Everything you need to know about the factors affecting pricing decisions. This article will further help you to learn about:
1. Factors Affecting Pricing Decisions in Marketing Management 2. Internal Factors Affecting Pricing Decisions 3. Factors Influencing Price Determination 4. Examples of Factors Affecting Pricing Decisions.
Factors Influencing Price Decisions and Determination in Business: Internal Factors, External Factors, Impact and Examples
Factors Affecting Pricing Decisions in Marketing Management:
Several factors influence the pricing decisions of a firm and they can be divided into two broad divisions, namely internal factors and external factors.
Internal Factors Influencing Pricing Decisions:
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The factors influencing pricing decisions are divided into internal and external factors on the basis of whether the management has control over the factors or not.
If the management has control over the factors, it will come under internal factors, if not it will come under external factors. So the internal factors are within the control of the management and are particularly related to the internal environment of a firm.
The internal factors affecting pricing decisions are:
1. Company Objectives:
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This has considerable influence on the pricing decisions of a firm. Pricing policies and strategies must be in conformity with the firm’s pricing objectives. For example- if a company desires a targeted rate of return on capital investment, then the pricing decisions are so made that the total sales revenue from all products, exceeds the total cost by a sufficient margin, to provide the desired return on the total capital investment.
2. Organisation Structure:
Another significant internal factor affecting pricing decisions is the organisational structure of the firm. Generally, the top management has full authority for framing pricing objectives and policies. Some firms allow workers’ participation in decision making and therefore in such firms, all the employees give their views and suggestions for the pricing policy. This is helpful to the firm if the firm has several products, requiring frequent pricing decisions and where prices differ in different markets.
Similarly, the marketing manager also helps and assists the top management in framing the pricing policies and strategies. The determination of the selling price is a major policy decision for the firm and the cost accountant can make an important contribution to this decision making process by providing the management with costs, which are relevant to the pricing decision at hand.
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3. Marketing Mix:
Price, product, promotion and place are the four ‘p’s of a marketing mix. The pricing policy of a firm must consider the other components of a marketing mix as well, because these factors are closely related. Moreover, these factors will change according to changing market conditions and will be different for each market. Thus, marketing research and the marketing information system can be utilised to form the appropriate pricing policy.
4. Product Differentiation:
If a product is different from its competitive products, with features such as a new style, design, package, etc., then it can fetch a higher price in the market. For example- Lee, Arrow and Park Avenue shirts, are sold at a high price in the market. Thus, if the product has distinguishing features, then the firm has greater freedom in fixing the prices and customers will also be willing to pay that price.
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5. Cost of the Product:
Pricing decisions are based on the cost production. If a product is priced less than the cost of production, the firm has to suffer the loss. But the cost of production can be reduced, by co-ordinating the activities of production properly, the firm can reduce the price accordingly.
External Factors Influencing Pricing Decisions:
The external factors affecting the pricing decision of a firm are:
1. Demand:
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Market demand for a product or service has great impact on pricing. If there is no demand for the product, the product cannot be sold at all. If the product enjoys good demand, the pricing decision can be aimed to utilise this trend.
2. Competition:
There has been a revolutionary change experienced in the Indian market after the liberalisation and opening up of the economy. The impact of competition is more pronounced than in the earlier days. The market is flooded with too many products, both Indian and foreign. The number, size and pricing strategy, followed by competitors have a significant role to play in the pricing decision. If the product cannot be differentiated with special features, a firm cannot charge a higher price than that of its competitors.
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If there are no ready takers for the product, it is said to have failed in the market. Pricing decision is thus related to the characters, nature and preferences of the buyers.
They supply the required items of production to the firm. As already pointed out, the firm can reduce the price, if it can reduce the cost of production. If not, the usual tendency is to charge the increased cost of production to the consumer. For example- the price hike for petrol or diesel will automatically increase the price of vegetables, fruits, provisions, etc. If a firm could get the required raw materials at reasonable rates from suppliers, then it can also price the goods at a less rate.
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This also affects the pricing decision of a firm. In a depressed economy, business activities will be considerably less, but in a boom condition, there will be hectic business activity. Therefore, economic conditions affect the demand for goods and services. So, in a depressed economy, in order to accelerate business one sells goods at a lesser price, but in a boom period, goods can be sold at a high price.
The government has the power to regulate the activities of business firms, so that they do not charge high prices and don’t indulge in anti-social activities. The government does this by passing various acts; For example- the MRTP Act, Consumer Protection Act, etc.
To quote one case, Nestle has advertised that they are giving one Kit Kat chocolate free with another product of the company, the MILO beverage. Actually, the company increased the price of MILO, by adding the price of a bar of KIT KAT to it. This attracted the attention of the MRTP enquiry committee. The company was asked to cancel the offer and was also punished for wrong trade practices.
Factors Influencing Price Determination: Internal and External Factors
The factors that can influence price decisions may be divided into two groups:
A. Internal Factors:
They are generally within the control of the organization. At times they are called ‘built-in factors’ and these are costs and objectives.
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1. Costs:
The most decisive factor is the cost of production. It involves finding I out cost per unit and adding necessary profit with the cost of production to arrive at the price. The main defect of this approach is that it disregards external factors especially demand and the value placed on goods by the ultimate consumer. Whatever be the cost of production, there is a price at which the consumer is willing to buy.
2. Objectives:
Large manufacturing companies establish marketing goals/ objectives and pricing contributes its share in achieving such goals.
These goals may together be termed as ‘Pricing Policies’ which may be classified into:
(i) Target Rate of Return,
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(ii) Stability in prices,
(iii) Maintenance or increase in the share of the market,
(iv) Meeting or preventing competition, and
(v) Maximising profits.
3. Marketing Mix:
Price is only one of the elements of marketing mix. It must be coordinated with other elements, i.e., product, place and promotion. Decisions made for other elements may affect pricing decisions. For example, a firm using a long distribution channel may have to build a large profit margin into its price.
B. External Factors:
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These factors are generally beyond the control of an organisation, but they have to be considered.
