8 – Pricing: Understanding and Capturing Customer Value

Introduction

You’ve probably noticed that most marketing decisions involve marketing managers spending money. Spending money is required to construct an advertising campaign or to hire salespeople. Price is the only marketing mix component that directly impacts an organization’s income.

For enterprises with a higher volume of sales and a narrower profit margin, a minor pricing error can jeopardise the company’s very existence. If a corporation maintains its prices low, it may be able to create large sales while making a lower profit. Choosing a price for a product is one of the most challenging tasks for many organisations. One must be very careful about the pricing decision because if the price is perceived as high, it may not invite a higher level of sales, and if the price is perceived as low, either people who value quality will not buy, or the profit contribution will be comparatively low due to marginal gain in each sale. This section will teach you how businesses set prices for their goods and services.

8.1 Price Setting

Price setting is a significant component of a company’s marketing mix decisions. Pricing issues might arise because of the meaning ascribed to price. The sole component creates money for the organisation; all others are expenses. Marketing aims to allow profitable transactions between the marketer and the customers.

The value exchanged in a marketing transaction is represented by price. A marketer typically sells a specific combination of a need-satisfying product or service and ancillary services such as a warranty or guarantee. According to Donald Lichtenstein, Nancy M. Ridgeway, and Richard G. Niemeyer, pricing is highly obvious in most marketing transactions, and buyers and sellers are aware of the value that each must part with to complete the exchange. However, pricing does not necessarily have to be expressed in monetary terms.

Barter is the oldest form of transaction and is still used occasionally between countries for various items. Settlements have been built on bargaining since people learned to use barter to effect exchanges. In the majority of countries, bargaining is still practised in markets. Websites like Priceline.com and eBay.com rely on negotiation between buyer and seller for various goods and services.

The pricing begins with understanding the company’s mission, target audiences, and marketing goals. Pricing objectives are developed based on these considerations. Management must assess the costs to determine its flexibility and the lowest price level required to fulfil profit and other company objectives. The role of prices in other marketing mix elements establishes boundaries and rules for pricing decisions. Pricing considerations should consider the impact on other products in the line, promotional decisions, and distribution methods. There are two types of pricing choice situations: new product pricing and modifying existing product prices. In particular, pricing plans for new items are a high-level duty shared by marketing and other top-level executives.

Buyers have limited resources. Thus, their interest in pricing reflects their expectations of a product’s potential to provide the needed satisfaction. Customers must decide whether the utility value obtained is worth the purchasing power lost in a trade. With time, buyers in nearly all modern civilizations have learned to assess products, services, and ideas, among other things, in terms of financial pricing to quantify the value commonly utilised in exchange.

People are surrounded by price, which is expressed in various ways in various marketing settings.

Insurance firms charge a premium; colleges charge tuition, lawyers or physicians charge a fee, taxis charge a fare, banks charge interest on a loan, taxes are paid for government services, some bridges have tolls, and so on.

Pricing should never be viewed as a stand-alone component of a company’s marketing strategy. Companies invest a lot of money in product creation, promotion, and distribution and face many risks. Price is frequently the sole part of the marketing mix that can be modified fast to respond to changes in demand or competitor manoeuvres. Creating new items, modifying current ones, and changing advertising programmes or distribution systems all take significant time and work. As previously stated, price is the only factor directly related to the total income generated. Miscalculating selling prices in a business with high turnover and a low profit margin can significantly impact profitability.

As a result, pricing impacts a company’s profitability and is critical to its long-term existence. Price emotionally impacts buyers and can represent product quality and user status. This is especially true for ego-driven items. A corporation may promote the product’s quality and user status by keeping the price high.

Setting prices may be difficult for most businesses, requiring scientific analysis and intuitive trial and error. This is especially true when a corporation introduces a new product with no historical data or precedent to base estimates of how much consumers are willing to pay for it.

