CHAPTER VI

PRICING

Price: In economics and business, the price is the assigned numerical monetary value of a good,
service or asset. The concept of price is central to micro economics where it is one of the most
important variables in resource allocation theory (also called price theory). Price is also central to
marketing where it is one of the four variables in the marketing mix that business people use to
develop a marketing plan.

Price may be defined as the value of product attributes expressed in monetary terms which a
consumer pays or is expected to pay in exchange and anticipation of the expected or offered utility.
Price is therefore, a link that binds consumers and the company. It helps to establish a mutually
advantageous economic relationship and facilitates the transfer of ownership of goods and services
from the company to buyers.

FACTORS AFFECTING PRICING DECISIONS

Before a firm develops the pricing strategy, it should take into consideration the different factors
which affect price decisions. These factors are external as well as internal. External considerations
should be studied before enacting a pricing strategy. Fig Pr-1

Pricing forces

Demand
Organization
Objectives
Competition
- Mkt. Share
Cost - Mkt. skimming
Consumer's quality perceptions - Target return on
Pricing investment
Middlemen (distributors), etc. Image Objective(s) - Meet competition
Market penetration
Suppliers
Product differentiation
Government

Economic conditions
Marketing Mix
Ethical considerations

Cost of raw materials

External considerations * Internal considerations

Fig PR - I pricing objectives and pricing forces.

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EXTERNAL FACTORS

1. Demand
Demand for the product is the total volume that is bought by a customer group(s) in a definite time
period, in a definite geographical area, in a particular marketing environment and with the defined
marketing mix.

For a marketer it is necessary to understand the relationship between price and the consumer
perception. The relationship can be explained by two economic concepts Law of Demand and
Elasticity of demand.

The law of demand states that consumers usually purchase more units at a low price than the high
price. The price Elasticity of demand shows the sensitivity of buyers to price changes in terms of
quantities they will purchase.

Elastic demand occurs if relatively small changes in price result in large changes in quantity
demanded total revenue goes up when prices are reduced or goes down. Price elasticity is more
than 1.
Q1 - Q2
Price Elasticity = Q1 + Q2 = % age change in Qty. demand
P1 - P2 % age change in price
P1 + P2

Unitary elasticity Price elasticity Price inelasticity Negative elasticity

Qty. (a) (b) (c) (d)

In elastic demand takes place if considerable price change has little impact on quantity demanded.
Price elasticity is less than one. Total revenue goes up when prices are raised.

Unitary demand exists when there is no impact of price on demand. Total sales revenue remains
constant. Price elastic is one.

Negative demand exists if change in price has the adverse impact on demand. Price increase leads
to increase in demand.

Research confirms that not all consumers use price as the dominant purchase determinants. The
marketer has to study the type of product and type of customers to whom he want to serve and
price elasticity of demand before arriving at a pricing decision.

2. Competition. Another factor that contributes to the degree of control a firm has over prices is
the competitive environment within which it operates. A company's marketing program is
influenced considerably by a particular type of competitive structure in which the company
operates.

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Pure competition is a market situation in which there are too many small buyers and sellers, each
with the complete market information no single buyer or seller controls market demand, market
supply or price. The product is homogenous i.e., each seller markets the same product. It is easy to
enter or leave this type of market. This type of competition is rare.

Monopolistic Competition there are many buyers and sellers but they lack the complete
information. Each seller attempts to gain a differential advantage over its competitors.

An oligopoly is a market structure where there are only a few large sellers, marketing essentially
similar products, accounts for all or almost all of an industry's sales.

A monopoly is a market structure in which only one firm is marketing a particular produt or
service and there are no close substitutes. While planning the pricing strategies each seller must
consider the possible reactions of the competitors.

Table PR III: characteristics of competitive market structure

STRUCTURE
Pure Monopolistic Oligopoly Monopoly
competition competition
Number of Large Many Few One
competitors
Size of competitors Small Varies Large
There are
none
Nature of product Homogenous Differentiated Homogenous Unique no
or close
differentiated Substitute
Seller's control over None Some, Some but be Complete
Characteristics

price depends on careful (within

degree of regulations)
differentiation
Entry into industry Very easy Easy Difficult Very
difficult

3. Channel Members

Each channel members seeks to play a significant role in setting prices in order to generate sales
volume, obtain adequate profit margins, derive a suitable image, ensure repeat purchases and meet
specific goals.

