ISSUES INVOLVED IN PRICING

Discussions of issues related to pricing of: Aviation Industry Tariffs, Rental for a multiplex at Worli seaface

Submitted by R.M. CHATURVEDI PhD Batch 2005 To

Dr. H Mankad As part of economics course Delivered By Dr. H Mankad, Ex Director NMIMS

In partial fulfillment of the requirements for the DOCTORAL PROGRAMME IN MANAGEMENT (Ph.D.) BUSINESS MODEL FOR SERVICE INDUSTRIES IN COMPETITIVE ENVIRONMENT (An analytic study for telecom sector) Under the guidance of Dr. Bal Chansarkar Senior Professor, Middlesex University Dr. Bindi Mehta Chairperson, Research and Publications, NMIMS At

NARSEE MONJEE INSTITUTE OF MANAGEMENT STUDIES

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MAIN ISSUES INVOLVED IN PRICING

R M Chaturvedi Ph D Batch NMIMS Mumbai Just as management, pricing is also an art and a science. Pricing strategies for various products and services have been changing as economy is changing. Price plays a much important role as price defers from the other three marketing mix elements in that, it produces revenue while the other elements create cost. And as such for a company to realize its maximum profit potential, the most effective way for a company is to get its pricing right. It is also to highlight that it may be a very difficult and lengthy exercise to rectify the pricing wrongs. Once a bad price is established it can be devilish to fix it. Importance of pricing right can be stated as, while poor marketing can damage an organization; poor pricing can damage a market. Because pricing decisions not only effect your own organization but they also have a major impact on the whole market as other companies can not ignore and have to respond to the marketing strategies of their competitors. In this communication I am going to discuss various issues involved in pricing along with the two examples for pricing strategies. Various pricing methodology are used for deciding the price. Few important ones are placed below: 1. Cost plus pricing. Cost plus pricing and its variants will provide for calculation of the cost of a product along with an additional mark up which may be based on target ROI. This method is utilized for services where what the cost is, may be calculated based on activity based costing. Typical examples will include catering and shared corporate services. While this method has simple formula and standard mark up, it has the disadvantage of ignoring the demand and the value customer places, on the product as well as competition. While calculating the cost there may be flawed procedures. This type of pricing may result in overprice in weak markets and under price in strong markets.

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2.

Market driven, competitive pricing. In this case market and the competition determine or have major influence on the price. i.e. the underlying personality of the purchaser and characteristics of the products have major influence on the price. Airlines and internet service providers etc. have to use this method. While this method is always competitive or near competitive on price, it ignores the fact that price does not always drive the purchase decision and ignores the value to the customer and value of non price attributes.

3.

Non linear / two part pricing. This method provides for two separate charges for consumption of a single product i.e. the total cost may constitute a fixed component and a variable component and the fixed price paid may determine the variable price paid. Amusement parks (entry and per ride fee) and utilities such as telephone, gas, electricity, water etc. use this pricing method. This pricing method encourages greater usage, fixed cost covers the cost of providing infrastructure and reduces churn by creating switching cost. However, it requires complex decision making with significant amount of data, and discounts for high volumes become necessary as willingness to pay declines. The communication of this pricing can also become complex and difficult.

4.

Dynamic pricing. Industries like internet cafes, stocks and commodities, road products etc. need continuous adjustment in pricing and as such free and continuous fluctuations in prices in line with demand and supply become a important characteristics of pricing methodology. Dynamic pricing also includes revenue / yield management and auction. Dynamic pricing has the advantage of discovering the market clearing price, minimizing the consumer surplus and is suitable

