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Unit 10
Unit 10
Structure: 10.1 Introduction Learning Objectives 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 10.9 Terminal Questions 10.10 Answers 10.11 Mini-case
Pricing
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. Retailers like Big Bazaar, Fair Price and Subhiksha target price conscious consumers. Manufacturers and service providers all over the world outsourced some of their functions to the developing countries to get cost advantage which help them in reducing their final price. Internet has become an alternative tool for shopping to the consumers. It offers a wide range of products at lesser price. Learning Objectives After studying this unit, you will be able to Find out the factors that influence the pricing strategies. Understand various approaches to pricing Analyze the pricing strategies adopted by marketers Know the situations when marketer should initiate the price cuts.
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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 determination. If the organization is able to integrate their supply chain well, then it will be having a distribution advantage over others. For example, Nokia when it introduced 1100 handset in Indian market priced it 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 Rs 3800. 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 exist. 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 types of markets, companies set their prices according to the competition. For example, in a stock market, prices of shares are frequently affected due to the large number of buyers and sellers. b. Monopolistic competition: The nature of the market where many buyers and sellers exist but no particular buyer or seller has total control over the market. The difference between perfect competition and monopolistic competition is that in case of the latter, prices for the products vary according to product differentiation, whereas in case of the former, there is a single price. In case of monopolistic competition, prices are fixed by the gap in the product line of all competitors and on the level of differentiation. For example, food suppliers, footwear manufacturers and various service providers exist in monopolistic competitive market. c. Oligopolistic competition: The market consists of few suppliers who dominate a large portion of the market. They do not allow new players to enter the market. They are price sensitive to each other and so are
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dependent on each other For example, automobile manufacturers, pharmaceutical companies do business in oligopolistic market. d. Monopoly: In a monopolistic market there is only one seller due to regulatory, technical or economic entry barriers. Indian Railways has monopoly over the railway industry in India. It is able to sell its products and services at the determined rates. Prices are economical in the monopoly markets that are usually controlled by the government. Demands for the product vary according to the price set. The general customer belief is that higher the prices better the quality of the product and lower the price, lower the quality. Marketer should understand this perception because this perception will determine the demand for the product. For example, a customer thinks of Mercedes as a high quality product and Chik shampoo which costs less than other shampoos as low quality. After analyzing the perception about the price, marketer has to find out the price elasticity of demand. The price elasticity of demand is defined as a percentage change in the quantity demanded to a percentage change in the price. Assuming that the price of a 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 then company expects 900 units to be sold in the particular month. Then 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 lower the price elasticity of demand, easier it is for the marketer to change the price. Marketers who are interested in sales and when products have inelasticity of demand, then they will go for lowering the prices of the products. 5. Competition: Price is also determined by how intense the competition is in the particular 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 a no frill airline
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made other airliners like Go Air, Spice Jet and Paramount to reduce their prices. 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 the company cannot control. Activity 1: Highlight the factors that affect the prices of the local shoe shop that you go to. Find out, how often discounts are offered and when they offer? Are there any competitors to this shoe shop?
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Solution: Unit cost = = = = = = VC+ (FC/ unit sales) 5+ (200,000/75000) 7.67 Unit cost/ (1- desired return on sale) 7.67/ (1-0.3) 10.85
Price
Approx Rs 11/unit. 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 becomes standard. 3. It is fair 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 leads 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 at 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.
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Assume: Fixed cost: Rs 1,000,000 Price: Rs 20 Variable cost: Rs 12 BEV = 1,000,000/ (20-12) = 125,000.
Unit Expected Total Total cost iv( assumed demand unit revenue iii = fixed cost Rs 10 Lakh Price needed to demand at Price* and constant variable break even given price cost Rs 12) (iv) (ii) (i) (ii) Rs 16 Rs 18 Rs 20 Rs 22 Rs 24 250,000 166,667 125,000 100,000 83,333 340,000 180,000 140,000 90,000 60,000 4,800,000 3,240,000 2,800,000 1,980,000 1,440,000 5,080,000 3,160,000 2,680,000 2,080,000 1,720,000
Product
Cost
Price
Value
Customers
Customers
Value
Price
Cost
Product
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Cost based pricing starts with the development of product and prices are fixed later. In case of value based pricing customers are given utmost importance. In value based pricing method, the product is developed only after the price and cost estimation. For example 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. Then the company sets the price on the basis of customer values. 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 sales promotions to lower the prices on temporary basis. For example, Products such as deodorants, body sprays and other cosmetics are priced high but from time to time there are offers like buy one get one free on such products. 2. Competition Based pricing: In this method a seller uses prices of competing products as a benchmark instead of considering own costs or the customer demand. Some techniques of competition based pricing are as follows a) Destroyer Pricing This strategy is used as an attempt to eliminate competition. It involves lowering the prices of the companys products to an extent where competition cannot compete and consequently they go out of 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 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.
