Pricing

Learning Objectives
Understand

The role of pricing as an element of the marketing mix.

Pricing from the perspectives of the seller as well as
the buyer

Different methods of pricing ranging from economic
based theories to market based to cost based models.

Pricing situations.

Chapter Five Pricing 1

Structure

5.1 Introduction.

5.2 Role and Perception of Price.

5.3 External Influences on Pricing Decisions.

5.4 Internal Influences on Pricing Decisions

5.5 Pricing Strategies

5.6 Summary


5.1 Introduction

Price not only directly generates revenues that allow
organizations to create and retain customers at profit but can
also be used as a communicator / as a bargaining tool / and
also as a competitive weapon.
Pricing can also have emotive dimensions for example ‘high
price’, ‘low price’.

It is thus important to understand the meaning of price
from the customer’s point of view and to price
products in accordance with the ‘value’ that
customer places on the benefits offered.


5.2 Role and perception of price.
Customer’s Perspective

Price represents the value they attach to whatever is being
exchanged. In assessing price they review expected
benefits of the product.
a. Functional : relate to the design of the product and its
ability to fulfill its desired function.
b. Quality customer may expect price to reflect the quality
level.
c. Operational in business to business B2B markets price
may be judged in relation to the product’s ability to
influence the production process.


Customer’s Perspective

d. Financial : in B2B markets purchases are seen as
investments & hence the expected returns on the
investments can influence whether the price is justified or
not.
e. Personal benefits are a little difficult to gauge particularly
as they measure price against intangibles / individual /
psychological benefits such as comfort, status, self
image etc.
Price perceptions vary as per circumstances , a house wife
will compare prices when she wants to buy a water pipe
for replacement but will pay premium price in case of a
plumbing burst.

Seller’s Perspective

For seller, price generates revenue = units sold x price per
unit. Hence seller’s profit = total revenue less total cost.
Usually reduction in price should yield higher volumes of
sales. But seller must evaluate price from customer’s
perspective. Fall in price may be perceived by customers
as dilution in quality in which case the volumes can drop
when price is reduced.
Similarly buyers equate high price with high quality, & here
increase in price can result in increase in volumes of
sales.


Pricing contexts:-

Pricing is not just a cost driven exercise but a skill that
requires knowledge and understanding of both
customers and external environments.
Consumer markets :- are marked by competition for
consumer’s disposable income, they have discretion over
whether to spend or not. Further they buy not because
they need to but just because they want to.
Sometimes they want to buy within a certain price band. Like
Rs. 150 to 200 for a T shirt.
In price sensitive market segments consumers compare
prices and go for the best ones.


Pricing contexts:-

Retail & Wholesale markets :- intermediaries have a more
rational approach to prices. Intermediaries being aware
of alternative price offerings, can bargain better and
manufacturers make concessions to secure patronage of
powerful retail chains.

Service markets :- since service is intangible , it is often
difficult to assess quality before purchasing. Price
comparison is the nearest a potential buyer can get. In
high end services, where resources are limited, high
price is a means that precludes demand.


Pricing contexts:-
Non Profit markets :- here organizations exist and operate for
the benefits of the public rather than for the creation of
profits. Since the objective is to encourage people to use
their services / products / participate in their activities,
pricing has to demonstrate below market rates.

B2B markets :- there is always a marked difference between
price and the real cost. Lowest price may not be the
lowest , cost wise. Organizations may use value
engineering / value management, to eliminate
unnecessary costs.


5.3 External influences on pricing decisions
The main areas of external influences are :-
1. customers & consumers/demand and price elasticity
2. competitors
3. channels of distribution
4. legal and regulatory requirements.

1. Customers and Consumers
Feelings & sensitivities of the end buyers considered.
Marketers set price within an area bound by cost at the
bottom and what the market will tolerate at the top.
Larger the area more is discretion the marketer has in
setting price.


1. Customers and Consumers – contd.

Customer’s upper threshold is linked closely with the
perception of the product. A product which is common
and has neither brand name nor loyalty will have a
relatively lower threshold when compared with one with
huge brand loyalty. Customer’s strong desire for the
product blunts her price sensitivity.

Customers’ attitudes towards price and their responsiveness
to it are reflected in economic theories of demand.


