Pricing should be seen from the point of view of the customers, consumers and competitors. Customers and consumers are looking for the value of their money, so marketing must work hard on how they perceive the price of the product/ brand; what they must offer is value which is perceived as better than their competitors:
Price must also be seen as a part of the marketing mix; it is an important signal to the market of what quality to expect, and it must be consistent with the brands/ products positioning.
The approaches to setting a price are: cost-plus; marginal pricing and break-even analysis; target pricing; perceived value or product analysis pricing; competitive pricing; others (geographical, psychological). The advantages and disadvantages of each are described.
Therefore, in pricing the product line, it is possible to set different levels of profit of different models within the line; often the basic model has the lowest margin, and the top of the line the greatest.
1. Cost-plus
The cost-plus approach usually starts with standard costs of the product: and estimate of the total direct costs (labor, materials, and components) divided by the assumed member of the products to be manufactured. This may be a straightforward calculation, but in a complex manufacturing situation it may become difficult, even impossible. For example, where there are thousands of different products and common costs. In these cases, some assumptions have to be made and estimates used. This is acceptable, as long as every one knows that they are being made what they are, and what effect changes in the assumptions would have on the calculations.
It becomes even more difficult at the next stage, when indirect cost are added. This is an attempt to allocate direct fixed costs (investment in plant and machinery) and overheads (central salaries, office costs, etc.) Total costs are allocated to each product according to some measure such as relative volume, input costs, or labor costs. These allocations are invariable crude, and may be actually misleading. Research in recent years has shown, for example, that many firms use relative labor cost as the allocation method, but that it is an increasingly unreliable indicator of actual costs, as stated by Johnson and Kaplan (1987). Moreover, all allocations depend on an estimate of sales, which is bound to be in accurate to the least some extent. Yet this method is more commonly used than any other. From a marketing point of view, it is acceptable that costs should be an input to the pricing decision, but not that costs should be the sole determinant.
2. Marginal pricing and break-even analysis
This approach is often advocated when all fixed costs have been allocated to normal production, and the opportunity arises to sell an extra batch-come-off contract, or an unexpected export order. Marketing executives are often tempted to use this approach, especially in product line pricing, seeing it as more market-oriented: it is the market’s perception of each product which should determine its price, not some arbitrary allocation of a particular firm’s costs. This is true, and it is a fact that there are situations when it makes sense for a firm to accept a contract which makes a contribution, but not an actual “profit”. The danger are apparent, however, too many pricing decisions taking account only of marginal costs may lead to a lowering of a total company profit or, in the worst case, to revenue failing to cover all costs.
The problem of overlooking profit can be avoided by break-even analysis. This takes the contribution per unit, and by dividing it into total fixed costs calculates how many units need to be made and sold to cover those fixed costs and start to make a profit. Break-even analysis is particularly useful in deciding on the price of a new brand. Different prices giving different contributions per unit can be used to give different break-even levels; these can be examined against market size and share estimates. Break-even analysis cannot give the right price, but it may show that at a given price, break-even would need a market share of 60 percent; that sort of result should send everyone back to the drawing board.
3. Target Pricing
This usually means pricing to achieve a target profit. Most companies have some idea of the profit they want to make on each product; it may be expressed as a percentage mark-up or margin, as an absolute amount, or as a return on investment.
| Target | Example |
|---|---|
| Variable cost plus 120 percent |
| 15 percent of sales revenue |
| Minimum of P30 million/ year |
| 20 percent ROCE (Return on capital Employed) |
How the target is expressed will largely depend on the type of business: percentage mark-up often used in professional service companies, while return on investment is frequently found in manufacturing. The targets may be combined, and an absolute amount is often set as a hurdle.
For marketing people, the question always be, “How will the market react to this proposed price?” The fact that a particular set of price and sales figures meets a target does not mean that those results can be achieved in the market place.
