According to Kotler an organization goes through the following steps in setting its pricing policy: 1. Setting the Pricing Objectives 2. Determining the Demand 3. Estimating Costs 4. Analyzing the Pricing of the Competitors 5. Selecting a Pricing Method 6. Selection of a Pricing Policy.
Step # 1. Setting the Pricing Objectives:
The first step is identifying pricing objectives.
The company first decides where it wants to position its marketing offering, pricing objectives include:
(i) To maximize profits
(ii) To achieve a target return on investment
(iii) To achieve a target sales figure
(iv) To achieve a target market share
(v) To match the competition, rather than lead the market.
Firms can estimate the demand and costs associated with alternative prices and choose the price that produces 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. Firms can set the low price policy to attract price sensitive customers.
Step # 2. Determining the Demand:
Demand forecasting is the next step, it is better to set prices if the total volume of demand is known to marketers because volume of production affects the cost of production if company expect high demand in future they can make a suitable pricing strategy. Each price will lead to a different level of demand and therefore have a different impact on a company’s marketing objectives.
As we know that demand and price are inversely related the higher the price, the lower the demand. However if the price is too high, the level of demand may fall. Customer can switch over a brand in case of higher price than competitors. The process of estimating demand therefore leads to estimating price sensitivity of market, analysis demand curve and determining price elasticity of demand.
Step # 3. Estimating Costs:
Cost can be estimated by calculation of cost of factors of production and marketing cost, in order to make a profit, a business should ensure that its products are priced above their total average cost. In the short-term, it may be acceptable to price below total cost if this price exceeds the marginal cost of production.
Fixed cost and variable cost are the main component of total cost fixed cost remains constant in short term but variable cost varies with the level of production. To price smartly, management needs to know how its costs vary with different levels of production.
Step # 4. Analyzing the Pricing of the Competitors:
A firm must analyze the competitor’s costs, prices and possible price reactions into account. Marketers must collect information related to price and quality of each competitor’s product or service. In case of close substitute, demand can vary sharply with the change in price of product that’s why Pepsi and Coca Cola have same pricing policy. High prices can be charge by adding value to the product and services.
Marketers must carefully analyze how competitors will retaliate to the company’s pricing policies. Companies should, therefore, carefully plan their pricing policies, otherwise, ensuing price wars may force marketers to significantly reduce the price of their products and eventually lose their market share.
Step # 5. Selecting a Pricing Method:
Depending on the market situation and nature of products and services companies have various options for selecting a pricing method. A firm can adopt any of the following pricing methods, namely, mark-up pricing, target return pricing, perceived value pricing, going rate pricing, sealed bid pricing, tender pricing, differentiated pricing, and value pricing.
Step # 6. Selection of a Pricing Policy:
The selection of a pricing policy is vital for an organization, since it is the single most important factor on which the existence of the organization depends. There are several pricing policies that companies adopt. The selection of a pricing policy is dependent on its internal and external environment.
Some of these pricing policies are briefly discussed below:
i. Value Pricing:
Value pricing is a method in which marketers offer low prices for high quality products or services. The idea of value pricing is to help the customers perceive that they are getting a high quality product at a low price. Value pricing is not implemented as a response to the pricing patterns of the competitors. On the contrary, it is an outcome of improved research and development that helps the company delivers high quality goods at low prices.
For example, The Times of India started a revolution in the newspaper market by offering the daily newspaper for as less as Re.1 on some days of the week. Similarly, in the shampoo and detergent markets, HLL and P and G have recently reduced their prices by 15-20% in an attempt to send a message to customer that they are getting better value for their money.
ii. Psychological Pricing:
It a common observation that high priced goods are superior in quality, status related goods are also high priced, they feel that a higher priced product normally indicates good quality. This perception of customers is more apparent when we observe the pricing patterns of certain goods like high-end automobiles, cell phones, jewelry etc. If no other information is available to the customers about the quality of the product, then price becomes a major factor in judging its quality. Marketers often try to get around consumer psychological barrier in respect of price, like tag of price Rs. 495 instead of Rs. 500.
iii. Transfer Pricing:
When one division of an organization transfers or sells goods or services to another division, the price charged for the goods is called transfer pricing. Generally, this happens in multinational companies when one division in a country sells its products or services to another division in another country.
iv. Geographical Pricing:
When customers are geographically scattered in different locations, marketers adopt different pricing for different regions using a pricing method that adequately covers their delivery expenses. This form of pricing is known as geographic pricing since it is based on the geographic location of the customer.
For example, if manufacturing plant of company is located in Mumbai then price of that product would be lower prices than those in Assam.
There can be different types of geographic pricing – uniform delivery pricing, zone pricing, and basis point pricing. In uniform delivered price, the company fixes same price for the entire market it serves. In zone pricing, marketers split the target market into different zones depending on population density, transportation infrastructure, shipping costs, etc. The prices in one zone remain constant.
v. Promotional Pricing:
Promotional pricing is adopted by marketers to achieve a short-term increase in sales, it was found that off season price reductions resulted in more profits because they are of below average magnitude and marketers need to communicate the value of the promotional offer again and again by increasing the frequency of promotions.
It is useful when products are in maturity stage. The purpose of offering a product or a service at a promotional price is to increase its sales to the maximum extent possible. Marketers should carefully plan the promotional pricing patterns to achieve maximum sales in short span of time.
vi. Discriminatory Pricing:
In discriminatory pricing, companies charge different price of same product from different customers on the basis of their paying capacity and the value of the customers. When a company adopts discriminatory pricing, it generally divides its markets into geographical segments and adopts discriminatory pricing to ensure that the customers who buy its products at lower rates do not sell the same for a profit to the other market segments, as they are located elsewhere. Example of discriminatory pricing are price of electricity in rural and urban areas, price of magazines, which are different for regular subscribers and occasional purchasers.
vii. Expansionistic Pricing:
Expansionistic pricing is a more overstated form of penetration pricing and involves setting very low prices aimed at establishing mass markets, possibly at the expense of other suppliers. The product enjoys a high price elasticity of demand so that the adoption of a low price leads to significant increases in sales volumes.
Expansionistic pricing strategies may be used by companies attempting to enter new or international markets for their products. This practice is closely observed by governments since it can impact negatively. Domestic producers can be out of business and many countries have enacted anti-dumping legislation.
viii. Prestige Pricing:
Prestige pricing refers to the practice of setting a high price for an product, throughout its entire life cycle – as opposed to the short term ‘opportunistic’, high price of price ‘skimming’. This is done in order to evoke perceptions of quality and prestige with the product or service.
Products for which prestige pricing may apply, the high price are itself an important motivation for consumers. As incomes rise and consumers become less price sensitive, the concepts of ‘quality’ and ‘prestige’ can often assume greater importance as purchasing motivators. Thus advertisements and promotional strategies focus attention on these aspects of a product, and, not only can a ‘prestige’ price be sustained, it also becomes self-sustaining.
ix. Extinction Pricing:
Extinction pricing has the overall objective of eliminating competition, and involves setting very low prices in the short-term in order to ‘under-cut’ competition, or alternatively repel potential new entrants. The extinction price may, in the short term, be set at a level lower even than the suppliers own cost of production, but once competition has been extinguished, prices are raised to profitable levels.
Only firms dominant in the market, and in a strong financial position will be able survive the short-term losses associated with extinction pricing strategies, and benefit in the long term. The strategy of extinction pricing can be used selectively by firms who can apply it either to limited geographical markets.