Pricing Theory
and Practices
Course # 412
Fourth Year Second Semester – 2013
Lesson - 1
TOPICS:
i.
Understanding on overall course
objectives
ii.
Semester plan for course completion
iii.
Planning for supporting knowledge
development program
The learning objectives
for this course include:
1) Introduce to the
theory of pricing and to be equipped with basic pricing skills and knowledge.
2) Introduce the
role of pricing in the Marketing-Mix and its importance to the business
strategy of the corporation.
3) Develop and
enhance the ability to design and implement profitable pricing decision
4) Understand the
key components and capabilities of Pricing and Profitability Management
5) Learn how to use
pricing analytics to help set prices and diagnose profitability management
problems
6) Gain exposure to
the Pricing Technology landscape and the various offerings currently available
in the market
7) Assess common
organizational obstacles to realizing pricing improvements and how to overcome
these obstacles
Tasks to Accomplish the
Objectives:
I.
Conceptual knowledge development through study text
books and discussion in class lectures
II.
Establishing knowledge by theoretical tests
III.
Practical output generating preparing assignment,
case, field visit, and presentation
Semester
Plan:
Team
Building:
ü Divide CGPA
categories considering 10 items in each category
Team Work:
v There will be 10
members team considering third year CGPA mixing high grade to low
v One team leader
will lead up to finishing one test
v Every task
{except class tests} will be accomplish by team work
Class Schedule:
§ 35 class lectures
§ Two class tests
§ Three team
assignment presentations
§ Three team
presentations
§ One field study
report presentation
Assessment Scoring:
Ø Attendance score
will be measured as per program curricula
Ø Two class tests
average score will considered [if someone miss one test; they have to sit for
one alternative test]
Ø Assignment scores
will be measure deliberating document preparation, slide preparation, questions
answer [not more than three members],
and presentation [not more than three
members]
Ø Team Presentation
will be eligible for every persons
Ø Report
presentation can present anyone on behalf of team for carrying team score
Ø No alternative
for missing assignment & presentations, except special issues
Team
Leaders’ Tasks:
a)
Present in the class before other members come
b)
Stay close with team
c)
Cooperate and coordinate in team issues
d)
Keep in touch with teachers
e)
Save class resources
f)
Take the ownership of the class
Supporting Knowledge
Development:
Supporting
Knowledge & Skills:
1)
Communication Skills
2)
Team Building and Leadership Skills
3)
Problem Solving and Decision Making Skills
4)
Management & Organizing Skills
5)
Computer Operating Skills
6)
Nature, Environment, and Economic Knowledge
Pricing Theory
and Practices
Course # 412
Fourth Year Second Semester – 2013
Lesson - 2
TOPICS:
i.
Understanding on concept and role
of price
ii.
Importance of price to marketing
iii.
Environmental pressure on Pricing
iv.
Objectives of pricing
Concept of Price:
The amount of money changed for a product or service,
or the sum of the values that customers exchange for the benefits of having or
using the product or service.
Price
is the amount of money we must sacrifice to acquire something we desire. That
is, we consider price as a formal ratio indicating the quantities of money (or
goods and services) needed to acquire a given quantity of goods or services.
• A
value that will purchase a definite quantity, weight, or other measure of a
good or service.
• In
exchange, buying and selling, price forms the essential basis of transactions.
• In
marketing price is determined by what
Price Equation:
Thus, when the price of a pack of
is quoted as
BDT15, the interpretation is the seller receives BDT15 from the buyer and the
buyer receives one pack of alooz chips.
§
A buyer is willing to pay,
§
A seller is willing to accept, and
§
The competition is allowing to be
charged.
Importance Of Price To Marketing:
Pricing decisions are critically important for both
consumers and marketers.
1.
Price system allocates resources.
Higher profits from the investment in a particular resource act as an incentive
to invest in those resources to produce even greater qualitative of the
products.
·
Price provides guidelines how
resources should be used.
·
Prices determine what products and
services should be produced and in what amount.
·
Prices determine how these products
and services should be produced;
·
Prices determine where these goods
and services should be produced;
·
Prices determine for whom the
products and services should be produced.
·
Price affects supply and demand for
a particular product and the same of its’ substitutes.
2. Price
affects spending behavior of consumer. Price is the ultimate basis of
consumer buying decision.
