CHAPTER SIX

PRICING STRATEGY

6.1 INTRODUCTION
All profit and nonprofit organizations must set prices on their products and services. Price goes
by many names (rent, tuition, fee, fare, rate, interest, and etcetera). Price is the amount of money
charged for a product or service or the sum of the values that consumers exchange for the
benefits of having or using the product or service. Historically, price has been the major factor
affecting buyer choice. Recently, however, non price factors have become increasingly important
in buyer-choice behavior. It should be remembered that price is the only element in the
marketing mix that produces revenue; all other elements represent costs. Price is also one of the
most flexible of elements of the marketing mix. It has been stated that pricing and price
competition is the number-one problem facing many marketing executives.
6.2 MEANING OF PRICE

Price is the amount of money charged for a product or service or it is the sum of the values that
consumers exchange for the benefit of using the product/service. Therefore pricing represents the
value of a good or service for both the seller and buyers. From business point of view pricing is
important because it is the only revenue generating elements of a marketing mix, others consume
resource and it is also one of the most flexible elements: It can be changed quickly.
Simply, price is the amount of money and/or other items with utility needed to acquire a product.
Utility is an attribute that has the potential to satisfy wants. Price is significant to the economy, to
an individual firm and in the consumer's mind.
6.3 PRICE AND NON-PRICE COMPETITION

Competition between marketers to attract customers and generate income is made in different
ways, which can be broadly categorized into price and non-price competition.

a) Price competition – Here sellers influence demand of the purchaser primary through
changes in price level. Sellers move along a demand curve by raising or lowering their
prices. Price competition is a flexible tool because price can be adjusted quickly and

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 easily. However, of all the controllable marketing variables pricing strategy is the easiest
for competitors to duplicate i.e. competitors can have the flexibility to adjust their prices.
b) Non-price competition – Emphasizing on factors other than price in relation to
competitors product occurs when the sellers decides not to focus on price and use other
factors to distinguish their product from competitors offer. It includes quality, delivery
service, unique feature etc. Even though this competitive tool is challenging and difficult
to adapt, it helps the firm to develop ‘good will’
6.4 FACTORS TO CONSIDER WHEN SETTING PRICES

A company’s pricing decision is affected by both internal company factors and external
environmental factors. In the next part of this unit these factors will be discussed in detail.
6.4.1. Internal Factors Affecting Pricing Decision
Internal factors affecting pricing include the company's marketing objectives, marketing mix
strategy, and costs.
I. Marketing Objectives
Before setting price, the company must decide on its strategy for the product. If the company has
selected its target market and positioning carefully, then its marketing mix strategy, including
price, will be fairly straightforward. The clearer a firm is about its objectives, the easier it is to
set price. Examples of common objectives are survival, current profit maximization, market
share leadership, and product quality leadership.
Companies set survival as their major objective if they are troubled by too much capacity, heavy
competition, or changing customers’ wants. To keep a plant going, a company may set a low
price, hoping to increase demand. In this case, profits are less important than survival. As long as
their prices cover variable costs and some fixed costs, they can stay in business. However,
survival is only a short-term objective. In the long run, the firm must learn how to add value that
consumers will pay for or face extinction.
Many companies use current profit maximization as their pricing goal. They estimate what
demand and costs will be at different prices and choose the price that will produce the maximum
current profit, cash flow, or return on investment. In all cases, the company wants current
financial results rather than long-run performance. Other companies want to obtain market
share leadership. They believe that the company with the largest market share will enjoy the

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lowest costs and highest long-run profit. To become the market share leader, these firms set
prices as low as possible.
A company might decide that it wants to achieve product quality leadership. This normally
calls for charging a high price to cover higher performance quality and the high cost of R&D. A
company might also use price to attain other, more specific objectives. It can set prices low to
prevent competition from entering the market or set prices at competitors' levels to stabilize the
market. Prices can be set to keep the loyalty and support of resellers or to avoid government
intervention. Prices can be reduced temporarily to create excitement for a product or to draw
more customers into a retail store. One product may be priced to help the sales of other products
in the company's line. Thus, pricing may play an important role in helping to accomplish the
company's objectives at many levels.
II. Costs
Costs set the floor for the price that the company can charge for its product. The company wants
to charge a price that both covers all its costs for producing, distributing, and selling the product
and delivers a fair rate of return for its effort and risk. A company's costs may be an important
element in its pricing strategy. Companies with lower costs can set lower prices that result in
greater sales and profits.
 Types of Costs
A company's costs take two forms, fixed and variable. Fixed costs (also known as overhead) are
costs that do not vary with production or sales level. For example, a company must pay each
month's bills for rent, heat, interest, and executive salaries, whatever the company's output.
Variable costs vary directly with the level of production. Each personal computer produced
involves a cost of computer chips, wires, plastic, packaging, and other inputs. These costs tend to
be the same for each unit produced. They are called variable because their total varies with the
number of units produced. Total costs are the sum of the fixed and variable costs for any given
level of production. Management wants to charge a price that will at least cover the total
production costs at a given level of production. The company must watch its costs carefully. If it
costs the company more than competitors to produce and sell its product, the company will have
to charge a higher price or make less profit, putting it at a competitive disadvantage.