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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 Activity 2: Select any local supplier who is dealing with a specific type of product and find out his pricing strategies under situations: a) when competition is more; b) when there is no competition; c) when demand is more than supply; d) when there is no demand Self Assessment Questions 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 revenue c. Total cost equals variable cost d. All the above 3. ______________ market consists of few number of sellers a. Perfect market b. Monopolistic c. Oligopolistic d. Monopoly 4. Unit cost equals to a. Variable cost+ ( fixed cost/unit sales) b. Fixed cost + ( variable cost/ unit sales) c. (Variable cost+ fixed cost)/unit sales d. All the above 5. Every day low pricing is a. Value based pricing b. Competition based pricing c. Cost based pricing d. All the above.
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In the above example of Nokia mobile phones Nokia 1110 is priced @ Rs 1349, Nokia 7610 priced @ 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. 2. Optional Product pricing: this strategy is used to set the price of optional or accessory products along with a main product.
Figure 10.2
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
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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 accessory 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: It 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 is adopting by-product pricing. 5. Product bundle pricing: It is offering companies several products together as a bundle 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.
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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 a 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. 2. 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. 3. 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 something about the product. For example, V. K. export sets Rs 299 and Rs 399 for their leather product which in turn creates the impression that the price is in the range of 200 rather than 300. Similar pricing strategy is observed in Jeans and shoes. Promotional pricing: Organizations set the price of their product below the list price and sometimes even below cost. The objective of such pricing is to achieve immediate sales, increase the customer footfall, avoid the competition and introduce the product. Big Bazaar annual clearance sale etc is an example of this type of pricing. 4. Geographical pricing: setting the price on the basis of geographies they are selling and freight charges. In this strategy, different options
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exist for the company. They are a. Freight charges to be paid by the customer (FOB or Free on Board pricing) For example, when delivering a equipment from another country or state, company will charge according to FOB price b. Different zones have different prices, i.e. company may charge different prices in south and north zone. (Zone pricing). For example, MTR sells its products at different prices in different states. c. Same price plus freight charges for all the customers (Uniform delivered pricing). For example, when you place an order for Books, its prices are fixed and also the freight charges. 5. International pricing: Organizations should consider the different external factors and customer profiles in different countries before arriving at a pricing strategy. 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. Apart from the above price adjustment strategies, companies also adopt promotional pricing where prices of the products are lowered to a major extent so as to attract sales. These price offers are given during offseasons, to clear old stocks, to balance over-production of goods or whenever the market conditions demand for such strategy. For example, Shoes, Dress materials, crockery items are sometimes sold at direct sale or at factory rate. Even offers such as Buy one, get one free are regarded as promotional pricing where at the price of one, consumer gets one more item.
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Buyer reactions to price changes a. Reduced price means reduced quality 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 manufacturers sometimes initiate the price changes. In such case the 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 6. ____________ Strategy is used to set a price for a product that must be used along with a main product. 7. 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 8. Razor and cartridge example indicates a. Bundle pricing b. By product pricing c. Captive pricing d. Options pricing
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9. FOB pricing is an example of a. Promotion pricing b. International pricing c. Discounts and allowances d. None of these 10. ___________ is given when the customer makes early payment before the due date.
10.8 Summary
There are four major objectives on which prices are determined. They are survival, current profit maximization 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). The price elasticity of demand is defined as percentage change in quantity demanded to the percentage change in the price. Optional Product pricing strategy is used to set the price of optional or accessory products along with a main product. By product pricing is determining the price for by products in order to make the main products price more attractive Product bundle pricing is offering companies several products together at the reduced price.
