Chapter 9.

Designing Pricing Strategy.

Chapter 9.
DESIGNING PRICING STRATEGIES:

Price:

Sacrifice made by buyer to avail benefits provided by product.

Determine revenues that a firm generates in conjunction with units sold.

Firm needs to set price:

When it develops a New Product/ acquires New Product.
When it enters new distribution channel/ geographical area.
When it enters bid on new contractor.

Firm needs to decide product position based on:

Quality.
Price.

Based on these, strategies could be:

PRICE

LOW

PRODUCT
QUALITY
MEDIUM

ME
D
I
UM

H
I
GH

HIGH

MEDIUM

LOW

3. SUPER VALUE
STRATEGY

1. PREMIUM
STRATEGY

2. HIGH VALUE
STRATEGY

4. OVER
CHANGING
STRATEGY

5. MEDIUM
VALUE
STRATEGY

6. GOOD VALUE
STRATEGY

7. RIP OFF
STRATEGY

8. FALSE
ECONOMY
STRATEGY

9. ECONOMY
STRATEGY

Diagonal strategies 1/5/9 can co-exist in the same market.

Strategies 2/3/6 would attack the diagonal strategies.
Strategies 4/7/8 amount to over pricing product in relation to its quality. These are
avoidable.

To set pricing policy, firms need to consider various factors. Hence a formal procedure
is used for price setting.
Procedure is:
Select pricing Objectives.
Determine demand.
Estimate costs.
Analyse competition costs/prices/ offers.
Select pricing method.
Select final price.

Chapter 9.
Designing Pricing Strategy.

Selecting Pricing Objectives:

Company has to decide what it wants to accomplish with a particular product.
Objectives that could be pursued are:
Survival:
In this case prices are very low. Price covers Variable Cost & some Fixed Cost if
possible.
Occurs if:
o Company has over capacity.
o Company is intense.
o Consumer wants to keep changing.
Can be continued for short period.
Maximizing Current Profit:
Company tries to estimate demand/ cost associated with alternate pricing plans.
Price with maximum current profit/ cash flow/ return on investment.
Assumes forecast of demand/ cost is accurate.
Ignores effect of other marketing mix elements & competition reaction.
May sacrifice long term performance.
Maximizing Current Revenue:
Price set to maximum current revenue based on demand forecast for alternate prices.
Based on belief that revenue maximization will lead to:
Market share growth.
Long Run profit maximization.
Maximise Sales Growth (Market penetration pricing):
Example: Tide.
Assumes that market in price sensitive.
Hence, product priced at a level, where sales growth is highest. This would lead to
lower unit costs & higher long term profit.
Used when:
Market is price sensitive.
Production/Distribution costs decreases with accumulated production expenses.
Low price discourages actual/ potential competition.
Maximise Market Skimming:
Example: Nokia.
High price set to skim market.
Price lowered progressively to draw in market layer of customer in terms of purchasing
power.
With each price decrease features of product may/may not be reduced.
Used when:
Sufficient number of buyers has high current demand.
Cost/unit is not very for small volume as compared to large volume.
Initial high price does not attract competition.
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Chapter 9.
Designing Pricing Strategy.

High price communicates image of a superior product.

Product Quality Leadership:

A company may aim to be product leader in the market.
Create a high quality product.
Price it higher than competition.
Used for:
Premium product (FMCG: Dove).
Low maintenance in Consumer Durables (Compaq).
Determining Demand:
Price has a direct impact on demand & hence on other marketing objectives.
Price Elasticity of demand for a product needs to be understood/analysed.
Buyers price sensitivity may be impacted by:
Unique Value Effect:
Uniqueness of product.
Substitute Awareness Effect:
Knowledge of substitutes.
Difficult Comparison Effect:
Quality of substitutes not easy to compare.
Total Expenditure Effect:
Price as a % of monthly earnings.
End Benefits Effect:
If product is a part of a product benefits set, then the value/price
of a product as a % of full benefits.
Shared Cost Benefits:
Is the cost borne by another party?
Example: Bus travel/Motels on a business tour.
Sunk/Investment Effect:
Product used in conjunction with other assets already bought.
Example: Spare parts.
Price Quality Effect:
Does the product have more perceived quality/prestige?
Inventory effect:
Price sensitivity is low if the product cannot be stored by a buyer.
Example: Processed Cheese, Fruits.

