Learning objectives of this chapter are:
Ø Meaning and objectives of pricing
Ø Importance of pricing
Ø Factors affecting the price determination
Ø Methods of pricing Determination-Cost-oriented,
Demand-oriented, and Competition-oriented
Ø Initial and price responses to price
changes
Ø Price policies and strategies
Ø Pricing strategies in Nepal
|
Chapter preview: This chapter focuses on the second important element of the marketing mix- Price. Among 4Ps of the marketing mix, all other 3Ps directly contribute to the company as an input generating a tool of marketing success whereas price contributes as a revenue-generating tool at the end. In this chapter, we discuss the meaning, objectives, and importance of pricing, dig into three major pricing methods, and some important pricing strategies, and look at internal and external factors that affect pricing decisions.
7.1 Meaning and Concept of Price and Pricing
Price is the amount that customers pay for a product. It is the exchange
value of the products or services expressed in terms of money. Price can be
found in different forms in our daily lives. You pay a bill for electricity, tuition
for education, the fare for public
transport, rent for the apartment, the premium for insurance, all these bills,
tuition, fare, rent, and premium are different forms of price.
Price is a distinct element of the marketing mix because it generates
revenues. Pricing decision directly affects revenues rather than costs.
Generally, high-quality products have a high price and low-quality products have a low price. Price is the compensation given from one party to another in return
for products and services. It is measured in monetary terms.
According to Philip Kotler and Gary Armstrong- “Price is the amount
charged for a product or service or the sum of the values that consumers
exchange for the benefits of having or using the product or service.”
According to David J. Schwartz- “Price is the exchange value of the
product or service expressed in terms of money.”
Thus, price is the amount charged for a product or service or the sum of
the values that consumers exchange for the benefits of having or using the
product or service.
Pricing is the process of determining the price of a product. Pricing is
the method a company uses to set the price of its product. At the time of
pricing, you must take into account not only the cost of items such as
materials, time, labor, and overhead but, must also consider the competition’s
price and potential legal matters that may arise with the product. A company’s
pricing decision is affected by both internal and external factors.
Pricing involves asking many questions such as how much to charge for a
product? What are the pricing objectives? Do we use profit maximization
pricing? How to set the price? Should there be quantity discounts? What prices
are competitors chagrining? And what is the chance of getting involved in a
price war?
In conclusion, pricing is the process of fixing the price of the product. It
is a complex process. Both internal and external environmental factors affect
this process. The product price should be equal to its utility or value.
7.2 Objectives of pricing
There are several objectives of pricing. They can be classified into
three categories as follows:
1.
Profit-oriented objectives
To achieve a target result and to maximize profits are profit-oriented
objectives of pricing.
· To achieve a target result: The objective of pricing is to achieve a
certain target. It is a desirable profit of marketers. For example, a 10% profit on
sales or 15% profit on cost and so on. Wholesalers and retailers who do not
need to face competition apply this pricing objective.
·
To maximize profits: Profit maximization is another objective of
pricing. Firms should adopt long-term profit maximization rather than
short-term profit maximization by increasing the sales volume with a lower
profit margin.
2.
Sales-oriented objectives
To increase sales volume and market share are sales-oriented pricing
objective of pricing.
· To increase sales volume: Increasing sales volume of product is sales-oriented
pricing objectives of pricing. This emphasizes to increase certain percent
increase in sales volume by reducing the price or offering certain discounts in a certain time period. For example, a 15% increase in sales volume this year.
· To increase market share: Another objective of pricing is to increase the market share of the product. A decrease in price or stability in price is adopted
in order to increase the market share in the competitive market.
3.
Status-quo oriented objectives
Stability in price, to meet competition, and to survive is status-quo
objectives of pricing. It means a firm strives to stay at the current position
rather than trying to be a price leader in the market.
· To stabilize the price: Price stability is one of the most important
pricing objectives. Firms do not fluctuate their prices and keep the same price
for all the time-prosperity, recession, depression and recovery.
· To meet competition: This is the age of competition. So every
firm needs to determine its product price with a view to meeting market
competition.
· To survive in the market: Another objective of pricing is survival.
This objective is essential in the time of increasing competition, decreasing
demand, and changing in the taste and preference of the customers. In this
pricing objective, price of the product is made equal to its cost of production or
price of the product is fixed at a rate of the breakeven point.
