PRINCIPLES OF MARKETING

Topic 10: Pricing

Learning Objectives

• Define the term price

• Describe the factors that influence price
• Describe the pricing methods
• Describe the pricing strategy of new products
• Describe price adjustment strategies

Introduction

Among all the 4 Ps, price is the only strategy that brings revenue to a firm and the most
flexible. Other marketing mix strategies like product, promotion, and place involve costs
and are less flexible. If a firm wishes to change the price of a product, the strategy could
be implemented immediately.

Definition of Price

Price is the perceived value of a good or service, most commonly

expressed in dollars and cents.

Prices can also be expressed in terms of other goods especially when barter trading
takes place.

Price is related to the perceived value at the time of the transaction and is based on the
amount of expected satisfaction to be received from the good or service. It is not based
on actual satisfaction.

Importance of price

1. Price multiplied by the number of goods sold gives a company its revenue.

2. Prices need to be set right. Otherwise, sales will be lost.

Factors Influencing Price Decision

A. Pricing objectives

Pricing objectives should be specific, attainable, and measurable. The objectives need
frequent monitoring to determine the effectiveness of the strategy. The objectives can be
defined in terms of meeting profit or sales goals, or maintaining the status quo.
 1. Profit-Oriented Pricing Objectives

Profit maximization refers to determining prices so that total revenue is as large

as possible relative to total costs for a given item. The target return on
investment (ROI) is the most common profit objectives. It measures the
effectiveness of management in generating profit. It is calculated as:
ROI = Net profits after taxes

Total assets

The value of targeted ROI is determined ahead of time and the value depends on
the industry the firm operates.

2. Sales-Oriented Pricing Objectives

The sales-oriented pricing objectives, market share and sales maximization, both
depend on actual sales of the product, rather than on the firm’s overall cost
structures or production efficiencies. Although these objectives may be measured
in dollar sale or unit sales, measurement in terms of revenues is most common.

Market share refers to a company’s product sales as a percentage of total sales

for that industry. Market share can be expressed in dollars of sales or units of
product. Comparisons vary depending on the terms used.

Some companies’ objectives are to maximize dollar or unit sales especially in an

attempt to generate maximum amount of cash in the short run or to sell off
excess inventory.

3. Status Quo Pricing Objectives

This pricing objective seeks to maintain the existing prices in order to meet
competition. This strategy needs little planning except for monitoring competitors.

B. Demand

Demand and supply equilibrium determines the equilibrium price of the product’s market.
Ineffective pricing causes shortages and surplus.

Elasticity of demand influences the price of a product.

When consumers are sensitive to price changes, demand of the product is elastic. In this
case, if price goes reduces, the revenue increases. But price should not go up as
revenue will go down.
On the other hand, if the consumers are not sensitive to price changes, the demand of
the product is inelastic. In this case, prices can go up because the revenue increases.
The price should not be brought down because the revenue will also go down.
C. Cost

Costs serve as a floor below which a good should not be priced.

1. Types of costs
 Variable costs refer to costs that changes with the level of output
 Fixed costs refer to costs that do not vary as output is increased or decreased.
Includes rent, building insurance, vehicles insurance and administrative salaries.
 Average variable cost is total variable costs divided by the quantity of output.
Average total cost refers to total costs divided by total output.
 Marginal cost is the change in total costs in relation to a unit change of output.

2. Markup on costs
Assuming that the product costs per unit = RM5

If the manufacturer adds RM5 to the cost when selling the product to a retailer, the
selling price of the product for the manufacturer is RM10.

Markup on Cost for Manufacturer = {(Selling Price – Cost) /Cost} x 100 = {(10-5)/5)} x
100 = 100.

The markup percentage to the manufacturer is 100 percent.

3. Markup on selling price

The most popular method used by wholesalers and retailers. The calculation is done
by adding to cost an amount for profit and for expenses not previously accounted for.

For example, if your product costs RM5 to make and the selling price is RM7.50,
then the markup percentage would be 50%: ( RM7.50 – RM5) / RM5 = . 50 x 100 =
50%.

4. Formula Pricing
This is a predetermined formula that ignores demand. For example, the price of a
fried noodle is twice the costs of the raw materials.

