Friday, December 4th, 2009
Competitor-Related Pricing Systems
Competitor-related pricing systems fix prices by reference to the going rate – the level of competitors’ prices. Less attention is paid to demand and, while the aim is to cover costs, they are not the main determinant of prices.
The market is divided according to the levels of quality, service or prestige provided by suppliers of the produce or service. Each sector has a price leader who determines the going rate. The price leader is the market leader with, usually, but not always, the highest sales in the sector. The market leader makes the first move on prices, up or down, and his or her competitors tend to follow.
When using this approach, the company has to decide on its pricing policy. It may go for market leadership, bearing in mind John Winkler’s advice that ‘Market leaders make most money. On average their price is better, their volume is greater and their unit costs are lower… [if] you want to outsell everyone then get your price about 7 per cent above the average.’ Or the company may decide to maintain its prices in line with the average or broadly in the middle segment of the range. It may then follow a policy of parallel pricing by aligning its price increases with those of its competitors. If oligopolistic conditions prevail, in other words if the market consists of a few powerful suppliers, prices may be closely aligned throughout the market and parallel pricing will be the general rule. Two variants of this approach are described below – competitive pricing and discount pricing.
Competitive pricing
Competitive pricing means tackling the price leader in the market segment in which the company is operating. Where possible, the aim would be to set a slightly higher price than the price leader’s (say 7 per cent) and then launch a marketing campaign to demonstrate that what Winkler calls a ‘discernible product difference’ exists. This means demonstrating that the company’s product offers a distinct improvement over its competitor’s.
If the firm cannot compete on quality it may have to set slightly lower prices or offer higher discounts of at least 10 per cent but not more than 15 per cent or so.
Discount pricing
Discount pricing is a technique that sets artificially high prices but then offers large discounts to attract customers. It is advisable not to offer discounts on a permanent basis. Flexibility is important.
Considerations affecting pricing strategy
Product costs set a floor to the price but are not the only consideration. A ceiling may be set by the unique features that the company offers, although this level will also be influenced by the company’s strength and prestige in the marketplace. Competitors’ prices and the prices of substitutes provide an intermediate point that the company has to consider in setting its price. Finally, demand has to be taken into account. The relative elasticity of demand will influence the extent to which the company can maintain the volume of unit sales after a price increase, or can increase sales by means of a cut in prices.
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Wednesday, December 2nd, 2009
Market-Based Pricing
Market-based pricing emphasizes price as a variable element of the marketing mix. Its concern is how it can affect the company’s position in the marketplace. Value is included in this notion of price, and the underlying marketing theme is to set prices at ‘what the market will bear’.
Profit maximization is natural in marketing, but it is not feasible to do this on all products/services amongst all customer groups. Companies can employ many pricing tactics that might promote sales yet reduce margins in the short term. The general objective might be profit maximization, but the company’s product mix should be examined in terms of individual items, and price tactics applied individually, rather than singular pricing decisions applying to the complete range. Prices should adopt a customer focus, and this will determine whether the product is bought or not.
Although the assumption behind market-based pricing techniques is that prices are a major factor in achieving competitiveness, this can also be attained through non-price competition. Market share can be improved through customer care, the delivery of value for money, quality and high levels of service (response, delivery and after-sales service).
The main market-based pricing techniques are described below.
Penetration pricing
Penetration pricing involves setting prices at a sufficiently low level to make them attractive to the mass market. The aim is to achieve high initial sales, which are maintained during the life cycle of the product. An associated aim is to deter competitors. Penetration pricing is particularly appropriate for products where unit cost reductions can be achieved through initial mass production.
Setting-up costs are usually high and initial development costs are recovered over a long period. The task of marketing is to ensure that customers retain interest during the life of the product.
Skimming
A skimming approach adopts a high-price strategy, charging what the market will bear. The aim is to ‘skim the cream off the market’. This policy is particularly attractive to a company with a new and unique product. When the cream has been skimmed, prices can be progressively reduced.
Perceived value pricing
Perceived value pricing determines prices from assumptions made about the beliefs that consumers have of the value of the product to them. These assumptions may be founded on market research aimed at establishing in buyers’ minds values about the basic product and the various special features in the product that appeal to them.
If the company charges more than the buyer-recognized value, sales will suffer. Revenue may also fall below attainable levels if prices are lower than the perceived value.
Psychological pricing
Many consumers use price as an indicator of quality. Prestige pricing uses higher prices to promote the idea of value and status.
Price levels can be set just below a round figure, for example £9.99 rather than £10.00. These pricing points, as they are called, persuade people to think that the price is in a lower range than they expected.
