problems of prd line pricing

PROBLEMS OF PRODUCT-LINE PRICINGJOEL DEAN

Columbia University

How should a manufacturer deter-mine the best pattern of prices fora group of related products, e.g., similarproducts that differ in size, quality,style, or features; or dissimilar productsthat are substitutes or complements?My analysis of this problem, which isconfined to manufacturers who haveenough pricing jurisdiction to have price-ing problems, has two parts: (i) a briefexploration of a broad approach to theproblem of product-line pricing; and (2)an examination of selected areas ofapplication.

I. APPROACH TO PRICING RELATEDPRODUCTS

Character of ProblemThe problem of product-line pricing is

to find the proper relationship amongprices of members of a product group.This problem is here broadly conceivedto include not only the pricing of prod-ucts that are physically distinct, butalso those that, though physically thesame, are sold under demand conditionsthat give the seller an opportunity tocharge different prices. Thus use-dif-ferentials (e.g., fluid milk versus cheesemilk), seasonal differentials (e.g., morn-ing movie specials), and style cycle dif-ferentials are all phases of product-linepricing. The justification for this hetero-dox approach is that the nature of pricediscrimination is essentially the sameregardless of the source of the oppor-tunity to charge different prices.

The dividing line between the kindsof price differentiation that are here in-cluded in product-line pricing and thosewhich are viewed as distribution dis-counts is of course, arbitrary. But a con-

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venient and administratively useful dis-tinction can be made between: (i) dis-tribution discounts, i.e., price differentialswhich are based upon the nature of par-ticular buyers or orders, (e.g., quantitydiscounts, trade status discounts, geo-graphical discounts) ; and (2) product dif-ferentials, i.e. price differentials whichare tied solely to the characteristics ofthe product and its use (e.g. qualityspreads, size differentials, and otherdimensions of product-line pricing).

The problem of determining theseproduct-price differentials should alsobe distinguished from the problem ofsetting the firm's price level or basicprice (e.g., basic price versus "extras"in steel pricing). Different pricing analy-ses and criteria are needed for these twoproblems.Opportune Time for Overhaul

This is an opportune time for an over-haul of product-line pricing. Recent vio-lent changes in the price level, wagerates, the distribution of income, thestructure of competition, and productimprovement and innovation have mademany product-line price structures ob-solete. Few manufacturers can hope todevelop a pattern of price relation-ships and then walk away from it. Un-less the original pattern was just rightand unless none of the foregoing changesaffected it significantly, reappraisal ofthe structure of product price differ-entials is called for today. Price ob-solescence that was obscured by con-ditions of boom demand may becomepainfully conspicuous in a period of ad-justment. A strategic time to correct ob-solete price relationships is during theperiod of general decline in prices.

THE JOURNAL OF MARKETING 519

Alternative Policies of Price RelationshipA logical approach to product-line

pricing is to start with a picture of thealternative kinds of policy regarding therelationships among prices of members ofa product line. This assumes that it isdesirable to have some kind of under-lying system of relationship of productprices, which is debatable. But beforeadopting a philosophy of chaos it is wellto examine systematic patterns, severalof which are sketched below.

1. Prices that are proportional to full cost,i.e., produce the same percentage netprot margin for all products.Under this scheme, each product as-

sumes its full allocated share of all com-mon and overhead expenses, and eachproduces a uniform percentage profitover this full cost. Relative prices arethus determined by the accounting con-ventions that govern the allocations ofcommon costs among products. In prac-tice these allocations are necessarily ar-bitrary from an economic viewpoint.Moreover, this plan gives no considera-tion to market factors.

2. Prices that are proportional to incre-mental cost, i.e., produce the same per-centage contribution-margin over in-cremental costs for all products."^

This pricing approach is largely, butnot entirely free from the defect of ar-bitrary allocation of common costsfound in the first plan. But this pricepattern also takes no account of differ-ences in demand and competitive con-ditions. Incremental cost is a handy toolfor product line pricing; but its useful-ness is destroyed if it becomes the basis

* Incremental cost is the additional cost of addedunits. It is often moderately well approximated bythose out^f-pocket costs that are directiy traceable tothe product. Contribution margin is the spread betweenprice and incremental cost.

for a mechanical cost-plus pricing for-mula.3. Prices with prot margins that are pro-

portional to coniersion cost, i.e. thattake no account of purchased materialscost.

