Ch-9(designing Pricing Strategies)

Chapter – 9. Designing Pricing Strategy. Chapter – 9. DESIGNING PRICING STRATEGIES: •

Price:  

Sacrifice made by buyer to avail benefits provided by product. Determine revenues that a firm generates in conjunction with units sold.

Firm needs to set price:  When it develops a New Product/ acquires New Product.  When it enters new distribution channel/ geographical area.  When it enters bid on new contractor. Firm needs to decide product position based on:  Quality.  Price. Based on these, strategies could be:

PRICE

LOW

PRODUCT QUALITY MEDIUM

ME D I UM

H I GH

HIGH

MEDIUM

LOW

1. PREMIUM STRATEGY

2. HIGH VALUE STRATEGY

3. SUPER VALUE STRATEGY

4. OVER CHANGING STRATEGY

5. MEDIUM VALUE STRATEGY

6. GOOD VALUE STRATEGY

7. RIP OFF STRATEGY

8. FALSE ECONOMY STRATEGY

9. ECONOMY STRATEGY

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Diagonal strategies 1/5/9 can co-exist in the same market. Strategies 2/3/6 would attack the diagonal strategies. Strategies 4/7/8 amount to over pricing product in relation to its quality. These are avoidable.

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To set pricing policy, firms need to consider various factors. Hence a formal procedure is used for price setting. Procedure is:  Select pricing Objectives.  Determine demand.  Estimate costs.  Analyse competition costs/prices/ offers.  Select pricing method.  Select final price.

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Chapter – 9. Designing Pricing Strategy.

Selecting Pricing Objectives:  Company has to decide what it wants to accomplish with a particular product.  Objectives that could be pursued are: Survival:  In this case prices are very low. Price covers Variable Cost & some Fixed Cost if possible.  Occurs if: o Company has over capacity. o Company is intense. o Consumer wants to keep changing.  Can be continued for short period. Maximizing Current Profit:  Company tries to estimate demand/ cost associated with alternate pricing plans.  Price with maximum current profit/ cash flow/ return on investment.  Assumes forecast of demand/ cost is accurate.  Ignores effect of other marketing mix elements & competition reaction.  May sacrifice long term performance. Maximizing Current Revenue:  Price set to maximum current revenue based on demand forecast for alternate prices.  Based on belief that revenue maximization will lead to:  Market share growth.  Long Run profit maximization. Maximise Sales Growth (Market penetration pricing):  Example: Tide.  Assumes that market in price sensitive.  Hence, product priced at a level, where sales growth is highest. This would lead to lower unit costs & higher long term profit.  Used when: • Market is price sensitive. • Production/Distribution costs decreases with accumulated production expenses. • Low price discourages actual/ potential competition. Maximise Market Skimming:  Example: Nokia.  High price set to skim market.  Price lowered progressively to draw in market layer of customer in terms of purchasing power.  With each price decrease features of product may/may not be reduced.  Used when: 2

Chapter – 9. Designing Pricing Strategy. • current demand. • compared to large volume. • competition. • superior product.

Sufficient number of buyers has high Cost/unit is not very for small volume as Initial

high

price

does

not

attract

High price communicates image of a

Product Quality Leadership:  leader in the market.     Dove).  Consumer Durables (Compaq).

A company may aim to be product Create a high quality product. Price it higher than competition. Used for: Premium product (FMCG: Low

maintenance

in

Determining Demand:  Price has a direct impact on demand & hence on other marketing objectives.  Price Elasticity of demand for a product needs to be understood/analysed.  Buyer’s price sensitivity may be impacted by:  Unique Value Effect: • Uniqueness of product.  Substitute Awareness Effect: • Knowledge of substitutes.  Difficult Comparison Effect: • Quality of substitutes not easy to compare.  Total Expenditure Effect: • Price as a % of monthly earnings.  End Benefits Effect: • If product is a part of a product benefits set, then the value/price of a product as a % of full benefits.  Shared Cost Benefits: • Is the cost borne by another party? • Example: Bus travel/Motels on a business tour.  Sunk/Investment Effect: • Product used in conjunction with other assets already bought. • Example: Spare parts.  Price Quality Effect: • Does the product have more perceived quality/prestige?  Inventory effect: • Price sensitivity is low if the product cannot be stored by a buyer. • Example: Processed Cheese, Fruits. 3

Chapter – 9. Designing Pricing Strategy. 

