Developing Pricing Strategies

Mukhtar Ahmed
Contents
• How do consumers process and evaluate prices?
• How should a company set prices initially for products or services?
• How should a company adapt prices to meet varying
circumstances and opportunities?
• When and how should a company initiate a price change?
• How should a company respond to a competitor’s price change?
A changing Pricing Environment
• Pricing practices have changed - Consumer has easy access to
credit.
• Internet – changing how buyer and seller interacts.
• Buyer can get instant price comparison from thousands of vendors.
• Buyer can Name their prices and have it met.
• Seller can monitor customer behavior and tailor offer to individuals.
• Give certain customer access to special prices.
 New-Product Pricing Strategies
• Pricing strategies changes as the product passes through its life cycle.
• A new product face the challenge of setting prices for the first time.
• They can choose between two broad strategies:
• market-skimming pricing
• market-penetration pricing.
How Companies price

• Smaller firms vs. larger firms.

• Larger Firms, Management sets general pricing objectives & policies.
• If pricing is a key competitive factor, firms establish a pricing dept.
• Many companies do not handle pricing well.
• Calculate cost and industry’s traditional margins.
• Not revising pricing enough:
• to capitalize on market changes
• for different product items, market segments and purchase occasions
Consumer Psychology and
Pricing
• Effectively pricing strategies requires understanding of consumer
pricing psychology (a systematic approach to setting, adapting & changing
prices).
• Consumers process price information, interpret it from past purchasing
experience, formal communication, informal communication, point-of-
purchase or online, and other factors.
• Purchase decisions are based on how consumers perceive prices and
what they consider the price to be – not on the marketer’s stated price.
• Customers have a lower and upper threshold.
Consumer Psychology and
Pricing
• Reference Prices:
• Consumers often employ reference price. Comparing to an internal reference
price they remember or an external frame of reference.
• Price-Quality Inferences
• Many consumers use price as an indicator of quality. Image pricing is especially
effective with ego-sensitive products. Some brands adopt exclusivity & scarcity.
• Price Endings
• Many sellers believe price should end in an odd number. Price encoding in this
fashion is important if there is a mental price break at the higher, rounded, price.
Setting the Price
The firm must consider many factors in pricing policy. Six steps process.
1. Setting the pricing objective
2. Determining Demand
3. Estimating cost
4. Analyzing Competitor’s costs, Prices, and Offers
5. Selecting a Pricing Method
6. Selecting the final price
Setting the Price
Step1. Selecting the pricing objectives

a) Survival
• A short run objective. Companies with overcapacity, intense competition, or
changing consumer wants.
• As long as prices cover variable & some fixed costs, the firm stay in the business.
b) Maximum current profit:
• Estimate demand with alternative prices & choose the price to maximize profits.
• Assumption - the firm knows its demand & cost functions
• The Firm may sacrifice long run performance by ignoring the effects of other
market variables, competitors’ reactions, & other legal restraints on price.
Setting the Price
Step1. Selecting the pricing objectives
c) Maximum market share:
• Firm believe that higher sales volume will lead to lower unit cost & higher
long-run profits.
• Following conditions favor adopting a market-penetration pricing strategy:
1. Price sensitive market & a lower price stimulate the market growth.
2. Production & distribution cost falls with accumulated production
experience.
3. A low price discourages actual and potential competition.
Setting the Price
Step1. Selecting the pricing objectives
d) Maximum market skimming:
• Set high prices for Products with new technology to maximize market
skimming. E.g. Sony, Apple
• Consumers who buy early at the highest prices may feel unhappy when
they compare with those who buy at a lower price. E.g. Honda Jazz
• Market skimming make sense under following conditions.
• A sufficient number of buyers have a high current demand.
• High initial price does not attract more competitor to the market.
• The high price communicates the image of a superior product.
Setting the Price
Step1. Selecting the pricing objectives
e) Product-quality leadership:
• A company might aim to be the product-quality leader.
• Most brands strive to be “affordable luxuries”, high level of perceived quality,
taste, and status with a price just high enough not to be out of consumers’
reach. e.g. Starbucks

