Product Mix Pricing Strategies Marketing Essay

Published Date: 23 Mar 2015

From time to time we come across instances where businesses are not realizing their full potential when setting prices. Sometimes this can mean missed revenue, in other cases it can have a negative effect on the brand, sending a mixed message of what it stands for. In either case profits can be lost. In this study, we take a look at the key factors to consider while reviewing the pricing strategy. Price is the only revenue generating element amongst the 4P's, the rest being cost centers. Pricing is the manual or automatic process of applying prices to purchase and sales orders, based on factors such as: a fixed amount, quantity break, promotion or sales campaign, specific vendor quote, price prevailing on entry, shipment or invoice date, combination of multiple orders or lines, and many others. Automated systems require more setup and maintenance but may prevent pricing errors. In setting pricing policy, a company estimates the demand curve, the probable quantities it will sell at each possible price. It estimates how its costs vary at different levels of output. In this paper, we also study situations when companies often face situations where they may need to cut or raise prices. The firm facing a competitor's price change must try to understand the competitor's intent and the likely duration of the change.

Table of Contents

Introduction

Simplistically speaking, price is the consideration given by the customer in exchange for a product in a commercial transaction. Anytime anything is sold, there must be a price involved. One of the four elements of the marketing mix, price is an important and strategic one. For, it not just apprises the customer about the value of the product but also communicates across its various features such as the product quality and its positioning. Too often when managers think about pricing, the first question they ask themselves is, "What should the price be?" In fact, what they must be asking is, "Have we addressed all the considerations that affect the final price?"

To work effectively, pricing efforts must complement an overall marketing strategy by sending a message that it is in sync with the company's desired product image. Developing a pricing strategy is one thing; managing the change process to embed that strategy in the organization is quite another. The truth is that implementing effective pricing strategy involves changing the expectations and behaviors of all of the actors involved in the sales process. Customers must learn that they will be treated fairly and that abusive purchase tactics will not be rewarded with discounts. Sales must learn that they will be rewarded for closing deals that increase firm profitability rather than using price as a tactical lever to increase sales volume. Finance must learn to look beyond cost as a determinant of price to better understand the tradeoffs between price, cost, and market response. All successful pricing efforts share two qualities: the policy complements the company's overall marketing strategy and the process is coordinated and holistic. Execution of a proper pricing strategy requires inputs and participation from all departments, and lack of communication or cooperation between them can make overall pricing performance dismal.

A company's pricing policy sends a message to the market- it gives customers an important sense of a company's philosophy. Ideally, a well-chosen price must look to generate optimal revenue and maximizing long term profits, be able to fit into the realities of the market place & support the products' positioning and be consistent with the other variables in the marketing mix. From the marketer's point of view, an efficient price is a price that is very close to the maximum that customers are prepared to pay. In economic terms, it is a price that shifts most of the consumer surplus to the producer. A good pricing strategy would be the one which could balance between the price floor (the price below which the organization ends up in losses) and the price ceiling (the price beyond which the organization experiences a no demand situation).

Understanding Pricing

 Price is not just a number on a tag or an item; Price is all around us. We pay rent for our apartment, tuition for our education, and a fee to our physician or dentist. The airline, railway, taxi, and bus companies charge us a fare; the local utilities call their price a rate; and the local bank charges us interest for the money we borrow. The price for driving your car on the Pune-Mumbai expressway is a toll, and the company that insures your car charges you a premium. Clubs or societies to which you belong may make a special assessment to pay unusual expenses. Your regular lawyer may ask for a retainer to cover her services. The "price" of an executive is a salary, the price of a salesperson may be a commission, and the price of a worker is a wage. Finally, although economists would disagree, many of us feel that income taxes are the price we pay for the privilege of making money.

Throughout most of history, prices were set by negotiation between buyers and sellers. "Bargaining" is still a sport in some areas especially in India. Setting one price for all buyers is a relatively modern idea that arose with the development of large-scale retailing at the end of the nineteenth century. F. W. Woolworth, Tiffany and Co., John Wanamaker, and others advertised a "strictly one-price policy," because they carried so many items and supervised so many employees. [1] Today the Internet is partially reversing the fixed pricing trend. Computer technology is making it easier for sellers to use software that monitors customers' movements over the Web and allows them to customize offers and prices. New software applications are also allowing buyers to compare prices instantaneously through online robotic shoppers. As one industry observer noted, "We are moving toward a very sophisticated economy. It's kind of an arms race between merchant technology and consumer technology". [2] Traditionally, price has operated as the major determinant of buyer choice. This is still the case in poorer nations, among poorer groups, and with commodity-type products. Although non-price factors have become more important in recent decades, price still remains one of the most important elements determining market share and profitability. Consumers and purchasing agents have more access to price information and price discounters. Consumers put pressure on retailers to lower their prices. Retailers put pressure on manufacturers to lower their prices. The result is a marketplace characterized by heavy discounting and sales promotion.

