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A STUDY OF PRICE FIXATION

(Term Paper towards the fulfillment of the assessment in the subject of Cost and Management
Accounting)

NATIONAL LAW UNIVERSITY, JODHPUR


SUMMER SESSION (2016-2017)

Submitted to:

Submitted by:

Ms. Ruchi Bhandari

Abha Mehta

Faculty of Cost and Management Accounting

B.B.A. LL.B
Roll no: 1154

V
SemesterCONTENTS

OBJECTIVES..................................................................................................................................3
RESEARCH METHODOLOGY....................................................................................................3
introduction......................................................................................................................................4
FACTORS AFFECTING PRICING................................................................................................4
A. INTERNAL FACTORS..........................................................................................................4
B. EXTERNAL FACTORS.........................................................................................................6
Role of Objectives in price fixation.................................................................................................7
Pricing under different market structures......................................................................................10
PRICING METHODS IN PRACTICE.........................................................................................12
PRICING OF A NEW PRODUCT................................................................................................14
pRICING OF EXPORTS...............................................................................................................15
APPROACHES IN SETTING PRICES:.......................................................................................16
CONCLUSION..............................................................................................................................18
BIBLIOGRAPHY..........................................................................................................................19

OBJECTIVES
The objectives of the Term Paper are as follows:

To determine an enterprises objectives while fixing the price of the product.


To identify the factors affecting price of a product
To identify and analyze advantages and disadvantages of different pricing methods
adopted by an enterprise

RESEARCH METHODOLOGY
Data shall be collected from secondary sources. Annual Reports of the identified companies,
Articles and Research Papers, Books, and other publically available documents shall be used in
the course of preparation of the project.

INTRODUCTION
3

Price-fixation is an important managerial function in all business enterprises. If the price set is
quite high, the seller may not find enough number of consumers to buy his product. If the price
fixed is too low, the seller may not be able to cover his cost. Thus, fixing appropriate price is a
major decision-taking function of any enterprise. Price- decisions, no doubt, need to be reviewed
from time to time.
As per the traditional Economic Theory price is determined by the interaction of demand and
supply. Thus, the buyers and sellers determine the price. However, in practice some other parties
and several other factors are involved in fixation of the price. The two main parties are the
Competitors and the Government. Competitors are in the form of potential rivals who
manufacture and sell related products; these may be in the form of close substitutes. In such
cases the price fixed by one producer may influence the price fixation policy of the other. The
Government influences prices through the imposition of taxes or providing subsidies and also
through measures of direct controls.

FACTORS AFFECTING PRICING


Following are the factors affecting price fixation of a product by an enterprise:1
A. INTERNAL FACTORS
Costs: Firms while fixing prices should consider the costs for producing the product. In case of
several products, costs constitute a large part of the price. The firm must plan to recover both the
variable cost and the fixed costs. However, a firm selling bulk of its supplies in the home market
and a part of the production in the overseas market, then all the fixed costs may be recovered
from the home market, and the only variable costs may be charged for the overseas markets.
Objectives of the firms: The marketer must consider the objectives of the firm, while fixing
prices. Price of products is directly related to objectives of the firm. For instance, if the objective
1http://www.yourarticlelibrary.com/marketing/pricing/pricing-decisions-internal-and-externalfactors-with-diagram/50888/

of the firm is to increase return on investment, then it may charge a higher price, and if the
objective is to capture a large market share, then it may charge a lower price.
Product: the product plays an important role in fixing price. If the product is of superior quality,
then a firm may either adopt premium strategy or high value strategy. In premium pricing, the
firm would charge high price for high quality, and in the case of high value pricing. The firm
would charge moderate price for high quality. There are also firms that adopt super value
strategy, where a high quality product is sold at low price.
Image of the firm: the firms enjoying the good image in the market may charge a higher price,
as compared to those firms which do not enjoy reputation in the market. This is because;
consumers have trust and confidence in the firms enjoying name and reputation in the market.
For instance, firms like P&G, HLL can command a higher price for their brands, as they enjoy
goodwill in the market.
Brand image: The image of a brand can affect its price. Those brands, which command a good
image in the market, would fetch higher prices. For instance, in India, the titan brand of watches
enjoys a good image, and as such, it can command higher price as compared to other Indian
brands of watches.
Promotional Activities: Pricing is related to promotional activities. If a firm undertakes heavy
advertising and sales promotion, then price planning must ensure that these promotional costs
will be recovered, at least in the long term. It is often observed that highly advertised or
promoted brands command high price as compared to lowly promoted brands.
Product Life Cycle: the stage of a products life cycle affects pricing. For instance, when a firm
introduces a product in a competitive market, then it may charge a lower price to attract the
customers. During the growth stage, a firm may increase the price, especially in a low
competition market.
Product Line: pricing can be affected by the pricing of various products in the product line. For
instance, when other products in the product line are priced higher, then the firm may charge a
higher price for a newly introduced product. However, these are firms that introduce a products