·
Price helps consumers to make up
their mind to buy or not buy a particular product. At what price you will not
buy the particular product.
·
That means price determines what to
buy and how much of the each product or item to buy.
·
Grapes are sour if it is beyond he
reach of the customers. Value of an offering to the consumer depends on the
price they have to pay for the item.
·
Pricing decision creates consumer
surplus or consumer deficit;
·
Price signals about quality; it is
one of the indications of quality.
3. In many cases marketers
use price as promotional tool;
·
Instrument of competition
·
Price is often used to enhance the
image of a product.
·
Price is a key element in the
marketing mix because it relates directly to the generation of total revenue.
The price affects an organization’s profits, which are its life-blood for
long-term survival. It affects the profit equation in several ways. It has a
direct bearing on the profit as is explicit.
·
”Nothing happens until somebody
sells something”. At present the urgency is for increased marketing and not
merely for increased production.
·
Price is also important in ‘not for
profit’ organizations where services or products are sold or dispensed. Here,
the organization must work within budget constraints so any revenues that might
be accrued from the sale or dispensation of services must be within the
constraints of the agreed budget.
4. The right
price is very critical to both marketers and consumers.
The question of a correct price of a product is still
a complicated problem to the marketing managers. Inflation, recession,
government regulation, rising consumerism are other factors that have forced
marketing managers to become more price conscious. Perhaps, this may be the
reason why strategic importance of pricing has increased during the last
decade. It is through effective pricing techniques that external forces are
bought under some control.
Environmental Pressures on Pricing Decisions:
1. Faster technological progress:
§
New product will not last long as
new
§
Urgency to recover the money
invested in R& D
2. Proliferation of new products
§
Customization and Customerization
forced to provide varieties and options
3. Increased demand for services
§
Increasing demand for supplementary
services
4. Increasing global competition
§
Making things different
5. Changing legal environment
§
Increased number of compliance
6. Economic uncertainty
§
Inflation
§
Shortage of resources
§
Recession
Pricing Objectives
Marketing objectives of the company: Companies define
pricing objectives in terms of survival, growth, sustainability, maximizing
current profits, market share, maximizing current revenue, return on investment
product quality leadership etc.
v
Survival-
Huge competition, natural calamity, war or political turmoil, transition of
economy or the industry and so on may force the company to think about
survival. To ensure survival profit is less important. It is so urgent to keep
the plant operating, capacity utilization and inventory turn over. So, price
should be set at the lowest possible level just to cover costs, keep the
employees with the organizations and keep the share price stable. However, such
pricing can be applicable for short term. It is expected that the situation
will be favorable after a short period of time. And then the company would be
able to make reasonable profit.
v
Maximum
current profit- Growth and maturity stages of PLC sales will be
maximum and company should try to earn maximum current profit. In some cases it
may assumed that the industry may go
some sort of change in near future so company should try to maximize current
profit setting the price at the highest possible level. It needs to estimate
the costs, demand, identify the price sensitivity level, calculating profit
from cash flow using alternative prices. Downsides: Knowledge of demand and
price sensitivity is important. In reality that is not so easy task. Besides,
in the long run company might face problem in the face of competition.
v
Maximizing
sales growth- If it is observed that the industry growth rate is
very attractive new market segments are emerging company should focus on
maximum capacity utilization and maximizing sales. In this case price should be
at lower level to earn a little from per unit sales. Assumption is that higher
sales lead to lower unit costs through ensuring capacity utilization.
v
Product
quality leadership- positioning the product with a
distinctive quality image and high priced item. In such cases products should
be highly differentiated and high value added. It may not work in the price
sensitive market segments.
v
Full
cost recovery- Pricing on the basis of total costs. When company is
planning to abandon their current business, company is planning to transfer
capital in other business, it is not the objective of the company to earn
profit from this SBU full cost recovery may be the objective of pricing.
v
Market
penetration - Setting a low price for a new product in order to
attract a large number of buyers and large market share. Several conditions
must be met for this low price strategy:
ü
The market is highly price
sensitive
ü
Costs decreases with increase in
sales
ü
Company have cost advantage
ü
It is assumed that the life span
the product is relatively longer
v
Maximum
market skimming - Setting a higher price for a new
product to skim the cream or maximum revenues within a shortest possible time
from a few sales. Market skimming makes sense only under certain conditions.
