Marketing Management 10

8/22/2019 Marketing Management 10

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Marketing Management Unit 10

Sikkim Manipal University 160

Unit 10 Pricing

Structure

10.1. Introduction

10.2. Factors affecting price determination

10.3. Cost based pricing

10.4. Value based and competition based pricing

10.5. Product mix pricing strategies

10.6. Adjusting the price of the product

10.7. Initiating and responding to the price change

10.8. Summary

Terminal questions

Answers to SAQs and TQs

10.1. Introduction

Price determination is very important aspect of strategic planning. Marketers fix the price of the

product on the basis of cost, demand or competition. Dell, which allows customers to customize the

product adopted flexible pricing methods. In contrast, Indian oil companies product prices are fixed

by the government where company does not have any control. Retailer like big bazaar Fair price and

Subhiksha targeted price conscious consumer. Manufacturers and service providers all over the

world outsourced some of their functions to developing countries to get cost advantage which help

them in reducing their final price. Internet has become alternative tool for shopping to the consumer.

It offers wide range of products and lesser price.

Learning Objectives

After studying this unit, you will be able to

1. Find out the factors that influence the pricing strategies.

2. Understand various approaches to pricing

3. Analyze the pricing strategies adopted by marketers

4. Know the situations when marketer should initiate the price cuts.


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10.2. Factors Affecting Price Decisions

1. Marketing objectives: There are four major objectives on which prices are determined. They are

survival, current profit maximization, Market share leadership and product Quality leadership.

Survival strategy adopted when company is facing stiff competition from the competitors and it wants

quick reaction and recovery. Current profit maximization strategy is used to defend the market

position. To explain, assume a company is operating in the lubricants business. Its sales and market

share are very high. It always tries to hold their current position. To do this it increases the price of

the product. The next objective is market share leadership. Here, company strives to achieve the

leadership position in the market. It reduces the price of the product so that more number of

customers buys the product. Through volume generation company gets the market leadership

position. Product quality leadership objective is used when company decides to come with high

quality product and premium price. The intention of the company is to cater to the needs of the niche

segment.

2. Costs: The cost of marketing and promoting the product will have direct impact on the price. For

example, Airline fuel cost went up recently. All airline companies increased the price of the ticket.

Company will be incurring fixed cost (plant, Machinery etc...) as well as variable cost (Raw material,

labor etc) The fixed cost will go down if the number of products produced increases. The variable

cost of the product decreases if the product is produced up to optimal level and then once again it

goes up. Hence the total cost (fixed cost plus variable cost) vary according to both fixed cost andvariable cost. Marketer is interested in knowing the break even analysis when he introduces the

product in the market. The break even point for a product is the point where total revenue received

equals the total costs associated with the sale of the product (TR=TC). A break even point is typically

calculated for businesses to determine whether it would be profitable to sell a proposed product, as

opposed to attempting to modify an existing product instead so it can be made lucrative. Break-Even

Analysis can also be used to analyze the potential profitability of an expenditure in a sales-based

business.

3. 4Ps of marketing: The price of the product is determined by the other marketing mix elements

also. Product influences the price level i.e. if the product quality is very high company would like to

price it high and vice versa. The new product requires aggressive promotion and results in higher

promotion cost and higher price. Supply chain management also plays an important role in the price
http://wiki/Businesshttp://wiki/Product_%2528business%2529http://wiki/Breakeven


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determination. If the organization able to integrate their supply chain well then it will be having

distribution advantage than others. Let me explain these concepts with examples. Nokia when it

introduced 1100 handset in Indian market priced at Rs 5200. It did so to get back its R&D and

promotion cost. When the sales picked up, the price of the product has come down to Rs3800. Cavin

care introduced sachets and priced at 50 paisa. HUL was forced to come out with sachets at the

same price.

