Pricing: Methods and Strategies
1. Learning Outcome
After completing this module, the students will be able to:
Describe the concept of price
Explain various methods of determining price
Understand different pricing policies.
Explain various pricing strategies followed by firms
2. Meaning
Price denotes the value of product or service expressed in monetary terms which a consumer pays or is expected to pay in exchange of expected utility. Price is the amount charged for product or service which is inclusive of any warranties, discounts, guarantees, services that are part of conditions of sale.
Pricing is the act of determining product value in monetary terms by the marketing managers before it is offered for sale to target consumers.
Price is a powerful marketing instrument. It has a unique role in marketing. It is the only marketing variable to determine revenues or inflow of funds. It is essential for the firm to determine a right price to achieve the goal of maximum profits and large market share.
3. Types of Prices
Administered Price : It is the price set by marketing manager or authorized company official after considering various factors such as cost, demand, competition, customer expectation, value of products, image of the company etc. It is the result of conscious and deliberate managerial action. The administered price does not change frequently and is fixed for a number of sales transactions or for a certain time period. Different price structures may be developed to meet market requirements or consumer needs. The administered prices of homogenous products in the market are more or less similar. In such cases, companies resort to non-price competition such as after sale services, free home delivery, liberal credit, sales promotion, money back guarantee, advertising, product improvements, personal salesmanship and product innovations, branding or packaging. Thus, it is the administered price in which the firms or marketers are more interested to achieve pricing as well as marketing objectives.
Regulated Price : The administered price may lead to consumer exploitation and harm national interests. That is why these prices are usually subject to government regulations. Thus, regulated price is the price set as per government regulations. It may take any of the two forms. First, setting the price as per the formula or method laid down by the state as applicable in cotton textile industry. Second, setting the prices as stated by government agency. In India, for example, it is applicable in steel and aluminium industries.
In real life situation, the administered price is set within the framework of government regulations and its determination is the major concern for marketing managers. For this, they can opt for any method as described in further discussion.
4. Methods of Price Determination
There are various methods of price determination. These have been categorised as follows:
(i) Cost based method or cost plus method
(ii) Demand based method
(iii) Hybrid method or cost-demand based method
(iv) Competition based method
(v) Perceived value pricing method
(i) Cost Based Method: In this method, price is determined on the basis of cost of manufacturing a product. A certain percentage of cost, known as mark up, is added to the cost. Cost based price is also called as ‘floor price’ as any sale below this price would mean loss to the organisation. This is simple and a popular method used by many companies in India.
The cost taken as base may be total cost or incremental cost. Total cost includes fixed costs and variable costs. Fixed costs are the costs which remain fixed upto a certain level and do not vary with the level of production. They get distributed more and more among the units produced as the production rises. Depreciation, rent of building, salary of administrative staff are few examples of fixed costs. Variable costs, on the other hand, vary in direct proportion to level of production. These costs include direct wages, cost of raw material and selling and distribution expenses etc.
Incremental costs are the additional costs which are incurred due to changing the level or nature of activity such as using new machinery or adding new product. When a firm uses total cost for pricing a product, it is called full cost pricing while use of incremental cost as base is referred to as contribution pricing.
Further cost, as mentioned above, may be historical cost (i.e. actual cost incurred), standard cost (the cost which should be under assumed standard conditions of volume) or expected cost (forecast of actual cost for the pricing period).
Cost plus method is simple as cost is comparatively easy to estimate or ascertain. It assures the recovery of cost of production and is considered best to neutralize the impact of cyclical shifts in business. The advocates of this method consider it socially fair as the firms do not try to earn more profit in case of rising demand by charging higher prices. This method is suitable in case of highly unpredictable future environment.
Cost plus method has certain weaknesses. It is difficult to allocate joint cost among different products. This method completely ignores demand factor which also influences price. It is difficult to use this method in case of new products. This method does not take into consideration the probable competitive reactions. Historical cost base method may not be relevant to the pricing situation. In some cases, opportunity cost may be more relevant but it is not available through accounting records. Under this method, management fails to take initiatives for optimizing product mix (as every product is profitable) and reducing those inefficiencies which lead to cost increase.
(ii) Demand Based Price
The price can be determined on the basis of demand. Management may ignore cost and allow demand to determine price. In this method, price can be determined in any of the following ways :
Test marketing : For setting the initial price i.e. base price, a firm can place a product with different prices in different markets under controlled conditions on a trial base and prepare a demand schedule indicting demand (sales volume or revenue) at different prices. Management can select that price which is ensuring maximum revenue. Thus, this method provides a rough estimate of demand which is reliable to some extent.