How Companies Price

Pricing is carried out by companies in a variety of ways. In small firms it is generally the boss who takes a final call on the price using his own intuition and knowledge about the subject. In larger companies a more systematic process is followed while pricing a product and the matter is handled by division and product-line managers. The top management sets pricing objectives and policies and the lower management uses these objectives as guidelines to propose a price number. In some companies there is a separate pricing department set up to decide or assist others in determining appropriate prices, especially in industries where pricing is a key. The pricing department generally reports to the next higher departments like marketing department, finance department or directly to the top management. Some people who exert a considerable influence on the price of a product include sales managers, production managers, finance managers and accountants. For some executives pricing is a big headache and gets worse every day. Many companies which cannot handle the issue of pricing give up and choose to stick to cost margin pricing and industry prices. Another common mistake which many companies make is that they do not revise their prices very often based on the external environment and consider pricing as an independent entity separate from the marketing mix independently of the marketing mix.

Successful companies have often used pricing as a strategic tool and have leveraged its effect on the bottom line. Prices and offerings are not standardized but rather customized across various segments and customer groups. The importance of pricing for profitability was demonstrated in a 1992 study by McKinsey & Company. After examining 2,400 companies, McKinsey concluded that a 1% improvement in price created an improvement in operating profit of 11.1%. By contrast, 1 % improvements in variable cost, volume, and fixed cost produced profit improvements, respectively, of only 7.8%, 3.3%, and 2.3%. [3] To effectively design and implement the right kind of pricing strategies it is essential that the company have a clear understanding of consumer pricing psychology and must adopt a systematic approach to setting, adapting and changing prices. For a pricing strategy to work it is crucial for a company to understand the relationship between price and quantity demanded in the market and also the impact of pricing on sales by estimating the demand curve for the product. Experiments can be performed for existing products at prices above and below the current price in order to determine its price elasticity of demand.

Pricing Mechanisms

Based on the marketing objectives for the product, various companies follow different pricing methodologies for their products. Given below is a list of some of these mechanisms; although the list is not exhaustive, it depicts the logical framework adopted by companies when they go about pricing their products.

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Cost plus pricing

This pricing mechanism involves setting the price of a product by adding a fixed amount or percentage to the cost incurred in making or buying it. Although this method is still widely used, it is considered as quite old fashioned and hence considered as a discredited pricing strategy.

Cost plus pricing (more commonly known as 'mark-up' pricing) technique is widely used in pricing retail goods where the retailer wants to know with some certainty what the gross profit margin per sale is going to be. One advantage of this method of pricing is that the business will know till what extent their costs are being covered. The major disadvantage of this method is that it may lead to pricing of the products un-competitively with respect to other available products in the market.

For example, if the cost incurred per unit for an imaginary product is say Rs. 100, and the company decides to apply a mark-up of 50% on its cost. In this case, the price will now be Rs. 150, and the company makes a profit of Rs. 50 per unit sale of this product.

Cost incurred

Rs. 100

Mark up percentage

50%

Price

Rs. 150

The obvious question which arises after carrying out this exercise is how much of a mark-up should be applied on the cost so that the final price is justified? Generally the mark-up is decided by the going competitive trend in the market for similar products, but sometimes factors such as the customers' willingness to pay for the product, availability of substitutes and the product positioning also play a crucial role in determining the optimal mark-up over cost that must be applied.

Demand oriented pricing

Good pricing starts with understanding how the customer's perception of value affects the prices they are willing to pay. There is a close relationship between price and demand for the product. Each price the company might charge will lead to a different level of demand. In the normal case, demand and price are inversely related, and the demand curve slopes downwards. Thus, consumers with limited budgets are not encouraged to buy more if the price is high.

In the case of prestige goods, the relationship between price and demand may be reversed, and the demand curve in such cases slopes upwards. This means that consumers think that higher price means better quality.

Marketers also need to be informed of the price elasticity of the demand curve i.e. how sensitive demand will be to price changes. This information will be useful whilst deciding to increase or decrease the price of the product. If the demand is too price sensitive and changes hugely with a slight change in price, it is said to be price elastic. Conversely, if the demand is price insensitive and hardly changes with per unit change in price, then it is said to be price inelastic.

Price sensitivity varies for with the type of product in question. Buyers are less price sensitive when they are buying a product that is unique or has high quality, prestige or exclusiveness. Also, buyers are less price sensitive when there are less number of substitutes available, or when they are not easily able to compare the quality of substitutes. The same behavior applies when the total expenditure for a product is low relative to their income or when the cost is shared by another party. [4] 

Competitor based pricing

Customers are faced with a wide array of options when there is strong competition in the market. In such a situation the customer becomes mindful of the offerings available before him and is able to determine the reasonable and market price for the product, hence making a decision that may be based on comparing relative product quality, customer service or convenience. Most firms in a competitive market are unable to set a price substantially different from their competitors and tend to use 'going-rate' pricing which is in line with the prices charged by their competitors. Such businesses are known as 'price takers' as they accept the going market price as determined by the market forces.

Value based pricing

Value based pricing uses buyers' perceptions of value, not the seller's costs as the key to pricing a product. Various customer groups do not just differ in terms of how they rate individual product features such as quality or functionality and performance; the same applies to price. This is because consumers not only differ in terms of how much they are willing to spend on a product or service; they also differ in terms of the extent to which price actually influences their purchase decision. In value based pricing the marketer does not design a product and marketing program before setting a price. The company first assesses customer needs and value perceptions, post which it is able to set its target price based on these customer perceptions. Based on this target price and value it is decided what costs can be incurred for developing the product and then the product design is initiated.