A manufacturer can gain greater control over price by using an exclusive distribution system.

A whole seller or retailer can gain stronger control over price by stressing its importance as a
customer to the manufacturer.

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To maximize channel member cooperation regarding price decisions, the manufacturer need to
consider four factors

(a) Channel member profit margins,

(b) Price guarantees,
(c) Special deals, and
(d) The impact of price increases.

4. Economic conditions: The inflationary or deflationary tendency affects pricing. In recession

period, the prices are reduced to a sizeable extent to maintain the level of turnover. On the other
hand, the prices are increased in boom period to cover the increasing cost of production and
distribution. To meet the changes in demand, price etc, several pricing decisions are available
a) Prices can be boosted to protect profits against rising cost,
b) Price protection system can be developed to link the price of delivery to current cost
c) Emphasis can be shifted from sales volume to profit margin and cost reduction etc.
5. Buyers The various consumers and businesses that buy a company's products or services
may have an influence in the pricing decision. Their nature and behavior for the purchase of a
particular product, brand or services etc, affect pricing when their member is large.
6. Government Price decision is also affected by the price controlled by government,
through enactment of legislation, when it is thought proper to arrest the inflationary trend in
prices of certain products.

Internal Factors

1. Organizational Factors
Pricing decision occur on two levels in the organization. Over-all pricing strategy is dealt with by
top executives. They determine the basic ranges that the product falls into in terms of market
segments. The actual mechanics of pricing are dealt with at lower levels in the firm and focus on
individual product strategies. Usually, some combination of production and marketing specialists
are involved in choosing the price.

2. Marketing Mix Marketing experts view price as only one of the many elements of the
marketing mix. A shift in any one of the elements has an immediate effect on the other three-
production, promotion and distribution. In some industries, a firm may use price reduction as a
marketing technique. Other firms may raise prices as a deliberate strategy to build a higher
prestige product line. In either case, the effort will not succeed unless the price change is
combined with a total marketing strategy that supports it. A firm that raises its prices may add a
more impressive looking package and may begin a new advertising campaign.

3. Product Differentiation
The price of the product also depends upon the characteristics of the product. In order to attract
the customers, different characteristics are added to the product, such as quality, size, color,
attractive package, alternative uses etc. Generally, customers pay more prices for the product
which is of the new style, fashion, better package etc.

4. Cost of the Product

Cost and price of a product are closely related. The most important factor is the cost of
production. In deciding to market a product, a firm may try to decide what prices are realistic,
considering current demand and competition in the market. The product ultimately goes to the

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public and their capacity to pay will fix the cost; otherwise, product would be flapped in the
market.
5. Objectives of the firm
A firm may have various objectives and pricing contributes its share in achieving such goals.
Firms may pursue a variety of value oriented objectives, such as maximizing sales revenue,
maximizing market share, maximizing customer volume, minimizing customer volume,
maintaining an image, maintaining stable price etc. Pricing policy should be established only after
proper considerations of the objectives of the firm.

PRICING OBJECTIVES
Goals that specify the role of price in an organization's marketing and strategic plans are pricing
objectives. To the extent possible, these organizational pricing objectives are also carried to lower
levels in the organization, such as setting objectives for marketing mangers responsible for an
individual brand. These objectives help the company in integrating price with other marketing
inputs so as to develop a synergic effect in the marketing and corporate strategies of the company.
It is for this purpose also that pricing objectives are set with in the framework of marketing and
corporate objectives. Pricing objectives or goals give direction to the whole pricing process.
Determining what your objectives are is the first step in pricing. When deciding on pricing
objectives you must consider: 1) the overall financial, marketing, and strategic objectives of the
company; 2) the objectives of your product or brand; 3) consumer price elasticity and price points ;
and 4) the resources you have available.