8.1.1 Price Competition

Price competition is fierce in free market economies all over the world. A corporation can compete by adjusting its prices or responding to price adjustments made by competitors. This has an impact on decisions about other marketing mix factors. Price-based competition typically emerges when consumers are unable to distinguish between competing goods. Companies in this situation utilise pricing to differentiate their products from competitors’ products to beat or match prices established by competitors. To pursue this competitive strategy, a corporation must be a low-cost producer. If all competitors charge the same price, the firm that produces at the lowest cost will be the most lucrative. Companies that use price-based competition tend to promote standardised products and are generally competent at or ready to modify pricing regularly.

A corporation that uses price-based competition might be more flexible in adjusting to cost changes or product demand. Over time, most businesses can reduce costs at varied levels and modify prices. Too frequent price cuts might lead to price wars and harm companies.

In India, for example, Coke and Pepsi occasionally decrease prices in an attempt to take advantage. When one announces a price decrease, the other company’s response is immediate, and neither firm appears to gain an edge.

8.1.2 Non-Price Competition

The non-price competition focuses on elements other than price that differentiate a product from different brands, such as distinctive product features, quality, service, packaging, and promotion. Rather than adjusting its price, the corporation tries to provide more value to its brand to increase sales. Consumers must be able to recognise and value these distinctions.

Example: When we go to buy an otherwise regular object, such as a toothbrush, we find substantial price discrepancies ranging from 5 to 38. Major brands distinguish themselves by bristle-head flexibility and tiny shock absorbers that assist teeth and gums.

This strategy is more suited when buyers do not buy a product just for price reasons, such as those considered commodities by customers. Customers who favour a brand because of its features, quality, or service are less inclined to switch to other brands, and sales are less price-reliant. Despite this, a corporation cannot entirely ignore the prices of competing items. Even when the market context and product nature favour non-price competition, pricing is an important marketing mix component.

8.2 Pricing Objectives

Pricing objectives are concerned with what a corporation hopes to achieve by setting pricing. These goals should be clear, simple, and understandable to all parties engaged in pricing decisions. Pricing objectives influence decisions in other functional areas, such as finance and production, and they must be consistent with the company’s broader mission and objectives. There are various aims, and most businesses have various price goals. Some of these goals may be short-term, while others may be long-term. Furthermore, corporations often change their price targets to respond to changing market conditions as and when they see fit. Most businesses do not lose sight of the notion that price is a strategic instrument and do not let costs or the market determine prices.

Survival: This is the most comprehensive and fundamental price goal of any organisation because staying in business is critical in challenging circumstances such as overcapacity, fierce cutthroat competition, and changing consumer demands and preferences. Most companies will face obstacles if their prices cover variable costs and even a tiny portion of fixed costs, allowing them to stay in business and devise means of adding value.

Profit: Many businesses adopt profit maximisation as their pricing goal. Profit maximisation is more likely to be advantageous in the long run. However, the company may have to endure low profits or losses in the short run. The main issue with the maximisation objective is that it is difficult to determine whether profit maximisation has been achieved. It is nearly complicated to decide on the highest feasible profit. Because of these difficulties, firms rarely establish a profit target and settle for a profit figure or percentage change over the previous quarter that their decision-makers consider optimal profit.

Return on Investment (ROI): ROI is another profit goal that tries to achieve a specific rate of return on a company’s investment. Large corporations, such as Tata or Reliance, are better positioned to define pricing goals regarding ROI. They may elect to set pricing objectives that are usually independent of competition, but smaller enterprises do not. Because all relevant cost and revenue data cannot predict the ROI when price setting, return on investment pricing objectives are established through trial and error. ROI pricing objectives do not account for competing prices or consumer price perceptions.

Market Share: Many businesses set their pricing goals based on the percentage of total industry revenues they intend to achieve. The goals can be to maintain current market share or increase in percentage. Companies strive to maximise market share because they believe increasing sales volume will result in lower unit costs and more enormous profits in the long run. Prices are set as low as feasible to increase sales and market share. Prices are cut more as unit costs fall.

Intel, for example, takes a different strategy. When it builds a quicker, better processor, it maintains high costs to skim the market. As a result, with declining unit costs, it cuts its pricing regularly to acquire the maximum market share.