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III. Marketing Mix Strategy
Price is the only marketing tool that the company uses to achieve its marketing objectives. Price
decision must be coordinated with product design, distribution and promotion decision to form a
consistent and effective marketing program. Decision made for other marketing mix elements
may affect pricing decision. For example, the decision to position the product on high quality
will mean that the seller must change higher price to cover its higher costs.
Thus, the marketer must consider the total marketing mix when setting prices. If the product is
positioned on non-price factors, then decision about other marketing mix tools will strongly
affect price. If price is a crucial positioning factor then price will strongly affect the decision of
other marketing mix elements.
6.4.2. External Factors Affecting Pricing Decisions
The external environmental factors, which affect pricing decision, are;
a) Demand
Whereas costs set the lower limit of prices, demand sets the upper limit. Both
consumer and industrial buyers balance the price of a product or service against the benefits of
owning it. Thus, before setting prices, the marketer must understand the relationship between
price and demand for its product.
The relationship between price and consumer purchase decision can be explained by the
economists’ law of demand which state that consumer usually buy more units at lower price and
less units at higher prices. Price elasticity can also be used to describe the influence of demand
on price decision. Price elasticity of demand is a measure of consumers’ price sensitivity and it is
estimated by dividing relative changes in the quantity sold by the relative price change.

Percentage change in quantity demand

e=
Percentage change in price

Although difficult to measure, there are two methods commonly used to estimate price elasticity.
First, price elasticity can be estimated from historical data. Second, price elasticity can be
estimated by sampling a group of consumers from the target market and polling them concerning
various price/quantity relationship.
relationship
There is less price sensitivity when:

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  The product is more distinctive,
 Buyers are less aware of substitutes,
 Buyers cannot easily compare the quality of substitutes,
 The expenditure is a lower part of buyer’s total income,
 The expenditure is small compared to the total cost of the end product,
 Part of the cost is borne by another party,
 The product is used in conjunction with assets previously bought,
 The product is assumed to have more quality, prestige, or exclusiveness, and
 Buyers cannot store the product.
b) Competition
The level of competition also affects pricing. Therefore in order to set or change prices, the firm
must consider its competition and how competition will react to the price of the product. Here
emphasis must be given by the firm for the following factors.
 Number and size of competitors.
 Location of competitors.
 Number of products sold by competitors.
 Cost structure of competitors.
 Past/previous reaction of competitors to price change.
These factors determine whether the firm’s selling price should be at, below, or above
competition. (Each of these pricing strategies will be discussed later under pricing strategy).
When setting prices, the company also must consider other factors in its external environment.
Economic conditions can have a strong impact on the firm's pricing strategies. Economic factors
such as boom or recession, inflation, and interest rates affect pricing decisions because they
affect both the costs of producing a product and consumer perceptions of the product's price and
value. The company must also consider what impact its prices will have on other parties in its
environment. How will resellers react to various prices? The company should set prices that give
resellers a fair profit, encourage their support, and help them to sell the product effectively.
3. Government Regulations
Prices of certain goods and services are regulated by state and federal governments. Public
utilities such as gasoline, taxi-fare are examples of state regulations of prices. Since most

