PRICING DECISIONS AND STRATEGIES

By B.W.MAINA

MARKETING DEFINITION
A total system of interacting business forces designed to plan price promote, and distribute want-satisfying products and services to present and potential customers.

SYSTEM CONCEPT
A system is an assemblage of things which are interconnected so as to form a complete whole or unity. All parts of a system must be properly integrated. All parts of a system must work together in harmony to produce synergy. As a system marketing should be seen as an integrated process rather than a fragmented assortment of institutions and functions.

MARKETING MIX
The four elements of marketing mix are: Product, Place (Distribution System), Price and Promotion. Price is only one of elements of the mix but one that is critically important. Ingredients of marketing mix must be properly integrated to produce optimum results or synergy. Marketing entails getting the right goods and services to the right people at the right time at the right price and with the right communications and promotion

PRICING DECISIONS
In making pricing decisions management must: Determine the base price, and Determine the specific price to be charged after making various price adjustments: discounts and allowances.

PRICE - MEANING
The money value attached to an item good or service. The amount of money, plus possibly some goods, needed to acquire in exchange, some combined assortment of a product and its combined services.

TYPES OF PRICES
Price goes by many names, such as: Rent House Rate Local Government Services Wage - worker Tuition Education Fee Medical or Accounting Services Fare Bus or Airline Premium Insurance Policy Honorarium Guest Lecturer Commission Salesperson Salary Manager Tip waitress Interest Loan Fine - Transgression

PRICE IMPORTANCE IN THE ECONOMY

Price keeps the market economy operating by regulating the entire economic system and influencing the allocation of resources to determine: The amount and type of products that will be produced; How the products will be produced; and How the products will be distributed.

PRICE IMPORTANCE IN THE FIRM

Affects demand for companys products. Produces revenue for the firm while other elements of mix represent costs. Affects the firms competitive position and market share. Affects choice of the firms marketing programme i.e. combination of the 4Ps. Used as indicator of products quality. Affluence of customers may influence importance of price to consumers - sensitivity

SETTING THE PRICE

The following factors may be considered when setting the price: Select the price objective. Determine demand. Analyse competitors prices

SELECT PRICE OBJECTIVE

Survival - When times are bad, overcapacity or intense competition exists, consumer tastes and wants are changing. Current profit maximisation The basic economic objective of a business firm. Target return on investment Cost plus mark-up for profit method is used. Price stabilisation Common in oligopolistic markets to avoid price wars and collusion. Maintain or improve market share low price Meet or prevent competition low price. Product-Quality leadership High price charged

DETERMINE DEMAND
Demand refers to the quantity of a commodity that an individual is willing and able to buy at a specific price over a given period. Price and quantity demanded are normally inversely related the higher the price the lower the quantity demanded. N.B. Other factors that may influence demand are held constant e.g. consumers incomes, prices of related goods, tastes and preferences.

CONTRAVENTION OF LAW OF DEMAND

Giffen Good an inferior good for which the quantity demanded increases as the price rises and falls as the price falls. Veblen Good Prestige or luxury goods that acquire snob value only at higher price giving consumers exclusiveness or distictiveness. Price-Quality Association in some cases the higher the price the better the quality is perceived to be and the greater the demand.

PRICE ELASTICITY OF DEMAND

Shows how sensitive consumers are to price changes. Consumers may very sensitive to price changes (demand is elastic), or

They may be insensitive to price changes (demand is inelastic)

PRICE ELASTICITY OF DEMAND FACTORS TO CONSIDER

Demand will tend to be elastic if: Many substitutes for the product exist Many competitors exist Product is a luxury Price of product is high relative to consumers income so that a high proportion of income is spent on the product Buyers think the high price is justified Buyers are quick to change their buying habits The product has a wide range of uses.

INELASTIC DEMAND FACTORS TO CONSIDER

Demand will tend to be inelastic if: Product does not have good substitutes There are few competitors Product is a necessity Price of product is low relative to consumers income so that consumers spend a low proportion of their income on the product The product has few uses Consumers buy the product as a form of habit Buyers think the high price is justified e.g. due to inflation Buyers are slow to change their buying habits

IMPORTANCE OF ELASTICITY

When demand is elastic: Raising price reduces total revenue Lowering price increases total revenue. When demand is inelastic: Raising price increases total revenue Lowering price reduces total revenue. Price changes should be done with due consideration of implications of elasticity.

