Sunday, August 17, 2014

Principles of Marketing - Pricing, Methods and Factors Affecting Pricing Decisions

Price and Pricing
Price is defined as the amount we pay for goods or a service or an idea. Price is the only element in the marketing mix of a firm that generates revenue. All other elements generates only cost. Price is a matter of importance to both seller & buyer in the market place. Only when a buyer & a seller agree on price, we can have exchange of goods and services leading to transfer of ownership.
The term ― Price need not be confused with the term ― Pricing. Price is the value that is put to a product or service and is the result of a complex set of calculations, research and understanding and risk taking ability. A pricing strategy takes into account segments, ability to pay, market conditions, competitor actions, trade margins and input costs, amongst others. It is targeted at the defined customers and against competitors. 

Objectives of Pricing
A business firm will have a number of objectives in the area of pricing. These objectives can be short term or long term or primary objectives:-
(i) Profit maximization in the short term.
(ii) Profit optimization in the long term.

(iii) A minimum return on investment
(iv) A minimum return on sales turnover.
(v) Achieving a particular sales volume.
(vi) Achieving a particular market share.
(vii) Deeper penetration of the market.
(viii) Entering new markets.
(ix) Target project on the entire product line.
(x) Keeping competition out, or keeping it under check.
(xi) Keeping parity with competition.
(xii) Fast turnaround & early cash recovery.
(xiii) Stabilizing price & margins in the market.
(xiv) Providing the commodities at prices affordable by weaker section.
(xv) Providing the commodities at prices that will stimulate economic development.

Importance of Pricing:
Importance of pricing is spelled out by the following points.
1. Price is the pivot for an economy: Price is the prime mover of the wheels of the economy namely, production, consumption, distribution & exchange price influences consumer purchase decision. It reflects purchasing power of currency. It can determine the general living standards of people. In essence, by and large every facet of our economy life is directly or indirectly governed by pricing.
2. Price Regulates Demand: Price increase or decrease the demand for the product de- marketing strategy can be easily implemented to meet the rising demand for goods & service.
3. Price is the competitive weapon: The marketers have to perform in a highly competitive environment. Price is a very important instrument to fight competition. It is the competition that contributes maximum to the importance of pricing. Pricing is a highly dynamic function. Because of the immense competition and in meeting competition, pricing decisions acquire their real importance.
4. Price is the Determinants of profitability: Price determines the profitability of firm by influencing the sales revenue. Low price is not always necessary to increase profit. A right price can increase the sales volume and there by profit. The impact of price rise of fall is reflected instantly in the rise or fall of the product profitability.
5. Price is a Decision Input: Pricing is highly risky decision area & mistakes in pricing might reasonably affect the firm, its profits, growth and future.
6. Marketing Communication: Price plays an important role in marketing communication. High price may indicate higher quality. Price communicates value to the consumer. Customers are basically value-maximizes. They want to have the maximum value from a given purchase. They form an expectation of value and act on it. A buyer’s satisfaction is a function of the product’s perceived performance and the buyer’s expectations. So, if the product meets the expectations of consumers and their value definitions at the given price point, price is seen as acceptable. Otherwise consumers tend to be dissatisfied. They may say that the product is overpriced and they may reject the offer. 
The above discussion indicates that pricing is a critical element in any company’s marketing plan, because it directly affects revenue and profit goals. Effective pricing strategies must consider costs as well as customer perceptions and competitor reactions, especially in highly competitive markets. Today, many firms are trying to follow the low-price trend. At the same time, many marketers have been successful in selling more expensive products and services by combining unique product formulations with engaging marketing campaigns. 

Pricing Methods
There are several methods of pricing & they can be grouped into few broad categories:-
(1) Cost Based Pricing
(2) Demand Based Pricing
(3) Competition Oriented Pricing
(4) Value Pricing
(5) Product Line Oriented Pricing
(6) Tender Pricing
(7) Affordability Based Pricing
(8) Differentiated Pricing.

