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Pricing

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In this presentation, we will discuss the role and perception of pricing, factors that influences pricing decisions and pricing strategies. …

In this presentation, we will discuss the role and perception of pricing, factors that influences pricing decisions and pricing strategies.
To know more about Welingkar School’s Distance Learning Program and courses offered, visit:
http://www.welingkaronline.org/distance-learning/online-mba.html

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  • 1. 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
  • 2. 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 Chapter Five Pricing 2
  • 3. 5.1 IntroductionPrice not only directly generates revenues that alloworganizations to create and retain customers at profit but canalso be used as a communicator / as a bargaining tool / andalso as a competitive weapon.Pricing can also have emotive dimensions for example ‘highprice’, ‘low price’.It is thus important to understand the meaning of pricefrom the customer’s point of view and to priceproducts in accordance with the ‘value’ thatcustomer places on the benefits offered. Chapter Five Pricing 3
  • 4. 5.2 Role and perception of price.Customer’s PerspectivePrice 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. Chapter Five Pricing 4
  • 5. 5.2 Role and perception of price.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. Chapter Five Pricing 5
  • 6. 5.2 Role and perception of price.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. Chapter Five Pricing 6
  • 7. 5.2 Role and perception of price.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. Chapter Five Pricing 7
  • 8. 5.2 Role and perception of price.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. Chapter Five Pricing 8
  • 9. 5.2 Role and perception of price.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. Chapter Five Pricing 9
  • 10. 5.3 External influences on pricing decisionsThe main areas of external influences are :-1. customers & consumers/demand and price elasticity2. competitors3. channels of distribution4. 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. Chapter Five Pricing 10
  • 11. 5.3 External influences on pricing decisions1. 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. Chapter Five Pricing 11
  • 12. 5.3 External influences on pricing decisions1. Customers and Consumers – [a] demand determinantsNormally for most products, when price goes up the demand falls and vice versa. At price P1 quantity sold is Q1 as price rises toPrice P2 quantity falls to Q2. P2 P1 Q2 Q1 Quantity Chapter Five Pricing 12
  • 13. 5.3 External influences on pricing decisions1. Customers and Consumers – demand determinantsMarketer by offering better value can shift the demand curve Price to a higher plane. ( Q1 to Q2) P1 Q1 Q2 Quantity Chapter Five Pricing 13
  • 14. 5.3 External influences on pricing decisions1. Customers and Consumers – demand determinantsIn 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 Q3PriceP3P2 .P1 Q3 Q1 Q 2 Chapter Five Pricing 14
  • 15. 5.3 External influences on pricing decisions1. Customers and Consumers – [b] Price Elasticity of DemandMarketer 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 causesPrice elastic demand to shift down from q1 to q2 p2 p1 q2 q1 Quantity Chapter Five Pricing 15
  • 16. 5.3 External influences on pricing decisions1. Customers and Consumers – [b] Price Elasticity of DemandMarketer 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 causePrice inelastic demand to shift down from q1 to q2 greatly. p2 p1 q2 q1 Quantity Chapter Five Pricing 16
  • 17. 5.3 External influences on pricing decisions1. Customers and Consumers – [b] Price Elasticity of Demand Factors Influencing Price Sensitivity in General1. Unique value effect Better differentiated the product lower the price sensitivity.2. Substitute awareness Greater number of effect. substitutes more price sensitivity3. Difficulty in comparing lower sensitivity4. Total expenditure effect smaller proportion , lower sensitivity Chapter Five Pricing 17
  • 18. 5.3 External influences on pricing decisions Factors Influencing Price Sensitivity in General5. 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 sensitivity9. Inventory effect buyers with stock are more sensitive to price Chapter Five Pricing 18
  • 19. 5.3 External influences on pricing decisions Factors Influencing Price Sensitivity in B2B Markets1. 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. Chapter Five Pricing 19
  • 20. 5.3 External influences on pricing decisions Factors Influencing Price Sensitivity in B2B Markets4. Contribution to quality effectHigher the quality of buyer’s own product lower the price sensitivity5. Degree of customization effectMore customized / differentiated the product, lower the price sensitivity.6. End customer sensitivityMore price sensitive the buyer’s customers more the price sensitive the buyer will tend to be . Chapter Five Pricing 20
  • 21. 5.3 External influences on pricing decisions Factors Influencing Price Sensitivity in B2B Markets7. Buyer’s ability to absorb costsMore profitable the buyer’s business, less price sensitive the buyer will be.8. Buyer’s ignoranceLess the buyer is conscious about the market conditions, lower the price sensitivity of the buyer.9. Decision maker’s motivation effectLesser the decision maker is motivated to lower costs lower is the price sensitivity. Chapter Five Pricing 21
  • 22. 5.3 External influences on pricing decisions2. Channels of DistributionOrganization’s approach to pricing must factor in needs and expectations of channel partners in the distribution chain e.g. their margins and markups.3. Competitorsa] Monopoly : these are usually government enterprises. But when monoliths in private sector exist, the State intervenes to ensure pricing is within justified means. Chapter Five Pricing 22
  • 23. 5.3 External influences on pricing decisions3. Competitorsb] 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 Chapter Five Pricing 23