Demand at various price levels can be estimated thru::  Time series analysis using past data/ trends.  Price based experimental research.  Causal marketing research.

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Based on above, demand curves created to forecast demand.

Estimating Costs:  Company costs set the floor price.  Costs should cover cost of • • • •

Manufacturing/production. Distribution. Selling products. Return on Investment/ Risk.

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Total cost = Fixed Cost (over-heads) + Variable Cost. Costs needs to be estimated: o At different levels of production. o As a function of differentiated marketing segments/buyers. o As a function of accumulated production/ experience.

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Many companies may use target costing as a means of reducing costs to pre-planned desired level.

Analysing Competitor’s Costs/ Prices / Offers:  Company needs to benchmarks its costs against its competition to learn whether it is operating at a cost advantage/disadvantage.  Company also needs to learn about competitor’s price & quality of offers /product offerings.  Information on competitor’s costs/ prices/ offers used to orient own products costs/ price /offers. Selecting Pricing Method:  Once 3 C’s Customer demand schedule, Cost function, Competitor price, is ready, company is now ready to select price. For this, first a pricing method is selected.  Pricing method could be: 4

Chapter – 9. Designing Pricing Strategy. • • • • • • Mark Up Pricing:  cost.  Variable cost/ unit Fixed cost Expected sales

Mark up price. Targets return pricing. Perceived value pricing. Value pricing. Going rate pricing. Sealed bid pricing. Add standard mark up to product Example: = Rs.10/-. = Rs. 2, 00,000/-. = 40,000 units.

Unit cost

= Variable Cost + Fixed Cost/Sales. = 10 + (2, 00,000/40,000). = Rs. 15/-. Suppose mark up price = 20%, i.e., (Desired return= 0.2). Price = Unit Cost/ (1-desired return). = 15/ (1-0.2). = 18.75/-. This is Net dealer price (NDP). To this trade margin are added to get final customer price. Target Return Price:  Price determined based on target Return on Investment. Suppose target return = 20%. Investments = Rs. 2, 00,000/-. Expected sales = 40,000 units. Units cost = Rs. 15/-. Target return price = Unit Cost + {(Target Rate) * (Investment)}/Expected Sales. = 15 + (0.2 * 2, 00,000/-)/40,000. = 16/-. Perceived Value Pricing:  Used in the business analysis stages of new product development.  Buyer’s perception of value used as key to price product.  Product/ Place/ Promotion used to build up perceived value.  Procedure: o Company develops product concept for a particular target market with planned quality & price. o Based on this sales volume is estimated along with sales plant capacity /investment /unit costs are determined. o Based on above, profits are estimated. If profits are satisfactory company goes ahead with product, otherwise, it is dropped. Value Pricing: 5

Chapter – 9. Designing Pricing Strategy.  

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A comparatively low price is charged for a high quality product/ accepted product. Used typically in mature markets, which, witnesses continuous “Sale Offers”. Credibility erosion may be avoided using a low value price which is constant (No discounts given). For value pricing to succeed company may need to overhaul manufacturing/ distribution/ sales functions so that costs are minimized & the value price can be sustained. Example: o NIIT’s Swift Program started with 2500/-@16hours course now coming at Rs. 500/- @8 hours plan which is value priced. o APtech’s Vidya Program started with 2200/-@16hours course now coming at Rs. 600/- @8 hours plan which is value priced.

