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Objectives of the Session 1. To understand the price setting process 2.To examine cost oriented, competition oriented and customer oriented pricing methods
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The Price-setting Decision Process Set strategic pricing objective Influences and constraints Estimate demand •SBU and marketing strategies and price elasticity demand •Target market characteristics Determine costs and their •Product characteristics relationships to volume •Competitor characteristics Examine competitors’ prices •Company strengths and and cost weaknesses •Environmental influences Select a method for Economic trends calculating price Legal restrictions Set a price level Adapt price structure to meet variations in demand and cost across geographic territories, market segments, etc.
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Strategic Pricing Objectives 1. Maximise sales growth – penetration pricing 2. Maintain differentiation 3. Maximise current profit – skimming 4. Subsidising pricing
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1- Maximise sales growth & Penetration • When a firm is an early entrant into a new product-market with the potential for substantial growth, its objective may be to maximise its product’s rate of sales growth (in units). • This suggests it should set a relatively low price to attract as many new customers as quickly as possible and to capture a large share of the total market before it becomes crowded with competitors. This low-priced strategy is called penetration pricing.
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Penetration Pricing Penetration pricing is appropriate when, in addition to a large market: 1. Target customers are relatively sensitive to price. 2. The firm’s costs are low compared to competitors’ and the SBU is pursuing a low-cost strategy. 3. Production and distribution costs per unit are likely to fall substantially with increasing volume. 4. Low prices may discourage potential competitors from entering the market.
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2- Maintain Quality or Service Differentiation • When a firm has a strong competitive position based on superior product quality or customer service, its primary pricing objective is to generate sufficient revenue to maintain that advantage. • Such a firm usually asks a premium price for its product for two reasons: • First, it needs additional revenue to cover the R&D, production, distribution, and advertising costs it takes to maintain both the reality and the perception of superior quality or service.
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2- Maintain Quality or Service Differentiation • Second, customers are usually willing to pay more for a superior offering; high quality decreases the elasticity of demand. • A premium price policy is most appropriate for businesses pursuing differentiated defender strategies
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3- Maximize Current Profit • When firms pioneer the development of a new product-market, sometimes their pricing objective is to maximise short-run profits. They adopt a skimming price policy, setting the price very high and appealing to only the least price- sensitive segment of potential customers. • Skimming is most relevant to a small market & appropriate for businesses pursuing prospector strategies involving investments in the development and commercialisation of a stream of new products with proprietary technology.
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3- Maximize Current Profit • At the other end of the life cycle, some product-markets decline rapidly as customer preferences change or new technologies and substitute products are introduced. • Firms facing this situation adopt a harvesting strategy to maximise short-term profits before demand for the product disappears. This typically involves cutting marketing, production, and operating costs of the product, while setting a high price to maintain margins and maximise profits. • This is an appropriate strategy only where there is no way – such as by making product improvements or increasing promotion – to sustain market demand or the item’s competitive position very far into the future.
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3- Maximize Current Profit • Businesses with an established product in a market expected to grow or experience stable demand well into the future run into trouble because of strategic mistakes, such as failing to adapt to customers’ changing desires or to competitive threats, or building excess capacity. • If such mistakes are correctable, the firm may adopt a pricing objective of Survival, i.e. simply keeping the product alive while strategic adjustments are made.
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4- Social Objectives • Some organisations may forgo possible profits – at least among some price- sensitive customer segments – by offering a low price to those customers to achieve some broader social purpose. • This is most common among not-for-profit organisations such as performing arts organisations and public hospitals, especially if subsidised by government agencies, foundations, or private contributions and not relying on sales as their sole source of revenue.
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Estimating Demand and Perceived Value • Demand sets the ceiling on the range of feasible prices for a product. The familiar demand curve depicts this variation in the quantity demanded at different prices. In most cases there is an inverse relation between a product’s price and the quantity demanded: the higher the price, the less people want to buy. Thus, the typical demand curve has a negative, or downward, slope. • However, luxurious products and those whose quality is difficult to objectively judge sometimes have positively sloping demand curves. Some customers use price as an indicator of the prestige or quality of such products, and they are induced to buy more as the price increases.
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Factors Affecting Customer Sensitivity to Price • Unique value effect • Price-quality effect • Degree of necessity • Buyers’ relative knowledge of the market • Buyers ability to pay • Importance of time
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Price Elasticity Graph to illustrate the price elasticity of demand in a market P0 Relatively price-inelastic demand curve Price P1 0 Q0 Q1 Q demanded
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Price Elasticity of Demand Price elasticity of demand (E) = Per cent change in quantity demanded Per cent change in price
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Estimating Costs • Fixed Costs (or overhead) - constant in the short-term, regardless of production volume or sales revenue • Variable Costs – vary directly in line with the level of production • Total Costs = FC + VC
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Cost-oriented Pricing – Approach 1 Cost Plus Pricing • Popular pricing method • Add a mark-up to the cost of the product – cost plus or mark up • Unit cost = VC + FC/expected unit sales • Doesn’t consider price sensitivity of demand or pricing practices of competitors
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