List of Key terms Monopoly Perfect competition Oligopolistic competition Break-even pricing Pricing strategies Total cost
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10.10 Answers
Answers to Self Assessment Questions: 1. Market position. 2. Total cost equals total revenue. 3. Oligopolistic 4. Variable cost+ ( fixed cost/unit sales) 5. Value based pricing 6. Optional product pricing 7. Bundle pricing 8. Captive pricing 9. None of these 10. Cash discount Answer to Terminal Questions: 1. 2. 3. 4. 5. Refer 10.2 Refer 10.3 Refer 10.4 Refer 10.6 Refer 10.5
10.11 Mini-Case:
Price Plus No exchange, No bond or post-dated cheque. Simple redemption. Bonus profit, announced the tag-line of a full-page ad in one of the capitals leading English language dailies. No, the ad is not there to sell fixed deposit coupons for some non-banking financial company or even the much maligned teak bonds for some obscure plantation company. Instead it spells out in vivid details; now hold your breath, on how good money can be made almost six years down the line by buying an Akai color television today! Flip a few pages, and there is yet another one of them, this time from Videocon, which announces it as the Greatest Money Back Offer. The
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superlative here, it seems, is only an age-old advertisers tendency to exaggerate. But get the subtle drift. It is no longer your television against mine. Or even your technology against mine. Or even your brand against mine. But my financial offer against everyone elses! For that is what marketing, or whatever we understood of it, in the consumer durable market has been reduced to. Simply, and some would add sadly, an act of financial drudgery, re-engineering if you like. Well, we should see it coming. First, it was the bundling. Dont just sell a television set alone-throw in the CD video and audio player, high-wattage speakers and call it a home theater or something of the sort. Never mind, if the consumer is completely flummoxed (or stumped) on the individual value of the respective elements. Then came, bundling by any other name, brand associations. So you had a hotchpotch of refrigerators, washing machines and television brands peddled as the home-maker of sort. Akai initiated exchange mania your old television for new-almost became marketing currency with durable marketers across the board. But, what takes the cake, is the latest money back salvo from Akai and Videocon? Amidst all these innovative approaches, whatever happened to good old classical marketing and branding? To justify the blatant disregard for accepted consumer marketing, these durable marketers are terming it as redefinition in consumer value. In fact, their version of it is essentially a function of just price. They have thrown all concepts of branding to the wind, adds Suhel Seth, CEO, Equus Advertising. Simply put, consumer value cannot be on mere price corollary; it has other elements to it. You need to look at this phenomenon from the categorys lifecycle-I have seen it happening with all sorts of categories, tyres for instance, opines Vinayaka Chatterjee, Chairman, Feedback Ventures Private Ltd. Ultimately, two things will happen. One, some people may not find it worthwhile to operate in such a market, and then some degree of shake-out may happen. Plus, demand perk up in the future will somewhat restore demand supply imbalance. And then back to old classical marketing games.
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However, there is another school of thought which is more charitable. Marketing looks at making sure to create consumers in the short, medium and in the long run. Akai is doing fine on the short and the medium levels. I think it will be a player in the long run as well, adds Shumu Sen of Quadra Consultants. Even others agree on the fact that such innovative offers have managed to attract a very basic need oriented consumer. But what beyond that? In the long run, brands have to be built, adds Seth. The moot question, however, remains whether or not brands such as Akai are able to sustain themselves on any offer? Such offers may bring relevance (price-related) and even salience (schemes advertising related) to the brand. But, what about consumer empathy and esteem, thats so very essential for the survival of the brand in the long run? That can be only built working around the entire spectrum of the marketing rainbow, and not just on price, adds Rajeev Karwal, Vice-President, Marketing and Sales, LG India Electronics Pvt. Ltd. My hypothesis is that you can turn a brand into a commodity and sell it on price sensitivity, the way Akai is doing. But over the time the game perforce has come back to the brand, adds Gautam Bhattacharya, professor of marketing at a New Delhi-based management institute. Marketing is about creating consumer empathy with the brand. When the consumer feels that this is my brand, adds Karwal, where is that quintessential quality of marketing in todays consumer durable market? Or are we to live forever with age-old adage, Theres no brand loyalty which two cents off cant overtake. In the era of price-war the questionable issue is whether marketers formulate their strategies on price or value for money and secondly whether consumers end up paying more than they bargained for. Analyze this issue in the current scenario of price wars.
(Source: Price Plus case study; Cases and Simulations in Marketing Management edited by Prof. M.K. Rampal and Dr. S.L. Gupta)