Going Rate Pricing: Here company pays attention to its own costs/ demand. Price is based on competition’s prices. Company may charge more/ same/ less than competition. This would depend on: • Product type. • Market leadership. If product is not differentiable (as in commodities) price is lower/same as competitors.  If company is not the market leader, then its product may be lower than market leader’s price. Price charged would follow the leader. Going rate pricing: • Reflects industry collection wisdom. • Maintains industrial harmony. Sealed Bid Pricing: • Used for quoting against tenders. • Normally, in such cases, other things being equal, contract is awarded to lowest bidder. • Hence company should calculate its profits & probability of getting the order at various prices. • A final price is the price with highest pay offs/ expected profit. • (Pay Off = Profit * Probability). Selecting Final Price: • Pricing methods narrow the price range from which company must select its final price. • To select final price company should also consider: Psychological Pricing: • A high price may convey higher quality to consumers (Customer perception). 6

Chapter – 9. Designing Pricing Strategy. • • •

Sales of certain products may increase with price decrease.  Example: Liquor/Perfumes. Price may be kept high to serve as a reference point in customer mind. A discount may give a customer a feeling of getting a good deal. Odd pricing may give customer a feeling of lower prices.  Example: BATA: 199.95/-.

Influence of Other Marketing Mix Elements: • Final price must take in account of product’s quality & advantage relative to competition. • Brands with average relative quality & high relative advantage are normally able to charge a premium. Customer, normally are willing to pay higher prices for known products than for unknown products. • Brands with high relative quality & high relative advertising charges the highest price. • Brands with low relative quality & low relative advertising charge low prices. • High prices & high advertising are positively correlated especially for, Mature products. Market leaders. Low cost products. Company’s Pricing Policy: • Product’s price should be consistent with company’s pricing policies. • Price of others products also need to be seen in this content to position product suitably. Impact of Prices on other Parties: • Company needs to consider impact of pricing on: o Distributors/ Dealers. o Sales Force. o Competition. o Suppliers to company. o Government. • Adverse reactions should be minimized to extent possible.

Price Adaptation: • • •

Typically, price set as per procedure seen above is the original product price & pricing structure. Real field situation is normally dynamic. Variations may occur in: o Geographical Demand/costs. o Market Segment Requirements. o Purchase Timings. o Order levels/Delivery Frequency. o Guarantees/Service Contracts.

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Chapter – 9. Designing Pricing Strategy. • • •

As a result a company may need to adapt/change its final price from time to time. This is called “Price Adaptation”. Price adaptation strategy could be: o Geographical pricing. o Price Discounts & Allowances. o Promotional Pricing. o Discriminatory Pricing. o Product Mix Pricing.

Geographical Pricing: • Typically occurs for exports/ imports/ international trade. • Manifest through counter trade. • Counter trade is the practice of making payment in part/ full through other items instead of currency. • Counter trade could be in the form of: • Barter: • Exchange of goods. • No Money. • No third party involved. • Compensation Deals: • Sellers receive some % of payment in cash & the rest in products.

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•

Buyback Arrangements: • Seller sells capital goods (Plant/Equipments/Technology). • Buyer pays part of payment through products produced with equipments purchased. • Balance in cash. Offset: • Seller receives full payment in cash but agrees to spend part of the money in buying goods from purchaser country within stipulated time frame. • At times counter trade may involve more than 2 parties.

Price Discounts /Allowance: • Most companies modify their basic price to reward customer/ distributor for  Early Payment.  Volume purchases.  Off season buying. • While doing so, companies should be careful to make some profit out of resulting sale. Producer

Distribution Channel Price discounts/ allowances

Customer Promotional Pricing (Pull Strategy)

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Chapter – 9. Designing Pricing Strategy. (Push Strategy) •

Price adjustments (Discounts/Allowances) could be:

Cash Discounts: • Cash Discount is a price reduction to buyers who pay their bills promptly.