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Good value pricing [5] is a trend which has picked up in the past decade where marketers have tweaked their pricing approaches to bring them into line with the changing economic conditions and consumer price perceptions. Good value pricing is a modified version of value based pricing and offers the customer just the right combination of quality and good service at a fair price.

This method of pricing has been adopted for numerous products in the recent past where companies have been able to introduce less expensive versions of established, brand-name products. Recent examples include McDonalds' 'value menus', Armani's less expensive 'Armani Exchange fashion line' and Tata Motors' economical car 'Nano'. An important type of good value pricing at the retail level is the 'everyday low pricing' (ELDP) which involves charging a constant, low price with free or no temporary price discounts.

Pricing strategies

Pricing strategy mainly revolves around three elements-cost and profit objectives, competition, and consumer demand. A successful pricing strategy is one which is devised based on a solid analytical foundation which goes well beyond high level customer values and competitive anecdotes. This requires the use of quantified models involving customer decision making and an insight into competitive economics.

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New product pricing strategies

The introductory phase of the product is challenging, especially when it comes to pricing. As such, the pricing strategy for any product changes across its lifetime as the product passes through its life cycle. Depending on the product's positioning and the competitive scenario, companies may choose to employ the relevant pricing strategy.

Market-Skimming Pricing

Sometimes companies introduce their products at high initial prices to 'skim' revenues layer by layer from the market. As the product spends time in the market, its price is continuously reduced to make it more affordable and appealing to new buyers. In this way the company is able to skim maximum amount of revenue from various segments of the market.

This strategy makes sense only if the product meets certain criteria. Firstly, the products' quality and image must support its high price, and there must be enough buyers in the market ready to pay the high price for the product. Secondly, the cost of initially producing small volumes must not supersede the effect of charging a high price in the initial stages. Finally, there must be enough entry barriers to the market to prevent entry of competitors who might undercut the high price and steal away potential buyers.

Use of the Price skimming strategy is frequently observed in the electronics and technology industry and companies have successfully used this strategy to maximize their revenues. Sony used this strategy this strategy when it introduced the world's first high definition television (HDTV) into the Japanese market in 1990. These high tech television sets were initially priced at $43,000 and were purchased only by customers who wanted new technology and could afford to have them. Over the next several years Sony rapidly reduced the price on its HDTV sets to attract new buyers. The price of the HDTV in 2001 was $2000 which was a price that was affordable to many. Today the price of the same TV set is even lower and it continues to fall, enabling Sony to attract customers from various segments of the market and generate maximum revenue from them.

Market-penetration pricing

In this strategy, companies set a rather low initial price in order to penetrate the market quickly and deeply in order to attract a large number of customers quickly and consolidate a sizable market share. The loss of revenue due to low initial price is offset by the high sales volume, which helps in recovering this lost revenue when the price of the product returns to normal. Also due to the high sales volume production costs are low, allowing companies to further cut prices.

Market-penetration pricing works only for products meeting certain conditions. Firstly the market must be highly price sensitive so that potential customers are willing to switch over to your product willingly and produces more market growth for the product. Secondly, the high sales volume must allow the production and distribution costs to fall, so that companies are able to initially set a low penetrable price for the product. Finally, the low price must prevent competition from entering the market and steal away the low price position of the player, or else the low price advantage may only be temporary.

Diligent Media Corporation of the Essel Group used this Market penetration strategy when they introduced the news daily DNA in 2005 across major cities in India. At the time, the market consisted of established players such as Times of India, Indian Express and Sakaal to name a few. The newspaper was initially offered as a yearly subscription which was priced at Rs. 100 per year in a market that is very price sensitive. This price was substantially lower than the daily price of Rs. 3 to Rs. 5 commanded by the established players in the market. The bundling of the product as a yearly subscription ensured a high sales volume plus the offering was at such a low price that it attracted the customer's attention and got them to switch to the new product, at least temporarily. The strategy proved successful for DNA and today the news daily commands the second largest market share in Mumbai. [6] 

Product Mix pricing strategies

When a product is part of a product mix, the strategy for setting a products' price often has to be changed. In such situations, firms are on a lookout for prices that would maximize the total profits of the product mix as such. Also pricing becomes a difficult task as different products have different demands and face different degrees of competition.

Product line pricing

Some companies develop entire product lines rather than a single product. To price these separate offerings in the product line companies employ Product line pricing strategy where in the management decides the price steps set between the various products. The price steps are not arbitrarily decided but take into account cost differences between the products in the line and account for differences in customer perception of value of the different features of the various products.

Bata, a major footwear company offers an entire range of products in the Indian market, from premium European collection priced at Rs. 2499 to ordinary leather shoes priced at Rs. 749. It offers similar product range for women and children too, starting from economy to premium prices. This pricing strategy allows Bata to offer products across different segment of the Indian market at prices based on customer's value perception and affordability.

Optional Product pricing

In this pricing strategy, companies offer to sell optional or accessory products along with the main product. It involves pricing of optional or accessory products along with a main product which the company is offering. Pricing these optional offerings can be tricky as firms have to correctly decide which items to include in the base price and which to offer as options.