f) Other objectives:
• Nonprofit & public organization may have other pricing objectives.
• A university aim for partial cost recovery, knowing that it must rely on
private & public grants.
• A nonprofit hospital may aim for full cost recovery in its pricing.
Setting the Price
Step 2: Determining demand
• Each price will lead to a different level of demand and have a
direct impact on a company’s marketing objectives.
• The normally inverse relationship between prices and demand.
• The higher the price, the lower the demand.
Setting the Price
Step 2: Determining demand
Price sensitivity:
• Consumers are less price sensitive to low-cost items or items they buy
infrequently. They are also less price sensitive when:
• There are few or no substitutes or competitors.
• They do not readily notice the higher price.
• They are slow to change their buying habits.
• They think the higher price is justified.
• They think price is only a small part of the total cost of obtaining , operating, and
servicing the product over its lifetime.
Setting the Price
Step 2: Determining demand
Estimating demand curve:
• Most companies attempt to measure their demand curves using
several different methods.
• Surveys can explore how many units consumers would buy at different
proposed prices.
• Price experiments can vary the prices of different products in a store or of
the same product in similar territories.
• Statistical analysis of past prices, quantities sold and other factors can
reveal their relationship. E.g. “go-better-best”
Setting the Price
Step 2: Determining demand
Price elasticity of demand:
• Marketers need to know how responsive, or elastic demand is to a change in price.
 Setting the Price
Step 2: Determining demand
Price elasticity of demand:
• The higher the elasticity, the greater the volume growth resulting from
price reduction.
• Lower the price
• Long-term price elasticity may differ from short-run elasticity.
• Demand is more elastic if buyers continue to buy from a current supplier after
a price increase but eventually switch suppliers. (the distinction between short-
term and long-turn elasticity means that seller will not know the total effect of a price change until
time passes)
 Setting the Price
Step 3: Estimating costs
Types of Costs and Levels of Production
•Firm wants to charge a price – that covers cost of
producing, distributing, and selling the product,
including a fair return.
•Types of costs and level of production
• Fixed cost - that do not vary with production level or sales
revenue.
• Variable costs - vary directly with the level of production.
• Total costs – consists of the sum of the fixed and variable
costs for any given level of production.
• Average cost – cost of per unit at that level of production; it
equals total cost divided by production.
Setting the Price
Step 3: Estimating costs
Accumulated production
• Average costs falls with
accumulated production
experience.
Setting the Price
Step 4: Analyzing Competitor’s Response
• Competitors are likely to react when firms are few, the product is
homogenous, and buyers are highly informed.
• How a firm can anticipate a competitor’s response?
• Assume the competitor reacts in the standard way to a price change.
• Assume the competitors treats each price change as a challenge and reacts
according to self interest.
• Company need to know the competitor’s current financial situation,
recent sales, customer loyalty & corporate objectives.
• If competitor has a market share objective, it is likely to match price difference.
• If it has a profit-maximization objectives, it may react by increasing its advertising
budget or improve product quality.
Setting the Price
Step 4: Analyzing Competitor’s Response
• Respond to a competitor’s cut, company must consider the:
• Product’s stage in life cycle
• its importance in the company’s portfolio
• The competitor’s intentions and resources
• The market’s price and quality sensitivity
• The behavior of cost with volume
• Company’s alternative opportunities
• In homogenous product markets, the firm can search for ways to
enhance its augmented products, if not, need to meet the price cut.
Setting the Price
Step 4: Analyzing Competitor’s Response
• Market leaders often face aggressive price cutting by smaller firms
trying to build market share.
• Three possible responses to low cost competitors are:
• Further differentiate the product or services.
• Introduce a low-cost venture
• Reinvent as a low cost player.
• The right strategy depends on the ability of the firm to generate
more demand or cut costs.
Setting the Price
Step 5: Selecting a pricing Method
• Major considerations in price setting:
• Cost set a floor to the price
• Competitor’s prices and the price of substitute.
• Customers’ assessment of unique features establish the price ceiling.
Setting the Price
Step 5: Selecting a pricing Method
Markup Pricing

Variable cost per unit (Rs) 10

Fixed costs (Rs) 300,000

Expected unit sales (Rs) 50,000

Fixed cost
Unit Cost = Variable cost + = 10
Unit sales

300,000
Unit Cost = 10 + = 16
50,000

Unit cost 16
Markup price (Rs) = = = 20
(1-desired return on sales) 1-0.2
Setting the Price
Step 5: Selecting a pricing Method
Target-Return Pricing
Target-Return Pricing:  
 
• The firm determines the price that
Pen manufacturer investment (Rs) 1,000,000  
yield its target rate of ROI.    
• What if sales do not reach 50,000 Desired return on Investment (%) 20  
   
units?
Expected Unit Sales 50,000  
desired ROI x invested capital
Target - Return Price = Unit Cost +  
Unit sales
   
0.20 x 1,000,000
Unit Cost (Rs) = 16 +  
50,000
   
Unit Cost (Rs) = 16 + = 20
4
 Setting the Price
Step 5: Selecting a pricing Method
Break-Even Volume

Variable cost per unit (Rs) 10

Fixed costs (Rs) 300,000
Expected unit sales 50,000
Price (Rs) 20

Break even Fixed cost

=
volume (Price-variable cost)

Break even 300,000

=
volume (20 -10)

Break even 300,000

= = 30,000
volume 10

Break Even Volume:

• The manufacturer can prepare a break-even chart to learn what would happen at other
sales levels.
Setting the Price
Step 5: Selecting a pricing Method
Perceived-Value Pricing
• Perceived value is made up of host of inputs.
• Firm must deliver the value proposition, and the customer must
perceive this value.
• Firm use the other marketing program elements such as advertising,
sales force, and the internet, to communicate & enhance perceived
value in buyers’ mind.
Setting the Price
Step 5: Selecting a pricing Method
Value Pricing
• Firm charging a fairly low pricing for a high quality offering.
• It is a matter of re-engineering the company’s operations to become a
low-cost producer without sacrificing quality. E.g. Ikea, Southwest airlines.
Setting the Price
Step 6: Selecting the final Price
Impact of other marketing activities:
• In selecting final price, consider additional factors i.e impact of other marketing
activities, firm pricing policy, impact on other parties.
• A study examined the relationship among relative price, relative quality and relative
advertising for 227 consumer business and found the following.
• Take into account the brand’s quality and advertising relative to the competition.
• Brand with average relative quality but high relative advertising budgets could charges premium
prices. Consumers were willing to pay higher prices for known rather than unknown products.
• Brands with high relative quality and high relative advertising obtained the highest prices.
Conversely, brands with low quality and low advertising budget charges the lowest prices.
• For market leader, the positive relationship between high price and high advertising held most
strongly in the later stages of the product life cycle.
Setting the Price
Step 6: Selecting the final Price
Company pricing policies
• Price to be consistent with company pricing policies. Yet firms are not averse to
establishing pricing penalties under uncertain circumstances.
• Hotels on no show, Airlines charge those who change reservations on discount ticket etc.
• Although these policies are justifiable, marketers must use them judiciously.
• Firms develop a pricing structure that reflects variations in geographical demand
and costs, market segment requirements, purchasing timing, order delivery, order
frequency
Q/A