P Producer

I1 C/F

I2

I3

Distributor Whole-seller

R

C

retailer

Consumer

2/10 met 30 • Example: 2/10 met 30 • Credit for 30 days. • 2% discounts if bill cleared in 10 days. • Normally used with distributors/ retailers I3 is selling goods worth Rs. 100 to R & discounts @ 2/10 met 30. In such cases R will borrow money from a financer on 10th of the month. The maximum amount of interest which R will pay the financer will be @ 36% 2% discounts = 20 days 1 day = 2/20 30 days = 2/20x 30 =3x12months = 36% • Benefits: o Retailer will be able to pay money back to I3 at lower interest rates. o In 10 days there will be some selling: Retailer has to pay interest on lesser amount than whole of 100. o This will result in additional generation of income just by going for this arrangement. Quantity Discounts: • Quantity Discount is a price reduction to buyers who buy large volumes. • Example:  Rs 25 per unit for up to 99 units.  Rs 23 per unit for 100-Plus units. • Quantity Discount should be offered equally to all customers. • Quantity Discounts amount normally should not exceed cost savings to seller as a result of selling large quantities (cost savings includes reduced expense on selling /inventory/ transportation). • Quantity Discount may be offered:  Non Cumulatively: On each order.  Cumulatively: On total order in a given period. Functional Discounts (Trade Discounts): • Functional Discount is the trade margin offered by manufacturer to distributor/ Whole Seller/ Retailer for performing functions. 9

Chapter – 9. Designing Pricing Strategy. •

Different channel may be offered diff discounts.

Seasonal Discounts: • Seasonal Discount is price reduction to buyers who buy out of season. • Seasonal Discount allows manufacturer to maintain steadier production schedules. Allowances: • Other types of price reductions are called allowances. • Types could be: o Trade in allowances:  Price reduction on new item in exchange for old item. o Promotional allowances:  Payments/ price reductions to dealers/ distributions to reward them for their participation in advertising/ sales promotion. Promotional Pricing: • purchase. • 

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Promotional pricing techniques are used to stimulates early Techniques could be: Loss leader pricing: • Used by retailers to stimulate additional store traffic by dropping prices on well known brands. Special event pricing: • Special prices offered in certain seasons to draw-in most customers. Cash Rebates: • Consumes offered cash rebates to encourage purchasing within specific time period. • Often used to clear inventory without reducing list price. Low interest financing: • Customers offered low interest financing instead of reducing price. Longer payment terms: • Financial companies stretch their loans over longer periods to bring down EMI. • As a result product becomes more affordable. Warrants/ Service contracts: • Company tries to increase by adding on to warranty/ service contracts terms either free/reduced cost. Psychological Discounting: • Inflating product price & then discounting it. • May amount to RTB, hence care should be taken while doing this.

• zero sum game:

Promotional pricing may turn out to be a

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Chapter – 9. Designing Pricing Strategy. • If they work, competition will copy it & create a level playing field, • If they don’t work, it wastes a lot of good money for the company. This money could have been utilized for long term activities such as product quality increases or increases product image. Discriminating Pricing: • Companies may offer basic price modification to accomplish difference in customer/ products/ locations. • Discount Pricing /price discount occurs when a company sells a product/ service at a different prices that do not reflect proportional difference in cost. • Forms of Discriminating Pricing could be: o Customer Segment Pricing:  Different prices to different customer groups.  Example: • Railways student concession, Senior citizen discounts. • Banks: Higher % interests for Senior citizen fixed deposits. o Product Form Pricing:  Different versions of a product are priced differently, but not in proportion to their costs.  Example: Surf: 1Kg pack/ Sachet. o Image Pricing:  Same /similar product priced at different levels based on image difference/ branding.  Example: Clothes/ Wrist watches or Company: Videocon (Kenstar). o Location Pricing:  Same product priced at different prices based on location even though costs are the same.  Example: Movie theatre tickets. o Time pricing:  Price varied as per: • Season. • Week days/Week-ends. • Time of the day (happy hours).  Could be in the form of yield pricing as used by Hotels/ Cruise Ships/ Airline (Air India red).  Red Hour: When there is a hopping flight for Mumbai-Delhi-London, then the tickets is available for much lower prices for passengers traveling to Delhi. • For Discriminating Pricing to be successful, conditions are:  Market should be segmentable.  Segment should show different demand intensities.  Members of lower segment should not be able to resell product to higher price segment.  Competition should not be able to undersell firm higher price segment. 11

