A firm must set a price for the first time when it develops a new product, when it introduces its regular product into a new distribution channel or geographical area, and when it enters bids on new contract work.
Procedure for a pricing policy
A firm must set a price for the
first time when it develops a new product, when it introduces its regular
product into a new distribution channel or geographical area, and when it
enters bids on new contract work. The firm has to consider several factors in
setting its pricing policy. A useful 6-step procedure to develop the pricing
policy is discussed below.
Selecting the pricing objective
The firm first decides where it
wants to position its market offering. The clearer a firm’s objectives, the
easier it is to set price. A firm can pursue any of the objectives classified
under four major groups, viz. profitability objectives, volume objectives,
meeting competition objectives and prestige objectives. This was discussed in
the previous lesson.
Each price will lead to a
different level of demand and therefore have a different impact on a firm’s
marketing objectives. The relation between alternative prices and the resulting
current demand is captured in a demand curve. In the normal case, demand and
price are inversely related: the higher the price, the lower the demand. In the
case of prestige goods, the demand curve sometimes slopes upward.
However, if the price is too high, the level of demand may fall. The demand
curve sums the reactions of many individuals who have different price
sensitivities. The first step is estimating demand is to understand what
affects price sensitivity. Generally speaking, customers are most price
sensitive to products that cost a lot or are bought frequently.
They are less price sensitive to
low cost items or items they buy infrequently. They are also less price
sensitive when price is only a small part of the total cost of obtaining,
operating and servicing the product over its lifetime. Firms, of course, prefer
customers who are less price sensitive. The following is a list of factors
leading to less price sensitivity, as identified by Nagle and Holden.
1. The product is more distinctive
2. Buyers are less aware of substitutes
3. Buyers cannot easily compare the quality of
4. The expenditure is a smaller part of the buyer’s
5. The expenditure is small compared to the total cost
of the end product
6. Part of the cost is borne by another party
7. The product is used in conjunction with assets
8. The product is assumed to have
more quality, prestige or exclusiveness
9. Buyers cannot store the product
Most firms make some attempt to
measure their demand curves using methods like statistical analysis, price
experiments and surveys. In measuring the price-demand relationship, the
marketer must control for various factors that will influence demand. The
competitor’s response will make a difference. Also, if the company changes
other marketing mix factors besides price, the effect of the price change
itself will be hard to isolate and measure.
In the earlier discussion on
costs, it was noted that demand sets a ceiling on the price, whereas costs set
the floor. Also, the types of costs and the impact of economies of scale and
learning curve on pricing was explained. To price intelligently, management
needs to know how its costs vary with different levels of production. It is
important to be aware of the risks presented by pricing based on the
experience/learning curve. It assumes that competitors are weak followers.
It leads the company into
building more plants to meet the demand, while a competitor may be innovating a
lower-cost technology. Then the market leader will be stuck with the old
technology. Today’s firms try to adapt their offers and terms to different
buyers. A manufacturer may negotiate different terms with different retail
chains. One retailer may want daily delivery (to keep inventory lower) while
another may accept twice-a-week delivery in order to get a lower price.
The manufacturer’s cost will
differ with each chain and so will its profits. To estimate the real
profitability of dealing with different customers with differing requirements,
the manufacturer needs to use activity-based cost (ABC) accounting instead of
standard cost accounting. ABC accounting tries to identify the real costs
associated with serving each customer. It allocates indirect costs like
clerical costs, office expenses, supplies and so on, to the activities that use
them, rather than in some proportion to direct costs. Both variable and
overhead costs are tagged back to each customer. Another interesting costing
concept is target costing.
Costs change with production
scale and experience. They can also change as a result of a concentrated effort
by designers, engineers and purchasing agents to reduce them through target
costing. Market research is used to establish a new product’s desired functions
and the price at which the product will sell, given its appeal and competitors’
prices. Deducting the desired profit margin from this price leaves the target
cost that must be achieved. Each cost element - design, engineering,
manufacturing, sales – must be examined and different ways to bring down costs
must be considered.
The objective is to bring the
final cost projections into the target cost range. If this is not possible, it
may be necessary to stop developing the product because it could not sell for
the target price and make the target profit.
competitors’ costs, prices and offers
Within the range of possible
prices determined by market demand and company costs, the firm must take
competitors’ costs, prices and possible price reactions into account. The firm
should first consider the nearest competitor’s price. If the firm’s offer
contains features not offered by the nearest competitor, their worth to the
customer should be evaluated and added to the competitor’s price.
If the competitor’s offer
contains some features not offered by the firm, their worth to the customer
should be evaluated and subtracted from the firm’s price. Now the firm can
decide whether it can charge more, the same or less than the competitor. But
competition can change their prices in reaction to the price set by the firm.
a pricing approach
Given the three Cs – the Customer’s
demand schedule, the cost function and the competitors’ prices – the firm is
now ready to select a price. Figure 3.3.1 summarizes the three major
considerations in price setting. Costs set a floor to the price. Competitors’
price and the price of substitutes provide an orienting point.
Customers’ assessment of unique
features establishes the price ceiling. Firms select a pricing approach that
includes one or more of these three considerations. The pricing approaches are
cost-based or buyer-based or competition-based. These approaches were discussed
at length in the previous lesson.
Selecting the final price
Pricing methods narrow the range
from which the company must select its final price. In selecting that price,
the company must consider additional factors, including the impact of other
marketing activities, company pricing guidelines, gain-and-risk-sharing pricing
and the impact of price on other parties. The final price must take into
account the brand’s quality and advertising relative to the competition.
The price must be consistent with
the firm’s pricing guidelines. When a firm establishes pricing penalties, it
must be done judiciously so as not to unnecessarily alienate customers.
Sometimes, buyers may resist accepting a seller’s proposal because of a high
perceived level of risk. The seller has the option of offering to absorb part
or all of the risk if it does not deliver the full promised value.
Management must also consider the
reactions of other parties to the contemplated price. For instance, the
reaction of marketing intermediaries must be thought about. The reaction of the
sales force must be taken note since they will be the ones to sell at that
price in the marketplace. All these reactions might hold clues to fine tune the
Tags : MARKETING MANAGEMENT - Pricing Policies and Constraints
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