Pricing

Price
• The economic value of goods and services, determined
by the interaction of demand and supply.
• Guides decisions and economic activities of agents
through signalling incentives and disincentives.
• Important variable both economically and politically
• Serves as a tool of intervention into markets to
influence the behaviours of producer and consumers
(price policies).
• Serves as a subject of policy intervention to influence
income distribution and others with welfare objectives.
 Pricing
• The task of pricing is reiterative because it takes
place within a dynamic environment:
– shifting cost structures affect profitability,
– new competitors and new products alter the
competitive balance,
– changing consumer tastes and disposable incomes
modify established patterns of consumption.
• This being the case, an organization must not
only continually assess its prices, but also the
processes and methods it employs in arriving at
these prices.
 The process of Price determination
Corporate objectives

Marketing objectives

Marketing Mix

Pricing objectives

Factors impinging on pricing decisions

External Internal

Demand Competitive Cost-volume Corporate

patterns activity relationship philosophy and
ethics
Stakeholders Customer ROI targets
behavior

Pricing strategy

Price determination
Cost oriented
Market oriented methods

Market response
 Pricing
• Pricing decisions are not made by organizations operating
within some kind of vacuum.
• When making pricing decisions marketers have to take into
account a range of factors. Some of these are internal to
the company, such as its marketing objectives, its
marketing mix strategy and the structure of its costs.
• Factors which are external to the company include the
state of market development, the pattern of supply and
demand, the nature and level of competition and a host of
environmental considerations (e.g. legislation, political
initiatives, social norms and trends within the economy)
 Pricing Objectives
• Whilst pricing objectives vary from firm to firm,
they can be classified into six major groups
– Profitability
– Volume
– Competition
– Prestige
– Strategic and
– Relationship objectives.
 Profitability Objectives

• Commercial enterprises, and their management, are

judged by their ability to produce acceptable profits.
• Prudent managers are likely to take the strategic
view when making pricing decisions. That is, they
will not necessarily seek to maximize profits in the
short-term at the expense of long-term objectives.
– Example, profits may be low, or even negative, during a
period when the company is seeking to penetrate a new
market. Again, heavy investments in capital equipment
and/or R&D may adversely affect the short-term
profitability of an enterprise, but are likely to provide a
foundation for longer term commercial success.
 Profitability Objectives
• Target return on investment (ROI) - This is a cost-oriented
approach to pricing decisions.
• ROI = (revenues/assets)*(profits/revenues)*(assets/equity)
– Three components: Turnover, Earnings, Leverage.
• Typical pricing objectives might be a 20–25% annual rate of return
on investment (after tax) and a 5–8% return on sales.
• Maximizing revenues: When it is difficult to calculate cost
functions (e.g. when costs are indirect and/or are shared by
different products) marketing managers often seek to maximize
revenues when setting prices.
• Managers need only to estimate the patterns of demand and they
believe that if current revenues are maximized then, in the long run,
profits will be maximized.
 Volume objectives
• Sometimes, the pricing decisions of managers have
more to do with sales maximization than profit
maximization.
• In these cases, organizations set a minimum acceptable
profit level and then set out to maximize sales subject
to this profit constraint.
• This is common where, as a matter of policy, a
company commits itself to mass marketing, as opposed
to serving narrow market segments.
• Minimum sales volumes can be more important than
profit maximization in another situation.
– Example, agricultural machinery manufacturers will seek to
keep volumes up, even if it means sacrificing potential
profits, if their factories and skilled work force are kept
employed as a result.
 Volume objectives

• Maximizing market share: Another volume-

related pricing objective is the maximization of
market share.
• The organization's specific goals may be either
to maintain its share of a particular market or to
increase its market share.
• There is frequently a positive relationship
between high market share and profitability
since the additional volumes help lower unit
production costs.
 Competitive objectives
• Pricing decisions must take into account the
current behavior of competitors and seek to
anticipate the future behavior of those
competitors.
• Going-rate pricing: Competing firms will
sometimes set out to match the industry leader's
prices. The net result is to take the emphasis away
from price competition and refocus competition
on to other elements of the marketing mix.
– Although pricing is an effective tool for gaining a
differential advantage over competitors, a price move
is easily imitated.
 Competitive objectives
• Anti-competitive pricing: In some cases, a firm might
price its products with a view to discouraging
competitors from entering the market or to force them
out of the market. This is done by maintaining relatively
low prices and profit margins.
 Prestige Objectives

• These objectives are unrelated to profitability or

volume objectives.
• They involve establishing relatively high prices to
develop and maintain an image of quality and
exclusiveness that appeals to status-conscious
consumers.
• Such objectives reflect a recognition of the role of price
in creating the image of an organization and its
products or services.
 Strategic Marketing Objectives