These are:
ü
The product quality and image
support higher price
ü
A significant number of consumers
want that product at that price
ü
The costs of producing a smaller
volume cannot be so high that they cancel the advantage of charging more.
ü
Competitors are not able to enter
the market easily and undercut the high price
ü
It is assumed that the life span of
the product is relatively shorter.
Pricing Theory
and Practices
Course # 412
FourthYearSecond Semester – 2013
Lesson - 2
TOPICS:
i.
Understand the Objectives of
pricing
ii.
Define the relationships among
Price and other elements of marketing mix
Marketing objectives of the company:
Companies define pricing objectives in terms of survival, growth,
sustainability, maximizing current profits, market share, maximizing current
revenue, return on investment product quality leadership etc.
v
Survival- Huge competition, natural
calamity, war or political turmoil, transition of economy or the industry and
so on may force the company to think about survival. To ensure survival profit
is less important. It is so urgent to keep the plant operating, capacity
utilization and inventory turn over. So, price should be set at the lowest
possible level just to cover costs, keep the employees with the organizations
and keep the share price stable. However, such pricing can be applicable for
short term. It is expected that the situation will be favorable after a short
period of time. And then the company would be able to make reasonable profit.
v Maximum current profit- Growth and maturity stages of PLC sales will be maximum and
company should try to earn maximum current profit. In some cases it may assumed
that the industry may go some sort of
change in near future so company should try to maximize current profit setting
the price at the highest possible level. It needs to estimate the costs,
demand, identify the price sensitivity level, calculating profit from cash flow
using alternative prices. Downsides: Knowledge of demand and price sensitivity
is important. In reality that is not so easy task. Besides, in the long run
company might face problem in the face of competition.
v Maximizing sales growth- If it is observed that the industry growth rate is very attractive
new market segments are emerging company should focus on maximum capacity
utilization and maximizing sales. In this case price should be at lower level
to earn a little from per unit sales. Assumption is that higher sales lead to
lower unit costs through ensuring capacity utilization.
v Product quality leadership- positioning the product with a distinctive quality image and high
priced item. In such cases products should be highly differentiated and high
value added. It may not work in the price sensitive market segments.
v Full cost recovery- Pricing on the basis of total costs. When company is planning to
abandon their current business, company is planning to transfer capital in
other business, it is not the objective of the company to earn profit from this
SBU full cost recovery may be the objective of pricing.
v Market penetration - Setting a low price for a new product in order to attract a large
number of buyers and large market share. Several conditions must be met for
this low price strategy:
ü The market is highly price sensitive
ü Costs decreases with increase in sales
ü Company have cost advantage
ü It is assumed that the life span the product is relatively longer
v Maximum market skimming - Setting a higher price for a new product to skim the cream or
maximum revenues within a shortest possible time from a few sales. Market
skimming makes sense only under certain conditions. These are:
ü The product quality and image support higher price
ü A significant number of consumers want that product at that price
ü The costs of producing a smaller volume cannot be so high that they
cancel the advantage of charging more.
ü Competitors are not able to enter the market easily and undercut the
high price
ü It is assumed that the life span of the product is relatively
shorter.
Price
and other Elements of Marketing Mix / Implications of Pricing Decisions
All the other
variables in the marketing mix generate costs. Product development,
distribution and marketing promotion involve expenditures. Price is the only
element in the marketing mix that generates income. But price has direct impact
on demand, costs, competition, and other elements in the marketing mix.
Demand Implications
The eventual
effect on sale volume and revenue is determined by the degree to which buyers’
demands are sensitive to price. However, price setters often misunderstand or
overlook some basic factors.
Ø
Market versus Product Elasticity: (1)
demand for the general product (primary demand) and (2) demand for the firm’s
specific offering (secondary demand). Generally, it would be expected that
secondary demand would be more responsive to price changes. Price elasticity
varies by brand, stage of the product’s life cycle, and whether the price is
increased or decreased.
Ø
Derived Demand for Buyers’ Output
Ø
Likelihood of Competitive Entry
Ø
Demand Consequences of a Product Line
Cost Implications
Cost -- Volume
-- Profit
Cost is the sum
of product cost, promotional cost and distribution cost
Volume is the
result of product quality and marketing promotion
Profit is the
outcome of customer satisfaction or customer delivered value which directly
related with price customer has to pay for a particular product.