Optional product pricing is widely used by automobile companies in a bid to improve sales. Car manufacturers such as Tata Motors offer various models of the same car with different sets of accessories and add-ons for each offering. Being differently priced too, these models appeal to different sets of customers and enables Tata Motors to tap into various customer segments having specific needs.

Captive product Pricing

Some companies make products which have to be used with along with a main product the customers are already using, like razor blades, mosquito repellents etc. For these products companies apply a Captive Product pricing strategy. In this pricing strategy, the prices on the main products are set low while the supplies are highly priced. For once the customer has bought the main product they will be compelled to use supplies of the same company in order to continue using the same product. However, the supplies should not be priced too high as the customers might resent the brand once they are trapped into using the product and have to pay a high price at the same time for it. Gillette sells low priced razors which are a one-time buy for the consumer and mainly makes money from the subsequent cartridges that customers buy. A Gillette Mach3 razor along with a single replacement cartridge comes for Rs. 200, but once you've bought the razor you are committed to buy the razor cartridges of the same company and make, which are priced at Rs. 750 for eight cartridges.

In case of services, the captive productive pricing is called 'two-part pricing', the first part generally being a fixed fee post which customers have to pay a variable usage rate. This strategy is seen to be employed in amusement parks where customers have to pay a one- time fixed entry fee to enter the park and then pay separately for the specific rides and services they wish to enjoy at the place.

Product Bundle Pricing

This strategy involves combining several products and offering the bundle at a reduced price than individual product offerings. Using this strategy, sellers are able to promote sales of products which consumers might otherwise not buy individually. However, the combined price must be low enough to get the customers to buy the bundle.

An example of such strategy being used may be seen in the case of fast food restaurants such as McDonalds, which bundles various products like burgers, fries and soft-drink at a 'combo price'. Similarly, resorts sell specially priced vacation packages that include airfare, accommodation, meals and entertainment.

Price Adjustment Strategies

The base price set for a product may not last during the products lifecycle. According to changing market situations and various customer differences, companies need to adjust its base price. The following are some of the strategies which are used by companies to account for the changing market conditions.

Discount and allowance pricing

Some companies use such price adjustments to reward customers for certain responses, such as early payment of bills, volume purchases and off-season buying. Companies then reward their customers in the form of discount payments and allowances, either to reward their past response or to induce similar buying behavior. Discounts include cash discounts, where there is a price reduction in case customers pay the bill promptly, or quantity discounts where in the customer receives a price reduction after buying a product in large amounts at a single time. A functional discount, also known as a trade discount is offered by the seller to trade channel members for performing certain activities like selling, storing and record keeping. A seasonal discount is a price reduction to buyers who buy merchandise or services in the off season.

Allowances are another type of reduction from the list price of the product. Trade-in allowances are price reductions given for turning in an old item when buying a new one. Such allowances are most common in the automobile and electronic industry.

Segmented pricing

Companies often vary their prices for different segments according to differing customer needs, locations and products. Thus in segmented pricing, a company may sell a product or service at two different prices, the difference not being attributed to differences in costs. Segmented pricing takes several forms. Customer-segment pricing involves different types of customers paying different prices for the same product or service. This strategy is usually seen to be used in museums which charge different admission charges for children and senior citizens. Another form of segmented pricing is product-form pricing, where in different products of similar types are priced differently without having cost as a basis for pricing. For example, the price of a 1 liter bottled drinking water maybe Rs. 20, the price of a half-liter bottle is Rs. 12, and the price of a 2 liter bottle is Rs. 35. Although the water in the bottles comes from the same source and is packaged by the same company, the prices for different forms of packaging are not price proportionally to their volumes.

Under location pricing, company charges different prices for different locations even though the cost of offering for all locations is the same. For example in a movie theatre, seats are sold as Gold, Silver and Platinum for varying prices depending on their location within the theatre, although the cost of setting up each seat is the same. Time pricing is another pricing strategy where companies sell the product or service depending on the time it is purchased. Airlines regularly employ such strategies to sell their tickets at varying costs, depending on when the customer buys them although the cost incurred by the airline per passenger is the same.

Psychological pricing

Price is not merely the amount a customer pays for the product or service received; it also says something about the product. Many consumers use price to judge the quality of the product. Using psychological pricing, firms consider the psychology of the consumers and are not simply limited to economics. Because most consumers consider highly priced products as having high quality, having a high premium on the product may do wonders. However, such customer behavior disappears as the customer comes in contact with the product and judges it by examination or relying on past experience. Having said this, in cases where they lack skill and sufficient information about the product, price becomes the only indicator for consumers about the quality of the product.

Vodka manufacturer Heublein used this pricing strategy very effectively to their advantage some years ago when their vodka brand Smirnoff was attacked by another competing brand named Wolfschmidt, who claimed to have the same quality as Smirnoff and was priced one dollar less than it. To counter this move, Heublein smartly raised the price of Smirnoff by one dollar, introduced a brand named Relska in the market to compete with the competitor brand Wolfschmidt and finally introduced another brand Popov which was priced even lower than Wolfschmidt. Using price as a signal, Heublein was successfully able to communicate to the consumers of the quality of Smirnoff and made money on it, although in reality all its three products were similar in nature but just differently positioned.