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for highly uncertain markets. However, it generally requires dedicated pricing resources and mistakes can be very costly. 5. Value based pricing. One of the important methods evolving for the product and services which provide value to the customer is to price a product or service or a component of it according to the value it delivers to the purchaser. The examples would include online advertising and pay performance listings, in various search engines. The value based pricing is designed to capture more value and not more sales and it is equitable. However, at times it can be difficult to sell to customer, measurement of value has to be fair and accurate, and it has to be known what customers value. Supply and Demand: While above considerations are based on marketing view point as far as economics is concerned price is primarily decided by the functions of demand and supply. As we all know the supply is a upward sloping curve and demand is a downward sloping curve. The two intersect at an equilibrium price point where supply equals the demand. As the price increases the customers would be less willing to buy but at the same time producers will be willing to produce more. The supply and demand will further depend on some other issues placed below: Marginal revenue and cost: Marginal revenue from the sale should exceed the marginal cost to produce and the enterprise would continue to produce until its M.R. = M.C. as at this point of equilibrium the marginal profit on the next unit sold will equal zero. And as such no profits are left on the table. Further the capacity will also play a role as once a factory reaches capacity, the marginal cost of producing one additional unit will be very high and increases beyond the cost of the last unit produced. However, marginal revenue concept can only be used for additional business and the fixed or basic cost has to be recovered from the regular customers. Hence marginal costs and revenues are critical in making marginal pricing and production decisions but to evaluate profitability of an
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entire business rather than one transaction it is total revenue which must exceed total cost to make a bottom-line company profit. Price elasticity of demand: Elasticity of demand i.e. buyers responsiveness or sensitivity to change in price plays a important role in pricing decisions. Every company wants to know how a price change will effect demand for their brand. When consumers are not sensitive to prices the demand is stated to be inelastic. Necessities such as medical services or cigarettes fall into this category. Quantification of elasticity is done by calculation of elasticity coefficient. Usually, a great deal of research is necessary to determine elasticity and use of historical data with elimination of non price influences is used to calculate elasticity. Further, elasticity is not constant at all price levels. For example at lower price levels the demand may be relatively inelastic but at higher price levels it may become elastic. Those with unlimited cash tend to be more price inelastic and buy regardless of price. For a company what really matters is not elasticity of quantity demanded but elasticity of total revenue which are two different things. As those who are willing to buy at higher prices, make up for the lost revenue of higher sales volumes. Competition: Another important issue in making pricing decision is the competitive environment which drives supply, demand and prices. The greater the competition in a given market, the more sensitive the market prices are to changes in supply and demand. To take an example, this is why diamond prices remain high and relatively stable and predictable in contrast to gold prices. Pricing decision will depend on the market structure of the product / service i.e. Pure monopoly. Oligopoly. Monopolistic competition. Pure competition. Organizational Strategy: Pricing will also depend on companys strategy as to whether the company wants to follow the skimming strategy or penetration strategy.
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Skimming pricing strategy will set higher prices related to value, will focus on margins rather than volume, and be used for products with short life cycle, high barriers to entry, inelastic demand, clear competitive advantage and well defined market segments. Penetration pricing strategy would be used to penetrate the market at large with low prices related to value, will focus on volumes rather than margins and will be used for products with long product life cycles, low barrier to entry, elastic demand and where economies of a scale or experience plays a role. Penetration pricing strategy can undermine prestige brands. The Product Life Cycle: Pricing decision will depend on the stage of the product in its life cycle. i.e. infancy, growth, maturity or decline and also as per the innovation adopting stage i.e. the price is set for innovators, early adopters, early majority, late majority or laggards. It is to highlight that catching up is cheaper than trailblazing as a second mover can see what works. Traditional economic theory usually talks about two parties i.e. a buyer and seller while in reality there are many more players. Further it assumes and analyses as if the firms sell a single product only, while in reality firms sell several products which may partially form substitute to each other. The economic theory also assumes that the firm seeks to maximize profits while in fact non profit objective may also exist. These factors which differentiate pricing decision based on economic theory from the pricing decisions based on marketing concepts have to be considered while deciding prices for markets.

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Issues related to pricing for Indian Airlines:

Indian Airlines is incumbent air transport service provider in India and is now facing competition from various other private air transport service providers. It provides full range of services and is a high cost schedule airline, has a network for long and short haul travel, has multiple classes and multiple distribution channels. The company has low to medium aircraft utilization, uses large as well as small airports managed by Airport Authority of India and has multiple aircraft types. The airline is facing competition from airlines providing full service as well as from low cost airlines and airlines operating in limited sectors. The low cost airlines are using low tariff to attract customers, have point to point short haul travel, provide no frills one class service, preferably use direct sale through multiple channels and aim high aircraft utilization etc. In view of this, Indian Airlines has to use pricing strategies which are competitive in nature and focus on its competitive advantage to maintain its competitiveness and profitability. It may consider and take following steps while deciding its pricing strategies. Maximum the load factor first and then the yield. Offer competitive fares within market. Benchmark for a minimum of half full service airline by providing fully flexible fares. Dynamic price according to demand, route, season etc. Increase fares as flight departure approaches. Not to sell flights out before day of departure. Target excess seats with promotions. Overbook where possible Airline market has shifted from monopoly to oligopoly wherein there are only a few suppliers for the services with practically no substitute. As there are only few competitors prices can be maintained at high levels if the service providers choose not to compete on prices. However, Indian Airlines being an incumbent service provider and belonging to government sector has a important role to play in benchmarking the prices as per government policy. In case the market players are not able to settle to avoid competing on price, price wars will break out. However, once it becomes clear that nobody can win as happens in oligopoly; oligopolyst return prices to higher
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levels. We have been watching this for some time and the prices have been fluctuating in past. In the air transport market there have been clear segmentation of the market based on time of purchase by Indian Airlines as well as other players. There is wide range of fares to cover all market conditions.

Pricing issues for rental for a multiplex at Worli Seaface

Following issues need to be considered and kept in view while taking pricing decisions for rental, for a multiplex at Worli Sea face. Worli sea face is an important locality located about 10 kms from the southern tip of Mumbai city and unlike Marine Drive which also provides a nice sea face has a more active sea and the sea waves are much stronger. Hence it is visited by many tourists and residents of Mumbai. Worli sea face is situated away from any suburban railway station and as such visitors are either staying in surrounding areas or visit the same by their own vehicles which ascertain the class of persons visiting that area. There is already a very popular mall named Big Bazar which is not far from Worli and lot of further malls, multiplexes and residential complexes are under construction and further planned for construction in the nearby area of Parel / Lower Parel where the land has become available due to closing of various textile mills. However, Worli Sea face has a added attraction that the visitors can have a nice view of sea in addition to visiting the multiplex which will provide additional reason of entertainment and hanging around. In view of this, the persons visiting can be clearly categorized as those visiting for fun and will do impulse buying or those who will plan the visit, will belong to higher middle or higher income group and will visit for repeated purchases. As Worli Sea face provides a unique characteristic of availability of a large well maintained sea face and a tourist attraction, this uniqueness can be used to advantage in pricing which can be leveraged through increasing the prospective customer base through advertising and increasing awareness through multiple channels including Internet.
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Thus we have seen and discussed important issues involved in pricing relate to economic considerations as well as marketing considerations and organizational strategy. Pricing has a very important role to play and must be given due consideration as it effects not only profitability of the company but market as a whole.

R M Chaturvedi Ph D Batch II NMIMS, Mumbai

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