Everything you need to know about the methods and techniques adopted for pricing your products! Learn about:
A. Methods of Product Pricing 1. Cost-Based Methods 2. Break-Even Concept
B. Product Pricing Methods 1. Demand and Perceived Value-Oriented Pricing 2. Competition-Oriented Pricing.
Also learn about the product pricing methods, concept, approaches and strategies.
How do marketers of products and services arrive at a specific amount that they expect consumers to pay? Do marketers use ad hoc approach or is price based on some kind of systematic procedures?
In some cases the price is decided by using an elaborate system, while in others rule of thumb is used. By pricing method, or pricing strategy, we normally mean the route taken in fixing the price.
Evidently, the method/ strategy must be appropriate for achieving the desired pricing objectives. There are several methods of pricing. Each of them is appropriate for achieving a particular pricing objective or a combination of pricing objectives.
Methods of Product Pricing: Methods, Concept, Approaches Techniques and Strategies
Methods of Product Pricing – Cost Based Methods and Break Even Concept
1. Cost-Based Methods:
Cost-based methods as a class, have certain merits and demerits. The main merit is that so long as the methods work, the firm is assured of the target profit. The risk involved is minimal. The main demerit is that the methods assume a level of demand for the product independent of price.
And the second demerit is that the profit percentage is often arbitrary. There is the chance that a much better opportunity for profits is lost by keeping the price too low; there is also the chance that the sales volume is lost because of expectation of a higher level of profit which the market cannot return.
2. Break-Even Concept:
An idea of the break-even concept is essential for correctly understanding most of the cost-based methods of pricing. We shall therefore touch upon this concept before proceeding with the discussion on the other methods of pricing.
In any business, costs, volume, price and profits are interrelated. For most products, different demand levels and sales volume may materialize act different price levels. And different volume levels have different associated cost levels. A particular volume level and its associated cost level, generates a particular profit level, the price remaining the same.
When we consider different price levels, we have different profit levels, resulting through their associated levels of volume and costs. The firm can project profits at different price levels and choose the one that is particularly suited to it.
In producing and selling a certain volume of any product, certain fixed costs and certain variable costs are incurred. When the volume is increased or decreased, the variable costs go up or down. The fixed costs usually remain the same. The firm is essentially concerned with the total of the variable and fixed costs incurred for the particular volume.
At that volume, and at the assumed level of price, a particular level of total revenue is generated. The break-even exercise is aimed at relating these two entities -the total costs and the total revenues at different levels of volume and consequently at different levels of prices.
At a level where the total costs exactly equal the total revenues, the breaking even of costs and revenues takes place. The result is zero profit. At a level where the revenues exceed the costs, profits are earned and at the other level losses are incurred. The number of units that are required to be produced and sold in order to reach a no loss no profit position at the given level of unit price, is indicated by the break-even point.
Usually, when more units than the break-even level are produced and sold at the given price, the profits go up. And each additional unit made and sold brings in some additional profit. Each unit made and sold below the break-even point results in a loss.
Many business firms use the break-even concept in their pricing methods. They use the concept not only for price fixation but also for determining levels of production or levels of utilization of the production capacity that is required for achieving the desired levels of profits. The concept is also used in the appraisal of new projects. It is a tool for making volume-cost-profit analysis. The various methods listed under cost-based pricing utilize the break-even idea in one way or the other.
Break-Even Concept:
Demand/Market Based Pricing:
The following methods belong to the category of demand / market based pricing:
i. What The Traffic Can Bear’ Pricing
ii. Skimming Pricing.
iii. Penetration Pricing
The basic feature of all these demand-based methods is that profits can be expected independent of the costs involved, but are dependent on the demand.
i. ‘What the Traffic Can Bear’ Pricing:
As per pricing based on ‘what the traffic can bear’, the seller takes the maximum price, which the customers are willing to pay for the product under the given circumstances. It is not a sophisticated method. It is used more by retail traders than by manufacturing firms. This method brings high profits in the short-term. But in the long run, ‘what the traffic can bear’ is not a safe concept.
Chances of errors in judgment are very high. Also, it involves trial and error. It can be used where monopoly / oligopoly conditions exist and where demand is quite inelastic with respect to price. Buyers oppositions on consumerism is bound to set in course of time when a firm sets its prices on the basis of what the traffic can bear.