Setting the Price

A firm must set a price for the first time when it develops a new product and when it introduces its regular product into a new distribution channel or geographical area. It must also decide how to position its product on quality and price. The following framework is generally seen to be followed by most companies.

Step 1: Selecting the Pricing Objective

It is here where the company first decides where it wants to position its market offering. The clearer a firm's objectives, the easier it is to set price. A company can pursue any of five major objectives through pricing i.e. survival, maximum current profit, maximum market share, maximum market skimming, or product-quality leadership.

Survival

 In dire situations, companies tend to pursue survival as their major objective if they are afflicted with overcapacity, intense competition, or changing consumer needs. As long as prices cover variable costs and some of the fixed costs, the company would do well to stay in business. Survival must never be a long term objective for any firm. It should be treated as a short term emergency objective and in the longer run the firm must find ways to add value to the business or face the danger of winding up.

Maximum current profit

Many companies look to maximize current profits by setting prices accordingly. After estimating product demand and associated costs, it chooses a price for the product that would maximize short term gains, cash flows or return on investment. An assumption for applying this strategy is that the firm has prior knowledge of its demand and cost functions which in reality are difficult to estimate. Also the company might have to sacrifice long term gains in exchange for short term profits as it would be ignoring the effects of other marketing-mix variables, competitors' reactions, and legal restraints on price.

Maximum market share

Maximizing market share might be the main objective for some companies. They might pursue their objectives by reducing prices and expecting a high sales turnover, which will in turn reduce unit costs and improve long term gains. Of course, this assumption holds if the market is very price sensitive in the first place. Also, the low price must stimulate market growth, costs of production and distribution must fall owing to the learning curve and the low price must discourage actual and potential competition.

Maximum market skimming 

Companies unveiling a new technology favor setting high initial prices to maximize market skimming in the later stages of the product lifecycle. Sony used this strategy this strategy when it introduced the world's first high definition television (HDTV) into the Japanese market in 1990. These high tech television sets were initially priced at $43,000 and were purchased only by customers who wanted new technology and could afford to have them. Over the next several years Sony rapidly reduced the price on its HDTV sets to attract new buyers. The price of the HDTV in 2001 was $2000 which was a price that was affordable to many. Today the price of the same TV set is even lower and it continues to fall, enabling Sony to attract customers from various segments of the market and generate maximum revenue from them.

Product -quality leadership 

Some companies aspire of becoming the product quality leader in the market. Many brands strive to be "affordable luxuries", products or services that are characterized by high levels of perceived quality, taste, and status with the price just within the reach of the consumers reach. Many brands such as BMW, Starbucks, Victoria's secret lingerie and many more have been able to achieve this and are quality leaders in their respective categories after being able to successfully combine elements of quality, luxury and premium pricing.

Other objectives

Objectives may not always be related to monetary benefits; some companies such as NGO's and public organizations have different pricing objectives. Universities and hospitals may aim to partially or fully recover the costs incurred by them, while a social service may set a service price which is linked to the clients' income. The objectives may vary for different types of firms, but it is important to understand the significance of employing a sound and valid pricing strategy rather than allowing market forces to determine the prices.

Determining Demand

Different prices lead to different levels of demand and hence have varying effects on the company's marketing objectives. The demand curve captures the relationship between alternative prices and changing demand. Normally, there is an inverse relationship between demand and price but this relationship is reversed in the case of prestige goods. This is so as for prestige goods the price serves as an indicator of product quality, and a high price drives consumers to buy the product. Of course, if the price is too high, it will deter consumers from buying the product; hence the price must be justified.

Price sensitivity

The relation between price of a product and its demand in the market is shown by the demand curve. It is a collective representation of the numerous individuals in the market who have different price sensitivities. In estimating demand the first step is to understand the factors affecting the price sensitivity of the product. Customers are more price-sensitive to products which are regular purchases or which are highly priced. Similarly consumers display less price sensitivity towards products which are not highly priced or which are purchased very infrequently.

With the advent of the internet, the decreasing information asymmetry between buyers and sellers gives opportunity to consumers to become more price sensitive in their purchases, but this is not what is observed. According to a McKinsey study, 81 % of the sample population visited only one music store, 89% visited only one book store and 84% visited only one toy store while carrying out online purchases. This shows that there is lesser price comparison from the buyers side than is possible when it comes to shopping over the internet.

In this manner companies need to understand the nature of price sensitivity amongst its consumers rather than targeting only highly price sensitive consumers. In doing so, they would be 'leaving their money on the table'.

Estimating demand curves

 Demand curves are determined by companies in different ways:

Statistical analysis on historical data of prices, quantities sold and such factors can show the variation in product demand with respect to its price. The data that is used for this computation may be longitudinal (over time) or cross-sectional (different locations at the same time) in nature. It takes considerable skill to build the appropriate model and fit it with the proper statistical data.

