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 the
fact that all other aspects of marketing can be easily identified and quantified
whereas pricing is more of an ‘art’ than a science.
The product pricing issues that face any company are very
complex in nature – due to the numerous variables that have to be considered
before understanding pricing parameters.
A company may have two objectives in its pricing policy. One may be to increase
market share – the other to increase profitability. It is NOT possible to
achieve both objectives simultaneously.
We will now consider the factors that should be taken into
account when trying to resolve the question of whether the business should try
to gain market share or increase profitability.
These factors are:
Objective of the business and the product portfolio;
The product life cycle;
Costs (own and competitors);
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 that
it calls for short term profits. However, the business owner should be conscious
that any decision made only for short term profitability will impact the long
term survival of the business. This is especially true if pricing decisions are
made in an ad-hoc manner it is probable that the goodwill that the company has
generated with its customers will be destroyed due to unreasonably high prices.
The setting of marketing objectives for any particular product is therefore
without doubt the starting point in any consideration of pricing.
Product life cycle
According to the product life cycle a product passes through 4
stages, 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
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 be
understated. Obviously the pricing strategies at the different stages should
differ to ensure that profits are maximized.
The term product positioning has already been explained. It is a
very important concept in setting the price of the product. It is clearly very
foolish to position a product as a high quality exclusive item, and then price
it too low.
Price is one of the clearest signals that the customer has about
the value of the product being offered. So there should always be a sensible
relationship between the product and the price.
Competition and potential competition
Although the product has been well positioned there will always
be competitors and it goes without saying that the threat of the competition
should be carefully considered. In a situation of high competition it is
important to note that competing purely on price is counter productive. The
business should consider all elements of the marketing mix and how they interact
to create demand and value for the product should be considered in setting the
overall competing strategy.
Some firms launch new products at high prices only to find that
they have made the market attractive to competitors who will launch similar
products at much lower prices. A lower launch price might make diffusion in the
market quicker and allow for greater experience and the margin for a competitor
to enter the market will be reduced.
Another key variable in pricing is costing – this is not only
the business cost but also the cost to competitors. There are many cost concepts
but the two main concepts are marginal cost pricing and full absorption costing.
The conventional economists model of product pricing indicates
that pricing should be set at the point where marginal cost is equal to marginal
revenues i.e. where the additional cost of production is equal to the additional
income earned. The theory is undisputed but considers only price as variable. In
the real world there are many more variables than only price.
In practice the cost of production provides key guidelines to
many businesses in setting price. This is called the ‘cost plus method‘ of
pricing where a fixed mark up is added to the price.
Channels of distribution
The standard product pricing theory does not provide insight to
what should be one’s policy toward distributor margins. The distributor
performs a number of functions on behalf of the supplier which enables which
enables the exchange transaction between the producer and the customer.
There are a number of devices available for compensating the
trade intermediaries, most of which take the form of discounts given on the
retail 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
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. The
aspects 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
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 pricing
decision. We now have to amalgamate all these decisions into one framework. It
has been demonstrated that as a firm develops expertise in producing a
particular product the cumulative cost of producing every additional unit falls.
This is demonstrated by the learning curve. The effect of the learning curve
should be considered in pricing of new products.
There are in principle only two main pricing policies they are
price skimming policy and price penetration policy. The factors that should be
considered before implementing either policy are given below.
The factors that favour a price skimming policy are:
Demand is likely to be price inelastic;
There are likely to be different price market segments,
thereby appealing to those buyers first who have a higher rage of acceptable
Little is known about the cost and marketing the product
The variables that favour a price penetration policy are:
Demand is likely to be price elastic;
Competitors are likely to enter the market quickly;
There no distinct price-market segments;
There is possibility if large savings in production and
marketing costs if large sales volumes can be generated.
Go back to marketing plan guide
Detailed articles and tools on product pricing