variant at low price to fight competition in the market, even though the other products in the
product line are of higher price.
B. EXTERNAL FACTORS.
Competition: the marketer has to consider the degree of competition in the market. When there
is high competition, prices may be lower, and vice-versa. Price of competing brands, as well as
those of substitutes must be considered while fixing prices. Normally, the price must be within
the range of that of the competitors.
Demand: price of goods to a great extent depends upon demand. For instance, an increase in
demand may lead to an increase in price, even though there may be no rise in costs. Demand may
increase due to economic conditions in the market, problems with the supplies of competitors
and so on. It is to be noted, that increase in demand need not result in increase in prices, as
nowadays, socially responsible marketers pass on a part of the benefits of large-scale production
and distribution to the consumers.
Consumers: the marketer should consider various consumer factors while fixing prices. The
consumer factors that must be considered include the price sensitiveness of buyers, purchasing
power, buying pattern, and soon.
Government Control: the government control and regulations must be considered while fixing
prices. In case of certain products, government may announce administered prices, and therefore,
the marketer has to consider such regulation while fixing prices. The marketers catering to
foreign markets must consider the incentives, and trade barriers while fixing prices. The taxes
and duties levied by the government authorities must be considered.
Economic Conditions: the economic conditions prevailing in the market must be considered
while fixing prices. During the times of recession, when consumers have less money to spend,
the marketers may reduce the prices to influence buying decision of the consumers. However,
during economic boom, the marketers may charge a higher price.
Channel Intermediaries: the marketer must consider the number of channel intermediaries and
their expectations. The longer the chain of intermediaries would increase the price of the goods.

ROLE OF OBJECTIVES IN PRICE FIXATION


The first step in developing a pricing strategy is to develop pricing objectives what the pricing
decisions must accomplish. Pricing objectives must support the broader objectives of the
marketing department (such as increasing market share) and that of the organizations overall
objectives (such as enhancing shareholders wealth or enhancing corporate image).
Survival
It is the most important objective of pricing; especially when companies are faced with the
problem of over capacity, intense competition, or changing consumer wants. Most firms adopt
survival objective during recession, when customers on an average have less money to spend.
Prices are reduced in order to maintain sufficient flows of cash for working capital. Profits are
less important than survival. As long as prices cover variable However, survival is a short-term
objective, as price-cutting is not always the answer. Marketers need to be careful with the pricing
strategy that brings short term benefits at the expense of long-term goals. Reducing prices in
order to increase sales can cause customers to be price sensitive.2
Profit Objective
One of the main objectives of pricing is to earn profit. The profit objective of pricing can be
expressed in two ways:3
Return on investment: a good number of firms fix their prices to stimulate consumer interest in
their brand over other competing brands. Attractive prices result in higher sales ,which in turn

http://www.yourarticlelibrary.com/economics/pricing-policies-considerations-objectives-and-

factors-involved-in-formulating-the-pricing-policy/29035/

Ibid.

