking market share away from a competitor or closing it down, then raising prices on consumers when they have fewer, or no options after that competitor is gone. This is illegal. 5. The Use of Loss Leaders Some businesses price products or services at or below cost to get customers into their businesses, who then spend more money elsewhere. For example, big-box retailers might buy large quantities of tennis balls, selling them at or below cost to entice affluent tennis players who use many cans of balls during the year into their stores. By placing the low-cost balls at the back of the store, they hope to generate impulse buys as the shopper walks to the sports arena and back to the front. Restaurants offer low-margin specials to offer a change-of-pace to regular diners to keep their normal business, or to let regulars bring friends who want upscale dishes at a moderately priced eatery.

OBJECTIVES OF PRICING Pricing objectives reflect the overall goals a firm wants to accomplish through pricing. Some of the pricing objectives include: 1. Profits-related Objectives Profit has remained a dominant objective of business activities. Company’s pricing policies and strategies are aimed at following profits-related objectives:

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Maximum Current Profit

One of the objectives of pricing is to maximize current profits. This objective is aimed at making as much money as possible. Company tries to set its price in a way that more current profits can be earned. However, company cannot set its price beyond the limit. But, it concentrates on maximum profits. 

Target Return on Investment

Most companies want to earn reasonable rate of return on investment. Target return may be: (1) Fixed percentage of sales (2) Return on investment (3) Fixed rupee amount. Company sets its pricing policies and strategies in a way that sales revenue ultimately yields average return on total investment. 2. Sales-related Objectives The main sales-related objectives of pricing may include: 

Sales Growth

Company’s objective is to increase sales volume. It sets its price in such a way that more and more sales can be achieved. It is assumed that sales growth has direct positive impact on the profits. Pricing decisions are taken in way that sales volume can be raised. Setting price, altering in price, and modifying pricing policies are targeted to improve sales. 

Target Market Share

A company aims its pricing policies at achieving or maintaining the target market share. Pricing decisions are taken in such a manner that enables the company to achieve targeted market share. Market share is a specific volume of sales determined in light of total sales in an industry. For example, company may try to achieve 25% market shares in the relevant industry.

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Increase in Market Share

Sometimes, price and pricing are taken as the tool to increase its market share. When company assumes that its market share is below than expected, it can raise it by appropriate pricing; pricing is aimed at improving market share. 3. Competition-related Objectives Competition is a powerful factor affecting marketing performance. Every company tries to react to the competitors by appropriate business strategies. With reference to price, following competition-related objectives may be prioritized: 

To Face Competition

Pricing is primarily concerns with facing competition. Today’s market is characterized by the severe competition. Company sets and modifies its pricing policies so as to respond the competitors strongly. Many companies use price as a powerful means to react to level and intensity of competition. 

To Keep Competitors Away

To prevent the entry of competitors can be one of the main objectives of pricing. The phase ‘prevention is better than cure’ is equally applicable here. If competitors are kept away, no need to fight with them. To achieve the objective, a company keeps its price as low as possible to minimize profit attractiveness of products. In some cases, a company reacts offensively to prevent entry of competitors by selling product even at a loss. 

To Achieve Quality Leadership by Pricing

Pricing is also aimed at achieving the quality leadership. The quality leadership is the image in mind of buyers that high price is related to high quality product. In order to create a positive image that company’s product is standard or superior than offered by the close competitors; the company designs its pricing policies accordingly. 

To Remove Competitors from the Market

The pricing policies and practices are directed to remove the competitors away from the market. This can be done by forgoing the current profits by keeping price as low as possible

in order to maximize the future profits by charging a high price after removing competitors from the market. Price competition can remove weak competitors. 4. Customer-related Objectives Customers are in center of every marketing decision. Company wants to achieve following objectives by the suitable pricing policies and practices: 

To Win Confidence of Customers

Customers are the target to serve. Company sets and practices its pricing policies to win the confidence of the target market. Company, by appropriate pricing policies, can establish, maintain or even strengthen the confidence of customers that price charged for the product is reasonable one. Customers are made feel that they are not being cheated. 

