Pricing policies and strategies

LEARNING OBJECTIVES
When you have read this chapter you should be able to understand:
(a) the strategic role and significance of price;
(b) the ways in which price can be used tactically;
(c) the factors which need to be taken into account when setting a price;
(d) the nature of pricing objectives;
(e) methods of pricing.
INTRODUCTION
For many organizations price is potentially 'the most controllable and flexible element
of the marketing mix. It is also in many cases one of the most important elements and,
together with the product, a key component of an organization’s marketing strategy. In this
ehapter we therefore focus" on the strategic and the tactical roles that price is capable of
playing and how pricing decisions influence and interrelate with the other elements of the
marketing mix.
THE ROLE AND SIGNIFICANCE OF PRICE
it is generally acknowledged that pricing decisions are ainong the potentially most
difficult that marketing managers are required to make. There are several reasons for this, the
most significant of which is the nature and complexity of the interaction that commonly
exists between three groups consumers, the trade, and obmpetitors and the need that exists to
take this interaction into accoimt when either setting or changing a price. An added
complexity is that pricing decisions often have to be made quiekly and without testing, but
almost invariably have a direct effect upon profit. Largely because of. this, many marketing
managers work to reduce the relative importance of price by, for example, giving far greater
emphasis to the product’s distinctive values and to its image. In Other cases, the pricing
decision is taken .out of the hands of the .marketing strategist .by . a combination of.
marketrrelated factors. Prominent among these is the presence of a large and aggressive
competitor who in effect determines prices for the industry as a whole and who, with the
exception of just one or two small niche players, all other organizations are obliged to follow.
The issue faced then by the strategist revolves not around the question of what price to set,
but rather how to ensure that costs are contained in such a way that profits can still be made.
The Nature and Structure of Competition
Having identified the firm’s overall objectives, the focus of attention switches to the
nature of competition and to the ways in which the competitive environment is likely to
influence the implementation of a pricing strategy. If, for example, the market is dominated
by a large and aggressive competitor the firm 1s likely to be forced into the position of
having to follow the market leader with little or no real control over the price charged. This,
in turn, may. have consequences for prices in Other markets either because a policy of price
standardization is being pursued, or because it is seen to be necessary to increase prices
elsewhere to compensate for these pressures. In other circumstances the firm may find itself
in a market in which it has a degree of technologicalleadership or in which its manufacturing
or marketing expertise provides it with a significant: competitive advantage and hence a
greater degree of pricing flexibility .
The significance of competitive factors in influencing pricing decisions was
highlighted by the results of a study conducted by Farris and Reibstein (1979) 1n which they
examined the relationship between relative price, relative quality, and relative advertising.
The Study, which covered_227 businesses, found that:
1. brands, and particularly those in mature markets, which had an average relative
quality but a high relative advertising budget were able to charge higher prices than
was possible for less well known brands;
2. brands with a high relative quality and high relative levels of advertising spend
achieved the highest prices;
3. brands with low relative quality and levels of advertising were unable to rnove away
from the lowest prices;
4. the relationship between high prices and high advertising was strongest in the later
stages of the product‘life cycle (PLC).
The Product Life Cycle
The role of the product life cycle (see pp. 273-8) in marketing strategy was discussed
in some detail at an earlier stage in the text and at this point we will do little more than
remind the reader that as the firm’s products move through their life cycle, so the role of each
element of the marketing mix changes. In determining the pricing policy, consideration
should therefore be given to three main factors:
1. the probable length of the product’s life cycle; .
2. the scope that exiSts for a competitor to “introduce a new product or new technology
possibly from another market thereby artificially shortening the length of the life
cycle
3. the firm’s profit expectations.
DECIDING ON THE PRICING OBJECTIVES
Survival
Return on Investment
Market Stabilization
The Maintenance and Improvement of Market Position
Meeting or Following Competition
Pricing to Reflect Product Differentiation
Market Skimming
Market Penetration
Early Cash Recovery
Preventing New Entry
In deciding on the obiective(s) to be pursued, the strategist needs to she consideration
not just to the organization’s general competitive stance, but also to the issue of time. It is of
coursealways possible for short-tetm objectives to conflict with long-term objectives; perhaps
the most obvious example of this is the scope for confliet that exiSts between high short-term
and long-term profits. Only rarely can the Strategist pursue the two simultaneously. Because
of this and because of the uncertainty regarding the future, many organizations pursue pricing
methods which reflect an essentially shortto medium-term orientation, rather than the long
term. This has been commented on by Fisher (1966) who has identified what he suggeSts are
the eight most commonly pursued specific short-term pricing objectives:
1. to penetrate the market and preempt competitors by offering a low price;
2. to skim the market and aim for early profits by opting for a high price;
3. to phase out an old product by raising the price and making it unattractive;
4. to discourage competitors from entering the market;
5. to develop the campany’ s image;
6. to be regarded as ‘fair’ by customers;
7. to encourage market growth by a low ptice/high volume policy;
8. to avoid unnecessary provocative action.