Cost-Plus Pricing
Maximizing Margins
Pricing with Scarce Resources
Product and price
A product is a
bundle of utility. Each and every utility creating characteristics of the
product has costs, which finally constitutes the price of the product. Buyers
normally judge the utility of these product features in relation to costs in
other words price they have to pay for. Customer delivered value can be defined
as a ratio between what the customer gets and what he gives.
Value
= Benefits / Costs
Or, V
= B – C
= (Functional benefits + Emotional
benefits)/ (Monetary costs + Time costs + Energy Costs + Psychic costs)
Here, Benefits
refers to the translation of products features into utility to customers and
Monetary costs refer to the
price of the product to the customers.
Thus, according
to hedonic approach (utility producing approach) a product’s price is
determined by the utility or satisfactions or benefit producing characteristics
of the product. The contribution each characteristic makes to price can be
estimated by a regression between prices and product characteristics. The
regression equation can be used to predict the price that consumers are willing
to pay.
A Hotel room with bed, room services
A Hotel room with bed, room services,
seating arrangements
A Hotel room with bed, room services,
seating arrangements, AC
A Hotel room with bed, room services,
seating arrangements, AC, food
A Hotel room with bed, room services,
seating arrangements, AC, food, transportation
A computer with Intel or Celeron processor
A computer with accessories, UPS
A computer with accessories, UPS, printer
A computer with accessories, UPS, printer
and table
Pricing
decisions mostly depend on the product life cycle stages.
Stages
|
Pricing
|
Introduction:
|
Skimming or penetration
|
Growth
|
Lower price/keep stable
|
Maturity:
|
Price adjustment or keep stable
|
Decline:
|
Price cut or harvesting
|
Price
and marketing promotion
·
Promotion serves to either
increase or decrease buyer’s price sensitivity to price.
·
If promotion differentiates the
product then the price sensitivity is decreased.
·
On the other hand, increase of
information flow through promotion makes buyers more prices sensitive.
Models for optimal price and advertising
strategies are assuming that demand is a function of both price and marketing
promotion.
Pricing
and advertising model for nondurable product:
Feature of the model
·
The initial trial of the
product is assumed to be random because of the uncertainty of the product’s
performance.
·
Pricing and advertising
decisions are assumed to be probabilistic functions of the rate of market
penetration.
·
The market is segmented between
triers and nontriers.
The model indicates
if demand is insensitive to price, and
advertising in the repeat purchase market helps to differentiate the product
the penetration introductory pricing strategy is optimal.
If the market demand is initially not price
sensitive, but the repeat purchase market becomes price sensitive, a skimming
pricing strategy would be appropriate.
Price
and distribution
·
Price charged by the stores
affect its shopper types or it can be the other way.
·
Shoppers select an outlet on
price before choosing the product.
·
Price set by the stores depends
on the assortments. Or, market segment
of particular price range motivates shoppers to offer an assortment of product.
·
Distribution cost is one of the
major components of the price.
Pricing Theory and Practices
Course # 412
FourthYearSecond
Semester – 2013
Lesson - 4
Price Determination in Theory
Pricing
decisions are made by a complex of private and public institutions. Many of
these decisions are made within large, multifaceted, and complex
profit-oriented as well as not-for-profit organizations. The way these pricing
decisions are made is considerably different from the decision process
described by traditional economic theory.
The essentials
of the economic theory of the firm tell us how a firm will decide which
production technique (method) to use and what the particular input proportions
will be to produce the desire product. Given its production method and its
decision as to what to produce, the firm seeks to minimize its input costs. The
firm then decides the quantities of each product it plans to sell and the price
per unit at which it hopes to sell each product. The input purchase plans and
the sales plans the firm chooses depend on:
- The Objectives of the Firm
- The Time Span of the Plans
Economic
analysis uses three time periods: (1) Market Period – which is so short that
managerial plans cannot be changed; (2) Short Run – where there is sufficient
time to vary some input plans; and (3) Long Run – where all input plans are
capable of being changed. The objective of the firm is assumed to be profit
maximization.
