Principles of Marketing

“ Pricing Products: Pricing Considerations”

What is a Price?1. Price is what you pay for what you get.

2. It is the amount of money and /or other items with utility needed to acquire a product.

3. It is the amount of money 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.

4. Conventional pricing was set by negotiation between buyers and sellers. Modern day follows the concept of Fixed pricing policies, i.e. charging one price from all buyers ( used mostly in retailing). However some companies are now using ‘dynamic pricing’ – charging different prices depending on individual customers and situations. E.g. on the Internet buyers can negotiate prices at online auctions and exchanges.

Pricing is an important BUT difficult decision because:

1. In the Economy: A product's price influences the wages, rent, interest and profits. It is the basic regulator of the economic system because it influences the allocation of the factors of production: land, labor and capital. Price determines what will be the produced supply and who will get the good and service produced

2. In the Customer’s Mind: Price is an important component of value and value is the ratio of the perceived benefits to price and any other incurred costs.

3. In the Individual firm: A product’s price is a major determinant of the market demand for it. Through prices, money comes into the organization. It is the only element of the marketing mix that produces revenue.

Factors to consider when setting prices

INTERNAL FACTORSa) Marketing Objectivesb) Marketing Mix Strategyc) Costsd) Organizational Consideration

EXTERNAL FACTORSa) Nature of the market and demandb) Competitionc) Other environmental factors

MARKETING OBJECTIVES- The Pricing strategy is largely determined by decision on

the market positioning of the product.- Survival a) where a company sets prices so low to make it hard for

competitors to enter the market b) Set prices to keep the loyalty of the resellersc) Reduce prices to create temporary excitement- Current Profit maximization where you estimate what

demand and costs will be at different prices and then set the price which will produce maximum profits

- Market Share Leadership – where prices are set as low as possible to attain market share leadership.

- Product quality leadership – here a high price is charged to cover the high cost of quality and R&D

- Partial and full cost recovery – adopted by public and non-profit organizations where when an institution is relying on publics grants and gifts they try and price in order to cover their costs.

MARKETING MIX STRATEGY The overall pricing strategy should be in accordance to

the product design, distribution and promotion in order to form a consistent and effective marketing program.

If the marketer decides to position product based on its high performance quality, it means that the seller will have charge a higher price to cover the higher costs.

‘Target costing’ has reversed the entire process of costing, it starts off with an ideal selling price based on customer considerations and then targets costs that will ensure that the price is met.

It is often not the best strategy to charge the lowest price for your good in order to attract customers, in fact it is better if you try and create a point of differentiation and convince buyers of the high quality of the product and convince them to pay a higher price for it.

COSTS

Costs set the floor for prices, the company wants to charge a price that both covers the cost of producing, distributing that good and also delivers a fair return.

There basic types of costs are:1. Fixed Cost such as rent, salaries, property tax remains

constant regardless of how many items are produced.2. Variable Cost such as labor or materials is directly related

to production.3. Total cost is the sum of all fixed and variable costs for a

specific quantity produced.

Total fixed costs do not change in the short run, despite increases in quantity produced. Variable costs are the cost of inputs and total variable costs increase as production increases

Cost at Different Levels of Production To price wisely management needs to

understand how cost will vary at different levels of production.

In a fixed production capacity plant , cost will remain low as long as the plant is working within its capacity, however this cost will rise if the plant is stressed to produced more as efficient production under restricted capacity cannot be carried out. Henceforth this cost will keep rising in the short run.

If the plant’s production capacity is increased, in the long run an optimum level can be achieved at which production cost is lowest.

(1) (2) (3) (4) (5) (6) (7)

Qty produced

Total fixed costs

Total variable

costs

Total Costs

(2)+(3)

Average fixed costs

(2)/(1)

Average variable

costs

(3)/(1)

Average total costs

(4)/(1)

0 256 0 256 Infinity Infinity Infinity

1 256 84 340 256 84 340.00

2 256 112 368 128 56 184.00

3 256 144 400 85.33 48 133.33

4 256 224 480 64.00 56 120.00

5 256 400 656 51.20 80 131.20

The average fixed cost declines as output increases because the total fixed cost is spreading over a number of units and each unit is bearing a small portion of the cost. The average variable costs starts high because the average variable costs for the first few units of output are high. Variable cost per unit declines as the company realizes efficiencies in production, eventually an optimum point is reached where average variable cost is lowest . Beyond this point the cost rises because of overcrowded facilities and other inefficiencies.

