All profit organizations and many non-profit organizations set prices on their products.
Buyers and sellers, negotiating with each other, set Price. Sellers would ask for a higher price than they expected to receive, and buyers would after less than they expected to pay. Through bargaining, they would arrive at mutually acceptable price.
Price is the only element in the marketing mix that produces revenue. The other elements produce costs. Price is also are of the most flexible elements of the marketing mix, is that it can be changed quickly, unlike product features and channel commitments. At the same time, pricing and price competition are the number-one problem facing many marketing executives.
Companies handle pricing in a variety of ways. In small companies, prices are often set by top management rather than by marketing or sales people. In a large company, division and product line mangers typically handle pricing.
3.2 Meaning of Price
Simply, price is the amount of money and/or other items with utility needed to acquire a product. Utility is an attribute that has the potential to satisfy wants.
Price is significant to the economy, to an individual firm and in the consumer's mind.
3.3 Objective of Pricing
Every marketing activity-include pricing should be directed toward a goal. Thus management should decide on its pricing objectives before determining the price itself.
To be useful, the pricing objectives management selects must be compatible with the overall goals set by the company and the goals for its marketing program.
Some of the pricing objectives set by the firm may include:
- Profit oriented
- To achieve a target return
- To maximize profit
- Sales oriented
- To increase sales volume
- To maintain or increase market share
- Status quo-oriented
- To stabilize prices
- To meet competition
3.3.1 Profit – Oriented Goals
Profit goals may be set for the short or long run. The company may select one or two profit oriented goals for its pricing policy.
- Achieve a target return
A firm may price its product to achieve a target return – a specified percentage return on its sales or on its investment. Many retailers and wholesalers use a target return on sales as a pricing objective for short period such as a year or a fashion season.
They add an amount to the rest of the product, called a mark up, to cover anticipated operating expenses and provide a desired profit for the period.
- Maximize Profit
The pricing objective of making as much money as possible is probably followed more than any other goal. The trouble with this goal is that to some people, profit maximisation has an ugly connotation, suggesting profiteering, high price and monopoly.
3.3.2 Sales- Oriented Goals
In some companies management’s pricing is focused on sales volume. The pricing goal may be to increase sales volume or to maintain or increase the firm’s market share.
Increase Sales Volume
The pricing goal of increasing sales volume is typically adopted to achieve rapid growth or to discourage potential competitors from entering a market. The goal is usually stated as a percentage increase in sales volume over same period, say 2 years or 2 year. Management may seek higher sales volume by discounting or by same other aggressive pricing strategy.
Maintain or Increase
In some companies, both large and small the pricing objective is to maintain or increase market share. Most industries today are not grouping much, if at all, and have excess production capacity. Many firms need added sales to more utilize their production capacity, and in turn, gain economies of scale and better profit.
3.3.3 Status Quo Goals
Two related goals – stabilizing prices and meeting competition – are the least aggressive of all pricing goals. They are intended simply to maintain the firm’s current situation – that is, the status quo. With either of these goals, a firm seeks to avoid price competition.
Price stabilization often is the goal in industries where the product is highly standardized (such as steel or bulk chemicals) and one large firm.
3.4 Factors Influencing Price Determination
Knowing the objective of its pricing, a company then can move to the heart of price management: determining the base price of a product.
Base price, or list price, refers to the price of one unit of the product at its point of production or resale. This price does not reflect discount, freight charges, or any other modification.
The same procedure is followed in pricing both new and established products.
Other factors, beside objectives, that influence price determination are discussed below:
3.4.1 Estimated Demand
In pricing, a company may estimate the total demand for the product. This is easier to do for an established product than for a new one. The steps in estimating demand are
a) Determine whether there is a price the market expects and
b) Estimate what the sales volume might be at different prices.
A product must also consider a middleman's reaction to price. Middlemen are more likely to promote a product if they approve its price. Retailer and wholesale buyers can frequently make an accurate estimate of the selling price that the market will accept for a particular item.
Moreover, the seller is gauging price elasticity of demand, which refers to the responsiveness of quantity demanded to price changes.
