Discuss the steps involved in setting pricing policy.

1) Specify Pricing Objective-
Pricing objectives refer to the targets to be achieved via pricing strategies in the marketing plan. These should be clearly outlined in quantitative terms so as to be understood by all the members involved in pricing decisions.

Depending on the challenges a firm faces in the market, the objective can be either of these – survival, maximise current profit, maximise market share, product-quality leadership. These objectives can be short-term or long-term.

a) Short term pricing objectives-
• Attracting new customers, middlemen, etc.
• Generate interest in the product
• Discourage competition
• Sales or profit growth
• Rapidly establish market position
• Meeting competition
• Maintain market share
• Promote new products
• Recover costs of a product in decline stage
• Secure key accounts

b) Long term pricing objectives-
• Stabilise industry prices
• Market share growth
• Maximise long-run profits
• Strategic pricing in different markets
• Retaining or capture market share
• Maintain price leadership
• Maximise return on investment
• Product and quality leadership

Whether the objectives are long term or short term, they should be clearly defined and easily understandable.

2) Determine Costs –
There is a close relationship between price and cost. The organisation strives to make profits to ensure the various costs it incurred in production and marketing of the products are covered. Careful analysis of costs need to be done to make profits. Many firms fail to set price basis the costs believing that the costs will be covered over a long term through economies of scale. Costs incurred at various stages of product development including the services from departments other than production like legal Consultants, market research, finance, etc., promotion activities, and inflation should be carefully accounted for pricing strategy.

A company incurs two forms of costs – Fixed costs and variable costs. Fixed costs are that which the organisations incur irrespective of the production or sales revenue. These include staff salaries, property tax, interest, rent, etc. not dependent on production or sales. Variable costs vary with production. Less the production of units will result in decrease in costs.

It has been observed that with increase in production and experience, production costs decline due to the learning curve effect. Many times organisations set the price below the initial total cost. As the sales and production increases, the costs decrease with experience. If this is not taken into account and the price is set higher, there is increase in profits which attracts competition. The profits earned this way are generally short run. It is therefore important that the organisations understand the cost theory.

The management should consider the probable production stages, manufacturing improvements that result from experience, variable and fixed costs for proper estimation of costs.

3) Evaluate Demand –
The lower limits of price are set by costs and the upper limits are set by demand and competition. The law of demand states that Price is inversely proportional to demand. Increase in price will lower demand, and decrease in price will increase demand provided all other relevant factors remain constant. This does not holds true in all the cases. Sometimes price reflects product quality like in prestige goods. Customer responses to different price levels are difficult to estimate. Marketers use market opportunity analysis and demand estimation methods to evaluate demand.

Change in demand is studied with increase in price. A small percentage increase may not affect the demand largely but a significant increase in price may decline demand substantially. The response of demand to price change is measured by price elasticity of demand. It is the relationship between changes in sales with the percentage change in price. The changes at alternative price levels are studied closely.

According to the product type, the demand elasticity also changes. Elasticity is the result of consumer behaviour. Increase in price of Petrol or Diesel fuel didn’t affect the sales of large vehicles. The affect was very insignificant.

According to Prof. Kotler there are many reasons for less elastic demand –

• Less or no substitutes, competitors
• Buyers fail to notice the price change
• Buyers are slow to change their buying habits
• Buyers think the price raise is fair

The buyers may continue buying the product at an increased price but not for a longer period. They will eventually switch to substitute or competitor products. The response of customers to prices must be evaluated for the total market. Reducing the price may increase sales but it should justify and should be beneficial for the organisation in the target market.

4) Evaluate Competition –
Most of the time, organisations set their price basis the price of the competitors. They set the price above the competition, below the competition or at par with the competition. For this the organisation must study the industry structure it operates in. The organisation may change the price irrespective of costs incurred just because the competitor has done so. The organisation should compare the product features with substitute and competitor products. Then basis the value and benefits offered by the product, the management should set price of the product. If the product offers more features, the management can set a little higher price and vice versa. If the products in the market are similar, competition becomes intense and leads to price wars. As customers can easily check prices of products from different manufacturers, study of competitor’s prices becomes essential.

5) Select Pricing Method –
Once the organisation has analysed Demand, Costs and Competition, it initiates the process of setting the price. Organisations choose from any of the below pricing methods –

1. Cost Oriented Pricing method – Costs form the base of price range and there are two commonly used methods of setting the price – Cost-Plus/ Markup pricing and Target Return pricing.

1.1 Cost-Plus/ Markup Pricing – It involves adding an additional percentage of profit to the sellers per unit cost of the product. The profit or markup is percentage of the selling price instead of the cost. The following formula can be used to determine the price-

Selling price = Average unit cost/ (1 – Desired markup percentage)

If the average unit cost is $10 and the markup is 20%, then the selling price will be $12.5. [10/1-0.2).

This method is successful only if the marked-up price generates expected sales. The major drawback of this method is that it ignores the demand, competition and perceived value of the product.

This method is popular in retail and wholesale trade. It depends on the type of goods. The markups are set higher on seasonal goods, speciality goods, goods with high storage and distribution costs, goods with inelastic demand like medicines. Premium goods will have a higher markup as compared to ordinary consumer goods.

There are benefits of using this method. It avoids price wars as competition is not taken into account. The costs are identified and taken into consideration which is easier to analyse as compared to demand and competition. As demand is not considered for setting a price, the consumers are charged fairly. Else the price will be set higher if the demand is severe in the market.