1. Customers and Consumers – [a] demand determinants

Normally for most products, when price goes up the demand falls and vice
versa. At price P1 quantity sold is Q1 as price rises to
Price P2 quantity falls to Q2.

P2

P1

Q2 Q1 Quantity


1. Customers and Consumers – demand
determinants

Marketer by offering better value can shift the demand curve
Price to a higher plane. ( Q1 to Q2)

P1

Q1 Q2 Quantity


1. Customers and Consumers – demand determinants

In certain cases where the product has deep psychological relationships with the
consumers, a reverse price demand curve may be exhibited. As the price
moves up from P1 to P2 demand moves up
from Q1 1 to Q2 . However when price crosses
upper threshold at P3 the demand drops to Q3

Price

P3

P2
.

P1

Q3 Q1 Q 2


1. Customers and Consumers – [b] Price Elasticity of Demand
Marketer must know sensitivity of demand for his products to
price changes. It is reflected by steepness of the demand
curve. A small increase in price from p1 to p2 causes
Price elastic demand to shift down from
q1 to q2

p2
p1

q2 q1 Quantity


1. Customers and Consumers – [b] Price Elasticity of Demand
Marketer must know sensitivity of demand for his products to
price changes. It is reflected by steepness of the demand
curve. An increase in price from p1 to p2 does not cause
Price inelastic demand to shift down from
q1 to q2 greatly.
p2

p1

q2 q1 Quantity


1. Customers and Consumers – [b] Price Elasticity of
Demand
Factors Influencing Price Sensitivity in General

1. Unique value effect Better differentiated the
product lower the price sensitivity.
2. Substitute awareness Greater number of
effect. substitutes more price sensitivity
3. Difficulty in comparing lower sensitivity
4. Total expenditure effect smaller proportion , lower
sensitivity


Factors Influencing Price Sensitivity in General

5. End benefit effect Greater & more valued
benefit, lower the price sensitivity.
6. Shared. cost effect Buyer bearing only a part
of the total cost is less sensitive.
7. Sunk investment effect buyers locked to a
system are more sensitive.
8. Price quality effect higher the quality lower the
sensitivity
9. Inventory effect buyers with stock are more
sensitive to price


Factors Influencing Price Sensitivity in B2B Markets

1. Total expenditure effect:
Smaller the proportion of total spend the product represents,
lower the price sensitivity.
2. Penalty for failure effect:
Greater the cost of failure if wrong choice made lower the
price sensitivity.
3. Overall savings effect:
Greater the overall savings or improvement in performance
the product makes lower the price sensitivity.



4. Contribution to quality effect
Higher the quality of buyer’s own product lower the price
sensitivity
5. Degree of customization effect
More customized / differentiated the product, lower the price
sensitivity.
6. End customer sensitivity
More price sensitive the buyer’s customers more the price
sensitive the buyer will tend to be .



7. Buyer’s ability to absorb costs
More profitable the buyer’s business, less price sensitive the
buyer will be.
8. Buyer’s ignorance
Less the buyer is conscious about the market conditions,
lower the price sensitivity of the buyer.
9. Decision maker’s motivation effect
Lesser the decision maker is motivated to lower costs lower is
the price sensitivity.


2. Channels of Distribution

Organization’s approach to pricing must factor in needs and
expectations of channel partners in the distribution chain
e.g. their margins and markups.

3. Competitors
a] Monopoly : these are usually government enterprises. But
when monoliths in private sector exist, the State
intervenes to ensure pricing is within justified means.



3. Competitors
b] Oligopoly : even in deregulated telecommunications sector
, airlines, typically a small number of powerful providers
dominate the markets. Pricing is a very sensitive issue in
these markets as oligopolists choose to price very
closely with each other, whereby accusations of
collusions may arise.
c] Monopolistic competition : where there are competitors ,
but still large organizations carve out a special niche be it
in terms of quality / uniqueness of offering and rule as
virtual monopolists in that domain. Examples – mobile
hand sets or PCs



3. Competitors

d] Perfect competition: implies there are many
sellers in the same category with products that
are indistinguishable from each other in the eyes
of the buyer and hence little flexibility in price
because no one seller can lead others.
Vegetables, way side eateries etc.


