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Pricing is one of the most important elements of the marketing mix, as it is the only mix, which generatesa turnover for the organisation. The remaining 3ps are the variable cost for the organisation.It costs toproduce and design a product, it costs to distribute a product and costs to promote it. Price must supportthese elements of the mix. Pricing is difficult and must reflect supply and demand relationship. Pricing aproduct too high or too low could mean a loss of sales for the organisation. Pricing should take intoaccount the following factors:

1. Fixed and variable costs.2. Competition3. Company objectives4. Proposed positioning strategies.5. Target group and willingness to pay.

An organisation can adopt a number of pricing strategies. The pricing strategies are based much on whatobjectives the company has set itself to achieve.

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Pricing Strategy

One of the four major elements of the marketing mix is price. Pricing is an important strategicissue because it is related to product positioning. Furthermore, pricing affects other marketing

mix elements such as product features, channel decisions, and promotion.

While there is no single recipe to determine pricing, the following is a general sequence of stepsthat might be followed for developing the pricing of a new product:

1. Develop marketing strategy - perform marketing analysis, segmentation, targeting, andpositioning.

2. Make marketing mix decisions - define the product, distribution, and promotionaltactics.

3. Estimate the demand curve - understand how quantity demanded varies with price.4. Calculate cost - include fixed and variable costs associated with the product.

5. Understand environmental factors - evaluate likely competitor actions, understandlegal constraints, etc.

6. Set pricing objectives - for example, profit maximization, revenue maximization, orprice stabilization (status quo).

7. Determine pricing - using information collected in the above steps, select a pricingmethod, develop the pricing structure, and define discounts.

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These steps are interrelated and are not necessarily performed in the above order. Nonetheless,

the above list serves to present a starting framework.

Marketing Strategy and the Marketing Mix

Before the product is developed, the marketing strategy is formulated, including target marketselection and product positioning. There usually is a tradeoff between product quality and price,so price is an important variable in positioning.

Because of inherent tradeoffs betweenmarketing mixelements, pricing will depend on otherproduct, distribution, and promotion decisions.

Estimate the Demand Curve

Because there is a relationship between price and quantity demanded, it is important to

understand the impact of pricing on sales by estimating thedemand curvefor the product.

For existing products, experiments can be performed at prices above and below the current price

in order to determine theprice elasticity of demand. Inelastic demand indicates that priceincreases might be feasible.

Calculate Costs

If the firm has decided to launch the product, there likely is at least a basic understanding of thecosts involved, otherwise, there might be no profit to be made. The unit cost of the product sets

the lower limit of what the firm might charge, and determines the profit margin at higher prices.

The total unit cost of a producing a product is composed of the variable cost of producing eachadditional unit and fixed costs that are incurred regardless of the quantity produced. The pricing

policy should consider both types of costs.

Environmental Factors

Pricing must take into account the competitive and legal environment in which the company

operates. From a competitive standpoint, the firm must consider the implications of its pricing on

the pricing decisions of competitors. For example, setting the price too low may risk a price warthat may not be in the best interest of either side. Setting the price too high may attract a large

number of competitors who want to share in the profits.

From a legal standpoint, a firm is not free to price its products at any level it chooses. For

example, there may be price controls that prohibit pricing a product too high. Pricing it too low

may be considered predatory pricing or "dumping" in the case of international trade. Offering adifferent price for different consumers may violate laws against price discrimination. Finally,

collusion with competitors to fix prices at an agreed level is illegal in many countries.

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Pricing Objectives

The firm's pricing objectives must be identified in order to determine the optimal pricing.

Common objectives include the following:

Current profit maximization - seeks to maximize current profit, taking into accountrevenue and costs. Current profit maximization may not be the best objective if it resultsin lower long-term profits.

Current revenue maximization - seeks to maximize current revenue with no regard to

profit margins. The underlying objective often is to maximize long-term profits by

increasing market share and lowering costs.

Maximize quantity - seeks to maximize the number of units sold or the number of

customers served in order to decrease long-term costs as predicted by theexperience

curve.

Maximize profit margin - attempts to maximize the unit profit margin, recognizing thatquantities will be low.

Quality leadership - use price to signal high quality in an attempt to position the productas the quality leader.

Partial cost recovery - an organization that has other revenue sources may seek only

partial cost recovery.

Survival - in situations such as market decline and overcapacity, the goal may be toselect a price that will cover costs and permit the firm to remain in the market. In this

case, survival may take a priority over profits, so this objective is considered temporary.

Status quo - the firm may seek price stabilization in order to avoid price wars and

maintain a moderate but stable level of profit.