Cost Behavior

0

100

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400

500

600

700

1 2 3 4 5

Qty Produced

Cos

t

Total fixed costs

Total variable costs

Total Costs

Average fixed costs

Average variablecosts

Average total costs

The average total cost curve represents the behavior of cost in the long run as production goes up, it starts high reflecting the fact that total fixed costs are spread over so few units of output. As output increases , the average total cost curve declines because unit fixed cost and unit variable cost is decreasing. Eventually the point of lowest total cost per unit is reached (4), beyond that optimum point , diminishing returns set in and average total costs rise.

Cost as a Function of Production Experience

The Experience Curve

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1 2 3 4 5 6 7 8

Qty Produced

Co

sts

Average costs

The experience curve represents the drop in average per unit production costs that comes with accumulated production experience

A downward experience curve is highly significant for the company because it signifies that costs will fall faster if the company makes and sells more in a given time period.

This curve is irrelevant though if the extra output does not find its place in the market, henceforth pricing should be low so that sales increase causing a subsequent decrease in costs and a further downward slope in the experience curve.

WARNING!!: It is important not to:

1. fall prey to low pricing as this may give product cheap image and

2. Assume constantly that competitors are weak and not willing to fight back at your price cuts.

ORGANIZATIONAL CONSIDERATION

In small companies prices are often decided by top management rather than by marketing or sales department.

In large companies pricing is typically handled by divisional or product line mangers

In industries where pricing is a key factor , a pricing department is set to the best possible prices.

NATURE OF THE MARKET AND DEMAND Costs set the floor and market and demand sets

the ceiling for pricing. The market structure signifies the pricing

freedom the seller has.

1. In pure competition no one buyer or seller has control over the going market price. This is prevalent when the goods are uniform commodities like wheat , copper or financial securities. Charging a higher or lower price is unnecessary as they can sell all they want at the going market price. New sellers can easily enter the market. Marketing has a minor role henceforth not much time is spent on the marketing strategy.

2. Under monopolistic competition there are many buyers and sellers and they are trading over a range of prices. Offers can be differentiated. Marketing plays an important role in this kind of market.

3. In oligopolistic competition the market consists of few sellers who are highly sensitive to each others pricing and marketing strategies, product may be uniform like steel or non uniform like cars. No of sellers are few as it is hard to enter market

4. Under pure monopoly prices are manipulated by a single seller.

Consumer perception regarding price is associated directly with value. If they feel that the price

charged is greater than the value (benefits derived from product) , they will NOT buy the product, if

they feel the price is lower than the value, they will buy the product but the seller loses profit opportunities.

Q2

P2

Q1

P1

This is the demand curve – it represents the number of

units the markets will buy in a given period at different prices

that might be charged.

Price and demand have an inverse relationship i.e. the higher the price the lower the demand. In the curve shown above, however the net change in quantity demanded when price is increased from P1 to P2 is not a very large change i.e. from Q1 to Q2. This kind of demand which remains unaffected by price is termed as inelastic demand.

In the case of prestige goods this curve would be upward sloping when a higher price is charged, because higher price is perceived as better value henceforth quantity demanded increases.

Price elasticity shows how responsive demand will be to price.

Price Elasticity of Demand

Q2

P2

Q1

P1

This demand curve shows that when price is increased from P1 to P2 the net change in

quantity demanded is greater as compared to the first figure, henceforth demand in this case is

elastic.

Price Elasticity of Demand = % Change in Quantity Demanded

% Change in Price

Suppose demand falls by 14% when the seller raises its price by 2%, henceforth price elasticity is -7, where the minus sign confirm inverse relationship b/w D & P, and the demand is elastic, however if demand fell by 1% when seller raised prices by 2% , the price elasticity would only be -1.5 and demand is inelastic.

What determines price elasticity of demand?