7.3 Importance of pricing
Importance of pricing can be classified into three categories. They are
important to the economy, importance to the organization, and importance to customers.
1.
Importance to the economy
Price is an important element of the economy. It directly affects demand
and supply of the products, factors of productions, and saving and investment.
· Determination of demand and supply: Price is determinant of demand and supply.
According to the law of demand and supply, if demand increases and supply remains
fixed, a shortage occurs, leading to a higher product price. Likewise, if
demand decreases and supply remains fixed, a surplus occurs, leading to a
lower product price. Similarly, If demand remains fixed and supply increases, a
surplus occurs, leading to a lower product price, and if demand remains fixed
and supply decreases, a shortage occurs, leading to a higher product price.
·
Determination of factors of production: Price of the product is an important factor of the economy. It is a basic regulator of the economic system because it influences
the factors of production such as capital, labor, land, and venture. High wage
attracts labor, high rent attracts land, high interest attracts capital and
high profit attracts ventures. Thus, price strongly affects the factors of
production.
· Determination of saving and investment: When the price of products increases,
consumers’ saving decreases, due to which investment is also decreased. On the
other hand, when the price of products decreases, consumers’ saving increases and
investment also increased. Thus, the price of the products affects saving and
investment.
2.
Importance to the organization
Price is also important to the organization,
which can be expressed in the following points:
· Revenues and profit: Price is only one revenue generating the element
of the marketing mix. It plays an important role in revenue generation and profit
maximization of an organization. Profit can be calculated by using the following
formula:
Profit= Total Revenue - Total cost
Where Total Revenue= Price per unit X Unit
sold
Total Cost=Fixed Cost +Variable Cost
Thus, profit can be increased or decreased by
increasing or decreasing the price per unit of product.
· Competition: This is the age of competition. Thus, firms
compete with each other and have to manage competition by increasing or
decreasing the price of the product.
· Expansion of the product line: Price directly affects firms to expand
product lines. If there is a higher scope of profits, then adding new product
lines are preferred by firms. Thus, price helps firms to decide whether to add
new product lines or not by allowing to compare its cost with the price.
3.
Importance to the customers
Price also helps customers to decide whether
to buy the products or not. The following points depict the importance of price
to the customers.
·
Product selection: Price helps to take product selection
decision to the customers. Customers always want to have a higher quality
product at a reasonable price. Thus, price helps customers to select the right
products at the right price.
· Quality perceptions: Generally, high-quality products have a high
price and vice versa. Thus, customers perceive high priced products as quality
products and select the products accordingly.
· Customers’ benefits: Both high and low price increase the
customers’ benefits. Those customers, who give priority to their social
dignity, respect, and satisfaction would prefer to buy expensive products
whereas those customers who are price sensitive would buy at discount price.
7.4 Factors affecting price determination
There are internal and external factors that affect the determination of
price of a product.
a)
Internal Factors:
Internal factors (also called controllable factors or forces) consist of
business efficiency, organizational factors, costs, pricing objectives, and
other components of marketing mix.
1. Business efficiency: If a company’s management is skilled,
experienced and capable then it can conduct its business activities
effectively. Thus, it brings business efficiency which in turn reduces the cost
of production and the price of product.
2. Organizational factors: Organizational factors such as production
system, internal politics, participation, climate, pricing policies etc. can
directly affect the price of the product. Price can be determined after
analyzing such organizational factors in details.
3. Costs: Cost directly affects the price of the product. A company’s total cost
is made up of several kinds of costs such as direct costs, factory overheads,
administrative overheads, selling and distribution costs and so on. If these
costs increase then the price of products also increases and vice versa.
4. Pricing objectives: Pricing objectives such as achieving target
return, profit maximization, capturing market sharing, price stability affect
the price determination of products. For example, if the objective is to
maximize the profit then the price should be high. But if the objective is to capture
the market share then price should be low.
5. Other components of the marketing mix: Other components of the marketing mix such as
product, place, and promotion also affect the price of the product.
· Product: If
the product is new and innovative then pricing for such products becomes high,
but if the product is imitated then there should be a competitive price. Price of the
same products may differ in every stage of its product life cycle.