Price experiments could be conducted to determine the relationship of product demand and its price. Bennett and Wilkinson [7] systematically varied the prices of several products sold in a discount store and observed the results. Another approach is to observe the effect on sales after charging different prices in similar territories. The job is much more simplified by the use of the internet as we have analytical soft wares that would plot out the price-demand relationship for us after feeding in the required data. As an experiment, an e-business could increase the price by 5 % for every fortieth customer that visits and test the impact of the price increase on purchase response and sales alike. However, all such experiments must be carefully designed and must not end up alienating customers permanently, as it happened in the case of Amazon when it price-tested discounts of 30 percent, 35 percent, and 40 percent for DVD buyers, only to find that those receiving the 30 percent discount were upset. [8] 

Surveys can be used to explore the units consumers would buy at different proposed prices, although there is always the possibility that they might purposely understate their purchase intentions at higher prices in a bid to discourage the company from setting higher prices. The market researcher must control for various factors that will influence demand while measuring the price-demand relationship. The competitor's response is bound to make a difference in results compared to when it is not factored in the experiment. Also, the effect of the price change itself will be hard to isolate if the company changes other marketing-mix factors besides price. Nagle presents an excellent summary of the various methods for estimating price sensitivity and demand. [9] 

Price elasticity of demand

 Marketers need to know how responsive, or elastic, demand would be to a change in price. Consider the two demand curves in Figure . With demand curve (a), a price increase from$10 to $15 leads to a relatively small decline in demand from 105 to 100. With demand curve (b), the same price increase leads to a substantial drop in demand from 150 to 50. If demand hardly changes with a small change in price, we say the demand is inelastic. If demand changes considerably, demand is elastic.

The higher the elasticity, the greater is the volume growth resulting from a 1 % price drop. Demand is likely to be less elastic if there are few or no substitutes or competitors, buyers do not readily notice the higher price, buyers are slow to change their buying behavior and they think the higher prices are justified. If demand is elastic, sellers will consider lowering the price as a lower price will produce more total revenue. This holds true as long as the cost of producing and selling more units does not increase disproportionately. It is very important to consider the price elasticity of customers and their needs while developing marketing programs. In 1997, the Metropolitan Transit Authority in New York introduced a new purchase plan for subway riders that discounted fares after passes were used 47 times in a month. Critics pointed out that the special fare did not benefit those customers whose demand was most elastic, suburban off-peak riders who used the subway the least. Commuters' demand curve is perfectly inelastic; no matter what happens to the fare, these people must get to work and get back home. [10] 

The magnitude and direction of the contemplated price change plays a major role in helping determine price elasticity. It may differ for a price cut versus a price increase, and there may be some prices within a price indifference band for which price changes have little or no effect. A McKinsey pricing study estimated that the price indifference band can range as large as 17 % for mouthwash, 13 % for batteries, 9 % for small appliances, and 2 % for certificates of deposit [11] . Finally, short-run price elasticity may differ from long-run elasticity. Buyers may eventually switch suppliers after a price increase starts to hurt their purchasing capacity. Here demand is more elastic in the long run and less in the short-run, and then reverse too may happen: Buyers may drop a supplier after being notified of a price increase but return later. The implication underlying these behavioral displays is that sellers will not know the total effect of a price change until time passes.

Step 3: Estimating Costs

Demand sets a ceiling on the price the company can charge for its product while costs set the floor. The company wants to charge a price that covers its cost of producing, distributing and selling the product, which also includes a fair return for its effort and risk. Yet, the net result is not always profitability when companies price products to cover full costs.

Types of costs and levels of production

A company's costs take two forms, fixed and variable. Fixed costs (also known as overhead) do not vary with production or sales revenue and remain constant over a period of time. Examples of fixed costs are the bills a company must pay each month for rent, salaries and so on, which is regardless of output. Variable costs vary directly with the level of production achieved. For example, each hand calculator produced by an electronics company involves the cost of plastic, microprocessor chips, packaging etc. These costs are constant per unit produced by the company. Their total varies with the number of units produced hence they are called variable costs. The sum of the fixed and variable costs for any given level of production comprises total costs. The cost per unit at that level of production is known as the average cost and is mathematically equivalent to total costs divided by units produced. In an ideal situation the management would charge a price that will at least cover the total production costs at a given level of production. To price intelligently, the management needs to know how its costs vary with different levels of production. A clear understanding of variation of costs with other variables such as quantity produced, productivity achieved, downtimes etc. will help a company properly price its products after accounting for such variations and thus justify the price.

Accumulated production 

After the passage of time, a company develops a certain expertize in manufacturing a product and is thus able to use this to its advantage and reduce production costs. But experience curve pricing has its own set of risks. Aggressive pricing might result in a product receiving a cheap image. Also, the strategy assumes that competitors are weak followers. This leads the company into building more plants to meet demand, while the competitor develops a lower-cost technology. The market leader is now stuck with the old technology and cannot do much about it. Most experience-curve pricing has focused on reducing manufacturing costs, but all costs can be improved on including marketing costs.

