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What is Pricing ? | Definition, Objectives, Types, Importance & Factors Influencing Pricing Decisions

Pricing


What is Pricing ?


The only component of marketing mix that generates returns is called price, however, others only generate costs. Price can be easily altered, whereas, other product aspects like channel obligations and product attributes cannot be changed so easily. Therefore, price is the most flexible component of the marketing mix. For a manufacturer, price is that amount of money (or in case of barter trade, goods or services). which he will receive from the buyer for his product. For a customer, price is something he sacrifices for owning the product or service and therefore, it displays his perception for the product value. It can conceptually be defined as : 

             Quantity of money received by the seller 
Price = ------------------------------------------------
            Quantity of goods and services rendered/ 
             received by the buyer

As per this equation, the numerator as well as the denominator is crucial while taking price decisions. A product's price is based on the seller's decision regarding its monetary worth to the buyer. The method used to convert the worth of a product or a unit of service into quantitative form (i.e., rupees and paisa) at a given time for customers is called "pricing".

Definition of Pricing


According to Prof. K.C. Kite :
"Pricing is a managerial task that involves establishing pricing objectives, identifying the factors governing the price, ascertaining their relevance and significance, determining the product value in monetary terms and formulation of price policies and the strategies. implementing them and controlling them for the best results".

Pricing can, therefore, be defined as the task of deciding the monetary value of an idea, a product or a service by the marketing manager before he sells it to his target customers. In particular, pricing is the process of formulating objectives, deciding the flexibility that is available, devising strategies, setting prices, and implementing and controlling the above elements. Pricing is one of the strongest marketing instruments that the company possesses. Pricing decision is an important aspect of a marketing plan. Thus, marketers need to take exact and premeditated pricing decisions.

Objectives of Pricing


There always exists a motive behind pricing a product or service, may it be revenue, survival, or any other competitive advantage. Following are some of the pricing objectives :

Objectives of Pricing

1) Capturing the Market : 
Capturing the market is also an important objective of pricing. When a big organisation introduces its product in the market, it fixes the price of its product lower than its competitors. This is done keeping in mind the competitive structure of the market and with the aim capture a big market share.

2) Profit Maximization : 
The basic aim of a pricing decision is to increase the profits of the firm. The pricing policy thus must be made in a way that it can help the firm achieve to maximum profits.

3) Facing Competition : 
Another objective of price decision is to handle the market competition effectively. The competitive situation must be kept in mind while finalizing the prices of products and services. At times, management prices its product very low as compared to its competitors in order to discourage all the possibilities of competition.

4) Price Stability : 
It must be ensured that prices remain as stable as possible. When a pricing. policy is stable, it gains customer confidence and enhances the reputation of the company. This can be done by taking into account long-term and short-term elements.

5) Achieving a Target-return : 
The reputed and well set-up firms aim to set a specific rate of return on investment (either for the product quality or for the company's/brand's name). They calculate the product's price in such a manner so as to achieve the desired rate of return on investment. Different products may have different target returns, but they must all be associated with one final targeted rate of return.

6) Survival : 
Survival strategy is preferred by firms dealing with it's over capacity, extreme and fresh competition or varying consumer behavior. It is also an important objective of pricing in certain organisations. It helps companies sail through rough waters and is hence a short-term objective. The company prefers this strategy until the price is more than variable costs and some of the fixed costs are retrieved. However, the company must strive to add value in the long-term.

7) Firm's Well-being in the Long-run : 
The prime objective of certain organisations is to set the price of their product in a manner that best suits the organisation in the long-run. While doing this, the economic situation and market conditions must be kept in mind.

8) Product-Quality Leadership : 
To achieve product-quality leadership is also one of the important pricing objectives. Firms producing products that are better in quality than the competitor frequently try to become the product quality leaders in the market. They price their products higher, but try to convince the customers that due to the enhanced quality, reliability, product experience and other such benefits, the prices are worth the product values. They convince the price sensitive customers by assuring them that they will be benefited in the long-run. The point of importance here is that rather than allowing cost to decide the price, it is better to use price as a strategic tool If an organisation has a product that is better than the competitor's, it should make it known in the market and charge higher price for it. Then, it will be able to earn more profits.