· Place/Distribution:
If the distribution channel is long, more cost is needed for it. As a result, the price
of products increases. Means of transportation such as air transport, road
transport, and ship transport also affect the cost of products and price. For
example, compared to air transport, the cost of road transport becomes less
expensive.
· Promotion: Promotional
activities such as advertising, personal selling, sales promotion, publicity,
and public relations also affect the price determination of products. If more
expensive promotional activities are done, then the price of products also increases
and vice versa.
Fig: Factors affecting price determination
b)
External
Factors
External factors (also called uncontrollable factors or forces) consist
of competition, suppliers, pressure groups, economic environment, market
demand, government, political environment, and market intermediaries and
facilitators.
1. Competition: The level of competition in the market
affects the price of the products. If there is intense competition, then price
of the product has to be kept below or equal to competitors’ price and vice
versa. Different market structures such as monopoly, perfect completion, oligopoly
or duopoly also affect the price determination of the products. For example,
monopoly pricing is only possible in the monopoly market but in a competitive market,
no firms can charge whatever they want because they can be only price taker in the competitive market.
2. Suppliers: Suppliers provide raw materials, fabricating materials and parts,
installations, equipment, and operation supplies. If they provide such
products at a lower cost, then the price of products becomes low and vice
versa.
3. Pressure groups: In every country, different pressure groups
such as Save the Environment, Consumers’ Associations, Human Rights, and Women
Association etc. are formed. These pressure groups give pressure to firms for
their own interest and social welfare. For example, Consumers’ Association can
give pressure demanding for providing high-quality products at a lower price.
Thus, these pressure groups are not under the control of firms and affect the
price determination directly.
4. Economic environment: Economic Environment includes various
economic factors such as income, inflation, interest rate, employment,
productivity, the gross domestic product which also affects the price of the
products positive as well as negatively.
5. Market Demand: Market demand may be increased or decreased
due to many factors such as total no. of customers, income level, competition
among substitute products, and so on. These factors are also responsible for the determination of the price of the products.
6. Government/political situations: Government imposes many rules and
regulations for protecting the consumers’ rights for goods and services. If
favorable rules and tax exception are introduced by the government then the
price of products decreases and vice versa. Likewise, if the political situation of
a country stable then one price is set and if not then another price must be
determined.
7. Market intermediaries and facilitators: Market Intermediaries such as agents,
wholesalers, and retailers and market facilitators such as transport companies,
insurance companies, finance companies, and banks affect the price of the
products. If such intermediaries and facilitators increase their commission,
fare, premium, and interest then price of the products also increase, and vice
Versa.
7.5
Methods of pricing determination-cost-oriented,
demand-oriented, and competition oriented
There are several methods of pricing. They are classified into three
categories.
1.
Cost-oriented pricing method
Cost-plus pricing, target return pricing, and breakeven pricing are major
cost-oriented pricing methods.
·
Cost-plus pricing: This pricing method (also known as mark-up
pricing) is very simple and popular. Under this method, we must add all the
costs such as direct material cost, direct labor cost, and overhead costs for a
product, and add to it a markup percentage in order to derive the price of the
product. Let us take an example, suppose costs of making a product involves the
following:
-
Direct
material costs= Rs. 50
-
Direct labor
costs= Rs. 25
-
Allocated
overhead costs= Rs. 25
-
Mark
up=25%(Desired profit margin)
Based on the above information, the cost plus
pricing of a product can be calculated by using this formula:
Cos plus pricing = Total Cost + Mark-Up
= Rs. 100+ 25% of Rs.
100
= Rs. 125
· Target return pricing: Target return pricing method is a pricing
method in which a formula is used to calculate the price to be set for a
product by assuming a desired profit or rate of return on investment that a particular quantity of the product is sold. This pricing method is used almost
exclusively by market leaders. Let us take an example,
Suppose a calculator manufacturer has the
following information:
Total investment= Rs. 9,00,000
Target Return on Investment=20%
Total cost= Rs. 5,00,000
Unit sales= 10,000
Based on the above information, the price of a
calculator can be calculated as follows:
Target ROI= 20% of Rs. 9,00,000=Rs. 1,80,000
Price per unit= (Total cost + Target ROI)/Unit
sold
= (5,00,000+180000)/10,000
=Rs. 68
· Breakeven pricing: Another method of cost-oriented pricing is
breakeven pricing. It is the practice of setting a price point at which a
company will earn zero profits on a sale. It is the situations of no gain no
loss for the company. The objective of breakeven pricing is to use low prices
as a tool to gain market share and drive competitors away from the marketplace.