Market share and product quality both impact a company’s profitability. As a result, corporations frequently define their pricing intentions in terms of market share. Maintaining or expanding market share may not be entirely contingent on industry sales growth.

Product Quality: A company’s goal may be to be the industry’s leader in product quality. Consumers directly associate price with quality, particularly in the case of ego-intensive or technologically based products. Such businesses continually strive for and maintain excellent quality, and as a result, they charge higher rates to pay the high cost of research and development. Caterpillar, Nikon, and Canon products have expensive pricing to represent their excellent quality.

8.3 Factors Affecting Pricing Decisions

Pricing decisions are influenced by various internal and external factors, which can be complicated. In general, there is apprehension about how consumers, competitors, resellers, and others will react to price increases. Prices are vital in market planning, analysis, marketing mix variables, demand forecasts, competitive structure, expenses, and government actions. To demonstrate the idea, consider just one issue: the competitive market structure and its impact on price decisions. However, it is essential to recognise that all internal and external factors combine to influence price decisions.

1. Internal Factors: Marketers must consider several factors from corporate decisions and activities when determining pricing. These elements are, to a considerable part, under the company’s control and, if necessary, can be changed. However, while the organisation may control these elements, immediate adjustment is not always possible. For example, product pricing may be substantially influenced by the productivity of a manufacturing plant (e.g., how much can be produced within a certain period). The marketer understands that boosting productivity can lower the cost of creating each product, allowing the marketer to cut the price of the product potentially. However, increasing efficiency may necessitate significant adjustments at the production site, which will take time (not to mention money) and will not result in lower-priced products for some time.
2. External Elements: Various influencing factors are beyond the company’s control but impact price decisions. Understanding these factors necessitates marketer research to monitor what is happening in each market served by the organisation, as the effect of these factors varies by market.

Competitive Structure: Market conditions fluctuate wildly, and market structure influences not only price decisions inside a company but also the type of reaction other competitors in the same industry are likely to give. Much is determined by the number of buyers and sellers in a market and the extent of entry and exit barriers. These variables influence a company’s pricing flexibility.

Number of Buyers/Sellers and their influence on the Market

A non-regulated monopoly can set prices at whatever level it deems suitable. However, in the event of a regulated monopoly, pricing freedom is limited, and the corporation can establish prices that make a reasonable profit. In the event of oligopoly, there are few sellers and significant market entry barriers, such as in the auto business, computer processor industry, mainframe-computer industry, and steel industry, among others. When an industry member raises their pricing, it expects that others will follow suit.

When a firm lowers its pricing to grow its market share, other companies will likely follow suit, and the initiating company obtains no discernible advantage. A monopolistic market structure implies many vendors with distinct offerings regarding tangible and intangible features and brand image. This enables a business to establish pricing that is different from that of its competitors. The nature of competition in most successful cases is likely based on non-price variables.

When there is perfect competition, many vendors and customers perceive all products in a category to be the same. Because buyers are unwilling to pay more than the prevailing market price, all sellers fix their prices at the going market price. Sellers have no price-setting leeway.

8.4 Pricing Strategies

A pricing strategy is a plan of action designed to influence and steer price-setting decisions. These strategies aid in realising pricing targets and address various aspects of how price will be employed as a variable in the marketing mix, such as new product releases, competitive situations, government pricing regulations, economic conditions, or pricing objective execution. More than one pricing strategy may be chosen to meet the needs of different markets or to capitalise on opportunities in specific markets.

Numerous pricing techniques help businesses achieve their goals. Some of the most essential and often utilised ones are mentioned here.

8.4.1 New Product Pricing

In the absence of government price control, the base price of a new product is easily modified. A pioneer can establish a high base price to recover product development costs quickly. When determining the introductory pricing, the corporation evaluates how quickly competition will enter the market, the strength of the entry campaign, and the influence this will have on the primary demand. Suppose the company believes competitors will join with a heavy campaign with little effect on the primary market. In that case, the company may pursue a penetration pricing policy and set a low base price to discourage competitors’ entry.