EXPECTED PRICE
Expected price is the price at which customers consciously or unconsciously value the product i.e. what they think the product is worth and what they therefore expect to pay. To determine expected price for a new product: Submit the article to experienced wholesaler for appraisal Survey potential customers and ask them what they would be willing to pay for the product Survey of Buyer Intentions Test-market the product.

ANALYSE COMPETITORS PRICES

The company needs to know the price and quality of competitors products. This may be done by Getting competitors price lists Asking buyers how they perceive prices and quality of each competitors offer. The firm relates its price to that of the competitor considering the products quality and how differentiated it is.

COMPETITORS PRICES (Cont)

Note that competitors could change their prices in response to the firms price. Where no direct competition exists, consider potential competition. Competition could eventually come from New entrants into the market, or Imports where trade is liberalised Always anticipate competitive reaction

PRICING STRATEGIES TO REACH MARKET SEGMENTS

Two basic pricing strategies (or Pioneer Pricing) to reach a market segment are: Skim-the cream Pricing (or Market Skimming) Strategy, and

Penetration Pricing Strategy

SKIM-THE-CREAM PRICING
Involves setting a price that is high in the range of expected prices. You aim at the cream of the market rather than the mass market. Its effective for new high quality products which might give the consumer distinctiveness and exclusiveness. The products may be aggressively promotedd.

REASONS FOR USING MARKET SKIMMING STRATEGY

Demand is likely to be inelastic due to lack of competition and good substitutes. Entry could be restricted e.g. through patents and/or franchises. The high-income market segment is large enough to allow profitable operations. Acts as a hedge against a possible mistake in setting the price as its easier to lower a price than to raise it due to consumers rsistance. Funds generated can be used for market expansion or to support other products.

PENETRATION PRICING
Entails setting a low initial price in order to reach the mass market immediately. The strategy is more aggressive than market skimming. It may be also used be used at a later stage in the Products Life Cycle to save the product from premature death or premature old age by switching from market skimming.

REASONS FOR USING PENETRATION STRATEGY

When the companys main aim is survival. When there is over-capacity and business is slack. When demand is very elastic. When large-scale production is possible so that economies of scale can be realised. When the product faces competition soon after it has been introduced to the market so that the low price keeps competitors away. When the high-income market is inadequate to sustain a skim-the-cream price.

BASIC METHODS OF SETTING PRICE

Two basic methods may be used to set prices: Prices based on costs (Cost-based pricing). Full costing (Full Cost-plus approach) Marginal costing (Contribution method) Break-even method Prices based on the market (Market-based or Going rate pricing) Pricing to meet competition Pricing above competitive level Pricing below competitive level

FULL COSTING
A price is set to: Recover all costs, and Earn a profit that provides a satisfactory return on investment. Total cost = Fixed Costs(FC) + Variable Cost(VC) Fixed Costs = Those that do not vary with changes in the quantity of output e.g. rent, rates, interest, insurance, salaries. Variable Costs = Vary directly with changes in output e.g. raw materials, power, direct wages.

FULL COSTING (Cont)

Variable costs can be identified with a product and can therefore be determined directly. Fixed costs cannot be identified directly with a product and must be apportioned or allocated to a product on a fair basis. Total cost of a product includes variable cost plus a fair share of fixed costs appropriately apportioned.

FULL COST-PLUS APPROACH PROBLEMS

Depending on the apportionment method used, the price can be low, medium, or high, making the product look very profitable, marginally profitable or distinctly unprofitable. The method pays no attention to market demand and ignores competition, which can be dangerous. A company that charges more than the cost of efficient production and marketing is likely to lose business to more efficient and realistic competitors. With a high price a company can price itself out of existence.

FULL COST-PLUS APPROACH BENEFITS

If it works the company recovers the total cost of production and earns a specified profit. The method is simple to understand. The method is popular with monopolistic firms and regulatory agencies who set prices e.g. price control by Government.

MARGINAL COSTING PRICING (CONTRIBUTION APPROACH)

This consists of setting a price that at least covers the variable costs of production. Any excess over variable cost is considered as a contribution to fixed costs (overheads) and profits. Contribution per unit = Price per unit Variable costs per unit.

MARGINAL COST PRICING WHEN TO USE

When times are bad, business slack and the company wants to keep its labour force employed to avoid costly shut-downs and startups. The firm has idle capacity and facilities. The company wants to increase its market share. Company wants to introduce a product that attracts business for another e.g loss maker. Deciding whether to drop a product or add another to existing line. Dumping products in a foreign market.

