Pricing is a price-fixing process that businesses use to fix the price value that a manufacturer will receive for offering its products or services. An example of pricing is the amount set for a car’s MSRP (Manufacturer Suggested Retail Price). Pricing can also refer to the strategies used to set prices, such as competitive pricing, market-based pricing, or cost-plus pricing.
Different pricing methods are used for adjusting the cost of goods or services which is suitable for the manufacturer as well as the target customer. Businesses decide the price to sell their products or services to their customers. Pricing is considered to be a fundamental aspect of product management. It is also a part of the 4 Ps (product, price, place, and promotion) of the marketing mix. Among the four Ps of the marketing mix, price is the only factor that generates revenue.
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What is Pricing?
Pricing is a method used by businesses, companies, or manufacturers for deciding the best price for their products or services. A method to decide on price will help you choose prices to maximize profits and shareholder value as well as understand consumer and market demand.
Deciding price is an economic and financial term used to establish a value for a product or service a company offers to its customers. It means how much a customer has to pay to get a company’s product or service to its customers.
Meaning of Pricing
The process of deciding the price is crucial for deciding the price at which a business can sell its products and services. While finalizing the price of a product or service, businesses consider-
- Price of similar goods and services in the market
- The total cost of production like raw material, machinery cost, labor cost, inventory cost, transit, etc
- Marketplace, Competition, and Market Condition
- Target audiences
- Brand and Quality of product
- External elements like government rules, regulations, policies, and economy
Finalizing the price is considered to be the most crucial concept of marketing. It is used as a strategic and tactical decision regarding the overall competition, organizational, and market situations. There are different strategies a firm can go with before setting up prices, and this all depends upon the conditions mentioned above.
Several things need to be taken into consideration when setting prices. These considerations are the manufacturing costs a business incurs, the marketplace, market condition, brand, the costs at which the company incurs goods, and the quality of its products or services.
Objectives of Pricing
The prices of products or services are influenced by the quality of the product offered, promotions used on that product, and the type of channel used in distribution.
The objectives of the process are-
- To prevent competition
- To meet competition
- There may be related financial objectives behind following a particular strategy.
- Marketplace realities, considering if the customers will be keen to buy it at that price
- Price consistency across different lines of products
- Expansion of current profits, etc
Types of Pricing Method
1) Cost Oriented
It is one of the most common methods of finding prices of the finished goods. It is further divided into three ways-
- Cost-Plus – It calculates the cost of production sustained, plus adds a fixed percentage (also known as markup) for finding out the selling price.
- Markup – In this, the fixed number or a percentage of the total cost of a product will get added to the end price of the product to find out the selling price of a product.
- Target-Returning – The company will fix the cost of the product for finding out the Rate of Return on Investment.
Price determination is done as per the market research-
- Perceived-Value – It lets businesses decide the cost considering the customer’s approach towards the products and services along with other elements like product quality, distribution, advertisement, promotion, etc. that can influence perceptions of the customers.
- Value pricing- In this companies make products that are high in quality but low in price.
- Going-Rate – It lets companies analyze the competitor’s rate as a foundation for finalizing the price of their products.
- Auction Type – With the booming prevalence of online mediums, this method of deciding price is being quite popular. Different online platforms like eBay, Quickr, OLX, etc use it to let customers buy and sell products.
- Differential – It is used when prices need to be different for different groups of customers. This type of price method changes with the product, time, area, etc.
Benefits of Pricing strategy
A company reaps several benefits by following a price-deciding strategy that aligns with its goals.
There is an increase in competitiveness. A company using a price strategy that attracts customers to it so that they keep buying from you will help a business become more competitive.
It helps in increasing margins on products that are priced higher. Suppose there is a strategy in work that encourages recurring purchases. In that case, it will help in generating higher profits in a situation where the margins of the company are based on the sales in the initial phases.
There is a reduction in customer price resistance. Customers will buy from the company and trust it if they think they are getting a good deal.
It makes it easy for the customers to trust and understand a brand if a company’s marketing message focuses on benefits and value and not on price.
Common Pricing Strategies
Many businesses set the prices of their products and services without giving too much thought to it. This is a big mistake as price decision is considered the most essential marketing strategy. A price strategy is a company’s methodology and processes to set prices. A company can choose any strategy to set its prices, but there are a few common strategies:
In competitive pricing, the company sets the prices following the existing market rate for similar products or services chosen by competitors,
In cost-plus pricing, the product production cost is taken into account, and a certain percentage is added to it.