Price skimming is the practice of charging the highest possible price that a sufficient number of the product’s most desired buyers will pay. Because demand is inelastic during most of this period due to the absence of competitors, this technique provides the maximum freedom to a pioneer during the product’s debut stage. Skimming generates much-needed financial flows to cover the high product development costs. Most companies that launch successful pioneering items use a price-cutting strategy.

Price skimming can yield quick returns that offset the product’s R&D costs. This technique limits the product’s market expansion because only the most desirable clients buy the goods. The possibility of earning high margins promotes new entrants into the industry.

For example, when DVD players were initially released, their costs were exceptionally high because they were a one-of-a-kind product manufactured just by one business. Prices have dropped dramatically now that competitors have caught on to the idea, but they still make a reasonable profit.

The penetration pricing strategy necessitates setting a lower price than rival brands and aims for market penetration to swiftly grab a substantial market share. When demand is elastic, businesses will use this method. Companies sometimes use penetration pricing to hold a significant market share quickly.

For example, the first two or three editions of a monthly magazine may be supplied at a cheaper cost, say, ’20,’ but the magazine price thereafter rises to’ 50. ‘ Because most people are interested in the first versions of the magazine, they are motivated to continue purchasing it in the future.

Increased demand necessitates more production, which lowers per-unit production costs. Because of the low unit production cost, the marketer has an advantage in further reducing the price, making it difficult for aspiring new competitors to enter the market.

Furthermore, a low unit price is less likely to appeal to competitors because a lower per-unit price leads to fewer per-unit earnings. With this strategy, it becomes harder to raise the price later on. Some marketers first skim the market before deciding on penetration pricing. A reduced price makes the market less appealing to new entrants.

8.4.2 Price Adaptation

The organisation must acknowledge that price adaptation is a complex issue. While it is an effective marketing strategy, it may be contentious. As a result, careful thought is required to establish efficient adaptation tactics. Since segmentation is the foundation of a marketing strategy, it is logical to expect segmentation to impact pricing significantly. Prices can be changed to satisfy the needs of different consumer groups.

Student discounts, off-peak travel, bulk purchases, and so on.

However, caution is required because individuals who pay the total price may misperceive adaptive pricing and believe they are subsidising other parts.

For example, certain banks have been chastised for solely offering mortgage discounts to new customers.

Price adaptation frequently includes a discount policy. Discounts, used creatively, may be a powerful marketing tool. They can boost demand and can be used both directly (e.g., a price decrease) and indirectly (e.g., a promotional offer) (e.g., interest-free credit, extended payment terms, optional extras provided at no additional charge).

The fourth area of price adaptation is in response to competitors’ actions. When excess supply in a market or consumer loyalty is seen as weak, companies are likelier to follow competitors’ price decreases. Price increases will likely be matched when excess demand or industry expenses are rising.

8.4.3 Psychological Pricing

Psychological pricing is appropriate when customer purchases are based on sentiments or emotional elements rather than rational considerations, such as love, affection, prestige, and self-image. Price can sometimes be used as a proxy for quality. Product differentiation is becoming more challenging as technology advances and many organisations are attempting to differentiate their offerings based on non-functional product features such as image and lifestyle. Psychological pricing is unsuitable for industrial products.

According to John C. Groth and Stephen W. McDaniel, marketers employ prestige pricing, and customers equate a more fantastic price with higher quality.

For example, Acer and Sony have implemented this pricing strategy for their Ferrari and Vaio Lifestyle laptop PC lines, and Apple uses it for its high-end PowerBook laptop computers.

This price strategy necessitates the development of a strong brand image through promotion programmes that reinforce the brand’s excellence and impression of ultimate exclusivity.