• Price stabilization: The objective of stabilizing

prices is met in the same way as that of removing
price as the basis of competition.
• Supporting other products: Pricing decisions
are often focused upon the aim of maximizing
total profits rather than maximizing profits
obtained from any single product within the
portfolio.
 Strategic Marketing Objectives
• In this case, some products may be designated as
loss leaders whereby their price is set at a level
that produces low or even negative returns in
order to improve the sales and profitability of
others within the range.
– Example, a manufacturer of a herbicide/pesticide
may sell a knapsack sprayer at or below cost in an
attempt to stimulate sales of the high-margin
chemicals which it is designed to apply.
 Strategic Marketing Objectives

• Maintaining cash flow: Many businesses fail

not so much because there is an inadequate
demand for their products and services, but due
to cash outflows running ahead of cash inflows.
• Prices can be structured in such a way that
customers are encouraged either to pay cash or
to repay credit earlier than they might otherwise
do.
 Strategic Marketing Objectives
• Target markets: The sensitivity of buyers to
prices can vary across different market
segments. Some consumers will view products
as commodities and therefore purchase mainly,
or wholly, on price.
• Others will perceive differences between
competing brands and will perhaps make their
choice on the basis of characteristics such as
quality, freshness and convenience rather than
on price.
 Strategic Marketing Objectives

• Product positioning: The category into which a

product is placed by consumers, and its relative
standing within that category, is referred to as its
position within the market. The same product can hold
different positions depending upon which segments of
its market are under consideration.
• Price setters have also to take account of perceived
price-quality relationships. The product has to be
priced at a level commensurate with the target quality
image and market positioning.
 Relationship pricing objectives

• Commercial organizations have several important

stakeholders with which they must establish and
maintain relations conducive to a positive operating
environment.
• Channel of distribution members
– Where there is intense competition for distributive outlets it is
the organization which proves most knowledgeable and
sensitive about the needs of intermediaries that will fare best.
• Suppliers of raw materials and accessories
 Relationship pricing objectives

• The general public

– Companies have to be careful in the way they report prices
and profits since these can easily be perceived as being
excessive.
• Government
– Governments often take a keen interest in the prices charged,
particularly if the product is a staple food.
 Note on Elasticity
• The elasticity of demand is the percentage change in the
quantity of a product demanded divided by the percentage
change in its price.
• The price elasticity of supply of a product is the percentage
change in the quantity of product supplied divided by the
percentage change in its price.

 q  p
p  
 p  q
• A price cut will increase revenue only if demand is elastic
and a price rise can only raise total revenue if demand is
inelastic.
 Note on Elasticity
• Factors that influence the price elasticity of demand
– the availability of substitutes
– the number of uses to which a commodity can be put
– the proportion of income spent on a particular product and
– the degree of commodity aggregation.
 Note on Elasticity
• Availability of substitutes
– Any commodity for which there are close substitutes is likely
to have a highly elastic demand.
– Even relatively modest price increases are likely to bring about
a sizeable fall in its demand as consumers switch to
substitutes.
• Number of uses to which a commodity can be put
– The more uses a commodity has, the more elastic will its price
elasticity tend to be.
– A price reduction is likely to increase demand in several end-
use markets and total demand could be dramatically affected.
 Note on Elasticity
• Proportion of income spent on the product:
The larger the product's share of the consumer
expenditure, the more sensitive will the
consumers become to changes in its price.
• The demand for most foods in poorer countries
is generally more elastic than for comparable
foodstuffs in rich countries.
 Note on Elasticity
• Degree of commodity aggregation
– The price elasticity of demand will depend on how widely or
narrowly a commodity is defined.
– The demand for meat is normally more price elastic than the
demand for all meat. Similarly, the price elasticity of all
meat is likely to be more price elastic than the demand for all
food.
– Commodity aggregation reduces the number of substitutes.
 Note on Elasticity
• Elasticity also tends to vary along a demand curve. In
general, price elasticity of demand will be greater at
higher price levels than at lower price levels.
• If demand for a product is inelastic then, ceteris paribus,
total revenue will fall when price is reduced and will
increase when price is raised.
• Conversely, when demand is elastic, total revenue goes
up when price is cut and falls when price is increased.
• Clearly these patterns of demand, in response to price
movements, are of fundamental importance to pricing
decisions made by marketing personnel.
 The meaning of price to consumers
• The price of a product or service conveys many diverse
messages to consumers.
• Some consumers will see price as an indicator of product
quality; others will perceive the price as a reflection of
the scarcity value of the product or service; some others
will view price as a symbol of social status; and yet
others will simply see price as a statement by the supplier
about the value he/she places on the product or service.
• Thus, consumers will perceive a given price in a variety
of ways: as being too high or too low, as reflecting
superior or inferior quality, as indicating ready availability
or scarcity of supply, or as conveying high or low status.
 Price as indicator of quality
• In the absence of other information on which to base
their judgment, consumers often take price to indicate
the quality level of the product or service.
• Low prices can, in certain circumstances, prove as much
a barrier to sales as prices which are too high. If the
product is perceived to be too cheap then consumers
begin to question whether it can be of adequate quality.
• In electing not to purchase the cheapest brand among
competing products, the consumer is seeking to avoid
the risk of acquiring a product with a performance
considered to be substandard.
 Pricing Strategies
• Pricing strategies are of two generic types
– those that are based upon the organization's costs and
those to which some margin is added.
– Those that are market-oriented.
– Whereas cost-plus approaches to pricing are proactive, in
that prices are largely determined by the organization's
financial performance objectives, market-oriented
approaches are reactive to market conditions and are
shaped by the organization's marketing goals.
 Cost-plus methods of price
determination
• Used most frequently.
• Involves calculating all the costs associated with
producing and marketing a product on a per unit basis
and then adding a margin to provide a profit.
• The per unit profit can be expressed either as a
percentage of the cost, in which case it is referred to as
the mark-up, or as a percentage of the selling price,
when it is referred to as the mark-on, or margin.
Cost-plus methods of price determination

