Pricing Procedure

What is Pricing Procedure ?

One of the most challenging decisions that marketers make is decisions related to price setting. This may affect the profitability of the organization and once set prices cannot be easily changed. Although the price - may be planned by the accountant, the decision to pay the same is taken by the customer. Practically, pricing decisions being financial aspect of the organization, must be made on the basis of the findings regarding competition target market product content, distribution and positioning.

What are the 6 Steps in Setting the Price ?

There are 6 steps in price setting process. Prices can be set by following the below mentioned procedure :
Steps in Setting the Price

Setting the Pricing Objectives

Identifying the pricing objective is the foremost step towards pricing. Deciding target market is one of the pre-requisites of selecting pricing objectives. If the objectives are clear, it becomes easier to set the price In case the firm is facing intense competition, having over capacity or dealing with varying consumer needs, survival becomes its main objective. By designing price, which balances variable as well as some portion of fixed costs attached with the production of goods and services, the organisation is able to remain in business. Survival is considered to be a short-term objective. The firm must find out ways to increase its value, otherwise the situation of extinction may arise.

Various firms price their products in order to maximize their current profits. They look for alternative prices and assess the demand and cost associated with it. Once this is done, they select the price that delivers maximum cash flow, current profit or rate of return on investment. It is assumed in this strategy that the firm is aware of its cost and demand functions, which are difficult to evaluate in reality.

Increased market share is also a pricing objective for several organisations. As per these organisations, if the sales volume is high, the unit costs will become low resulting in higher long-term profits. They assume that the market is price sensitive and keeping that in view, set the price at lowest level. Setting low price would be effective in such conditions. Market is immensely price sensitive and that is why, market growth is increased if prices are low. Gathered production experience reduces the production as well as distribution costs. Potential and actual competition decreases due to a low price. Finns that are introducing a latest technology believe in setting the price high in order to "skim" the market.

For example, Sony practices market skimming' pricing strategy on a regular basis. Irrespective of the specific objective, profits will be higher for companies which use pricing as their strategic tool as compared to those who allow cost or market to decide about their prices.

Determining Demand

Once the objectives are identified, the firm decides the demand. The level of demand is different for each price Hence, it will impact the marketing objectives of the firm differently. Generally, demand is inversely proportional to price, i.e. demand decreases with the increase in price. At times, for prestige goods, the demand curve has an upward inclination.

For example, when a perfume company increases its prices, more of its goods get sold. Sometimes, higher prices depict better quality products for some consumers. Yet, if the prices are too high, demand for the product decreases.

Demand curve displays the relationship between alternate prices and the subsequent current demand. Demand for a particular product can be determined by observing following elements : 

1) Price Sensitivity : 
Price sensitivity is impacted by the following nine factors :

i) Unique Value Effect : 
In case of products that are unique, the buyers become less price-sensitive.

ii) Substitute-Awareness Effect : 
If the buyers are not much aware of the alternatives, they become less price-sensitive. 

iii) Difficult-Comparison Effect : 
When buyers. are not able to compare the features of the substitutes easily, they become less price sensitive.

iv) Total Expenditure Effect : 
If the expenditure, i.e., a share of their total income is low, buyers become less price-sensitive.

v) End-Benefit Effect : 
If the cost of the end product is higher than the expenditure, the buyers become less price-sensitive.

vi) Shared-Cost Effect : 
If some of the cost is tolerated by the other entity, buyers become less price-sensitive. 

vii) Sunk-Investment Effect : 
If there are some previously bought assets that are used in combination with the product, the buyer becomes less price-sensitive.

viii) Price-Quality Effect : 
Buyers become less price-sensitive in case of prestigious, special or high quality products.

ix) Inventory Effect : 
If the buyers are not able to store the product, they become less price sensitive.

2) Estimating Demand Curves : 
There are various methods that a company can use for measuring the demand curve:
  • In the first method, past prices, quantities sold and other such factors are statistically analysed and their relationships are studied.
  • In the second method, price experiments performed. For example, the prices various products sold at a discount store changed and the results are monitored.
  • In the third method, buyers are questioned about the number of units they plan purchase at different proposed prices.

