PRODUCT PRICING

PRODUCT PRICING

BRIAN WILLCOX

ACTION MRPII

Pricing is a complex business and, although a company may know how they would like to handle pricing, so much depends upon the costs incurred by manufacturing and distribution, and the current climate in the market place.

Determining the most advantageous pricing strategy to be used by a company is most important, as under certain circumstances it can effectively either put the competition out of business, or yourself. There are many pricing methods to choose from but first we need to understand the objectives of a pricing strategy.

1. Pricing Strategy Objectives

When setting a pricing strategy, a company must be quite clear in what it is trying to do.

Obtain Market Share -<

If the company is trying to break into an existing market with several well established players, they will need to set the price lower initially but provide a high quality product. This way they hope to win people over from their usual suppliers. Perhaps the best example of this was when the Japanese successfully broke into the American car market.

Return On Investment -<

For a company well established in a mature market, it is a common practice to be satisfied with a percentage return on the investment made on the product.

Remove Marginal Competitors -<

When a company is well established in the market place, they will have many small competitors who continually nibble away at the market and cause cost and inconvenience to the company. One approach can be to lower the price for a period and force the small competitors out of the business.

Discourage New Competitors -<

When a company has a high market share with a profitable product there is a concept of not being greedy. By keeping the sales price relatively low the company can make a good regular profit. This approach reduces the chance of new competitors trying to break into the market as they can see there are no easy big profits to be made and would have a problem justifying development and launch costs to break into the market.

Maintain Price Leadership -<

When a company is the market leader, it may maintain a relatively higher price which it believes it can justify by being the market leader.

2. Effects of Price Another point to be considered when determining the pricing strategy is the effect price can have on the prospective customer. In many people’s mind price infers quality. The higher the price the better the product or service must be. Thus if it is cheaper it can’t be any good! As we have already said, the market leader may keep his prices higher because people will pay more for his product. It is not that it is necessarily any better than that of his competitors who came into the market later and are still trying to become established.

Customers want to feel they are paying a fair price for a product or service so it is important that the marketing approach confirms that it is good value for money. Where the customer can see one product is better than another, or it provides more features, then a higher price is acceptable.

The reverse logic to this is the elitist approach. It requires a person to pay more for an average product with a special/designer label so they can gloat to their peers!

3. Pricing Strategy Application There are many to choose from and a company must decide upon its objectives before selecting the one to use.

Market Skimming -

When launching a new product the price is set high in an effort to recover the development cost. Customers will pay a higher price initially because it is new. Once it becomes established and the manufacturing operation has become more effective, the price is gradually reduced. As competitors produce similar products the price will stabilize finding a realistic market related price.

Leader Pricing -

So often there is a market leader in an industry who sets his price and then the competitors position themselves just below the leader’s price. When the leader has a price increase, the competitors all increase their prices by about the same percentage. This means that if the leader is managing his costs more effectively due to his volumes, then the competitors gradually have a smaller percentage margin.

Loss Leader Pricing -<

This is a strategy often practiced in the retail outlets. The objective is to advertise and sell a recognized product at a very low price, often at cost. This approach is used to encourage customers to come into the store and whilst they are there they will buy other items at the normal price.

Perception Pricing -<

This is the approach of charging a price which the customer believes is a realistic price for the item. In many cases it bears no relationship to the item’s cost.

Cost Pricing -

This is when the selling price is based on the cost of the item. For a manufacturing company it may include not only the current production costs, but the recovering of the investment made in the original development costs.

Value Pricing -

The price of an item or service is based on the value it will provide the customer. This must be compatible with other similar items or services available.

Marginal Pricing -

This is setting the price based on the variable cost and the cost of selling that order only. This is often used when competing for additional large orders from a different market. The logic is that the overheads are already being recovered by the regular volumes, so do not need to be included in the price of this order.

Full Cost Pricing -<

This is setting the price to recover the full cost and to provide an acceptable markup.

As can be seen, there are many ways of setting prices an it all depends upon the company’s objectives which one it chooses for a particular product.

January 2000