Skimming pricing aims at high price and high profits in the early stage of marketing the product. As the word skimming indicates, this method literally skims the market in the first instance through high price and subsequently settles down for a lower price. In other words, the method profitably taps the opportunity for selling at high prices to those segments of the market which do not bother, much about the price.
The method is very useful in the pricing of new products, especially, the ones that have a luxury or specialty element. For example, when the new product is a luxury item, enjoying the patronage of an affluent and price insensitive segment of the market, the firm can opt for the skimming strategy.
As the product has novelty and as it is aimed at the affluent sections, the quantity that can be sold is not affected by the price level. Skimming will also help the firm feel the market/demand for the product and then make appropriate decisions on pricing.
Penetration pricing, as the name indicates, seeks to achieve greater market penetration through relatively low prices. It is the opposite of skimming pricing. This method too is quite useful in pricing of new products under certain circumstances. For example, when the new product is not a luxury item and there is no affluent/price insensitive segment backing it, but is capable of bringing in large volume of sales, the firm can choose the penetration pricing and make large size sales at a reasonable price before competitors enter the market with a similar product.
The strategy suits this type of products and also brings many advantages to the firm. For, in such products, the quantity that can be sold is highly sensitive to the price level even in the introductory stage. And soon after introduction, the product may encounter stiff price competition from other brands/substitutes. Penetration pricing in such cases will help the firm obtain a good coverage of the market and keep competition out for quite some time.
Moreover, for products of this category, large sales may be necessary for break-even, even in the initial stages and penetration pricing alone can bring in the high volume of sales required for breaking even and making profits,
In Product Development, we had seen that market related pricing such as skimming and penetration pricing rather than cost based pricing would be the apt strategy for products that are really new. We had also seen that the firm could choose either the skimming strategy or the penetration strategy, depending on the products and the marketing context involved.
Product Pricing Methods – Cost-Based Pricing
By pricing method, or pricing strategy, we normally mean the route taken in fixing the price. Evidently, the method/ strategy must be appropriate for achieving the desired pricing objectives.
There are several methods of pricing. Each of them is appropriate for achieving a particular pricing objective or a combination of pricing objectives. For example, skimming pricing is suited for achieving the pricing objective of short-term profit maximization.
Broad Categories of Pricing Methods:
The different methods of pricing can be grouped under the following broad categories:
I. Cost-Based Pricing
II. Demand-Based Pricing
III. Competition-Oriented Pricing
IV. Product Line-Oriented Pricing
V. Tender Pricing
VI. Affordability-Based Pricing
VII. Differentiated Pricing
Under each of the above categories, there are several different pricing methods. They may vary from one another in some respects, but as a category they share a common orientation. We will discuss in detail some of the more important and commonly used pricing methods.
Cost-Based Pricing:
Under this category, there are several approaches/ methods like:
i. Mark-up Pricing/Cost Plus Pricing
ii. Absorption Cost Pricing/Full Cost Pricing.
iii. Target Profit Pricing/Rate of Return Pricing.
iv. Marginal Cost Pricing
While these methods vary from one another in some respects, all of them are based on costs.
i. Mark-Up Pricing:
Mark-up pricing refers to the pricing method in which the selling price of the product is fixed by adding a margin to the cost price. The mark-ups vary depending on the nature of products and markets. Usually, the higher the value of the product (unit cost of the product) the larger the mark-up and vice versa. Again, the faster the turn round of the product, the smaller the mark-up and vice versa.
Mark-up pricing proceeds on the assumption that demand cannot be known accurately, but costs are known. A reasonable mark-up is added to the costs. And the price, as well as the mark-up is adjusted by trial and error. The objective is to maximize profits in the short run without sacrificing sales due to excessive prices. Usually the distributive trade and marketing firms who do not have any manufacturing of their own, prefer this pricing method.
Absorption cost pricing or full cost pricing rests on the estimated unit cost of the product at the normal level of production and sales. The method uses standard costing techniques and works out the variable and fixed costs involved in producing, selling and administering the product. When the costs of these three operations are added, the total cost becomes available.
To the total cost, the required margin is added towards profit and the total becomes the selling price of the product. This method is also known as full cost pricing since the method envisages the realization of the full costs from each unit sold. The method has some merits and a number of limitations.