• Mark-up
Selling price  Cost price
 100
Cost price

• Mark-on (margin) – more common

Selling price  Cost price

 100
Selling price
Cost-plus methods of price determination

• Mark-up
Mark on
 100
100%  %Mark on

• Mark-on (margin) – more common

%Mark up
 100
100%  %Mark up
 Examples
Cost price of tef Birr 500
Seller’s addition Birr 200
(mark-up)
Selling price Birr 700
Mark-up 40%
Mark-on (margin) 28.6%
 Examples
• If we know the cost Birr %
price and the required
mark-on (margin), we Selling ? (128.6) 100
can calculate the selling price
price. Cost 90 ? (70)
• A retailer buys a quintal price
of tef for 90 and he Margin ? (38.6) 30
knows he should secure
30% margin.
 Calculating Mark-on (margin)
Producer’s cost 100 Margin = 9.1%

Producer’s selling price 110

Retailer’s cost 120 Margin = 20%

Retailers selling price 150

Wholesaler’s cost 150 Margin = 25%

Wholesaler’s cost 200

 Breakeven Analysis

• The breakeven point is where the number of units of the

product sold, at a given price, is just sufficient to cover
both the fixed and variable costs incurred.

fixed costs
# of units tobreakeven 
price  variable cost
 Breakeven Analysis
• Example
– Say a seed company carries fixed costs of 100,000 birr.
– Assume a variable cost of production per quintal of seed be 500
birr.
– Suggested selling price per quintal 1000 birr.
– How much should the company sell before it breaks even
= 100,000/(1000-500) = 200 quintals
– The company will wish to estimate total sales, and therefore total
profitability, at a selling price of 200 birr per quintal.
– Marketing managers will repeat the same calculations for several
possible selling prices.
– Look example on excel!
 Breakeven Analysis
• Important note:
– Maximizing sales volumes and maximizing profits
are not necessarily one and the same objective. It is
equally useful in underlining the fact that maximizing
sales revenues does not automatically provide the
best profit performance.
– Look example on excel!
 Market Oriented Pricing (MOP)
• Market-oriented pricing begins from a
consideration of factors external to the
organization, i.e. the marketplace.
• Two broad alternatives are open to companies
launching new products on to the market:
skimming or penetrating.
– Skimming strategies involve setting high prices and
heavily promoting the new product. The aim is to
“skim the rich cream” off the top of the market.
– Profit objectives are achieved through a large margin
per unit rather than by maximizing sales volumes.
 Market oriented pricing