The original rationale for this policywas primarily that conversion costs(i.e., the labor and overhead required toconvert raw material into finished prod-ucts) reflect the firm's social contribu-tion, whereas purchased costs do not.The notion that some elements of costare more worthy of bearing a profitmark-up than others is hard to justify,particularly since this mechanistic ap-proach to pricing ignores the differencesin price elasticity among products, andin present and potential competition.

4. Prices that produce contribution mar-gins that depend upon the elasticity ofdemand of different market segments.Buyers with high incomes are usually

less sensitive to price than those thatmake up the mass market, and it isoften profitable to put higher profitmargins on products for the plushy"class" markets than for the rough-and-tumble "mass" markets. Variations instyle and features among models of asingle product can create a partialbarrier to flow of demand betweenmarket segments. For example, the de-luxe models of washing machines sold atabout twice the price of the strip modelsbefore the war. Ignorance, snobbishness,and inertia are mainstays of the segmen-tation that makes such price discrimina-tion effective.

The applicability of this approach issomewhat restricted. It is fully usableonly for products that are sheltered fromthe full blast of competition. Moreover,it must be possible to break the marketinto sectors that differ in demand elas-

520 THE JOURNAL OF MARKETING

ticity, without substantial leakageamong sectors, if full profit potentialsare to be reaped.

An extreme form of market segmenta-tion is to charge different prices to dif-ferent individual buyers. Such discrimi-nation is possible only when the sellerhas complete control of a product whichis substantially different from that ofrivals. This kind of pricing policy is es-sentially an extension of discriminatorymarket segmentation, with each buyerviewed as a separate segment.

Two kinds of individualized price dis-crimination may be distinguished. Onemight be labeled the "ability-to-pay"type, which is exemplified by physicians'fees. It is based on the assumption thatthe richer the man the less elastic is hisdemand. The other kind of individual-ized discrimination might be labeled the"benefits received" type.* Royalty li-censing of patents and "unit-charge"leases of equipment, where the rental de-pends upon the output of the machine,are examples. Film rentals that are basedon a percentage of the gate or of grossprofits and may differ among theatresalso attempt to charge each buyer a dif-ferent price depending upon the service-value of the product to him.

In general, traditional cost guideshave been more harmful than helpfulfor this problem. The notion that eachproduct should pull its own weight, inthe sense of having a price that yields auniform percentage margin on full allo-cated cost, robs market segmentation ofits point and of its potential profita-bility. Margins should be systematicallydifferent and inversely related to the de-mand elasticity of the market sectors.Moreover, incremental cct, rather than

> When the dinnishing maipnal utility of money istaken into account these two categories are dmely re-lated. Fnun this viewptnt, on appendectomy is worthmm doUais to a ridi man becaose die dollars have lessutility.

full cost, is the proper bench mark forestablishing such margins.5. Prices that produce contribution mar-

gins that are related to the stage of de-velopment of the product.

Under this policy the price differentialsamong products vary with the changingpower of products to bear the commoncosts of the enterprise. A continuousanalysis of the shifting contributionabilities of products is required.

This approach to the product pricingproblem is free of the restrictions of costtheology and margin uniformity and itrecognizes the dominant role of demandconsiderations in pricing. It also pointsup the dynamic nature of the patternsof relative maturity and customer ac-ceptance among members of a productline. However, to be applied to pricesetting, it must fall back uf)on criteria ofcompetitive intensity and price elasticityof demand, which are hard to measure.

The foregoing classification of policyalternatives is not exhaustive. But abackground of analysis in terms of puretypes will serve to sharpen the issues andhigh-light the basic choices. As in otherpolicies, exceptions to the selected under-lying scheme of relationship are ex-pected. Moreover, different policies arelikely to be appropriate for differentproduct-lines, and a combination of pat-terns is often desirable.