Merits and Demerits of Absorption Cost Pricing:
The main merit of this method is that as long as the market can absorb the production at the determined price, the firm is assured of its profits without any risks whatsoever. Firms preferring great amount: of safety in their pricing method may follow this method of pricing. On the demerits side, it must be mentioned first that the method does not take cognizance at all of the demand factor; it simply assumes price to be a function of cost alone.
In a competitive market where demand of the product at the determined price cannot be taken for granted, this method becomes ineffective. In fact in a competitive market, if a firm swears by absorption cost pricing it is likely to lose portion of its sales. Secondly, the method relies excessively on standard costing and normal level of production and sales. The calculations are upset if the actual production and sales fall short of the assumed/ normal level of production and sales.
Thirdly, quite often, significant variations occur in the cost of the inputs that go into the product between the time when the absorption costs were worked out and the time of actual production/sale of the product. To obviate this position, frequent updating of the costs becomes necessary. And this may not be practicable in all cases.
Fourthly, absorption cost pricing is not a dynamic method of pricing. In certain situations, it may be advantageous to the firm to compete in the market and attract additional sales at prices that are lower than the absorption cost prices. But when a firm sticks to the policy of absorption of full cost on each unit of sale, it loses the opportunity of trying other alternatives and benefiting from them.
iii. Rate of Return Pricing:
The rate of return pricing is similar to the absorption cost pricing, but is different from It m some respects. In the absorption cost pricing, after the costs of manufacturing, selling and administering are absorbed on a per unit basis; the firm adds its mark-up towards profits. This mark-up is often decided on an arbitrary basis. On the other hand, the rate of return pricing uses a rational approach to arrive at the mark-up. It is arrived at in such a way that the return on investment criteria of the firm is met in the process.
Merits and Demerits of Rate of Return Pricing:
The rate of return pricing too has its merits and limitations. It amounts to an improvement over absorption cost pricing since it uses a rational basis for arriving at the mark-up. Secondly, since rate of return on the funds employed is a function of mark-up as well as turnover of capital employed, rate of return pricing method constantly reminds the firm that there are two routes for profits -improvement in the capital turnover and increase in the mark-up.
The main limitation of the method is that the rate of return is linked to the level of production and sales assumed. When the level changes, the rate of return will also change.
iv. Marginal Cost Pricing:
The marginal cost pricing aims at maximizing the contribution towards fixed costs. The marginal costs will include all the direct variable costs of the product. In marginal cost pricing, these direct variable costs are realized fully. In addition, a portion of the fixed costs is also realized.
The main difference between ab3orption cost pricing and marginal cost pricing is that the latter gives the flexibility to leave out a portion of the fixed costs unrecovered depending on the market situation. It also gives the flexibility to recover a larger share of the fixed cost from certain customers or a certain segment of the business and a smaller share from others.
Merits and Demerits of Marginal Cost Pricing:
Like the other methods, the marginal cost pricing too has its associated merits and limitations. In the first place, the marginal cost approach, unlike the other two cost-based pricing approaches, takes into account cost aspects as well as demand aspects. Thus, under competitive market conditions, the marginal cost pricing will be useful.
Moreover, when a firm has a number of products/product lines, marginal cost pricing will be useful. It gives the flexibility for realizing the fixed costs through different products/product lines at different rates depending on market conditions, while recovering all the marginal costs (i.e., variable costs) directly from the concerned product. The method may be particularly useful in quoting for competitive tenders and in export marketing.
However, marginal costing makes certain assumptions regarding cost and revenue behaviour and these assumptions may turn out incorrect in some cases. Moreover, while marginal costing semi-variable costs, or mixed costs. Marginal costing ignores this reality .On account of these factors, some distortions can enter the picture and affect the validity of the marginal cost pricing.
Again, marginal cost pricing can be circumstances. No firm can afford to depend on this method on a long- term basis. And in highly capital-intensive industries, selling on this marginal cost basis may pose an additional problem as the difference between the marginal cost price and the full cost price will be very large.
Product Pricing Methods – Top 3 Methods
Products are made available at a price. For instance, consumer durables such as refrigerator and sofa set; services such as mobile service and insurance; fast moving consumer goods such as toothpaste and hair oil; and fruits and vegetables are quoted by their sellers in terms of some monetary value.
How do marketers of these products and services arrive at a specific amount that they expect consumers to pay? Do marketers use ad hoc approach or is price based on some kind of systematic procedures? In some cases the price is decided by using an elaborate system, while in others rule of thumb is used.
