Pricing Policies and Practices

PRICING
Pricing denotes revenue to seller
Perceived Value to buyer Pricing strategy Important for new product, modified

product, new market, new market segment, objective of firm Basic determinants are supply and demand

PRICING PRACTICES
General Considerations To Be Kept In Mind While Formulating A Pricing Policy: Objectives of business- Notwithout considering its impact on all objectives Market structure Competitors strategy Price Sensitivity/ elasticity(even for monopolist) Conflicting Interests of Manufacturers and Middlemen, consumers
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General Considerations
Routinisation of Pricing- Speed required in

decision-making, quality of data available, competitive market Role of Non Business Groups in pricing DecisionsGovernment, political considerations , farmers and business lobbies, Trade Unions etc

Types of Pricing
1.
2. 3. 4. 5. 6. 7.

COST BASED PRICING BASED ON FIRMS OBJECTIVE COMPETITION BASED PRICING PRODUCT LIFE CYCLE PRICING CYCLICAL PRICING MULTIPRODUCT PRICING ADMINISTERED PRICING

I. COST BASED PRICING

Cost Based Pricing Cost Plus or Mark Up Marginal Cost pricing Target Return pricing

Cost Based Pricing

i. Cost Plus / Full Cost/Average Cost/ Mark-up Pricing Price set to cover cost plus a percentage for predetermined profits. P= AC+ m where, m =mark-up percentage

 Mark up depends on target rate of return, degree of

competition, price elastiicty, substitutes etc

- Most common Simple to fix the price More defensible on moral grounds

Cost Based Pricing

Drawbacks: -Historical cost rather than current cost data is used, which may lead to over/under pricing -Inappropriate if variable cost fluctuates frequently -Some critics say it ignores demand side (But firm determines mark up on the basis of what the market can bear) - Ignores marginal cost as it uses average cost - Not suitable if competition is tough or when entering new market
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Marginal Cost Pricing

ii. Marginal Cost Pricing/ Incremental cost pricing: Price of product = Variable cost plus a profit margin. Only those costs which are directly attributable to the output of a specified product Here price will be lower than the full cost pricing.

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Marginal Cost Pricing

All past outlays are historical and a firm should deal solely with anticipated revenues and outlays
Firm is more interested in future changes in cost due to changing decisions Unlike fixed costs , MCs are controllable in the short run Total costs can not be of use in case of multiproduct/ markets/ process situations

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Marginal Cost Pricing

Useful to beat competition Also, to enter the market Used for pricing public utility where profit is not the motive Weaknesses: Can only be a short term strategy (as it omits fixed costs) Can be only restricted to pricing of specific orders

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Cost Based Pricing

Iii) Target Return Pricing Producer rationally decides the minimum rate of return which must be earned by the product Methodology similar to the above, but margin is decided on the basis of target rate of return, on the basis of experience, consumers paying capacity, risk involved etc

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II. Based on Firms Objective

Pricing Based on Firms objective

-Profit Maximisation- considers total cost -Sales Maximisation- should adopt competitive pricing, say marginal pricing

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III. COMPETITION BASED PRICING

i. Penetration Pricing : Low price when entering new market dominated by existing players (Nirma, Deccan Air) ii. Entry Deterring- Price kept low to make market unattractive for competitors (Common in oligopoly)

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Competition Based Pricing

iii. Going Rate Price: Why? Firms do not want price wars Small/ new firms may not be sure of the effect of charging a different price Products are close substitutes with high cross elasticity

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Competition Based Pricing

Popular in monopolistic and oligopoly markets because a) of low product differentiation and b) for consumer the cost of switching is minimal Uniform price of packaged water or fruit juice

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IV. PRICE DISCRIMINATION

First degree Price Discrimination

-Each unit of output is sold at a different price or each consumer is charged a different price . Entire consumers surplus wiped out

Price

Quantity
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Second Degree Price Discrimination

D P1 Price P2 P3 A B C D Seller gets part of consumers surplus. Highest price of OP1 for OQ1 units. Price is OP2 for Q1Q2 units Lowest price of OP3 for the next Q2Q3 units. Monopolist maximises revenue at

Q1

Q2

Q3

TR= (OQ1*AQ1)+ (Q1Q2*BQ2)+ (Q2Q3*CQ3)

Demand
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Third Degree Price Discrimination

MC Cost & Revenue

B
A T MRa Qa Da Db AR=D MR O Q

MRb
Qb Quantity Demanded o

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Third Degree Price Discrimination

Monopolist has 2 markets, A and B. For market A, Da is the average revenue (demand) curve and MRa is the marginal revenue curve. For market B, Db is the average revenue (demand) curve and MRb is the marginal revenue curve. Horizontal summation of the two markets give the aggregate AR=D and MR curves for the monopolist.

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Third Degree Price Discrimination

Firms MC intersects MR curve at T.
Drawing a perpendicular from T we get the optimum

level of the firms aggregate output at OQ.

At this level of output, MR=MC.

