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DESIGNING PRICING STRATEGIES AND PROGRAMS


Price is a payment to receive a good or service. In broad spectrum, price may be a rent (of a building), a fair, fee or charge, premium of insurance policy, interest of loan, salary, commission, bid, taxes, etc paid to acquire some goods or services. Historically prices are set by negotiations between buyers and sellers. Sellers would ask for a higher price and buyers would offer a low price and finally, the price will be bargained. Price is one of the most important elements in determining a company’s market share and profitability. Price covers both cost and profit; the cost includes production, distribution, and selling cost. The price is set either by the management, or marketing manager, or the product manager, or brand manager.

THE PRICE SETTING PROCESS

A price is set when a new product is launched or changed at a later stage. The price setting process includes some key steps, such as:

1. Selecting the pricing objective,
2. Determining demand,
3. Estimating cost,
4. Analyzing competitors’ prices,
5. Selecting a pricing method, and
6. Selecting the final price.

( A ) SETTING THE PRICING OBJECTIVE: A couple of pricing objectives are available to set the final price.

1. SURVIVAL: Survival is the object at the outset of the business. It’s the short-run objective or may range few years, but in the long run, companies need higher profits to avoid extinction. At this stage, a firm will lower its prices and profit margins just to keep its inventories turning over, raise sales, and market share.

2. MAXIMUM CURRENT PROFIT: With this objective in mind, managers first estimate the demand and cost associated with alternative prices and then they choose the price that maximizes the current profit, cash flows, and return on investment. For example, a firm might estimate that it can sell 1000 units of a hair brush at a price for Rs100 each, while it can sell 2000 and 4000 units respectively at a price for Rs60 and Rs30 respectively. Each unit costs the firm Rs25 inclusive of production, distribution and selling cost. It will reckon the demand, cost and profit at all three alternate prices to determine the most profitable price, which is Rs100 per unit. Consider the calculation:
a. Rs100*1000 units = Rs100000; profit Rs75*1000 units = 75000
b. Rs60*2000 units = Rs120000; profit Rs35*2000 units = 70000
c. Rs30*4000 units = Rs120000; profit Rs05*4000 units = 20000

3. MAXIMUM SALES GROWTH AND MARKET SHARE: It’s a proven theory that a higher sales volume leads to a lower unit cost and higher long-run profits. Here, the firm sets the lowest price, assuming that the market is price sensitive and the lower price discourages actual and potential competition. This objective has been adopted by Dollar ink and Piano ball point pens. This is also called market penetration price.

4. MAXIMUM MARKET SKIMMING: This object or formula is common in innovative and hifi technological products, such as cell phones and electronic products. When an invented or innovated cell phone of Nokia enters the market, they price it higher or charge a premium price, which also communicates the image of a superior product. But when competitors like Sony and Samsung launch rival brands, Nokia launch even more advanced brand and lower the price of its earlier brand for a lower layer of customer segment.

5. PRICING OBJECTIVES FOR NON-PROFIT ORGANIZATIONS: Non-profit organizations charge a lower price than that of competitors. A hospital may charge a relatively lower price but it may cover its cost plus adds some profit for the development expenditure. A non-profit university may charge a price that covers half of its cost and rely on private gifts and public grants to recover the rest of cost.

(B) DETERMINING DEMAND: Each price a company sets will lead to a different level of demand therefore will have a different impact on profit and marketing objectives. Here, some of the methods are:

1. TOTAL MARKET DEMAND: It will be determined from sales statistics of last years and current retail sales in a given area.

2. DEMAND SCHEDULE: It shows the number of units market will buy at alternate prices in a given time, such as in the above example of hair brush. The law of demand explains that higher the price, lower the demand or conversely. In case of prestige goods, such as perfumes, watches, mobile phones, luxury cars, etc, the situation is vice versa ie the higher the price and advertising or brand image, the higher the sales.
3. THE PRICE ELASTICITY OF DEMAND: If demand slightly changes with a small percentage change in price, we say the demand is inelastic but if demand changes considerably (or at a great extent), we say the demand is elastic. Suppose the demand of a soap fells to 30%, when the price is increased from Rs40 to Rs45 ie 10% price addition, we say the demand is elastic.