Price decisions are crucial to the marketer. Therefore, these cannot be taken without giving regard to a number of factors that include price’s influence on demand, cost, and investment. Broadly, price’s relationship between cost, demand, revenue, and investment must be factored in while setting price.
The major orientations to setting prices are:
1. Cost orientation,
2. Demand and perceived value orientation, and
3. Competition orientation.
Method # 1. Cost Oriented Pricing:
This approach, also known as cost-plus pricing approach, is driven by the cost of product. The key consideration governing price is that a product’s price should be able to recover all costs because cost recovery is essential to stay in business. Under-recovery is a path to getting out of business.
Therefore, firms aim to fix a price that is higher than cost. A price over and above cost results in profit or surplus. The price is arrived by a simple formula summed up as cost + profit margin = price.
This method of pricing is widely used for its simplicity. What is a matter of debate in cost pricing is what cost should be considered for pricing. There are different ways of looking at cost. For instance, there is total cost, fixed cost, variable cost, and marginal cost. Then there is direct cost and indirect cost.
Generally, total cost is included in cost-plus pricing approach including overhead costs.
Two types of pricing can be distinguished in cost oriented pricing, namely:
i. Markup pricing and
ii. Target pricing.
i. Markup Pricing:
Markup method treats pricing as a simple exercise in which a percentage is simply added to cost to arrive at price. For instance, a retailer may add 5 per cent markup to all of the products that it sells in the fresh food section. This is commonly practised in retailing. Different markups could be used for various goods.
Markup pricing is also common to trades where lack of standardization does not allow calculation of one generalized cost across different units. For instance, in industries such as construction or made-to-order automobiles each job involves its own unique cost structure.
In such cases, the firm may use a simple rule of thumb that a specific percentage of cost would be added as markup to fix the price. Markup levels depend upon the nature of trade and practices. It will be an interesting study to find out how markups differ in different products such as liquor, groceries, and jewellery.
Markup pricing can be exemplified with the following business situation-
Consider an outdoor caterer who is given a contract to prepare meals for a party of 100 people. He calculates the cost for arranging a five course meal for 100 guests at Rs.1,00,000. The caterer cannot afford to provide catering service below this cost. Suppose he adds Rs.10,000 to cover his profit, which is his markup amount. The selling price therefore becomes Rs.1,10,000.
Selling price = Cost (Rs.1,00,000) + Markup (Rs.10,000)
As a matter of practice, markup is usually expressed as percentage rather than in rupee terms. Markup can be expressed in two ways—as percentage of cost and as percentage of selling price. That is, in the previous case if it is expressed as percentage of cost, it works out at 10 per cent (i.e., Rs.10,000/Rs.1,00,000 = 10 per cent) and if it is expressed as percentage of selling price, the markup is 9.09 per cent (i.e. Rs.10,000/Rs.1,10,000 = 9.09 per cent).
It must be noted that markup is usually expressed as a percentage of selling price, which is added to cost. So in our case, the markup of Rs.10,000 comes out to be 9.09 per cent. Markup is generally related to price. It must be noted that the expression of markup as percentage of cost is not technically wrong. All that is required is while expressing markup it must be clarified on what basis it is calculated.
The formula for calculating price based on markup is as follows-
Selling price = Item cost/(1 — Markup)
Rs.1,10,000 = 1,00,000/(1 – 0.10)
Markup pricing is popular with retailers, wholesalers, and distributers who sell a large number of items. Thousands of items are typically stocked by a grocery store in a neighbourhood. Some of these items often constitute a small portion of the total sales. In such situations, setting price individually for each item may involve lot of time and energy.
Fast turnover would also add further complications because each time new stock would be added. Markup pricing in these situations offer an easy solution. Therefore, standardized markups added to different categories of products. The only thing critical is that markup should be sufficient to cover up all the operating expenses and some amount of profit.
One of the guiding principles is to fix markup in the close range of gross margin of the marketing entity. Gross margin is the figure that is arrived at by deducting cost of goods sold from total sales revenue. It is expressed in percentage terms of total sales revenue. On the surface, it appears that a higher gross margin leaves the firm with more money.