In dynamic pricing, the prices are constantly changed by the change in demand. It is also known as demand pricing, surge pricing, and time-based pricing.
It takes place when companies offer basic versions of their products in a way that users will eventually pay for upgrading or accessing more features.
It is used when companies initially sell a product at a high price and later lower the price to finally go up to an extremely low price when the product drops in novelty or relevance.
It is also known as rate-based pricing which is used by freelancers, consultants, contractors, laborers, and other individuals who offer business services.
In this, the price of the product is kept high initially and gradually, and they are brought down to tap different sections of consumers to increase revenue.
It is the opposite of hourly pricing and it suggests charging a flat fee per project rather than a direct exchange of money for time. Contractors, consultants, freelancers, and other individuals use this strategy.
In value-based pricing, the prices of the products are set following what the consumers believe is the product’s worth.
This strategy suggests offering products in the bundle that has two or more complementary products or services together and offering them for a single price.
Psychological pricing is used by businesses for targeting the human psychology of the target audiences for boosting their sales.
Geographic pricing takes place when products or services are priced differently as per the geographical location or market.
In economy pricing, the product’s price is to be set lower than the competition so that the money is earned through increased volume.
Cost-based pricing suggests that other sellers are setting their prices for the same or similar sorts of products or services.
Right Pricing Strategy for a Business
To determine which strategy would work best for the company, business owners and sellers need to determine their needs and target market segment. The company should focus on selecting the range of the right costs.
To have consistent business growth and a gradual increase in revenue, a company needs to price the inventory properly. It doesn’t matter what kind of products a company sells or what kind of stores it has until it has pricing that works towards its profits.
Importance of Nailing Your Pricing
A business needs to have pricing that is effective and generates consistent revenue for the firm. It should help the firm strengthen its position with the help of trust-building with the customers and, on the other hand, achieve all the business goals set by the company.
A winning strategy is one which-
- A lower price portrays a product that is lower in value too. A product that is higher in price portrays a product that is high in value too.
- A high price has the potential to depict value, but if the price is way too much, it can backfire. An ideal price is the one that persuades people to buy the product.
- Confidence building, a product that is priced high, depicts the exclusivity and value put into that product and vice versa.
Weak pricing comes with many downsides like-
- Not able to portray the value, the company has to persuade its customers that it has a good product; that s the reason why the prices are high. If the prices are too low, it may have the opposite effect.
- Uncertainty about buying, a price that’s too low or high will cause uncertainty in the customers’ minds, just like the right price will strengthen the customer’s conviction.
- Targets the wrong customers; there are different kinds of customers in the market; some prefer value, some luxury. The company needs to set prices accordingly.
Things to consider while deciding the price of your product or service-
- Costs should be the first on your list of things to consider when pricing your product. Costs include both fixed costs as well as direct costs.
- The company should look at what it is selling, whether the customers are looking for high-end products or low end.
- The company should understand where it wants to be, and it should figure out whether it needs to be a high-end company or a cheap company, or a company in between.
- A company should keep an eye out on its competitors, and it should look at what are they charging, what services are they providing, and what kind of customers are they targeting.
- The profit should be taken into consideration, too; a company needs to add value to itself. It a company should ask itself how much profit it wants to make. And act accordingly.
Impact of Pricing on Efficiency
If a company doesn’t care about optimizing its pricing it is harming itself. A company that doesn’t work on its pricing is throwing away the benefits it could reap from the fundamental economics of any business.
The pricing has the potential to grow your business to new heights; it would be self-harming to do otherwise.
There was a strong foundation for growth for companies that conducted reviews while finalizing their prices. More strategic pricing and iterations to the pricing of new products had the potential to generate greater revenue numbers, and this should be done by companies rather than wasting money on customer acquisition.
How to Set the Pricing
Let us now attempt to understand the process of how firms set prices. When does a firm set prices?
A firm must set a price for the first time when it develops a new product, when it introduces its regular product into a new distribution channel or geographical area, and when it enters bids on new contract work. Is Setting prices easy ?
It involves making a number of guesses about the future. You would want to know how? – an organization should proceed as follows:
- Identify the target market segment for the product or service, and decide what share of it is desired and how quickly.
- Establish the price range that would be acceptable to occupants of this segment. If this looks unpromising, it is still possible that consumers might be educated to accept higher price levels, though this may take time.
- Examine the prices (and costs if possible) of potential or actual competitors.