Chapter – 9. Designing Pricing Strategy. • Example: Tide slashed price.  Cost of segmenting & monitoring market should not exceed profits from extra revenue.  It should not result in customer resentment/ illwill.  It should not be illegal. Product Mix Pricing: • Price setting logic needs to be modified when the product is part of a product mix. • In such a situation, firm searches for a price that would maximize profits on total product mix. • In addition to normal pricing procedure, we need to take into account:  Demand of various products, in product mix.  Their cost inter-relationships.  Competition for each product. •

Product mix pricing based on above could be:  Product Line Pricing.  Optional Feature Pricing.  Capture Product Pricing.  Two Part Pricing.  By-Product Pricing.  Product Bundling Pricing.

Product Line Pricing: • Normally companies have a product line rather than single products. • Pricing starts with the most basic product at the lowest level. As we go up the product line featured & other differentiators get added to the product. • Difference in price from one product to the next level is called a price step. HLL

DOVE

PRICE STEP

LUX/LIRIL

LIFEBUOY

• • • •

• •

The value/amount of price step needs to be planned carefully. If the step is small, customer may prefer higher product. If price step is large, customer may prefer lower product. Price step is based on:  Customer differences between the two products  Customer evaluation of the differences.  Competition prices. If price step is larger than cost, company benefits when customer buys higher products. Example: Cambridge shirts/ trousers. 12

Chapter – 9. Designing Pricing Strategy.

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 Cambridge.  Cambridge gold.  Cambridge classic.  Cambridge premium. Sellers task is to establish perceived quality difference that justify price difference

Optional Feature Pricing: • Company differentiates optional products/ features along with normal product. • Example:  Car • Options could be: o Choice of music system. o Interiors.  Motorcycle • Options could be: o Disk brakes. o SP Styling. o Accessories. • Optional pricing provides customer flexibility to ……own product to a certain extent. • Company may charge a premium of optional features which customer may not mind paying. Captive Product Pricing: • Some products may require the use of captive pricing. o Example:  Razor needs Razor blades.  Camera needs film. • Company making both may price the durable product low & the consumable product on the higher side with good quality. • However if consumable (after market) is priced too high, it may lead to piracy. o Example: Automobile spare parts of Bajaj Auto Limited scooters. Two Part Pricing: • Company may engage in two- part pricing, i.e., a fixed fee for a product plus a variable usage fee. • E.g.  Reliance Infocom (Mobile).  Appu ghar /Essel world entry fee + Rides. • Fixed fee kept low to induce purchase. • Profits earned through usage fee. By Product Pricing: • Production of certain goods may result in by-product. o Example: Petroleum/Chemicals. • If by-product has value to a customer group, it may be priced as per perceived value.

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Chapter – 9. Designing Pricing Strategy. • •

Income on by-product may help company to face price competition in main product category better. Example: Al Kabeer’s o Meat products (main products). o Skins (by-products) sold to leather producers.

Product Bundle Pricing: • Seller may bundle their products at a set price. o Example:  Restaurant : Thali.  Publisher : Combinations of magazines.  Set of text books for a specific class school. • A customer may not want full bundle. In such cases, a seller may agree to un-bundle the offering but would ensure profit optimization in the product.

Price Setting

Setting Objective. Determining Demand. Estimating Costs. Analyse Competition. Select Pricing Method. Select Final Price. Barter. Compensation. Buyback arrangements. Offset.

Price Adaptation

Geographical demand Market segment Purchase Timing. Order levels/ Delivery frequency. Guarantee’s/ Service Contracts.

Initiate Price Change. React/ Respond to price changes.