The demand tends to be less elastic or buyers are less price-sensitive under the following conditions: 1. there are few or no substitute products or competitors, such as in a monopoly or oligopoly market; 2. buyers do not readily notice the price hike; 3. buyers are slow to change their buying habits and search for low price brands; 4. buyers think that the higher prices are justified by quality improvements, innovations and inflation, etc; 5. buyers find it difficult to compare the associated benefits of similar products, for instance health and life insurance products; 6. when buyers income level is very high and the price is easily affordable; 7. when buyers feel the end benefits of the product are higher than the price, such as renowned personal care brands; 8. when the price is paid by another party or sponsor; 9. when the product is used in conjunction with another product bought previously.

(C) ESTIMATING COST: The three types of cost are:

1. FIXED COSTS (also known as overheads): These are costs that do not vary with the amount of production, such as, monthly rent of business place, connection charges for phone and electricity, interest on loan, executives salaries, etc. a company has to incur such expenses whether the sales support the running expenditure or not.

2. VARIABLE COSTS: These are directly linked with the level of production. Because the higher the quantity of goods produced, the higher the variable expenses because of greater input of raw material, utilities consumption like gas and electricity, labor size and salaries, etc.

3. TOTAL COSTS: Total cost consists of fixed cost and variable cost in a specific period.

The two types of costing methods are:

(a) EXPERIENCE CURVE / LEARNING CURVE: The decline in average cost with accumulated production experience is called the experience curve.

(b) TARGET COSTING: The Japanese invented this method, which is to design a product, build its initial model or prototype, estimate its production and marketing cost, and then determine its final price. If the price offers low profit margin or can’t compete with the prices of rivals, then the target cost is reengineered.

4. ANALYZING COMPETITORS’ COSTS: Along with rivals’ costs and prices, their products’ quality, advertising, promotional offers and distribution network is also evaluated. Such an analysis can be done by taking rivals’ price lists and asking dealers and buyers their quality and offers, etc, which will assist in determining a competitive cost structure.

5. SELECTING A PRICING METHOD: Some of the pricing methods are:

I. MARKUP PRICING: The principle is to add a standard markup or profit in the total cost, for example, a grocery shop keeper may add a 20% markup in the cost of unbranded food items. Markups are normally higher on seasonal and slow moving items and lower on fast moving consumer items (FMCG’s). The formula to calculate markup price is:
a. Unit cost = variable cost + fixed cost = 10+ Rs300000 = Rs16
a. units sales quantity 50000
b. Unit cost = price per unit = Rs16 = Price per unit Rs20
c. 1-desired markup 1–0.20

II. TARGET-RETURN PRICING: It’s alike markup pricing but the profit margin is set in relation with the target rate of return on investment (ROI). Suppose, company X wants to earn 20% profit on its investment in a season or a year. The formula to calculate the price is:

Target-return price = unit cost + desired return * invested capital
units sales quantity
= Rs16+0.20*Rs1000000 = Price per unit Rs20
50000

It means, by investing Rs1 million the company X can earn 20% profit or Rs200000 in a period, if it sells 50000 units of the goods.

(III) PERCEIVED-VALUE PRICING: Many companies set the price of a product on the basis of their positioning strategy, such as a premium price for a superior product because they believe buyers will realize the justification of price charged. The formula is:

Suppose the cost of production and marketing of a luxury car is Rs1,000,000, the automobile company can add substantial amounts in the price as to gain full edge of the perceived-value, Rs200000 as the brand family or product line image, Rs200000 as the corporate image, Rs100000 for innovative features, Rs50000 for reliability and durability value, and Rs50000 each for warranty and resale value. Consequently, the final price will be Rs1650000.

(IV) CARTEL PRICING: Here the firm prices its products equivalent to the that of competitors’ prices. It’s common when firms in an industry form a cartel or group and fix one price of a product, for instance, Oil Producing & Exporting Countries (OPEC) organization sets the price of crude oil. In Pakistan, Oil & Gas Regulatory Authority (OGRA) regulates and fixes the prices of refined gasoline/ petroleum products.