1. Buyers are less price sensitive when the product they are buying is a prestige good

2. They are also less price sensitive when substitute products are hard to find or when quality is not comparable

3. When the total expenditure of purchasing the product is low relative to their income or someone else is sharing in as well.

If demand is elastic, sellers will want to reduce their price to increase the revenue earned,

however they should take care not to let the cost exceed the extra revenue.

Competitors costs, prices and offers must also be considered to make a better pricing strategy.

Other external factors such as economic conditions, the government and social concerns also effect pricing.

General Pricing Approaches

Costs set the floor and the consumer perceptions regarding value sets the cileing, b/w then the marketer must determine what price to charge.

The different kinds of approaches used are cost plus pricing, , buyer based approach and competition based approach.

Cost Based Pricing- Cost plus pricing means setting the price of one unit of a product equal

to the total cost of the unit plus the desired profit on the unit.- In order to determine how much profit will be earned on one unit , unit

cost should be determined:

Sabir & Bros make locks, the VC is Rs 12 and the FC is Rs 200,000, Expected Sales are 60,000 henceforth unit cost will be

Unit Cost = VC +FC/Expected Sales = 12+200,000/60,000 = 12+3.33

= Rs. 15.33 is the unit costIf Sabir & Bros wants to earn a 20% profit on each unit sold, the price

charged should be:Markup Price = unit cost/(1-desired return on sales) = 15.33/(1-0.2) = 15.33/0.8 = 19.1625 or Rs 19.0Henceforth the company should charge dealers Rs.19 per lock and make a

profit of Rs 4.0, if dealers want to earn a 50% profit they will charge Rs 38.325 for each lock

Cost Based Pricing This approach has limitations, one is that it does not

recognize various costs or the fact that these costs are affected differently by changes in the level of output. E.g. if the expected sales fall then FC increases and henceforth realized markup on sales becomes lower

Secondly it ignores market demand that is cost plus pricing assumes that cost determines the value of the product or what customers are willing to pay for it, But what if the same number of units could be sold at a higher price? Using this method the seller does forgo some revenues.

Cost Based Pricing

This method is however popular because:

1. Sellers are more certain about cost than they are about demand.

2. When all firm in the industry use this method prices tend to be similar and price competition is thus minimized

3. Thirdly people feel that this method is fairer to both buyers and sellers as it lets sellers earn a valid return on their investment and does not take advantage away from buyers.

Break Even Analysis and Target Profit Pricing

Through this approach a price is set to break even on the costs of making and marketing a product or setting the price to make a target profit.

Target Pricing uses the concept of a break-even chart which shows the total cost and total revenue expected at different sales volume levels.

Break Even Volume = Fixed Cost

Price – Variable Cost

A B C D E F G

Unit Price

Expected unit demand at given Price Fixed Cost

Constant Unit Variable Cost

Total Cost = (B*D)+C

Total Revenue = B*A

Total Profit = F-E

14 71000 300,000 10 1,010,000 994,000 - 16,000

16 67000 300,000 10 970,000 1,072,000 102,000

18 60000 300,000 10 900,000 1,080,000 180,000

20 42000 300,000 10 720,000 840,000 120,000

22 23,000 300,000 10 530,000 506,000 - 24,000

10 20 30 40 50

0

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1200

TC

TR

FC

Break Even Point where TR =TC

@ 30,000 units

Target Profit

The company reaches breakeven at 30,00 units which will yield a total

revenue of Rs 600,000. At the same price i.e. Rs 20, each units sold above

30,000 will yield a profit

Value Based pricing This approach uses buyers perception of value, not

sellers cost as the key to pricing, the marketer starts pricing strategy by talking to customers regarding the value they would like out of a product or the value they expect

Cost based pricing is product driven whereas value based pricing is customer driven.

Value Pricing is offering just the right combination of quality and good service at a fair price

Value added marketing is when a company wants to escape the price competition and justify higher prices and margins without losing share.

Competition Based Pricing

This is going rate pricing in which firms base their prices largely on competitors prices with less attention paid to its own costs or demand.

This type of pricing is used when demand elasticity is hard to measure.

This is used when firms bid for jobs, a company usually prices thinking how much competitors will charge instead of thinking about their own costs.