Charge what the traffic will bear : Here the idea is to charge that maximum price what the customer can or may be made to pay depending on skill of seller and demand intensity. No base price or list price is determined and price varies from consumer to consumer. With passage of time, it becomes easy to arrive at a price acceptable to consumer. In India, this method is usually adopted by railways and professionals like doctors, lawyers etc.
Forecasting : Price may be determined on the basis of forecast of demand trends by looking into demand data available from company records or other sources and preparing demand schedules keeping in mind the possible future trends.
The demand based pricing considers consumers’ price elasticity. It also takes into consideration consumer preferences. This method removes the weaknesses of cost plus pricing method as discussed earlier. But it is not socially fair and also ignores the need of competitive harmony in some cases.
Both cost plus and demand based methods have their own merits and demerits. Hence, any one method is imperfect as there is consideration of only one factor either cost or demand. However, for effective pricing both cost and demand should be considered and thus, a hybrid method can be followed.
(iii) Hybrid method or cost-demand based method : This method considers cost and demand factors and then determines a realistic price. Cost data is obtained from accounting records. Management also prepares demand schedules which depict consumer demand and revenue generation at different price levels. Management carries out break even analysis i.e. determines the relationship between cost, profit and volume to determine the base price.
This method is more realistic in case demand and cost are relatively stable. But it can not be used if demand estimates are inaccurate and frequent fluctuations occur in cost. This method also ignores the competition prevailing in the market.
(iv) Competition based method: Management can determine the price of product on the basis of price charged by competitors selling similar products. It can fix the price of product more or less same the price of competitors without giving any due consideration to cost of production/sales and demand situations.
The price prevailing in the market is ascertained first and then middlemen’s margin (as prevailing) is deducted from this price. This enables management to fix a price ceiling irrespective of its cost and demand constraints.
This method is suitable when products are homogeneous and their market is highly competitive. However, in case of differentiated products, this method is not suitable. This method compels management to exercise cost control methods to increase profits. Management cannot resort to price increase as it will lead to fall in market share.
(v) Perceived value pricing method : This method suggests that price should be determined on the basis of consumers’ perception of utility of the product. The argument in the support of this method is that consumers make comparison of the cost of the product to them and the benefits (utility, durability, reliability) they will get from the product and then take a purchase decision. Management should make cost-benefit trade off while determining price of the product. However, this includes creativity and complex calculations.
Various methods described above provide the understanding about various ways in which pricing of the product can be done. Each method has its own merits and demerits. The selection of appropriate method will depend upon the needs of the management and its readiness to accept strengths and weaknesses associated with a particular method.
5. Pricing policies
Pricing policies act as guidelines to management to evolve appropriate pricing decisions which can match prices with market needs. Various pricing policies have been described as follows:
Leader Price Policy : In this policy, the firm sets the price with an aim that this will be followed by other firms in the industry. The firms which have a substantial share in market, take lot of initiative, have good reputation and deal in highly standardized products use this policy. The non-leading firms i.e. followers have no other option than to follow the leader in their price fixing.
Geographic price policy : Under this, management charges different prices from buyers depending upon their locations and transportation cost involved. Management follows this policy due to wide geographical distances between manufacturing centres and consuming centres. This ensures competitiveness of firms’ products and helps in maintaining market share. The firm can mention ex-factory price in which the buyer has to bear the cost of transportation or it can fix price inclusive of freight and other transportation charges.
Flexible price policy : It is also called as variable or negotiated price policy. In this policy, seller charges different prices from different buyers for the sale of similar goods in comparable quantities at a given time under similar conditions of sale.
Seller may also charge different prices from different group of buyers purchasing in comparable quantities. He may set one price for wholesalers, one price for retailers and one price for distributors. Thus, price within the group remains same but it differs among groups. This policy is also termed as non-variable policy by some authors as price within the group remains same. This policy provides flexibility but creates dissatisfaction among consumers due to discrimination by seller.
Flexible price policy is suitable when products are not standardized and individual sale transaction involves large quantity and sums.
Single price or one price policy : It refers to setting one price for all buyers irrespective of their class, quantity ordered or condition of purchase. There is no question of bargaining. It saves a lot of time of salesman. This policy secures confidence of customers and helps in maintaining seller’s goodwill. But it does not provide any incentive for bulk purchases.
Psychological price policy : It means setting the prices at odd points e.g. Rs. 1999, Rs. 995 etc. to influence the psyche of customer. It is based on the belief that a customer is mentally prepared to pay a little less than the rounded figure like Rs. 995 instead of Rs. 1000. It can create expected motivation. Thus, more goods can be sold at psychological odd prices. This policy is followed mostly in consumer goods industry. In India, Bata India Ltd use this policy for shoe wears.