3.4.2 Competitive Reactions
Competition greatly influences base price. A new product is distinctive only until the inevitable arrival of competition. The threat of potential competition is greatest when the field is easy to enter and profit prospects are encouraging.
3.4.3 Other Marketing - Mix Elements
The other ingredient in the marketing mix influences a Product’s base price considerably.
We have already observed that a product's price is affected by whether it is a new item or an established one. Over the course of a life cycle, price changes are necessary to keep the product competitive.
- Distribution Channels
The channels and types of middlemen selected will influence a producers pricing. A firm selling both through wholesaler and directly to a retailers often sets a different factory price for these two classes of customers. The price to wholesaler is lower because they perform services that the producer would have to perform - such as providing storage, granting credit to retailers, and selling to retailers.
The extent to which the product is promoted by the producer or middlemen and the methods used are added considerations in pricing. If major promotional responsibility is placed on retailers, they ordinarily will be changed a lower price for a product than if the producers advertises it heavily.
3.4.4 Discount & Allowances
Discount & allowances result in a deduction form a 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 allowances. Discount & allowances are commonplace in business dealings. Discount takes several forms as explained below:
- Quantity Discounts
Quantity discounts are deductions from a seller's list price intended to encourage customers to buy in large amounts or to buy most of what they need from the seller offering the deduction. Discounts are based on the size of the purchase, ether in Birr or in units.
e.g. from 1-10 units none
10-20 units 2% discount
21-30 units 3% discounts etc.
- Trade Discount
Trade discount sometimes called functional discounts, are reductions form the list price offered to buyers in payment for marketing functions the buyers will perform - functions such as storing, promoting and selling the product. A manufacturer may quote a retail price of $300 with trade discount of 30% and 10%. The retailer pays the wholesaler $230($300 less 30%), and the wholesaler pays the manufacturer $215 ($230 less 10%). The wholesaler is expected to keep the 10% to cover costs of the wholesaling functions and pass on the 30% discount to retailers.
- Cash Discount
A Cash discount is a deduction granted to buyers for paying their bills within a specified time. The discount is composed on the net amount due after first deducting trade and quantity discounts from the base price. Every cash discount includes three elements.
- The percentage discount
- The period during which the discount may be taken &
- The time when the bill becomes overdue
Let's say a buyer owes $250 after other discounts have been granted and is offered terms of 2/10, n/20 on an invoice dated November 8. This means the buyer may deduct a discount of 2% ($7.20) if the bill is paid with in 10 days of the invoice date - by November 18, otherwise the entire (net) bill of $250 must be paid in 20 days - by December 8, etc.
3.4.5 Cost of a Product
Pricing of a product also should consider its cost. A product's total unit cost is made up of several types of costs, each reacting different to changes in the quantity produced.
Cost means the amount of expenditure incurred to produce a job or a product or to render a particular service. The total cost of a product is divided as material cost, labor cost, and other expenses incurred. These costs are further divided in costing as:
1. Direct material cost & indirect material cost
2. Direct labor cost & indirect labor cost
2. Direct expenses & indirect expenses.
Direct material cost plus direct labor cost plus direct expenses is known as prime cost. Indirect material cost plus indirect labor cost plus indirect expenses are known as overheads and prime cost plus overheads is the total cost.
These costs are further classified as per their common characteristics as follows:
- According to their nature: - such as material cost, labor cost and overheads.
- According to their functions: - such as prime cost, factory costs, office & administration costs, selling costs, and distribution cost.
- According to their variability: - such as fixed costs, variable cots, and semi-variable costs etc.
1. According to their nature
In this classification cots are divided as material cost, labor cost, and overheads.
Material cost: " The cost of commodities supplied to an undertaking.
Labor cost: the cost of remuneration (wages, salaries, commission, bonus etc) of the employees of the undertaking.
Overheads or Expenses: the cots of services provided to an undertaking & the notional cost of the use of owned assets.
2. According to their Function
In this classification costs are divided as prime cost, factory cost, office & administration cost & selling & distribution costs.
Prime cost: Cost of direct material, direct labour and direct expenses.