In selecting an appropriate pattern(or combination), alternative policiesshould be evaluated in the light of theindividual firm's demand relationships,structure of competition, and costs of theproducts.Demand Relationships

In essence, demand considerationsthat enter into the pricing of a product-line are peculiar in three important re-spects. The first is the interdependence


of the demand for various members ofthe product line. Interdependence takesmany forms. Products may be substi-tutes, e.g., different models of radios orgrades of tires. Products may be comple-ments, e.g., tabulators and punchedcards. Products may also be supple-ments in a more remote and subtle senseof augmenting one another's accepta-bility, e.g. in enhancing the reputationof the firm.

Interdependence also has a time di-mension. Today's price of one productmay affect tomorrow's sale of another.Striking examples are introductorymodels, such as trial subscriptions andchildren's editions of magazines, midgetpencil sharpeners, and diminutive sport-ing equipment, etc. But this aspect ofrelationship extends into any productgroup where the sale of one producttends to tie the customer to future pur-chases of other products, as exemplifiedby the new slow-speed phonographs andtheir records.

A second peculiarity is the entity,from the standpoint of demand, of theproduct group as a whole. The promo-tional advantages of a full line oftenmake the whole greater than the sum ofits parts. This calls for a strategic ap-proach to product-line pricing whichtakes account of the effect of individualproduct prices upon the long term cus-tomer acceptance of the entire productgroup. The tactical advantages of a fullline of sizes, grades, and supplementaryproducts in getting good deders and inmerchandising high margin specialtiesmakes this kind of interrelationship ofdemand a prominent factor in product-line pricing. Some would go so far as todeny the validity of analyzing contribu-tion margins for individual members ofa product group because they contributeto each other's sales and profits and be-cause the economic unit of merchandis-

ing activities is the whole group ofproducts.

A third demand peculiarity of product-line pricing arises from opportunities andproblems that stem from market seg-mentation and price discrimination.Market segmentation, as we have seen,involves breaking up the market intosectors that differ in price elasticity ofdemand so that different prices canprofitably be charged in different sectors.When feasible, market segmentation canincrease total profits by expanding salesinto mass markets, yet preserving richmargins in the inelastic sectors of themarket.

Cost EstimatesThe kind of cost concepts and esti-

mates that are relevant depend upon thenature of the product-line pricing prob-lem. The distinction made by economistsbetween the long run and the short runsituation is useful here. Some product-line pricing decisions are long run in thesense that expansion or replacement ofplant and equipment and changes in thescale of operations could result from theproduct-price (and strategic) decisionin question. Setting the price for a per-manent addition to the product line is anexample of a long run decision, in whichfixed costs are relevant and estimates offuture long run economies of scale maybe important. Such pricing decisionsoften amount to the same thing as adecision to add or not add the productin question, since the offering price istantamount to a decision not to offer theproduct unless at least this price can bereceived.

The kind of cost estimates that areappropriate also depend upon the pricingobjective. Although it is usually assumedthat businessmen want to make as muchmoney as possible, maximizing profits isnot always the company's pricing goal.


If the objective is to make a specified,limited profit, then cost estimates playa quite different role in pricing thanwhen maximum earnings is the objective.Cost may then determine prices directlyand mechanistically, rather than indirect-ly through selection of optimum prices.

The sort of costs that are relevant forproduct line pricing and the way thatthey are used depend upon the seller'salternatives. The nature of these alter-natives is different when demand fallsshort of the company's productioncapacity than when demand is in bal-ance, or exceeds capacity. In depressionperiods the alternative is usually idle-ness; then incremental costs alone arerelevant. It is the marginal contributionof a product to common costs and profitthat is the significant consideration.Pricing should be designed to get backincremental costs and as much more asdemand conditions will permit.

When demand exceeds capacity, thealternatives are sharply different. Thelimited factory capacity should in gen-eral be used for the most profitable prod-ucts. In efifect, it should be auctionedto the highest bidder; and selling activ-ities and price strategy should be di-rected toward this end. Products whichmake relatively small marginal contri-bution should be pushed out (insofar aslong term strategy permits) in favor ofproducts that make greater contribu-tion per unit of capacity absorbed.

II. SPECIFIC PROBLEMS OF PRODUCT-LINE PRICING

The philosophy of product-line pricingsketched above can be illustrated by ajvplying it to a few sample problems.