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marketing managers are not trained as lawyers, they usually seek legal counsel when developing
pricing strategies to ensure conformity to state and federal legislations.
6.5. GENERAL PRICING STRATEGIES
The price the company charges will be somewhere between one that is too low to produce a
profit and one that is too high to produce any demand. Product costs set a floor to the price;
consumer perceptions of the product's value set the ceiling. The company must consider
competitors' prices and other external and internal factors to find the best price between these
two extremes. Companies set prices by selecting a general pricing approach that includes one or
more of three sets of factors. We examine these approaches: the cost-based approach (cost-plus
pricing, break-even analysis, and target profit pricing); the buyer based approach (value-based
pricing); and the competition-based approach (going-rate and sealed-bid pricing)
a) Cost-Based Pricing
Cost-Plus Pricing (Mark Up Pricing)
The simplest pricing method is cost-plus pricing—adding a standard markup to the cost of the
product. Construction companies, for example, submit job bids by estimating the total project
cost and adding a standard markup for profit. Lawyers, accountants, and other professionals
typically price by adding a standard markup to their costs. Some sellers tell their customers they
will charge cost plus a specified markup; for example, aerospace companies price this way to the
government. To illustrate markup pricing, suppose any manufacturer had the following costs and
expected sales: Then the manufacturer's cost per toaster is given by:
Unit Cost = variable Cost + Fixed Cost
Unit sales
The manufacturer's markup price is given by: Markup Price = Unit Cost
(1-desired return on sale)
Suppose a toaster manufacturer has the following costs and sales expectations:
Variable costs per unit $10
Fixed cost $ 300,000
Expected unit sales 50,000
The manufacturer’s unit cost is given by:
Unit Cost = variable Cost + Fixed Cost = $10 +$300.000 = $ 16
Unit sales 50,000

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Assume the manufacturer wants to earn a 20 % markup on sales. The manufacturer’s markup
pricing is given by:
Markup Price = Unit Cost = $16 =$ 20
(1- desired return on sale) 1 – 0.2
The manufacturer would charge dealers $20 per toaster and make a profit of $4 per unit.
Markup pricing works only if that price actually brings in the expected level of sales.
Break-even Analysis and Target Return Pricing
Another cost-oriented pricing approach is break-even pricing or a variation called target profit
pricing the firm tries to determine the price at which it will break even or make the target profit it
is seeking. This pricing method is also used by public utilities, which are constrained to make a
fair return on their investment. Target pricing uses the concept of a break-even chart, which
shows the total cost and total revenue expected at different sales volume levels.
Fixed costs are same regardless of sales volume. Variable costs are added to fixed costs to form
total costs, which rise with volume. The total revenue curve starts at zero and rises with each unit
sold.
Suppose the toaster manufacturer has invested $1 million in the business and wants to set a price
to earn a 20 percent ROI, specifically $200,000. The target-return price is given by the following
formula:
Target-return price = unit cost + desired return x invested capital
Unit sales

= $16 + .20 X $1.000.000 = $20

50,000
Break-even Volume = Fixed Cost
Price - Variable Cost
Break-even volume = Fixed cost = $300,000= 30,000
(Price - variable cost) $20-$10
The manufacturer should consider different prices and estimate break-even volumes, probable
demand, and profits for each.

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b) Value-Based Pricing
An increasing number of companies are basing their prices on the product's perceived value.
Value-based pricing uses buyers' perceptions of value, not the seller's cost, as the key to pricing.
Value-based pricing means that the marketer cannot design a product and marketing program
and then set the price. Price is considered along with the other marketing mix variables before
the marketing program is set.
Cost-based versus value-based pricing
Cost-based pricing is product driven. The company designs what it considers to be a good
product, totals the costs of making the product, and sets a price that covers costs plus a target
profit. Marketing must then convince buyers that the product's value at that price justifies its
purchase. If the price turns out to be too high, the company must settle for lower markups or
lower sales, both resulting in disappointing profits.
Value-based pricing reverses this process. The company sets its target price based on customer
perceptions of the product value. The targeted value and price then drive decisions about product
design and what costs can be incurred. As a result, pricing begins with analyzing consumer needs
and value perceptions, and price is set to match consumers' perceived value.
A company using value-based pricing must find out what value buyers assign to different
competitive offers. However, measuring perceived value could be difficult. Sometimes,

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consumers are asked how much they would pay for a basic product and for each benefit added to
the offer. Or a company might conduct experiments to test the perceived value of different
product offers. If the seller charges more than the buyers' perceived value, the company's sales
will suffer. Many companies overprice their products, and their products sell poorly, other
companies under price. Under priced products sell very well, but they produce less revenue than
they would have if price were raised to the perceived-value level.
c) Competition-Based Pricing
Consumers will base their judgments of a product's value on the prices that competitors charge
for similar products. One form of competition-based pricing is going-rate pricing, in which a
firm bases its price largely on competitors' prices, with less attention paid to its own costs or to
demand. The firm might charge the same, more, or less than its major competitors. In
oligopolistic industries that sell a commodity such as steel, paper, or fertilizer, firms normally
charge the same price. The smaller firms follow the leader: They change their prices when the
market leader's prices change, rather than when their own demand or costs change. Some firms
may charge a bit more or less, but they hold the amount of difference constant.
Thus, minor gasoline retailers usually charge a few cents less than the major oil companies,
without letting the difference increase or decrease. Going-rate pricing is quite popular. When
demand elasticity is hard to measure, firms feel that the going price represents the collective
wisdom of the industry concerning the price that will yield a fair return. They also feel that
holding to the going price will prevent harmful price wars. Competition-based pricing is also
used when firms bid for jobs. Using sealed-bid pricing, a firm bases its price on how it thinks
competitors will price rather than on its own costs or on the demand. The firm wants to win a
contract, and winning the contract requires pricing less than other firms. Yet the firm cannot set
its price below a certain level. It cannot price below cost without harming its position. In
contrast, the higher the company sets its price above its costs, the lower its chance
of getting the contract.
Pricing decisions are subject to an incredibly complex array of environmental and competitive
forces. A company sets not a single price, but rather a pricing structure that covers different
items in its line. This pricing structure changes over time as products move through their life
cycles. The company adjusts product prices to reflect changes in costs and demand and to