This method is quite useful for larger companies which have sufficient
resources to lower prices and difficult for smaller companies which have no
sufficient resources to survive in the long term with zero profit.
Suppose a manufacturer had the following information:
Fixed cost (FC) = Rs. 32,000
Variable Cost Per Unit (VCPU) = Rs. 12
Selling Price Per Unit (SPPU) =Rs. 22
Breakeven Point (BEP) =?
Using formula,
BEP in Units=FC/(SPPU-VCPU)=32,000/(22-12)=3200 units
BEP in Rupees=FV/[1-(VCPU/SPPU)]=32,000/[1-(12/22)]=Rs. 70,400
2.
Value/Demand-oriented pricing method
Perceived value pricing and customer value
pricing are the major value-oriented pricing methods.
·
Perceived value pricing: In perceived value pricing method, first,
the producer collects buyer’s views, experiences, feelings, and perception of
the value and fixes the price around the average perceived value of the
product. Price is set at a higher level that your target market is willing to
pay, given these benefits.
·
Customer value pricing: In this method, the low price is charged for a high-quality product to attract value-conscious customers. This method is applied
by companies to some products but not to all products. They sell other products
or services at premium prices.
3.
Competition-oriented pricing method
Competition-based pricing can be divided into the following types of pricing.
· Going rate pricing/Meet competition pricing: Going rate pricing is a popular method that
involves pricing a product at the same rate as the rest of the competitors’
prices. The main objective of this method is to place the products or services
in the market at the same rate as set by other competitors. Generally, this method
is used in steel, paper, fertilizer, agricultural and mineral products.
·
Pricing below competition: It is a competitive pricing method in which
initial price is set at levels intended to be below competitors’ prices. The
main objective of this pricing method is to attract price-sensitive customers
by sweeping market competitors aside. In this method, the price of every product is
determined lower than the competitors’ prices. Nepal Airlines Corporation has
determined its fare lower than other airlines in our country.
·
Pricing above competition: It is a competitive pricing method in which
initial price is set at levels intended to be above competitors’ prices. In
this method, the price of every product is determined higher than the competitors’
prices The main objective of this pricing method is to show the customers that
the product is of higher quality and more useful than those of competitors.
Generally, this method may be applied for quality products or reputed brands.
For example, Apple uses this pricing method to show its customers that its
iPhones are of higher quality than those of other competitors: Samsung, HUAWEI.
· Sealed bid pricing: Another competition oriented pricing method
is sealed bid pricing. In this method, a sealed bid is used for pricing tender
transaction where a bidder tries to bid at lower prices rather than other
bidders say competitors to win the contract. If the higher bids are rejected
and the lowest bid is awarded the order.
7.6 Price policies and strategies
Price is the amount of money charged for a product or service. It is the
only one of the important elements of the marketing mix that produces revenue.
Pricing is a dynamic process, and pricing strategies usually change as the
product passes through its life cycle. The introductory stage-setting price for
the first time- is especially challenging. A company can adopt a variety of
pricing strategies which are discussed below.
1.
Market entry pricing strategies
Market skimming and market penetration pricing are market entry pricing
strategies.
a)
Market skimming pricing: Market skimming pricing is the setting a
high price for new product to skim maximum revenues layer by layer from the
segments willing to pay the high price; the company makes fewer but more
profitable sales. The main objective of this pricing strategy is to get maximum
benefits from those customers or segments that are willing to pay more to have
the products sooner. For example, Apple charges a high price of its iPhone
when launching for the first time in the market.
b)
Market penetration pricing: Market penetration pricing is the setting a
low price for a new product in order to attract a large number of buyers and a
large market share. The main objective of this pricing strategy is that
customers will buy and become aware of the new product due to its lower price
in the marketplace relative to rivals. This strategy is most effective for
increasing market share and sales volume and discourages competitors or
rivals.
2.
Product mix pricing strategies
Product line pricing, optional product pricing, captive product pricing,
by product pricing, and product bundle pricing are major product mix pricing
strategies.
a)
Product line pricing: Product line pricing is the setting a single
price for all products in a product line. For example, price Rs. 5,000 for the high
priced line of shoes, Rs. 3,000 for the medium-priced line of shoes, and Rs.