These factors include:
(i) Demand – In a consumer-oriented market, the consumers influence the price. The value of a given product to the consumer is the prime consideration. Marketing research is used as an effective aid in ascertaining the consumer demand.
(ii) Competition – No manufacturer is free to fix his price without considering Competition unless he has a monopoly. It is difficult to determine how far competition prices range from that of direct substitutes to that of other items which are close substitutes. Convenience goods have a wide range of competing products while shopping and speciality goods have a narrow group of competitors.
(iii) Distribution Channels – Compensation paid for the services of the middlemen between the manufacturer and the ultimate consumer must be included in the ultimate price the consumer pays. Because of these costs, it sometimes happens that the price of the product becomes so high that the consumer rejects it.
(iv) Political and Legal Aspects – Government interference, such as control of prices, levying of taxes etc. are other considerations which affect the pricing of the products.
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Pricing is important as:
(i) It affects the quantity of the product to be sold, and
(ii) It determines the amount of the revenue of a firm.
New products appeal too many as novel items. But this distinctiveness created by novelty is only temporary. The price factor which may be ignored initially would become important when the product becomes an ordinary one because of being in constant use. Competitors may also appear in the market. The new products are hard to be produced, especially with a right price. Incorrect pricing will definitely lead to product failure.
For setting a price of a new product, three points are to be considered:
(i) Making the product acceptable,
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(ii) Maintaining the market, and
(iii) Retaining the profits.
If the product is entirely NEW in all respects, skimming method could be used. A strategy of high prices coupled with heavy promotional expenditure in the initial stages has been proved successful in a number of cases.
Penetration pricing is intended to help the product penetrate into markets to hold a position. This can be done only by adopting a low price in the initial period or till such time the product is finally accepted by the customers. One must keep in mind the fact based on the EASE and the SPEED with which the competitors can bring out substitute products.
Thus, price is an important element of marketing mix, as it influences the acceptability, sales volume and competitive strength of a product. Return on investment, market share, meeting competition and profit are the main objectives of pricing.
Factor Influencing of Pricing Decision: Internal Forces and External Forces
Two categories of factors-internal and external factors influence the pricing decisions of any enterprise. In each of these categories some may be economic factors and some psychological factors, again some factors may be quantitative and yet qualitative.
I. Internal Forces:
The firm has certain objectives long term and immediate in pricing. For example – it has certain costs of manufacturing and marketing and it seeks to recover these costs through the price. The firm is also seeking a particular public image through its pricing policies.
It may have a basic philosophy on pricing. The pricing decisions of the firm have to be consistent with this philosophy. Pricing also has to be consistent with the overall objectives of the firm. All these constitute the internal factors that influence pricing.
Moreover, pricing strategy has to fit into the overall marketing strategy. It cannot exist independently. In this sense, overall marketing strategy is another internal factor that influences pricing.
Further internal factors influence the price:
1. Corporate and marketing objectives of the firm.
2. The image sought by the firm through pricing.
3. The basic characteristics of the product.
4. The stage of the product on the product life-cycle.
5. Price elasticity of demand of the product.
6. Use pattern and turn round rate of the product.
7. Costs of manufacturing and marketing.
8. Composition of the product line of the firm.
II. External Forces:
In addition to all the internal forces mentioned above, any business firm has to encounter a set of external factors while formulating its pricing strategy. In the first place, the nature of the economy and the nature of competition have to be reckoned with.
The purchasing power of the consumer as well as consumer behavior, in the larger sense of the term, also has to be reckoned with. In the country like India, the state exercises a lot of influence on price decisions in respect of a large variety of products.
It includes direct price controls through statutorily fixed maximum selling prices as well as indirect pressures to hold the price line at certain levels. Such external dimensions also have to be reckoned while formulating the pricing decision.
Further external forces influence the price:
1. Market characteristics.
2. Buyer behaviour in respect of the particular product.
3. Extent of bargaining power of major customers.
4. Competitor’s pricing policy.
5. Government controls regulation or pressures on pricing.
6. Other relevant legal aspects.
7. Societal considerations.
8. Understanding, if any, reached with price cartels.
Factors Affecting Price Determination (Internal and External Factors):
Numerous factors affect the pricing policies and decisions of a firm.
Such factors could be studied under two groups:
(1) Internal Factors; and
(2) External Factors.
Internal factors are the forces which can be controlled by a firm to a certain extent such as company objectives, marketing mix, costs, etc. But external factors are the forces outside the firm over which a business has not control. They include demand, competition, buyers, suppliers, economic conditions and government.
(1) Internal Factors:
(i) Objectives of the Firm:
A firm may have various objectives and pricing contributes in achieving them. Firms may pursue a variety of objectives, such as maximising sales revenue, maximising market share, maximising customer delight, maintaining a particular image, maintaining stable price, etc. Pricing policy should be established only after proper considerations of the objectives of the firm.
(ii) Role of Top Management (Organisational Factors):
It is the top management which generally has full authority over pricing. The marketing manager’s role is to assist the top management in price determination and administer the pricing within policies laid down by top management. Pricing activities have such direct effect on sales volume and profit that the marketing manager cannot keep himself aloof pricing policy marking.
However, in many companies, some authority is also granted to lower level executives for setting prices, especially where pricing varies in different markets, or where there are numerous product and frequent pricing decisions are required.
(iii) Cost of the Product:
Cost and price of a product are closely related. The most important factor is the cost of production. In deciding to market a product, a firm should also try to decide what prices are realistic, considering current demand and competition in the market.
(iv) Product Differentiation:
The price of the product depends upon the characteristics of the product. In order to attract the customers, different characteristics and benefits are added to the product, such as quality, size, colour, attractive package, alternative uses, etc. Generally, customers pay more price for the product which is of the new style, design, better package, etc.
(v) Marketing-Mix:
Price is one of the important elements of the marketing mix and, therefore, must be coordinated with the other elements – production, promotion and distribution. In some industries, a firm may use price reduction as a marketing technique; others may raise prices as a deliberate strategy to build a high-prestige product line. In either case, the effect will fail if the price change is not commensurate with the total marketing strategy that it supports.