5. Profit maximization pricing

Profit = Total revenue – Total Cost
In order to maximize profit, a firm can either increase revenue, reduce costs or
increase revenue and reduce costs together.
Profit is maximized when Marginal Revenue is equal to Marginal Cost.

6. Breakeven pricing
This is the price that covers the costs incurred. Profits are not made at this point. By
knowing the value, a firm can determine the amount of sales volume that will cover
costs.
 Breakeven quantity = Fixed Cost
Price – Variable Cost
D. Product’s life cycle

Price strategy changes as a product goes through different phases of its life cycle.

 Prices are normally high during introduction stage to recover development of

costs and take advantage of high demand. Such goods that started with high
prices are microwave oven, CD player and hand hones.
 Once a product enters the growth stage and competitors start coming in, prices
begin to lower down and stabilize.
 At the point of maturity, prices go down further because competition is tougher
and weaker firms are eliminated.
 In the decline stage, prices fall lower in view that producers are capturing the last
scrap of demand.

E. Competition

Competitors entering a new market may decide to:

 Price the product below the market price in order to gain market share
 Price the product above the market price if it has a unique competitive advantage
 Price the product equal to the prevailing price to avoid price war and if it can
succeed with non-price competition.

F. Distribution strategy
 Offering of large profit margins to retailers or wholesalers
 Offering of trade allowance dealers to help offset the costs of promotion and to
stimulate demand.

G. Promotion strategy
Price is often used as a promotional tool either through discounts or coupons.
One may find being a frequent-member of a retailer allows for certain discount
purchases.

H. Quality of product
Consumers tend to perceive that high prices indicate high quality products. For some
products the relationship is strongly viewed than the others. High prices can be used to
enhance the image of a product in some cases. This is a prestige pricing strategy.

New Product Pricing Strategy

A price strategy defines the initial price and gives direction for price movements
over a product’s life cycle.

The price policy is set for a specific target market. It is based on a well-defined
positioning strategy. It must also fit with the overall marketing strategy.
The degree of freedom for a company to set a price depends on the market conditions
and other elements of marketing mix.

Three policies for setting a price on new goods or services are skimming pricing,
penetration pricing and status quo pricing.

A. Skimming pricing

This strategy demands that for a high introductory price for a new good. The firm may
lower the price once goods are distributed widely.

This strategy is best implemented when:

 the demand for the product is relatively inelastic
 it represents a technological breakthrough
 the production is limited due to technological difficulties, shortages, or lacked of
skilled crafts people.

B. Penetration pricing

This strategy sets a relatively low price to a new product in order to reach mass market
in the introduction stage of a product’s life cycle.
The strategy is designed to dominate the market, producing large volume, which will
lower the production cost. As a result, it may hinder potential new entrants into the
market because of cost factor.

C. Status quo pricing

This strategy is to maintain existing price. This choice may be the safest way towards
long-term survival especially for a mall firm.

Price Adjustment Strategies

Adjustments are made to price to fine-tune the base price of a product to suit certain
conditions. The base price is the general price level at which the company charges after
choosing a price strategy. These adjustments are short run approaches that do not
change the general price level. However, it allows the company to adjust the price for
certain conditions. These conditions include changing competitive environment,
changing government regulations, changing demand situations and meeting promotional
and positioning goals. The adjustment strategies are discounts, allowances and rebates,
geographic pricing, special pricing and economic situation pricing.

A. Discounts, allowances, and rebates

There are several types of discounts.

 Quantity discount – for purchases made in multiple units or above a determined
amount of money.
 Cumulative quantity discount – incremental discounts are given for cumulative
purchases within a period. This tactics intends to create loyalty.
 Non-cumulative quantity discount – discounts applies to a single order.
  Cash discount – reduction offered to prompt payment of a receipt.
 Functional discount – for wholesalers and retailers who perform distribution
channel functions.
 Seasonal discount – price reduction for buying out-of-season products.

Promotional allowance is a payment made to a distributor for promoting the

manufacturer’s product. This allowance is both a pricing and promotional tool.

Rebate is a cash refund given for the purchase of product during a specified period.
Firms may gain from ‘slippage’ where purchasers are induced by the rebates but do not
send off for the rebate.