1.2 Target Return Pricing – In this method the price is set such that the profit would give a target rate of return on the investment (ROI). It determines the level of sales needed to cover all the costs. The firm tries to determine the price at which it will break even or make the target profit it is seeking. The fixed and variable costs are determined before setting the price.

Target Return Price = unit cost + [desired return*invested capital/unit sales]

Target return pricing is based on break even analysis.

Break-even volume = fixed cost /(price – unit variable costs)

Different prices are considered and their impact on sales and profits are estimated.

This method ignores the market demand and is solely derived from costs. But it helps ensure that the price set exceeds the costs which helps in earning profits.

2. Demand Oriented Pricing method – Demand cannot be ignored while considering pricing decisions. What customer thinks about the product (perceived value) and the market demand is given importance in this method. There are two ways of setting prices under this method – Perceived value pricing and Value pricing.

1.1 Perceived value pricing – in this method the price is set either matching or lower than customer perceived value of the product. The organisation invests in promotion activities like advertising and sales force to communicate and educate customers on the perceived value of the product. For consumer products, it is based on psychological pricing strategy. Many times customers are willing to pay higher price depending on their perception of quality for which they are paying. It becomes essential for organisations to conduct market research. The data collected through research should give a realistic estimate of the market’s perception of the value of the product. Perceived value can be based on brand image, product value based on its performance, quality, distribution network, after sales service, etc.

For example, an electronic manufacturer created a temperature sensing device. Unsure of setting the price, the organisation conducted a survey on their expectations as compared to similar or same products in the market. It was learned that the existing products were not as accurate. The customers showed great interest on the reliability and accuracy of the product. This helped the organisation price the product little higher that the competing product in the marked based on customer perception. The organisation’s product was more accurate than those available in the market.

The organisation should strive to deliver more value that the competitor’s product and communicate the same in the target market.

1.2 Value pricing – the price is set lower that the value being offered to the customer. The price is generally lower as compared to the high quality of the product. Reliance Jio is adopting this strategy for providing high speed internet at fairly lower price than its competitors. Other examples include pricing strategy adopted by Wal-Mart, Big Bazaar. Every day low pricing (EDLP) is another value pricing tool used at retail level. There are no special sales or promotions done. In high-low pricing, the prices are set higher for a longer period but promotions are done to sell products even lower than EDLP for a certain period. Big Bazar sells products at lower prices on Wednesdays. The ecommerce giants like Flipkart and Amazon have low prices for products on festival days (Flipkart’s Big Billion sale on Diwali festival in India generates revenues in billions on a single day).

1.3 Demand-Modified Break-Even pricing – in this method the demand estimates in conjunction with break-even analysis and setting the alternative prices to achieve the highest profit. The estimates of market demand are required at feasible price. Then break-even points and expected total sales revenue is calculated. Here the primary challenge facing the organisation is obtaining the right estimate of the price and quantity relationship. For example, a unit sold at $5, $7 or $10 can generate break-even at different profit earnings depending on the demand forecasts. The organisations can do analysis on historical data, conduct direct customer interviews to check their response for different prices, or conduct in store experiments where consumers make purchase decisions.

3. Competition Oriented Pricing method – although an organisation cannot overlook the demand and cost factors when setting price, many organisations set the price of a product in relation to the competitors prices.

1.1 Going-Rate pricing – the price of the product is set equal, above or lower than that of the competitor. This method is more popular in cases where costs are difficult to measure and demand has no relation with the price. The organisation believes that the market leaders are better able to set the price. This method is also more suitable when costs and demand are stable and have minimal effect on sales and profits.

1.2 Sealed-bid pricing – the firms bid the lowest to increase the odds of being selected. The firm sets a price anticipating how the competitor will respond instead of relying on the costs and demands associated with production. The organisation can win the contract which requires pricing less than other firms. However, the cost factor cannot be ignored as the firm is in the business of making profits.

4. Auction based pricing and Group pricing are also becoming popular with the increased use of internet.
The above methods narrow down the approach in setting the final price. However, other pricing methods also should be considered.

Psychological pricing –the law of demand is now always successful for making sales and profits. Customers are influenced via psychological pricing methods like odd-even pricing ($19.99), pricing the product highlighting the quality, etc. Customers usually estimate the price of a product based on their past experience or noticing the prices at some places or media channels. The sellers try to tab on these perceptions and manipulate these reference prices. They may display the product among prestige and expensive products, etc.

Influence of other marketing mix elements –Price can also be set basis the brand image, quality, advertising, etc. in relation to competition. If an organisation has invested heavily on advertising for an average quality product, consumers are willing to buy a product that is well known. Similarly, customers are willing to buy a product only if there is a service centre for the manufacturer in their town. For example, customers are happy buying a Samsung mobile instead of an Apple’s iPhone in a developing country because of easy access to Samsung service centre.

(The above discussion is loosely based on David Cravens, Gerald Hills and Robert Woodruff.
Marketing Management, AITBS books, Delhi 2002; and Prof. Kotler’s, Marketing Management, 11th edition)

6) Implementation and Control –
Apart from studying the response from the consumer, the impact of pricing on distributors and sales people should also be considered. The successful implementation of price and making changes to it depends largely in coordination with the distributors and sales team. These are the people who directly talk to consumers and their inputs become very valuable in price changes. For successful control of prices, an organisation should closely collect data from-

• Consumers,
• Distributors,
• Staff members who come in direct contact with consumers,
• Reaction from competitors.

The data collected should be carefully monitored and acted upon by the managers who work on pricing objectives and strategies.