Unit 10 Pricing

Dr. Smita Choudhary

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Contents
• • • • • • • Introduction Factors affecting price determination Cost based pricing Value based and competition based pricing Product mix pricing strategies Adjusting the price of the product Initiating and responding to the price change

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Introduction
• Price setting is very important part of strategic planning. • Marketers fix price of the product on the basis of cost, demand and competition. • For example, Dell adopted flexible pricing methods whereas the prices of the products of Indian Oil are fixed by the Government and the company has no control over pricing. • Manufacturers and service providers outsource some of their work to developing countries to get cost advantage which helps them in reducing their final price.

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Learning Objectives
After studying this chapter you will be able to
• • • • Find out the factors that influence the pricing strategies. Understand various approaches to pricing Analyze the pricing strategies adopted by marketers. Know the situations when marketers should initiate the price cuts.

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Factors Affecting Price Decisions
1.

Marketing objectives
Prices are determined on the basis of four major objectives. They are survival, current profit maximization, market share leadership and product – quality leadership. Survival strategy is adopted when a company is facing strong competition from the competitors and it wants quick recovery. Current profit maximization strategy is used to defend the market position. Market share leadership strategy is used when a company wants to achieve leadership position in the market. For this, it reduces the price of its products so that more number of people buy the product. Product quality leadership strategy is used when a company wants to provide high quality products at high prices. Here, the company targets a particular section of the market.

• • •

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2. Costs
• The cost of marketing and promoting a product directly affects the price of the product. • A company incurs fixed cost (plant, machinery, etc.) and variable cost (raw material, labor, etc.) in producing a product. • Marketer wants to know the break even analysis when he introduces the product in the market. • The break even point for a product is the point where total revenue received is equal to the total costs associated with the sale of the product (TR=TC). • The break even point helps to find whether it would be profitable to sell a proposed product or modify an existing product so that it can be made more attractive. • Break-even analysis can also be used to analyze the potential profitability of an expenditure in a sales-based business.

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3. 4 P’s of marketing
• • • • • • The price of the product is determined by other marketing mix elements also. The price of a product depends on its quality. If the quality of product is very good, company will charge high price for it and the reverse is also true. If the product is new, it requires aggressive promotion and thus cost of promotion increases. This increase the price of the product. Price is also determined by supply chain management. If the company has a good supply chain network, then it will have a distribution advantage over others.

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4. Nature of the market and demand
• • a) b) c) d) The price of a product also depends on the nature of the market. The markets are classified into following categories Perfect competition Monopolistic competition Oligopolistic competition Monopoly

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a)

b)

c)

d)

Perfect competition: In this type of market, there are many buyers and many sellers. Buyers and sellers have the habit of switching over. In such markets, companies should set their prices according to competition. Monopolistic competition: In this type of market, there are many buyers and sellers. In monopolistic competition, prices of products change according to differentiation, whereas in perfect competition, there is only one price. Textile and publishing industry. Oligopolistic competition: In this type of market, there are few large players in the market. They do not allow new players to enter the market. Example-Airline Industry Monopoly: In this type of market, there is only one seller. Indian Railways has monopoly over railway industry in India.

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• •
• •

• • •

Demand for the product changes according to price. Customers normally think that high priced products are better in quality and low priced products are poor in quality. Marketers should understand this perception of customers. The price elasticity of demand is defined as percentage change in quantity demanded to percentage change in price. For example, let original price of a product be Rs. 12 and demand per month is 1000 units. Now, the new price of the product is Rs. 13 and demand per month is 900 units. Therefore, price elasticity of demand = % change in quantity demanded / percentage change in price = -10 % / 8.33 % = -1.2

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5. Competition • Price also depends upon the degree of competition in the industry. • Cellular industry and airline industry in India are involved in such price wars. • Following Air Deccan, other airlines like Go Air, Spice Jet and Paramount also reduced the price of their airlines. 6. Environmental factors • The external factors also play an important role in pricing decisions. • For example, if Government increases tax on certain product, then the company will increase the price of the product. • Here, the price hike is determined by the Government which is external to the company.