9) Mobilization of Resources : 
Another objective relating to pricing is the mobilization of appropriate resources for the growth and development of the organisation. Therefore, organisations aim to price its products in such a manner that it can acquire enough resources.

10) Profit Margin of Middlemen : 
The product must be priced with the aim of providing the middlemen a reasonable return on the sale of a product. If this does not happen, they will not take relevant interest, in facilitating the product's sales.

Types of Pricing


Cost consideration and consumer situation are the two fundamentals that impact price decisions Unfortunately, there are many firms that do not have comprehensible pricing methods. Below mentioned are the general pricing methods:

Methods of Pricing

Value Based Pricing


Understanding the value offered to customers essential for accurately pricing the product or service of an organisation. In this method, cost is not determining factor for pricing. Customer's perception of the value associated with the product or service i the key to pricing decision. Here, first the product of service is designed, thereafter the marketing strategy, and finally the price is set by analyzing the other marketing mix elements. It will be clearly seen in the analysis that the below mentioned conditions can be obtained with the cost value price chain :

1) Value>Price>Costs : 
In the first condition, price of the product is kept lesser than the value offered, to attract the potential customers. However, significant profit is generated by maintaining the price above the cost of production. 

2) Price>Value>Costs : 
In this condition, value offered to customers through product is more than its cost of production. In order to maintain a significant level of profit companies set price more than value offered.

3) Price>Costs>Value : 
Sometimes, of cost production is more than the value offered through product. Profitability is maintained in this condition by setting the price above the production cost.

4) Price=Value>Costs : 
A condition may also occur, where production cost is lower than value offered. A reasonable amount of profit is generated by setting the price equal to the value offered.

Market/Competitor Based Pricing 


Under this method, prices are determined by observing the competitors' prices in a particular market. Generally, small organisations follow such pricing method in presence of a market leader. 
For example, a small Tyre manufacturer may follow the prices of Apollo Tyre's. Also in case of entering a new market, a low-cost supplier may follow the market/competitor-based pricing. A large number of companies carefully analyse the price structure of the competitors, before setting their product's price. Firms formulate premeditated policies and choose a competitive market for selling their products. When a company prices its products using this method, it has four pricing options : 

1) Going Rate Pricing/Parity Pricing : 
In this method, the competitor's product is taken as the benchmark to set the price of the product. A firm follows this approach either when it is new in market or when an already established firm launches a new product in the existing market. This type of pricing is suitable for the markets with severe competition.

2) Pricing Below the Level of Competition/Discount Pricing : 
When company sets the price of its product lower than the level of competition, i.e. below the price that the competitor is charging for a similar product, it is called 'pricing below the level of competition' or 'discount pricing'. This method is effective in markets, where customers equate to price. It is implemented by firms that are new in the market.

3) Pricing Above the Level of Competition/Premium Pricing : 
When company sets the price of its product upper than the level of competition, it above the price that the competitor is charging for a similar product, it is called 'pricing above the level of competition' or 'premium pricing'. This is done to depict better quality product by the company. This pricing policy can be implemented only by firms that have a good reputation in the market (as their image is that of a quality producer in the customer's mind) This makes them the market leader.

4) Tender Pricing/Sealed Bid/Competitive Bidding : 
The sealed bid is another competitive pricing method followed by firms. There are numerous projects, government purchases and industrial marketing activities where suppliers are called to submit their quotations to get the tender. The prices that are quoted, show the cost incurred by the company and what it understands about competition.
A firm that offers a price at the cost level may become the lowest bidder and bag the contract, but would not earn any profit from the deal. Thus, it is crucial for the firms to take into account expected profits at various price levels and finally quote the price that is most profitable.