5.4 Internal influences on pricing decisions
1. Organizational Objectives

Marketing plans are linked to Corporate Strategy. Pricing
needs to satisfy in addition to the customer needs,
corporate aspirations also.
Pricing can be used as a tool to be a market leader usually by
offering lowest prices.
It can be used to obtain quality / premium position leadership,
usually by offering both high quality at high prices.
Organizational objectives change as markets evolve and so
does pricing strategy.


5.4 Internal influences on pricing decisions
2. Marketing Objectives

Company can have different products in different segments of
the market
Each segment will have its own pricing.

3. Costs
While pricing is primarily relates to what the customers are
willing to pay, it cannot be oblivious to costs.
While as a strategy , one may sell without recovering total
costs, but one cannot price below variable costs.


Objectives

1. Understand managerial process that leads to price
settings and influences that affect its outcomes.
2. Appreciate the multiple & sometimes conflicting
objectives impacting pricing decisions.
3. Understand available pricing methods & tactics and their
most appropriate use.
4. Appreciate special issues affecting pricing in B2B
markets.
5. Determining a price range overview.


Stage 01 Stage 02
Set the pricing Assess the demand
Objectives. at different levels
price.
Stage 03
pricing policies
& strategies.

Stage 05 Stage 04
Pricing tactics & Set the
Adjustments. Price range.


Conflicting Objectives

Price Objectives

Financial
Profits Marketing Survival
Cash flow Share
Positioning
Volume
Status quo


Financial Objectives
Can be short term or long term.
1] Return on investment :
To ensure a specified ROI. Can be counter productive if it
defeats the long term strategy to build market strength.
2] Profit maximization
Is idealistic but difficult to practice. Needs full knowledge of
cost and demand functions.
3] Cash Flow
Pressure to generate cash is high when the product life cycle
relatively short.


Sales and Marketing Objectives
Can be short term or long term.
Market Share & Positioning

Maintenance of share = no increase in price this trading
period.
Reduce share to meet competition who undercuts.
Increase share by dropping price.
A high pricing policy is adopted to acquire high quality
position.



Volume Sales

While this objective is a part of market share, it can be an
operational requirement.
During recession firms may build inventory.
When firms are in service industry or deal in perishables,
prices have to be dropped to increase utilization.



Status Quo

Firms want to maintain the market share.
Any step to increase share by drop in prices is feared to
result in a price unwanted war.
Survival
When firms experience prolonged recession, to survive
they sell at no profit.
This cannot continue for long.


Pricing Policies & Strategies

These guide and direct pricing decisions.
Provide a frame work within which decisions can be
made.
tell how to respond to competitive price threats in a mass
market.
These relate to new products, product mix and management
of price changes both market and cost based.


New Product Pricing Strategy

Launch price has to be correct as any revision later is
difficult. An error on lower side may give a wrong signal
of low quality.
On the other hand error on the upper side may bring in more
competitors or prompt customers to reject the product
due to price sensitivity.
Lower price can be launched as an introductory price and
later increased if conditions demand.
A ‘me too product’ has reference point in other brands in
market which is not the case with a new introductive
product.


Product Mix Pricing Strategy

A product which is a part of range of products cannot be
priced in isolation from the rest of the products.
Managing Price Changes
Competition, costs, government policies, changing customer
habits , substitutes all force price changes over a long
periods.
A ready reckoner has to be prepared to find out by how much
sales volume has to be increased to maintain profit levels
when a price cut is contemplated e.g. a 2% cut on a
price of a product with 10% gross profit margin, requires
25% increase in volume to maintain profits.


Managing Price Changes

To increase capacity utilization organization might be
prompted to cut price.
On the other hand an organization with market leadership can
cut prices to wipe off competition.
We must, however, remember that no decision on pricing can
be done on the basis of any single factor.
One must consider
the economic scenario
the market environment
the cost consideration.

Market Based Pricing

1. Going rate pricing for ‘me too’ products.
Where a company is introducing a new product, pricing
strategy has to review parameters of comparative price
and quality. Price
High Low
Quality High Premium Superb Value
Low Non workable Cheap
Premium price and Cheap price are options available to
marketer. Superb value will lead to losses & high price
for low quality cannot work.



