Some business managers set prices simply by adding a percentage over costs to provide an acceptable profit.
Some business managers set prices
simply by adding a percentage over costs to provide an acceptable profit. That
approach has two advantages. Price is simple to calculate and if a firm is a
low-cost producer, relative to competitors, so-called ‘cost-plus’ pricing may
seem to provide some protection from competitive attack. The trade-off for
simplicity and security may be lost profits. In theory, the amount of profit
that is sacrificed is the difference between what customers actually paid and
what they would have been willing to pay. Compared with cost-plus pricing, pricing according to the value of the product to
the customer is more difficult and speculative. The challenge is to determine
what the value of the product is in the customer’s mind.
First, it is useful to
distinguish between perceived value and potential value. Perceived value is
what the buyer now recognizes. Potential value is what the buyer can be
educated to see in the product. That is the task of marketing. It may be
accomplished through advertising, personal selling and getting the buyer to try
Second, product value may be
perceived differently by different customer groups or market segments.
Different segments may place different values on the several elements that make
up the set of product (which in the broadest sense, includes the product or
service itself, its brand image, its availability, and the service that the
seller provides) attributes.
For example, a large firm may
place little value on the technical service a supplier offers it (the large
firm) has comparable or superior technical resources of its own. But a small
company may be highly dependent on the supplier’s technical services and place
high value on them in making purchasing decisions.
A third factor to consider in
establishing customer value is the options that a potential buyer may have.
Clearly, if the buyer can purchase a product at a lower price from one source
than another, the lower price sets the upper bound in the marketplace. But for
the buyer to have such effective options, he/she must have knowledge of them.
Another option the customer has
may be not to buy the product at all but to make-do with what one has. Given
this choice, the buy-not buy decision may be made by comparing the outcome of
one course of action with the other.
These actions are quantifiable.
One may calculate the operative savings in either instance and relate this to
the cost of buying new, as the case may be. The anticipated savings may be
expressed as a percentage return on investment (ROI). This, the amount of
realizable savings establishes the value of a product to the customer.
Calculated for each of several possible uses for available funds, ROI measures
may serve to establish the buyer’s purchasing priorities. The
choice between buy-not buy, of course, may not always be easily quantified with
reference to expected savings. Nevertheless, it is a real and important
Finally, the price set by the
seller is often taken by the potential customer as one measure of the value of
the product. It is often interpreted by buyers as the supplier’s estimate of
the worth of the product it sells. If the seller does not value the product
highly, it is not likely that the buyer will. Therefore, pricing a product
significantly below what the buyer might pay for its functional equivalent can
be self-defeating. The buyer may infer that value is, in fact, connoted by
price and choose the higher-priced option.
Value, then, for a given product
tends to be a function of (1) the utility of its several attributes to the
prospective buyer, (2) the options the buyer has and is aware of (i.e. the
offerings of competing suppliers and the option of not buying at all), and (3)
the extent to which the buyer perceives price itself as a measure of product
If the seller truly value-prices,
then different prices would be charged for the product to different customer
groups. It is referred as price discrimination. A relevant consideration in
thinking about price as an expression of product value is how sensitive is the
buyer to price. Price sensitivity will vary considerably among purchasers and,
for the same purchaser, it will vary from one time and one set of circumstances
to another. Buyers who can pass on the cost of the purchase are less sensitive
to price than those who cannot.
Price sensitivity also relates to
the performance standards by which the purchaser measures. Viewed differently,
performance measures effectively establish the relative worth of different
product attributes for the manager who has to make the decision and be judged
for it. Another factor in price sensitivity is the uncertainty that attends
switching from one supplier to a lower-priced source. Modest price differences
are often insufficient to overcome the purchaser’s uncertainties about an
untried supplier’s product quality, reliability and service.
Tags : MARKETING MANAGEMENT - Pricing Decisions
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