For new products, the pricing objective often is either to maximize profit margin or to maximize

quantity (market share). To meet these objectives, skim pricing and penetration pricing strategiesoften are employed. Joel Dean discussed these pricing policies in his classic HBR article entitled,

Pricing Policies for New Products.

Skim pricing attempts to "skim the cream" off the top of the market by setting a high price and

selling to those customers who are less price sensitive. Skimming is a strategy used to pursue the

objective of profit margin maximization.

Skimming is most appropriate when:

Demand is expected to be relatively inelastic; that is, the customers are not highly price

sensitive.

Large cost savings are not expected at high volumes, or it is difficult to predict the costsavings that would be achieved at high volume.

The company does not have the resources to finance the large capital expenditures

necessary for high volume production with initially low profit margins.

Penetration pricing pursues the objective of quantity maximization by means of a low price. It

is most appropriate when:

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Demand is expected to be highly elastic; that is, customers are price sensitive and the

quantity demanded will increase significantly as price declines.

Large decreases in cost are expected as cumulative volume increases.

The product is of the nature of something that can gain mass appeal fairly quickly.

There is a threat of impending competition.

As theproduct lifecycleprogresses, there likely will be changes in the demand curve and costs.

As such, the pricing policy should be reevaluated over time.

The pricing objective depends on many factors including production cost, existence of

economies of scale, barriers to entry, product differentiation, rate of product diffusion, the firm'sresources, and the product's anticipatedprice elasticity of demand.

Pricing Methods

To set the specific price level that achieves their pricing objectives, managers may make use of

several pricing methods. These methods include:

Cost-plus pricing - set the price at the production cost plus a certain profit margin.

Target return pricing - set the price to achieve a target return-on-investment.

Value-based pricing - base the price on the effective value to the customer relative to

alternative products.

Psychological pricing - base the price on factors such as signals of product quality,popular price points, and what the consumer perceives to be fair.

In addition to setting the price level, managers have the opportunity to design innovative pricingmodels that better meet the needs of both the firm and its customers. For example, software

traditionally was purchased as a product in which customers made a one-time payment and thenowned a perpetual license to the software. Many software suppliers have changed their pricing toa subscription model in which the customer subscribes for a set period of time, such as one year.

Afterwards, the subscription must be renewed or the software no longer will function. This

model offers stability to both the supplier and the customer since it reduces the large swings insoftware investment cycles.

Price Discounts

The normally quoted price to end users is known as the list price. This price usually is

discounted for distribution channel members and some end users. There are several types of

discounts, as outlined below.

Quantity discount - offered to customers who purchase in large quantities.

Cumulative quantity discount - a discount that increases as the cumulative quantity

increases. Cumulative discounts may be offered to resellers who purchase large quantities

over time but who do not wish to place large individual orders.

Seasonal discount - based on the time that the purchase is made and designed to reduce

seasonal variation in sales. For example, the travel industry offers much lower off-season

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rates. Such discounts do not have to be based on time of the year; they also can be based

on day of the week or time of the day, such as pricing offered by long distance andwireless service providers.

Cash discount - extended to customers who pay their bill before a specified date.

Trade discount - a functional discount offered to channel members for performing their

roles. For example, a trade discount may be offered to a small retailer who may notpurchase in quantity but nonetheless performs the important retail function.

Promotional discount - a short-term discounted price offered to stimulate sales.

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GCSE / Level 2 Revision Notes

Marketing - Pricing approaches and strategies

There are three main approaches a business takes to setting price:

Cost-based pricing: price is determined by adding a profit element on top of the cost of making theproduct.Customer-based pricing: where prices are determined by what a firm believes customers will beprepared to payCompetitor-based pricing: where competitor prices are the main influence on the price setLets take a brief look at each of these approaches;

Cost based pricing

This involves setting a price by adding a fixed amount or percentage to the cost of making or buyingthe product. In some ways this is quite an old-fashioned and somewhat discredited pricing strategy,although it is still widely used.

After all, customers are not too bothered what it cost to make the product they are interested inwhat value the product provides them.

Cost-plus (or mark-up) pricing is widely used in retailing, where the retailer wants to know with somecertainty what the gross profit margin of each sale will be. An advantage of this approach is that thebusiness will know that its costs are being covered. The main disadvantage is that cost-plus pricing maylead to products that are priced un-competitively.

Here is an example of cost-plus pricing, where a business wishes to ensure that it makes an additional50 of profit on top of the unit cost of production.

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Unit cost 100

Mark-up 50%

Selling price 150

How high should the mark-up percentage be? That largely depends on the normal competitive practice ina market and also whether the resulting price is acceptable to customers.