The firm is able to retain more on each rupee of sales that is used to meet other obligations and costs. Gross margin must be distinguished from net margin. Net margin or income is profit after all expenses, overheads, and interest payments have been deducted from gross income. The deductions are made for selling and general administrative expense, interest payments, and taxes.
Gross margin per cent = (Revenue — Cost of goods sold)/Revenue
It may be assumed that higher markup leaves more money for the firm. However, this assumption is not correct. Higher markups push the price of the good or service. Doing so, the price may become too high for consumers such that the product or service becomes an unattractive proposition.
Therefore, paying attention to markup with a singular view to make more money may actually create an opposite situation. The demand impact of margin must be borne in mind. On the contrary, a lower markup may be more beneficial for a firm. Lower markup can make the product or service price attractive to more consumers and encourage higher consumption.
For instance, a seller is able to sell 100 units of a commodity with 20 per cent markup per cycle. If he reduces the markup to 10 per cent he may end up selling 250 units.
The concept that works with regard to stock movement is stock turnover rate that means the number of times stock is turned around in a period. A low stock turnover rate is directly linked to inventory carrying cost. For instance, if a Rs.50,000 sale is made in a year and it is done in one sale, than the stock turnover rate is 1.
It means a sum of Rs.50,000 is tied for a year in inventory. However, if Rs.50,000 sales is reached by selling 10,000 goods five times in a year, it means than only Rs.10,000 was tied in inventory at a particular period in time. Suppose the inventory carrying cost is 10 per cent, then in the first instance the stock turnover rate is 5,000, which gets reduced to only 1,000 in the second case when the turnover rate is 5 (Rs.50,000/Rs.10,000).
This connection often makes marketers to choose lower markup to increase turnover rate. Based on these insights, retail companies often use lower markup on fast moving items and higher markup on slow moving items.
ii. Target Pricing:
It is a cost oriented method in which a marketer sets price that would give a specific rate of return on total cost at an estimated volume. This pricing assumes that the firm is not only guided by a motive to earn profit but a specific return on investment. For instance, a company like Hero may seek to set a price for its products at a specific volume that would give it a 10 per cent rate of return on investment.
Target pricing involves much more complications than cost-plus pricing. It can be arrived by the following steps. First, total cost at different production levels is calculated. This can be done by combining fixed cost with variable costs. Second, after cost estimation of production at different level, the number of units that would be sold is chosen.
Third, the target rate of return is specified. For instance, the firm wishes to earn 10 per cent profit on cost and this amount stands at Rs.20,000. This amount is then added to the total cost. Fourth, price per unit is calculated by adding cost with target return and dividing it by the number of units to be sold.
Target return pricing suffers from a major conceptual drawback. The price is arrived at by making an assumption that the firm would be able to sell a specific number of units beforehand. That is, demand is given irrespective of what price is arrived at. In reality, price has a major influence on demand. Demand function is completely ignored in target oriented pricing procedure. The price so arrived by using this procedure may be too high that the real demand may not coincide with the assumed sales.
Method # 2. Demand and Perceived Value-Oriented Pricing:
Pricing in this category is based on the nature of consumer demand. Markets are rarely made of homogeneous consumers. Consumer variations manifest in different types of demands. Consider the demand for public transportation; office goers who need to report to their place of work on time have inelastic demand as compared to people who do not have the compulsion to report on time.
Similarly, people may differ in their attachment to a fashion product like branded sunglasses. Marketers therefore base their price setting decisions according to consumer demand being faced instead of cost of products.
There are two ways to approach pricing based on demand considerations—pricing based on consumer perceptions of value of a product or service and charging different prices from different consumers for almost similar product.
These two approaches are called:
i. Perceived value pricing and
ii. Price discrimination.
i. Perceived Value Pricing:
Consumers may perceive a product differently depending upon how they see or value it. It is highly unlikely that a product is perceived uniformly by consumers. This can be proved by a simple experiment. Show a branded pen like Montblanc to a group of people by hiding its brand name and ask them to reveal the monetary sacrifice that they would be willing to make for the same.
The monetary value attached to the pen in all probability is likely to exhibit huge variations. The value of a product or service is influenced by a number of factors. For instance, a person in an emergency situation would attach more importance and will be willing to pay higher price. In perceived value pricing the buyer’s perception of value serves as the base on which pricing decision is made instead of the cost, which was the key consideration in cost-based methods.
