What You Need to Know About Pricing

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By: Site Engineer, Staff

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Once the entrepreneur has developed a product, he has to decide how to price it. Unfortunately, there are no easy answers to this. Deciding on a price is tricky, and the stakes, are high. If the company charges too much, it will make fewer sales; if it charges too little, it will sacrifice profits that it might have gained. Price, as one of the elements of the marketing mix (the 4ps), is very important. This is because it is the only element that creates revenue, while others create costs.

The company’s pricing decisions are influenced by a variety of internal and external factors. The firm’s marketing objectives and cost provide a rough indication of what it should charge for its goods or services. But before establishing a final price, the firm also considers the level of demand, the nature of the competition, and the needs of wholesalers and retailers who distribute the product to the final customer.

Definition of Price

Price can be described as the monetary value placed on goods or services offered for sale. It can be defined also like the amount of money (plus possibly some goods), which is needed to acquire in exchange some combined assortment of a product and its accompanying services.

Price normally reflects the costs of goods (or services) sold, including administrative and selling expenses and, probably some profit. Pricing is, therefore, the process of estimating the amount a given product will be sold or exchanged.

Price is important because it regulates the economic system and influences the prices paid for all factors of production and the allocation of these factors. It influences the wages paid to workers, the rent a company pays and the profit a company makes. The demand for an item is dependent on the price of the product.

Pricing Objective

The entrepreneur must take the setting of the price of a product into consideration. However, a bad decision here might negatively affect the corporate existence of the company and thereby send the entrepreneur to the unemployment market. The entrepreneur should decide what he is trying to accomplish with a particular good or service.

Some of the most common objectives are:

  • To Achieve Market Skimming: Here the entrepreneur tries to fix the price higher according to the demand or according to the high cost of the materials used. Before adopting skimming, as pricing policy, the entrepreneur must make sure his product is the leader in the industry; so as he skims, others follow.
  • To Achieve a Satisfying Return: The entrepreneur should know the performance of his product in the market. If the product is not on Category “A” in the market rating, the entrepreneur is rather advised to adopt a price that will bring a return that will make a minimum profit that will maintain a satisfactory rate of return on investment.
  • To Accomplish Social Or Ethical Goals: The entrepreneur, during planning, should state the pricing policy objective his company wants to achieve. At times, the entrepreneur may want to accomplish some social needs or wants of his consumers by a certain price tag. If there is a need for the entrepreneur to develop a product line that will take care of the social responsibility of the company he can go ahead pursuing that objective. At times, if the entrepreneur is trying to achieve an ethical goal by adopting a pricing strategy or technique, he should go ahead to adopt such a price provided a minimum profit is equally achieved.
  • To Maintain and Improve Shares of Market: The share of the market is maintained or improved for an articulate pricing focus. The company must determine what share of the market to control and go ahead maintaining it or improving it through its pricing policy.
  • To Maximize Profit: This is one of the general aims of any organization to maximize profit. The maximization of profit can be achieved through high pricing policies, which the entrepreneur is advised to be careful with, because the high price of his product may scare away his consumers.
  • To Meet or Prevent Competition: The entrepreneur sets his price policy to meet his competitors when the competitors are the leader in the market. He merely follows them gradually and only increases his price when they increase theirs. He is said to be a market follower. He equally sets a certain price to prevent his competitor from pushing him out of the market. Here, he will lower his price in order to penetrate the market and expand his market share.
  • To Achieve Market Return On Investment (ROI) or Net Sales: Companies, during planning, agree to achieve a certain return on investment, say 30 or 40%. This is achieved through a pricing policy method. The unit price is determined and the agreed percentage is found on it and added to the cost to find the mark-up selling price.
  • To Achieve Market Penetration: In a situation where the market is already filled with competitors, the entrepreneur will use a penetrating price to enter the market. He has to do market research of the available competitors’ prices and adjust his own somehow lower or on average.
  • To Increase Sales: Here again, the entrepreneur should pursue a penetrating or competitive pricing policy that will help him increase his sales.
  • To Promote a particular Product Image: In a situation where the entrepreneur has many products in the market, he can use different appealing prices to sell each of the products. At times, the already established entrepreneur with a proliferation of product strategy will equally use a proliferation of price strategy to meet the needs and wants of his different market segments.