(2) External Factors:
(i) Demand:
The market demand for a product or service has a big impact on it pricing. Since demand is affected by the prospective buyers, their capacity and willingness to pay, their preference etc. are taken into account while fixing the price. A firm can determine the expected price in a few test-markets by trying different prices in different markets and comparing the results with a controlled market in which price is not altered.
If the demand of the product is inelastic, high prices may be fixed. On the other hand, if demand is elastic, the firm should not fix higher prices, rather it should fix flexible (lower) prices than that of the competitors.
(ii) Competition:
Competition in the market is a crucial factor in price determination. The prevailing information about what price the competitors are charging for similar products and what possibilities lie ahead for raising or lowering prices also affect pricing.
(iii) Buyers:
The nature and behaviour of the consumers and users, for the purchase of a particular product or service, do affect pricing, particularly if their number is large or if they perceive a product of better quality and a symbol of status and prestige.
(iv) Input Suppliers:
The suppliers of raw materials and other inputs can have a significant effect on the price of a product. For example, if the price of cotton goes up, the increase is passed on by suppliers to manufacturers. Manufacturers, in turn, pass it on to consumers.
Sometimes, however, when a manufacturer appears to be making large profits on a particular product, supplies will attempt to cash in on the profits by charging more for their supplies. In such a case, the manufacturer may decide to absorb the additional costs and not increase the prices.
(v) Government Regulations:
The regulatory pressures, anti-price rise and control measures by the Government effectively discourage companies from cornering too large a share of the market and controlling prices. Table 1 lists the factors that influence prices in practice.
Factors Affecting Pricing Decisions (Top 5 Factors):
Price is the only element of marketing mix that helps in generating income. Therefore, a marketer should adopt a well- planned approach for pricing decisions. The marketer should know the factors that influence the pricing decisions before setting the price of a product.
Now, let us discuss the factors affecting the pricing decisions briefly:
Factor # 1. Organizational Objectives:
It affects the pricing decisions to a great extent. The marketers should set the prices as per the organizational goals. For instance, an organization has set a goal to produce quality products, thus, the prices will be set according to the quality of products. Similarly, if the organization has a goal to increase sales by 18% every year, then the reasonable prices have to be set to increase the demand of the product.
Factor # 2. Costs:
It influences the price setting decisions of an organization. The organization may sell products at prices less than that of the competitors even if it is incurring high costs. By following this strategy, the organization can increase sales volumes in the short run but cannot survive in the long run. Thus, the marketers analyze the costs before setting the prices to minimize losses.
Factor # 3. Legal and Regulatory Issues:
It persuades marketers to change price decisions. The legal and regulatory laws set prices on various products, such as insurance and dairy items. These laws may lead to the fixing, freezing, or controlling of prices at minimum or maximum levels.
Factor # 4. Competition:
It affects prices significantly. The organization matches the prices with the competitors and adjusts the prices more or less than the competitors. The organization also assesses that how the competitors respond to changes in the prices.
Factor # 5. Pricing Objectives:
Help an organization in determining price decisions. For instance, an organization has a pricing objective to increase the market share through low pricing. Therefore, it needs to set the prices less than the competitor’s prices to gain the market share. Giving rebates and discounts on products is also a price objective that influences the customers’ decisions to buy a product.
Thus, these are the major factors that influence the pricing decisions. Let us now discuss the process of setting the prices.
Factors Affecting Pricing Decisions (15 Factors):
(1) Objectives:
Many companies have established marketing goals or objectives and pricing is based to achieve such goals. On the basis of the marketing objectives, the pricing policies are adopted. The various policies may be- (1) Cost-oriented pricing policy; (2) Demand- oriented pricing policy; and (3) Competition-oriented pricing policy.
(2) Costs:
The most decisive factor in pricing is the cost of production. In the past, fixing of price was a simple affair- just add up all the costs incurred and divide the final figure by the number of units produced. Adding necessary profits with the cost of production would give the price. The main defect with this approach is that it disregards the external factors, particularly demand and the value placed on goods by the ultimate consumer.
Again under this approach, the manufacturer believes that whatever may be the price, the consumer will buy. Furthermore, today, on account of the various lines of production as well as distributing, the overhead costs finding the cost of production is not so simple.
(3) Demand:
In consumer-oriented marketing, the consumers influence the price. Every product has some utility for the buyer. It gives the buyer service, satisfaction, pleasure, the consumer would continue to buy the product. Higher the demand for a product, lesser the need for giving additional discounts, credit etc. to the distributors and dealers. This leads to higher-price realisation.
(4) Competition:
Another factor that influences pricing is competition. No manufacturer is free to fix his price without considering competition, unless he has a monopoly. To avoid competitive pricing, a firm may decide that its product may be sufficiently different from that of the others. This is achieved through methods of advertising, branding, etc.
Sometimes, a higher price may itself differentiate the product. This is known as prestige pricing. But this is possible only when the product is backed by perfect quality. Sometimes the opposite also takes place. It is seen that many products are sold at low prices, mostly in the initial stages. This is referred to as “Mark down Prices” or Price Cutting.
(5) Distribution Channels:
Distribution channels also sometimes affect the price. There are many middlemen working in the channel of distribution between the manufacturer and the consumer. Each one of them has to be compensated for the services rendered. This compensation must be included in the ultimate price which the consumer pays. Because of these costs, sometimes it happens that the price of products becomes so high that the consumer rejects it.
(6) Supply of the Product:
If the supply is less than demand, then the price of the product will be more.
(7) Achieve Planned Return on Investment:
While fixing the expected rate of return, the cost of the product, inflation rate, profits desired, etc. are taken into account.
(8) Availability of raw materials in the domestic market will generally enable the firm to bring down cost of production. The firm can fix a low selling price.
(9) Profit Expectations:
If the firm expects higher price per unit of the product, they may charge a higher price for the product.
(10) Trade Barriers:
Trade restrictions such as duties, taxes and quotas would increase the price of the product and the firm fixes a higher price to recover the taxes and duties.