2 Geographic Pricing
Where a company has a preference for its product in a
particular area , it can have slightly higher price in that
location.
3. Sealed bid pricing

Big projects, especially in a government sector, call for
sealed tenders whereby contractor has to put up his
quotation in a sealed bid. The marketer here has to
anticipate the likely bids from the competitors.



4. Skimming the cream, pricing.
Organizations coming out with an innovative product or
the one that needs huge investment have no competition
in initial stages. As such they can charge high price and
make high profits until competition catches up.
5. Loss leader pricing

Marketer prices product lower with the objective of
gaining market acceptance.
Subsequently marketer hikes prices of accessories, parts
supplements at substantially high rate.



6. Bait pricing.
Marketer offers a lower price on aa selected few
products to attract customers to the shop who then buy
other products at regular prices.

7. Keystone pricing

In certain fashion items, marketer gets star
endorsements and sells the product at a very high price,
knowing well that sales will last only till the product is on
the fashion circuit.



8. Snob value pricing.
Marketer charges higher price to satisfy ego of the select
customers.
9. Penetration pricing

Price is kept deliberately low to reach larger market and
increase consumption.
10. Cartel
Marketer get together and some how come to a common
pricing strategy for their products. Often, Government
intervenes to break such cartels to protect consumers

Cost Based Pricing
1. Full Cost vis-à-vis Marginal Cost Pricing
Soap Manufacturer finds that the variable [marginal] cost
per soap is Rs. 10/- and fixed cost per month Rs 75,000/-
He decides to manufacture 50,000 soaps a month. His
total cost per piece is [50000x10 + 75,000] ÷ 50000 = 11.50.
IF he decides to add Rs 0.50 or Rs. 1.00 per piece as
profit and arrange sales at a price of Rs. 12/- or Rs.
12.50 , he follows Full Cost Pricing & earns a profit of Rs.
25,000/- & Rs. 50,000/- resp.
But if at a price of Rs 12/-, if he sells only 40,000 pieces
his profit is not 0.50 x 40,000 = Rs 20,000/-


Cost Based Pricing

When he sells 40,000 pieces his variable cost is 10 x
40,000 = 4,00,000 & fixed cost 75,000 giving Total Cost
of Rs 4,75,000. When you deduct it from sale value of Rs
4,80,000/- profit is just Rs 5,000/- plus unsold 10,000
cakes.

Hence Marketer often considers marginal cost while
taking pricing decisions. He finds that at a price of Rs 12
there is a demand for 50,000, price of Rs 11.75 demand
for 60,000 , price of Rs. 11.50; 80000 and at 11.25 ;
90000 pcs


Cost Based Pricing

His profits for these prices are
Price Sales Cost Rs. lacs Profit
Pieces Amount Rs. Variable Fixed Total

12/- 50,000 6 lacs 5.0 0.75 5.75 0.25
11.75 60.000 7.05 lacs 6.0 0.75 6.75 0.30
11.50 80,000 9.2 lacs 8.0 0.75 8.75 0.45
11.25 90,000 10.125 9.0 0.75 9.75 0.375
With change in the approach to marginal cost based pricing, it
is determined that price of 11.50 yields max profit.

Cost Based Pricing

For each price, there is a break even volume of sales
which recovers fixed cost fully, and there is neither profit
nor loss.
This is determined by dividing fixed costs by contribution
[ price less variable cost] per piece at that price.
Thus at Rs. 12/- a piece break even volume in the last
example is = 75,000 ÷ [12 – 10] = 37,500.
As marketer expects to sell 50,000 units at this price , he has
a safety margin of [50,000 – 37,500] 12,500 which is very
good. One point to note here is that at no stage can he
sell below marginal cost, as each sale adds to the loss.

Cost Based Pricing
2. Conversion Cost based pricing
Used by goldsmiths, furniture makers etc.
Here cost of base materials [ gold , wood ] is worked out and
marketer determines labour, other materials [ stones,
polish] and expenses that he needs to incur to convert
into finished product. Final price is based on this
conversion cost plus profit mark up.
3. Joint product pricing
Applicable in dairy industry where raw milk is purchased to
sell milk, butter, ghee & skimmed milk powder. Different
methods are used to split cost. One based on selling
price is common.


