Objectives of Pricing Policy.

The pricing policy of the firm may vary from firm to firm depending on its objective. In practice,
we find many prices for a product of a firm such as wholesale price, retail price, published price,
quoted price, and actual price.

Special discounts, special offers, methods of payment, amounts bought and transportation
charges, and trade-in values are some sources of variations in the price of the product. For any
pricing decision to succeed, one has to define the price of the product very carefully.

Pricing decision of a firm in general will have considerable repercussions on its marketing
strategies thus, when the firm makes is setting a price, it has to consider its entire marketing
efforts. Pricing decisions are usually considered an integral part of the general strategy for
achieving a broadly defined goal.

While setting the price, the firm may aim at the following objectives:

(i) Price-Profit Satisfaction.

The firms are interested in keeping their prices stable within certain period of time irrespective of
changes in demand and costs, so that they may get the expected profit.

(ii) Sales Maximization and Growth.

A firm has to set a price which assures maximum sales of the product. Firms set a price which
would enhance the sale of the entire product line in order to achieve growth.

(iii) Making Money.

Some firms want to use their special position in the industry by selling their product at a
premium and make quick profit as much as possible.

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(iv) Preventing Competition.

Unrestricted competition and lack of planning can result in wasteful duplication of resources.
The price system in a competitive economy might not reflect society’s real needs. By adopting a
suitable price policy the firm can restrict the entry of rivals.

(v) Market Share.

The firm wants to secure a large share in the market by following a suitable price policy. It wants
to acquire a dominating leadership position in the market. Many managers believe that revenue
maximization will lead to long run profit maximization and market share growth.

(vi) Survival.

In these days of severe competition and business uncertainties, the firm must set a price which
would safeguard the welfare of the firm. A firm is always in its survival stage. For the sake of its
continued existence, it must tolerate all kinds of obstacles and challenges from the rivals.

(vii) Market Penetration.

Some companies want to maximize unit sales. They believe that a higher sales volume will lead
to lower unit costs and higher long run profits; in this way they set the lowest price, assuming the
market is price sensitive.

(viii) Marketing Skimming.

Many companies favor setting high prices to ‘skim’ the market. Dupont is a prime practitioner of
market skimming pricing. With each innovation, it estimates the highest price it can charge given
the comparative benefits of its new product versus the available substitutes.

(ix) Early Cash Recovery.

Some firms set a price which will create a mad rush for the product and recover cash early. They
may also set a low price as a caution against uncertainty of the future.

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(x) Satisfactory Rate of Return.

Many companies try to set the price that will maximize current profits. To estimate the demand
and costs associated with alternative prices, they choose the price that produces maximum
current profit, cash flow or rate of return on investment.

Considerations in formulating the Pricing Policy.

The following considerations are involved in formulating the pricing policy:

(i) Competitive Situation.

Pricing policy is to be set in the light of market situation that is, we have to know whether the
firm is facing perfect competition or imperfect competition. In perfect competition, the producers
have no control over the price rather; they have to accept the price fixed by demand and supply.
Pricing policy has special significance only under imperfect competition.

In monopoly, the producer fixes a high price for his product; in oligopoly and monopolistic
competition, the individual producers take the prices of the rival products in determining their
price.

(ii) Sales & Profit Maximization.

The businessmen use the pricing tool for the purpose of maximizing profits. They should also
stimulate profitable combination sales in order for the sales to bring more profit to the firm.

If the objective is profit maximization, the critical rule is to select the price at which MR = MC
in order to obtain a reasonable profit; in effect, most businessmen prefer holding the price at
constant level as opposed to frequent price fluctuations. This forces decision makers to focus on
the changes in production cost, revenue and profit associated with any contemplated change in
price.

(iii) Long Range Welfare of the Firm.

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Generally, businessmen are reluctant to charge a high price for the product because this might
result in bringing more producers into the industry. In real life, firms want to prevent the entry of
rivals. Pricing should take care of the long run welfare of the company.

(iv) Flexibility.