(1) Cost Based Pricing: Under the cost based pricing, different methods used are:-
Ø  Mark Up Pricing
Ø  Absorption Cost Pricing
Ø  Target Rate of Return Pricing
Ø  Marginal Cost Pricing

Mark Up Pricing: It refers to the pricing methods in which the selling price of the product is fixed by adding a margin to its cost price. The mark ups may vary depending on the nature of the product & the market. Usually, the higher the value of the product, the larger is the mark up.
Absorption Cost Pricing: ACP rests on the estimated unit cost of the product at the normal level of production & sales. The method uses standard costing techniques & works out the variable & fixed costs involved in manufacturing, selling & administering the product. By adding the costs of operations, we get the total costs. The selling price of the product is arrived by adding the required margin towards profit to such total costs.
Target Rate of Return Pricing: It is similar to absorption cost pricing. The rate of return pricing uses a rational approach to arrive at the mark up. It is arrived in such a way that the ROI criteria of the firm are met in the process. But this process amounts to an improvement over absorption costing since it uses a rational basis for arriving at the mark up.
Marginal Cost Pricing: It aims at maximizing the contribution towards fixed costs. Marginal costs include all the direct variable costs of the product. In marginal cost pricing, these direct variable costs are fully realized. In addition, a portion of the fixed costs is also realized under competitive market conditions marginal cost pricing is more useful.
(2) Demand Based Pricing: The following methods belong to the category of demand / market based pricing:-
Ø  What the Traffic can Bear’ Pricing
Ø  Skimming Pricing
Ø  Penetration Pricing
What the Traffic can Bear’ Pricing: The seller takes the maximum price that the customers are willing to pay for the product under the given circumstances. This method is used more by retail traders than by manufacturing firms. This method brings high profits in the short term. But in the long run it is not a safe concept, chances of errors in judgment are very high.
Skimming Pricing : This method aims at high price & high profits in the early stage of marketing the product. It profitably taps the opportunity for selling at high prices to those segments of the market, which do not bother much about the price. This method is very useful in the pricing of new products, especially those that have a luxury or specialty elements.
Penetration Pricing : Penetration pricing seeks to achieve greater market penetration through relatively low price. This method is also useful in pricing of new products under certain circumstances. For e.g. when the new product is capable of bringing in large volume of sales, but it is not a luxury item & there is no affluent / price insensitive segment, the firm can choose the penetration pricing & make large size sales at a reasonable price before competitors enter the market with a similar product. Penetration pricing in such cases will help the firm have a good coverage of the market & keep competition out for some time.
In all demand based pricing methods, the price elasticity of demand is taken into account directly or indirectly.
(3) Competition Oriented Pricing : In a competitive economy, competitive oriented pricing methods are common. The methods in this category rest on the principle of competitive parity in the matter of pricing. Three policy options are available to the firm under this pricing method :
Ø  Premium Pricing
Ø  Discount Pricing
Ø  Parity Pricing
Premium pricing means pricing above the level adopted by competitors. Discount pricing means pricing below such level & parity pricing means matching competitors pricing.
(4) Value Pricing : Value pricing is a modern innovative & distinctive method of pricing. Value pricing rests on the premise that the purpose of pricing is not to recover costs, but to capture the value of the product perceived by the customer. Analysis will readily show that the following scenarios are possible with the cost value price chain:
Ø  Value > Price > Costs
Ø  Price > Value > Costs
Ø  Price > Costs > Value
Ø  Price > Value > Costs
(5) Product Line Pricing : When a firm markets a variety of products grouped into suitable product lines, a special possibility in pricing arises. As the product in a given product line are related to each other, sales of one influence that of the others. They also have interrelated costs of manufacturing & distribution. It can fix the prices of the different product in such a manner that the product line as a whole is priced optimally, resulting in optimal sales of all the products put together & optimal total profits from the line.
(6) Tender Pricing : Business firms are often required to fix the prices of their products on a tender basis. It is more applicable to industrial products & products purchased by Institutional customers. Such customers usually go by competitive bidding through sealed tenders. They seek the best price consistent with the minimum quality specification & thus bag the order.
(7) Affordability Based Pricing : The affordability based pricing is relevant in respect of essential commodities, which meet the basic needs of all sections of people. Idea here is to set prices in such a way that all sections of the population are in a position to buy & consume the products to the required extent.
(8) Differentiated pricing : Some firms charge different prices for the same product in different zones/ areas of the market. Sometimes, the differentiation in pricing is made on the basis of customer class rather than marketing territory.