Activity-based cost accounting 

Firms continually try to adapt their offers and terms to different buyers. It is possible that a manufacturer negotiates different terms with different retail chains, as the clients have varying sets of demands. One retailer may want daily delivery while another may accept once-a-week delivery to get a lower price. The manufacturer's costs will be different in serving each chain and so its profits will also be different. To estimate its profitability of dealing with different retailers, the manufacturer can use activity-based cost (ABC) accounting instead of standard cost accounting. ABC accounting identifies the real costs associated with separately serving each customer. Indirect costs like clerical costs, office expenses, supplies etc. are allocated to the activities that use them in proportion to direct costs. Variable and overhead costs are both tagged back to each customer. Companies that don't measure their costs correctly are not measuring their profit correctly and are likely to misallocate their marketing effort. The key to effectively employing ABC is to define and judge activities correct manner.

Step 4: Analyzing Competitor's Costs, Prices and Offers

Along with considering the range of possible prices determined by market demand and company costs, firms must also take into account competitors' costs, prices, and possible price reaction. After considering the nearest competitor's price the firm should see whether their offer contains features not offered by the nearest competitor. The worth of the firm's products to the customer should be hence evaluated and added to the competitor's price. Similarly if the competitor's offer contains features which are not offered by the firm, their worth must be subtracted from the firm's price. Using this basic thumb of rule the firm can decide whether it has the ability to charge more, the same or less than the competitor.

Step 5: Selecting a Pricing Method

After understanding customers' demand schedule, the cost function for the product, and competitors' prices in the market, the company is now ready to set a price. It must be noted here that costs set a floor to the price while competitors' prices and the price of substitutes provide an orienting point and finally, customers' assessment of unique features establishes the price ceiling. Companies include one or more of these three considerations while selecting a pricing method. Given below is some of the most commonly applied price setting methods:

Markup pricing 

The most elementary pricing method, it involves adding a standard markup to the product's cost. This practice is regularly followed by construction companies who submit job bids by estimating the total project cost and add a standard markup for profit. Lawyers and accountants also typically price their services by adding a standard markup on their time and costs incurred.

Target-return pricing

In target-return pricing firms determines the price that would yield its target rate of return on investment (ROI). Target return pricing is commonly used by automobile sellers, which prices its automobiles to achieve an ROI of 15 to 20 %. Public utilities which need to make a fair return on their investment also use this method.

Perceived-value pricing 

Of late an increasing number of companies have started to base their price on the customer's perceived value. In order to be successful they must deliver the value promised by them in their value proposition and the customer must perceive this value at the receiving end. Marketing elements such as advertising and sales force are used to communicate and enhance perceived value in consumers' minds. Various elements such as the buyer's image of the product performance, the channel deliverables, the warranty quality, customer support, and softer attributes such as the supplier's reputation, trustworthiness, and esteem play a role in determining perceived value. Furthermore, different weights are placed by each potential customer places on these different elements, with the result that some will be price buyers, others will be value buyers, and still others will be loyal buyers. Different strategies must be adopted by the company to address these three groups. Companies need to offer stripped-down products and reduced services for price buyers, they must keep innovating new value and aggressively reaffirming their value for value buyers, and for loyal buyers companies must invest in relationship building and developing customer intimacy.

Value pricing

Several companies in recent years have adopted value pricing. Loyal customers are won by charging a fairly low price in exchange for a high-quality offering. Examples of the best practitioners of value pricing are IKEA and Southwest Airlines. In the early 1990s, Procter & Gamble created quite a stir when it reduced prices on supermarket staples such as Pampers and Luvs diapers & liquid Tide detergent to value price them. [12] It was found that a brand-loyal family paid an equivalent of $725 premium for a year's worth of P&G products compared to private-label or low-priced brands. P&G underwent a major overhaul to offer value prices. It redesigned the way it developed, manufactured, distributed, priced, marketed, and sold products to deliver better value at every point in the supply chain. [13] 

Value pricing is a matter of setting lower prices along with re-engineering the company's operations to become a low-cost producer without compromising on quality. An important type of value pricing which takes place at the retailer level is everyday low pricing (EDLP). Retailers who hold an EDLP pricing policy charge a constant low price with little or no price promotions. Constant low prices help in eliminating week-to-week price uncertainty this can be contrasted with the 'high-low' pricing strategy where the retailer charges higher prices on an everyday basis but then runs frequent promotions in which prices are temporarily lowered below the EDLP level.

 Due to increased levels of competitions faced by supermarkets every day, many are of the opinion that using a combination of high-low and everyday low pricing strategies, with increased advertising and promotions is the key to drawing daily customers.

Going-rate pricing

Application of going-rate pricing involves the firm basing its price largely on competitors' prices. The firm might charge the same, more or less than major competitors. Firms normally charge the same price in oligopolistic industries that trade commodities. The smaller firms change their prices in sync with the market leader's prices rather than when their own demand or costs change. Sometimes firms may charge slightly different prices than their competitors in the form of a slight premium or slight discount, but the amount of difference is finally preserved. An example of this is when minor petrol retailers charge a few paise less per liter than the major oil companies, keeping this difference in price constant. Firms feel that the going price is a good solution where costs are difficult to measure or competitive response is uncertain, as it is thought to reflect the industry's collective wisdom.

