103 EADB

Chapter-4

Dr. Rakesh Bhati

Pricing Methods
• Definition: The Pricing Methods are the ways
in which the price of goods and services can be
calculated by considering all the factors such as
the product/service, competition, target
audience, product’s life cycle, firm’s vision of
expansion, etc. influencing the pricing strategy
as a whole.
Cost-Oriented Pricing Method: Many firms consider the Cost of Production as
a base for calculating the price of the finished goods. Cost-oriented pricing
method covers the following ways of pricing:
Cost-Plus Pricing: It is one of the simplest pricing method wherein the
manufacturer calculates the cost of production incurred and add a certain
percentage of markup to it to realize the selling price. The markup is the
percentage of profit calculated on total cost i.e. fixed and variable cost.
E.g. If the Cost of Production of product-A is Rs 500 with a markup of 25% on total cost,
the selling price will be calculated as Selling Price= cost of
production + Cost of Production x Markup Percentage/100
Selling Price=500+500 x 0.25= 625
Thus, a firm earns a profit of Rs 125 (Profit=Selling price- Cost price)
Markup pricing- This pricing method is the variation of cost plus
pricing wherein the percentage of markup is calculated on the
selling price.E.g. If the unit cost of a chocolate is Rs 16 and
producer wants to earn the markup of 20% on sales then mark up
price will be:
Markup Price= Unit Cost/ 1-desired return on sales
Markup Price= 16/1-0.20 = 20
Thus, the producer will charge Rs 20 for one chocolate and will
earn a profit of Rs 4 per unit.
Target-Return pricing– In this kind of pricing method the firm set the price to
yield a required Rate of Return on Investment (ROI) from the sale of goods
and services.E.g. If soap manufacturer invested Rs 1,00,000 in the business
and expects 20% ROI i.e. Rs 20,000, the target return price is given by:
Target return price= Unit Cost + (Desired Return x capital invested)/ unit
salesTarget Return Price=16 + (0.20 x 100000)/5000 Target
Return Price= Rs 20
Thus, Manufacturer will earn 20% ROI provided that unit cost and sale unit is
accurate. In case the sales do not reach 50,000 units then the manufacturer
should prepare the break-even chart wherein different ROI’s can be calculated
at different sales unit.
Market-Oriented Pricing Method: Under this method price is calculated on the
basis of market conditions. Following are the methods under this group:
Perceived-Value Pricing: In this pricing method, the manufacturer decides the
price on the basis of customer’s perception of the goods and services taking
into consideration all the elements such as advertising, promotional tools,
additional benefits, product quality, the channel of distribution, etc. that
influence the customer’s perception.
E.g. Customer buy Sony products despite less price products available in the
market, this is because Sony company follows the perceived pricing policy
wherein the customer is willing to pay extra for better quality and durability
of the product.
Value Pricing: Under this pricing method companies design the low priced
products and maintain the high-quality offering. Here the prices are not kept
low, but the product is re-engineered to reduce the cost of production and
maintain the quality simultaneously.
E.g. Tata Nano is the best example of value pricing, despite several Tata cars, the
company designed a car with necessary features at a low price and lived up to
its quality.
Going-Rate Pricing- In this pricing method, the firms consider the competitor’s
price as a base in determining the price of its own offerings. Generally, the
prices are more or less same as that of the competitor and the price war gets
over among the firms.
E.g. In Oligopolistic Industry such as steel, paper, fertilizer, etc. the price charged
is same.
Auction Type pricing: This type of pricing method is growing popular with the more
usage of internet. Several online sites such as eBay, Quikr, OLX, etc. provides a
platform to customers where they buy or sell the commodities. There are three
types of auctions:
1. English Auctions-There is one seller and many buyers. The seller puts the
item on sites such as Yahoo and bidders raise the price until the top best price is
reached.
2. Dutch Auctions– There may be one seller and many buyers or one buyer and
many sellers. In the first case, the top best price is announced and then slowly it
comes down that suit the bidder whereas in the second kind buyer announces
the product he wants to buy then potential sellers competes by offering the
lowest price.
3. Sealed-Bid Auctions: This kind of method is very common in the case of
Government or industrial purchases, wherein tenders are floated in the market,
and potential suppliers submit their bids in a closed envelope, not disclosing the
bid to anyone.
Differential Pricing: This pricing method is adopted when different
prices have to be charged from the different group of customers.
The prices can also vary with respect to time, area, and product
form.
E.g. The best example of differential pricing is Mineral Water.The
price of Mineral Water varies in hotels, railway stations, retail
stores.
Thus, the companies can adopt either of these pricing methods
depending on the type of a product it is offering and the ultimate
objective for which the pricing is being done.
Types of pricing strategies
General strategies
Profit maximisation. One strategy is to ignore market share and try to