– Penetration strategies aim to achieve entry into the

mass market. The emphasis is upon volume sales.
Unit prices tend to be low. This facilitates the rapid
adoption and diffusion of the new product.
– Profit objectives are achieved through gaining a
sizeable sales volume rather than a large margin per
unit.
 MOP – Discriminatory pricing
• Discriminatory pricing involves the company selling a
product/service at two or more prices, where the differences in
prices are not based on differences in costs. Has different forms:
– Segmentation pricing - prices are set to achieve an organization's
objectives within each segment. Customers in different segments
will pay different prices, for the same product.
– Product-form pricing - different versions of the product are
priced differentially, but often not in proportion to differences in
their costs.
– Time pricing - this involves varying prices seasonally. Typically
this is done to encourage demand by reducing prices at times
when sales are seasonally low and by raising prices to contain
demand when it is strong and likely to outstrip supply.
 Psychological Pricing
• Pricing has psychological as well as economic
dimensions and marketers should take this into
account when making pricing decisions.
– Quality pricing - when buyers cannot judge quality by
examining the product for themselves or through previous
experience with it, or because they lack expertise, price becomes
an important quality signal.
– Odd pricing - creates the illusion that a product is less costly
than it actually is, for the buyer. An odd numbered price, like
$9.99, will be more appealing than $10, supposedly because the
buyer focuses on the 9.
 Psychological Pricing
• Product line pricing
– The practice of marketing merchandise at a limited number of
prices. For instance, John Walker has 4 ( Red, Black, Blue and
Green) labels of Whisky priced (estimated) at $15, $30, $60
and $100, respectively.
– These price points are important factors in achieving product
line differentiation and enable the company to serve several
market segments.
– The skill in price lining lies in selecting price differentials
which are sufficiently far apart for consumers to distinguish
between them, but not so far apart that a gap is left for
competitors to fill.
 Psychological Pricing
• Customary pricing
– In the case of certain low cost products there is
widespread resistance to even modest price
increases.
– Under such circumstances a common strategy is to
maintain the unit price as far as is possible whilst
reducing the size of the unit. This is termed
customary pricing”.
 Geographic Pricing
• Geographic considerations sometimes figure in pricing decisions.
• FOB Pricing
– FOB factory - purchasers pay all transportation costs
beyond the factory gates.
– FOB destination - the supplier meets all of the costs
incurred up to the point where the goods
are delivered to the customer.
– The disadvantage of FOB is that for more distant customers a
supplier operating the FOB factory pricing system will seem a
high cost source of supply. The buyer's problem is overcome if
the supplier applies FOB destination pricing, but the supplier's
profit margin can be eroded to a substantial extent.
 Geographic Pricing
• Uniform delivered pricing
– Uniform delivered pricing is the opposite of FOB pricing. The
selling price incorporates a freight charge never explicitly
identified as such to the buyer which is an average of total
freight costs.
– This system has the advantage that it is easy to administer and
the company can advertise its prices nationally.
– The disadvantage is that those customers situated in close
proximity to the manufacturer will find cheaper supplies from
other manufacturers in the locality offering FOB prices.
 Geographic Pricing
• Zone pricing
– Zone pricing falls between FOB origin pricing and
uniform delivered pricing.
– The company sets up a series of geographical zones.
All customers within a zone pay the same total price
and this price is higher in the more distant zones.
– This system can work well enough except that the
dividing line between zones has to be drawn
somewhere.
 Geographic Pricing

• Freight absorption pricing

– The seller who is anxious to do business with a
certain customer or geographical area might absorb
all or part of the transport cost in order to get the
business.
– The seller might reason that gaining more business
will result in lower average costs and that this will
more than compensate for the extra freight cost.
– Freight absorption pricing is useful in achieving
market penetration and also in holding on to
increasingly competitive markets.
 Administered prices

• Prices which are imposed on the market by

some external body!
Demand Forecasting
 Demand Forecasts -Forecasting methods
– Qualitative • Quantitative methods
• Personal opinion – Time series
• Panel consensus • Freehand method
• Delphi method • Smoothing methods
• Market research (rapid • Exponential smoothing
appraisal) methods
• Trend projection
• Historical comparison
methods
• Trend projection
adjusted for seasonal
influence
– Causal
• Linear regression model
 Demand Forecasts
• Analyzing components of price time series
– Usually little is known about why a time series
behaves so.
– Hence we approach it in terms of components
(Trend, Cycle, Seasonality, Random term)
– Trend is the broad long-term tendency of either
upward or downward movement in the average
value of the forecast variable (say y) over time. E.g.
Sale 1+2
 Demand Forecasts

– Cycles – An upward and downward oscillation of

uncertain duration and magnitude about the trend
line due to seasonal effect with fairly regular period
or long period with irregular swings is called a cycle.
E.g. Sale 2+3
• The movement is through four phases: from peak
(prosperity) to contraction (recession) to trough
(depression) to expansion (recovery or growth).
 Demand Forecasts
• Seasonal – is a special case of a cycle component of
time series in which the magnitude and duration of the
cycle do not vary but happen at a regular interval each
year.
– Sales in festival seasons.
• Irregular (random) – an irregular or erratic movement
in a time series is caused by a short-term unanticipated
and non-recurring factors. These follow no specific
pattern.
 Demand Forecasts

– Need to identify patterns of data representing a

variable and, based on identified patterns, need to
forecast future values of a variable
– Trend and seasonality are the two most common
patterns describing economic time series
– Likewise, time series analysis of agricultural prices
involve identification of trend and seasonality
behaviors.
 80 .0 0 Dot/Lines show Means

Linear Regression
70 .0 0

n=15
60 .0 0
sale2

sale2 = -258.90 + 0.16 * year1

50 .0 0
R-Square = 0.00

40 .0 0

19 92 19 96 20 00 20 04

year1