Pricing policies should be flexible enough to meet changes in economic conditions of various
customer industries. If a firm is selling its product in a highly competitive market, it will have
little scope for pricing discretion. Prices should also be flexible to take care of cyclical
variations.

(v) Government Policy.

The government may prevent the firms in forming combinations to set a high price. Often the
government prefers to control the prices of essential commodities with a view to prevent the
exploitation of the consumers. The entry of the government into the pricing process tends to
inject politics into price fixation. This applies only command economies, however, in market
economies the gov’t generally, does not interfere in the economic decisions of the economy.

(vi) Overall goals of the Business.

Pricing is not an end in itself but a means to an end. The fundamental guides to pricing,
therefore, are the firms overall goals. The broadest of them is survival. On a more specific level,
objectives relate to rate of growth, market share, maintenance of control and finally profit. The
various objectives may not always be compatible. A pricing policy should never be established
without consideration as to its impact on the other policies and practices.

(vii) Price Sensitivity.

The various factors which may generate insensitivity to price changes are variability in consumer
behaviour, variation in the effectiveness of marketing effort, nature of the product, importance of
service after sales, etc. Businessmen often tend to exaggerate the importance of price sensitivity
and ignore many identifiable factors which tend to minimise it.

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(viii) Routinization of Pricing.

A firm may have to take many pricing decisions. If the data on demand and cost are highly
conjectural, the firm has to rely on some mechanical formula. If a firm is selling its product in a
highly competitive market, it will have little scope for price discretion. This will have the way
for routinised pricing.

(ix) Demand.

Demand is more important for effective sales that is, the elasticity of demand is to be recognized
in determining the price of the product. If the demand for the product is inelastic, the firm can fix
a high price. On the other hand, if the demand is elastic, it has to fix a lower price.

In the very short term, manufacturers of durable goods always set high prices, even though sales
are affected. If the price is too high, it may also affect the demand for the product and in that they
wait for the arrival of a rival product with competitive price.

(x) Cost Data.

There are different types of costs incurred in the production and marketing of the product and
these are production costs, promotional expenses like advertising or personal selling, and
taxation. This implies that they may necessitate an upward fixing of price e.g. the prices of petrol
and gas

(xi) Consumer Psychology in Pricing:

Demand for the product depends upon the psychology of the consumers. Sensitivity to price
change will vary from consumer to consumer and in a particular situation, the behavior of one
individual may not be the same as that of the other.

Consumer behavior will be influenced by the factors such as product quality, product image,
customer service, promotional tools, advertising, and extra features. Thus consumer’s perception
towards price of the product is an essential element while framing the pricing strategy.

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PRICING STRATEGIES.
Pricing is the process of determining what a company will receive in exchange for its product or
service. While pricing policy helps to explain how prices are determined under different types of
market conditions.
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 overall market; defend an existing
market from new entrants; to increase market share within a market or to enter a new market.
Certain guidelines are followed in pricing of the new product and the common pricing strategies
include:

Pricing a New Product.

The marketing of a new product poses a problem because new products have no past
information.
Fixing the first price of the product is a major decision and the future of the company depends on
the soundness of the initial pricing decision of the product. In large multidivisional companies,
top management needs to establish specific criteria for acceptance of new product ideas.
The price fixed for the new product must have completed the advanced research and
development stage, satisfy public criteria such as consumer safety and earn good profits. In
pricing a new product, two types of pricing can be selected:

a) Skimming Price.
Skimming price is a short-term method for pricing; and in this case companies tend to
charge higher price in initial stages, this helps them to “Skim the Cream” of the market as
the demand for new product is likely to be less price elastic in the early stages.

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 b) Penetration Price – Penetration price is also referred to as ‘stay out price policy’ to
counteract the competition. It entails charging the lowest price for the new product which
enhances prompt sales and keeps away competitors. It is a long term pricing strategy and
should be adopted with great caution.

Pricing Multiple Products

Multiple products refer to production of more than one product. The conventional theory of price
determination assumes that a firm produces a single homogenous product, but in reality firms
usually produce more than one product with existence of interrelationships among them.