(11) If the brand is very popular among consumers, the manufacturer can charge a higher price for the product.
(12) If the purchasing power of the consumers is high then the company can charge a higher price for the product.
(13) Promotion cost would normally increase the selling price as the company would like to recover the cost from the consumers.
(14) Research and Development:
Many large organisations spend millions of rupees in developing new products and new processes and would like to recover the cost of research by increasing the price of the products.
(15) Legal constraints, Government interference-such as control of prices, levying of taxes etc. are other considerations which also affect the pricing of the products.
Factors Affecting Pricing Decisions in Marketing Management (Examples):
Example # 1. Objectives of the Business:
The management has to review the objectives of the firm as they are the real deciding factor. A firm may have alternative objectives such as a suitable return on the capital employed, maximisation of sales, capturing market from competitors, etc. The price should be fixed keeping in view all these factors.
Example # 2. Cost of Goods:
The price charged should cover the unit cost of production and earn a reasonable profit. No firm would want to operate at a loss. The cost of manufacturing is a key factor in determining the price of a product. The firm may adopt a cost-plus strategy, target pricing or break-even pricing according to its policies.
Example # 3. Market Position:
The position of the firm in the market and the nature of prospective buyers will influence the price. If customers belong to elite class and competition is low, the firm may adopt skimming. In case the product is for middle class and there is high competitiveness in the market, the firm will fix a lower price.
Example # 4. Competitor’s Price:
The organization will keep in view the prices adopted by its close competitors. If the company fixes a price that is much higher than that of the competitors, then people would not be attracted towards this product. But at the same time, he should not fix a too low price as people will suspect that the goods are not of high quality. A price near to the competitor’s which also provides for some profits should be chosen.
Example # 5. The Marketing Policies Pursued by the Sales Organization:
It is important to consider the channels for distribution selected to market the products. The longer the chain of distribution, the higher is the margin added to cost in fixing the price.
Warranties and after-sale service facilities attached to a sale also have a bearing on the pricing of goods. Proper adjustment should be made for regular or irregular rebates, concessions, cuts or other reductions in prices, allowed to customers as an incentive to promote sales.
Example # 6. Governmental Policies and Legal Restrictions:
Sometimes, the government may announce a general policy about pricing of goods. The government may specifically fix and control prices of goods like coal, sugar, petrol, etc. Under these circumstances the sales manager has little or no control over the prices and he has to fall in line with the public policy. There is also a legal restriction imposed on the maximum retail price that can be charged by the producers.
Factors Affecting Pricing Decisions:
When one starts thinking about factors affecting pricing decisions, the first and foremost is the consideration of costs and profits but this can lead to various problems of consumer acceptance and stabilizing sales volumes.
To take care of these problems, one must consider the following factors that affect the pricing decisions:
(a) Current Demand for the Product:
Current demand of the product decides the pricing decisions. Current demand can show three variations normally that can be explained as follows-
i. Steady Demand- When the demand is steady, prices are maintained at the same level as competition.
ii. High Demand- When the demand is high, prices can be increased to get higher profits.
iii. Low Demand- When the demand is low, prices should be maintained at the same level even if the competitor increases them. The other alternative is to maintain prices on par with competitors, but keep offering consumer promotions to attract more customers and increase demand.
(b) Current Supply of the Product from Various Sources:
Current supplies can be of three types normally as follows-
i. Steady Supply- When the supplies are steady, prices remain steady.
ii. High Supplies- When supplies are high, prices drop in the case of commodities but in the case of FMCG, the marketing manager will offer consumer promotions and hold the price levels. This helps him attract more customers as the customer effectively sees the product dropping, as additional benefits in terms of promotions come with the product.
iii. Shortages- During shortages, commodity prices go up but in FMCG it is a time to consolidate hold on the consumers by increasing loyalty of the consumers. So the marketing manager ensures steady supplies to the customers, which may be at lower quantities.
(c) Pricing of Competition:
Pricing of competition plays a major role in pricing decisions.
Price decisions are strategically taken in the following ways:
i. Follow the Leader:
When the competitor is stronger than your product and is the market leader with higher market share than your market share, marketing managers always follow the leader in pricing decisions and maintain the price parity.
ii. Premium Pricing:
If your product is the market leader, you can maintain premium pricing to earn more profits than the competitor as the customers are willing to pay premium for the popular product.
iii. Lower than Competitor:
When your market share is much lower than the market leader, it is advisable to maintain prices lower than the market leader and attract consumers because of the saving achieved.
iv. Market Penetration Pricing:
In a highly competitive market with many players, the marketing manager may use this pricing policy that helps him enter the market and establish its position. In market penetration pricing, the product is offered to consumers at nearly the cost price so that the difference between the product and the competitor is very high.
This attracts customers for trials and if the product is found to give higher returns than the price paid, many customers switch over to this product. The marketing manager may increase the price of the product gradually.
v. Market Skimming Pricing:
When an innovative product is introduced in the virgin market, where market entry barriers are absent and entry of competition is a matter of time, the marketing manager can use this strategy to earn maximum profits due to its innovativeness. The marketing manager may not change the price after entry of the competitors, but offer high consumer Pull promotions to maintain sales volumes, making it difficult for the competitors to establish themselves.
(d) Objective behind Pricing:
Objective pricing is basically simple and that is to earn maximum profit by selling the product. This is possible when the consumers are waiting to buy your product and you have monopoly, but normally that is not the situation and one needs to take pricing decisions based on various objectives.