4. Nature of the market and demand: The price determination depends on the nature of the market

also. The nature of the market is classified into following categories.

a. Perfect competition

b. Monopolistic competition

c. oligopolistic competition

d. Monopoly

a. Perfect competition: The nature of the market where many buyers and sellers exists. Both the

buyers and sellers exhibit the switching habit. If the seller charges more for the product then buyer

will shift to another seller. Usually in these type of market companies should set their prices

according to the competition.

b. Monopolistic competition: The nature of the market where many buyers and sellers exists. The

difference between Perfect competition and monopolistic competition is in case of latter prices for the

products vary according to the differentiation where as in case of former there is only one price

exists. In case of Monopolistic competition prices are fixed by the gap in the product line of all

competitors and level of differentiation the company is able to do.

c. Oligopolistic competition: The market consist few players and dominant in the market. They do

not allow new players to enter the market. They are price sensitive to each other

d. Monopoly: Here market consists of one seller. An Indian railway has monopoly over the railway

industry in India. It is able to sell its products and services at the determined rates. In the monopoly

markets usually controlled by the government prices are economical.


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Demands for the product vary according to the price set. Generally customers think that higher the

prices better the quality of the product and lower the price lower the quality of the price. Marketer

should understand this perception. This perception will determine the demand for the product. For

example, customer thinks that Mercedes as high quality product and chik shampoo which costs less

than other shampoo as low quality. After analyzing the perception about the price, marketer is

interested in finding out the price elasticity of demand.

The price elasticity of demand is defined as percentage change in quantity demanded to the

percentage change in the price. To explain, assume that the price of the product is Rs 12 and

market is perfect. Company is able to sell 1000 units per month. If the price is revised to Rs 13 and

company expects 900 units to be sold in the particular month. The price elasticity of demand for the

product is

Price elasticity of demand= % change in quantity demanded/ % change in price.

= -10%/ 8.33%

=-1.2

This means company is having negative Price elasticity of demand.

The marketing implication is less is the prices elasticity of demand it is very easy for the marketer to

change the price. Marketers who are interested in sales and product have inelasticity of demand will

go for the lowering of the prices.

5. Competition: Price is also determined by how intense the competition is in the industry. Cellular

industry and airline industry in India are involved in such type of price wars. The price war between

Hutch (Now Vodafone) and Airtel is exemplary. Air Deccan which started no frill airline made other

airliners like go air, spice jet and paramount to reduce the price of their airlines.

6. Environmental factors. These external factors are very crucial for the companys price decisions.

We discussed the impact of Macro and micro environment on the companys strategies. For

example, in the union budget tax on cigarette is increased. Hence company that manufactures

cigarette should increase the price. The increase in the price is determined by the government

environment which is external to the company.


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10.3. Cost based pricing

I. Cost plus pricing:The method of adding markup to the total cost of the product

Procedure for calculating cost plus pricing:

a. Find out the variable cost per unit and fixed cost.

b. Estimate the number of units the company is intended to sell.

c. Calculate the Unit cost by the following formula

Fixed costs

Unit cost = Variable cost +-----------------------------

Unit sales

d. Find out the required mark up( desired return on sales)

e. Calculate the price by the following formula.

Unit cost

Price= -----------------------------------------------

(1- Desired return on sales)

Problem: Company X would like to sell 75,000 units in the year 2008. The fixed cost of the company

is Rs 2 Lakh and variable cost is Rs 5 per unit. Company wants 30 % profit after sales. Calculate the

Price of the product to achieve desired sales and profit.

Solution:

Unit cost= VC+ (FC/ unit sales)

= 5+ (200,000/75000)

= 7.67

Price = Unit cost/ (1- desired return on sale)

= 7.67/ (1-0.3)

= 10.85

Approx Rs 11/unit.


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Advantages of cost plus pricing:

1. Sellers are more certain about the cost than the demand.

2. If all the companies in the industry use this method price become standard.

3. It is fairer to both buyers and sellers.

Disadvantages of cost plus pricing:

1. It ignores the demand and competition

2. If fewer units are sold then fixed cost will be spread to less number of units. This lead s to

higher unit cost and higher final price.

II. Break even pricing:

The firm determines the price at which it will make the target profit.