Although in an ideal world the strategist-would simply determine the pricing
objective(s) and then move on to develop the detail of the pricing structure, there are in
practice several problems that are cOmmonly encountered and that conspire to prevent
theobjectives being achieved unless an-allowance is made for them. In“ commenting on
these, Oxenfeldt (1973, p. 50) suggests that they include:
1. prices may be too high when compared with those of competitors and lead either to a
reassessment of objectives or -a11 acceptance of an erosion of market share; 
2. a given price, while acceptable in one sector of the market, may be too high or low
elsewhere;
3. the price may be viewed by sections of the market as exploitative and the company
consequently seen as untrustworthy;
4. price differentials across the product line may be illogical;
5. the price may destabilize a previously stable market;
6. the price may lead to a degree of confusion 1n the market;
7. theprice may damage or inhibit brand loyalty; .
8. the strategy. may welllead to an increase in buyers price sensitivity.
METHODS OF PRICING . 1
Agaihst the 'backgroundnof our discussion so far it should be apparent that there are
four principal factors which influence the pricing decision:
1. the company’s marketing objectives;
2. the company’s pricing objectives:
3. the determinai‘its of demand in‘ciuding costs, competitors and consumers;
4. the product itself and the extent to which it has any distinguishing features.
 The relative importance of these varies 'considerabiy from one product and market
sector to another. All four, however, need to be taken into account in the choice of the pricing
method. This is illustrated diagrammatically in Figure 12.5.
Although a number of approaches to measuring price sensitivity have been developed,
one of the most useful has been proposed by Nagle (1987, Ch. 3) Who suggests that there are
nine principal influencing factors:
1. the unique vaiue effect: the inore distinctive a product is, the less price sensitive
buyers become;
2. the substitute awareness effect: the more aware consumers become of subStitutes, the
greater their price sensitivity;
3. the difficult comparison effect: the more difficult it is to make direct comparisons
between products, the less price sensitive they are likely to be;
4. the total expenditure effect: the lower the expenditure is as a proportion of their total
income, the lower the degree of price sensitivity; . ,
5. the end benefit effect: as perceived benefit increases, so price sensitivity; reduces;
6. the sunk investment effect: when the product is used in association with products
bought previously, price sensitivity is reduced;
7. the shared cost effect: price sensitivity is reduced when the costs are shared ,  with
one or more other parties
8. 8 the price-quality effect: the greater the degree of perceived quality or exclusiveness,
the lower the price sensitivity;
9. the inventory effect: when the product cannot be stored and consumption takes place
immediately, price sensitivity again reduces.
One of the recurring themes of this book has. been the need for competitive analysis
and for the information that is generated through this to be taken into account when
developing strategy. In the case of pricing decisions the need to understand competitors’ cost
levels and their likely patterns of price behaviour is particularly important, since in many
industries a competitive attack can be launched most readily and effectively through the price
mechanism. Recognizing this, the strategist should monitor particularly closely each
competitor’s prices and price movements for any evidence of a possible price offensive. By
doing this it is possible to build a price profile for each competitor which includes a statement
of the firm’s likelihood and ability to engage in a price war. This involves taking account of
nine factors:
1. each firm’s general competitive posture -is it, for example, offensive defensive and, in
Porter’s terms (see Chapter 4), a ‘good’ or a ‘bad’ competitor?
2. their cost levels and hence the scope that exists for price cutting;
3. the level of resources that would be available in the event of a price war breaking out;
4. their relative dependence upon each product and market sector;
5. the potential returns from cutting prices; .
6. the relative importance of each market sector to competitors and hence the probable
depth of commitment; -’
7. their past price history (offensive or defensive);
8. the distinctiveness of each competitor’s major products and the apparent degree of
brand loyalty that exists; .
 9. the probable response of distributors and any others in the distribuno channel.
USING PRICE AS A TACTICAL WEAPON
The bulk of our discussion so far has centred around the strategic role played by price.
In many cases, however, price is used very largely as a tactical weapon, a role to which,
because of its flexibility, it is well suited. There are several ways in which this tactical role
can be performed, including:
 varying prices to reflect geographic differences;
 offering discounts for early payment, off-season buying, and to encourage high
volume purchases;
 trade-in allowances to boost sales when the economy generally is sluggish;
 discriminatory pricing in order to capitalize upon the ability or willingness of
particular market segments to pay a higher price;
 optional-feature pricing which'allo'ws the price of the basic product such as a car to be
kept low, but for substantial profits then to be made by adding accessories such as a
sunroof;
 hitting at competitors. who appear particularly vulnerable.
Perhaps the most obvious and most important tactical role that can be played by price
stems from the periodic need or Opportunity to raise or lower prices in order to gain or retain
a competitive advantage.
Price 'cutting‘, for example, can be used topu't pressure on competitors and reverse a
falling market share. Equally, it can be used to solve the problem of short-term excess
capacity.'Raising prices can Often be a means of overcoming the problems of excess demand
and generating an increase in profits.
