Course Title: Pricing Theory & Practice

Course Code: MKT 415

Price:
Price is the amount of money charged for a product or service.
In another way price can be defined as the sum of all values that customer give up in order to
gain all the benefit of having or using the product.

Concepts of Price, Cost, Profit & Revenue (relations):

Price = Cost + Profit
= (Fixed cost + Variable Cost) + Profit
Profit = Price – Cost
Revenue = Price x Volume of sale
Net Profit = Total Income – Total Cost
= {(Price x Volume of sale) – (Fixed cost + Variable Cost)}

Key Notes:
 Price is the only marketing mix tools that produce revenue.
 Price is the most flexible element of marketing mix tools.
 Pricing is the number one problem faced by a marketing executive.
 According to expert, 1% rise in price caused 12.5% rise in profit for most organization
 1% fall in price caused 4% decrease in profit for most organization

Some other terms used to mean “price”:

Alternative terms What is purchased
Price Most goods
Tuition College course, education
Rent Use of place to live or se of equipment for period of time
Interest Use of money
Fee Professional service: for lawyers, doctors, consultants
Premium Insurance
Fare Transportation: air, taxi, bus
Toll Use of road, bridge or long distance phone rate
Salary Work of manager
Wages Work of hourly workers
Commission Sales effort

Factors to consider when setting price:

 Internal factors
 Pricing objective
 Product cost
  Marketing mix strategies
 Organizational considerations
 External considerations
 Competitors costs, price and offers
 Nature of market and demand
 Other environmental elements
(Economic condition, Social consideration, Government & legal regulations)
 Marketing/Pricing method used

Pricing procedure:

Step 1: Select Pricing objectives

Step 2: Determine demand

Step 3: Estimate cost

Step 4: Analyze competition

Step 5: Select Pricing method

Step 6: Select final price

Step 1: Select Pricing objectives

Pricing objectives may be:

 Survival
 Maximize current profit
 Maximize current market share (Market penetration strategy)
 Market skimming (Market skimming strategy)
 Product quality leadership
 Partial cost recovery (Non-profit organization)

Step 2: Determine demand

Price Sensitivity:
Inelastic Demand Elastic Demand
Price

Price

$15 $15

$10 $10

100 105 50 150

Quantity demanded per period Quantity demanded per period
Tasks:
1. Understand the factor that affect the price sensitivity
 Condition under which customers are less price sensitive:
a) Product is more distinguished
b) Buyers are less aware of substitute
c) Buyers cannot easily compare the quality of substitute
d) The expenditure is a lower part of buyers income
e) The expenditure is small compared to the total cost
f) Part of the cost is born by another party
g) The product is used with asset previously bought
h) The product is assumed to have more quality, prestige or exclusiveness
i) Buyer cannot store the product

2. Estimate demand
 Condition under which demand is less elastic:
a) There are few or no substitute
b) Buyer do not readily notice the higher price
c) Buyers are slow to change their buying habits and search for lower price
d) Buyers think higher price are justified

3. Understand price elasticity of demand

% Change in Quantity Demanded

Price elasticity of demand = -----------------------------------------------------------
% Change in Price

Step 3: Estimate cost

 Types of cost and level of production
a) Fixed cost
b) Variable cost
c) Total cost
 Accumulated production leads to cost reduction via experience curve
 Differentiated marketing offers create different cost level

Step 4: Analyze competition

 Firm must analyze competition with respect to
i) Costs
ii) Price
iii) Quality
iii) Possible price reactions
Step 5: Select Pricing method
 Pricing strategy should reflect the 3 Cs’ of pricing
I. Cost-based Pricing
a) Markup pricing/Cost-plus Pricing
b) Target profit pricing/Break-even Pricing

II. Customer-based Pricing

a) Good value Pricing/Perceived value Pricing
b) Value added Pricing

III. Competition-based Pricing

a) Going rate Pricing
b) Auction-type Pricing

Ceiling Price
Floor Price

Low Price Customers Competitor’s High Price

assessment of Orient
price and price
(No possible unique Cost (No possible
of substitute
Profit at this Fig: Three CsPoint
product model for price setting Demand at
price) feature this price)

Step 6: Select final price

Additional factors to consider
 Psychological pricing
 Gain and risk share pricing
 Influences of other marketing mix variables
 Company pricing policies
 Impact of price on other parties

------------------- ------------------------------ --------------------------------- ----------------------- --------------

General Pricing Approaches:

 Markup pricing/Cost-plus Pricing:

Pricing method is to add a standard markup to the product’s cost. Construction
companies submit a job bid by estimating the total project cost a standard markup for profit.
Suppose a toaster manufacturer has the following cost and sales expectations:
Variable cost per unit = $10
Fixed Cost = $300,000
Expected sales unit = 50,000
The manufacturer’s unit cost given by:
 Fixed cost $300,000
Unit cost = Variable cost + -------------------------- = 10 + -------------- = $16
Unit sale 50,000
Now assume that the manufacturer wants to earn a 20% markup on sales. The manufacturer’s
markup price is given by:
Unit Cost $16
Markup price = ------------------------------------------ = -------------- = $20
(1 – Desired returns on sales) (1 – 0.2)

 Target Profit Pricing and Break-even Analysis:

In target profit pricing, the firm determines the pricing that would its target rate of return on
investment (ROI).
Suppose the toaster manufacturer has invested $1 million in the business and wants to
set a price to earn a 20% ROI.
Desired return x Invested Capital 0.2 x $1,000,000
Target return price = Unit cost + --------------------------------------------- = $16 + ----------------------- =
$20
Unit sale 50,000
But what if sales don’t reach 50000 units? The manufacturer can prepare a break-even chart to learn
what would happen at other sales levels.
Dollars (In thousands)

Total Revenue
1200

1000
} Target Profit
Total Cost

800 Break-even Point

600
Fixed Cost
400

200

0 10 20
Fig: Break-even
30 40
Analysis
50 60
 Perceived Value Pricing: Sales volume in units (In Thousands)
Perceived value is made up of several elements such as the buyer’s image of the product
performance, the channel deliverables, the warranty quality, customer support, and softer attributes
such as the supplier’s reputation, trustworthiness and esteem. Companies must deliver the value
promised by their value proposition, and customer must perceive this value. Firms use the other
marketing mix elements, such as advertising and sales force, to communicate and enhance perceived
value in buyers’ mind.
Why caterpillar’s tractors price is $100000 while the others are $90000? Answer is-
$90000 is the price equivalent to competitor
$7000 is the price for superior delivery
$6000 is the price for superior reliability
$5000 is the price for superior service
$2000 is the price for longer warranty
$110000 is the normal price to cover Caterpillar’s superior tractors
 $10000 discounts
--------------------------
$100000 Final price

 Going Rate Pricing:

In going rate pricing, the firm bases its price largely in competitors’ price, charging the same,
more, or less than major competitor(s). In oligopolistic industries that sell a commodity such as steel,
paper, or fertilizer, all firms normally charge the same price.

 Auction-type Pricing:
One of the major purposes of auctions is to dispose of excess inventories or used goods.
Companies need to be aware of the three major types of auctions and their separate pricing procedure.
[Link] Auctions (Ascending bids): One seller and many buyers. A highest
bidder gets the item. English auctions are used today for selling antiques,
cattle, real estate, and used equipment and vehicles.

[Link] Auctions (Descending bids): One seller and many buyers or one buyer
and many sellers. In the first kind, an auctioneer announces a high price for a
product and then slowly decreases the price until a bidder accepts the price. In
the other the buyer announces something he or she wants to buy, and
potential sellers compete to get the sale by offering the lowest price.

[Link]-bid Auctions: sealed-bid auctions would be suppliers can submit only

one bid and cannot know the other bids. A supplier will not bid below its cost
but cannot bid too high for fear of losing the job. The net effect of these two
pulls can be described en terms of the bid’s expected profit.

Geographical pricing:
a) Barter
b) Compensation deal
c) Buyback arrangement
d) Offset

Price discounts and allowance:

a) Cash discounts
b) Quantity discounts
c) Trade in allowance
d) Functional discounts
e) Seasonal discounts
f) Promotional allowance
Promotional pricing tactics:
a) Loss-leader pricing
b) Social-event pricing
c) Cash rebates
d) Low interest financing
e) Longer payment term
f) Warranties and service contracts
g) Psychological discounts

Discriminatory pricing tactics:

a) Customer segment pricing
b) Product form pricing
c) Image pricing
d) Channel pricing
e) Location pricing
f) Time pricing

 Price discrimination works when-

a) Market segment shows different intensities of demand.
b) Consumer in lower price segments cannot resell to higher-price segment.
c) Competitors cannot undersell the firm in higher price segments.
d) Cost of segmenting and policing the market does not exceed extra revenue.

Product mix pricing tactics:

a) Product line pricing
b) Optional feature pricing
c) Captive product pricing
d) Two part pricing
e) By-product pricing
f) Product bundle pricing

Initiating and responding to price change:

 Strategic pricing option includes
a) Maintain price & perceived quality selectively prune customer
b) Raise price & perceived quality
c) Partiality cut price and raise quality
d) Fully cut price and maintain quality
e) Maintain price & reduce perceived quality
f) Introduce an economy model

Key consideration when initiating or responding to price change:

 Initiating price cuts
 Circumstances leading price cuts:
 Excess plant capacity
 Declining market share
 Attempt to dominate the market via lower costs
Price cutting traps:
 Price/quality perceptions
 Low price don’t create market loyalty
 Competition may match or beat price cuts

 Initiating price increases

Circumstances leading to price increases:
 Cost inflation
 Over demand
Methods of dealings with overdemand
 Delayed quotation pricing
 Escalator clauses
 Unbundling
 Reduction of discounts

 Reaction to price changes

 Firm must monitor both customer and competitor reaction
 Competitor’s reactions are common when
 Few firms offer the product
 The product is homogeneous
 Buyers are highly informed

 Responding to competitors price changes

 The degree of product homogeneity affects how firm respond to price cuts initiated
by the competition
 Market leaders can respond to aggressive price cutting by smaller competitors in
several ways

Market leader responses to competitor initiated price cuts:

 Maintain price and profit margin
 Maintain price, add value
 Increase price, improve quality
 Launch a low-price fighter line
 Reduce price