BREAK-EVEN PRICING
The break-even point is that level of sales at which the companys total cost is equal to total revenue and the company makes no profit or losses Sales volume above break-even point results in profit while that below results in losses. Break-even analysis helps a company determine the minimum level of sales required to produce profit assuming a certain price. B-E point = Fixed Costs / Contribution per unit. B-E analysis tends to ignore maket demand

BREAK-EVEN ANALYSIS EXAMPLE

(1) Selling price (Shs) 60 80 (2)
Variable Cost per unit (Shs)

(3)

(4)

(5)
B-Even Point (4) / (3) (Shs)

Contributi Fixed on per unit Costs (1) (2) (Shs) (Shs)

30 30

30 50

250 250

8.3 5.0

100 150

30 30

70 120

250 250

3.6 2.1

MARKET BASED PRICING (GOING RATE PRICING)

Firms base their prices on competitors prices with less attention paid to own costs of production. The firm might charge the same, more, or less than its competitors in three options: Pricing to meet competition Pricing above competitive level Pricing below competitive level

PRICING TO MEET COMPETITION

When the market is highly competitive the firm might charge the same price as its competitors as in perfect competition. Appropriate when the product is not highly differentiated or in oligopoly.

PRICING ABOVE COMPETITIVE LEVEL

The price is set above the market level.

Appropriate when the product is unique, distinctive or highly differentiated.

PRICING BELOW COMPETITIVE LEVEL

The price is set below the market price as done by discount stores. The principle of low mark-up/high volume is used as supermarkets do. Appropriate for market penetration. N.B. Prices based on the market are regarded as the most ideal. However, production costs must be met for the firm to stay in business in the long run.

SPECIFIC PRICE POLICIES AND STRATEGIES

Various factors are taken into account in the formulation of specific price policies, such as: Price discounts and allowances Geographical pricing Promotional pricing Discriminatory pricing Captive product pricing Psychological pricing Price control by Government

PRICE DISCOUNTS AND ALLOWANCES

These comprise: Quantity discounts Trade (or Functional) discounts Cash discounts Seasonal discounts Promotional allowances Trade-in allowances

QUANTITY DISCOUNTS
These are deductions from list price to encourage a customer to buy in larger volumes or concentrate his purchases with the seller (patronage discount). May be offered on a one-off basis or cumulative basis where quantities are aggregated over a stated period of time. Large orders result in economies of scale, low production costs and low prices.

TRADE OR FUNCTIONAL DISCOUNT

Offered to trade-channel members for services rendered on behalf of the producer. The services might include storage, advertising, displaying goods at the point of sale, and transporting.

CASH DISCOUNTS
Given to customers who pay their bills within a specified time period. Example: 2/10, Net 30 means that payment is due within 30 days but the buyer can deduct 2% from the price if he pays the bill within 10 days. Cash discounts improve the companys liquidity or cash flow and minimise collection costs and bad debts.

SEASONAL DISCOUNTS
Given to buyers who buy merchadise or services out of season e.g. hotels and airlines offer discounts during the slack or low seasons. Seasonal discounts allow the seller to maintain steadier production during the year and increase profits. Contribution pricing may be used.

ALLOWANCES
Promotional Allowance Given to buyers in payment for promotional services performed. Trade-in Allowance Given to customers who turning an item when buying a new one e.g. in the car industry.

GEOGRAPHICAL PRICING
This involves consideration of shipping costs in respect of customers located in different parts of the country. Generally, the seller or buyer could pay the freight or share the expense

FOB ORIGIN PRICING

The buyer pays shipping cost from the carrier to the destination, while The seller pays the cost of loading the shipment aboard the carrier. This policy raises the final price of the product depending on distance and this disadvantages distant customers. The policy might encourage rivals to set up competing businesses near customers.

OTHER GEOGRAPHICAL PRICING POLICIES

Uniform Delivered Pricing The company charges the same price plus freight to all customers regardless of location postage stamp pricing. Freight Absorption Pricing The seller absolves all or part of the actual freight charges eg. in market penetration Zone Pricing The market is divided into two or more zones geographically and a uniform price is charged for each zone e.g. phone or bus services.

PROMOTIONAL PRICING
Temporary pricing of products below the list price or below full cost, such as in Loss Leader Pricing Entails pricing a few products at low prices to attract customers to the store in the hope that they will buy other things at normal prices. Special Event Pricing Pricing products at low prices to draw in customers as happens at a sale.