However, before making any changes to prices, the strategist needs to consider the impact on
the triumvirate to which 'we referred at the beginning of the chapter consumers, the trade, and
competitO'rsand‘heiice their likely reaction. Faced with a price increase, buyers and
distributors may, for example, both respond negatively: buyers by turning to another product
and distributors by focusing their attention on competitive products. A price increase might
also provide competitors with 'an opportunity which they then become determined to exploit
as far as possible. '
Price cutting can, in certain circumstances at least, also create difficultiES. Buyers may
respond by perceiving the quality to have been lowered, while distributors may feel their:
matgin has been eroded. Even where sales increase, this may simply be as the result of the
lower price and does not necessarily lead to any degree of brand loyalty. The implication of
this that when either the price rises at a later stage or when a competitdt lowers his price,
sales drop. However, perhaps the biggest problem with price cutting is the danger of sparking
off a price war. Faced with a price change that is initiated by a competitor, the strategist has a
number of choices:
 follow by increasing prices by the same amount;
 keep prices the same in' the hope that those who have previously bought from the
competitor will be encOutaged to Shift supplier
 cut prices to increase the price differential.
THE PRINCIPLES OF OFFENSNE PRICING
We commented an earlier stage that pricing decisions are among the potentially most
difficult; that marketing-managers are required to make. Recognizing this, a number of
writers have developed models that 'are designed to provide the basis for a more highly
structured approach toprice setting. Among those to have done this is Davidson (1987, .Ch.
10) who identifies what he refers to as ‘The Eight Principles of Offensive Pricing’. These
principles are listed below.
1. Know Your Price Dynamics
Pricing decisions must be based on a detailed understanding of the nature and degree
of. price sensitivity. that exists. in some markets, for example, overall demand may be
generally inelastic whilst thedemand for individual brands may be highly .price
responsive. The strategist should therefore consider:
 the frequency of purchase as a general mile of thumb, levels of price
sensitivity increase with the frequency of purchase;
 the degree of necessin -- the greater the need, the lower the sensitivity;
 unit pricehigh prices lead to greater price consciousness;
 the degree of comparability -- when this is easy, price awareness increases;
 the degree of fashion or status--as this increases, the direct importance of price
reduces '
2. Strengthen Your Pricing Muscles
By giving a greater emphasis to non-price features such as higher quality,
packaging, advertising and after-sales serviCe, the nature of the selling proposition
can be changed in the organization’s favour. An example of a company to have done
this with considerable success is Marks & Spencer ‘which succeeded in widening its
priCe premium by steadily strengtheningt/the appeal of its products overtime. Its food
prdducts earn a premium. because customers perceive them as fresher, of higher
quality and more exciting. They also generate (higher) profits’ (Davidson, p. 234).
Learning from this, other food retailers such as Sainsbury and Tesco have both made
significant changes to their product mixes over the past few years. 
3. Choose Your Price Segments
In choosing segments of the market in which the company is to operate
consideration needs to be given to the implications for pricing and to the
Organization’s ability to operate effectively. In certain market sectors, for example,
the prerequisite is not simply that the organization has a low cast base currently, but
that it is capable of maintaining this cost base over time. The issues which must
therefore be considered include:
 the relative profitability of each segment;
 the degree of organization 'segment fit
 competitors’ intentions and capabilities.
4. Consider the Alternatives
In what ways might price be integrated most effectively with other elements of
the marketing mix and hence the direct significance of price be reduced?
5. Manage the Ripples
In most competitive industrial or distributor markets, different buyers p
different prices depending upon their purchase volumes, delivery meth servicing
 demands and negotiating skills. Because of the potential sensitivity of this, the
strategist needs to give emphasis to:
 a clearly communicated trading strategy;
 understanding the profit implications of altering each of the variables referred
to above; , .
 building long-term relationships so that the implications of problems at a
particular level in the organization can be reduced.
6. Beware of Profit Cannibalization
This applies where a marketing initiative with one product significantly
reduces the profit on another. . '
7. If You Make a Pricing Mistake. Admit it and Remedy it Fast
8. Beware of Markets with Falling Prices .
This is the case unless you are confident that your organization has a
competitive edge which can be maintained and be used to keep competitors on the
defence
HOW DOES BRITISH INDUSTRY PRICE?
The question of how industrial firms approach the pricing task was the subject of a
major study, How British Industry Prices, publiShed in 1975 but which still provides a clear
insight to current practices. The study highlighted a series of points including:
 in most industrial companies, cost-oriented methods predominanted;
 prices were seemingly influenced by marketing policy to only a limited extent
 little variation in pricing behaviour was found to exist between the th markets covered
by the study (capital goods, components and materials
 the majority of organizations stated that prices were set either by the cost-plus
technique or by the target return on investment method;
 less than one-fifth of companies said that prices were primarily affected by factors
other than costs;
 the pricing stance was almost invariably defensive;
 prices tended to follow or reflect the patterns set by competitors;
 discounts were only rarely used within the overall framework of marketing objectives
and were instead mechanistically linked to individual or aggregate order size; _ '
 giving discounts appeared to be largely routinized;
 only some 30 per cent of companies conducted any research to determine price
acceptability before setting or modifying a price;
 the results of pricing decisions were seldom monitored;
 in general, pricing tended to be handled in an ad hoc rather than a systematic fashion.