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account for variations in buyers and situations. As the competitive environment changes, the
company considers when to initiate price changes and when to respond to them.
6.5 PRICING STRATEGY

I. New-Product Pricing Strategies

Pricing strategies usually change as the product passes through its life cycle. The introductory
stage is especially challenging. Companies bringing out a new product face the challenge of
setting prices for the first time. They can choose between two broad strategies: market-skimming
pricing and market penetration pricing.
a) Market-Skimming Pricing
Many companies that invent new products initially set high prices to "skim" revenues layer by
layer from the market. Intel is a prime user of this strategy, called market-skimming pricing.
Market skimming makes sense only under certain conditions. First, the product's quality and
image must support its higher price, and enough buyers must want the product at that price.
Second, competitors should not be able to enter the market easily and undercut the high price.
b) Market-Penetration Pricing
Rather than setting a high initial price to skim off small but profitable market segments, some
companies use market-penetration pricing. They set a low initial price in order to penetrate the
market quickly and deeply—to attract a large number of buyers quickly and win a large market
share. The high sales volume results in falling costs, allowing the company to cut its price even
further. Several conditions must be met for this low-price strategy to work. First, the market must
be highly price sensitive so that a low price produces more market growth. Second, production
and distribution costs must fall as sales volume increases. Finally, the low price must help keep
out the competition, and the penetration price must maintain its low-price position—otherwise,
the price advantage may be only temporary.
6.5.2 Pricing Strategies for Existing Products
When a company introduces a new product for itself but not for the market, it can take one of the
three strategies; pricing above the market, pricing below the market and market price.
a) Pricing above the market – This is when a firm sets a price to its product higher than
similar products sold by its competitors. If one uses price above the market the product

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 must be distinct or should have some unique features than competitor’s product in the
eyes of the consumer.
b) Pricing below the market – Marketers use this price when they plan to get profit by
increasing sales volume or when they are able to reduce cost per unit.
c) Market price – the price reflected the prevailing market, i.e. applying the price that is
currently charges by our competitors.
6.5.3. Product Mix Pricing Strategies
The strategy for setting a product's price often has to be changed when the product is part of a
product mix. In this case, the firm looks for a set of prices that maximizes the profits on the total
product mix. Pricing is difficult because the various products have related demand and costs and
face different degrees of competition. We now take a closer look at the five product mix pricing
situations
a) Product Line Pricing: Companies usually develop product lines rather than single products.
In product line pricing, management must decide on the price steps to set between the various
products in a line. The price steps should take into account cost differences between the products
in the line, customer evaluations of their different features, and competitors' prices. In many
industries, sellers use well-established price points for the products in their line. The seller's task
is to establish perceived quality differences that support the price differences.
b) Optional-Product Pricing: Many companies use optional-product pricing—offering to sell
optional or accessory products along with their main product. For example, a car buyer may
choose to order power windows, cruise control, and a CD changer. Pricing these options is a
sticky problem. Automobile companies have to decide which items to include in the base price
and which to offer as options. Until recent years, the economy model was stripped of so many
comforts and conveniences that most buyers rejected it.
c) Captive-Product Pricing: Companies that make products that must be used along with a
main product are using captive product pricing. Examples of captive products are razor blades,
camera film, video games, and computer software. Producers of the main products (razors,
cameras, video game consoles, and computers) often price them low and set high markups on the
supplies. Thus, camera manufactures price its cameras low because they make its money on the
film it sells.