Profit-Maximizing in
Firm
A firm
interested in maximizing profits determines how much to produce in the short
run when price is constant, i.e., price cannot be changed. Since price is
constant the total-revenue curve must go through the origin, but in the short
run some costs are fixed, so the total-cost curve does not go through the
origin. Since the firm is assumed to know its costs for each possible output
level, determining how much to produce is not a difficult task. As long as
revenue received from the sale of an additional unit of output (marginal
revenue) is greater than the additional costs of producing and selling that
unit (marginal cost), the firm will expand output. Since price is constant,
marginal revenue equals price, and the firm will produce at the quantity level
where marginal revenue (price) equals marginal cost.
In the long run, same conditions held but total-cost curve goes
through the origin, as does the total-revenue curve. Maximum profits are still
where marginal revenue equals marginal cost.
The firm
determines its output on the basis of where marginal revenue equals marginal
cost, but the price it receives for its output is determined by the demand
curve and varies according to how much is produced. Thus, as quantity produced
increases, the price per unit the firm receives for its output decreases. That
is, price is set at the level where the firm can sell its entire output.
The long-run solution, similar to the constant-price
situation; however prices can vary, the total revenue curve is not linear. A
firm having complete knowledge about its costs and revenues and managed by a
rational expert would always maximize profits. However, complete information
usually not available and managers are fallible human beings. Thus actual firms
depart more or less from the maximum-output or least-cost solutions.
Challenges to Profit-Maximizing
Objective
The assumption
of profit maximization has been challenged for two basic reasons. First, profits do not appear to be the
only objective of managers of the firm. And second,
managers who are concerned about profits many not appear to be attempting to
maximize.
It has been
argued that a business firm a complex organization comprised of individuals
with a set of individual motives. That is, some people are working solely for
the money they earn, others are also concerned with social relationships that
evolve, and some are interested in shouldering responsibility or wielding
authority. In addition, the participants within the organization are probably
very much concerned with long-run survival and hence would be interested in
maintaining a given level of security for the organization.
A second
challenge to the profit-maximization assumption accepts the importance of
profits but questions whether managers really attempt to maximize profits. It
suggests instead that their goal is to attain satisfactory profits. Satisfactory profits represent a level of
aspiration that managers use to assess alternative strategies. In essence, if a
strategy is predicted to generate an acceptable level of profits, then the
strategy is good enough and is implemented.
Economic Theory of Buyer
Behavior
We now turn to
discussing how price is believed to affect demand. We begin with economic
theory of buyer behavior, which provides the framework for most of the social
criticisms of pricing practices by manufacturers and retailers. Finally, we will
discuss various measures of demand sensitivity to price.
Decisions of Buyer
Essentially, the
buyer has two decisions to make: (1) what products should be purchased and (2)
how much should be purchased of each product. The quantity of each product to
buy depends on (i) the price of that product, (ii) the prices of all other
products, (iii) the income of the buyer, and (iv) the buyer’s tastes and
preferences. The consumer is assumed to be rational and to choose among
alternative products so as to maximize satisfaction (utility).
Assumption to Maximize Utility
Utility means
want-satisfying power which is common to all products and services. Utility is
subjective, not objective, and it is assumed that a choice of product A over
product B means the buyer perceives product A as having more utility than
product B. Utility maximization involves several assumptions about the buyer:
- The calculate deliberately (purposely) and choose consistently
- Deliberate choice rules out habit or impulse (desire) buying
- Consistent choice rules out vacillating (uncertain) and erratic
(unreliable) behavior; the buyer acts predictably
- If the buyer prefers product A to product B, and prefers
product B to product C, then consistency requires that he or she prefers A
to C
- Within these conditions of behavior, buyers choose as if they
are maximizing utility
- To maximize utility the buyer knows all alternatives and is not
ignorant about any aspect of his or her purchase
- Because of this perfect knowledge, there is never a gap between
the satisfaction the buyer expects from a purchase and the actual
fulfilment realized from the purchase
- Want and subjective utilities are not influenced by prices,
i.e., higher priced products do not provide additional utility or value
simply because of their higher prices
- Finally, it is assumed that total utility increases at a
diminishing rate as more of a product or service is acquired
Solutions to Buyers’ Assumptions
The solution to
the question of how much of a product will purchase requires the assumption of diminishing
marginal returns to utility as quantity purchased increases. The quantity
purchased is determined by the point at which total utility is maximized.
