how should a company set prices initially for products or services?

HOW SHOULD A COMPANY SET PRICES INITIALLY FOR PRODUCTS OR SERVICES?

A firm must set a price for the first time when it develops a new product, when it introduces its regular product into anew distribution channel or geographic area, and when it enter bids on new contact work.

This can be done in 5 steps.

STEP 1

Selecting the pricing objective.

The company first decides where it wants to position

its market offering.

STEP 1

Selecting the pricing objective.

The company first decides where it wants to position

its market offering.

There are 5 objectives to keep in mind.

SURVIVAL

Companies pursue survival as their major objective if they are plagued with overcapacity intense competition, or

changing want.

SURVIVAL

Companies pursue survival as their major objective if they are plagued with overcapacity intense competition, or

changing want.

Survival is a short-run objective; in the long run, the firm must learn how to add value or face extinction.

MAXIMUM CURRENT PROFIT

The company estimate the demand and costs associated with alternative prices and choose the price that produces

maximum current profit, cash flow, or rate of return on investment.

MAXIMUM CURRENT PROFIT

The company estimate the demand and costs associated with alternative prices and choose the price that produces

maximum current profit, cash flow, or rate of return on investment.

However, this strategy is difficult to implement.

MAXIMUM MARKET SHARE

Companies believe a higher sales volume will lead to lower unit costs and higher long-run profit. They set the lowest

price assuming the market price is sensitive.

MAXIMUM MARKET SHARE

Companies believe a higher sales volume will lead to lower unit costs and higher long-run profit. They set the lowest

price assuming the market price is sensitive.

The following conditions need to be fulfilled first:

• The market is a highly price sensitive

MAXIMUM MARKET SHARE

Companies believe a higher sales volume will lead to lower unit costs and higher long-run profit. They set the lowest

price assuming the market price is sensitive.

The following conditions need to be fulfilled first:

• The market is a highly price sensitive

• Production costs fall with rise in production experience

MAXIMUM MARKET SHARE

Companies believe a higher sales volume will lead to lower unit costs and higher long-run profit. They set the lowest

price assuming the market price is sensitive.

The following conditions need to be fulfilled first:

• The market is a highly price sensitive

• Production costs fall with rise in production experience

• A low price discourages competition

MAXIMUM MARKET SKIMMING

A pricing strategy by which a firm charges the highest initial price that customers will pay.

As the demand of the first customers is satisfied, the firm lowers the price to attract another, more price sensitive

segment.

PRODUCT QUALITY LEADERSHIP

Many companies strive to be “affordable luxuries”; products or services characterized by high levels of perceived quality, taste and status with a price just high enough not to be out

of consumers’ reach

STEP 2

Determining Demand

There are 3 main factors that help determine demand

PRICE SENSITIVITY

Price sensitivity (also called price elasticity of demand) is the degree to which price affects a consumer’s decision to purchase a product or service.

PRICE SENSITIVITY

Customers are less price sensitive when:

• There are few or no substitutes or competitors

• They do not readily notice the higher prices

• They are slow to change their buying habits

• They think the higher prices are justified

• Price is only a small part of the total cost involved in purchasing the product or service

ESTIMATING DEMAND CURVES

Most companies attempt to measure their demand curves using several different methods such as surveys, price experiments & statistical analysis.

PRICE ELASTICITY OF DEMAND

It is measured to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price.

PRICE ELASTICITY OF DEMAND

There is Elastic demand:

If a small change in price is accompanied by a large change in quantity demanded, the product is elastic.

PRICE ELASTICITY OF DEMAND

And there is inelastic demand:

If a change in price is accompanied by very little change in quantity demanded, the product is inelastic.

STEP 3

Estimating Costs

There are 3 ways companies perform cost estimation

CONSIDERING DIFFERENT TYPES OF COSTS

Fixed Costs

These are costs defined as expenses that do not change as a function of the activity of a business, within the relevant

period.

For example, a retailer must pay rent & utility bills irrespective of sales.

CONSIDERING DIFFERENT TYPES OF COSTS

Variable Costs

Those costs that vary depending on a company’s production volume; they rise as production increases and vice versa.

Examples are rent, advertising, insurance & office supplies.

CONSIDERING DIFFERENT TYPES OF COSTS

Total Costs

This consists of the sum of the fixed and variable costs for any given level of production.

CONSIDERING DIFFERENT TYPES OF COSTS

Average Costs

This is the cost per unit at that level of production; it equals total costs divided by production.

ACCUMULATED PRODUCTION

The average cost pricing method, but using an estimate of future average costs , based on accumulated production creating an experienced learning curve.

TARGET COSTING

Target costing is a pricing method where overall cost of a product is reduced over its entire life cycle with the help of production, engineering, research and design.

STEP 4

Analyzing Competitor’s Costs, Prices & Offers

Competitors are most likely to react when there is any price change and when the number of firms is few, the product is

homogeneous, and buyers are highly informed.

Analyzing these reactions and consequent strategies can be beneficial.

STEP 5

Selecting a Pricing Method

There are 3 major considerations in price setting:

• Costs set a floor to the price.

STEP 5

Selecting a Pricing Method

There are 3 major considerations in price setting:

• Costs set a floor to the price.

• Competitor’s prices and the price of substitutes provide an orienting point.

STEP 5

Selecting a Pricing Method

There are 3 major considerations in price setting:

• Costs set a floor to the price.

• Competitor’s prices and the price of substitutes provide an orienting point.

• Customer’s assessment of unique features etablishes the price ceiling.

SELECTING A PRICING METHOD

Keeping these three considerations in mind, these are the six methods of pricing:

MARKUP PRICING

SELECTING A PRICING METHOD

Keeping these three considerations in mind, these are the six methods of pricing:

MARKUP PRICING

TARGET-RETURN PRICING

SELECTING A PRICING METHOD

Keeping these three considerations in mind, these are the six methods of pricing:

MARKUP PRICING

TARGET-RETURN PRICING

PERCEIVED-VALUE PRICING

SELECTING A PRICING METHOD

Keeping these three considerations in mind, these are the six methods of pricing:

MARKUP PRICING

TARGET-RETURN PRICING

PERCEIVED-VALUE PRICING

VALUE PRICING

SELECTING A PRICING METHOD

Keeping these three considerations in mind, these are the six methods of pricing:

MARKUP PRICING

TARGET-RETURN PRICING

PERCEIVED-VALUE PRICING

VALUE PRICING

GOING-RATE PRICING

SELECTING A PRICING METHOD

Keeping these three considerations in mind, these are the six methods of pricing:

MARKUP PRICING

TARGET-RETURN PRICING

PERCEIVED-VALUE PRICING

VALUE PRICING

GOING-RATE PRICING

AUCTION-TYPE PRICING

STEP 6

Selecting the Final Price

Pricing methods narrow the range from which the company must select its final price.

In selecting that price, the company must consider additional factors such as…….

SELECTING THE FINAL PRICE

Impact Of Other Marketing Activities

SELECTING THE FINAL PRICE

Company Pricing Policies

SELECTING THE FINAL PRICE

Gain & Risk Sharing Pricing

SELECTING THE FINAL PRICE

Impacting of Price On Other Parties

SO TO RECAP….

The Main Strategies Of Pricing are:

Selecting the Pricing Objective

Determining Demand

Estimating Costs

Analyzing Competitor’s Costs, Prices and Offers

Selecting a Pricing Method

Selecting the Final Price

THANK YOU

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Created byKunal Eapen, IIIT AllahabadDuring an internship under

Prof Sameer Mathur, IIM Lucknow

www.iiminternship.com