Some of the more common pricing objectives are:

 1) Maximize short-run and long-run profit
 2) Increase sales volume (quantity)
 3) Increase sales in terms of Birr
 4) Increase market share
 5) Obtain a target rate of return on investment (ROI) and return on sales
 6) Stabilize market or stabilize market price
 7) Maintain price leadership
 8) Discourage new entrants into the industry
 9) Match competitors prices
 10) Encourage the exit of marginal firms from the industry
 survival
 11) Be perceived as fair by customers and potential customers
 12) Discourage competitors from cutting prices
 13) To get competitive advantage

PRICING POLICES AND STRATEGIES
Pricing policies represents the general framework within which pricing decisions are changed. It
provides guidelines to carry out pricing strategy. There are five stages in developing the pricing
strategy. Like any other activity strategy formulation starts pricing with the clear statements of
objectives. It is essential that pricing decision be integrated with the firms over all marketing
program.
Formulation of marketing strategy is not a one time phenomenon. It should be flexible that is it can
be molded according to the need of the hour because pricing strategy is the plan of action to face
the challenges of a particular market situation.

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Major dynamic pricing strategies available to management are:

1. New-Product Pricing Strategies

Pricing strategies usually change as the product passes through its life cycle. In preparing to enter
the market with a new product, management must decide whether to adopt a skimming or a
penetration pricing strategy.

a. Market - Skimming Pricing

Setting a relatively high initial price for a new product is referred to as market-skimming pricing.
A firms introducing a new or innovative price that customers really desiring the product are willing
to pay. These customers are not very price sensitive because they weigh the new products price,
quality, and ability to satisfy their needs against the same characteristics of substitutes. As the
demand of these customers is satisfied, the firm lowers the price to attract another, more price
sensitive segment. Thus, skimming pricing gets its name from skimming successive layers of
"Cream", or customer segments, as prices are lowered in series of steps.

The initial pricing of VCRs at more than $1500 and the Trivial Pursuit game $39.95 are examples
of skimming pricing within 3 years after their introductions, both products were often priced at less
than half their initial prices. Some times minor modifications are made in the product when it is
offered at a lower price to a new segment; publishing hardback best selling novels in paper back is
an example. Skimming pricing is an effective strategy when (i) enough prospective customers are
willing to buy the products immediately at the high initial price to make these sales profitable
(ii) the high initial price will not attract competitors.
(iii) Lowering price has only a minor effect on increasing the sales volume and reducing the unit
costs, and
(iv) Customers interpret the high price as signifying high quality.

These four conditions are most likely to exist when the new product is protected by patents or
copyrights or its uniqueness is understood and appreciated by customers.

b. Market - Penetration Pricing

In market-penetration pricing, a relatively low initial price is established for a new product. The
price is low in relation to the target market's range of expected prices. The primary aim of this
strategy is to penetrate the mass market immediately and, in so doing, generate substantial sales
volume and a large market share. At the same time, it s intended to discourage other firms from
introducing competing products. Texas Instruments (TI) consciously chose a penetration strategy
when it introduced its hand-held calculators and digital watches. As demand for these products
increased, unit product costs fell, which permitted TI to lower its prices further.

The conditions favoring penetration pricing are the reverse of those supporting skimming pricing.

i) Many segments of the market are price sensitive.

ii) a low initial price discourages competitors from entering the market, and
iii) Unit production and marketing costs fall dramatically as production volume increase.

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Thus, the firm using penetration pricing may (i) maintain the initial price for a time to gain profit
loss from its low introductory level or (ii) lower the price further, counting on the new volume to
generate the necessary profit.

In some situations penetration pricing may follow skimming pricing. A company might initially
price a product high to attract price-sensitive consumers and recoup initial research and
development costs and introductory promotional expenditures. Once this is done, penetration
pricing is used to appeal a broader segment of the population.

2. Product Mix Pricing Strategies

The strategy for setting a product's price often has to be changed when the product is part of a
product mix. In this case, the firm looks for a set of prices that maximizes the profits on the total
product mix. Various product mix strategies are as follows:

(a) Price lining Often a firm that is selling not just a single product but a line of products
may price them at a number of different specific pricing points, which is called price lining. For
example, a department store manager may price a line of women's dresses at $59, $79, and $99. As
shown in figure PR 7, this assumes that demand is elastic at each of these price points but inelastic
between these price points. In some instances all the items might be purchased for the same cost
and than marked up at different percentages to achieve these price points based on color, style, and
expected demand. In other instances manufacturers design products for different price points and
retailers apply approximately the same mark up percentages to achieve the three or four different
points offered to consumers. Sellers often feel that a limited number (such as three or four) price
points is preferable to 8 or 10 different ones, which may only confuse prospective buyers.