The following pricing decisions are found to be in force:
i. Profit Maximization:
Organizations work for the single most important objective of making profit and lots of profits at that. Getting very high profits is possible only if the product is essential and the organization has a monopoly. If the market is competitive, there are limitations on the price and so profit maximization comes in. The marketer has to price the product in accordance with the pricing of the competitor.
ii. Price Acceptance:
When the product is not an essential product, the marketer cannot keep a high price even in monopoly situations as the consumers may not accept the product at a price higher than their expected value of benefit in return. So the marketer needs to find out the price at which the consumer will readily purchase the product. A consumer market research survey will give an answer to this.
iii. Market Entry Pricing (Market Penetration Pricing):
When the market has strong competition with very high market share, it becomes difficult to attract the customers towards a new product with ‘me too’ qualities. So the marketer needs to create a USP and if he cannot create any product feature giving better benefit, he can go in for low price entry that creates a money-saving attraction for the consumer and the chances of the consumer trying and adapting a new product increases. In this situation, the saving needs to be substantial and attractive.
iv. Superior Quality Image (Premium Pricing):
If the marketer can create a superior product quality image for the product, he can go in for premium pricing where the marketer can say that the ingredients are of superior variety and give better benefits to the consumer that suit the premium price.
For example, when BOOST was launched, it talked about being ‘more creamy and more chocolaty’ and so was launched at a premium price even when the competitor Bournvita was holding a near 100% market share.
When HUL launched ‘Dove’ they also advertised it to have superior quality ingredients and so it was launched at a high price and it continues to be priced at a higher level than all the soaps in the market.
v. Blocking Competition Pricing:
A brand leader who is ruling with a high market share can decide to work on wafer-thin profit margins and sell the product at a very very low price, making the entry in the market difficult for new products (because of high investment cost and marketing cost to establish).
This way it becomes very difficult to enter the market and challenge the market leader. For example, Parle Glucose is being sold at an unbelievably low price and so no new product has entered this market to challenge their monopoly for many years.
Factors Affecting Pricing Decisions (With Impact):
The setting of the price will depend on the factors affecting the pricing decisions.
Let us look at these factors one by one and their impact on the pricing decisions:
I. Determining Demand:
The first step in determining the demand is to decide the segment of the market where you want to position your product. While discussing the product development we have seen that the choice of segment will lead to minimum required features and the benefits that the customers will expect from the product and the price that customers in this segment will be willing and capable of paying.
The choice of segment also tells us the profile of the customer and the number of customers present in the segment in a given area. Market research will let us know the consumption pattern of these customers and therefore the frequency of purchase of the product and the monthly expected demand for the product. A good marketing research agency will give you these figures authentically.
The following are some of the reputed market research agencies-
i. AC Nielson
ii. ORG-Marg
The market research agency will also tell the marketer whether the demand is growing, stagnant or reducing. Depending on the condition of the demand, the marketer will decide the pricing strategy and promotion strategy.
II. Determining the Current Supply:
Once current demand is established, one can do research on the current supply position.
The market may have the following conditions:
i. No Supply:
In such a condition, the marketer has a pioneer advantage position. If the product idea is acceptable, he can have premium pricing strategy to skim the market till such time that competition sets in, when he can reduce the price to make market entry difficult for competition.
If the product is a new concept, the marketer will be required to do concept selling that requires high costs. Again the marketer will be required to sell the product at a high price to cover extra marketing costs for concept selling.
ii. Not Adequate Supply from Few Competitors:
The competitor can enter the market with the ‘ME TOO’ pricing of the market leader. Since the market is starved, acceptance will not be difficult.
iii. Adequate Supply from Few Competitors:
In such a situation, the marketer will be required to enter the market with a ‘Penetration pricing strategy’ i.e., keep the price lower than that of competitors to make the customer aware of low price – better quality or low price – same quality condition.
iv. Full Supply from Many Competitors:
Here the marketer needs to decide whether to enter the market and fight competition to gain market share. He should do so if the market is growing at a good rate, but if the market is not growing, he should think twice before entering the market.
To enter the market, he needs to use Product Differential Policy where he gives the customer the same product with a big difference and more benefits. This will attract the customers towards the product and the chances of success are higher. E.g. Dove.
v. Analysis of Suppliers:
In case of Industrial/Institutional products, one more aspect is required to be considered, viz., who are the current suppliers and is the customer happy with the current suppliers. The analysis will tell the manufacturer whether he has any chance to enter the market and get orders from the customers.
III. Analyzing Competitor’s Pricing:
The marketer will analyze the competitor’s pricing policy to understand the reasons and objectives behind the pricing adapted by the competitor.
i. There is always a chance that the competitor is pricing his products at a very low price as he is the market leader with a very large market share. This way he can block the market entry of any competitor.
For example, Parle Glucose. In such a situation, the marketer is required to analyze whether he can sustain losses for a long period of time till he gets enough market share, to make it economical to sell at a low price.
The marketer can come with product differential policy and charge a higher price but then he will be required to spend a lot of money educating the customers that his product is better in quality than the competitor’s and so they should pay more for his product.
ii. There is also a chance that the competitor is using market skimming price. The marketer can enter the market at a much lower price and give price advantage to the customers and capture a large market share.
Caution is required in such a condition to ensure that consumers do not think that the price is substantially low which means quality must also be low. In India, most customers have this mentality. Imported products/high priced products mean the best quality.
For example, when Videocon entered the refrigerator and other products market, it had a cost advantage of ‘Tax Holiday’ for fifteen years because the factory was established in the economically backward area of Ahmed Nagar district. The current players then were Godrej, Kelvinator, Voltas and Alwyn etc.
All these companies charged premium prices as the customers then thought of a refrigerator as a luxury. Videocon priced all its products low and marketed them well to gain a market leader position in all the categories. Videocon maintained its market leader position for many years till Whirlpool and LG dethroned it on the quality aspect.
IV. Selecting Pricing Method:
Depending on the demand, supply and competitor’s analysis, the marketer then selects his pricing method/strategy to decide the price and promotions.
The following methods are common:
a. Mark-Up Pricing:
Mark-up pricing is the method in which the price is determined in the method of pricing based on cost calculations.
Mark-up pricing method is used for commodities in India by traders where they add all the costs to the purchase price (storage, inventory cost, damages caused in storage, thefts, insurance etc.) along with the desired profit percentage before deciding the selling price.
In western countries where government regulations about MRP (maximum retail price) are absent, the retailers decide their mark-up price and so the same product is available at differing rates in different retail outlets. In Walmart, the entire product range is at the lowest mark-up price.
b. Value-Based Pricing:
Value based pricing needs consumer research to find the consumer’s perception about the product. The pricing is based on the perceived value of the product by the consumers. E.g. when an organization selling coconut hair oil adds paraffin to it in equal quantity, the price of the final product should drop as paraffin is priced much lower than coconut oil.
