Product Pricing

Product pricing is one of those aspects of the marketing plan that is neglected– in some plans it is completely absent! The reason for this stems from thefact that all other aspects of marketing can be easily identified and quantifiedwhereas pricing is more of an ‘art’ than a science.

The product pricing issues that face any company are verycomplex in nature – due to the numerous variables that have to be consideredbefore understanding pricing parameters.

A company may have two objectives in its pricing policy. One may be to increasemarket share – the other to increase profitability. It is NOT possible toachieve both objectives simultaneously.

We will now consider the factors that should be taken intoaccount when trying to resolve the question of whether the business should tryto gain market share or increase profitability.

These factors are:

1. Objective of the business and the product portfolio;

2. The product life cycle;

3. Competitors;

4. Potential competitors;

5. Costs (own and competitors);

6. Channels of distribution

 

Objectives and the product portfolio

Every business should have a series of objectives relating to sales, profits,market share and return on capital. The business objectives might be such thatit calls for short term profits. However, the business owner should be consciousthat any decision made only for short term profitability will impact the longterm survival of the business. This is especially true if pricing decisions aremade in an ad-hoc manner it is probable that the goodwill that the company hasgenerated with its customers will be destroyed due to unreasonably high prices.
The setting of marketing objectives for any particular product is thereforewithout doubt the starting point in any consideration of pricing.

Product life cycle

According to the product life cycle a product passes through 4stages, they are:

• Introduction: Product has been just introduced to the market – so the price will typically be at the higher end;
  

• Growth: this is the stage in which a products sales increases rapidly – price is set high at the growth phase to skim the market;
  

• Maturity & saturation: Here the product reached optimal sales and plateaus out – price is gradually reduced to maintain market share and meet the threat of competition;
  

• Decline: The product ceases to be popular due to a variety of reasons and decline sets in – price cutting is in full swing to make sure that all inventory is exhausted before market demand runs out, a type of harvesting the market.
  

The importance of the product life cycle in pricing cannot beunderstated. Obviously the pricing strategies at the different stages shoulddiffer to ensure that profits are maximized.

Product Positioning

The term product positioning has already been explained. It is avery important concept in setting the price of the product. It is clearly veryfoolish to position a product as a high quality exclusive item, and then priceit too low.

Price is one of the clearest signals that the customer has aboutthe value of the product being offered. So there should always be a sensiblerelationship between the product and the price.

Competition and potential competition

Although the product has been well positioned there will alwaysbe competitors and it goes without saying that the threat of the competitionshould be carefully considered. In a situation of high competition it isimportant to note that competing purely on price is counter productive. Thebusiness should consider all elements of the marketing mix and how they interactto create demand and value for the product should be considered in setting theoverall competing strategy.

Some firms launch new products at high prices only to find thatthey have made the market attractive to competitors who will launch similarproducts at much lower prices. A lower launch price might make diffusion in themarket quicker and allow for greater experience and the margin for a competitorto enter the market will be reduced.

Costs

Another key variable in pricing is costing – this is not onlythe business cost but also the cost to competitors. There are many cost conceptsbut the two main concepts are marginal cost pricing and full absorption costing.

The conventional economists model of product pricing indicatesthat pricing should be set at the point where marginal cost is equal to marginalrevenues i.e. where the additional cost of production is equal to the additionalincome earned. The theory is undisputed but considers only price as variable. Inthe real world there are many more variables than only price.

In practice the cost of production provides key guidelines tomany businesses in setting price. This is called the ‘cost plus method‘ ofpricing where a fixed mark up is added to the price.

Channels of distribution

The standard product pricing theory does not provide insight towhat should be one’s policy toward distributor margins. The distributorperforms a number of functions on behalf of the supplier which enables whichenables the exchange transaction between the producer and the customer.

There are a number of devices available for compensating thetrade intermediaries, most of which take the form of discounts given on theretail selling price to the ultimate customer.

• Trade discount – This is the discount made on the list price for services made available by the intermediary. e.g. holding inventory, buying bulk, redistribution etc.

• Quantity discount – A quantity discount is given to intermediaries who order in large lots

• Promotional discount – This is a discount given to distributors to encoutage them to share in the promotion of the products involved.

• Cash discount - In order to encourage prompt payments of accounts, a small cash discount on sales price can be offered.

Gaining competitive advantage

It is possible to use price as a strategic marketing tool. Theaspects of competitiveness have been listed below:

• Reduce the life cycle/ alter the cost mix – customers are often willing to pay a considerably higher initial price for a product with significantly lower post-purchase cost.
  

• Expand value through functional redesign. E.g. a product that increases customers production capacity or throughput, product that improves quality of the customers product, product that enhances end-use flexibility.
  

• Expand incremental value by developing associated intangibles. For example service, financing, prestige factors etc.
  

Preparing the product pricing plan

We have considered some of the factors that affect the pricingdecision. We now have to amalgamate all these decisions into one framework. Ithas been demonstrated that as a firm develops expertise in producing aparticular product the cumulative cost of producing every additional unit falls.This is demonstrated by the learning curve. The effect of the learning curveshould be considered in pricing of new products.

There are in principle only two main pricing policies they areprice skimming policy and price penetration policy. The factors that should beconsidered before implementing either policy are given below.

The factors that favour a price skimming policy are:

1. Demand is likely to be price inelastic;

2. There are likely to be different price market segments, thereby appealing to those buyers first who have a higher rage of acceptable prices.

3. Little is known about the cost and marketing the product
   

The variables that favour a price penetration policy are:

1. Demand is likely to be price elastic;

2. Competitors are likely to enter the market quickly;

3. There no distinct price-market segments;

4. There is possibility if large savings in production and marketing costs if large sales volumes can be generated.
   

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