Trade loading happens when a manufacturer offers a lower price to wholesalers and
retailers who purchase more goods than can be sold in a reasonable time.

Everyday low prices are to solve trade-loading problems of idle inventory by lowering
prices and eliminating functional discounts.

B. Geographic pricing

❑ FOB (free on board) origin pricing

Requires purchaser to absorb the freight costs. Goods are placed free on board a
carrier.

❑ Uniform delivered pricing

Seller pays the freight charges but bill every purchaser an identical flat freight charge
irrespective of location.

❑ Zone pricing
Seller pays the freight charges but flat freight rate is charged differently to
purchasers at different geographic zone.

❑ Freight absorption pricing

Sellers pay the whole or part of the actual freight charges and do not pass them to
the buyers.

❑ Basing-point pricing
Sellers choose a base point and charge the buyers freight cost from the base point.

C. Special pricing

These tactics are used to stimulate demand for specific products, to increase store
patronage, and to offer wider choice of merchandise at a specific price point.

❑ Single-price tactic – sells all goods and services at the same price (or two or three
prices). This tactic eliminates price comparisons from buyer’s decision making
process. Example will be RM 10 stores.
❑ Flexible pricing – charges different customers different prices for the same
merchandise bought in equal quantities. This tactics allow the seller to meet the
price of competitors or to satisfy price-conscious customers.

❑ Professional services pricing – fees charged by professional service providers

like lawyers or accountants for a service rendered rather than the amount of time
spent.

❑ Price lining – several items in a product line is offered at specific price points. For
example, a furniture shop sells several Italian sofas at RM 5999, RM 6999, or RM
7999. Italian sofa in that shop is not available at any other price.

❑ Leader pricing (loss leader pricing) – products are sold near cost or below cost in
order to attract customers to buy other products in store.

❑ Bait pricing – customers are attracted into a store through false or misleading price
advertising and they are persuaded to buy more expensive items. This practice is
illegal.

❑ Odd-even pricing (psychological pricing) – using odd-numbered prices to imply

bargains and even-numbered prices to imply quality. RM 1.95 is in the mind of
customers to be much cheaper than RM 2.00.

❑ Price bundling – two or more goods or services are packaged together for a
special price. Hotel meals, train fares and razors and blades are examples of such
bundling.

❑ Two-part pricing – consumers have to pay two separate prices to consume a

single product or service. A social club member has to pay membership fees and
yearly subscription in order to use the club facilities.

D. Economic situation pricing

1. Inflation
• Removal of products with low margin from product line
• Delayed –quotation pricing: price is set when a product is completed
• Escalator pricing: the final selling price reflects increase in cost. A clause
allows the price increase based on a formula.
• Price shading: Use of discounts by sales team to increase demand for one or
more products in a line.

2. Recession
• Value pricing: stresses to the customers the good values they are getting
• Bundling or unbundling: Features are added to offer a greater value.
Offerings can be unbundled and at the same time base price is lowered to
stimulate demand.
• Product line management: Scrapping unprofitable products from product lines
for resources to be used elsewhere.
• Cost cutting:
 a. Adopt new, more efficient technologies
b. Reduces salaries
c. Reduce cost of supplies by negotiations with vendors, offering help,
keeping the pressure and reduces the number of suppliers.

SUMMARY

Once decisions on products, distribution, and promotion are made, an organization has
to decide on the price of the product. As pricing is the marketing strategy that brings
revenue to a firm, choosing the right price will determine the survival of the firm in the
market. In making such decisions, the firm must determine its objectives. It also needs to
analyze any other factors that will influence the price decision. From that analysis, the
firm needs to choose the right price strategy to determine the product’s base price. From
time to time, there will be adjustments to the price - adding or reducing from the base
price in order to suit the situation.

Review Questions

1. Differentiate the market-skimming strategy from a market-penetration strategy in

determining the price of new products? Describe the situation when each of the
above strategy is most appropriate, or when it should be used as the primary
strategy.

2. (a) List four price adjustment strategies that a firm may implement.
(b) Describe the strategies and give an example how each strategy could be
implemented by the firm.

3. If the unit cost of the packed of fried noodle is RM 3 and the company wants a
desired return on sales of 10%, what would be the selling price of the product?