But in actual effect, the coconut oil with paraffin sells at a much higher rate than pure coconut oil as consumers perceive its non-sticky quality at a much higher rate.
Similarly, most of the luxury products are priced at a much higher price than their production cost as consumers perceive them to be of a higher value.
c. Target Return Pricing:
In this method, the manufacturer decides the quantum of profit he wants to earn and sets the price based on expected sales levels. If the targeted sales are achieved, the manufacturer gets his targeted profit. If more sales are achieved, he gets more profits and if lower sales are achieved, he gets lesser profits.
d. Going Rate Pricing:
This method of pricing is used when there is competition already present in the market. The marketing manager decides to sell the product at an average price of the similar products available in the market. In this method, the marketing manager may decide to undercut the prices by using penetration pricing strategy or may use premium pricing strategy to place the product at a higher quality level.
V. Estimating Costs:
Depending on the demand, supply position and the competitor’s price analysis, the marketer will finalize his market entry strategy and the promotional strategy and work out the cost required. Indian entrepreneurs look for breakeven to be achieved in a short period of a maximum of two years because there are very few Indian products which are launched on a large scale and become successful.
Multinationals are willing to wait and watch for a longer period of time and are willing to keep spending money on new products for many years. Multinationals are happy if the product achieves breakeven in five years.
VI. Setting Pricing Objectives:
Setting pricing objective is a strategic decision decided by the management on what they want to achieve through the launch of the product. Various pricing objectives can be listed as follows-
Survival- In this case, the organization lowers its prices to survive the onslaught of the competitor as a short-term strategy or sometimes long-term objective to keep getting sales, maybe at lower profits.
Profit- An organization may decide at a particular profit level irrespective of sales volumes.
Sales- The organization may decide a particular volume of sales and decide pricing based on that volume of sales. It can decide high price at a low volume of sales and low price for a high volume of sales.
Status Quo- In this objective, the marketing manager maintains price levels in comparison to competition and holds on to the market share without losing it.
VII. Value Chain Analysis:
The pricing also depends on the analysis of value chain. The method was introduced by Michael E. Porter who proposes that a superior value chain can lead to reduced costing and higher profits. If the organization’s value chain is superior, the organization can also demand premium price for its products benefiting from both sides – (a) reducing the cost and (b) demanding premium price.
Value chain activities include-
(a) Inbound Logistics- Ordering, receiving, warehousing inputs (such as raw materials), then distributing them to operations as needed.
(b) Operations- Transforming inputs into finished products and services with high quality at lower costs.
(c) Outbound Logistics- Warehousing/distribution of finished goods, without any stock-out situations or high inventories at any point.
(d) Marketing & Sales- Identification of customer wants/needs, creation of sales through proper promotional activities.
(e) Service- Customer support before and after the goods are sold. The activities that are included-
i. Installation of machinery
ii. Training of machine operators
iii. Rectifying the settings to suit the purchaser
iv. Providing maintenance support
v. Providing spares
(f) Firm Infrastructure- Structure, leadership, control systems, and company culture.
(g) HR Management- Recruiting, hiring, training, compensation.
(h) Technology to support value-creating activities- Research and development of existing and new products.
(i) Procurement- Purchasing inputs such as materials, supplies, equipment.
VIII. Selecting Final Price:
Selecting the final price becomes a mere formality after doing all the above steps.
Adapting the Price:
Adapting the final price is different in different industries. In the consumer industry where MRP (Maximum retail price) is compulsory from the government authorities, the same price pan India becomes a rule.
Some organizations had tried to use geographical pricing which led to confusion in the minds of customers and resulted in the loss of sales. For industrial and institutional products where there is no MRP, prices can be adapted in different methods. Let us look at various pricing methods.
In geographical pricing, different prices are planned for different geographical regions.
The reasons behind this can be listed are as follows:
(a) Variations in Tax Rates:
In India, the government is trying to bring in uniformity in tax rates by introducing VAT earlier and now the GST (goods & services tax). Earlier, the tax structures in all the states were different for different products and that led to products moving from one state to another without any papers and people making money with complete loss to the state government whose taxes were high.
Currently, also with taxes on fuel having high differentiation within two states, the truckers pick up the maximum quantity of fuel in a state where the prices are low and avoid buying fuel in that state. For example, Maharashtra has very high VAT on fuel and truckers buy high quantity of fuel before they enter Maharashtra.
The variation in tax rates leads to differences in the final consumer price for commodities and illegal border crossing of products in packaged commodities (FMCG).
(b) Significant Difference in Transport Costs:
In commodities and raw materials and machineries where the transportation is added to the basic price while supplying to customers, the end price changes from customer to customer on the basis of the significant differentiation in the transport cost.
This is one of the reasons why the industry chooses to be close to the source of raw material, if the quantity of raw materials required is substantially high. For example, steel industry is located near the source of iron ore and supply of coal.
(c) Variation in Channel Structure:
Change in channel structure affects the pricing to a great extent as there are profit margins of the channel partners and depends on the number of channel partners between the manufacturer and the customer (levels of distribution channels). For example, the products in defense canteens are much cheaper because of the change in channel structure and the tax differences.
(d) Collaboration with Local Organizations:
When an organization is engaged in international sales, there is difference in pricing between products exported and products manufactured in that country with collaboration of the local organization. The reason behind this is due to the saving on import duties and transportation costs.
(e) Strategy to Fight/Take Advantage of Local Competition:
Organizations can have a different pricing structure as a strategy to fight competition in a particular location. For example, they can have a low price to fight competition or can have a higher price for taking advantage of not having competition (monopoly).
Depending upon the product and market conditions, the manufacturer can decide to offer price discounts and allowances to the customers which are a part of negotiating the purchase deal with various customers.