Cost Based Pricing


The most important variable as well as the basis of pricing a particular product, is the production cost of that product. Costs may be of different kinds like total cost, variable cost, fixed cost, marginal cost. average cast, etc. These costs must be critically analysed in order to set a product's price, Methods for finding out the cost oriented price are as follows : 

1) Mark-up/Cost-plus Pricing : 
This method requires the marketer to approximately calculate the total production or manufacturing cost of the or the product and after that adding a mark-up or margin (that the firm intends to earn) to it. This is the most basic pricing method which is used to price a number of projects and services. The below mentioned formula can be used to calculate the mark-up price :
                                 α
Mark up price = ----- 
                               (1-r)

where, α = Unit cost (Fixed cost + Variable cost) 
r = Expected sales returns (expressed as per cent)

2) Full Cost/Absorption Cost Pricing : 
In absorption/full cost pricing, the unit cost is finalized with reference to regular production and sales level. With the help of standard costing approach, variable as well as fixed costs concerning the production, sales and administration of the product are finalized. It is called full cost pricing as it aims to recover total costs incurred on the product from its sales.

3) Incremental Cost/Marginal Cost Pricing : 
In this method of pricing, the company strives to recover its marginal cost so as to aid its overheads. This pricing method gives best results in the market, where large firms operate or where there is extreme competition and the firm works with the sole aim of establishing itself in the market. The firm adopts this pricing method when it : 
  • Encounters intense competition
  • Focuses on a new market
  • Possesses unexploited capacity

4) Break Even Point/B.E.P. Pricing : 
The sales volume, where the total cost becomes equal to the product's total sales revenue is known as 'break-even point'. In other words, the sales volume of the product, which neither witnesses profit nor loss, is break-even point. Hence, this method is also called 'No Profit No Loss Method of Pricing'. In order to calculate price using this method, total production cost is divided into: fixed and variable cost. The final price is same as the product's production cost. It is believed that the firm will not earn any profits in the short term, but in the long-term it will begin earning profits. The price of a competitive product can be easily calculated by using this method. B.E.P can be e calculated by the formula mentioned below : 

                                    Fixed Costs
B.E.P. (In Units)= ---------------------------
                                  Selling Price per unit -
                                  Variable Costs per unit

                                Fixed Costs x Total Sales
B.E.P. (In Rs.) = ------------------------------------- 
                               Total Sales - Total Variable Costs

5) Target Pricing/Rate of Return Pricing : 
In this pricing method, the company needs to calculate the desired rate of return on the capital it has invested in producing the product. This rate of return helps in calculating the desired quantity of profit. This quantity of profit' and 'production cost' are summed up to find the 'per unit price' the product. A company can employ this pricing method, when it needs to get a specific return on the capital it has invested. This method can be price' of used only in markets with no competition at all.

Customer Demand Based Pricing


The fundamental aspect of the demand oriented costing is that the cost involved does not have an impact on the profits but on the demand. This method, contrary to cost-based pricing, begins by finding out the price that the consumer market intends to pay for the product. Then, a backward estimation of the level of cost and profit (that the organisation can afford due to that price) is undertaken. Following methods are used to determine the customer demand-based pricing :

1) What the Traffic Can Bear' Pricing : 
Using this method, the seller charges the customer with the maximum possible price that they will pay willingly under the present situation. This method is far from being sophisticated and I is followed by retail traders and few manufacturers. In the short-run, it provides the company with large profits but is an unsafe method in the long nun. Error in judgments can easily take place as it is based on trial and error But in markets with monopoly/oligopoly and price-inelastic demand. it can conveniently be applied.

2) Skimming-based Pricing : 
Skimming pricing is the commonest pricing method. In this method. the companies by selling at premium prices fulfill their desire of skimming the market. The results are obtained in the below mentioned situations :
  • When high price is supposed to be a testimony of high product quality, especially in an environment, where target market relates product quality with its price.
  • When a customer willingly purchase the product at higher price, just in order to become the opinion leader.
  • When the customers status is believed to be increased by product.
  • When the entry as well as exit barriers are so low that there is almost no competition in the industry or the industry fears a threat from potential competition.
  • When a visible technological advancement is displayed by the product, which makes the product a high technology product.
When the firm adopts skimming pricing technique, it aims to attain its break-even point at an early stage and takes lesser time to maximize its profits (or find a niche to earn profits).