Demand at various price levels can be estimated thru::

Time series analysis using past data/ trends.
Price based experimental research.
Causal marketing research.

Based on above, demand curves created to forecast demand.

Chapter 9.
Designing Pricing Strategy.

Estimating Costs:
Company costs set the floor price.
Costs should cover cost of
Manufacturing/production.
Distribution.
Selling products.
Return on Investment/ Risk.

Total cost = Fixed Cost (over-heads) + Variable Cost.

Costs needs to be estimated:
o At different levels of production.
o As a function of differentiated marketing segments/buyers.
o As a function of accumulated production/ experience.

Many companies may use target costing as a means of reducing costs to pre-planned
desired level.

Analysing Competitors Costs/ Prices / Offers:

Company needs to benchmarks its costs against its competition to learn whether it is
operating at a cost advantage/disadvantage.
Company also needs to learn about competitors price & quality of offers /product
offerings.
Information on competitors costs/ prices/ offers used to orient own products costs/
price /offers.
Selecting Pricing Method:
Once 3 Cs
Customer demand schedule,
Cost function,
Competitor price,
is ready, company is now ready to select price.
For this, first a pricing method is selected.
Pricing method could be:
Mark up price.
Targets return pricing.
Perceived value pricing.
Value pricing.
Going rate pricing.
Sealed bid pricing.
Mark Up Pricing:
Add standard mark up to product cost.
Example:
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Chapter 9.
Designing Pricing Strategy.
Variable cost/ unit
Fixed cost
Expected sales

= Rs.10/-.
= Rs. 2, 00,000/-.
= 40,000 units.

Unit cost

= Variable Cost + Fixed Cost/Sales.

= 10 + (2, 00,000/40,000).
= Rs. 15/-.
Suppose mark up price = 20%, i.e., (Desired return= 0.2).
Price = Unit Cost/ (1-desired return).
= 15/ (1-0.2).
= 18.75/-.
This is Net dealer price (NDP). To this trade margin are added to get final
customer price.
Target Return Price:
Price determined based on target Return on Investment.
Suppose target return = 20%.
Investments
= Rs. 2, 00,000/-.
Expected sales
= 40,000 units.
Units cost
= Rs. 15/-.
Target return price = Unit Cost + {(Target Rate) * (Investment)}/Expected Sales.
= 15 + (0.2 * 2, 00,000/-)/40,000.
= 16/-.
Perceived Value Pricing:
Used in the business analysis stages of new product development.
Buyers perception of value used as key to price product.
Product/ Place/ Promotion used to build up perceived value.
Procedure:
o Company develops product concept for a particular target market with
planned quality & price.
o Based on this sales volume is estimated along with sales plant capacity
/investment /unit costs are determined.
o Based on above, profits are estimated. If profits are satisfactory company
goes ahead with product, otherwise, it is dropped.
Value Pricing:
A comparatively low price is charged for a high quality product/ accepted product.
Used typically in mature markets, which, witnesses continuous Sale Offers.
Credibility erosion may be avoided using a low value price which is constant (No
discounts given).
For value pricing to succeed company may need to overhaul manufacturing/
distribution/ sales functions so that costs are minimized & the value price can be
sustained.
Example:
o NIITs Swift Program started with 2500/-@16hours course now coming at Rs.
500/- @8 hours plan which is value priced.

Chapter 9.
Designing Pricing Strategy.
o APtechs Vidya Program started with 2200/-@16hours course now coming at
Rs. 600/- @8 hours plan which is value priced.

Going Rate Pricing:

Here company pays attention to its own costs/ demand.
Price is based on competitions prices.
Company may charge more/ same/ less than competition.
This would depend on:
Product type.
Market leadership.