Basically, this kind of price adaptation is a part of industrial/institutional selling practices where pricing is a part of the negotiations of the supply contract. In such a pricing, all the pricing elements are quoted differently along with the base price. For example –
i. Base price for product ‘X’ is Rs. 10,000/-.
ii. Add excise duty @ 10% – Rs.1,000/-.
iii. Add installation cost @ Rs.3,000/-.
iv. Add Vat@ 12% – Rs. 1,680/-.
v. Add Transportation – Rs.2,500/-.
vi. Add annual maintenance contract (AMC) Rs. 2,500/- per visit (minimum one visit) with cost of spares extra.
vii. Add training of operators @ Rs. 2,000/- per operator.
While negotiating the final price, the sales person offers discounts and allowances depending on the quantity being negotiated, long term association expected with the customer, payment terms being negotiated etc. The sales officer will give some of the above named items free to customers and negotiate higher quantity.
The objective here is to extract the maximum price even if the items may have already been added while calculating the base price. The sales person who negotiates the price at the highest level with maximum quantity is then rewarded in terms of incentives.
Discounts and allowances can be a part of the pricing for FMCG products on a regular basis.
The manufacturer can offer various discounts that can be listed as follows:
i. Quantity Discount- Any customer who is purchasing a quantity more than a stipulated quantity, is offered discounted pricing to motivate him to keep doing so.
ii. Payment Policy Discount (Cash Discount)- In industrial sales, most of the customers have a policy to pay the suppliers after 90 days. To motivate them to pay on delivery or in advance, sellers offer cash discounts to the buyers in accordance with the interest rates operating in the financial markets.
The manufacturer can also offer certain allowances as a pricing policy to the FMCG customer which can be listed as follows:
(a) Sales Staff Allowances:
Sending company sales staff proves to be very expensive as the business and profit generated by the company sales staff and the salaries paid to them do not match. But not giving regular service coverage to the retailers/customers can lead to competition gaining advantage and loss of sale permanently.
To avoid this, many manufacturers offer fixed or variable allowance to their channel partners towards appointment of interim coverage sales staff allowance. By way of this, they ensure that channel partners appoint exclusive sales staff who give coverage to retailers/customers in absence of the company staff.
(b) Van Working Allowance:
Sales staff working ready stock has many inherent advantages. Most of the companies/channel partners avoid this process as it involves higher cost if not properly done. This is more so when selling is done in the rural markets. Rural market working involves travelling up to 40-80 kms a day but achieves visit to only 15-30 retailers/customers.
Booking orders and then supplying them for products having high volume/value sales per customers is possible but when the product value/volumes are small per customer, it becomes uneconomical.
Many times when brand loyalty and product differentiation between competitors is low, the customer may purchase an alternate product and refuse to accept delivery of stocks ordered earlier leading to costs without effecting sales.
To avoid such incidences, most of the organizations interested in rural market coverage offer van working allowance to their channel partners. The organizations may offer fixed per day/route allowance every month or sometimes send their own promotional vans regularly to ensure rural market coverage and sales.
When Hindustan Unilever found that their volume sales were lower than Nirma due to non-availability of their products in the rural markets, they initiated rural promotional vans through their channel partners that demonstrated the product superiority of ‘RIN’ by showing promotional advertising films to gain rural market share. They then introduced lower priced products for rural markets – ‘Wheel’ and ‘Lifebuoy’ to regain market leadership in both urban and rural market.
When Colgate-Palmolive discovered that they were number two in volume sales as ‘Pepsodent’ had overtaken them due to their rural market presence and absence of Colgate in the rural market, they initiated rural market coverage through their channel partners giving them specific van allowances.
Visual Publicity Allowance:
Many organizations offer visual publicity allowances to their channel partners on the basis of the turnover achieved by them. These visual publicity allowances can be used in various ways by the channel partners.
Popular amongst them are:
i. Street Hoardings with Channel Partner’s Name as Exclusive Dealer:
Most of the electronics goods and white goods organizations follow this policy of offering allowances for putting up street hoardings at strategic locations in the area of operation of the channel partners. The reasons behind this are very simple.
The channel partner gets motivated to sell the organization’s products over and above those of the competitors.
a. The channel partner starts getting identified as an exclusive dealer of an organization’s products.
b. The channel partner is the right person to choose the right location in his town/area of operation.
c. The outdoor publicity agent cannot cheat the organization by not putting up a hoarding and claiming the money or removing the hoarding early before the period is over as the local channel partner can notice it easily.
ii. Shop Signage:
Shop signages are becoming a common method of giving visual publicity allowance as there are no rentals involved and it gives an amount of visual publicity spread over in the cities and towns. All sorts of organizations are using this type of visual publicity allowance, more so liquor and cigarette companies as they are otherwise prohibited from doing visual publicity.
iii. Display Windows:
Organizations offer allowances for hiring display windows at various locations with high footfalls of various types of customers. For example, airport lounges, railway platforms, shopping malls, multiplexes etc. In these display windows also, the local channel partner’s name is used for the reasons stated above viz-
a. The channel partner starts getting identified as an exclusive dealer of the organizations products.
b. The channel partner is the right person to choose the right location in his town/area of operation.
c. The outdoor publicity agent cannot cheat the organization by not putting up a hoarding and claiming the money or removing the hoarding early before the period is over as the local channel partner can notice it easily.
d. Local Promotions Allowance: Many organizations offer local promotional allowance that is linked to the value/volume sales of a particular product. The channel partner can use this allowance for various local promotions that can be used to push the product sales considerably. For example,
e. Healthy baby contests sponsored by channel partner of baby food manufacturer with banners of baby food being displayed at the venue.
f. Products being promoted at local clubs, restaurants exclusively require fees to be paid to the club/restaurant management. For example, soft drink displays being given free, ice boxes, glasses being supplied free to restaurants with liquor logos.
g. Cosmetics being promoted through beauty parlours need to be given with higher discounts to the parlour owners.
(d) Sales Staff Uniform Allowance:
Various organizations keep exclusive sales staff in showrooms of channel partners to sell their products. Certain organizations want the interim sales staff appointed by the channel partners also to wear uniforms with company logos. These exclusive sales staff are given uniforms with the company logo to identify them with a particular company.