3) Price Elasticity of Demand : 
Price elasticity of demand or PED is the reaction in the form change in quantity demanded with respect change in price. The following formula is used t calculate it :

PED = % Change in Demand /% Change in Price

Estimating Costs

The price a company can set for its products is given a ceiling through demand. The floor is provided by cost. The company may intend to price its product so that it can balance its production, selling as well as distribution costs and earn a reasonable rate of return against its risks and efforts. Costs are divided into two types:

1) Overhead or Fixed Costs : 
This cost remains constant irrespective of the revenue earned from production and sales. For example, the amount of goods produced has no impact on the cost of land.

2) Variable Costs : 
This cost changes with the quantity of goods produced. For example, with the amount of goods produced the cost of raw material changes.

When fixed and variable costs at a particular level of production are added, it gives the total cost. On the other hand, per unit cost at a particular level of production gives the average cost. Gathered production experience reduces the average cost. This denotes the learning or experience curve. In the current scenario, companies strive to modify their terms and offers, as per different buyers' choices. Companies need to take up activity based costing (ABC) in order to calculate the actual profitability of handling different customers. Issues that need to be reflected upon are : 
  • Since several activities are executed in an organisation, costs are incurred. 
  • Since the organisation produces and sells goods, it performs these activities.
  • In activity based costing, the costs that are not directly credited to a specific product are related to the activities due to which those costs become necessary.
  • Then the accumulated costs incurred in performing the activities are attributed to the products due to which the activities become necessary.

Analyzing Competitor's Pricing 

Next crucial step that needs to be taken while setting prices is the analysis of competitors' costs, offers and prices. In addition, the company should also consider the competitors' price responses to market changes, which lie within the array of prices decided on the basis of company costs and market demand.

As the ceiling and floor to pricing are set by the demand and cost respectively, competitor's price. give the mid-point that must be analysed while setting the prices. Marketers need to send out comparison buyers in the market to collect price lists. of competitors. for comparing and buying competitors' products and services in order to judge their pricing as well as product quality. Marketers also need to know the customer perception about the price and quality of the product or service of the competitors. Prices are kept almost same to that of the major competitor in case of products and services being similar otherwise sales would be down. In case of an inferior product or service, the product must be priced lesser than that of the competitor. The competitors might even alter their prices as a response to the firm's price.

Selecting Pricing Method

The company needs to decide upon three elements called the 3 Cs while setting the final price : 

1) Cost-based Price : 
This lays down the floor for pricing. 

2) Competitor-based Price : 
This gives the orientation framework for pricing. 

3) Customer Demand-based Price : 
This lays down the ceiling for pricing.

Selecting Final Price

After selecting the suitable pricing method, it becomes easier for the organisation to finalize the price. Below mentioned are certain additional factors that the organisation needs to take into account while finalizing its price :

1) Psychological Pricing :
Price acts as quality indicator for certain customers. Generally, the perceptions regarding quality and price of products interact in consumer buying activity.
Products like cars, which are priced high, are believed to be of high quality and vice versa. When customers have alternative details regarding quality, price loses its importance as quality indicator. In case of lack of this information, price becomes the most crucial quality indicator. If Mercedes Benz costs 25 lacs only, customers will not perceive it to be prestigious. When buyer aims to buy a product, he has a reference price in his mind which he gathers by observing the current prices, past prices or the perspectives of buying. These reference prices are frequently influenced by the sellers.

2) Company's Pricing Policies : 
The prices should fall in line with the pricing policies of the company. Several companies have a separate department that takes care of pricing policies and develops or approves pricing decisions. Here, the main purpose is to make sure that the prices, which appear fair to the customers and are profitable to the organisation, are quoted by their sales people.

3) Impact of Price on Other Parties : 
The management needs to analyse how other parties are going to react to the final price. What are the responses of the dealers and distributors. concerning it? Are the sales people ready to sell. the product at that price? How will the competitors respond? Will the company's prices cause the suppliers raise their prices? Will the government interfere and stop the organisation from charging this price?

4) Influence of Other Marketing Mix Elements : 
The quality and advertising of the brand must be considered in comparison to competition. When the relationship between relative price, advertising and quality was studied, the following findings were revealed :
  • Premium prices were charged by brands providing average relative quality with the help of a high relative budget for advertising. For a product that was known to the consumers, they willingly paid higher prices as compared to the ones that were unknown.
  • Highest prices were charged by brands providing high relative quality with the help of a high relative advertising budget. On the other hand, lowest prices were charged by brands, providing low quality in presence of low advertising budget.
  • In the later stages of the product life cycle, the firm witnessed a positive relation between high advertising and high prices in case of leading brands.