Price differentials policy
Under this policy, actual price charged is less than the quoted price and difference is termed as price differentiation. Price differentials are the tactics used by the marketers to meet competitive pressures, to allow incentives to buy or to achieve specific financial objectives. The price differentials are usually designed in following forms:
Discounts: These are allowed to buyers as a result of specific services provided by them or meeting managerial expectations. Sometimes discounts are given for buying products in off season. These can be categorized as:
Trade discount
Quantity discount
Cash discount
Seasonal discount
Trade discount is allowed as deduction from quoted price to buyers occupying specific position in distribution channels like wholesalers, retailers.
Quantity discount is allowed to all the buyers as a result of purchasing a specific quantity of goods. They get deduction from quoted price.
Cash discount is allowed to the buyers who pay the price within a stipulated time. They get deduction from invoice price i.e. quoted price-rebate-trade or quantity discount
Sometimes, the manufacturer allows seasonal discount of say 15% or 10% to dealer, wholesaler, retailer or customer for placing order during slack season. It helps in effective use of plant and manufacturing facilities. It shifts the storing function from manufacturer to middlemen or customers. For example, manufacturers of woollen garments or heaters give seasonal discount during summer season.
Rebates: These are allowed to buyer by way of deduction from quoted price to accommodate various claims of buyers like defective deliveries of goods , delay in transit etc.
Allowances : The manufacturer may offer promotional allowances to intermediaries e.g. window display allowance or advertising allowance. There will be price reduction of an equal amount of service expected.
Price differentials may raise net price payable in relation to quoted price e.g. a firm may charge extra price for warranty besides the quoted price. Firm, thus, gets a remunerative price.
Dual price policy : It means charging different prices on the principle of usage and ability to pay e.g. electricity company use different rates for industrial and domestic users.
Premium pricing policy : This policy is used when the firm has a premium product i.e. good variety/superior quality. Firm employs premium promotion programmes and charges higher prices by ensuring customers that they are getting good value for money. This policy is adopted by established marketers. They have buyers who are willing to pay higher price for good quality product and wider choice. In India, Reliance adopted this policy for Vimal fabrics.
6. Pricing Strategies
Strategy is a competitive policy. There are various strategies available to firm to face market competition and achieve pricing objectives. At different times, it can use different strategies as per market requirements and its own need. The various pricing strategies are described as under:
Skimming pricing strategy: In this strategy, higher prices are charged to fully exploit the product distinctiveness by offering product to consumers in high income level group. It provides huge profits in short time. Marketers use skimming strategy at the initial stage of product which is distinctive and has price inelastic demand in the high income customer group.
Penetration pricing strategy: It refers to charging low initial price of product with a view to stimulate rapid and wide spread market acceptance. Once the product is accepted, the prices are increased. Penetration strategy is used in the initial stage of product if the product is not much innovative and its demand is highly elastic.
Pre- emptive pricing strategy: This strategy is also called stay out pricing strategy and is represented by very low price with a purpose of restricting entry of competitors.
Extinction pricing strategy: Under this strategy, a very low level of price is fixed to eliminate the existing competitors in the industry. The remaining inefficient firms will break even.
However, these strategies can be grouped as high price strategies and low price strategies. A firm can choose high price strategy or low price strategy as per the prevailing conditions.
Conditions favouring High Price Strategy
This strategy can be preferred under following conditions :
Goods are durable.
It is possible to make income based market segmentation and serve high income market segment first.
Demand is price inelastic due to product distinctiveness.
There is need for a cushion against possible adverse impact of initial pricing error.
Many ancillary services are required.
Production is as per order of customer.
High sales promotion expenditure is required.
Firm desires to keep demand within the limits of its production capability.
Firm prefers small market share at the initial stage.
Product package is unique.
Firm wants to generate more profits.
Firm needs funds for research and development expenditure to face competition in future.
Low stock turnover is expected.
Conditions favouring Low Price Strategy
This strategy can be preferred under following circumstances:
Firm desires a large market share.
There is high degree of price elasticity of demand.
Less sales promotion expenses are required.
High stock turnover is expected.
Tough competition is expected soon after the introduction of product in the market. In such case, low price will discourage entry of competitors.
Less additional services are required.
Goods are perishable.
High income market segment is not large enough to follow high price strategy.
Product is not highly distinctive.
Low price can generate more sales volume and help in realizing economies of large scale.
Thus, a firm can follow high price strategy or low price strategy depending upon the above mentioned conditions. However, the basic criterion usually remains product differentiation. As long as, there is no fear of loss of product distinctiveness, high price strategy (skimming price) can be followed. But if there is fear of high level of competition after product’s entry in the market, low or penetration policy can be followed.
In the introduction stage of product life cycle, a high price strategy and high expenditure on promotion will be beneficial. But at later stages of product life cycle low price strategy and normal promotion expenditure will be beneficial.