Direct material cost: It is the cost for material used for producing the product.
Direct labor cost: the wages paid to the workers who are manufacturing the goods are known as direct labor cost. If the work of a particular worker is clearly identified with the production of a particular product, then the amount paid for such work is direct wages.
Some indirect wages such as wages paid to foreman, inspectors etc. are charged as direct wages because they can be identified with the product.
Direct expenses are those, which can be identified with a particular cost unit or cost center. In other words direct expenses are those expenses, which are spent for a particular job or a particular product. Direct expenses however, do not include direct material cost and direct labor cost. Direct expenses are included in the prime cost.
3.5 Pricing Method
To determine their selling price, most companies establishes their prices using one of the following methods:
- Price are based on total cost plus a desired profit (Break even analysis is a variation of this method)
- Prices are based on marginal analysis (A consideration of both market demand and supply)
- Price are based on competitive market conditions (Market price)
3.5.1 Cost Plus/ Mark Up Pricing
Cost plus pricing means setting the price of one unit of a product equal to the total cost of the unit plus the desired profit on the unit.
Cost plus pricing when it is based on cost, the formula used is as follows
Mark up % = markup / cost
when mark up is based on selling price
Mark up % = markup / selling price
Adding standard markup to the cost of the product examples: -
- A retailer pays a supplier $10 for a product and marks it up to sell at $14. There is a 40% markup on the product and the retailer's gross margin is $4. If the operating costs of the store are $3 per unit adds, the retailer's profit margin is $1 or 10%.
- Suppose a manufacturer, whose unit cost of the product is $15, wants to earn a 20 percent markup on sales, his mark up price could be calculated in two ways.
i) Markup price = Unit cost / (1 - Desired return on sales)
= $15 / (1 - 0.2(20%)) = $20
Unit cost = $15
Markup = 20% (0.2)
Markup price (sales price) = P
P = 15 + 0.2p
P - 0.2p = $15
0.8p = $15
p = $15
One way to consider both market demand and cost in price determination is break-even analysis to calculate break even pints. A break even points is that quantity of output at which total revenue equals total cost.
3.5.2 Break-even Analysis & Target Profit Pricing (Marginal Analysis)
Another pricing method, marginal analysis, also takes into account of both demand and costs to determine the best price for profit maximization. Firms with other pricing goals might use price based on marginal analysis to compare price determined by different means.
This approach is particularly useful where there is high proportion of overhead costs to be included in the selling price. However, demand and the perceived value of the product should not be ignored.
Break-even analysis uses the concept of a break-even chart to develop a system of target profit pricing in which the organization tries to determine the price that will produce the profit it is seeking.
The chart shows the total cost and total revenue at different sales volume levels.
- Assume fixed costs to be $200,000
- Assume variable cost per unit to be $10
Variable cost plus fixed cost gives the total cost (TC)
Produce total revenue (TR) on the basis of a given price per unit sold.
Assume if company sales
20,000 units and
These are break-even volumes. For instance, at $20, the company must sell at least 20,000 units to break-even
Break-even Volume = Fixed Cost / (Price - Variable cost(contribution))
= $200,000 / ($20 - 10)
= 20,000 units
Suppose the enterprise wants to earn a tangent profit, it must sell more than 20,000 units at $20 each. Consider ABC company has invested $1,000,000 in the business and wants to set price to earn a 20% return, or $200,000. In that case it must sell at least 40,000 units at $20 each.
3.5.3 Market Pricing
The seller price may be set right at the above or below the market price.
3.5.4 Uniform Delivered Pricing
Under uniform delivered pricing, the same delivered price is quoted to all buyers regardless of their locations. This strategy is sometimes referred to as postage stamp pricing, because of its similarity to the pricing of the first class mail service.
Uniform delivered pricing is typically used when freight costs are a small part of the seller’s total costs. This strategy is also used by many retailers who believe is free delivery is an additional service that strengthens their market position.
3.5.5 Zone Delivered Pricing
Zone – delivered pricing divides a seller’s market into a limited number of broad geographic zones and them sets a uniform delivered piece for each zone. Zone delivered pricing is similar to the system used in pricing package – delivery service.