In modern marketing practice, firms create several brands of the same product category with different value perception and sell at different prices accordingly. For instance, the actual product difference between two brands of mobile phones like Galaxy S4 and Galaxy S5 is not in direct proportion to their price differential.
Similarly, three brands of detergents marketed by HUL, namely Wheel, Surf, and Surf Excel, are priced differently in accordance to their value perception as defined in their brand positioning intentions. Firms usually first decide the value spectrum that they seek to position their brand in and then create value perceptions accordingly with the use of brand imagery.
The Wheel ads convey a value for money idea with a typical middle class imagery. Surf Excel on the other hand exhibits an upper class user and positioning the brand as an instrument of satisfying higher order need that is good parenting.
The pricing of luxury brands in categories such as watch, garment, intimate wear, home, pen, cosmetic, and sunglasses is typically done on the basis of perceived value. For instance, people are conditioned to react with a higher perception of value on looking at products with brands such as Louis Vuitton, Chanel, and Gucci.
The basis of setting price under this method is the perceived value, that is, the value attached to a product or service. Inaccurate judgement of perceived value can lead to under or over setting of price. There are several ways to finding out the perception of value in a product or service.
They are:
a. Direct price rating,
b. Direct perceived value rating, and
c. Diagnostic method.
a. Direct Price Rating:
In this method the consumers or buyers are shown the product and requested to provide their estimation of price. For instance, the consumers may be shown three models of refrigerators such as A, B, and C. Then they are asked to express price of each one of them in rupee terms.
b. Direct Perceived Value:
This method uses an indirect approach to arriving at the perceived value. Taking on the earlier example of refrigerators, the consumers are now asked to assign points to each model from a maximum of 100. Suppose they give points as 80, 60, and 50 respectively. Therefore, the relative perceived value among these models is highest for A, followed by B and C.
c. Diagnostic Method:
This method uses an extended framework to arrive at the perceived value. First, the products are not perceived in totality rather consumers are asked to assess the perceived value on the basis of their attributes. In our example, each of the refrigerators will be rated on four criteria, namely durability, brand image, service, and quality.
Second, each of these attributes are given weights according to their importance out of a total of 100. Here the relative weight for durability, image, service, and quality could be 30, 20, 30, and 20. Third, consumers rate each attribute by allocating points out of 100, such as durability (50), image (40), service (70), and quality (60).
Fourth, the weights are then multiplied by the perception scores for each attribute and divided by 100 to arrive at relative perception score for all the brands. By comparing the company’s product with that of an average player, it can easily be found how the product in question stands in value perception in relation to an average product or brand.
A company with higher perceived value can steal market share by pricing its product in close proximity with the average product. This is because the company’s product would be seen to deliver better value at an average price. Alternatively, if a product’s perceived value is lower than an average product and the firm chooses to price it higher than an average product it may not find buyers. The consumers would find the product to be over-priced.
ii. Price Discrimination:
Price discrimination is another approach to price setting. It implies a strategy of selling almost same product at different prices. For instance, suppose a company bottles water from the same source but packs it in two different coloured bottles and vends these at Rs.20 and Rs.40 a litre.
The essence of price discrimination is that price differentiation among products does not correspond to their cost differences. Price charged for the product or service depends on considerations other than cost that could include customer, place, time, and product form.
a. Customer-Based Discrimination:
This is typically done by shops and vendors that practice fixed price policy. Price is charged by the seller on the basis of the kind of buyer. For instance, fruit and vegetable vendors charge price by assessing the demographic and psychographic characteristics of their customers. Typically men end up paying more and women manage to get lower prices by hard bargaining.
b. Place-Based Discrimination:
This kind of price discrimination is practiced by stores and cinema chains. For instance, grocery or fruit chains typically charge higher price at posh locations. Similarly, price of a cinema ticket is higher in Gurgaon. Place-based discrimination is done in response to prevalence of differing demand conditions.
c. Time-Based Discrimination:
This type of discrimination is practiced by the sellers after they study the seasonality of demand. Consider the prices of perishable goods such as vegetables and fruits. Their prices tend to be higher in the morning and tend to decline by night. The same is the situation with bakeries and cake shops. Similarly, mango prices are the lowest during harvesting season and they go up as offseason sets in.
d. Product Form-Based Price Discrimination:
Slight changes in the product features and form give marketers an opportunity to charge different prices. For instance, car makers charge varying prices for different models of the same car by creating differences in trim and finish. Similarly, cars with leather finish upholstery and wooden dashboard are typically sold at higher prices, which do not reflect differences in marginal cost.