Organizations pay the channel partner towards this expense as sales staff uniform allowance. E.g. Pizza delivery boys, courier company sales staff, LPG delivery staff, soft drink van salesmen, cosmetic counter sales girls, electronic goods showroom sales staff etc.
(e) Transit Damages Allowance:
Instead of going in for transit damages insurance, various companies go in for directly paying the channel partner a fixed percentage of the invoice as transit damages allowance, especially when the channel partner is transporting the goods by himself.
This way, the channel partner ensures safe transit of goods and a little extra money for him by way of keeping the transit damages lower than the allowance paid. So it is a win-win situation for both.
(f) ROI Adjustment Allowance:
This allowance is rare but is being given by some organizations to get better quality channel partners. When the distributors are not convinced of good ROI in distributing a particular company product they refuse to become distributors for the company.
In such conditions these companies offer them a minimum ROI guarantee and ask the sales staff to prepare a report every month and raise a credit note whenever the earnings are less than guaranteed.
Promotional pricing is defined as lowering of the price of a product temporarily to attract more customers and increase sales efforts. This lowering of price is a temporary action.
Following types of promotional pricing methods are used:
i. Price Offs:
Many organizations use this method of giving a price off on a pack as a Pull promotion to attract customers to purchase the product. These price offs can be offered in different styles. For example-
i. Single unit with price off.
ii. Buy one get one free offer (BOGOF)-
iii. Two, three, four units combined to get a price off.
iv. Two three four units combined with additional unit as free (four at the price of three).
v. Value purchase discount (buy goods worth Rs. 3000 and get 30% off).
ii. Free On-Pack Promotions:
Giving free on-pack promotions is a very popular form of giving price offs. This helps the marketer to get an opportunity to spend less and give more to the customer. The on-pack free offers are always procured by the marketer at a very low price due to the quantity discounts secured by him and the tax waiver on the free item being offered.
But the customer perceives the free pack’s value as the rate he/she would purchase it. E.g. Toothbrush free with the toothpaste.
iii. Discount Coupons:
Discount coupons are offered in various ways to customers and some of them can be as follows:
a. Newspaper Coupon Distribution- Coupons can be inserted in daily newspapers so that they reach all the households in a given area of operation. There is a validity period/date on the coupon and after producing this coupon in a retail store, that much money is deducted from your purchase bill. These coupons can be directed towards a particular product/particular company’s products or any purchase in the particular stores.
b. Discount Coupon through a Contest- An organization can declare some kind of contest for the customers, say, ‘Suggest a slogan for a product’ or ‘Write in one line why I like this product’. Every customer participating is given discount coupons and the winning customer gets a bumper prize.
c. On-pack Discount Coupons- Discount coupons can be distributed on- pack and these coupons can be en-cashed on the next purchase within a given period of time.
d. Purchase Value Discount Coupons- Some stores will offer discount coupons on the purchase of a particular value say ‘on the purchase of Rs.3000/- a discount coupon of Rs.1000/- free’. These coupons also need to be en-cashed in the next purchase within a given period of time.
iv. Scratch Cards along with the Pack:
Scratch cards are distributed on the pack with every product and these scratch cards can have various discount values printed on it. The customer, on scratching the card finds out the value of the discount that is deducted immediately from the bill.
v. Mileage Points:
Travel service organizations especially airlines give these mileages travelled by the customer. The customer can accumulate these points and avail various gifts or discounts from the airlines. This is one way of ensuring loyalty towards the airline.
vi. Loyalty Discounts:
Normally these discounts are offered on service products. E.g. Credit/debit cards, hospitality, chain stores etc. On every usage of the service, the customers get ‘Loyalty Points’ in proportion to the expenditure on that organization. The customer can accumulate these points and then either take a discount when purchasing the service the next time or get gifts worth those points.
Differentiated/Discriminating Pricing:
A manufacturer may offer differentiated prices for different customers based on various aspects which is called differentiated pricing or price discrimination.
Price discrimination/differentiation can be on the following points:
i. Quantity:
Discrimination based on the quantity purchased is a common method. Customers buying a higher quantity are given higher discounts/lower pricing.
ii. Quality:
Lower quality products are sold at a low price and higher quality products are sold at higher prices. For example, products are categorized into normal, superior, premium and executive and sold at prices going upwards from normal to executive. This is seen in the case of undergarments, textiles, hotel rooms etc.
Prices of food and rooms vary as per the quality gradations declared for them. For example, Grade I restaurants will charge high price for all the dishes while Grade V will charge the lowest. Similarly, five star hotels will charge the highest price while two star hotels will charge the lowest.
iii. Caste/Social Class:
Prices are discriminated on the basis of caste/social class of the customers. E.g. Backward classes and castes pay lower fees for education, competitive examinations etc.
iv. Sex:
Prices are discriminated on the basis of the sex of the customer. For example, women customers are allowed free entry for all sorts of dance parties and discos while male customers are required to pay a high entry fee.
v. Age:
Prices are discriminated according to the age of the customer. For example, children below three years are allowed free travel and children below twelve are allowed fifty percent concession on all travel charges and also in buffet lunches and dinners. Senior citizens get fifty percent concession on all government owned transport like railways, state road corporation buses etc.
vi. Time:
Price discriminations are seen during various timings. E.g. Multiplex tickets are cheap in the mornings and costly for night shows. Restaurants offer ‘Happy hour’ discounts on liquor in the early mornings and afternoons.
vii. Location:
Hotels at scenic locations charge the highest price and hotels in crowded locations charge lower prices. Hotels in the business district will charge high rates and hotels in residential places/by lanes will charge low prices.
viii. Place:
Prices for different places are discriminated upon. For example, in a cinema theatre, the front rows are charged less and back rows/balconies are charged more, while for drama theatres, front row charges are the highest while back rows are charged less.
In a restaurant, places with a view or privacy are separated and are charged a higher price.
ix. Season:
In the off-season, discounts are offered for various goods and services and in the peak season the rates soar to the highest level.