helps to achieve a certain level of return on investment or return on capital employed. This in
turn helps a firm to achieve its one of the overall objectives- enhancing shareholders wealth.
Profit maximization: A profit maximization objective seeks to get as much profit as possible.
Profit maximization does not necessarily involve fixing high prices. Low prices may bring in
higher sales and profits.
Sales objectives
Firms also fix prices in order to attain sales objectives. The sales objectives can be expressed in
two ways:4
Market share growth: A firm may fix the price of its products at a certain level so as to defend its
current market share, and if possible to increase the market share. for this purpose a firm may
adopt penetration pricing for its existing prices.
Sales growth: some marketing managers would like to achieve sales revenue growth in terms of
unit sales growth or in money terms. Increase in sales is an important indicator of a firms
success. However, increase in sales targets does not necessarily result in other objectives, such as
profits. This is because, sales may increase, but profits may actually decrease, or a firm may even
suffer losses despite growing sales. Therefore, pricing objectives should not just focus on growth
in sales, but also on profits.
Competitive-Effect Objectives
At times, a firm may deliberately seek to reduce the effectiveness of one or more competitors. It
may fix its prices in such a way that it would enable it to win over competitors customers. For
instance, a departmental store can offer a heavy discount in early November on garments,
footwear, etc.
Image differentiation:

Ibid.

Some firms may create image differentiation through pricing. They may change a premium price
for their products to create a distinct image vis-a- vis the competitors, in the minds of their target
audience. Firms like Mercedes Benz, Rolex watches, and others have adopted this strategy. Some
other firms may charge a moderate price for high quality products. For instance, a firm may
position its product on the moderate price vis--vis high quality.
Market skimming objectives
The firms that launch a new product in a market may adopt the market skimming strategy. in this
case, the product is launched at a high price, and then gradually it is reduced over a period of
time. Skimming, apart from other benefits, helps a firm to recover high development costs
associated with new products.
Early cash recovery
Firms that face liquidity problems or those that believe that life of the product or market is likely
to be short may adopt a pricing strategy designed with the objective to generate a high cash flow
and lead to an early recovery of cash. Such firms may provide a series of special offers and
discounts, and adopt a strict credit policy, so as to increase immediate sales and achieve prompt
payment.5
Preventing New Entries
Firms may adopt low price strategy with the objective of preventing others from entering the
market. The potential entrants would recognize the low returns available and the dangers of
getting involved in a price war. In this way, existing firms may be able to minimize the amount
of competition in the market.
Customer satisfaction objective
A good number of quality-focused firms believe that profits result from customer satisfaction, as
the primary objective. They believe that by focusing solely on short-term profits, a company
loses sight of winning customers and retaining them. These firms instead develop pricing
5

http://www.exporthelp.co.za/modules/13_costings/pricing_strategy.html

objectives based on pleasing customers over the long term. They may adopt a high value strategy
where product quality is high and the price is moderate instead of adopting premium strategy
where high quality product is sold at high price. However, it is to be noted that some customers,
especially, belonging to the upper-upper class would be satisfied with premium strategy, as they
enjoy prestige status with highly price items.
Social responsibility objectives
Social responsibility objectives often play a major role in pricing decisions of the government
and of non-profit organizations. Even professionals like doctors may adopt social responsibility
as their pricing objective. For instance, some doctors may charge consulting fee on the basis of
ability to pay. Poorer sections may be charged less, whereas the richer sections may be charged
more. Also professional business firms may pass on the economies of large scale production and
distribution, at least partly, to the consumers, with the objective of fulfilling social responsibility
towards the consumers.

PRICING UNDER DIFFERENT MARKET STRUCTURES

A firm operates in a market and not in isolation. We have earlier elaborately discussed the
Theory of Price Mechanism and Price Determination under different market categories. Under
Perfect Competition price is determined by the forces of demand and supply. The point of
intersection between demand and supply curves is the point of equilibrium which determines the
equilibrium price.6 Each firm under perfect competition is a price taker and not a price maker.
The Average Revenue Curve of a firm under perfect competition is horizontal and that AR = MR.
Further there is always a tendency towards the prevalence of only one price under Perfect

http://www.economicsdiscussion.net/price/price-determination-under-perfect-competition-

