Module – 5 Pricing

 PRICING OBJECTIVES Growth in sales Improve market share Profit level Control cash-flow Combat competition Maintaining the image

 PRICE DETERMINATION Identify the target market or the potential customers Estimate demand and study consumer behavior: Ascertain competitor’s price Establish expected market share Determine pricing strategy: For a new product, two popular strategies are available for pricing. [a] Penetration pricing [b] Skimming pricing Estimate costs and profit Consider company’s marketing policies Select the specific price

FACTORS INFLUENCING PRICING POLICY

 Internal factors are those which arise within the organization and are, therefore, controllable. The important internal factors are discussed below: 1. Product Cost: Cost of the product is the basic determinant of its price. Only after ascertaining cost, pricing can be achieved in a financially healthy manner. 2. Pricing Objectives: Pricing objectives of a company play a crucial role in determining the price. A well established company can afford to offer a very low price for its product, if the objective is to capture market and wipe out competition. 3. Product differentiation: The concept of product differentiation aims to distinguish one brand from the other on various dimensions. 4. Product life cycle: The price of a product is influenced by the stage in its life cycle. 5. Marketing mix: pricing decisions should be conducive to the working of the other elements in the marketing mix.

 The external factors are those which control the firm as they exist in the external uncontrollable environment: 1.Product Demand: Demand refers to the desire to purchase a product backed by purchasing power 2.Competition: Competition refers to other players in the market, within the industry, offering products which satisfy the same needs of the customers, as offered by the company under consideration. 3.Economic conditions: This refers to the play of business cycles. 4.Different kinds of buyers: Buyers can be either business buyers/industrial buyers or individual customers/final users. 5.Government regulations: The laws of the land govern every aspect of business and pricing is also covered among them.

COST-BASED PRICING METHODS:  Cost Plus Pricing Method: This method suggests that adding a percentage of cost (acting as profit) to the total cost to arrive at the selling price.  Target return Pricing: Here, a rate of return is set, for example, 15% of invested capital or 18% of sales revenue  Marginal or Incremental Cost Pricing: This method aims at recovering only the marginal costs or the variable costs and not the total costs

Important Merits of cost based pricing methods can be discussed as follows: 1. Simplicity: Cost is an internal factor to a firm. Ascertaining total cost is imperative and price based on total cost is therefore simple enough to be understood and calculated. This approach is further simple, as it is not influenced by external factors. 2. Peaceful competition: This approach establishes competitive stability as all firms adopt cost mark ups, which keep price wars at bay. This also ensures no particular player adopts extreme low or high price. 3. Safe: Since total cost is the influencing or determining factor, this approach ensures all costs are recovered. Thus, it will not let the management play with seasonal and cyclical shifts in the business. 4. Flexible: Cost based methods are flexible and reliable. This is because, whenever a new technology, prices are revised according to the changes occurring due to cost being the determining factor. 5. Justifiable: Compared to demand based or competition based methods, this method is fair as the rate of return remains the same regardless of changes in the demand level.

Demerits of Cost based methods: 1. Ignores demand and competition: This is the biggest drawback. Ignoring demand and competition makes a pricing method have very low practical value. 2. Challenges in cost allocation: To determine total cost, all kinds of costs need to be considered. Thus, variable, fixed and semi variable costs need to be identified for each product produced and grouped together to arrive at total cost 3. Irrelevance: Apart from product costs, certain other types of costs such as opportunity cost and sunk cost play an important role in business decisions. 4. New products: Pricing new products poses a problem as the firm lacks past experience. 5. Not logical: Sometimes, total costs increase due to operational inefficiency such as stoppage of work, lack of adequate raw materials etc. Even such cost is recovered in the price and therefore it is not logical.

COMPETITION BASED PRICING METHODS  Going rate pricing: Here, the firm will take the competitor’s price as a benchmark and keep it at par or slightly below it or even slightly above it.  Sealed bid pricing: This method is popular to win contracts form the government when there is more than one company trying to win the project. Merits of Competition based methods of pricing: a) It can prove to be virtuous as it is based on experience of other firms. b) New customers are willing to try the product as the price is competitive. Demerits of Competition based methods of pricing: a) If the price set by other firms is wrong, the firm also suffers. If the price is very low, then the firm is also compelled to keep it low. b) This method lacks creativity and innovation from the firm side as it is depriving itself of what it can achieve with internal factors, by paying attention only to one factor - competition. c) This method is not suitable for niche and unique products as competition does not play an important role it those. d) All internal factors take a back seat and the biggest of those will be the cost factor. In other words, recovering cost is not given primary focus. e) If a firm is not financially strong, it is not advisable to adopt this method.

DEMAND BASED PRICING METHODS:  Demand modified break-even analysis: This method intends to achieve highest profit, beyond the break-even point, in consideration of the amount demanded at alternate prices.  Perceived value pricing: Here, price is arrived in accordance to the perception of the customer and no the costs of the company