- Examine the range of possible prices within different combinations of the marketing mix (e.g. different levels of product quality or distribution methods).
- Determine whether the product can be sold profitably at each price based upon anticipated sales levels (i.e. by calculating the break-even point) and if so, whether these profits will meet strategic objectives for profitability.
- If only a modest profit is expected it may be below the threshold figure demanded by an organization for all its activities. In these circumstances, it may be necessary to modify product specifications downwards until costs are reduced sufficiently to produce the desired profit.
An organization goes through the following steps in setting its pricing policy –
Now let us discuss the process in detail
1. Selecting the pricing Objective
You would agree that the foremost step is identifying pricing objectives. The company first decides where it wants to position its marketing offering. The clearer a firm’s objectives, the easier it is to set prices. What are the pricing objectives?
A company can pursue any of five major objectives through pricing: survival, maximum current profit, maximum market share, maximum market skimming, or product-quality leadership.
Companies pursue survival, as their major objective if they are plagued with overcapacity intense competition, or changing consumer wants. As long as prices cover variable costs and some fixed costs, the company stays in business. Survival is a short-run objective: in the long run, the firm must learn how to add value or face extinction.
What happens when companies want to maximize profit? Many companies try to set a price that will maximize current profits. They estimate the demand and costs associated with alternative prices and choose the price that produces the maximum current profit, cash flow, or rate of return on investment. This strategy assumes that the firm has knowledge of its demand and cost functions; in reality, these are difficult to estimate.
Some companies want to maximize their market share. They believe that a higher sales volume will lead to lower unit costs and higher long-run profit. They set the lowest price, assuming the market is price sensitive. The following conditions favor setting a low price. The market is highly price sensitive, and a low price stimulates market growth. Production and distribution costs fall with accumulated production experience; A low price discourages actual and potential competition Companies unveiling a new technology favor setting high prices to “skim” the market. Sony is a frequent practitioner of market skimming pricing.
Whatever the specific objective, businesses that use price as a strategic tool will profit more than those who simply let costs or the market determine their pricing
2. Determining the demand
Following the identification of objectives, the firm needs to determine demand. Each price will lead to a different level of demand and therefore have a different impact on a company’s marketing objectives. In the normal case, demand and price are inversely related: the higher the price, the lower the demand.
In the case of prestige goods, the demand curve sometimes slopes upward. E.g. Perfume Company raised its price and sold more perfume rather than less! Some consumers take the higher price to signify a better product. However, if the price is too high, the level of demand may fall.
Do you agree that generally speaking customers are most price-sensitive to products that cost a lot or are bought frequently? They are less price-sensitive to low-cost items or items they buy infrequently.
They are also less price-sensitive when price is only a small part of the total cost of obtaining, operating, and servicing the product over its lifetime. A seller can charge a higher price than competitors and still get the business if the company can convince the customer that it offers the lowest total cost of ownership (TCO).
The process of estimating demand, therefore, leads to
i. Estimating the Price sensitivity of the market
ii. Estimating and analyzing the demand curve
iii. Determining price elasticity of demand.
3. Estimating Costs –
Demand sets a ceiling on the price the company can charge for its product. Can you discuss this statement in detail? Costs set the floor. The company wants to charge a price that covers its cost of producing, distributing, and selling the product, including a fair return for its effort and risk.
Do you know the different costs of the organization? How are these costs related to pricing? A company’s cost takes two forms, fixed and variable. Fixed costs (also known as overhead) are costs that do not vary with production or sales revenue. A company must pay bills each month for rent heat, interest, salaries, and so on, regardless of output.
Variable costs vary directly with the level of production. These costs tend to be constant per unit produced. They are called variables because their total varies with the number of units produced. Total costs consist have the sum of the fixed and variable costs for any given level of production. The average cost is the cost per unit at the level of production; it is equal to total costs divided by production.
To price intelligently, management needs to know how its costs vary with different levels of production.
Do you want to know what the Japanese do?
The Japanese Method – TARGET COSTING – Costs change as a result of a concentrated effort by designers, engineers, and purchasing agents to reduce them. The Japanese use a method called target costing. They use market research to establish a new product’s desired functions. Then they determine the price at which the product will sell, given its appeal and competitor’s prices. They deduct the desired profit margin from this price, and this leaves the target cost they must achieve.
4. Analyzing competitor’s costs, prices, and offers
You would agree that analyzing competitors’ costs, prices, and offers is also an important factor in setting prices. Within the range of possible prices determined by market demand and company costs, the firm must take the competitor’s costs, prices, and possible price reactions into account.