with-diagram/1727

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Competition; the respective changes in the forces of demand and supply alone influence the
price.
In case of Monopoly the situation is slightly different. A monopolist can be a price maker. He
can fix the price of his product, initially through a process of trial and error, by balancing losses
and gains7. He is in equilibrium at a point where MR = MC and corresponding point on the
Average Revenue Curve determines the price that he would charge so as to earn maximum profit.
As there are barriers to entry and no close substitutes, the monopolist will charge a high price
and subsequently enjoy monopoly profits.
The monopolist may also practice price-discrimination i.e. he may charge different prices to
different buyers and in different regions for the same product depending upon the elasticity of
demand for the product. In case of dumping also different prices will be charged for the same
product. In fact selling his product in foreign market at a price lower than his own market is itself
referred to as Dumping.8
In case of, Monopolistic Competition each producer is a monopolist of his product and a group
of producers producing same, though not identical product compete with each other in the
market.9 They differentiate their product and instead of having a price war with each other they
practice product-differentiation. However, the prices charged are quite competitive in nature.

7http://www.economicsdiscussion.net/monopolistic-competition/price-and-output-determinationunder-monopoly/4099

http://hubpages.com/education/How-is-Price-Determined-under-Monopoly-Market

9http://www.yourarticlelibrary.com/economics/price-determination-under-monopolisticcompetition-economics/28881/

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Under Oligopoly there are few sellers competing in the market. They may be rivals or may form
collusion. The price policy of one producer is affected by the price policy of the others. Each
producer before he fixes the prices of his product tries to understand the price behavior of other
producers in the market10. For instance producer A thinks that if he lowers the price of his
product and others dont then he will be able to capture wider market but it may so happen that if
he lowers the price of his product and others also lower their prices then he will not be able to get
more buyers and therefore all the producers may subsequently suffer. On the other hand, he may
feel that if he raises the price of his product and others also raise their prices he may not loose
out on many customers but it may so happen that when he raises his price and others dont raise
their prices, then demand for his product will go down. Therefore under Oligopoly there prevails
the phenomenon of price rigidity. They may prefer to resort to non-price competition leaving
each other to follow their own policies.

PRICING METHODS IN PRACTICE

1. FULL COST PRICING


This method is also known as Cost Plus Pricing. In this method the producer calculates per unit
cost of production and adds a margin of profit to it, which he considers fair and thereby arrives at
a price which is acceptable to the consumer.11 In fixing the price, the firm calculates the average
variable cost, adds to it the average fixed cost and to that adds the amount of fair profit. Fair
profit is normally taken as 10% to 15% of the cost.
10 http://www.yourarticlelibrary.com/economics/pricing-determination-under-oligopoly-marketeconomics/28916/

11

www.businessdictionary.com/definition/full-cost-pricing.html

12

Price = Average Variable Cost + Net Profit Margin + Average Fixed Cost
The rationale of Full Cost Pricing lies in its simplicity and apparent fairness. It appears
reasonable that price based on cost is a just price.
Limitations of the Full Cost Pricing

The main criticism against Full Cost Pricing is that it disregards demand, as also the

purchasing power of the buyers.


One of the weaknesses of the full cost pricing is that it tends to diminish the interest of
the sellers in cost control i.e. the seller will not make any effort to minimize cost because

the price fixed will automatically cover the cost.


In such pricing, historical cost is considered. This leads to over-pricing under decreasing

cost and under-pricing under increasing cost conditions.


Such type of pricing is difficult in case of wide fluctuations in variable cost.
It does not take account of the forces of competition.
In a dynamic market situation characterized by change and uncertainty, full cost pricing is
not a sound policy. It may be a useful starting point provided the sellers are willing to

deviate over a period of time.


2. MARGINAL COST PRICING
In case of Marginal Cost Pricing we have to consider the incremental cost of production. Fixed
cost is not taken into consideration. Marginal cost is the additional cost for producing additional
unit of output. In this method the price is related to marginal cost. The main difference between
Full Cost Pricing and Marginal Cost Pricing is that in Marginal Cost Pricing the fixed cost
component is not included. The Marginal Cost Pricing is useful in the short period whereas Full
Cost Pricing is mainly for the long period. As long as the marginal cost is covered there is a sort
of guarantee that the firm will not shut down.12
Advantages:

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It encourages aggressive price policy.