Cost Based Pricing
4. Return on Investment based pricing

Here certain % of required ROI is decided by marketer. He
then calculates fixed capital plus working capital
[ inventory + receivables] to arrive at total investments.
When the ROI % is applied to total investments we get
required profits. Let us say that total investments are Rs.
12.5 lacs & required ROI 10%.

To continue with earlier example the total cost for 50, 000
units was Rs 5.75 lacs to which we add 10% of Rs 12.5
lacs to arrive at Rs 7.00 lacs as required sales. To
achieve this SP shall have to be fixed at Rs. 14. [ 7 lacs ÷
50,000]

Cost Based Pricing
5. Pricing for Export Markets

You need to consider new factors like
rate of exchange for the currency of the
buyer.
incentives available for exports &
special expenses for export overseas.

If Indian Rupee gets stronger exporter’s earnings deplete as
the exchange rate falls [ importers benefit as they have
to shell less Rupees].
Since overseas markets are very competitive, it is necessary
for exporters to consider lower prices.

Cost Based Pricing
5. Pricing for Export Markets

Export orders allow marketer to increase volumes & thus
spread his fixed costs. They often fill the excess capacity
and come with incentives and tax concessions. These all
have to added to arrive at net earnings that are available
if export order at lower price is to be accepted.

Thus a price that looks unattractive for a local market can add
to overall profits if used only for the export markets.
One must never forget that export price cannot be less than
product’s variable cost, as in that case more you sell
more you end up in losses.


Cost Based Pricing
6. Pricing for long term projects

Pricing & profit calculations for such projects cannot use cost
and revenue figures as they appear. If the full price of a
project is to be received at the completion stage after a
few years, its present value is much less as we are
losing interest on it for that period.

Hence for correct comparisons of income and expense
amounts have to be discounted at company’s internal
rate of return [ cost of borrowing funds or returns that will
accrue if company’s funds are employed else where].
Let us see such discounting for a project that lasts four years.


Cost Based Pricing

Expected costs and revenue from a project of Rs. 200 crores
Year Cost Revenue after discounting at 12% p.a.
Cost Revenue

2008 20 10 20 10
2009 75 67
2010 25 40 20 32
2011 30 50 21 36
2012 50 32
2013 50 28
Total 150 200 128 138

Cost Based Pricing

Thus we observe that the initial business which was showing
a profit possibility of Rs. 50 crores on a sale of Rs. 200
crores i.e. 25%, now after calculating the present value
of future earnings and spendings , is showing a profit
possibility of Rs. 10 crores on a sale of 138 crores i.e.
only 7 %

Hence any price decision on a long term project can be
arrived at only after income and expense over a period of
years are discounted to net present value [NPV]


5.6 Summary
Price not only directly generates revenues that allow
organizations to create and retain customers at profit but
can also be used as communicators / as bargaining tool
/ and also as a competitive weapon.

Price is the value that is placed on something. It can mean
different things to different people. A buyer and a seller
may view it differently:
1. Customer’s perspective.
2. Seller’s perspective.
3. Pricing contexts
- Consumer markets
- Retail & Wholesale markets.
- Service markets
- Non-profit markets
- B2B markets

5.6 Summary
Main Areas of External Influences on Pricing Decisions.

customers and consumers/ demand and price
elasticity
competitors
channels of distribution
legal and regulatory requirements.

Main Areas of Internal Influences on Pricing Decisions.

Organizational objectives
Marketing objectives
Costs


5.6 Summary

Marketing considerations that can influence our pricing
decisions;

Going rate pricing for ‘me too’ products.
Geographic pricing
Sealed bid pricing
Skimming the cream pricing
Loss leader pricing
Bait pricing
Keystone pricing
Penetration pricing
Snob value pricing
Cartels


5.6 Summary
Cost Based Pricing

Full cost pricing vis-à-vis based on marginal costing.
Conversion cost based pricing
Joint product pricing
Return on investment pricing
Pricing for Exports markets.


With this we complete session five

next we move to session six

on “ Sales Force Evaluation”

Best Luck!


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