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Chapter – 9. Designing Pricing Strategy.

Initiating Price Changes: • Price changes could be:  Price cut.  Price increases. • Implications of both need to be understood before actual action is taken. Price Cuts: • Price cuts may be required due to:  Excess plant capacity.  Declining market share.  Effort to dominate market through lower costs.  Economic Recession. •

While cutting price, company needs to assess following risks:  Low quality perception: • Customer may feel product is inferior in quality.  Fragile Market share: • Market share may increase temporarily, but customer loyalty may not be there. If competition introduces lower priced product, customer may shift.  Sustainability: • If the price cut triggers a price war in the industry, only those companies with deep cash reserves will last.

Price Increases: • A successful price increase can increase profits considerably. • Example: Product price = Rs. 20/-. Profit = Rs. 2/-. 10% price increase = Rs. 22/-., Results in 100% profits increase. (Other things remaining the same). • Price increases may be due to:  Cost Inflation.  Anticipatory Pricing (in anticipation of change in environment/ government policy).  Over Demand. • While increasing prices, company should be careful not to disturb its market share/customer. Hence company may use various ways to increase price/increase profits. • Some of the methods could be: o Decrease amount of the product instead of increasing price.  Example: In sachets there is 8ml shampoo instead of 10ml. o Substituting ingredients with less expansion.  Example: Cadbury’s 5 star bar (Rs. 2 uses artificial coco powder)

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Chapter – 9. Designing Pricing Strategy. o Remove product features in standardised product, offer them as options. Also applicable to services offered.  Example: Maruti LX, VX. o Decrease cost of package material.  Example: Vegetable oil comes in jar & sachets. o Decrease discounts.  Example: Discount on any Product. o For long term contracts, use price evaluation clauses.  Example: Software services or maintenance. o Reduce number of sizes/depth of product.  Example: Lux:

20gms 75gms 175gms

Profit @ 1/unit Total Production Profit

20 units 20 units 20 units

= 60 units. = Rs. 2.5/unit.

o Create new economy Brands  Example: When SURF had to compete in the market, they introduced RIN so that they can increase SURF’s prices. o Increase prices in stages in small amounts rather than one big jump  Example: Petrol & Diesel – Govt. is increasing the prices slowly Responding to Competitors Price Change: • If competition changes its price, company may need to give suitable response. Responses would vary depending on homogeneity of product market. Homogenous Product Market (How product differentiates?) • If competition cuts price, firms may have very little choice but to reduce its own price. o Example: Commodities. • If competition increases price, company may /may not follow. If the industry as a whole benefits, then it is advisable to increase price. Non Homogenous Product Markets: • Due to presence of differentiators, buyers may not be very sensitive to minor price change. • Before reacting companies needs to understand reasons for competitor’s price change. • If competitor has decreased its price, reasons could be:  Increased market share.  Over capacity.  Change in its cost structure.  Lead an industry wide price change. • Also, companies needs to analyse whether price change is permanent or temporary. 16

Chapter – 9. Designing Pricing Strategy. • Further, if company does not respond, what would have happened to its market share /profits.

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Based on analysis, options for response could be: Reduce Price:  Reasons for this could be:  Otherwise it would lose market share.  It would be hard to rebuild market share.  It costs may reduce with volume. o Raise Perceived Quality:  Maintain price but improve its products/service communication (Advertisements). o Improve quality & raise prices with new brand:  Raise price of product & increase product quality with a new brand to create smaller market segment.  This may reduce volumes for competition which may make competition unviable. o Launch New Low Price Product(Fighter Line): Create new low price brand, especially low end customer is o

 price sensitive.

Example: HLL introduced WHEEL as a fighter product to

 protect SURF from NIRMA. o •

Maintain price: This is done if company believes that it: • It would lose too much profit if it decreases price. • May not lose too much market share. • Even if it does lose some market share, this loss can be regained easily.

• when competition increases price.

Similar analysis and responses are created

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