Pricing Products that Differ in SizeHow should we determine price dif-

ferentials for members of a product-linethat differ only in size? The first ques-

tion is whether price should differ at allwith size. If buyers' benefits do not varyand costs differ little (e.g. shoe sizes), auniform price is sensible. Custom mayforce uniformity even when costs differmaterially.

When price should vary with size, thenext question is whether any kind of pat-tern of systematic relationship in respectto size is desirable. Having a pattern hasadvantages. Price determination is madeeasier when new sizes are subsequentlyfitted into the line. The appearance ofequity is given the buyer. Management'stime is saved by a blanket decision whichcan be extended to individual pricingdecisions systematically.

Assuming that some kind of system-atic relationship of prices is desired, achoice may be made among several pos-sible patterns. Prices may be: (i) pro-portional to full average cost, whichproduces a uniform percentage net profitfor all products; (2) proportional to in-cremental costs, which yields a uniformpercentage contribution margin for allproducts; (3) proportional to some di-mension of size of the product, e.g. diam-eter of parachutes or weight of paper;(4) proportional to the service value ofthe product to the buyer, e.g. capacityof refrigerators or labor-saving power ofmachines; (5) related to competitive in-tensity and elasticity of demand ofmarket segments tapped, e.g. eight cyl-inder deluxe models vs. six cylinderstripped models of cars; or (6) relatedstrategically to the long run profit con-tribution of the various members of theproduct line, e.g. junior models of com-puting machines. Quite diverse patternsof product prices are obtained by apply-ing these different size-pricing philos-ophies.

Prices that are proportional to someaspect of size and prices that are pro-portional to full costs are probably the


two most common patterns. Except forvolume savings on popular sizes, thesetwo philosophies often produce priceladders with rungs in the same order,but steps that are different distancesapart. These two popular patterns haveadvantages in being easy to compute andto justify; but neither of them is neces-sarily the most profitable or strategicmethod of size pricing. When the differ-ent sizes of products differ in competitiveintensity and offer opportunities forprofitable market segmentation, thenproportioning price to any dimension ofcost or of size sacrifices potential profits,at least in the short run. Other strategicconsiderations should modify the patternof prices. The demand for the varioussizes is usually interrelated, particularlyin its future dimensions. Low prices onsmall sizes may induce buyers to getacquainted with the product, which maylead to future sales of larger sizes.

An example of the size-differentialpricing problem is found in the fractionalpage advertising rate of magazines.Often, eighth page, quarter page, halfpage and full page space is offered atprices that are not proportional to space.A decision as to this pattern of pricesshould involve: (i) an estimate of theincremental costs of each type of frac-tional page advertisement in order toestimate the marginal contribution toprofits and general overhead that eachsize of advertisement makes underpresent prices and also under other pos-sible price schedules; (2) some kind ofestimate of the pulling power of adver-tisements of various sizes in order to es-timate the service value of differentsized ads to the typical buyer of space;(3) an investigation of the hypothesisthat advertisers who buy eighth-pageads later grow up to full page ads. Onemagazine recently found that the nvim-ber of eighth-page advertisers who even-

tually became full-page advertisers wasextremely small. The proportion of ad-vertisers who would have to grow up tofull-page ads in order to justify the sac-rifice in contribution margin with thepresent eighth-page rate was severaltimes the proportion of advertisers whohad actually become full-page adver-tisers.

In selecting the pattern of relationshipof price to size much depends on whetherthe buyer typically has freedom to sub-stitute one size of product for another,so that two sizes are in competition. Ifsubstitution is possible, then there ismuch to be said for lower prices perservice unit for larger sizes, so that theywill induce the buyer to shift to thelarger sizes. This is especially desirablewhen there are important savings inmaking larger sizes, and when purchas-ing the bigger package will be morelikely to form the habit of using thebrand and will shelter the seller fromcompetition during such a longer con-sumption period.

The intensity of competition oftenvaries with size. Different sizes some-times go into quite different uses, so thatthe service value, as compared with al-ternatives, bears little relation to size orto the seller's costs. For example, po-tential use of parachutes differs in differ-ent sectors of the size range, from lower-ing whole airplanes to dropping cagedcarrier pigeons. Competition from otherparachutes, as well as from substitutes,is more intense in some sectors of thissize-use range than in others.