In the UK a standard retail mark-up is 2.4 times the cost the retailer pays to its supplier (normally awholesaler). So, if the wholesale cost of a product is 10 per unit, the retailer will look to sell it for 2.4x10 = 24. This is equal to a total mark-up of 14 (i.e. the selling price of 24 less the bought cost of10).

The main advantage of cost-based pricing is that selling prices are relatively easy to calculate. If themark-up percentage is applied consistently across product ranges, then the business can also predict

more reliably what the overall profit margin will be.

Customer-based pricing

Penetration pricingYou often see the tagline special introductory offer the classic sign of penetration pricing. The aimof penetration pricing is usually to increase market share of a product, providing the opportunity toincrease price once this objective has been achieved.

Penetration pricing is the pricing technique of setting a relatively low initial entry price, usually lowerthan the intended established price, to attract new customers. The strategy aims to encouragecustomers to switch to the new productbecause of the lower price.

Penetration pricing is most commonly associated with a marketing objective of increasing market shareor sales volume. In the short term, penetration pricing is likely to result in lower profits than would be thecase if price were set higher. However, there are some significant benefits to long-term profitability ofhaving a higher market share, so the pricing strategy can often be justified.

Penetration pricing is often used to support the launch of a new product, and works best when a productenters a market with relatively little product differentiation and where demand is price elastic so a lowerprice than rival products is a competitive weapon.

Price skimmingSkimming involves setting a high price before other competitors come into the market . This is oftenused for the launch of a new product which faces little or no competition usually due to sometechnological features. Such products are often bought by early adopterswho are prepared to pay ahigher price to have the latest or best product in the market.

Good examples of price skimming include innovative electronic products, such as the Apple iPad andSony PlayStation 3.There are some other problems and challenges with this approach:

Price skimming as a strategy cannot last for long, as competitors soon launch rival products which putpressure on the price (e.g. the launch of rival products to the iPhone or iPod).

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Distribution (place) can also be a challenge for an innovative new product. It may be necessary to giveretailers higher margins to convince them to stock the product, reducing the improved margins that canbe delivered by price skimming.A final problem is that by price skimming, a firm may slow down the volume growth of demand for theproduct. This can give competitors more time to develop alternative products ready for the time whenmarket demand (measured in volume) is strongest.

Loss leadersThe use of loss leaders is a method of sales promotion. A loss leader is a product priced below cost-price in order to attract consumers into a shop or online store. The purpose of making a product a lossleader is to encourage customers to make further purchases of profitable goods while they are in theshop. But does this strategy work?

Pricing is a key competitive weapon and a very flexible part of the marketing mix.

If a business undercuts its competitors on price, new customers may be attracted and existing customersmay become more loyal. So, using a loss leader can help drive customer loyalty.

One risk of using a loss leader is that customers may take the opportunity to bulk -buy. If the price

discount is sufficiently deep, then it makes sense for customers to buy as much as they can (assumingthe product is not perishable).

Using a loss leader is essentially a short-term pricing tactic for any one product. Customers will soon getused to the tactic, so it makes sense to change the loss leader or its merchandising every so often.

Predatory pricing (note: this is illegal)With predatory pricing, prices are deliberately set very low by a dominant competitor in the market inorder to restrict or prevent competition. The price set might even be free, or lead to losses by thepredator. Whatever the approach, predatory pricing is illegal under competition law.

Psychological pricingSometimes prices are set at what seem to be unusual price points. For example, why are DVDs pricedat 12.99 or 14.99? The answer is the perceived price barriers that customers may have. They willbuy something for 9.99, but think that 10 is a little too much. So a price that is one pence lower canmake the difference between closing the sale, or not!

The aim of psychological pricing is to make the customer believe the product is cheaper than it reallyis. Pricing in this way is intended to attract customers who are looking for value.

Competitor-based pricing

If there is strong competition in a market, customers are faced with a wide choice of who to buy from.They may buy from the cheapest provider or perhaps from the one which offers the best customerservice. But customers will certainly be mindful of what is a reasonable or normal price in the market.

Most firms in a competitive market do not have sufficient power to be able to set prices above theircompetitors. They tend to use going-rate pricing i.e. setting a price that is in line with the pricescharged by direct competitors. In effect such businesses are price-takers they must accept thegoing market price as determined by the forces of demand and supply.

An advantage of using competitive pricing is that selling prices should be line with rivals, so price shouldnot be a competitive disadvantage.

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The main problem is that the business needs some other way to attract customers. It has to usenon-price methods to compete e.g. providing distinct customer service or better availabil ity.

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