Step 6: Selecting the Final Price

The above discussed pricing methods narrow the range from which the company must select its final price. Companies must consider additional factors, such as the impact of marketing activities, company pricing policies, gain-and-risk-sharing pricing, and the impact of price on other parties. The final price must also take into account the brand's quality and advertising relative to the competition. In a classic study, Farris and Reibstein examined the relationships among relative price, relative quality, and relative advertising for 227 consumer businesses, and found the following: [14] Â 

"Brands with average relative quality but high relative advertising budgets were able to charge premium prices. Consumers apparently were willing to pay higher prices for known products than for unknown products. Brands with high relative quality and high relative advertising obtained the highest prices. Conversely, brands with low quality and low advertising charged the lowest prices. The positive relationship between high prices and high advertising held most strongly in the later stages of the product life cycle for market leaders."

Tackling price changes

Prices for products never remain the same and have to be changed either due to changes in the market environment, company's strategy or overall positioning of the product. Companies might find themselves in a position where they are ether initiating a price change or responding to one initiated by the competitor.

Initiating price changes

Several situations may compel a company to either increase or reduce the price of a product. In either case it must anticipate possible reactions from buyers and competitors.

Price cuts

A firm may indulge in price cuts for various reasons, like falling demand, over capacity or strong competition. In such situations simply cutting prices is not the smartest thing to do as it may lead to a price war amongst competitors and lead to overall loss of revenue for all players. Price cuts may be initiated in forms of discounts, promotional offers or special occasion offers. Big Bazaar, one of the most successful retailers in the Indian market, initiated their price cuts by declaring beforehand that 26th January would be the cheapest day of the year for customers. The initiative was successful and Big Bazaar crossed its seemingly impossible sales target of Rs. 260 million without much difficulty. In this manner, not only the retailer managed to rake up huge sales, but by declaring a single day as the cheapest day of the year it sent out a signal to its competitors that its price cuts were not permanent in nature.

Price increases

Successful price increases may improve the cash inflows of the company by substantially improving its profit margins. But raising the revenue level might not be the only reason why a company would increase its products' prices. Rising costs, cost inflation, over-demand are some of the reason a company may indulge in price increases. Although raising prices might turn out to be good in the short turn, it might not go down too well with customers, who might perceive this move as a means of exploitation. In the case of products such as petrol, even a slight rise in its prices outrages the customers who accuse the oil companies of enriching themselves at the expense of customers. This might lead to customers turning away from the company or even whole industry when they perceive the charged price as too high.

One way to tackle this issue is to try and justify the price increase and maintain a sense of fairness around the issue. This can be done by supplementing the event by communications from the company's side justifying the reasons for price increase. Making low visibility price moves will also help in preventing customer ire; this can be done by including dropping discounts, increasing minimum order sizes and curtailing production of low margin products. As much as possible, the company must look for ways to tackle increased costs by improving efficiency.

Responding to price changes

In responding to a price change by a competitor a company needs to understand why the competitor changed the price in the first place, whether the price change is permanent or temporary, how will it affect the company's market share, whether other competitors are going to respond or not, etc. Besides these things the company must also devise its own strategy of response to the price change and predict the reactions of its customers.

If a company decides to take effective action, it may be any of four responses. It could reduce prices to match competitor's prices after deciding probably that the market is price sensitive and not reducing prices will lead to a loss in market share. However, the company must ensure that its quality standards remain intact and are not diluted because of the price cut.

Alternatively a company may maintain its price but raise the perceived value of its offer by means of communications and an appropriate marketing campaign. Or, the company may improve quality and increase price, moving its brand into a higher-value position. In this way the company delivers greater customer value along with making higher margins.

Conclusion

Price is a critical element of the marketing mix despite the increased role of non-price factors in modern marketing. It is the only element that produces revenue while the other elements of the marketing mix incur costs for the company. A firm must follow a six-step procedure while setting pricing policy: it must start by selecting its pricing objective, then it must estimate the market demand curve for its product and understand the effects of variation of price and other factors on demand, after which it must determine how its costs of production vary at different levels of output, accumulated production experience and for differentiated marketing offers. After carrying out an extensive cost analysis, the firm must now examine its external environment which includes competitors' costs, prices, and offers. It should then move on to select the appropriate pricing strategy for the product, and finally must set the price for the product based on the remaining options that are available before them.

Companies generally adopt a pricing structure that reflects variations in geographical demand and costs, market-segment requirements, purchase timing, order levels amongst other factors. Several price-adaptation strategies are being used such as geographical pricing, price discounts and allowances, promotional pricing discriminatory pricing. Firms often face situations in which they need to change prices. A price decrease might be adopted due to declining market share, excess plant capacity or simply due to economic recession. A price increase might be adopted due to cost inflation or over demand for the product in the market. In either cases of changing prices companies must be fully aware of the repercussions of the same. At the same time companies must anticipate price changes from the competitors end and prepare a relevant contingent response strategy to counter it effectively. Maintaining or changing price or quality is amongst some of the responses that the company might use to counter the moves of competitor. It is imperative for any company to understand the competitor's intent before actually facing a price change from the competitors end. When attacked by lower priced competitors, market leaders can choose to maintain price and raise the perceived quality of their product, reduce its price to the competitors' level or launch a low-priced fighter line. Ultimately, pricing strategy is a tool in the marketer's arsenal, and it would be most effective when the marketer knows how to rightly wield it.