3) Penetration-based Pricing : 
Contrary to skimming pricing, penetration-based pricing focuses on keeping the prices low as compared to current competitors. Market penetration or gaining initial market share in an intensely competitive market, is the main objective of this pricing method. Below mentioned are the situations in which this method gives results : 
  • When the market is large in size and is still growing.
  • When the brands are bought by the customers not because of some definite inclinations but because of habit, i.e., customer loyalty is low.
  • When a stiff competition dominates the market.
  • When an entry strategy is employed by the firm.
  • When the company has weak price-quality coordination.

Importance of Pricing


Following points highlight the importance of pricing decisions :

1) Important Aspect of Sales Promotion : 
At times, as a feature of sales promotion, marketers opt for price adjustments. They decrease the price of their product for a small duration to enhance the customer's interest in the product. Price adjustments must not be done very frequently as this may result in customers getting used to anticipating a reduction in price and withholding purchase until the prices are reduced again.

2) More Flexible Marketing Mix Variable : 
Out of all the marketing decisions, pricing is the most elastic one for the marketers. This flexibility is especially important when the firm intends to promptly increase the demand of his product or act in response to a price action taken by the competitor.

3) Trigger of First Impressions : 
The customer may finally decide upon purchasing the product on the basis of the market offering as a whole (i.e., entire product). The customer might not judge a product only by its price. In such a case, pricing might become the most crucial element while making decisions as the marketer can establish that the customers are not showing interest in the product due to its price.

4) Fixing the Right Price : 
If pricing decisions are taken in hurry and the required research, strategic evaluation and analysis are not undertaken, the organisation prone to lose revenue. A lot of market knowledge is needed to set the exact price level. Specifically, when the product is new, various pricing options need to be tested.

5) Supply and Demand : 
Demand and supply are. inversely proportional to each other. When one rises, the other falls. Items like gas, food, etc., that are always in demand experience this more. If the business regularly reviews the demand and supply of the products and services, it can adjust its prices consequently.

6) Loss Leaders : 
In order to attract customers, certain firms use cost pricing or below cost pricing strategy. In this way, they drive customers to spend somewhere else the saved money.

7) Sales Volumes : 
The most prominent impact of pricing on business is an increase or decrease in the volume of sales. Price elasticity and how consumers react to a change in price are studied by economists.

8) Position : 
In simple words, the way the target market perceives a firm's offerings, as compared to firms selling similar product or service, define its position. There are firms, whose products or services are perceived to be of a high quality, and can hence charge more for their offerings.

Factors Influencing Pricing Decisions 


There are numerous factors that affect marketing decisions. The pricing policies must fall in line with pricing objectives. There are some internal and external factors influencing pricing decisions. The factors affecting price determination can be categorized as follows :

Factors Influencing Pricing Decisions

Internal Factors


Following are the internal factors influencing pricing decisions :

1) Marketing Objectives : 
Firms devise both specific as well as general objectives. Survival. market share leadership, current profit maximization and product quality leadership are some of the general objectives of the firm. The firm may price its products lower than its competitor to prevent their entry in the market or at times, set its price equal to its competitor so that market is stabilized. This is an example of specific objective. Products can be priced in. order to sustain the reseller's support and loyalty or to circumvent government intervention.

Marketers can decrease the prices to increase the customer interest towards the product or attract traffic into the retail outlet. A single product, if priced appropriately, can help to increase the sales of other products in the product line of the company. Hence, pricing decisions are greatly influenced by marketing objectives at various levels.