Since, it is
assumed that prices serve only to indicate the amount of money buyer must give
up to acquire a product, the amount of a particular product to be acquired
depends on the relation between the marginal utility of acquiring an additional
unit and the price of that additional unit.
Further, the
assumption of diminishing marginal utility implies that buyers are capable of
ranking all alternatives in terms of increasing preference, and that they
purchase first the most preferred product. Buyers will continue to buy
additional units of the preferred product until the marginal utility realized from
purchasing a unit of the second most preferred product.
Pricing Theory
and Practices
Course # 412
FourthYearSecond Semester – 2013
Lesson - 5
Price
determination: Accountant’s
Approach
The
philosophy underlying the accountants’ approach to pricing is to achieve a
targeted rate of return on investment from a given level of sales.
Once
total costs have been determined, the company then decides on the percentage of
profit it requires. This approach is termed ‘cost plus’ pricing.
This,
however, is a rather mechanistic approach that is not usually used in practice,
although mark-up pricing which simply adds a fixed percentage onto the cost of
goods and services, is still used a lot in the more traditional sectors of the
retail trade. The reality is that the overall profit margin is normally the
result of several pricing strategies applied to a variety of products in
response to changes in the market place.
Therefore,
the percentage of ‘plus’ is a function of market conditions and
individual customers which means that it is more a decision that marketing
should make rather than for finance. However, the target rate of return that is
expected in such circumstances should equate to the overall percentage that has
been agreed with finance. If certain contracts are agreed with customers at
less than this target rate of return, then this shortfall should be made up on
other contracts which will be priced at more than this target rate of return.
This technique is more flexible than simple cost plus pricing in that it allows
marketing more flexibility when dealing with customers and for obvious reasons
this pricing technique is termed ‘target pricing’.
In
a manufacturing situation where the company has to make and perhaps install
something that is unique and purpose designed a cost plus or target pricing
approach might be appropriate. Such a product might be for the design,
manufacture and commissioning of an oil refinery. Here the client is probably asking
for tenders from a number of companies so what the company must do is to
estimate the likely costs of such a project and then add a margin on top of
this for profit.
The
accountant also has to control the flow of cash in an organization and there is
normally a need to recoup the often high costs of development as early as
possible in the life cycle of a product. However, it is through the financial
function that a balance is kept between a variety of other demands on the
company’s limited resources. This means that a fine balancing act has to be
performed when attempting to meet the often conflicting demands and
requirements of, for instance, production, research and development, training
and marketing.
It
can then be seen that the accountant’s view of pricing is more governed by the
internal workings of the company than with the vagaries of the market place.
In
any manufacturing concern, there are fixed costs like depreciation and
maintenance of plant and equipment, rent and rates for factory buildings and
the costs of a minimum labor force which the company has to pay regardless of
the level of output.
Variable
costs have also to be added and these are a function of the level of output
that includes direct labour, materials and energy costs. The total costs are
the sum of fixed and variable costs.
Break-even
analysis
The
break-even quantity (BEQ) occurs when a certain number of units sold at a given
price generate sufficient revenue to exactly equal total costs.
Total
revenue is of course the amount of money that the company receives and this
will increase with output.
Therefore,
the gap between total revenue and total costs prior to the break-even point
will represent a loss to the company and the gap between these after break-even
will represent profit.
In
reality things do not work as neatly as this, as there are elements of extra
costs and reduced revenues that must be considered. As output and sales
increase to a certain level there will be additional costs like the
commissioning of a new production line which will incur a ‘step cost’. As sales
grow there will be a tendency to trim profit margins in order to attract more
customers.
Demand
orientated pricing might be viewed as being preferable to cost-based pricing,
but we should be aware of certain practical limitations when it is related to
break-even analysis. It assumes that costs are static, whereas they can vary
considerably (both up and down) in reality. Revenue is over-simplified as
market conditions can change rapidly, and even if they return to the condition
on which the analysis was originally based, the actual revenue may not be as
predicted. With these provisos taken into account, break-even analysis related
to demand can be an effective price computational technique, especially if
costs and demand levels are comparatively stable, even if only in the short
term. It should, however, be appreciated that accurate demand estimation is
difficult to achieve despite an organisation’s best efforts when attempting to
provide accurate forecasting.