While demand sets a ceiling and costs set a floor to pricing, competitors’ prices provide an in-between point you must consider in setting prices. Learn the price and quality of each competitor’s product or service by sending out comparison shoppers to price and compare. Acquire competitors’ price lists and buy competitors’ products and analyze them.
Also, ask customers how they perceive the price and quality of each competitor’s product or service. If your product or service is similar to a major competitor’s product or service, then you will have to price close to the competitor or lose sales. If your product or service is inferior, you will not be able to charge as much as the competitor. Be aware that competitors might even change their prices in response to your price.
5. Selecting a pricing method
Do you know any pricing methods? As consumers have you been able to distinguish between pricing strategies? Let us have a look at various pricing methods.
WHAT ARE VARIOUS PRICING METHODS?
There are three pricing methods that can be employed by a firm:
1. Cost-Oriented Pricing
2. Competitor Oriented Pricing
3. Marketing Oriented Pricing
Cost-Oriented Pricing –
Companies often use cost-oriented pricing methods when setting prices. Two methods are normally used
Full cost pricing – Can you attempt to explain this? What does a firm do here? Here the firm determines the direct and fixed costs for each unit of product. The first problem with Full-cost pricing is that it leads to an increase in price as sales fall. The process is illogical also because to arrive at a cost per unit the firm must anticipate how many products they are going to sell. This is an almost impossible prediction. This method focuses on the internal costs of the firm as opposed to the prospective customers’ willingness to pay.
Direct (or marginal) Cost Pricing – Do you have some idea about this? This involves the calculation of only those costs, which are likely to increase as output increases. Indirect or fixed costs (plant, machinery, etc) will remain unaffected whether one unit or one thousand units are produced. Like full-cost pricing, this method will include a profit margin in the final price.
The direct cost approach is useful when pricing services for example. Consider aircraft seats; if they are unused on a flight then the revenue is lost. These remaining seats may be offered at a discount so that some contribution is made to the flight expenses.
The risk here is that other customers who paid the full price may find out about the discounted offer and complain. Direct costs then, indicate the lowest price at which it is sensible to take business if the alternative is to let machinery, aircraft seats, or hotel rooms lie idle.
Competition-based approach –
Going-Rate Pricing – In going-rate pricing, the firm bases its price largely on competitors’ prices, with less attention paid to its own costs or to demand. The firm might charge the same, more, or less than its major competitors.
Where the products offered by firms in a certain industry are very similar the public often finds difficulty in perceiving which firm meets their needs best. In cases like this (for example in financial services and delivery services) the firm may attempt to differentiate on delivery or service quality in an attempt to justify a higher selling price.
Competitive Bidding – Many contracts are won or lost on the basis of competitive bidding. The most usual process is the drawing up of detailed specifications for a product and putting the contract out for tender. Potential suppliers quote a price, which is confidential to themselves and the buyer.
In sealed-bid pricing (i.e. only known to the client and not to the other parties tendering for the service), firms bid for jobs, with the firms basing the price on what it thinks other firms will be bidding rather than on their own costs or demand. All other things being equal the buyer will select the supplier that offers the lowest price.
Marketing-Oriented Pricing –
The price of a product should be set in line with the marketing strategy. The danger is that if the price is viewed in isolation (as would be the case with full-cost pricing) with no reference to other marketing decisions such as positioning, strategic objectives, promotion, distribution, and product benefits.
The way around this problem is to recognize that the pricing decision is dependent on other earlier decisions in the marketing planning process. For new products, price will depend upon positioning and strategy, and for existing products price will be affected by strategic objectives.
6. Selecting the final Price
Pricing methods narrow the range from which the company must select its final price. In selecting that price, the company must consider additional factors, including psychological pricing, gain, and risk pricing, the influence of other marketing-mix elements on price, company-pricing policies, and the impact of price on other parties.
Finally, it may be concluded that pricing strategies that fine-tune with the goals of a company will help in generating ever-increasing revenues for the company. But considering the different conditions and goals of a company, it is not important that a strategy adopted by one company will definitely work out for the other.
A company needs to take into consideration its own goals and the environment it is in to choose the best available strategy for itself that will help the company in increasing its value and profits significantly.
Now, on a final note, what kinds of pricing strategies do you find most useful for optimizing the value and sales of a brand? Share your opinion with us in the comment section below.
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