Pricing Products that Differ in QualityHow should we determine the relation-

ship among prices of products that differin quality? Much depends upon the stra-tegic objectives of having quality dif-ferentials. Sometimes the purpose ofhigh-quality items is to bring prestige to


the entire line (e.g., fifty-dollar cufflinksto glamorize a line of medium-pricedmen's jewelery). Then the price of theprestige items should not be set with anyview to its effect on sales of that productitself, but rather with the view of its ef-fect upon attitudes of customers towardthe lower-priced, high volume membersof the line. When the purpose of low-endarticles is primarily to counter price com-petition by keeping some items in theline competitive with the lowest priceproduct in the market, then an entirelydifferent pattern of quality-price differ-entials is needed. The main purpose ofthe "fighting brand" may be to maintainthe "never undersold" claim for the en-tire product line.

Another kind of strategic objective oflow-margin, stripped models is to wardoff potential competition by capturing amass market early in the game and at-taining economies of large scale produc-tion. Entry of new rivals is made lesstempting and more costly than if ex-ploitation were confined to the plushmarkets with premium prices. Similarly,low quality members of the line can serveto head off or contain the growth of dis-tributor-brand products, as occurred intires and refrigerators before the war.Another purpose of the low quality itemin the line may be to take up the shockof cyclical flexibility in pricing. Thus,third-grade gasoline is normally intro-duced and pushed in depression phasesof the cycle and disappears in prosperityphases. Similarly, third-grade tires a.p-pear and are emphasized when competi-tion is severe. Under such circumstances,the price of the "fighting brand" is de-termined not by costs, but primarily bythe competitive prices it is designad tomeet.

Another objective of multiple-qualitygrades is to break the market up intosectors which differ in price elasticity of

demand. For such strategy it is usuallyassumed that demand elasticity will beleast in the group appealed to by thehigh-quality prestige article, and thatthe demand elasticity will be greatest inthe sector of the market tapped by thelow-quality products. Hence, the marginover incremental cost should normally besystematically increased as quality stepsup- .

Price Lining. Price lining, i.e., a prede-termined pattern of relationship in theprice to the utlimate buyer, is a commonexample of quality differentials.

The widespread use of price lining inretail establishments and its growing ac-ceptance as a philosophv of product-lineplanning on the part of manufacturers,raises important problems of pricing theproduct line. But they are not solelypricing problems. Quite largely, from themanufacturer's viewpoint, it is a prob-lem of product design and selection. Thismay involve inverted pricing, whichstarts with the retail price goal and worksback through distributor margins andselling costs to necessary manufacturingcosts, and hence, to the design andselection of a product that will fit intothe product line strategically.

However, part of the impact of pricelining is absorbed by differences inmargins. This occurs both in the distri-bution channels and at the level ofmanufacturing. The tailoring of the de-sign of the product to fit the retailers'price lines must sometimes be supple-mented by variation of manufacturer's(and dealer's) profit margins.

Systematic Approach. In developingthe policy of price-quality differentialswhich will implement any of the stra-tegic objectives, three factiws must beweighed quantitatively. The first is anestimate of the incremental cost (overthe probable range of operation) ofeach quality variant in the line. Econ-


omies of lot size and of large-scale pro-duction will normally differ among items.These should be reflected in the esti-mates of incremental cost. Differences inmarginal cost should, of course, not con-trol differences in price, but they shouldbe useful in setting lower limits to pricesand they should aid in estimating theprofitability of alternative patterns ofprice differentials. Such cost estimatesare a key consideration in obtainingmaximum profits from market seg-mentation through quality spreads.

The second factor is a guess at de-mand elasticity for the market sectortapped by each different quality bracket.If there are differences in competitive in-tensity, they also affect price elasticity,since it is usually cross elasticity of de-mand that is relevant for this problem.The third factor is the interaction of de-mand of various members of the productline. Price charged for one qualitybracket will affect demand in otherquality brackets, both today and in thefuture. Its effects cannot be estimatedaccurately, of course, but they must beconsidered in reaching a correct pricepolicy.

Pricing Special DesignsIn pricing special designs, it is com-

mon practice to estimate "normal" fullcost, then add to cost a fixed percentageto represent a "fair" or desirable profit.Let us examine the usefulness and ade-quacy of this cost-plus procedure.