  • 24. 5.3 External influences on pricing decisions3. Competitorsd] 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. Chapter Five Pricing 24
  • 25. 5.4 Internal influences on pricing decisions1. 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. Chapter Five Pricing 25
  • 26. 5.4 Internal influences on pricing decisions2. Marketing ObjectivesCompany can have different products in different segments of the marketEach segment will have its own pricing.3. CostsWhile 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. Chapter Five Pricing 26
  • 27. 5.5 Pricing StrategiesObjectives1. 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. Chapter Five Pricing 27
  • 28. 5.5 Pricing StrategiesStage 01 Stage 02Set the pricing Assess the demandObjectives. at different levels price. Stage 03 pricing policies & strategies.Stage 05 Stage 04Pricing tactics & Set theAdjustments. Price range. Chapter Five Pricing 28
  • 29. 5.5 Pricing StrategiesConflicting Objectives Price Objectives Financial Profits Marketing Survival Cash flow Share Positioning Volume Status quo Chapter Five Pricing 29
  • 30. 5.5 Pricing StrategiesFinancial ObjectivesCan 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 maximizationIs idealistic but difficult to practice. Needs full knowledge of cost and demand functions.3] Cash FlowPressure to generate cash is high when the product life cycle relatively short. Chapter Five Pricing 30
  • 31. 5.5 Pricing StrategiesSales and Marketing ObjectivesCan 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. Chapter Five Pricing 31
  • 32. 5.5 Pricing StrategiesSales and Marketing ObjectivesVolume 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. Chapter Five Pricing 32
  • 33. 5.5 Pricing StrategiesSales and Marketing ObjectivesStatus 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. Chapter Five Pricing 33
  • 34. 5.5 Pricing StrategiesPricing 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. Chapter Five Pricing 34
  • 35. 5.5 Pricing StrategiesNew 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. Chapter Five Pricing 35
  • 36. 5.5 Pricing StrategiesProduct Mix Pricing StrategyA product which is a part of range of products cannot be priced in isolation from the rest of the products.Managing Price ChangesCompetition, 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. Chapter Five Pricing 36
  • 37. 5.5 Pricing StrategiesManaging Price ChangesTo 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. Chapter Five Pricing 37
  • 38. 5.5 Pricing StrategiesMarket Based Pricing1. 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 LowQuality High Premium Superb Value Low Non workable CheapPremium price and Cheap price are options available to marketer. Superb value will lead to losses & high price for low quality cannot work. Chapter Five Pricing 38
  • 39. 5.5 Pricing StrategiesMarket Based Pricing2 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. Chapter Five Pricing 39
  • 40. 5.5 Pricing StrategiesMarket Based Pricing4. 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. Chapter Five Pricing 40
  • 41. 5.5 Pricing StrategiesMarket Based Pricing6. 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. Chapter Five Pricing 41
  • 42. 5.5 Pricing StrategiesMarket Based Pricing8. 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 Chapter Five Pricing 42
  • 43. 5.5 Pricing StrategiesCost Based Pricing1. 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/- Chapter Five Pricing 43
  • 44. 5.5 Pricing StrategiesCost 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 Chapter Five Pricing 44
  • 45. 5.5 Pricing StrategiesCost Based Pricing His profits for these prices arePrice Sales Cost Rs. lacs Profit Pieces Amount Rs. Variable Fixed Total12/- 50,000 6 lacs 5.0 0.75 5.75 0.2511.75 60.000 7.05 lacs 6.0 0.75 6.75 0.3011.50 80,000 9.2 lacs 8.0 0.75 8.75 0.4511.25 90,000 10.125 9.0 0.75 9.75 0.375With change in the approach to marginal cost based pricing, it is determined that price of 11.50 yields max profit. Chapter Five Pricing 45
  • 46. 5.5 Pricing StrategiesCost 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. Chapter Five Pricing 46
  • 47. 5.5 Pricing StrategiesCost Based Pricing2. 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 pricingApplicable 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. Chapter Five Pricing 47
  • 48. 5.5 Pricing StrategiesCost Based Pricing4. Return on Investment based pricingHere 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] Chapter Five Pricing 48
  • 49. 5.5 Pricing StrategiesCost Based Pricing5. Pricing for Export MarketsYou 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. Chapter Five Pricing 49
  • 50. 5.5 Pricing StrategiesCost Based Pricing5. Pricing for Export MarketsExport 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. Chapter Five Pricing 50
  • 51. 5.5 Pricing StrategiesCost Based Pricing6. Pricing for long term projectsPricing & 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. Chapter Five Pricing 51
  • 52. 5.5 Pricing StrategiesCost Based Pricing6. Pricing for long term projectsExpected costs and revenue from a project of Rs. 200 crores Year Cost Revenue after discounting at 12% p.a. Cost Revenue2008 20 10 20 102009 75 672010 25 40 20 322011 30 50 21 362012 50 322013 50 28 Total 150 200 128 138 Chapter Five Pricing 52
  • 53. 5.5 Pricing StrategiesCost Based Pricing6. Pricing for long term projectsThus 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] Chapter Five Pricing 53
  • 54. 5.6 SummaryPrice 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 Chapter Five Pricing 54
  • 55. 5.6 SummaryMain 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 Chapter Five Pricing 55
  • 56. 5.6 SummaryMarket Based PricingMarketing 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 Chapter Five Pricing 56
  • 57. 5.6 SummaryCost 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. Chapter Five Pricing 57
  • 58. With this we complete session five next we move to session six on “ Sales Force Evaluation” Best Luck! Chapter Five Pricing 58
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