Such products are either joint products or multi–products. In joint products the inputs are
common in the production process while in multi-products the inputs are independent but have
common overhead expenses.
The following are the pricing methods followed:
a) Full Cost Plus Pricing Method.
Full cost plus pricing is a price-setting method in which a firm adds together the direct
material cost, direct labor cost, selling and administrative cost, and overhead costs for a
product and adds a markup percentage in order to derive the selling price of the product.
The pricing formula is: Pricing formula= Total production costs+Selling and
administration costs+Mark-up.

When applied:
In situations where products and services are provided based on the specific requirements
of the customer. Thus, there is reduced competitive pressure and no standardized product
being provided.
To set long-term prices that are sufficiently high to ensure a profit after all costs have
been incurred.

b) Marginal Cost Pricing Method

This is a pricing method where the price of a product is set to equal the extra cost of
producing an extra unit of output. In this case, a producer charges for each product unit

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 sold, only the addition to total cost resulting from materials and direct labor. Businesses
often set prices close to marginal cost during periods of poor sales.
For example, an item has a marginal cost of $2.00 and a normal selling price is $3.00, the
firm selling the item might wish to lower the price to $2.10 if demand has waned. The
business would choose this approach because the incremental profit of 10 cents from the
transaction is better than no sale at all.

c) Transfer Pricing
It relates to international transactions performed between related parties and covers all
sorts of transactions. The most common being distributorship, R&D, marketing,
manufacturing, loans, management fees, and Intellectual Property (IP) Licensing.

All intercompany transactions must be regulated in accordance with the applicable law
and comply with the ‘‘arm’s length’’ principle which requires an updated transfer pricing
study and an intercompany agreement based upon the study.

Some corporations perform their intercompany transactions based upon previously issued
studies or an ill-advice they have received to work at a ‘‘cost Plus %.’’ This is not
sufficient, such a decision has to be supported in terms of methodology and the amount of
overhead by a proper transfer pricing study and it has to be updated each financial year.

d) Dual Pricing
This entails offering different prices for the same product in different markets. Its
objective is to enter different markets or a new market with one product offering lower
prices in a foreign country.
For dual pricing to succeed, it requires following industry specific laws / norms and it is
common in developing countries where local citizens are offered the same products at a
lower price for which foreigners are pay more e.g. in an airline industry, companies offer
lower prices if tickets are booked well in advance given that the demand for this category
of customers is elastic and varies inversely with price.

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 As the time passes the flight fares start increasing to get high prices from the customers
whose demands are inelastic
thereby making airline companies to charge different fares for the same flight tickets. The
time of booking becomes the differentiating factor and not nationality.

e) Differential Pricing
It is a pricing strategy

Price Effect
This is the change in demand in accordance to the change in price, other factors
remaining constant which are: tastes & preferences of the consumer; income of the
consumer; and price of other goods.
Price Effect is given by the following formula:
Price Effect = Proportionate change in quantity demanded of X Proportionate change in
price of X. This implies that price effect is the sum of two effects, that is substitution
effect and income effect = Substitution effect + Income effect.

Substitution effect.
In this case, the consumer is compelled to choose a product that is less expensive so that
his satisfaction is maximized; as the normal income of the consumer is fixed e.g.
consumers will buy less expensive foods such as vegetables over meat; or, consumers
could buy less amount of meat to keep expenses in control.
Income Effect.
This arises due to the change in demand of goods based on the change in consumer’s
discretionary income. Income effect is composed of two types of products which are
normal goods whose price fall will lead to increase in demand as real income increases
and vice versa; and inferior goods whose demand increases due to an increase in the real
income.

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References:

1. https://www.economicsdiscussion.net/price/pricing-policy-meaning-objectives-and-
factors/21757

2. https://www.economicsdiscussion.net/price/4-types-of-pricing-methods-explained/3841

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3. https://www.economicsdiscussion.net/firm/pricing-strategies/types-of-pricing-strategies-
top-10-strategies/31481

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