To an important degree the price de-cision on special orders is really a de-cision as to whether or not to producethe product. Hence, cost plays a peculiarrole in special-order pricing. An essentialfoundation for special-order pricing istherefore skill in estimating accuratelythe future cost of unfamiliar products.This calls for analysis of previous cost

experience in the kind of detail that canbe focused on the estimating problem.In applying these estimates to a par-ticular order, conceptual problems arise:What cost concept is relevant, and whatprofit margin should be added? The solu-tions depends largely on the seller's al-ternatives, which are usually different indepression than in prosperity.

The problem of how to price specialdesigns can be usefully attacked ana-lytically by seeking answers to thesequestions:

1. What price is required to securethe order?

2. What is the lowest price that willmake the business acceptable to theproducer in the short run, in thelight of available alternatives?

3. What adjustments in the short runfigure should be made because oflong run future benefits (or draw-backs) ?

Business-Getting Price. To estimatewhat is the' highest price than can becharged and still get the business isoften a sheer guess. Partly for this reasonmuch of the quotation on special ordersis really a form of refusal pricing. Bid-ding in the dark as to what the productis worth to the buyer, the seller seeks tobe sure he accepts no business that willnot produce the desired unit net profitsover "normal" cost. He may carry thisconcept further, and have a policy of"discouragement pricing" on specialorders in order to channel demand intopurchase of his standard models.

At the other extreme there are caseswhere the maximum price is pretty defi-nitely known, so that the real problemis whether or not this price is acceptableto the seller. Between these extremes liesa dim area where estimates of buyers'benefits and alternatives and guesses atrivals' bids may give some indication ofthe upper limit.


Where buyers are few and power-ful and are also potential producers(e.g., automobile companies buying fromparts producers), pricing on the basisof full current cost may be logical.Buyers' intimate knowledge of theseller's production processes and costsmakes then sensitive to high unit mar-gins and their ability to produce theproduct themselves may make stay-outpricing on the part of the sellers a wisestrategy. But even under these circum-stances it is not the seller's costs whichare relevant but those that the buyerwould incur if he made the part himself,or the costs of some other potentialsupplier. The seller's costs are usefulprimarily as a guide in estimating thesepertinent costs.

Acceptable Price. A second problem isto determine the lowest price that theseller can afford to accept, consideringhis alternatives. A useful concept for thispurpose is "parity price." A parity price,as the term is used here, is one whichyields the same total contribution-profitas would have been obtained from theavailable alternative uses of the plantfacilities (or of the bottle-neck factor,e.g., skilled labor). The pricing action ofthe firm should depend upon what thesealternatives are. If the alternative is idle-ness, the parity price is incremental cost.Revenue from a special order must ex-ceed the incremental cost if this businessis to be acceptable. But this incrementalcost does not give price answers auto-matically and must, in fact, be used withcare.*

' The time periods of the revenue conjecture and theincremental cost estimate must be the same since theeffects of a short period volume increase will differ fromthose of a \O'B% period increase. Short run marginal costis normally much lower than longer run marginal cost.The estimate of incremental cost should, in adxlition,make allowance for the size of the volume incrementFor example, the acceptance of a large private brand or-der might involve increases in overhead or much quicker

If, however, the alternative is the pro-duction of regular lines, the parity priceis quite different. Then it is incrementalcost plus the dollars of contribution (toprofit and overhead) obtainable fromthe displaced regular production, i.e.,alternative uses of the production facili-ties (or in general the limiting scarcefactor, e.g., steel). If the alternative isthe production of some other specialorder, that should determine the "parityprice." Long run considerations, such asthe possibility that the special businesswill become permanent, the danger ofspoiling the market, etc., should modifythis first approximation.

Pricing Ephemeral GoodsAn important practical pricing prob-

lem is raised by the perishability of thepopularity of a product and of the dis-tinctiveness of its physical innovations.This perishablity results from severalcauses, such as the gyrations of the stylecycle, the running out of patents, theprogressive imitation of patented or un-patented innovations, etc.