Correlation Between Price and Demand

If the price for an item is too high, demand falls and the producers reduce their prices to stimulate demand.

As prices fall, profits decline, thereby discouraging further production. Equally, if the price for an item is too low, demand increases and the producers are motivated to raise prices. As prices climb and profit improves, producers boost their output until supply and demand are in balance and prices stabilize.

The relationship between price and demand is not always this clear-cut. However, some goods and services are relatively insensitive to changes in price. Marketers refer to this as inelastic demand-meaning that demand does not stretch or contract with changes in prices e.g., salt.

Conversely, a market that is highly responsive to price changes exhibits elastic demand. Undifferentiated goods and services typically fall into this category.

The entrepreneur must consider the followings when setting the right price:

  • The entrepreneur’s preferred market strategy
  • The product life cycle
  • Being aware of his prevailing business condition
  • The nature of the product or service to be sold
  • The intensity of the competition
  • The total cost of production

The entrepreneur is therefore advised not to treat price and demand in isolation if a maximum result should be achieved.

Pricing Strategies

The essence of pricing strategies is to set the price, which the products/goods will be sold by the entrepreneur.

These are strategies are:

1. Price Skimming Technique

This technique of pricing is used to segment the market, by fixing the high price of the product. Exclusively it can be used to appeal to a certain income group. Here the product is always a market leader.

2. Price Penetration Technique

This is the technique of fixing a low price to gain maximum penetration of the market as quickly as possible or to reach the mass market immediately.

The entrepreneur’s ambition is to demonstrate his product’s existence in the market rather than make a big profit at the initial stage; though he has hoped to make a profit through a large volume of sales later.

3. Variable Price Technique

As the name implies, this is about selling or pricing a product based on emotions and attachment. For example, the same product can be sold to two different customers at different prices at different places.

4. One-Price Technique

With this technique, the price of the product/service is the same irrespective of the place or customer. Here, there is no preferential treatment.

5. Break-Even Analysis Technique

Another approach to pricing involves the use of break-even analysis, which enables a company to determine how many units of a product it would have to sell at a given price to cover all costs or break even. The break-even point is the minimum sales volume that the company needs to keep from losing money. Sales above that point produce a profit; sales below that point result in a loss.

The relationship between fixed and variable costs is important in break-even analysis. Suppose that you have opened a hair salon and you are trying to figure out how to price your haircuts. Your fixed costs for rent, utilities, and salaries are $600,000 per year. The variable cost of giving a single haircut is $50.00, which covers the cost of shampoo and labor spent doing the haircut.

If you charge $200 for a haircut, each cut will give you $150 over and above your variable costs, which you can use to cover your fixed costs and provide you with a profit. After selling some number of haircuts, you will eventually reach the break-even point, the point at which you have accumulated enough revenue to pay all your fixed costs. Any haircuts that you make after reaching that point will provide you with a profit.

To find the break-even point for the hair salon when haircuts are $200.

You will have: BEP (v)  =         FC/P – PV

BEP (v)           =          600,000/200 – 50

=          600,000/150

= 4,000 units

The entrepreneur should note here that at $200 per haircut, the break-even point is 4,000 haircuts. But $200 is not the only pricing option. Assuming you charge $300 instead. Your units of haircuts now will be 2,400.

Break-Even Analysis shows that at $200 haircut, the break-even point is reached at 4,000 haircuts. Charging $300 per haircut yield break-even point at 2,400 haircuts. However, before the entrepreneur raises his haircut prices to $300, he must bear in mind that the lower price may attract more customers to enable him to make more money in the long-run.