Factors Affecting Pricing
Factors affecting pricing may be categorized into two categories- internal factors and external factors. In each of these categories some may be economic factors and some may be psychological factors. Some factors may be quantitative and some others may be qualitative. Some of the important factors affecting pricing are given below:
A. Internal Factors:
As regards pricing, the firm has certain objectives -long term as well as immediate. For example, the firm has certain costs of manufacturing and marketing; and it seeks to recover these costs through the price and thereby earning a profit. In respect of all the products, the firm may have a basic philosophy on pricing. The pricing decisions of the firm have to be consistent with this philosophy. Pricing also has to be consistent with the overall objectives of the firm. These objectives could be achieving market share, short term or long term profit. The firm may be interested in seeking a particular public image through its pricing policies. All these constitute the internal factors that influence pricing. From the above, it appears that pricing is influenced by objectives and marketing strategy of the enterprise, pricing philosophy, pricing objectives and policy. More specifically, the internal factors are: 
1. Corporate and marketing objectives of the firm: All pricing objectives emanate from the corporate and marketing objectives of the firm. A business firm will have a number of objectives in the area of pricing. Some of these objectives are long-term, while others are short-term. Profit is one of the major objectives in pricing. Firms may not be interested in profit maximization as such, they may be more interested in long term survival and growth.
2. The image sought by the firm through pricing: If a firm offers high quality goods at high prices, the firm will develop a premium image. 
3.The characteristics of the product: Sophisticated, complex and new to the world products normally carry high prices. Products having more features carry higher prices.
4. Price elasticity of demand of the product: If price increases, demand decreases and if price decreases demand increases. Marketers may decide on pricing based on ‘what the traffic can bear’. The marketer takes the maximum price which the customers are willing to pay for the product under the given circumstances.
5. The stage of the product on the product life cycle: When a product is introduced for the first time it carries a higher price. Gradually with increasing consumer acceptance and competition price decreases. 
6. Use pattern and turn around rate of the product: Price of newspaper and magazines may be different for the immediacy factor, permanence and the pass along readership. Newspapers are having a short life, while magazines enjoy a pass along readership.
7. Costs of manufacturing and marketing: Costs determine price to a great extent. Marketers will have to cover the cost and earn a profit. 
8. Extent of distinctiveness of the product and extent of product differentiation practised by the firm: Products having uniform size, shape and compositions can be manufactured at a lesser cost compared to products having differentiation. 
9. Other elements of the marketing mix of the firm and their interaction with pricing: Amount spent on product research, advertising, dealer development etc. are some factors which influence price of a product.
10. Composition of the product line of the firm: A firm may sell a number of products in the same product line.  In that case , the products are likely to be sold under different prices depending on their quality, features etc.
B. External Factors:
In addition to the internal factors mentioned above, any business firm has to encounter a set of external factors while formulating its pricing decisions. An enterprise exists in an environment and is influenced by environmental factors. The external factors are:
1. Market characteristics: Some markets are having very stiff competition and some are having less. The number of players in a market could be more or less. Market leadership factors also may be different. Different characteristics of the market have a bearing on price.
2. Buyer behaviour in respect of the given product: Value conscious buyers are likely to be interested in low prices. Image conscious buyers may be more attracted by product image rather than low price of the product.
3. Bargaining power of major customers: In industrial buying situations major buyers have a bargaining power. They are in a better position to negotiate prices.
4. Bargaining power of major suppliers: Similar is the case with major suppliers. They are in a better position to supply bulk quantities. They are also in a better position to negotiate terms.
5. Competitors’ pricing policy: Firm’s decision to set a price is heavily influenced by the price set by the competitors. In case of highly unique product having a niche market, a firm can have its own price. In most of the cases, competitive reactions to the price set by the firm have to be seriously studied for future programmes.
6. Government controls/regulations on pricing: As stated earlier the Governmental measures like import duties, excise, subsidy, sales tax etc. influence pricing decisions.
7. Social considerations: Firms have a responsibility to society and to its customers. Firms are not expected to exploit consumers by unnecessarily charging high prices.
As discussed above pricing decisions are complex. For pricing an individual product the firm has to consider its overall objective, prices set for other products, costs etc. These are internal factors. In addition, the pricing decisions are influenced heavily by the external factors as stated above.

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