Price discrimination is an opportunity for a marketer as he can enhance his revenue and profits by charging better prices.
George Stigler suggested that price discrimination is sustainable only in the presence of certain conditions that are discussed here:
a. Segmentation:
First, the market must be segmented into different consumer groups with differing demand intensities. For instance, business travellers have greater demand intensity for morning air flights than leisure travellers.
b. Movement:
Price differentiation is sustainable only when low-priced products cannot be sold in high price segment. For instance, price discrimination would collapse in a situation when products are sold at a lower price in Delhi but at a high price in Ghaziabad. This would result in products being moved from Delhi to Ghaziabad and sold there.
c. Competition:
Price discrimination is not possible if competitors start selling at a lower price in a segment where a firm charges higher price.
d. Cost and Benefits:
The cost of segmentation and guarding market with higher prices should not exceed the extra revenue derived from price discrimination.
e. Customer Resentment:
Price discrimination is sustainable if consumers are either not aware of the discrimination or are aware but do not resent it. A situation of resentment can cause price discrimination to collapse.
Method # 3. Competition-Oriented Pricing:
Most markets are characterized by rivalry between participating firms. For instance, in the bottled drinking water market companies such as Coca-Cola, PepsiCo, Parle, Tata, and a host of local players compete with each other to win. Unlike the previous methods of price setting in which customer or cost were considered in price setting decisions, competition-oriented pricing method is driven by the consideration of competition.
The price charged by competition assumes critical influence in a firm’s pricing decisions. This does not mean that the firm charges a price same as its competition. The price set by the firm can be lower or higher than the competition. Competition-oriented pricing is a pragmatic method of price setting because it is rare that a firm operates in a monopoly market structure.
Most markets in the present day environment are either oligopolistic or monopolistic in nature. Price retaliation and price wars are common phenomena in an oligopolistic market structure. A firm’s price that deviates from an established brand is perceived as an aggressive move to steal share. Hence, it is dealt with firmly and fiercely. Firms in their bid to avoid price-based competitive warfare adopt what can be termed as going rate pricing.
Going Rate Pricing:
In markets where products are not differentiated, pricing in line with the going rate is appropriate. Product homogeneity makes consumers open to effortless switching. The absence of perceived differentiation leaves marketers with little option but to charge a price in close proximity with the going rate.
A price higher than the going rate is unsustainable because it is unlikely to attract consumers and a price lower than going rate is likely to invite price retaliation. For example, private petrol vending through pumps by Reliance and Essar industries failed to attract customers primarily because they priced their petrol and diesel higher than the going rate.
Since automobile fuel is perceived by the market as a commodity devoid of differentiation, customers did not favour these fuel pumping stations. An almost similar situation is observed in economy air travel market in India. In the domestic airline industry, players such as Spicejet, IndiGo, and GoAir are quick to take note of pricing moves of each other and are very prompt to counter them.
Consider the cola market where both dominant players, Coca-Cola and Pepsi avoid playing the marketing game based on price. Notwithstanding the millions of rupees spent by companies for brand building, they realize it is difficult to create hard consumer loyalty. A slight price reduction is sufficient for consumers to switch sides.
In homogeneous markets characterized by fierce competition, the players are often called ‘price takers’, that is, they take price and not make price. The inability to make price for their products or services is caused by product homogeneity.
Marketing’s role in such a situation is to reverse the effects of competition. By successfully differentiating a product or service, a marketer can gain pricing freedom. It is for this reason firms invest resources in brand building. There are two ways to build differentiation—differentiation based on reality and perception.
Real product differentiation is hard to sustain because the differentiating attributes and features are quickly replicated by competitors. For instance, fuel efficiency enhancements achieved through fine engineering in the car market, especially at the lower and middle end of the market pyramid by a company like Maruti is quickly replicated by its rivals such as Hyundai and Honda.
It is for this reason, firms resort to building differentiation based on perceptions. Products are therefore transformed into mental entities by enveloping a psychosocial jacket. For instance, brands such as Tag Heuer and Omega are more of a perceptual entity than a time keeping instrument. Accordingly, these brands manage to charge prices that are far in excess of what a good quality time keeping device could command.