1,500 for the lower-priced line of shoes.
b)
Optional product pricing: Optional-product pricing is the pricing of
optional or accessory products along with the main product. Optional “extra” increases
the overall price of the product or service. For example, the car is the main
product and air-conditioned, power window, CD player, airbag, etc are optional
products.
c)
Captive product pricing: A captive product is an item that is
produced for use only with another specific product. Pricing strategy of such
products is known as a captive product pricing strategy. For example, refill
cartridges for pen, blades for the razor, and cameras for films. In most cases,
captive products are made by the same company that produces the item with which
they are to be used.
d) By-product pricing: By-product pricing is a pricing strategy for
by-products created during the production of the main product in order to make the
main product’s price more competitive. This is widely used in producing
processed meats, petroleum products, chemical products and so on.
e)
Product bundle pricing: In this pricing strategy, several products
are sold together as a package deal and charged one price. The objective of
this strategy is to stimulate purchases by offering attractive package deals.
For example, in McDonald, the price of a full meal (includes burger, fries and
coke) is always lower than the price of each item put separately.
3.
Price adjustment pricing strategies
Discount pricing, segmented pricing,
psychological pricing, promotional pricing, geographical pricing, and
international pricing are major price adjustment strategies.
a) Discount pricing: Discounts are reductions to the selling
price of goods or services. It can be trade discount and cash discount.
Allowance is promotional money paid by manufacturers to retailers in returns
for an agreement to feature the manufacturers’ products in some way.
b) Segmented pricing: Segmented pricing strategy is selling a
product or service at two or more prices, where the differences in prices are
not based on differences in costs. For example, WalMart offers the same product
$5 at online and $ 4.99 at offline store.
c)
Psychological pricing: Psychological pricing is a pricing strategy
based on the theory that certain prices have a psychological impact to the
customers. The retail prices are often expressed as odd prices. An example of
psychological pricing is setting the price of a mobile at Rs. 19,999 rather
than Rs. 20,000. In this pricing strategy, the price is used to say something
about the product.
d) Promotional pricing: Promotional pricing is the act of offering a
lower price (below the list price and sometimes even below the costs)
temporarily in order to increase short-run sales. For example, many companies
offer promotional pricing as a sales incentive when initially launching a
particular product line to potential consumers.
e) Geographical pricing: Geographical pricing is the practice of
modifying a basic list price based on the geographical regions of the buyer. It
is intended to reflect the costs of transportation to different locations. It
consists of several pricing strategies such as free on board(FOB) origin
pricing, uniform-delivered pricing, zone pricing, a base point pricing and so
on.
f) International pricing: International price is the equilibrium
product price that results from international trade. There are many variable
factors that influence international pricing such as currency exchange rate,
economic conditions, production expenses, competitors, and consumers.
Companies that market their products internationally must decide international
price.
4.
Price change pricing strategies
Price increase, price decrease, and price
maintain are the major prices changing strategies.
a)
Price increase: In price increasing strategy, the company
increases its product price due to the cause of inflation, taxes, shortage,
competitors’ price, and other factors.
b)
Price decrease: In price decreasing strategy, the company
decreases its product price to capture the market share, to sweep the
competitors away, to win the price war and so on.
c)
Price maintain: Under this strategy, the company tries to
maintain its product price by adjusting the value to the product. The value of the product might be increased or decreased but the price of the product remains
the same.
Review Questions/Important Questions
Brief Answer Questions:
1.
What is a
price? Write down any two objectives of pricing in today’s fast-changing environment?
2.
Give the
meaning of market skimming and market penetration pricing.
3.
List out any
four objectives of pricing.
4.
State the
perceived value pricing with a suitable example.
5.
A mobile shop
in Damak is setting a price of a mobile at Rs. 19,999 rather than Rs. 20,000.
Which pricing strategy is it adopting and why?
Short Answer Questions:
6.
Explain the
cost-oriented pricing methods and highlights its importance in marketing.
7.
Describe the
competition-based pricing methods with some examples.
Comprehensive Answer Questions:
8.
What is
pricing? Discuss the various internal and external factors affecting the
determination of price of a consumer product?
THANK YOU!
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