If product is not differentiable (as in commodities) price is lower/same as competitors.

If company is not the market leader, then its product may be lower than market leaders
price. Price charged would follow the leader.
Going rate pricing:
Reflects industry collection wisdom.
Maintains industrial harmony.

Sealed Bid Pricing:

Used for quoting against tenders.
Normally, in such cases, other things being equal, contract is awarded to lowest bidder.
Hence company should calculate its profits & probability of getting the order at various
prices.
A final price is the price with highest pay offs/ expected profit.
(Pay Off = Profit * Probability).
Selecting Final Price:
Pricing methods narrow the price range from which company must select its final price.
To select final price company should also consider:
Psychological Pricing:
A high price may convey higher quality to consumers (Customer perception).
Sales of certain products may increase with price decrease.
Example: Liquor/Perfumes.
Price may be kept high to serve as a reference point in customer mind. A discount may
give a customer a feeling of getting a good deal.
Odd pricing may give customer a feeling of lower prices.
Example: BATA: 199.95/-.
Influence of Other Marketing Mix Elements:

Chapter 9.
Designing Pricing Strategy.

Final price must take in account of products quality & advantage relative to
competition.
Brands with average relative quality & high relative advantage are normally able to
charge a premium. Customer, normally are willing to pay higher prices for known
products than for unknown products.
Brands with high relative quality & high relative advertising charges the highest price.
Brands with low relative quality & low relative advertising charge low prices.
High prices & high advertising are positively correlated especially for,

Mature products.

Market leaders.

Low cost products.

Companys Pricing Policy:

Products price should be consistent with companys pricing policies.
Price of others products also need to be seen in this content to position product suitably.
Impact of Prices on other Parties:
Company needs to consider impact of pricing on:
o Distributors/ Dealers.
o Sales Force.
o Competition.
o Suppliers to company.
o Government.
Adverse reactions should be minimized to extent possible.

Price Adaptation:

Typically, price set as per procedure seen above is the original product price & pricing
structure.
Real field situation is normally dynamic.
Variations may occur in:
o Geographical Demand/costs.
o Market Segment Requirements.
o Purchase Timings.
o Order levels/Delivery Frequency.
o Guarantees/Service Contracts.
As a result a company may need to adapt/change its final price from time to time.
This is called Price Adaptation.
Price adaptation strategy could be:
o Geographical pricing.
o Price Discounts & Allowances.
o Promotional Pricing.
o Discriminatory Pricing.
o Product Mix Pricing.

Geographical Pricing:
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Chapter 9.
Designing Pricing Strategy.

Typically occurs for exports/ imports/ international trade.

Manifest through counter trade.
Counter trade is the practice of making payment in part/ full through other items
instead of currency.
Counter trade could be in the form of:
Barter:
Exchange of goods.
No Money.
No third party involved.
Compensation Deals:
Sellers receive some % of payment in cash & the rest in
products.

Buyback Arrangements:
Seller sells capital goods (Plant/Equipments/Technology).
Buyer pays part of payment through products produced with
equipments purchased.
Balance in cash.
Offset:
Seller receives full payment in cash but agrees to spend part of
the money in buying goods from purchaser country within
stipulated time frame.
At times counter trade may involve more than 2 parties.

Price Discounts /Allowance:

Most companies modify their basic price to reward customer/ distributor for
Early Payment.
Volume purchases.
Off season buying.
While doing so, companies should be careful to make some profit out of resulting sale.
Producer

Distribution
Channel

Customer
Promotional Pricing

Price discounts/ allowances

(Pull Strategy)
(Push Strategy)

Price adjustments (Discounts/Allowances) could be:

Cash Discounts:
Cash Discount is a price reduction to buyers who pay their bills promptly.

I1

I2

I3
8

Chapter 9.
Designing Pricing Strategy.

