The University of the West Indies

St. Augustine

Faculty of Engineering

Department of Chemical Engineering

MENG 3000:- Engineering Management 1

Student name:- Steve Duncan

Student ID:- 809000757

Marketing Essay Topic:- Question 4- Pricing new products

Date submitted:- 11-18-11

Lecturer: - Professor Kit Fai Pun

Q4. Many companies decide on a selling price for their
products by adding a percentage to their costs. Comment on
this approach to pricing, indicating the other factors which
should be taken into account when deciding on the pr, ice of a
new product.

In todays society, there are many factors which have the potential to affect the profitability of
the average business owner. One crucial factor towards achieving a substantial profit lies within
setting the right price for the given product. Before implementing a pricing strategy to determine
the cost of the product, two key elements must be considered. These factors include the cost of
goods, which is the amount paid for the product plus shipping or handling expenses and the
operating expense, which may include overhead, payroll, marketing and office supplies. There
are many pricing strategies available, but the method of cost-plus pricing is by far one of the
most popular choices due to its simplicity and efficiency. Regardless of the pricing strategy used,
the retail price of the products should more than cover the cost of obtaining the goods plus the
expenses related to operating the business. Table 1.0 below illustrates the primary considerations
in price settings.

Figure 1: Primary considerations in price settings.

Four of the most widely used pricing strategies are competitive pricing, value based pricing,
customer based pricing and cost-plus pricing. Competitive pricing allows the consumers to have
many choices and they are generally willing to shop around to receive the best price. Retailers
considering a competitive pricing strategy will need to provide outstanding customer service to
stand above the competition. Another pricing strategy which is commonly used is known as
value based pricing. This pricing strategy puts the consumers perspective before that of the
seller when formulating the price of a product. The objective of this approach is to incorporate

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the price of the product with the value being conveyed therefore allotting different competitive
offers. Customer based pricing is the method whereby prices are determined by what a firm
believes customers will be prepared to pay.

The method of cost-plus pricing is illustrated in figure 2.0 below, and involves setting a product
price by adding a percentage or standard mark up to the cost of the product. This method is
popular since it may be implemented quickly and also ensures that sales revenue will cover costs
and generate profits. Also, an advantage of this method is that it insures the seller against
unpredictable or unexpected later costs, while stabilizing the market by minimizing price
competition. This stabilization would be achieved since competing businesses that also use the
cost-plus pricing method, will have products of similar prices. One disadvantage however, is that
this method does not take market needs into account when setting prices. Also, this method tends
to ignore the roles of the consumer and competition, thus leading to no incentive for an increase
in efficiency. Another disadvantage of this method is that the concept of price elasticity of
demand is completely ignored hence businesses can charge a higher or lower price to maximize
profits depending on the customers response to a price change. Also, if costs increase, the selling
price of the product will increase, and it may lead to uncompetitive prices relative to the
competitor.

Customer
Product Cost Price Value
s
Figure 2: The figure above illustrates a flow chart of the Cost-Based Pricing Approach.

There are many factors, both internal and external, which should be taken into account when
deciding the price of a new product. One major internal factor that must be considered is the cost

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of the product. The company must charge a price which earns enough revenue to cover the total
cost of production, promoting or marketing and distributing the product but at the same time
provide a fair rate of return to the company and its shareholders. It is important to note, that the
given company may not be able to cover the fixed costs in the initial stages of the company, but
once enough revenue is earned to cover the variable costs, the business will remain successful.
Also, the lower the cost of a product, the lower it may be priced, thus resulting in greater sales
and profits. Generally, as production volume increases, the total cost to manufacture a product
decreases.

Another important internal factor is the marketing objectives of the company, which is when the
company must decide on a startegy for a product, and who it must be sold to before setting a
price. Pricing stratergy would be determined primarily by decisions on market positioning since
the marketing mix stratergy will be straightforward once the target market and positioning are
carefully selected. Survival of the company is also facilitated in that when a low price is set for
their products, fixed and variable costs are covered, thus leading to the success of the buisness.
Marketing mix strategy is also a key factor, in that the price decisions of a company must be
coordinated with product design, distribution and promotional decisions in order to form a
consistent and effective marketing programs. Due to this fact,it is vital that marketers consider
the total marketing mix when setting prices. Price decisions must be coordinated with product
design, distribution and promotion. Also, prices have to be set whist taking into account the cost
to any distributors of the product to be sold.

Organizational considerations are also taken into account, in that management must decide who
within the organization should set price. It is a common practie that the top management would
set prices on products rather than the marketing or sales departments in small companies.
Whereas, in large companies pricing is typically handled by divisional or product line managers.
In this case, the top management selects the proposals for the pricing arrangements offered by
the lower management and also sets the pricing objectives and policies and approves the prices
proposed by lower level management. Companies often have a pricing department in industries
where pricing is a key factor to set the best prices or to help others in setting them.

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On consideration of the external factors which may affect the pricing of a product, the nature of
the market and demand for the product must be analysed. It is important that the marketer
understands the relationship between the price and demand for the given products, before setting
prices. Market and demands set the upper limits of the prices of the product, whereas the cost
sets the lower limit. Another external factor is the competitors prices, which affects decisions to
a great extent. If the market for a given product becomes saturated, the price of the product is
largely dependent on the price offered on similar products. This may cause limited
maneuverability for the company compared to one that faces less competition. It is important that
in setting its prices, the company must also consider competitors costs and prices and possible
competitor reactions to the companys own pricing moves.

Finally, other legal constraints and economical factors play an important role in the pricing
process. Taxation affects the price of many products, and as a result, the prices rise above the
price set by the company. This is especially prominent in the tobacco and alcohol
industries.Subsidization may also occur in cases of food production and public utilities, whereby
the price is lowered below the price set by the government, and the government pays the
difference. Economical factors such as recession and inflation also may have a strong impact on
pricing strategies since they affect the cost of production and the willingness of the consumer to
purchase the item based on the products price and value. In setting prices, a companys short-
term sales, profit goals and market share may have to be adapted with careful consideration.

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 References

1. Lanigan. M, Engineers in Business-The Principles of Management and Product

Design, Addison-Wesley Longman, United Kingdom 1996, pg 394 410

2. Kotler Philip, and Kevin Lane Keller, Marketing Management, Pearson Prentice Hall,
New Jersey, 2006, 431-461.

3. Kotler Philip, and Gary Armstrong, Principles of Marketing, Pearson Prentice Hall, New
Jersey, 2006, 304-333.

4. Pricing strategy, available at http://www.netmba.com/marketing/pricing/

(Accessed on October 4th 2011)

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