To keep the prices low the firm is encouraged to keep down the marginal cost.
https://www.britannica.com/topic/marginal-cost-pricing

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Under Marginal Cost Pricing the competitive price is maintained.


It is useful for multi-product, multi-process and multi-market firm.
This method of pricing is useful for pricing over the lifecycle of the product.

The firm generally follows Marginal Cost Pricing when it enters into a new market; the firm
having unutilized capacity and that there is high degree of competition in the market13.
Limitations:

This policy is useful only in the short-period and does not provide a long-run stable price

policy.
Under increasing cost conditions it may lead to higher price and under decreasing cost

conditions it will lead to lower price.


It may lead to frequent price changes which are not liked by the consumers. The buyers
prefer stable prices and not erratic price fluctuations.

It needs to be noted that the Marginal Cost Pricing provides the upper and lower limits of prices
whereas Full Cost Pricing clings to the middle points. In fact while fixing the price both the
theories should be taken into account as both the systems of pricing reinforce each other.
3. MULTI PRODUCT PRICING
Often we find that firms produce more than one product. Even the specialized firms produce
different sizes, models and styles of the product. The products are so differentiated that the
consumers look upon them to be separate products. The multi-product firms may produce joint
products. For example soap manufacturing company may be producing also glycerin, cosmetics
etc. Some firms may produce related products such as a ready-made garment manufacturing
company. Some firms may produce unrelated products. For example soaps, powder, steel
cupboards, lockers, refrigerators etc. While determining prices such firms have to consider
whether the products are complimentary or substitutes, whether production functions are fixed

13

www.accountingtools.com

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Pricing

Decisions

proportion or variable proportion and whether there exists unutilized capacity in the firm. In
most of these cases the fixed costs can get distributed over the nature of the product.14
Following factors may be considered while pricing in a multi-product firm:

If the products are totally independent pricing is like single product pricing.
If a firm is engaged in production of joint product the pricing principle should be that

total cost must be covered by pricing of the main and the by-product taken together.
When a firm is producing substitutes the market gets separated on the basis of degree of

elasticity of demand.
A multi-product firm is more like a discriminating monopolist fixing prices of different
products on the basis of their respective elasticities of demand.

PRICING OF A NEW PRODUCT


The new product may be either an entirely new one or it is one of the varieties of the existing
products. If there are many substitutes for the new product in the market then competitive price
will be charged. If the product is entirely new then through the process of trial and error the price
will be fixed not only to cover the cost of production but also to cover the cost of promotional
strategy. Two types of pricing methods are adopted in pricing of a new product.15

Skimming Price: In case of Skimming Price the producer makes an effort to fix the price
in such a way to skim away the consumers surplus i.e. the firm learns about the
maximum possible price which the consumer will be prepared to pay, rather than go
without the commodity, and then quotes the price accordingly. This price may be much
above the cost of production. The high price is accompanied by heavy sales promotion
practices. Gradually the firm brings down this price. The time and size of the price

14
http://www.wisdomjobs.com/e-university/managerial-economics-tutorial-307/pricing-practices1648/multiple-product-pricing-10241.html
15
Joel Dean, Pricing Policies of a New Product, Harvard Law Review, Nov 1976.
15

reduction has to be proper. As long as the product is able to maintain its distinctiveness
the firm continues with the Skimming Price policy. This policy is successful because in
the initial stages when the new product is introduced in the market the demand for it is

relatively inelastic and therefore the firm resorts to Skimming Price.


Penetration Price: Penetration Price policy implies that the objective of the firm is to get
into the market as early as possible even when there are other substitutes and therefore
considerately low price is charged. When the product is able to acquire greater demand
and capture bigger markets then the prices will be gradually raised.

PRICING OF EXPORTS
Pricing of export-oriented product is perhaps more complicated than pricing of the product
which remains in the domestic market. When it comes to export many more considerations are
involved besides merely the cost of transporting of the product. The producer has to consider the
following aspects:16

The nature of demand for his product in the foreign market.


The degree of competition depending on the quality of the product.
The differences in the technology employed by producers in other countries thereby

affecting costs.
The availability of substitutes.
Governments policy for promoting exports through providing subsidies, duties imposed
by the foreign Government on inflow of our product, the commission by the middlemen

and the brokers.