DISCRIMINATORY PRICING (PRICE DISCRIMINATION)

The company sells the same product or service to two or more different groups of consumers for reasons not associated with costs Examples: Hotels have high and low seasons Telephone companies have different rates for weekdays and weekends, night and day time Buses charge different fares for peak and offpeak times Electricity companies have different tariffs for domestic and industrial users of electricity. Doctors have rich and poor patients.

 The markets must be kept separate e.g. by time, age, sex, income, geographical location, or personal service - at a low cost to prevent transfer of product from market to market. Demand conditions in different markets must be different especially in terms of elasticity of demand so that different prices can be charged depending on sensitivity of consumers to prices. The product should not have good substitutes. The producer must have some monopoly power. The practice must not violate any applicable law.

NECESSARY CONDITIONS FOR EFFECTIVE PRICE DISCRIMINATION

CAPTIVE-PRODUCT PRICING
For products which must be used together the company may sell the main product at low price and make money on supplies. Examples include: razors/razor blades, mobile phones /air time, videos/video games, cameras/films, tooth brush/tooth paste, printers/cartridges.

PSYCHOLOGICAL PRICING
Odd Pricing Prices are quoted in odd rather than even numbers e.g.Shs 999 rather than Shs 1,000. Prestige Pricing Consumers believe that high prices mean high quality. N.B. Perception is very important

PRICE CONTROL BY GOVERNMENT

The government may control prices for various reasons: To stabilise prices of essential goods necessities. To control monopolies in the absence of competition. To prevent production costs from rising. To control cost-push inflation. To protect low-income families.

SHORTCOMINGS OF PRICE CONTROL

Excess demand likely to arise. Development of black markets due excess demand at the low (controlled) prices. Smuggling of the commodity to neighbouring countries willing to pay higher prices. Hoarding of the commodity and selling it to special customers. Misallocation of resources due to price distortions that make the affected product relatively less profitable than other products. Discouragement of production leading to shortages.

ONE-PRICE VS VARIABLE PRICE POLICY

One-Price Policy The company charges the same price to all similar types of customers who purchase similar quantities of the product under the same terms No bargaining or haggling is allowed.

EFFECTS OF ONE-PRICE POLICY

Builds customer confidence. Protects weak bargainers Great time saver. Allows for more orderly transactions process. Facilitates self-service retailing, mail-order selling and automatic vending. Reduces the need for many shop assistants.

VARIABLE PRICE POLICY

Here products are sold at different prices to similar buyers and bargaining is allowed Effects Offers the seller flexibility with different customers e.g. to make price concessions to woo a buyer away from a competitor. Helps the seller to build business from potential customers. Recognises the customers right to bargain.

RESALE PRICE MAINTENANCE

A practice by manufacturers to control the prices at which retailers will sell their products Manufacturer suggest list or retail prices e.g. Bata Breweries, Coca Cola. Effects Limits competition eliminates competition at retail level. Protects inefficient sellers. Penalises low-cost retailers who cannot use competitive advantage to pass on low prices to customers. Constricts profit margins for retailers experiencing high costs due to better service.

PRICE CHANGES POSSIBLE REASONS

Excess capacity exists and firm wants additional business. The firm wants to boost falling market share using price competition. Drive to dominate the market through lower prices. Inflation has led to rising production costs. The company wants to reduce excess demand e.g. may drop discounts.

PRICE CHANGES FACTORS TO CONSIDER

Price elasticity of demand. Reaction by other producers to, for instance, avoid price wars. Market structure in which the company is operating e.g. oligopoly, monopoly, perfect competition, monopolistic competition. Whether the price change is permanent or temporary. The real reason(s) for changing the price.

POSSIBLE INTERPRETATION OF A PRICE CHANGE

Price Increase The item is hot and may soon be unobtainable. The item represents good value for money. The quality has improved. The seller is greedy.

INTERPRETATION OF A PRICE DECREASE

The item is about to be replaced by a better model. The item is faulty and is not selling well. The quality has fallen. The firm is in financial trouble and may not stay in business to supply future parts. The price will come down even further and it pays to wait. The seller is giving us a real treat.

CONCLUSION
There is no one best way to price products and services and many factors must be considered as explained above. Pricing policy must be flexible i.e. not rigid. Price should be regarded as being on trial: If customers accept it , that is fine; If customers reject it, change the price as soon as possible or get out of the market.