The perceived quality and extent of advertising for a brand heavily influence price perceptions. Paul W. Farris and David J. Reibstein investigated the relationships between relative price, relative quality, and relative advertising in 227 consumer businesses and discovered that:

1. Brands with high relative advertising but average product quality could charge premium prices more successfully than relatively unknown brands.
2. Brands with both high relative advertising and high relative product quality may be able to charge the most. Brands with little advertising budgets and inferior quality achieved the lowest prices.
3. The positive link between high relative advertising and product quality was quite substantial for market leaders in later life cycle phases.

Odds-even Pricing: Marketers occasionally establish product pricing that ends in a specific number. The belief is that this form of pricing helps a product sell more. It is assumed that if the price is ‘99.95,’ buyers do not consider it to be ‘100,’ and that some sorts of consumers are more attracted by odd pricing than even prices. Even though extensive study findings do not support this notion, odd prices appear far more common than even pricing. Furthermore, allegedly, even prices favour exclusive or upscale product images, and consumers perceive the product to be a premium quality brand.

8.4.4 Promotional Pricing

Companies can use various pricing strategies to encourage customers to buy early. As the name implies, these techniques are essential to sales promotions. Some methods include loss leader pricing, special event pricing, low-interest financing, more extended payment periods, cash rebates, free auto insurance, warranties, increased free services, and so on. These techniques do not result in significant gains because most competitors can quickly copy them. To illustrate, only three strategies are discussed briefly.

Pricing for Loss Leaders: Large retail outlets may use loss leader pricing on well-known brands to promote store traffic. By bringing more customers to the store, businesses intend to increase sales of frequently purchased products, increasing sales volume and profitability. This compensates for loss leader brands’ lower margins. Firms whose brands are chosen as loss leaders are opposed to this technique because their brands’ image is weakened, and consumers are unwilling to pay the list price to merchants selling the same products.

Superficial Comparative Pricing: This is a type of superficial discounting. It entails setting an artificially high price and selling the product at a drastically lower cost.

For instance, the communication could state, “Regular price was 495, now reduced to 299.” Many retailers employ this deceptive strategy. We occasionally see adverts with 495 crossed (X) and a new price written as 250.

Special Event Pricing combines price cuts with advertising for seasonal or special events to attract customers by offering lower pricing. For example, before a new school session starts for young children, we see advertisements for shoes that are typically part of the uniform.

8.5 Selection of Pricing Methods

A company decides on a pricing method after deciding on a pricing strategy or strategies to achieve the pricing objectives. A pricing method is a methodical procedure for setting prices consistently. It calculates a product’s price based on demand, costs, and competition.

 8.5.1 Cost-based Pricing

Pricing methods based on cost are relatively common. The price is calculated by adding either a rupee amount or a percentage to the product’s cost to obtain the required profit margin. Cost-based pricing strategies do not consider aspects like supply and demand or competitors’ prices. They are not always tied to price policies or goals.

Markup Pricing

In markup pricing, a predetermined percentage of the product’s cost, known as markup, is added to the product’s cost to determine the price.

Example: Assume a watchmaker has the following costs and sales projections:

‘4,000,000’ in fixed costs

‘300 is the average variable cost per unit.

40,000 units are expected to be sold.

The unit cost of the watch manufacturer is given by:

Average Variable Cost + (Fixed Cost/Unit Sales) = 300 + (4,000,000/40,000) = 400

If the watchmaker wants to earn a 20% markup on sales, the markup price is determined by:

Unit Cost/(1 Desired Rate of Return) =’400/(1 0.2) =’500

The watchmaker would sell its watches to resellers for ‘500 each, earning a profit of ‘100 on each unit sold. If the resellers desire a 20% markup on their selling price, they will charge 625 per unit. Prescription medications are typically offered at exorbitant markups. Speciality and seasonal products are also subject to manufacturer markup pricing.

Target Return Pricing (Cost-Plus)

Some businesses use the target-return pricing method to determine the price to secure a specific fair rate of Return on Investment (ROI).

Example: Assume the watchmaker has invested ‘8 million in the company and desires a 20% return on investment.

The target-return price can, therefore, be determined as follows: Target Return Price = Unit Cost + (ROI Capital Invested/Forecasted Unit Sales) =’400 + (0.2’80, 000,000/20,000) =’800 Price Per Unit.