Now
that we have considered economists’ and accountants’ relatively disciplined
views of pricing we are now in a position to look at the marketer’s approach.
It should be emphasised here that what has been and is going to be put forward
are relatively theoretical constructs, and the purpose of theory is to enable
the world of reality to be viewed in a more ordered and disciplined manner. In
reality, if an accountant and an economist were faced with price making decisions
it would be unlikely that they would personally take their respective theories
too literally.
Price
determination: Marketer’s Approach
An
organisation should have to hand as much information as possible to use when
setting prices and this will depend on the overall marketing strategy. The
pricing techniques we have examined pay less attention to demand and
concentrate on cost. Marketing techniques place more emphasis on the combined
elements of the marketing mix as well as aspects of consumer behaviour in
relation to the way price is perceived.
Improvement
or maintenance of market share is a common pricing objective and this is
market-based. When a market is expanding, existing prices being charged by a
company may not encourage a corresponding improvement in market share. A
downwards price adjustment might increase sales in an expanding market to a
level where the return-on-investment increases in monetary terms although the
percentage return on each unit sold might have fallen. Market share is a key to
profitability and this is an indicator of an organisation’s general health.
Price levels and profit margins carry much of the responsibility in a marketing
mix designed to maintain or improve market share.
Smaller
firms generally have little influence over the level of prices in a given
market and organize their businesses so that costs are at a level which will
allow them to fall in line with the prices charged by the market leaders and
price leaders. This is sometimes termed ‘going rate’ pricing. Prices tend to be
market led with little scope for any deviation from the established price
structures. As long as returns are considered to be adequate, there is
justification for keeping things as they are by conforming with prices that
have been established by the leaders. It should, however, be noted that price
leadership does not equate to total authority in the market place. Many price
leaders are not necessarily market leaders. Non-price competition can improve a
company’s market share through manipulation of the marketing mix, so the group
with the final influence in price setting are indirectly end consumers who
react to a company’s manipulation of its marketing mix through their individual
purchasing actions.
If
a company desires a rapid growth in sales, then if clear product superiority
cannot be sustained, price is the component of the marketing mix that must be
manipulated. In such circumstances, the firm must appreciate the competitive
conditions in which it is operating and a price cutting action should always be
made with caution. This caution is not only in terms of competitors’ reactions,
but a sudden price reduction might also affect the balance of other elements in
the marketing mix and an example of such adverse reaction might apply in the
case of a manufacturer of an exclusive line of strongly branded perfume.
Profit
maximization is a natural policy for any business organization to pursue.
However, market conditions can make it impossible to maximize profits on all
products, in all markets, at the same time. For this reason, companies employ
pricing techniques that can promote sales, but reduce profits on certain
products in the short term. The overall objective is to maximize profits on all
goods that are to be sold over a period of time. The company’s product mix
should, therefore, be considered as a complete entity, rather than as a range
of products whose profits have to be maximized individually. This idea might
run counter to the product/brand manager system, with the premise being that
each product or brand manager is in control of a specific Strategic Business
Unit whose objective is to maximize profits. However, a more global view, like
the one expressed here, sometimes has to be taken by the marketing manager
which might mean that certain product lines be held back in the interests of
maximizing the overall profitability of the company.
Break-even
analysis has already demonstrated that to ensure profitability, prices must
ultimately exceed costs. It is logical then to consider cost as the first step
when planning price levels. However, market based pricing strategy should begin
with the consumer and then work backward towards the company. Pricing decisions
must be consumer-orientated, for it is customers who will ultimately decide
whether the product is purchased or not.
When
making market based pricing decisions, a number of sequential steps should be
taken:
- Customer
or market identification is to focus the
marketing decision-maker’s mind on the market from the beginning. It
prevents price from being perceived separately from other marketing mix
elements.
- Demand
estimation or more technically speaking,
sales forecasting, is a skilled process that should provide the company
with a series of potential demand levels at different selling prices. The
potential sales volume will directly affect costs, and the price necessary
for profit maximisation can then be calculated. The price a company is
able to charge will vary according to market conditions and the chosen
market segments in addition to less tangible criteria like the value
customers place on a given product.