Producer

C/F

Distributor Whole-seller

retailer

Consumer

2/10 met 30
Example: 2/10 met 30
Credit for 30 days.
2% discounts if bill cleared in 10 days.
Normally used with distributors/ retailers
I3 is selling goods worth Rs. 100 to R & discounts @ 2/10 met 30. In such cases R will borrow
money from a financer on 10th of the month. The maximum amount of interest which R will
pay the financer will be @ 36%
2% discounts = 20 days
1 day
= 2/20
30 days
= 2/20x 30
=3x12months = 36%
Benefits:
o Retailer will be able to pay money back to I3 at lower interest rates.
o In 10 days there will be some selling: Retailer has to pay interest on lesser
amount than whole of 100.
o This will result in additional generation of income just by going for this
arrangement.
Quantity Discounts:
Quantity Discount is a price reduction to buyers who buy large volumes.
Example:
Rs 25 per unit for up to 99 units.
Rs 23 per unit for 100-Plus units.
Quantity Discount should be offered equally to all customers.
Quantity Discounts amount normally should not exceed cost savings to seller as a
result of selling large quantities (cost savings includes reduced expense on selling
/inventory/ transportation).
Quantity Discount may be offered:
Non Cumulatively: On each order.
Cumulatively: On total order in a given period.
Functional Discounts (Trade Discounts):
Functional Discount is the trade margin offered by manufacturer to distributor/ Whole
Seller/ Retailer for performing functions.
Different channel may be offered diff discounts.
Seasonal Discounts:
Seasonal Discount is price reduction to buyers who buy out of season.
Seasonal Discount allows manufacturer to maintain steadier production schedules.
Allowances:
Other types of price reductions are called allowances.
Types could be:
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Chapter 9.
Designing Pricing Strategy.
o Trade in allowances:
Price reduction on new item in exchange for old item.
o Promotional allowances:
Payments/ price reductions to dealers/ distributions to reward them for
their participation in advertising/ sales promotion.
Promotional Pricing:
Promotional pricing techniques are used to stimulates early purchase.
Techniques could be:
Loss leader pricing:
Used by retailers to stimulate additional store traffic by dropping prices
on well known brands.
Special event pricing:
Special prices offered in certain seasons to draw-in most customers.
Cash Rebates:
Consumes offered cash rebates to encourage purchasing within specific
time period.
Often used to clear inventory without reducing list price.
Low interest financing:
Customers offered low interest financing instead of reducing price.
Longer payment terms:
Financial companies stretch their loans over longer periods to bring
down EMI.
As a result product becomes more affordable.
Warrants/ Service contracts:
Company tries to increase by adding on to warranty/ service contracts
terms either free/reduced cost.
Psychological Discounting:
Inflating product price & then discounting it.
May amount to RTB, hence care should be taken while doing this.

Promotional pricing may turn out to be a zero sum game:

If they work, competition will copy it & create a level playing field,
If they dont work, it wastes a lot of good money for the company. This
money could have been utilized for long term activities such as product
quality increases or increases product image.

Discriminating Pricing:
Companies may offer basic price modification to accomplish difference in customer/
products/ locations.
Discount Pricing /price discount occurs when a company sells a product/ service at a
different prices that do not reflect proportional difference in cost.
Forms of Discriminating Pricing could be:
o Customer Segment Pricing:
Different prices to different customer groups.
Example:
Railways student concession, Senior citizen discounts.
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Chapter 9.
Designing Pricing Strategy.

Banks: Higher % interests for Senior citizen fixed deposits.

o Product Form Pricing:
Different versions of a product are priced differently, but not in
proportion to their costs.
Example: Surf: 1Kg pack/ Sachet.
o Image Pricing:
Same /similar product priced at different levels based on image
difference/ branding.
Example: Clothes/ Wrist watches or Company: Videocon (Kenstar).
o Location Pricing:
Same product priced at different prices based on location even though
costs are the same.
Example: Movie theatre tickets.
o Time pricing:
Price varied as per:
Season.
Week days/Week-ends.
Time of the day (happy hours).
Could be in the form of yield pricing as used by Hotels/ Cruise Ships/
Airline (Air India red).
Red Hour: When there is a hopping flight for Mumbai-Delhi-London,
then the tickets is available for much lower prices for passengers
traveling to Delhi.
For Discriminating Pricing to be successful, conditions are:
Market should be segmentable.
Segment should show different demand intensities.
Members of lower segment should not be able to resell product to higher price
segment.
Competition should not be able to undersell firm higher price segment.
Example: Tide slashed price.
Cost of segmenting & monitoring market should not exceed profits from extra
revenue.
It should not result in customer resentment/ ill-will.
It should not be illegal.