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Cost Based Pricing
1. Cost plus pricing • It is the method of adding markup(total profit) to the total cost of the product. • The cost plus pricing is calculated as follows • Find out the variable cost per unit and fixed cost. • Estimate the number of units the company wants to sell. • Calculate the unit cost by the following formula. Unit cost = variable cost + fixed costs / unit sales • Find out the required mark up (desired return on sales) • Calculate the price by the following formula Price = Unit cost / (1 – desired return on sales)

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Example • Number of units to be sold – 75000 • Fixed cost – Rs. 2 lakh • Variable cost – Rs. 5 per unit • Required return on sales – 30% • Price = ? Solution Unit cost = Variable cost + (Fixed cost / Unit sales) = 5 + (200,000 / 75000) = 7.67 Price = Unit cost / ( 1 – Desired return on sales) = 7.67 / (1 – 0.3) = 10.85 Therefore price = Rs. 11 per unit (Approx.)

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Advantages of cost plus pricing • Sellers are more sure about the cost than the demand. • If all companies in the industry use this method, price becomes standard. • It is fairer to both buyers and sellers. Disadvantages of cost plus pricing • It ignores the demand and competition. • If the number of units sold is less, the fixed costs will spread to less number of units. This will increase unit cost and the final price will also increase.

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2. Break even pricing
• In this method of pricing, the firm determines the price at which it will make the target profit.

Procedure to calculate the break even volume • Find out the total fixed cost of the company. • Determine the price at which the company would like to sell. • Calculate the variable cost per unit. • Determine the break even volume by the following formula Break even volume = Fixed cost / (Price – Variable cost) Procedure to identify break even price • Determine the unit demand needed to break even at a given price. • Find out the expected unit demand at given price. • Find out the total revenue at a given price. • Calculate the total cost. • Determine the profit using the following formula 10/27/2012 Profit = Total revenue – Total cost

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Example • Fixed cost = Rs. 1,000,000, Price = Rs. 20, Variable cost = Rs. 12 • Break even volume = Fixed cost / (Price – Variable cost)
= 1,000,000 / (20 – 12 )

= 125,000
Price Unit demand needed to break even (i) 250,000 166,667 125,000 100,000 83,333 Expected unit demand at given price (ii) 340,000 180,000 140,000 90,000 60,000 Total revenue (iii) = Price * (ii) 4,800,000 3,240,000 2,800,000 1,980,000 1,440,000 Total Cost (iv) Profit (v) = (iii) – (iv) -280,000 80,000 120,000 -100,000 -280,000

Rs. 16 Rs. 18 Rs. 20 Rs. 22 Rs. 24

5,080,000 3,160,000 2,680,000 2,080,000 1,720,000

Hence, Rs. 20 is the ideal price to break even 10/27/2012

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Value Based and Competition Based Pricing
1. Value based pricing
• In this type of pricing, prices of a product are set on the basis of consumer’s value and not on manufacturer’s cost. • Difference between value based and competition based pricing

Cost Based Pricing
Product Cost Price Value Customers

Value Based Pricing
Customers Value Price Cost Product

Every day low pricing – Organization charges constant low prices and no temporary discounts. Example – WalMart. High low pricing – Organizations charge higher prices every day but lower the prices temporarily with promotions
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2. Competition based pricing
• In this method of pricing, the prices of competitive products are used as benchmark to set prices rather than manufacturer’s cost or customer demand.

• Competition based pricing is of three types a) Destroyer pricing: This strategy is used to
remove competition. Here, companies lower prices to an extent where there cannot be any competition and hence the company may go out of business.

b) Price matching or going rate pricing: In this
strategy, companies set prices that are closer to their competitors.

c)

Price bidding or close bid pricing: This
strategy is common with manufacturing, building and construction services. In this strategy, companies submit the quotations according to the tender specifications.
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Product Mix Pricing Strategies
1. 2. Product line pricing: It is the strategy of setting the price for the entire product
line.