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Third Degree Price Discrimination

OQ is divided between the two markets in such a way that the profit maximisation condition (i-e., MC (=TQ ) is equal to MR) is satisfied in both the markets.
This is achieved by drawing a line from point T parallel to X axis , through MRa and MRb. Optimum share for market A is OQa (at price AQa) and for market B the share is OQb (at price BQb).
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V. PRODUCT LIFE CYCLE PRICING

Refers to different pricing strategies for a product

depending on the different stages of its life cycle Each phase is unique- different demand patterns and competition So setting same price will mean less than optimum revenue

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V. PRODUCT LIFE CYCLE PRICING

Sales revenue Curve 1.Introduction
2.Growth 3.Maturity 4.Saturation 5. Decline

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PRODUCT LIFE CYCLE PRICING

i) New Product: a)Skimming Policy : Charging very high initial price and super normal profits-Lower price during maturity The first ball pens introduced in 1945 cost 80 cents to produce but were priced at $12.50. Initial high prices of computers 1st day movie tickets

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PRODUCT LIFE CYCLE PRICING

Why? Demand is likely to be less price-elastic in initial stages If life of product is likely to be short, the producer can get as much as possible as fast as possible The policy can lead to introduction of product for lower segments later. High initial price may finance the heavy initial costs of introducing a new product when other sources of finance may not be available
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PRODUCT LIFE CYCLE PRICING

Benefits of lower cost due to growing volumes and technological development allows for lowering of prices at a later stage.

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PRODUCT LIFE CYCLE PRICING

b) Low Penetration Price: Close to customary price- only minor adjustments required eventually. Objective of low penetration pricing is to keep off competition Appropriate where: Sales respond strongly to lower prices High volumes lead to lower costs Product acceptable for mass consumption To capture a large share of market quickly where there is a threat of potential competition
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PRODUCT LIFE CYCLE PRICING

High Skimming price

Low penetration Price

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PRODUCT LIFE CYCLE PRICING

ii) Rapid Growth- Stable price policy for sustained growth iii) Maturity: Growth occurs at diminishing rate- firm may introduce minor quality changes with higher prices iv) Saturation- Lower prices and discounts to clear stocks v) Decline- Wind up

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PRODUCT LIFE CYCLE PRICING

Product Bundling- Two or more products bundled together for a single price Strategy for both new and mature/ declining product Saves cost of spreading awareness Captures part of consumer surplus Regain customers during decline phase TOI and ET

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PRODUCT LIFE CYCLE PRICING

Perceived Value pricing: Psychological pricing depending on consumers perception of utilityTanishq jewelry, Parker pens etc-by creating a hype about high quality Value pricing- variant of iv. Try to create high value and charge a low price ie., price charged is lower than perceived value e.g., heavy discounts

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Product Life Cycle Pricing

Loss Leader Pricing: Here, multi product firms sell one product at a low price and compensate the loss by another product Charge lower price for a good that is durable and has a high value but high price for the complementary, low value consumable (HP printers and cartridges)

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VI.CYCLICAL PRICING
Rigid or flexible? Rigid price means Firms selling a stable price irrespective of the business cycle phase (Flexible pricing is meaningless for eatables etc where demand does not change with cycles; dangerous in case of durables as consumers will wait for the next recession to buy durables)

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VII. MULTIPRODUCT PRICING

Tata Sons produces steel as well as trucks and cars where steel is used as input
Demand Interdependence: A firm can produce goods which are substitutes(Zen and wagon R) or complements. If substitutes, either price them the same(coke and Thums Up) or resort to perceived value pricing; or even, going price strategy One firms output may be anothers input
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TRANSFER PRICING
Transfer Prices are the charges made when a company supplies goods, services, or financial services to its subsidiary or sister concern. Globally, 60% of transactions are between associated companies. MNCs are required to set Transfer Prices for supply of goods, technical know-how, marketing rights etc from parent to subsidiary or one subsidiary to another.

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TRANSFER PRICING
Govts keep strict watch on this in order to check tax evasion as companies try to reduce tax incidence globally by transferring higher income to low tax jurisdiction and higher expenditure to high tax countries In general regulatory authorities agree on arms length price- i.e., same price should be charged whether the transaction is between related or unrelated parties
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VIII. PEAK LOAD PRICING

Peak Load Pricing
Higher price at peak level of use and lower at slack

time ExamplesElectricity, telephone charges, air fares

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IX. Administered Price

Administered Price Originally associated with monopoly - Now understood as Fixed by authorities - Specific social objectives- social justice, correcting imbalances, price stability -Conflict between public utility approach and rate of return approach

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Guidelines for Price Fixing

Bates and Parkinsons Guidelines for Price Fixing: Find out how your costs compare with your competitors. Keep an eye on the market-if orders are difficult to come by, drop prices; if easy, raise. Goodwill of customers is probably gained more through advertising than keeping price low

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 If you can sell all your output at prices that give you substantial profit, consider expanding production.
If you find that your sales vary over seasons, adjust prices If your prices seem to be higher than those of your competitors although they scarcely cover costs, you may need to take a re-look at your production methods and organisational process
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 If you are one of very few producers in the industry,

what your competitors are likely to do may be a more important consideration in fixing prices rather than your costs. If you are a monopolist and follow a pricing policy that is seen as being against public interest, beware of government action and potential competition

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