Product Mix Pricing:

Price setting logic needs to be modified when the product is part of a product mix.
In such a situation, firm searches for a price that would maximize profits on total
product mix.
In addition to normal pricing procedure, we need to take into account:
Demand of various products, in product mix.
Their cost inter-relationships.
Competition for each product.

Product mix pricing based on above could be:

Product Line Pricing.
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Chapter 9.
Designing Pricing Strategy.

Optional Feature Pricing.

Capture Product Pricing.
Two Part Pricing.
By-Product Pricing.
Product Bundling Pricing.

Product Line Pricing:

Normally companies have a product line rather than single products.
Pricing starts with the most basic product at the lowest level. As we go up the product
line featured & other differentiators get added to the product.
Difference in price from one product to the next level is called a price step.
H LL

DOVE

PRICE STEP

LUX/LIRIL

LIFEBUOY

The value/amount of price step needs to be planned carefully.

If the step is small, customer may prefer higher product.
If price step is large, customer may prefer lower product.
Price step is based on:
Customer differences between the two products
Customer evaluation of the differences.
Competition prices.
If price step is larger than cost, company benefits when customer buys higher products.
Example: Cambridge shirts/ trousers.
Cambridge.
Cambridge gold.
Cambridge classic.
Cambridge premium.
Sellers task is to establish perceived quality difference that justify price difference

Optional Feature Pricing:

Company differentiates optional products/ features along with normal product.
Example:
Car
Options could be:
o Choice of music system.
o Interiors.
Motorcycle
Options could be:
o Disk brakes.
o SP Styling.
o Accessories.
Optional pricing provides customer flexibility to own product to a certain extent.

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Chapter 9.
Designing Pricing Strategy.

Company may charge a premium of optional features which customer may not mind
paying.

Captive Product Pricing:

Some products may require the use of captive pricing.
o Example:
Razor needs Razor blades.
Camera needs film.
Company making both may price the durable product low & the consumable product
on the higher side with good quality.
However if consumable (after market) is priced too high, it may lead to piracy.
o Example: Automobile spare parts of Bajaj Auto Limited scooters.
Two Part Pricing:
Company may engage in two- part pricing, i.e., a fixed fee for a product plus a variable
usage fee.
E.g.
Reliance Infocom (Mobile).
Appu ghar /Essel world entry fee + Rides.
Fixed fee kept low to induce purchase.
Profits earned through usage fee.
By Product Pricing:
Production of certain goods may result in by-product.
o Example: Petroleum/Chemicals.
If by-product has value to a customer group, it may be priced as per perceived value.
Income on by-product may help company to face price competition in main product
category better.
Example: Al Kabeers
o Meat products (main products).
o Skins (by-products) sold to leather producers.
Product Bundle Pricing:
Seller may bundle their products at a set price.
o Example:
Restaurant
: Thali.
Publisher
:
Combinations
of
magazines.
Set of text books for a specific class school.
A customer may not want full bundle. In such cases, a seller may agree to un-bundle
the offering but would ensure profit optimization in the product.

Setting Objective.
Determining Demand.
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Chapter 9.
Designing Pricing Strategy.
Price Setting

Estimating Costs.
Analyse Competition.
Select Pricing Method.
Select Final Price.
Barter.
Compensation.
Buyback arrangements.
Offset.

Price Adaptation

Geographical demand
Market segment
Purchase Timing.
Order levels/ Delivery frequency.
Guarantees/ Service Contracts.

Initiate Price Change.

React/ Respond to price changes.