4. Perceived value of product analysis pricing
This approach takes an explicitly market-oriented view, by looking at the price from the customer’s point of view, and trying to set a value to the customer of the various benefits offered. Product analysis suggests that the product should be analysed into its component parts, and each costed as if the costumer were buying it separately. The sum of all these, perhaps with a small discount, becomes the price of the package on offer. The approach is particularly appropriate in contracting or tendering situation.
From a marketing point of view, perceived of value is the overriding consideration in any pricing decision. A great deal of effort should go into establishing exactly what value buyers place on the various benefits, and in presenting these (in all the marketing communications) to demonstrate that the price offers value for money.
5. Competitive Pricing
For the most companies, competition is likely to be an enormously important influence on pricing decisions. Only the truly unique product, well protected by patents, or a genuine monopoly, has real pricing freedom; even then there are probably regulators looking to verb “excess” profits. It is worth repeating that it is marketing’s job to create uniqueness and local monopoly and thus to get away from a commodity situation, but the reality is that competitors can never be forgotten.
Precisely how much attention needs to be paid to competitor’s prices in setting one’s own depends partly on the market situation and partly on the company’s position and strategy. In some situations there will be long-term relationship in which supplier and buyer work closely together on the product or service; there may be a preferred supplier, or a small number of suppliers; switching costs may be high, so in this situation it is difficult for a new competitor to break in with a lower-price offer. In other situations price competition may be continuous and intense.
The other consideration is the positioning of the company. In most markets there is a price leader, recognized as such by most companies, whose general pricing levels are followed by everyone else. This may be the market leader by size, or the premium – price brand or the low-priced mass market product. It is not always clear how and why a particular price leader emerges. The advantages of being in that position are that you can choose the timing of price changes to suit yourself, rather than having to follow up others at what may be an inconvenient time.
The company probably also has an overall strategy which determines whether it is in the premium – price segment, the medium – price, or the economy bracket. This may mean that your price is always a given amount above (or below) a certain key competitor.
Other Approaches
1. Geographical Pricing
Kotler (1991) stated. “In some markets, particularly industrial one’s in which transport costs are significant, there is an issue of geographical pricing. The supplier there is an issue of geographical pricing. The supplier must decide whether to let each buyer carry all transport costs, making the price higher for more distant customers; to average out transport costs, making prices relatively higher for closer customers and lower for more distant one’s; to absorb transport costs and price accordingly; or to adopt some mixture of these. Changing the buyer all transport costs in known as FOB (Free on Board), while including all costs in the quoted price is known as CIF (Cost, Insurance, Freight); one or other may be established practice in a particular industry, as many other such as zone-based pricing or using such established practices, it is for the marketing people to look for opportunities for differentiation in providing a better service than the competitors”.
2. Psychological Pricing
This term refers to the effects (real or assumed) on buyers or particular prices. These are often referred to as “Shoulder prices” or “price points” and commonly show up as figure – P49.95 instead of P50.00, for instance. People operating in particular market segments have strong beliefs about these price points, based on experience. As such pricing considerations may lead to changing a lower price than would otherwise be set, the effect should if possible be checked by controlled experiment. Psychological factors also come into play with some cases of prestige pricing, where a very high price is set to suggest luxury, status or exclusivity. This happens not only in obvious categories such as perfume, but in other less obvious ones-even beer. Such pricing must be part of a coherent and consistent mix and positioning (product quality, packaging, distribution, advertising and promotion). Unduly high prices may also be difficult to enforce in practice.
3. Moral factors
Some people argue that pricing has a moral aspect (Winkler, 1983) – that is, there is a notion of a fair or just price. This is most likely to arise in areas of state or local authority provision, such as housing or transport; but it can be raised in the field of, for example, medicine. There have been protests at the prices of new drugs which offer cures or alleviation for serious diseases. The extreme opposite view is that business has no moral duty at all; its only objective is to make maximum return for shareholders. There is no single right answer to ethical dilemmas is this as in other cases, and each company and each executive must take a considered view in the circumstances.