- Assessing
competitive reactions assumes great
importance when products are easily inaugurated and markets are easy to
enter. Even when a company’s products or services can be differentiated in
some way, it is not usually too long before competitive offerings appear.
This competition appears from three sources:
- Direct or ‘head-on’ competition
from similar product offerings
- Competition from substitute
products or services
- Competition from products that are
not directly related, but which compete for the same funding sources or
disposable income and example of which is expensive perfume manufacturers
and jewellery manufacturers who might sometimes be in competition as
these items are often purchased as gifts.
- Market
share analysis is to consider production
factors against the anticipated share of the market. If a large market
share is envisaged then the price will probably need to be competitive. If
production capacity is insufficient to meet the demand that the
anticipated market share will produce then there is little point in
setting a low price that will bring in orders that cannot be fulfilled.
Pricing Theory
and Practices
Course # 412
Fourth Year Second Semester – 2013
Lesson – 6 & 7
Price and
consumer perception of value
- How
people form judgment and make decisions when they do not have enough
information about alternatives ?
- Why
buyers are more sensitive to price increases than price decreases ?
Explanations: Buyers judge prices comparatively with a reference price, which
they recall from last time buying, self of a retailer, or advertisements.
Decision
variables that affect perceptions of value and prices:
- Context
of purchase;
- Availability
of information
- The
order of price presentation – create the scope for negotiation or
bargaining
- Reference
price: Reference price is any price of an item that consumers use as a
basis for comparison in judging another price. External reference price means the price that marketers use in
ad Or claim the price in different locations or situations. Advertisement as on sale tends to create
perception of higher value and lower price. Internal reference prices are those prices retrieved by the
consume from memory
- Competitors
acts on pricing
- Competitive
factor(s)/variables in the industry: In case of differentiation consumer
will expect price differentiation. But when industry players compete on the
same variable like cost or price consumer expectation will be similar
price or even lower price.
Consumers usually have a set of prices that
are acceptable to them to pay for a product they tend to purchase.
If an offered price is not acceptable
consumers are likely to refrain from purchasing the product.
Perceived
product value
Total perceived value of a product is
considered for purchase is comprised of :
- Acquisition
value
- Transaction
value
Perceived
acquisition value = perceived benefits/perceived sacrifice
The greater the perceived acquisition
value, the greater is the likelihood that a consumer would be willing to
purchase the product.
Perceived benefits are related with the
buyer’s judgment of product quality.
Lacking information about quality many
consumers believe that there is a positive correlation between price and
quality.
That means, higher price product will be
perceived to provide higher quality and benefits
Transaction
value: Reference price -- Actual price
Perceived gains/losses relative to
reference point with the financial aspect of purchase.
Transaction value is positive if the actual
price is less than the reference price, zero if they are equal and negative
otherwise.
Reduction in sacrifice increases
transaction value.
Effects
of plausible reference prices
Plausible low price: prices are well within
the limit of acceptable price.
Plausible high: prices are near the higher
limit of the range but still believable.
Consumer tends to judge the value on the
basis of the limit they believe would he price. If the Advertised price is
higher that consumer do not believe, consumer tend to substitute the price
lower than the advertised price to assess the value of the offerings.
If the buyer has no prior experience about
he priced then the plausibility will be determined by the difference of
advertised reference price and advertised sale price.
Implausible: Prices are well above the
range of consumer’s acceptable price.
Major pricing errors
It is essential to understand how customers perceive
prices, price changes, and price differences. Price should be set to reflect
customers’ perceptions of value.
Major Errors:
1.
Setting priced not recognizing
the difference between absolute price and relative price;
2.
Setting priced ignoring
consumers concerns like perception of value and affordability;
3.
Setting priced not
distinguishing between pricing strategies and pricing tactics;
4.
Setting price without clear
understanding about target customer;
5.
Setting price ignoring
consumers value definition;
6.
Setting price contradicting
marketing objectives of the company;
7.
Setting price focusing more on
costs;
8.
Setting price ignoring
environmental issues like inflation, currency fluctuation etc.;
9.
Setting price ignoring market
reality; (competition, PLC and potential entrants, substitutes etc.)
Setting price ignoring the
nature of product; (convenience, prestige etc.);
Setting price ignoring
consumers price sensitivity; and
1
Setting price too low at the
start-up business.