The regularity or irregularity regarding the demand.
The conditions for delivering of the goods in the foreign markets.

On the basis of these considerations the following Export-Price strategies can be developed17.

16
http://www.eximguru.com/exim/guides/how-to-export/ch_11_export_pricing_and_costing.aspx
17
http://www.eximguru.com/exim/guides/how-to-export/ch_2_basic_planning_for_export.aspx
16

Penetration pricing to capture the foreign market.


Skimming price for maximizing profit.
Dumping i.e. the price charged in foreign market is lower than the price at

product is sold in domestic market.


Competitive pricing.
Standard world wide price for all the buyers in all the markets based on average cost of

production.
Dual pricing based on cost plus or marginal cost method.
Escalation pricing i.e. export price is higher than the domestic price.
Follow the leader pricing i.e. the price fixed is the same as the price charged by the

leading competitor in the foreign market.


Probe pricing is a policy of trial and error, balancing losses and gains in fixing the price.

which

Initially some price is charged and then on getting the feedback the price gets adjusted.

APPROACHES IN SETTING PRICES:

A variety of approaches are employed by businessmen in setting prices. These approaches are not
mutually exclusive but sometimes they complement or supplement one another.18
Intuitive Pricing: It is a psychological method of pricing in which prices are based on the feel
of the market. The system is more subjective rather than objective in nature. Initially the price is
estimated on the basis of cost plus method with flexible mark-up pricing. This method is fairly
common.
Experimental Pricing: It is a trial and error method of pricing. This method is widely used in
pricing of new products especially at retail level.
Initiative Pricing: In this method a firm decides to follow a price fixing policy of a price leader.
Backward Cost Pricing: Certain industries target price as the starting point for strategic
calculations. The selling price is determined first and by working backwards the firm arrives at a
product design.
18
http://www.dummies.com/how-to/content/considering-six-approaches-to-effective-pricing.html
17

Odd Number and Critical Number Pricing: Many firms believe that consumers have strong
price sensitivity at certain critical points. This is particularly noticeable in the retail trade. It is
very commonly believed that odd numbers are more attractive to the buyers than the even
numbers. The problem of the management is to determine that number which has the greatest
appeal.
Double Pricing: Double pricing is a technique in which two prices are shown on the price tag or
on the pack of the article. The original price is usually crossed out and substituted by a new price
at a lower range.
Prestige Pricing: Buyers are often price-conscious. There is some sort of price illusion. The
buyers often feel that higher the price, the more prestigious is the product and therefore greater
the demand for it. Some type of social scaling exerts a powerful influence on the pricing
behavior.
Multiple Pricing / Collective Pricing: Retail prices are usually expressed in terms of one unit.
Experience often reveals that sales can be increased if more units are offered for a price. This
technique of pricing is known as Multiple Pricing. The Multiple Pricing must offer small saving
to the consumer.
Peak-Load Pricing: Pricing done on the basis of the peak period demand and off peak period
demand is called Peak-Load Pricing. Higher prices are charged in the peak period and lower
prices are charged in the off-peak period.

CONCLUSION

It is observed that various pricing methods and pricing approaches prevail in domestic and export
market. However, the choice of pricing method eventually depends on the objectives of the firm.
In the course of this project, I came across many strategies and techniques of pricing that are
based on firms different types of objectives. Yet a common element of covering costs such as
variable and fixed cost was seen in every strategy and technique.

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Study of Costing helps enterprises realize the actual value of their product, what they actually
incur and how much should they take back from customers in order to achieve its objectives
effectively and efficiently.

BIBLIOGRAPHY
SEARCH ENGINES:

www.wikipedia.com
www.google.com
www.seanet.com
www.strategicmanagementsight.com
www.srceendigest.com
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www.studymode.com

BOOKS/EBOOKS:

Joel Dean: Managerial Economics


Pappas and Hirschey: Fundamentals of Managerial Economics
Peterson and Lewis: Managerial Economics
Darrell Oyer: Cost-Based Pricing: A Guide for Government Contractors
Robert C. Brenner: Pricing Tactics

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