If the company sells the expected number of units, the watchmaker will receive a 20% ROI. The company can use break-even analysis to examine prices and their potential impact on sales volumes and profits. This strategy disregards price elasticity and competition reactions to pricing.

8.5.2 Competition-based Pricing

This method is also known as going rate pricing. Costs and revenues are treated as secondary concerns in competition-based pricing, primarily focusing on the rivals’ prices. This pricing becomes more critical when rival products are nearly identical, and the price is the most crucial component in marketing strategies, such as cement or steel.

Depending on the extent of product differentiation achieved, a company can maintain a price that is higher, cheaper, or the same as its closest competitors. This strategy may necessitate regular pricing adjustments. This method, on the other hand, has the potential to help keep industry prices steady.

8.5.3 Demand-based Pricing

This method is primarily used by businesses concerned with the level of demand. When the product demand is high, the price is high; when the demand is low, the price is low. This strategy is relatively widespread in hotels, telephone companies, and museums, among other places. The marketer must be able to precisely predict how much product consumers will demand at various pricing points. Demand-based pricing can assist a corporation in increasing profits if consumers perceive a product’s value to be sufficiently higher than its cost. Demand-based pricing can be advantageous when the organisation can precisely anticipate demand at multiple prices, although it is sometimes difficult to forecast demand at different prices accurately.

Hotels and airlines, for example, frequently use this type of pricing. During peak season, when demand is high, they charge higher prices.

8.5.4 Perceived-value Pricing

Many businesses employ perceived-value pricing, determined by the customer’s perceived product or service value. The value proposition that the organisation communicates to its target clients must be delivered, and, of course, customers must see this value. Marketers carefully use various elements of the promotion mix to effectively communicate and enhance customers’ perceptions of the perceived value of a product or service.

Customers’ views of value are influenced by company image, trustworthiness, reputation, product performance, quality assurance, channel members’ image, warranty, after-sales services, etc. Much depends on how important each customer places on these various elements. Depending on the value evaluation of each consumer, some will be loyal purchasers, some will be value buyers, and others will be price buyers.

Companies have different strategies for each of these groups. Some work hard to build relationships with loyal buyers, while others innovate new value and effectively communicate it to value buyers. Companies offering a bare-bones product and few services to price-conscious customers consistently provide high-quality products at reduced prices.

Zenith Computers, for example, has this policy and offers high-quality desktop and laptop computers at lower prices.

8.5.5 Product Pricing Range

Many businesses sell a product line, and the price of each item should be based on the prices of other products in the line.

Optional Additional Items: These are optional extras or features that a consumer may or may not choose to add to the main product purchased. The price of the essential stripped-down product is low, and the margin on additional components is higher.

For example, some computer and auto companies maintain a lower price for the basic model and charge extra for additional components such as an LCD monitor, more RAM, power windows, or power steering.

Captive Product Pricing: Some businesses produce products that require ancillary products, such as razors and inkjet or laser printer manufacturers.

8.5.6 Two-Part Pricing

This price method is relatively widespread among service providers. They charge a fixed fee for the basic service and a variable usage rate.

For instance, telephone service providers may charge a monthly fixed fee plus variable per-call charges for calls over a certain number. Internet service providers charge a fixed fee for cable model installation and variable fees according to the number of usage hours.

Pricing decisions for such businesses involve determining how much to charge for the basic service and what rates to keep for variable consumption. The fixed price should be set at a level that attracts many customers, and profits can be made by adjusting use charges.

8.5.7 Bid Pricing

This pricing method entails the marketer submitting a sealed or open bid price for the buyer’s consideration. The buyer informs potential suppliers that their bids must be submitted by a specific date. The buyer evaluates these quotations based on quoted prices, product specifications, and suppliers’ ability to deliver specified products when and where needed according to the buyer’s schedule. Typically, the contract is awarded to the lowest bidder. This strategy is commonly used by central, state, or municipal government departments and construction corporations.