Explain in detail the Pricing Methods

Organisations mostly choose the pricing methods based on demand, costs or competition in the target market. Some of the pricing methods are given below-

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.

a) 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 are 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.

b) 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 total market demand is given importance in this method. There are two ways of setting prices under this method – Perceived value pricing and Value pricing.

a) 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 no as accurate as the product created and 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 should strive to deliver more value that the competitor’s product and communicate the same in the target market.

b) 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. Everyday 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).

c) Demand-Modified Break-Even pricing – in this method the demand estimates in conjunction with break-even analysis set 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.

a) 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.

b) Sealed-bid pricing – the firms bid the lowest to increase the odds of being selected. The firm sets a price thinking how the competitor will respond instead of 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.

c) 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 in a developing country because of easy access to Samsung service centre.

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