To Satisfy Customers

To satisfy customers is the prime objective of the entire range of marketing efforts. And, pricing is no exception. Company sets, adjusts, and readjusts its pricing to satisfy its target customers. In short, a company should design pricing in such a way that results into maximum consumer satisfaction. 5. Other Objectives Over and above the objectives discussed so far, there are certain objectives that company wants to achieve by pricing. These objectives include: i.

Market Penetration

This objective concerns with entering the deep into the market to attract maximum number of customers. This objective calls for charging the lowest possible price to win price-sensitive buyers. ii.

Promoting a New Product

To promote a new product successfully, the company sets low price for its products in the initial stage to encourage for trial and repeat buying. The sound pricing can help the company introduce a new product successfully.

iii.

Maintaining Image and Reputation in the Market

Company’s effective pricing policies have positive impact on its image and reputation in the market. Company, by charging reasonable price, stabilizing price, or keeping fixed price can create a good image and reputation in the mind of the target customers. iv.

To Skim the Cream from the Market

This objective concerns with skimming maximum profit in initial stage of product life cycle. Because a product is new, offering new and superior advantages, the company can charge relatively high price. Some segments will buy product even at a premium price. v.

Price Stability

Company with stable price is ranked high in the market. Company formulates pricing policies and strategies to eliminate seasonal and cyclical fluctuations. Stability in price has a good impression on the buyers. Frequent changes in pricing affect adversely the prestige of company. vi.

Survival and Growth

Pricing is aimed at survival and growth of company’s business activities and operations. It is a fundamental pricing objective. Pricing policies are set in a way that company’s existence is not threatened. FACTORS AFFECTING PRICING 1. Product Cost The most important factor affecting the price of a product is its cost. Product cost refers to the total of fixed costs, variable costs and semi variable costs incurred during the production, distribution and selling of the product. Fixed costs are those costs which remain fixed at all the levels of production or sales. The price for a commodity is determined on the basis of the total cost. So sometimes, while entering a new market or launching a new product, business firm has to keep its price below the cost level but in the long rim, it is necessary for a firm to cover more than its total cost if it wants to survive amidst cut-throat competition.

2. The Utility and Demand Consumers demand more units of a product when its price is low and vice versa. However, when the demand for a product is elastic, little variation in the price may result in large changes in quantity demanded. In case of inelastic demand, a change in the prices does not affect the demand significantly. Thus, a firm can charge higher profits in case of inelastic demand. Moreover, the buyer is ready to pay up to that point where he perceives utility from product to be at least equal to price paid. Thus, both utility and demand for a product affect its price. 3. Extent of Competition in the Market The nature and degree of competition in the market is a factor that affects the price for a product. A firm can fix any price for its product if the degree of competition is low. However, when the level of competition is very high, the price of a product is determined on the basis of price of competitors’ products, their features and quality etc. For example, MRF Tyre company cannot fix the prices of its tyres without considering the prices of Bridgestone Tyre Company, Goodyear Tyre company etc. 4. Government and Legal Regulations The firms which have monopoly in the market, usually charge high price for their products. In order to protect the interest of the public, the government intervenes and regulates the prices of the commodities for this purpose; it declares some products as essential products for example. Lifesaving drugs etc. 5. Pricing Objectives Another important factor, affecting the price of a product or service is the pricing objectives. Following are the pricing objectives of any business: (a) Profit Maximization: Usually the objective of any business is to maximize the profit. During short run, a firm can earn maximum profit by charging high price. However, during long run, a firm reduces price per unit to capture bigger share of the market and hence earn high profits through increased sale

(b) Obtaining Market Share Leadership If the firm’s objective is to obtain a big market share, it keeps the price per unit low so that there is an increase in sales. (c) Surviving in a Competitive Market If a firm is not able to face the competition and is finding difficulties in surviving, it may resort to free offer, discount or may try to liquidate its stock even at BOP (Best Obtainable Price). (d) Attaining Product Quality Leadership Generally, firm charges higher prices to cover high quality and high cost if it’s backed by above objective. 6. Marketing Methods Used The various marketing methods such as distribution system, quality of salesmen, advertising, type of packaging, customer services, etc. also affect the price of a product. For example, a firm will charge high profit if it is using ex...