Initiating Price Changes:

Price changes could be:
Price cut.
Price increases.
Implications of both need to be understood before actual action is taken.
Price Cuts:
Price cuts may be required due to:
Excess plant capacity.
Declining market share.
Effort to dominate market through lower costs.
Economic Recession.

While cutting price, company needs to assess following risks:

Low quality perception:
Customer may feel product is inferior in quality.
Fragile Market share:

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Chapter 9.
Designing Pricing Strategy.

Market share may increase temporarily, but customer loyalty

may not be there. If competition introduces lower priced product,
customer may shift.
Sustainability:
If the price cut triggers a price war in the industry, only those
companies with deep cash reserves will last.

Price Increases:
A successful price increase can increase profits considerably.
Example:
Product price
= Rs. 20/-.
Profit
= Rs. 2/-.
10% price increase = Rs. 22/-., Results in 100% profits increase.
(Other things remaining the same).
Price increases may be due to:
Cost Inflation.
Anticipatory Pricing (in anticipation of change in environment/
government policy).
Over Demand.
While increasing prices, company should be careful not to disturb its market
share/customer. Hence company may use various ways to increase price/increase
profits.
Some of the methods could be:
o Decrease amount of the product instead of increasing price.
Example: In sachets there is 8ml shampoo instead of 10ml.
o Substituting ingredients with less expansion.
Example: Cadburys 5 star bar (Rs. 2 uses artificial coco powder)
o Remove product features in standardised product, offer them as options. Also
applicable to services offered.
Example: Maruti LX, VX.
o Decrease cost of package material.
Example: Vegetable oil comes in jar & sachets.
o Decrease discounts.
Example: Discount on any Product.
o For long term contracts, use price evaluation clauses.
Example: Software services or maintenance.
o Reduce number of sizes/depth of product.
Example:
Lux:

20gms
75gms
175gms

Profit @ 1/unit
Total Production
Profit

20 units
20 units
20 units

= 60 units.
= Rs. 2.5/unit.

o Create new economy Brands

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Chapter 9.
Designing Pricing Strategy.
Example: When SURF had to compete in the market, they introduced
RIN so that they can increase SURFs prices.
o Increase prices in stages in small amounts rather than one big jump
Example: Petrol & Diesel Govt. is increasing the prices slowly

Responding to Competitors Price Change:

If competition changes its price, company may need to give suitable response.
Responses would vary depending on homogeneity of product market.
Homogenous Product Market (How product differentiates?)
If competition cuts price, firms may have very little choice but to reduce its own
price.
o Example: Commodities.
If competition increases price, company may /may not follow. If the industry as a
whole benefits, then it is advisable to increase price.
Non Homogenous Product Markets:
Due to presence of differentiators, buyers may not be very sensitive to minor price
change.
Before reacting companies needs to understand reasons for competitors price change.
If competitor has decreased its price, reasons could be:
Increased market share.
Over capacity.
Change in its cost structure.
Lead an industry wide price change.
Also, companies needs to analyse whether price change is permanent or temporary.
Further, if company does not respond, what would have happened to its market
share /profits.

Based on analysis, options for response could be:

o Reduce Price:
Reasons for this could be:

Otherwise it would lose market share.

It would be hard to rebuild market share.

It costs may reduce with volume.

o Raise Perceived Quality:

Maintain price but improve its products/service

communication (Advertisements).
o Improve quality & raise prices with new brand:

Raise price of product & increase product quality with a new

brand to create smaller market segment.

This may reduce volumes for competition which may make

competition unviable.
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Chapter 9.
Designing Pricing Strategy.
o Launch New Low Price Product(Fighter Line):

Create new low price brand, especially low end customer is

price sensitive.

Example: HLL introduced WHEEL as a fighter product to

protect SURF from NIRMA.
o Maintain price:

This is done if company believes that it:

It would lose too much profit if it decreases price.
May not lose too much market share.
Even if it does lose some market share, this loss can be
regained easily.

Similar analysis and responses are created when competition increases price.

17