(b) Optional - product pricing

Most firms offer optional/accessory products or features along with their main product. The
pricing strategy is to keep the prices of the optional product on the higher side comparatively. For
example, a car buyer may choose to order power windows, cruise control, and a radio with CD
player. Pricing these options is a sticky problem. until recent years General Motor's normal pricing
strategy was to advertise a stripped-down model for, say, $12,000 to pull people into showrooms
and than devote most of the show room space to showing option-loaded cars at $14,000 or $15000.
The economy model was stripped of so many comforts and conveniences that most buyers rejected
it. More recently, however, GM has followed the example of the Japanese automakers and
included in the sticker price many useful items previously sold only as options. The advertised
price now often represents a well-equipped car.

(c) Captive Product Pricing

Companies that make products must be used along with a main product are using captive Product
pricing. Examples are razor-blades, camera film, and computer floppy. The prices of main
products are kept on the lower side and the prices are comparatively higher for the next part.

Polaroid prices its cameras low because it makes its money on the film it sells. And Gillette sells
low-priced razors but makes money on the replacement blades. Camera makers who do not sell
film have to price their main products higher in order to make the same overall profit.

In case of services, this strategy is called two-part pricing. The price of the service is broken into
fixed fee plus a variable usage rate.

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Thus, telephone company charges a monthly rate the fixed fee plus charges for calls beyond same
minimum number the variable usage rate.

(d) By - Product pricing

In pricing of some products there are some residue products which are called as by products. If the
by products have little value and are in fact costly to dispose other manufacturer should accept any
price that comes more than the cost of disposing them. The by products have values to the
customer groups, and then they will give price on value. The revenue earned on the by products
will make it easier for the company to charge a lower price of the main product if the competition
is intense. For example, while processing of crude oil we get petrol as the main product and some
by products also come out as diesel, Kerosene out, coal tar etc. These prices of by products are
kept on the lower side.

(e)Product - Bundle Pricing

It calls for setting the prices of a bundle. Bundle pricing is less than the individual item pricing.
Price bundling can promote the sales of the products consumers might not otherwise buy, but the
combined price must be low enough to get than to buy the bundle.

3. Price Adjustment Strategies

Companies do not set a single price but rather a pricing structure that reflect the variations in the
changing situations. Price adjustment strategies include.

a) Geographical Pricing
b) Discount and Allowance Pricing
c) Segmented pricing
d) Psychological Pricing
e) Promotional Pricing
f) Value Pricing
g) International Pricing

a. Geographical Pricing
A company must decide how to price its products to consumers in different parts of the country.
Often geographical pricing is not negotiated but depends upon the traditional practices in the
industry in which the firm operates, and all companies in that industry normally conform to the
same pricing format. Following are the common methods of geographical pricing.

i) FOB (Free on Board) pricing:

In this type of pricing the buyer selects the transportation form and pays all freight charges. The
seller pays the cost of loading the goods (hence free on board). The delivered price to the buyer
depends upon the freight charges

ii) Uniform Delivered pricing

The Company charges the same price plus freights to al the customers regardless of their location.
The freight charges set at the average freight cost. Here the sellers pay for the freight.

iii) Freight Absorption Pricing: This method calls for absorbing all or part of the actual
freight charges in order to get the business. It can be done with the reason that if we are able to get
added business from that customer than the average cost would reduce.

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iv) Zone Pricing: It falls between FOB origin pricing and uniform delivered pricing. In this type
of pricing, goods are delivered at uniform delivered pricing to al the buyers within a
geographical zone. In multiple zone system, delivered prices vary by zone.

v) Basing point pricing: In this method the seller selects a given city as a basing point and
charges all customers the freight cost from that city to the customer location regardless of the city
from which the goods are actually shipped.