How should prices be determined inorder to develop a market rapidly andprofitably and still get back developmentcosts before the style demand or spe-cialty advantage runs out ? One solutionis a policy of high prices at the outset,while the monopoly power of innovationor of style popularity is at its height, thengradual reduction of price as competi-tive innovation arises or cyclical popu-larity dies out. But this pricing policymay encourage potential competitionand thus shorten the life of the company'smonopoly advantage. An alternativepolicy is to set low prices at the outset,in order to discourage prospective com-petitors and to develop the marketutilization of excess capacity from normal volumegTowth than would be the case for a small additionalvolume.


rapidly, so as to bring economies of largescale production quickly.

Each of these solutions may be correctfor a particular situation. Which one isright depends on several conditions: (i)whether mass-market pricing will in factreduce the chance of potential competi-tion; (2) whether it is practical to seg-ment the market and first exploit theinelastic sectors where snob appeal andprestige pricing have a significant rolein developing demand; (3) whether de-mand elasticity increases progressivelyover the course of the style cycle; (4)whether intensity of competition varieswith the phase of the style cycle; (5)whether elasticity of demand is great atthe early stage of market development(for non-style goods); and (6) whetherprospective economies of scale produc-tion or marketing are pronounced, andthe investment required to attain them isa substantial barrier to entry.

Little of a quantitive nature is reallyknown or can be known about thesefactors. However, study of the marketsituation against the background ofthese pricing considerations provides asystematic approach to pricing ephem-eral goods.

CONCLUSIONS

By way of epilogue my general ap-proach to product-line pricing may behigh-lighted by a few baldly stated con-clusions:

(1) The problem of determining thepattern of product prices should besharply distinguished from the problemof setting and changing the company'sgeneral level of prices. It should also bedistinguished from the problem of build-ing the structure of price discounts fordiverse conditions of distribution.

(2) Now is an opportune time for a re-appraisal of the structure of product-line prices. Revolutionary changes in the

basic economic conditions that controldemand and cost behavior have mademany product-price structures obsolete.A period of downward adjustment ofprices is a strategic time to correct suchproduct-line pricing obsolescence. More-over, product price differentials that areappropriate for a boom are not alwayssuitable in a period of declining businessactivity.

(3) An examination of several alter-native systems of product price relation-ship is a useful prelude to an overhaul ofproduct-line pricing. Prices may be pro-portional to full costs, to incrementalcosts or to conversion costs, or may berelated to market segmentation, stage ofproduct development or competitive in-tensity.

(4) The notion that the relationshipamong product prices should be deter-mined mechanistically by differences intheir costs is fatal for sensible product-line pricing. Unit profit margins overarbitrarily allocated full cost may betolerable in inflation when the problemof many firms is to limit profits ratherthan maximize them. But during periodsof declining business activity this policyis usually indefensible. The company'salternatives, if it does not get a fullmargin price on a particular product,are then sharply different from boomperiods.

(5) Cost must be used with sophistica-tion in product-line pricing. Differentcost concepts are needed for differentproblems. The main job of cost estimatesis to help select the most profitablepattern of prices in order to implementpolicies that take advantage of dif-ferences among members of the productline in competitive conditions and indemand elasticity. For this job incre-mental costs of individual productsrather than fully allocated costs arenormally appropriate. Another impor-


tant job of cost is in connection with newproducts. These long run price determi-nations, which often amount to decidingwhether to acquire, develop or com-mercialize added products call for esti-mates of full cost (including fixed over-heads) and these should be projectedinto the future and take account ofeconomies of scale and technology.

(6) Interdependence of demand andopportunities for profitable price dis-crimination are distinctive features ofdemand estimates for product-line pric-ing. Prices of individual products needto be aligned with competitive and sub-stitute bench-marks to get the kind ofbuyers' action and market-share resultsthat attain the company's long rangeobjectives.

(7) Products that differ in size arecommonly priced in proportion to fullcost or to some dimension of size. Bothof these policies may miss profit op-portunities that stem from differences incompetitive intensity, elasticity of de-mand, and strategic overtones.

(8) Products that differ in quality anddesign offer unusual opportunities forhigh margins in the elite market whileexploiting the mass market with thinner-margin models.

(9) Pricing special designs presentsproblems of product-line pricing inwhich cost estimates play an unusuallydominant role.

(10) Pricing goods whose demand isperishable offers opportunities for prof-itable market segmentation.

problems of prd line pricing

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