Procedure to calculate the break even volume:

1. Find out the total fixed cost of the company.

2. Determine the price on which company would like to sell

3. Calculate the variable cost per unit.

4. Determine the break even volume by the following formula

Break even volume= Fixed cost/ (Price- variable cost)

Procedure to identify breakeven price

1. Determine the unit demand needed to break even at a given price.

2. Find out the expected unit demand at given price.

3. Find out the total revenue at a given price.

4. Calculate the total cost ( assuming fixed cost and total of variable cost)

5. Determine the profit from the following formula

Profit= Total revenue total cost.

Assume:

Fixed cost: Rs 1,000,000


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Price: Rs 20

Variable cost: Rs 12

BEV = 1,000,000/ (20-12)

=125,000.

Price Unit demand

needed to

break even(i)

Expected unit

demand at given

price(ii)

Total revenue

iii= (Price*ii)

Total cost iv(

assumed

fixed cost Rs

10 Lakh and

constant

variable cost

Rs 12)

Profit v-iii-iv

Rs 16 250,000 340,000 4,800,000 5,080,000 -280,000

Rs 18 166,667 180,000 3,240,000 3,160,000 80,000

Rs 20 125,000 140,000 2,800,000 2,680,000 120,000

Rs 22 100,000 90,000 1,980,000 2,080,000 -100,000

Rs 24 83,333 60,000 1,440,000 1,720,000 -280,000

Rs 20 are the ideal price to break even.

10.4. Value Based and Competition Based pricing

I. Value based pricing: Setting the price of a product on the basis of consumers value rather than

manufacturers cost.

Difference between value based and competition based pricing

COST BASED PRICING


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VALUE BASED PRICING

Cost based pricing starts with development of product and prices were fixed later. In case of value

based pricing customers are given utmost importance. The product is developed only after the price

and cost estimation in value based pricing method. To explain both theories let me take examples,

company X that manufactures electric switches develops the product and sets the price on the basis

of total cost and target return required. Company Y that manufactures food products researches the

consumer need and prepares customer values. On the basis of values company sets the price

Every day low pricing:

In this strategy organization charges constant low prices and no temporary discounts. This method is

popularized by Wal-Mart.

High Low pricing:

Charging higher prices everyday but running frequent promotions to lower the prices on temporary

prices.

2. Competition Based pricing: Method in which a seller uses prices of competing products as a

benchmark instead of considering own costs or the customer demand

a) Destroyer Pricing

This strategy is used as an attempt to eliminate competition. It involves lowering companies

prices to an extent where competition cannot compete and consequently, they go out of

Product Cost Price Value Customers

ProductCostPriceValueCustomers
http://www.businessdictionary.com/definition/customer.htmlhttp://www.businessdictionary.com/definition/costs.htmlhttp://www.businessdictionary.com/definition/benchmark.htmlhttp://www.businessdictionary.com/definition/product.htmlhttp://www.businessdictionary.com/definition/competing.htmlhttp://www.businessdictionary.com/definition/price.htmlhttp://www.businessdictionary.com/definition/use.htmlhttp://www.businessdictionary.com/definition/seller.htmlhttp://www.businessdictionary.com/definition/method.html


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business. It is therefore important that one has to recognize how threatening the competition is

and research how competitive they can be with their prices: they may be able to compete with

organizations price cuts and consequently both, or even just competitor may go out of business.

b) Price Matching or Going Rate Pricing

Many businesses feel that lowering prices to become more competitive can be disastrous for

them (and often very true!) and so instead, they settle for a price that is close to their competitors.

Any price movements made by competition is then mirrored by the organization so long that one

can compensate for any reductions if they lower their price.

c) Price Bidding or Close Bid Pricing

Price bidding is a strategy most common with manufacturing, building and construction services.