work out the price for profit maximisation. In theory, this occurs at a
price where MR=MC. In practice, it can be difficult to work this out
precisely.
Sales maximisation. Aiming to maximise sales whilst making normal
profit. This involves selling at a price equal to average cost.
Gaining Market Share. Some firms may have a target to increase market
share, this could involve setting prices as low as they can afford,
leading to a price war. A similar concept to sales maximisation.
Pricing strategies to attract customers / increase profit
Premium pricing. This occurs when a firm makes a good more expensive to try
and give the impression that it is better quality, e.g. ‘premium unleaded fuel’,
fashion labels.
Loss Leaders This involves setting a low price on some products to entice
customers into the shop where hopefully they will also buy other goods as
well. However, it is illegal to sell goods below cost, so firms could be
investigated by OFT.
Price Discrimination. This involves charging a different price to different groups
of consumers to take advantage of different elasticities of demand. There are
different types of price discrimination from first degree to third degree.
Pricing strategies to attract customers / increase profit
Reference Pricing. This involves setting an artificially high price to be able to
later offer discounts on previously advertised price.
Price Matching. The purpose behind price matching is making a promise to
match any price cuts by your competitors. The argument is that this
discourages your competitors from cutting price. This is because they know
there is little point in cutting prices because you will respond straight away.
Very clear price matching stances can thus avoid price wars and give the
impression of being very competitive. For example, Tesco is offering £10
voucher to customers who can prove their shopping basket would have been
cheaper at other supermarkets.
Pricing strategies to attract customers / increase profit
Retail price mechanism RPM – when manufacturers set minimum prices for retailers, e.g.
net book agreement.
Psychological pricing. Setting price at important psychological levels to trigger purchase,
e.g. selling good at £9.99 to make it appear cheaper. Some firms use reverse
psychology and charge exact prices, e.g. clothes for £40 to indicate quality rather than
cheapness.
Premium decoy pricing. Where a firm sets the price of one good deliberately high to
encourage demand for a lower price. e.g. a car company may bring out a top of the
range sports car, which is very expensive to make the general brand more attractive.
Pay what you want. A situation where consumers are left free to decide how much to pay,
e.g. restaurants cafe where there is no cost – only tipping. When music companies
release a new recording and ask for donations.
Pricing strategies to attract customers / increase profit
Bundle pricing. When a firm gives special offers, e.g. buy 3 for the price of 2 –
very common for book sales e.t.c.
Price skimming. When a firm releases a new product, it initially sets a high price
to take advantage of those consumers with inelastic demand. Over time, the
price is reduced to attract those customers with more price elastic demand.
Penetration pricing. When a firm sets a low price to help establish market share
and get established. For example, a new printing company may offer very low
price for its printers to get established. Then it gets to make profits on selling
ink and over time increase the price. Or satellite tv company offering
introductory offer for a few months.
Pricing strategies to attract customers / increase profit
Optional pricing. When a firm tries to receive a higher price by selling extras.
For example, if you buy a DVD, you can get sold insurance or additional
features.
Dynamic pricing. When prices are regularly updated in response to shifting
market conditions. For example, if an airline receives high demand for certain
flights, it will increase the price to help fill up other departure times and
maximise revenue from the flight.
Pricing strategies to cement market share/market position
Limit pricing. This occurs when a monopoly set price lower than profit
maximisation to discourage entry. This enables the firm to make
supernormal profit, but the price is still low enough to deter new firms
to enter the market.
Predatory pricing. Selling price below cost to try and force rival out of
business. Predatory pricing is illegal. Predatory pricing can be made
easier through cross Subsidisation. This occurs when a big
multinational may use profits in one area to subsidise a price war in
another. The cross subsidisation enables a firm to sell a product very
competitively (or even at a loss) to try and force the rival firms out of
business.
Pricing strategies to help determine the price
Average cost pricing. When a firm sets the price equal to average cost plus a
certain profit margin.
Market-based pricing. When firms set a price depending on supply and demand.
For example, if football clubs, used market-based pricing, clubs like
Manchester United would probably increase the ticket price – because, at the
moment, all tickets are sold out – suggesting price is below the equilibrium.
Markup pricing. This involves setting a price equal to marginal cost of
production + x. (where x = the profit margin a firm wants to make on each
sale)
Profit maximisation. Setting price and quantity so MR=MC
Thank you for your Attention!!!
Any Questions?