(V) Sealed-bid pricing: It is common where firms bid jobs or temporary contracts. The lowest bidder wins the contract but the challenge is to reckon the cost and bid at a price with reasonable margin but not worsening the profit margin.

6. SELECTING THE FINAL PRICE: After applying any of the preceding methods, companies consider some additional pricing factors:

i. PSYCHOLOGICAL PRICING: It includes three methods: 1. Image pricing, such as high quality, high price or high quality, low price, and so on to influence the buyers. 2. Reference price, which abruptly appears in the buyer’s mind when buying a particular product. For instance, when we leave for dinning in a classic restaurant, we have a fair idea of the food prices at similar restaurants. Many companies use this simplest method of price setting by referring the competitors’ prices and position their product against a particular set of competitors. 3. Odd number price ends in an odd number, such as a DVD for Rs4999, which creates an image in consumers’ mind that the DVD is in the price range of Rs4000. The companies aiming to establish superior products at high prices should avoid odd number pricing because the consumers associate high quality with premium price.

ii. GEOGRAPHICAL PRICING: Many times companies set a specific price for one location or region and a high price for a distant region to cover its shipping and freight costs. The same procedure is complied in export pricing.

iii. PRICE DISCOUNTS AND ALLOWANCES: Most companies offer discounts, allowances, bonuses, schemes, and rebates to their customers on such acts as early payment, quantity or volume purchases, and off season buying. The typical examples of allowances include trade-in-allowance that is given on turning an old item and promotional allowance that is given to reward dealers in participating in advertising and sales-support programs.

iv. SPECIAL EVENT PRICING: Sellers will establish special prices in certain seasons to draw in more customers, such as specially discounted prices of Bata shoes in Ramdan or high fairs of transporters just before and after eid.

v. LOW-INTEREST FINANCING: Instead of lowering the price, a company can offer its customers a low-interest financing or can lease its products to the customers. For example, some auto makers charge 3% or even 0% interest rate from their customers.

vi. WARRANTEES AND SERVICE CONTRACTS: Instead of lowering its price, a company can offer warranty and free or discounted service.

vii. PSYCHOLOGICAL DISCOUNTING: Some companies artificially raise their prices, then decrease them and offer substantial savings on purchases, for example, Was Rs500, Now Rs300. In USA, such illegitimate discount tactics are protested and discouraged by Federal Trade Commission.

viii. CUSTOMER-SEGMENT PRICING: All the customer segments are charged differently. A five star hotel will charge premium prices for its luxury services, while a three star and one star hotel will charge lower prices for the similar services, because the customer class in all three types of hotels are upper, middle, and lower class respectively.

ix. PRODUCT’S ADVANCED VERSION PRICING: The previous example of Nokia cell phones fits here, where the advanced and latest cell sets are priced higher than its previous most expensive brands.

x. PRODUCT-PROMOTION PRICING: A company can increase or decrease its products’ prices as a consequence of its promotional policies. For instance, at the product introduction stage, a company may offer a discounted price but later on, it can increase its price due to increase in advertising or promotional tools like bonuses, coupons, gifts, free samples, schemes, etc.

INITIATING PRICE CUTS:

It’s done for many reasons, such as, to sell surplus or block inventory, increase market share, combat declining market share, dominate the market through lower prices, and combat economic recession.

INITIATING PRICE RAISES:

It’s done for many reasons, such as, to cover inflation, meet over-demand profitably, and rather than price raises reducing or withdrawing sales discounts and other promotional offers.

CUSTOMERS’ AND STAKEHOLDERS’ REACTIONS TO PRICE CHANGES:

The question for managers is whether or not the stakeholders including employees, distributors, suppliers, shareholders, financers or creditors will accept the price change justification or will react negatively.

COMPETITORS’ REACTIONS TO PRICE CHANGES:

The competitors and especially the market leaders and other major players may counter with various defensive strategies, such as, they might increase their advertising budget and promotional offers, improve their product quality and features, reduce price, launch low-price fighter line, and so forth.

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