(b) Discounts and Allowances

Discounts and allowances result in deduction from the base (or list) price. The deduction may be in
the form of a reduced price or some other concession, such as free merchandise or advertising
allowance. Discounts and allowances are common place in business dealings. Discounts and
allowances can be in the following manners.

i) Quantity Discounts Quantity discounts are deductions from a seller's list price intended to
encourage customers to buy larger amounts or to buy most of what they need from the seller
offering the deduction. Discounts are based on the size of the purchase, either in dollars or in units.
A noncumulative discount is based on the size of an individual order of one or more products. A
retailer may sell golf balls at $2 each or at three for $5. A manufacturer or wholesaler may set up a
quantity discount schedule such as the following, used by a manufacturer of industrial adhesives:

Bones Percent discount

Purchased in single order from list price
1-5 None
6-12 2.0
13-25 3.5
over 25 5.0

Noncumulative quantity discounts are intended to encourage large orders.

A cumulative discount is based on the total volume purchased over a specified period. This type of
discount is advantageous to a seller because it ties customers more closely to that firm. The more
total business a buyer gives to seller, the greater is discount. IBM offers an assortment of volume-
over-time discounts. Cumulative discounts are also common in selling perishable products. These
discounts encourage customers to buy fresh suppliers frequently, so that buyer's merchandise will
not become stale.

ii) Trade Discounts are some times called functional discounts, are reductions from the list price
offered to buyers in payment for marketing functions the buyers will perform such as storing,
promoting, and selling the product. A manufacturer may quote retail price of $400 with trade
discount of 40% and 10%

Note that the 40 and 10% discounts do not constitute a total discount of 50 percent off list price.
They are not additive; rather, they are discounts on discounts. Each discount is computed on the
amount remaining after the preceding discount has been deducted.

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iii) Cash Discounts
A cash discount is a deduction granted to buyers for paying their bills within a specified time. The
discount is computed on the net amount due after first deducting trade and quantity discounts from
the base price. Every cash discount includes three elements, as

- The percentage discount

- The period during which the discount may be taken
- The time when the bill becomes over due.

Cash discount is exhibited in the following fig.

3/10, Net 30

%age to be deducted Number of days from date Number of days form

if still is paid within of invoice in which bill data of invoice after
specified time must be paid to receive which bill is overdue
cash discount

1/7, Net 20

iv) Other Discounts and Allowances

A manufacturer of goods such as air conditioners or toys purchased on seasonal basis may consider
granting a seasonal discount. Forward dating is a variation on both cash and seasonal discounts. A
promotional allowance is a price reduction granted by sellers as payment for promotional services
performed.

c. Segmented/Discriminatory Pricing
Companies often will adjust their basic prices to allow for difference in customer, products, and
locations. In segmented pricing, the company sells a product or service at two or more prices even
though difference in prices is not based on differences in costs. Segmented pricing takes several
forms:

i) Customer Segment pricing. Different customers pay different prices for the same product or
service. Museums, for example, will charge a lower admission for students and senior citizens .

ii) Product form pricing. Different versions of the product are priced differently, but not
according to difference in their costs for instance, Black & Decker prices its most expensive iron at
$54.98, which is $12 more than the price of its next most expensive iron. The top model has a self-
clearing feature, yet this extra feature costs only a few more dollars to make.

iii) Location Pricing. Different locations are priced differently, even though the cost of offering
each location is the same. For instance, theaters vary their seat prices because of audience
preferences for certain locations, and state universities charge higher tuition for out-of-state
students.

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iv) Time pricing. Prices vary by season, the month, the day, and even the hour. Public utilities
vary their prices to commercial users by time of day and week and versus week day. The telephone
company offers lower "off-peak" charges, and resorts give seasonal discounts.

For segmented pricing to be an effective strategy, certain conditions must exist.

- the market must be segmentable, and the segments must show different degrees of demand.
- Members of the segment paying the lower price should not be able to turn around and resell
the product to the segment paying higher price.
- Competitors should not be able to under sell the firm in the segment being charged the higher
price.
- Costs of segmenting and watching the market should not exceed the extra revenue & obtained
from the price difference.

d. Psychological Pricing
Price says some thing about the product. For example, many consumers use price to judge the
quality. A $100 bottle of perfume may contain only $3 worth of scent, but some people are willing
to pay the $100 because this price indicates some thing special.

In using psychological pricing, sellers consider the psychology of prices and not simply the
economics. For example, one study of the relationship between price and quality perceptions of
cars found that consumers perceive higher - priced cars as having higher quality. By the same
taken higher quality cars are perceived to be even higher priced than they actually are.