Value for money can be emphasized by the effective presentation of discounts and free offers. The perceived value of offering one item free if four items are purchased may have a greater impact than a 20 per cent discount offered over the whole five purchases.
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Tuesday, December 1st, 2009
Pricing is the method used by a company to fix or change its price with regard to costs, sales and profit targets, the pricing policies of competitors and the perceived value of the product by customers.
Approaches To Pricing
The four basic approaches to pricing are:
The economist’s, which suggests that price is the medium through which supply and demand are brought into equilibrium.
The accountant’s, commonly used in manufacturing, which states that the aim of pricing is to recover costs and make a profit.
Market-based, which adopts a customer/demand focus.
Competitor-related, which fixes prices by reference to those charged by competitors.
The economist’s approach is of purely theoretical interest. In practice it is the accountant’s or the market-based approaches as described below that are the ones used.
The Accountant’s Approach
The aim of the accountant’s approach is to seek a targeted rate of return on investment for a specific level of sales. The main techniques used are:
cost-plus pricing;
standard cost pricing;
marginal pricing;
break-even analysis.
Cost-plus pricing
Cost-plus pricing (called mark-up pricing in retailing) means adding a standard mark-up to the total cost of the product. Thus, if a retailer pays a manufacturer £10 for a product and marks it up to sell at £15, there is a 50 per cent mark-up on the product and the retailer’s gross margin is £5. If the operating costs of the store are £4 per unit sold, the retailer’s profit margin will be £1 or 10 per cent.
This is a production-orientated approach commonly used in manufacturing and it is at odds with market-based approaches, which take account of customer preferences and the pricing policies of competitors. However, prices should cover costs, so all pricing systems are, to that degree, cost-related. Cost-plus or mark-up pricing systems do this, and have the additional virtue of being based on ascertainable facts rather than on suppositions about demand. Demand and the perceived value of the product cannot be ignored, however. There is a danger of overpricing if too much attention is paid simply to obtaining an acceptable profit margin over total costs, and of underpricing if the perceived value is underestimated.
Standard cost pricing
Standard cost pricing is based on the cost standards developed in management accounting systems.
The standard variable cost per unit is calculated by adding the total variable costs of production, namely the cost of materials and direct labour, and the cost of bought-in components, and dividing this sum by the number of units produced.
The steps taken to establish a standard cost price are as follows:
1. Calculate the standard variable cost per unit.
2. Calculate the fixed cost per unit (the running expenses, including administration and selling expenses of the business over a period of time divided by the number of units to be sold in that period.
Again, this approach is also used in manufacturing and takes no account of demand.
Marginal pricing
Marginal pricing fixes the selling price of additional units by reference to the marginal cost of manufacturing each unit.
The theory of marginal pricing is that, after a company’s total fixed and variable costs have been covered by the existing volume of production, the cost of producing an extra unit – of marginal production – will only be the total variable cost of producing and selling it. In such circumstances, the selling price of additional goods can be reduced, if necessary, to match the total variable cost without any loss to the company. Any amount by which the selling price exceeds the variable cost of marginal outputs is then an extra or marginal contribution to the company’s net profits and fixed costs. Again, this is a manufacturing approach.
Break-even analysis
Break-even analysis uses the concept of a break-even chart to develop a system of target pricing in which the company tries to determine the price that will produce the profit it is seeking. Although profit related, this form of pricing is based on an analysis of total costs, upon which is superimposed an assessment of total revenue.
Break-even analysis determines fixed and variable costs and enables the price-setter to investigate the profit implications of alternative price– volume strategies. A break-even chart represents the following elements of costs and revenue:
Fixed costs – the costs of production that will not vary in the short term, though at a certain level of output it may be necessary, for example, to install an extra production line, in which case there will be an increase in fixed costs, known as a step cost.
Variable costs of labour and materials, etc, which increase in proportion to volume.
Total costs – the sum of fixed and variable costs.
Total revenue – the sales made to customers, which increase with output, although as output increases, a company may have to trim its margins, and revenue may then decline.
Break-even point – this is reached when total revenue exceeds total costs.
Sales above this point will be profitable; below this point a loss will be incurred. Break-even analysis concentrates attention on the likely profit or loss that may be incurred by alternative pricing strategies. It is therefore an essential technique for selecting the best policy, as long as sufficient attention is paid to the demand curve. Unless the elasticity of demand (the impact of price changes on sales) is taken into account, break-even analysis can be misleading.
Target pricing
Target pricing techniques are based on break-even analysis. They involve:
estimating demand at different price levels;
drawing up total revenue curves at different price levels;
referring to the break-even chart and assessing the profit implications of setting different price levels;
making a final decision on price levels and profit targets by considering the profit implications in relation to estimates of sales volumes and then selecting the optimum alternative.
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