When using this pricing strategy, a seller must walk a tightrope to avoid charges of illegal price discrimination. The zone must be drawn so that all buyers who compete for a particular market are in the same zone. This condition is almost impossible to meet in dense population areas.
3.5.6 Odd Pricing
Odd pricing, another psychological strategy is commonly used in retailing.
Odd pricing sets prices at uneven (odd) amounts such as 39 cents, or $ 19.94, rather than at even amounts.
The rationale for odd pricing is that it suggests lower prices and as a result yields greater sales than even pricing. Recent research indicates that odd pricing can be an effective strategy for a firm that emphasizes low prices.
3.5.7 Value Pricing
In recent years several companies have adopted value based pricing in which they change a fairly low price for a fairly high quality offering. Value pricing says that the price should represent a high value offer to consumers. Lexus is a good example because Toyota could have priced Lexus, given its extra ordinary quality, much closer to Mercedes price.
3.5.8 Perceived Value Pricing
An increasing number of companies are basing their price on the product’s perceived value. They see the buyer’s perception of value, not the seller’s cost, as they key to pricing. They use the non-price variables on the marketing mix to build up perceived value in the buyer’s mind. Price is set to capture the perceived value.
3.5.9 Going Rate Pricing
In going rate pricing, the firm pays less attention to its own costs or demand and bases its price largely on competitors’ prices. The firm might change the same, more or less than its major competitors.
3.5.10 Sealed Bid Pricing
Competitive – oriented pricing is common where firms submit sealed bids for jobs. The firm bases its price on expectations of how competitors will price rather than on a rigid relation to the firm’s costs or demand.
The firms want to win the contract, and winning normally requires submitting a lower price than competitors. At the same time, the firm cannot set its price below cost without worsening its position.
3.6 New Product Pricing /Market Entry Strategies
In preparing to enter the market with a new product, management must decide whether to adopt a skimming or a penetration pricing strategy.
3.6.1 Market Skimming Pricing
Setting a relatively high initial price for a new product is referred to as market skimming pricing.
Ordinarily the price is high in relation to the target market's range of expected prices. That is, the price is set at the highest possible level that the most interested customers will pay for the new product.
Market-skimming pricing has several purposes. Since it should provide healthy profit margins, it is intended primarily to recover research and development costs as quickly as possible. Further it provides the firm with flexibility, because it is much easier to lower an initial price that meets with consumer resistance etc.
3.6.2 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 is intended to discourage other firms from introducing competing products.
Price is the amount of money and/or other items with utility needed to acquire a product.
Before setting a product's base price, management should identify its price goal. Major pricing objectives are (1) to earn a target return on investment or on net sales, (2) to maximize profits, (2) to increase sales, (3) to hold or gain a target market share, (4) stabilize prices, and (5) meet competition prices.
Besides the firms pricing objectives, other key factors that influence price setting are (i) demand for the product, (2) competitive reactions (2) strategies planned for other marketing mix elements, and (3) cost of the product.
Three major methods used to determine the base prices are cost-plus pricing, marginal analysis, and setting price in relation only to the market.
For cost plus pricing to be effective, a seller must consider several types of costs and their reactions to changes in the quantity produced.
In actual business situation, price setting is influenced by market conditions. Hence, marginal analysis, which takes into account both demand and cost to determine a stable price for the product, is a useful price determination method.
After deciding a pricing goals and setting the base price, marketers must establish pricing strategies that are compatible with the rest of the marketing mix.
When a firm is launching a new product, it must chase a market skimming or a market-penetration pricing strategy. Market skimming uses a relatively high initial price, market penetration is low are.
Strategies must be devised for discounts and allowances – deductions from the list price. Management has the option of offering quantity discounts, trade discounts, and cash discounts.
Management also should decide whether to change the same price to all similar buyers of identical quantities of a product.
In order to attract its customers, management is setting different prices – inform delivery pricing, odd pricing, value pricing, going rate pricing, sealed bid pricing etc.