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In the case of services, this strategy is called two-part pricing. The price of the service is broken
into a fixed fee plus a variable usage rate. Thus, a telephone company charges a monthly rate—
the fixed fee—plus charges for calls beyond some minimum number—the variable usage rate.
Amusement parks charge admission plus fees for food, midway attractions, and rides over a
minimum. The service firm must decide how much to charge for the basic service and how much
for the variable usage. The fixed amount should be low enough to induce usage of the service;
profit can be made on the variable fees.
d) Product Bundle Pricing: Using product bundle pricing, sellers often combine several of their
products and offer the bundle at a reduced price. Thus, theaters and sports teams sell season
tickets at less than the cost of single tickets; hotels sell specially priced packages that include
room, meals, and entertainment; computer makers include attractive software packages with their
personal computers. Price bundling can promote the sales of products consumers might not
otherwise buy, but the combined price must be low enough to get them to buy the bundle.
6.6. PRICE ADJUSTMENT STRATEGIES
Companies usually adjust their basic prices to account for various customer differences and
changing situations. These are: discount and allowance pricing, segmented pricing,
psychological pricing, promotional pricing and geographical pricing.
I. Discount and Allowance Pricing
Most companies adjust their basic price to reward customers for certain responses, such as early
payment of bills, volume purchases, and off-season buying. These price adjustments—called
discounts and allowances—can take many forms.
 A cash discount is a price reduction to buyers who pay their bills promptly. A typical
example is "2/10, net 30," which means that although payment is due within 30 days, the
buyer can deduct 2 percent if the bill is paid within 10 days.
 A quantity discount is a price reduction to buyers who buy large volumes. A typical
example might be "Rs10 per unit for less than 100 units, Rs9 per unit for 100 or more
units." By law, quantity discounts must be offered equally to all customers.
 A functional discount (also called a trade discount) is offered by the seller to trade
channel members who perform certain functions, such as selling, storing, and record

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 keeping. A seasonal discount is a price reduction to buyers who buy merchandise or
services out of season.
Allowances are another type of reduction from the list price. For example, trade-in allowances
are price reductions given for turning in an old item when buying a new one. Trade-in
allowances are most common in the automobile industry but are also given for other durable
goods. Promotional allowances are payments or price reductions to reward dealers for
participating in advertising and sales support programs.
II. Segmented/discriminatory Pricing
Companies will often adjust their basic prices to allow for differences in customers, products,
and locations. In segmented pricing, the company sells a product or service at two or more
prices, even though the difference in prices is not based on differences in costs.
 Under customer-segment pricing, different customers pay different prices for the same
product or service. Museums, for example, will charge a lower admission for students
and senior citizens.
 Under product-form pricing, different versions of the product are priced differently but
not according to differences in their costs.
 Using location pricing, a company charges different prices for different locations, even
though the cost of offering at each location is the same. For instance, theaters vary their
seat prices because of audience preferences for certain locations.
 Finally, using time pricing, a firm varies its price by the season, the month, the day, and
even the hour. Public utilities vary their prices to commercial users by time of day and
weekend versus weekday. The telephone company offers lower off-peak charges, and
resorts give seasonal discounts.
For segmented pricing to be an effective strategy, certain conditions must exist.
 The market must be segmentable, and the segments must show different degrees of
demand.
 Members of the segment paying the lower price should not be able to turn around and
resell the product to the segment paying the higher price.
 Competitors should not be able to undersell the firm in the segment being charged the
higher price.

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  Nor should the costs of segmenting and watching the market exceed the extra revenue
obtained from the price difference.
 Of course, the segmented pricing must also be legal.
III.Psychological Pricing
Price says something about the product. For example, many consumers use price to judge
quality. For example, one study of the relationship between price and quality perceptions of
cars found that consumers perceive higher-priced cars as having higher quality.
When consumers can judge the quality of a product by examining it or by calling on past
experience with it, they use price less to judge quality. When consumers cannot judge quality
because they lack the information or skill, price becomes an important quality signal.
IV. Promotional pricing
Smart marketers recognize that promotional-pricing strategies are often a zero-sum game. If
they work, competitors copy them and they lose their effectiveness. If they do not work, they
waste company money that could have been put into longer impact marketing tools, such as
building up product quality and service or strengthening product image through advertising.
 Loss-leader pricing: Stores drop the price on well known brands to stimulate
additional store traffic.
 Special-event pricing: Sellers establish special prices in certain seasons to draw in
more customers.
 Warranties and service contracts: Companies can promote sales by adding a free or
low-cost warranty or service contract.
 Psychological discounting: Used legitimately, this involves offering the item at
substantial savings from the normal price. “Was $359, now $299.”
 Longer payment terms: Sellers stretch loans over longer periods and thus lower the
monthly payments that customers pay.

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