Optional product pricing strategy: This strategy is used to set the prices of
optional or accessory products along with the main product. For example, car makers set the prices of accessories different from the standard product so that customers do not feel that the main product is costly.

3.

Captive product pricing: It is setting the price for a product that must be used
with the main product. For example, Gillette sells its razors at low price but charges high for the replacement blades.

4. 5.

By-product pricing: This is the strategy of setting the price for by products so
that the price of main product becomes more attractive.

Product bundle strategy: It is the strategy of offering many products together
at reduced prices. It helps the company to increase volume, get rid of unused products and attract price conscious customers. For example, Anchor toothpaste and brush are offered together at lower prices.

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Adjusting the Price of the Product
• Due to competition, companies are bound to change their base prices according to situation. • For adjusting prices, six strategies are used. They are: 1. Discounts and allowances 2. Location pricing 3. Psychological pricing 4. Promotional pricing 5. Geographical pricing 6. International pricing

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1. Discounts and allowances:
Companies offer four types of discounts to customers. They are a) Cash discount: Cash discount is given to the customer when he makes early payment before the due date. Quantity discount: It is a price reduction given to the customer when he buys products in large quantities. Functional discount: This discount is given to the customer when he carries the promotion or other marketing activities. Seasonal discount: This is price reduction offered to the customer when he purchases the product in off season. are paid to middlemen who are involved in promoting the products.

b)

c)

d)

• Allowances

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2.

3.

4.

Location pricing: In this method of price adjustment, prices of products are set according to the locations. For example, a company has two stores, one in the main market area and one in the outskirts of the city. It charges more in the market area and less in the store in outskirts. Psychological pricing: According to Kotler, psychological pricing approach considers the psychology of prices and not just the economics. For example, a price of Rs. 199 looks psychologically less than a price of Rs. 200. Promotional pricing: In this pricing approach, organizations set the prices of their products below the list price and sometimes even below the cost. This strategy is used to achieve immediate sales, avoid competition and introduce the product.

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5.

6.

Geographical pricing: It is the strategy of setting prices on the basis of geography (region) in which the products are sold and freight charges. The different options available for the company are a) Freight charges to be paid by the customer (FOB pricing). b) Different zones have different prices. A company may charge different prices in north and south zone (Zone pricing). c) Same price plus freight charges for all the customers (Uniform delivered pricing). International pricing: Different countries have different external factors and customer profiles. The company should adopt its product and prices according to the external factors and customer profiles of the countries. For Example-Cipla

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Initiating and Responding to the Price Changes
1. INITIATING THE PRICE CHANGES • Initiating the price cuts: The situations in which organizations think of starting price cuts are
a) Companies reduce price when they have excess stock. b) When company’s market share decreases due to strong competition. c) Company wants to dominate the market through lower costs.

• Initiating price increase: The situations in which organizations think of increases the prices are
a) When the cost of raw material increases. b) When the demand for the product is greater than supply.

• Buyer’s reactions to price changes
a) b) c) d)
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Reduced price means reduced quality. Reduced price means the sales of the product is not as expected. Prices may go down further. May avoid buying the product for some time.
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2. RESPONDING TO PRICE CHANGES
• • • In the competitive markets, sometimes other manufacturers start price change. In such situation, company should analyze two situations. If the price cut of other company is not affecting our company, then continue with the current price and maintain profitability of the company. If the price cut of other company is affecting our company, then take any of the following steps a) Reduce the prices of the product equal to the competition or below the competition. b) Increase the quality of the company and the product in customer’s mind. c) Improve the quality of the product and then increase the price. d) Launch different brands which can fight in the lower segment.

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