Another aspect of psychological pricing is reference prices-prices that buyers carry in their minds
and refer to when looking at a given product. The reference price might be formed by noting
current prices, remembering past prices, or assessing the buying situation. Sellers can influence or
use these consumers' reference prices when selling price.

Even small difference in price can suggest product differences consider a product priced at $500
compared to one priced at $499.95. Actual difference is just 5 cents by psychological difference
can be much greater. This is known as an odd pricing.

e. Promotional Pricing
With promotional pricing, companies will temporarily price their products below list price and
some times even below cost. Promotional pricing takes several forms. Super markets and
departmental stores will price a few products as loss leaders to attract customers to the store in the
hope that they will buy other times at normal markups. Promotional pricing takes several forms
and some of them are described below:

Loss leader pricing – It happens when retailers drop price on well-known brands to stimulate
store traffic in the hope that customers will buy other items also at normal mark-ups.
Special even pricing- is used in certain seasons to draw in more customers.
Cash Rebates – Manufacturers will sometimes offer cash rebates to consumers who buy the
product from dealers with in a specified time.
Lower-interest financing, longer-payment times, longer warranties –
Psychological discounting – offer discounts from normal prices to increase sales and reduce
inventories.

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 f. Value Pricing
During the recessionary, slow-growth, many companies adjust their prices to bring them into line
with economic conditions and with the resulting fundamental shift in consumer attitude to ward
quality and value. More and more, marketers have adopted value pricing strategies - offering just
the right combination of quality and good service at a fair price. In many cases, value pricing has
involved redesigning existing brands in order to offer more quality for a given price or the same
quality for less.

g. International Pricing
Companies that market their products internationally must decide what prices to charge in the
different countries in which they operate. In some cases, a company can set a uniform worldwide
price. For example, Boeing sells its jetliners at about the same price every where, whether in US,
Europe or a Third world country. However, most companies adjust their prices to reflect local
market conditions and cost considerations.

General Pricing Approaches

Cost-based Pricing- is the simplest pricing method – adding a standard markup to the cost of the
product. Example:
Variable cost ------------------------------- Br 10
Fixed Costs --------------------------------- Br 300,000
Expected unit sales ------------------------- 50,000 units
Then the manufacturer’s cost per unit is given by: Unit cost = variable cost +Fixed costs/unit sales.
= 10+300000/50000=Br 16
If the manufacturer wants to earn a 20% markup on sales, the manufacturer’s markup price is
given by: Markup price = Unit cost/(1-Desired Return on Sales) = 16/1-0.2 = Br 20

Does a using standard markup to set prices make sense? Generally no. Any pricing method that
ignores demand and competitive prices is not likely to lead to the best price. Markup pricing
works only if that price actually brings in the expected level of sales.

Break-even Analysis and Target Profit Pricing

Another cost-oriented pricing approach is break-even pricing or a variation called target profit
pricing. The firm tries to determine the price at which it will break even or make the target profit it
is seeking.
Total Revenue
1200

1000 Total Cost

800

600

400
Total fixed cost
200

0 10 20 30 40 50 Units sold (in’000)

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Total Fixed cost = Br 300,000
Variable cost per unit = Br 10
Slope of Total Revenue = Br 20 which is price of the good.
The total revenue and total cost curves cross at 30,000 units. This is the break-even volume. At
Br 20, the company must sell at least 30,000 units to break-even; that is, for total revenue to cover
total cost. Break even volume can be calculated using the following formula:

Breakeven volume = Fc/ price-vc = 300,000/(20-10) = 30,000 units

If the company wants to make a target profit, it must sell more than 30,000 units at Br 20 each.

Value-based Pricing – Uses buyer’s perceptions of value, not the seller’s cost as the key to
pricing. Value based pricing means that the marketer cannot design a product and marketing
program and then set the price. Price is considered along with the other marketing mix variables
before the marketing program is set.

Competition Based Pricing

Consumers will base their judgments of a product’s value on the prices that competitors charge for
similar products. One form of competition based pricing is going rate pricing, in which a firm
bases its price largely on competitors prices, with less attention paid to its own costs or to demand.
The firm might charge the same as , more than or less than its major competitors.

Competition based pricing is also used when firms bid for jobs. Using sealed –bid pricing, a firm
bases its price on how it thinks competitors will price rather than its own cost or on the demand.

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