PRICING DECISIONS

PRICING CONCEPTS
TERM Meaning / Description
Total Cost Total of all costs in producing the product / rendering the service
Sale Price Consideration Charged from the customer for product / service
Perceived 1. It is the value that the customer understands that the product has
Value delivered or will deliver
2. It is the price of a product that the customer is willing to spend to
have that product
True 1. It measures benefits that the product is intended to deliver to the
Economic customers relative to the other products, without giving regard to
Value whether the customer can recognize this value or not
2. AKA OBJECTIVE VALUE
3. TEV = Cost of next best alternative ( cost of comparable
product) + value of performance differential ( value of
additional features provided by the seller firm)
 PRICING DECISIONS & STRATEGIES

Any Price which is below Perceived Value and Above Total Cost gives
incentives to the Buyer & Seller and creates a win-win situation

Objectives of Pricing Policy

• Optimum Utilization of resources

• Lead to usage of improved technology
• Ensure proper balance between supply & demand forces
• Encourage customer to buy, thus maintaining a neat gape between Perceived
Value & Sale Price
• Avoid Adverse Effect on economy
PRICE SENSITIVITY

• Measures the change in customer’s behavior due to change in price of

product / service. Customer behavior is influenced by the following:
• Magnitude of price – generally higher in high-cost than low-cost
products (eg: 10% change in price of diamond is more sensitive than
change in toothpaste)
• Burden of Cost – Relatively lower when the user is different from the
buyer
• Competitor’s reaction – if price changes without corresponding
change in competitor price, results in higher sensitivity.
• As per Nagle – Factors/Effects which have an impact on price sensitivity
• Perceived Substitute Effect – More sensitive if product price is higher in
relation to a perceived substitute
• Unique value effect – less sensitive if buyers assign value to unique
attribute offered by competing products
• Switching cost effect – less price sensitive if cost ( monetary &
non-monetary) of switching vendors is higher
• Difficult comparison effect – less price sensitive with a known or reputed
supplier when they have difficulty in comparing products
• Price quality effect – less sensitive if higher price is perceived as better
quality
• Expenditure effect – more price sensitive when expenditure is larger
• End benefit effect – if end benefit is higher buyer will be less price
sensitive
• Shared cost effect – less price sensitive if cost of product is shared
• Inventory effect – less sensitive if product cannot be stored
 PRICE CUSTOMISATION
• Customary Pricing is a method of determining Price of goods or services
based on perceived expectations of customers
• Methods of Customization:
• Based on Product Line – Based on customer requirement, product can be
customized and accordingly priced. Customized electronics
• Based on Past customer behaviour: customer with good payment record
can be given additional discounts
• Based on demographics: different pricing may be adopted based on
different demographical factors
• Based on time differential: pricing different products & services woth
different prices for different time periods.
THEORY OF PRICE

• Price – Price which yields

maximum profits
• Profit Maximization Model:
• Economic Theory of Pricing
• Pricing under the economic theory:
• As per this theory , Profit is
maximum at a level of output
where Marginal Revenue
(MR) = Marginal Cost (MC).
• Basic Price Equation: used to The MARGINAL REVENUE EQUATION IS
determine the Price where
profit is maximum WRITTEN AS

MARGINAL REVENUE (MR) = a-2bQ

 COST PLUS PRICING
PRICING
COMPETITIVE PRICING
METHODS
VALUE BASED PRICING
 • Method of determining cost – Cost of product +
Profit margin
• Cost – means full cost at current output and
wage levels (relevant costs)
• Pricing based on total cost has 2 limitations:
• Allocation of inter-departmental overheads is based
COST on arbitrary basis
• Allocation of overheads will require estimation of
BASED normal output which cannot often be done

PRICING • Remedy for the above limitations: Relevant cost

approach and ABC
• Advantages
• Disadvantages
• Guaranteed Contribution • Ignores demand
• Assured Profits • Ignores competition
• Reduced risk & uncertainties • Arbitrary cost allocation
• Most suitable in long run • Ignores opportunity cost
• Full recovery of all costs • Price-volume relationships
• Price stability
• Simple calculation
 ROCE Pricing
• Rate of return Pricing is used when each business unit/division is treated as
a separate investment center
• Determination of ROCE: Firm should determine that level of average
mark-up on cost that will help in earning the desired ROCE
• For this the factors to be considered are:
• Basis & Assumptions on which capital employed is computed
• Components to be covered in ROCE &
• Fairness of ROCE
• Advantages:
• Attract investment/ additional capital
• Increase in number of factories, production capacity
• Increased competition leading to reduction in costs & prices
VARIABLE COST PRICING

• Pricing Below Variable Cost

• Short run selling price strategy
• Examples:
• When goods are of perishable nature
• To launch new product at competitive prices
• Eliminate competitors from market
• Obviate shut down costs
• Capture/retain future market
• Capture/retain foreign market
• Ensure sale of old & defective inventory, seconds etc
• Pricing above variable cost but below total cost
• Pricing used during periods of recession
• Advantages:
• Firm can continue to manufacture and use skills of skilled
labourers who are well trained and difficult to replace
• Plant and machinery can be prevented from deterioration
• Firm would be ready to take advantage of improved conditions
• Firm can continue in the market and reduce loss of market share
• Differential Pricing
• Different markets
• Different Products
• Conversion Cost Pricing
• Based on the assumption that profit should be
related to value added.
• Price = Conversion Cost + Profit margin on
conversion cost + cost of material
• Standard Cost pricing
• If standard costing system is well established, firm
may fox prices using this system
• It is simple system, useful for new orders and for
long term pricing
 • When a business fixes prices on the sole
determinant of competition then such pricing
policy is called as Competitive Pricing
• Business need not charge the exact same
prices as competitors. It can be lower or
higher than competitors by a certain
COMPETITIVE percentage
PRICING
• Such price does not consider factors such as
demand and cost or the relation between
price, demand & cost
• Different types:
• Going rate pricing
• Sealed Bid pricing
GOING RATE PRICING
• Meaning: Competitive pricing where firm tries to keep prices at
average level charged by the industry
• Advantages:
• Useful where it is difficult to measure costs
• Yields fair return to all firms in the industry
• Most conducive for industry harmony
• Signifies pricing practices in homogenous product markets
GOING RATE PRICING UNDER PURE
COMPETITION MARKET
There are many firms selling homogenous product & price differentiation is
not possible. Such firm also has very little chouce regarding pricing policy
There is a market determined price(aka going rate) which is established
through collective interaction of all firms in the market as well as the buyers

Firm charging more than the going rate will not attract customers

Firm charging less than the going rate will lose out profits

Firm should focus on cost control and not on pricing decisions

 • Pure oligopoly is characterized by few large firms
dominating the industry
GOING RATE
PRICING UNDER • Firms tend to charge same price as is being
OLIGOPOLISTIC charged by competitors. Since there are only a
MARKET few firms, each firm is aware of the other’s price
and so are the buyers.
• In the long run. Since industry costs and demand
change, the industry takes collective action to
raise prices, or lower them in rare cases.
• One firm assumes the role of Price Leader and
the others follow any change in price by the
leader
 SEALED BID PRICING
• It is a competitive pricing prevalent when firms compete for jobs
based on bids while quoting for specific assignments or jobs
• The BID consists of the firm’s offer price.

PEAK LOAD PRICING

• Pricing system based on capacity constraints, wherein higher price for
the same service or product is charged when it approaches physical
capacity limits
• Eg: car rentals, telephone lines, electricity connection, water supply