In this strategy, companies submit the quotation according to the tender stipulations

Self Assessment questions 1

1. Current profit maximization strategy is used to defend the ---------------------

2. Break even point occurs when

a. Total cost equals fixed cost

b. Total cost equals total revenuec. Total cost equals variable cost

d. All the above

3. ----------- market consists few number of sellers

a. Perfect market

b. Monopolistic

c. Oligopolistic

d. Monopoly

4. Unit cost equals toa. Variable cost+ ( fixed cost/unit sales)

b. Fixed cost + ( variable cost/ unit sales)

c. (Variable cost+ fixed cost)/unit sales

d. All the above.


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5. Every day low pricing is

a. Value based pricing

b. Competition based pricing

c. Cost based pricing

d. All the above.

10.5. Product Mix Pricing Strategies

1.Product Line pricing: strategy of setting the price for entire product line. Marketer differentiate the

price according to the range of products i.e. suppose the company is having three products in low,

middle and high end segment and prices the three products say Rs 10 Rs 20 and Rs 30 respectively.

Figure 10.1

NOKIA 1110 NOKIA 7610 NOKIA E90

Price: Rs 1349 Price Rs 6249 Price Rs 34599

In the above example of Nokia mobile phones Nokia 1110 is priced @ Rs 1349, Nokia 7610priced @

Rs 6249 and Nokia E90 priced @ Rs 34599. All the three products cater to the different segments

Low, middle and high income group respectively. The three levels of differentiation create three price

points in the mind of consumer. The task of marketer is to establish the perceived quality among the

three segments. If the customers do not find much difference between the three brands, he/she may

opt for low end products.

2Optional Product pricingstrategy is used to set the price of optional or accessory products along

with a main product.


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Figure 10.2

Body cover Rs 1521 Slide Molding Rs

1123

Rare underbody Rs

8883 Roof End Rs 6396

Maruti Suzuki will not add above accessories to its product Swift but all these are optional customer

has to pay different prices as mentioned in the picture for different products. Organizations separate

these products from main product so that customer should not perceive products are costly. Once

the customer comes to the show room, organization explains the advantages of buying these

products.

3. Captive product pricing: Setting a price for a product that must be used along with a main

product. For example, Gillette sells low priced razors but make money on the replacement cartridges.

4. By product pricing is determining the price for by products in order to make the main products

price more attractive. For example, L.T. Overseas manufacturers of Dawaat basmati rice, found that

processing of rice results in two by products i.e. rice husk and rice brain oil. If the company sells husk

and brain oil to other consumers, then company

5. Product bundle pricing is offering companies several products together at the reduced price. This

strategy helps companies to generate more volume, get rid of the unused products and attract the

price conscious consumer. This also helps in locking the customer from purchasing the competitors

products. For example, Anchor toothpaste and brush are offered together at lower prices.

10.6 Adjusting the price of the product.

Competition has forced companies to adjust their base prices according to the situations. There are

six different types of strategies companies are adopting. They are


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1. Discounts and allowances

2. Location pricing

3. Psychological pricing

4. Promotional pricing

5. Geographical pricing and

6. International pricing.

Discounts and allowances. Companies offer reduction in the price for the customers on the basis

of four different conditions.

a. Cash discount is given when the customer makes early payment before the due date. To explain

a manufacture gave 21 days credit to a grocery store person. If the customer pays the bill within 7

days company may ask him to pay 2% less than the actual amount.

b. Quantity discount is a price reduction to buyers who buy the products in large quantities.

Suppose a manufacture sells submersible pumps for Rs 20,000, and if customer buys three

motors at one go then he will reduce the price of the product to Rs 18,000.

c. Functional discount is offered when customer carries the promotion or other marketing

activities. To illustrate a chemist will be paid nominal amount for displaying the company products

or promoting the company products.

d. Seasonal discount is usually offered when customer purchases the product in the off season.

For example, if customers purchase the winter cloth in rainy season then he/she will get discount

on the total products produced.

Allowances are usually paid to the middlemen who actively involved in promoting the products.

1. Location pricing is the method of setting the price of the product according to the locations. Here

company changes the price from one location to another location though other cost remains the

same. To make it more clearer, company X is having two stores, one in a market area and

another in suburban area. It charges more in the market area and less in the suburban area.

