In the pricing objectives, an important issue to be decided by the top management is their corporate objectives. These will reflect the philosophy of the owners or principal share holders and also their perception of the external environment. The objective could be to skim the cream from the market or to penetrate the market and establish leadership or to balance the profits across the product lines. No pricing decision can be taken in the absence of these corporate objectives statement.
Competition affects price decisions. If the firm is the leader it can set a price and let the competition set its price level. But even the leader firm has to anticipate competitor firmâ€™s reaction to a price change. As we know that, the competitor can react by either following the leader or deciding to ignore him and retain or lower its price. Thus, in deciding the price strategy, a marketer has to anticipate competitorâ€™s reaction.
The governmentâ€˜s fiscal policy also contributes towards the pricing decisions. Here, the marketer has to consider taxation, customs and import duties, if any, on his product and on the inputs used by the firm. For example, if the firm uses a product which attracts a higher sales tax or whose prices are controlled by the government (as in the case of steel, cement, etc. until recently), then its finished product price will be high. Even if the firm wants to reduce the end price to the customer to generate demand, it may not be able to do so mainly due to government policies. This is true today for several products in India, as the excise duty, sales tax and other duties have formed a large proportion of the final productâ€™s price.
Barriers in the industry
The entry barrier in the industry not only affects the competition but also the firmâ€™s prices. High barriers always encourage inefficiency, high costs and high prices.
Thus, a price decision is complex and a marketer needs to be wary of all the influences on his decisions.
Costs, demand and competition underlie different pricing methods that a firm may adopt. Letâ€™s turn to these methods and see the benefits that each of them offers.
Cost oriented method
There are two pricing methods under this group. One is based on the full cost, the other on variable cost.
1. Full cost or mark up pricing: Under this method, the marketer estimates the total cost of producing or manufacturing the product and then adds to it a mark up or the margin that the firm wants. This is indeed the most elementary pricing method and many of the services and projects are priced accordingly. To arrive at the mark up price, one can use the following formula
Mark up Price = a / (1-r)
â€œaâ€? = Unit cost ( Fixed cost + variable cost)
â€œr â€œ = Expected return on sales expressed as a percent.
This approach ensures that all costs are recovered and the firm makes a profit. Indeed it satisfies the finance oriented executives but this method ignores the fact that it is not necessary that the firm is able to sell its entire merchandise at this price. It does not consider customerâ€™s value perception and also the competitorâ€™s reaction. Some firms use this as a launch strategy, but this could prove fatal if competition already exists within the industry. It may be a useful method if everyone in the industry adopts it, for this can minimize price wars.
Marginal cost or contribution pricing
Here, the company may work on the premise of recovering its marginal cost and getting a contribution towards its overheads. The method works well in a market already dominated by giant firms or characterized by intense competition. The objectives of the firm is to get a foothold in the market
Going Rate or â€œFollow the Crowdâ€?
This method is competition oriented. In this method, the firm prices its products at the same level as that of the competition. This method assumes that there will be no price wars within the industry. This method is commonly used in an oligopolistic market. Despite, it is necessarily true that all firms or the leader firm is operating efficiently. In case it is not, it will mean that the follower firm also adopts a price level which reflects leaderâ€™s inefficiency rather than the firmâ€™s efficiency. Besides, it is not always true that a decision taken in collective wisdom is the best. It may certainly not be so from the customerâ€™s point of view.
Sealed Bid Pricing
Another form of competition oriented pricing is the sealed bid pricing. In a large number of projects, industrial marketing and marketing to the government, suppliers are asked to submit their quotations, as a part of a tender. The price quoted reflects the firmâ€™s cost and its understanding of competition. If the firm was to price its offer only at its cost level, it may be the lowest bidder and may even get the contract but may not make any profit out of the deal. So, itâ€™s important that the firm uses expected profit at different price levels to arrive at the most profitable price. This can be arrived at by considering the profits and profitability of getting a contract at different prices.