6. Suggested Pricing Technique

Some manufacturers of consumer goods advertise their merchandise at suggested retail prices, a practice known as suggested pricing. They may even stamp such a price on a product at the factory. Retailers have the choice of selling the goods at the suggested price or selling for less and creating the impression that they are offering a bargain.

7. Going Rate Pricing Technique

This involves the pricing of goods and services in line with the prevalent market price. The entrepreneur watches his competitors see how much they charge for their products before setting his price in line with them. This type of pricing is also known as a competition-oriented pricing strategy.

8. Psychological Pricing Technique

This is the process of pricing that appeals to consumers’ psychology. We have four psychological pricing techniques that are distinguishable thus:

(a) Prestige Pricing

This is a type of pricing to convey to the consumer a message that the product is of high quality. Consumers often take a high price to be a sign of product quality, especially for products they cannot easily evaluate. The entrepreneur should not set the price too high as it may scare his customers nor set the price too low as it may be mistaken for a sign of inferiority.

(b) Promotional Pricing

From time to time, the entrepreneur will offer some promotional pricing strategies. This is a situation where the prices a few of his items below their mark-up or even below cost. Supermarkets and department stores often use this method. When the consumer comes in to buy those “cheap items” he may end up buying other costly items he would not have seen. These are called “loss leaders.” The entrepreneur uses this method to attract customers.

(c) Pricing Lining

This is the technique of offering prices of products at a limited number of set prices. For instance, companies marketing radio cassettes may offer $1,000 lines, $1,200 line, and $1,500 line.

Price lining has two advantages:

  • It simplifies the job of selling the products, and
  • It makes the consumer’s choice cashier by limiting the number of alternatives.

(d) Odd-Even Pricing

This refers to a pricing strategy where products are a little lower priced e.g., $999 instead of $1,000. Many sellers believe that buyers favor odd prices over even prices. This type of pricing attracts particularly the eccentric individuals who are money conscious but may repel others.

9. Discount Pricing Technique

This is the process of deduction from the price list by the entrepreneur. This deduction may be in the form of cash or other concessions such as the free case of merchandise.

These are five major distinguishable discount pricing techniques, thus:

(a) Quantity Discounts

This is an offer of a price reduction to buyers who buy larger volumes. In quantity discount, the price will vary according to the quantity bought on the basis that transport costs, administration and so on will be proportionally higher, on smaller deliveries than on large ones. A typical example would be $20 per unit for less than 200 units, $15 per unit for 200 or more units.

(b) Cash Discount

This is a deduction granted to buyers for paying their bills within a specified period. In a cash discount, three elements are present:

  • The percentage deduction
  • The period for payment to be eligible for the discount and
  • The number of days after which the bills are overdue.

(c) Functional or Trade Discounts

These are payments to channel members for performing marketing functions required by the seller, such as seller storing and record keeping.

(d) Allowances

Here the entrepreneur is at liberty to give on the spot allowance to his customer. This right must always remain with the entrepreneur as the managing director.

10. Cost Oriented Pricing Strategy

This strategy aims to charge a price that will be high enough to cover the cost of materials purchased, operating expenses as well as the profit. There are three types of cost-oriented pricing strategies namely; mark-up, cost-plus, and target pricing strategies.

(a) Mark-up

This is defined as the difference between the cost of an item and its selling price. In modern merchandising, firms generally express this difference in terms of the mark-up percentage. For example, if an item costs a firm $50, and is sold for $75; the mark-up percentage is 331/3 of the selling price.

The mark-up percentage has two purposes: it must cover all the expenses of the firm, including not only the cost of the item but also the cost of selling it, and it must be high enough to allow some profit.

(b) Target Pricing

This is the process of fixing the price that will enable the entrepreneur to achieve the target ROI (Return On Investment). This price is fixed after determining the total cost and volume being produced.

In this type of price strategy, the unit price is first ascertained, then a certain percentage is then added on that unit price to get the profit that will make the entrepreneur achieve the targeted Return On Investment (ROI).

 

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