2. Psychological pricing: According to Kotler Psychological pricing is a pricing approach that

considers the psychology of prices and not simply the economics the price is used to say


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something about the product. For example, V. K. export sets Rs 299 and Rs 399 for its leather

products.

3. Promotional pricing: Organizations sets the price of their product below the list price andsometimes even below cost. The objective of such pricing is to achieve immediate sale, increase

the customer footfall, avoid the competition and introduce the product. Big bazaar annual

clearance sale etc is the example of this type of pricing.

4. Geographical pricing: setting the price on the basis of geographies they are selling the product

and freight charges. In this strategy different options exist for the company. They are

a. Freight charges to be paid by the customer( FOB pricing)

b. Different zones have different prices i.e. company may charge different prices in south and north

zone. ( Zone pricing)

c. Same price plus freight charges for all the customers ( Uniform delivered pricing)

5 International pricing: organizations should consider the different external factors and customer

profile in different countries. It should adopt their products and their prices according to that. For

example, CIPLA sells its AIDS medicines in Africa and America with different prices.

10.7 Initiating and responding to the price changes

1. INITIATING THE PRICE CHANGES

Initiating the price cuts: Below we are discussing the situations when organizations think

of initiating the price cuts

a. Companies reduce their price when they have excess capacity.

b. Falling market share in the face of strong market competition

c. Dominate the market through lower costs.

Initiating price increasesa. Rising cost of raw materials.

b. Demand for the product exceeds the supply.

Buyer reactions to price changes

a. Reduce price means reduced quality


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b. Reduced price means company is not selling the product as expected.

c. Prices may go down further.

d. May avoid buying the product for some time

2. Responding to price changes

In the competitive world other manufacturer some times initiates the price changes. In such

situations company should analyze two situations

If the price cut of other company is not affecting our company, then hold current price and

monitor the market. This situation helps to keep the profitability of the company.

If the price change of other company affects the company then it should take any one of

the following steps

a. Reduce the price of the product on par with competition or below the competition.

b. Increase the perceived quality of company and product.

c. Improve the quality of the product and then increase the price.

d. Launch different brand which can fight in the lower end.

Self Assessment Questions 2:

1. ------------ Strategy used to set a price for a product that must be used along with a main product.

2. The pricing strategy in which company sells its several products at reduced price

a. Bundle pricing

b. By product pricing

c. Captive pricing

d. Options pricing

3. Razor and cartridge example is used for

a. Bundle pricing

b. By product pricing

c. Captive pricing

d. Options pricing

4. FOB pricing is an example of

a. Promotion pricing


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b. International pricing

c. Discounts and allowances

d. None of these

5. -------------- is given when the customer makes early payment before the due date.

10.8. Summary

1. There are four major objectives on which prices are determined. They are survival, current profit

maximization

2. The break even point for a product is the point where total revenue received equals the total

costs associated with the sale of the product (TR=TC).

3. The price elasticity of demand is defined as percentage change in quantity demanded to the

percentage change in the price.

4. Optional Product pricingstrategy is used to set the price of optional or accessory products along

with a main product.

5. By product pricing is determining the price for by products in order to make the main products

price more attractive

6. Product bundle pricing is offering companies several products together at the reduced price.

Terminal Questions:

1. Discuss the factors those influence price decisions

2. Write a note on cost based pricing.

3. Explain value based and competition based pricing.

4. How organizations should adjust their prices of the product?

5. Write a note on product mix pricing strategies.

Answers to Self Assessment Questions

Self Assessment Questions 1

1. Market position.
http://wiki/Product_%2528business%2529http://wiki/Breakeven


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2. Total cost equals total revenue.

3. Oligopolistic

4. Variable cost+ ( fixed cost/unit sales)

5. Value based pricing

Self Assessment Questions 2

1. Optional product pricing

2. Bundle pricing

3. Captive pricing

4. None of these

5. Cash discount

Answer to Terminal Questions

1. Refer 10.2

2. Refer 10.3

3. Refer 10.4

4. Refer 10.6

5. Refer 10.5

Marketing Management 10

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