Pricing Mechanisms

Price is the net payment by the buyer for the seller’s offering. Price differs from the other parameters of the marketing mix and it can be changed quickly. Decisions to change product, distribution, or promotion will take months to take a decision and the channel to operate as desired by the company. When fast actions are needed to oppose competitive moves or shifts in demand, price has the advantage.

Price is determined on the basis of three factors: competition, costs and demand. Of the three, competition is usually the most powerful, since it sets the upper limits of a seller’s price. Competition has an appeal on seller’s costs also. A company that cannot get its costs in line with competition will be forced out of business. Market demand for a product is another important factor. Price is fixed for the upper limit for the marketer’s pricing decisions. Products cannot be priced higher than what customers are willing to pay.

Forecasting product demand at the company level is known as ‘sales forecasting’. In normal times price may be assumed to remain constant.

Customer surveys, test marketing etc., also help in accurate price forecasting. However, management judgement is always an important input in price forecasting. The more experience the management has had with its own industry, the more confident it is in making pricing decisions for existing products. Taking into account other factors like units produced, experience, efficiency of plant and equipment, government regulations, management decides the pricing policy of a firm.

Many managers state that they establish prices covering all costs of production and distribution plus the normal profit. High profit margins induce competitors to enter the field and low profit margins would force the business out of market in the long run. The manufacturer should be able to strike a feasible balance between the two.

Pricing on the basis of out-of-pocket expenses may be the only alternative to survive in periods of economic crisis. Faced with threats of liquidation, sometimes, firms offer inventory at a very low price. To attract customers, at other times, firms carefully select loss leaders and price them below the cost.

The importance of price in marketing varies according to a number of factors: the stage of the product life cycle, intensity of industry competition, the company’s market position, company resources and type of competition. Any business should study the viability of its pricing options when planning its marketing policies.

An important marketing direction is to determine where the business should be positioned in its product markets. Price is one of the commonly employed means to segment a market. High price segment contains few competitors and large profit margins. Buyers seeking top quality products are less price sensitive. Medium price segment is subject to intense competition and therefore, offers lower profit margins. Low price segment offers an opportunity for producers and companies with weak brand names to get into the market. However, it suffers from intensive price competition and low margins.

Once price segment decisions have been determined, the next important decision is where to price within each segment. It largely rests on the strength of market position. Generally, the market share leader can command a higher price, whereas companies with low market shares must price below market.

Cost based strategies: There are three well known approaches to price setting: cost plus, target return, and marginal cost.

Cost-plus approach: This approach involves determining the product’s full cost and then adding a percentage for the profit margin. This approach may work well if the firm has a strong grip over the markets.

Target-return pricing: This approach is based on the belief that the single best measure of business performance is the profit earned on capital invested. This is designed to set prices that will provide a predetermined profit return on capital employed to produce and market each product.

Marginal cost pricing:  A marginal cost strategy is one in which orders are taken at prices which cover all variable expenses and some portion of fixed expenses. With excess production capacity, for instance a company may be better off taking orders at prices that make some contribution to fixed cost rather than lose orders at prices that cover full costs.

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