2) Marketing Mix Strategies : 
Marketing mix strategies of an organisation are very significant in influencing the organisational pricing. One marketing mix tool that the firm uses to accomplish its objectives is 'price'. While taking price decisions, the product design, promotion decisions and distribution plans must be aligned together to create a reliable and valuable marketing program Pricing decisions are strongly influenced by decisions that are made for other marketing mix variables. Usually, organisations position their products on the basis of price and after that modify other marketing mix decisions, according to the price they intend to charge. In such a scenario price is an important product-positioning factor that classifies the market, design and competition of the product. This kind of price-positioning strategy is supported by many firms. They use the target costing technique, which is a powerful strategic tool. 
For example, target costing was exercised by P&G while developing and pricing its very thriving electric toothbrush named 'Crest Spin Brush'.

Hence, the entire marketing mix must be taken into consideration by marketers while setting the prices If price is not used as a factor while positioning a product, decisions regarding quality, distribution and promotion have a strong impact on price. In case, positioning is done on the basis of price, then the decisions made regarding all the other marketing mix elements will be impacted by price. Although marketers may use price as an element for positioning, still they must keep in mind that customers seldom base their purchase solely on price. They look for products that provide them benefits worth the price they are paying for.

3) Costs : 
This is the base of the price that is charged by the firm. Firms intend to charge a price that can retrieve its production, distribution and sales cost and also provide a reasonable rate of return against risks and efforts. Costs incurred by a company play an important role while strategizing pricing. Various companies like Wal-Mart, Southwest Airlines and Union Carbide strive to be the industry's "low cost manufacturers". When costs are low, it becomes easier for the firms to set a lower price, which ends up in increased profits and sales.

4) Organisational Considerations : 
Decisions. regarding who would set prices of products and services in the organisation is very important. Pricing is managed in different ways. In firms that are small in size, top management, in place of sales or marketing department, sets the prices of the products. Whereas, in bigger firms, product line managers or divisional managers handle pricing. Sales people working in industrial markets, have the authority to bargain with the customers within a specified price range. All the same, the pricing policies and objectives are finalized by the top management who usually approves the prices that are suggested by the lower management or sales force. Certain industries like steel, aerospace, oil companies, railroads, etc., have pricing as the main element. They have a separate pricing department (which directly reports to the top management or the marketing department). which finalizes prices for their products or assists other departments in deciding the same. Sales managers, finance managers, production managers, accountants, etc., are the other people who can influence pricing decisions.

External Factors


Following are the external-factors that influence pricing :

1) Competitor's Costs, Prices and Offers : 
An organisation's pricing policy is strongly influenced by the costs and prices as well as discounts and offers of the current competitors. If someone is planning to purchase a Sony digital camera, he will compare the prices and value that Sony is offering with the value and prices of similar products offered by other brands like Nikon, Kodak, etc. The pricing strategy that the company implements also impacts the type of competition it encounters. For example, in the case of Sony. if it pursues a high-price, high margin strategy, competition may increase. Whereas, a low-price and a low-margin strategy might reduce competition or drive the competitors out of the market. Thus, Sony must benchmark its cost and value against that of the competitor. This benchmark can then be used while setting its own pricing.

2) Economic Conditions : 
A company's pricing strategies are also influenced by prevailing economic conditions. Economic conditions like recession, boom, inflation, interest rates, etc. have an effect on pricing decisions, since both the cost incurred in production and what the consumer perceives about the value and price of the product, are influenced by them. The company should also analyse the impact price on different members present in its environment and the manner in which resellers respond to different prices. Prices must be set in such a way that resellers earn sufficient profits, get necessary support and can sell the product easily.

3) Government Controls and Subsidies : 
With the intervention of the government, the freedom of the companies to adjust prices and maintain margins is restricted. As a form of control, the government can also ask the importers to deposit cash required in advance. As per this requirement, the company needs to lash out funds as non-interest bearing deposits for the amount of time it intends to import its products. These requirements motivate the company to reduce the prices of the imported products as lower prices account for smaller deposits. The subsidies that the government provides also compel companies to strategically use sourcing in order to become price competitive.

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