Pricing Objectives; Pricing Methods & Pricing Variables

What is Pricing?

Pricing can be defined as the process whereby a business sets the price to sell its products and services and may be part of the business’s marketing plan. It is a process of determining the value that a manufacturer/service provider will receive in exchanging services and goods.

Why is pricing difficult if any of you have tried to price the product? You know that there are many issues to consider, and often you don’t have all the information that could help you make a good decision?

Setting Pricing Objectives

You need to have some objectives in mind when setting prices. Some examples are

• Maximizing Profit,
• Maximizing Sales Or
• Revenue Maximizing Number of Units Sold
• Just Survival.

Maximizing Profit

In most cases, the desire for profits results in higher prices, and the firm retains more of the customer value. The profit-maximizing price can be developed mathematically if both the demand and the cost curves are known.

In most cases, they aren’t, and profit maximization is a general rather than mathematically rigorous objective. Profit maximization is appropriate when the segments you are trying to sell into are insensitive to the price increase.

There is low competition, and what competitive products there are highly differentiated, and customers know your brand and are very loyal to it. It is called skimming prices.

Objective to Maximize Revenue

Price Strategies, to maximize revenue, usually focus on setting a price that maximizes the sales volume, usually resulting in lower prices than maximizing profit objective.

To determine the revenue-maximizing price, one only considers the demand curve. Costs are not considered. How will many units at the higher price bring in the most revenue?

This often correlates to a penetration pricing strategy like profit maximization, and this objective has its roots in economic modeling like profit maximization.

We do not often have the data required to model the cost or demand curves exactly.

So, we make some judgments about the objectives of our pricing strategies. These objectives are often determined by answering the big question.

Why are we selling this product in the marketplace?

One key point is that, in general, to maximize revenue, objective results in a lower price than one intended to maximize profit.

Maximizing the Number of Units Sold

It often correlates to volume sales. Sometimes this is needed to maximize efficiencies in the manufacturing plant.

In this case, the customers may be price-sensitive, and a lower price discourages competition to enter or gain market share. Also, with typically a lower price than the other two objectives we have discussed, the company can absorb lower margins, at least in the short run.

Survival Objective.

Hopefully, this doesn’t happen often, but in the overall view, it may be an inappropriate short term objective when conditions warrant, competition is intense or demand is weak. You are just trying to hold on until the next generation product comes to market or there may be a glut of product in the market.

During the telecommunications market collapse in the late 19 nineties, many companies were faced with a survival objective.

Massive overcapacity in many telecommunications equipments existed for many years, and it took quite some time to recover from that.

Some companies never did recover and went out of business or were purchased by a competitor.

There may be secondary pricing objectives that also will influence pricing strategies. Some of them include supporting your channel partners that provide value to your customers also. Or you need to align with other products in your product line so that you are seen as a full-service provider or a change in your product brand or company.

Pricing Methods

Market-Based Pricing

Several methods can be used to set prices of products in market-based pricing. Products are priced based on customer benefits relative to the competition, which is the basic value concept.

There are two approaches to this approach. Economic Based Pricing and Value-Based Pricing

Economic value pricing

Economic value pricing is a quantitative analysis that compares the total cost of ownership of one product relative to the competition. It’s best applied when the cost of a competitive product or process can be compared directly to the new alternative.

Many businesses to business products can be priced using this economic value Pricing.

Value-Based Pricing

The sales guidance that results from economic value pricing is sometimes known as value-based pricing, customer value-based pricing, or perceived value pricing.

It is often used when it is difficult to quantify the economic benefit, and the customer holds perceptions about the product quality service, the company, the brand reliability, etcetera.

The economic value price might be the price of a Ford Focus versus a Tesla sports car’s value base price.

Most consumers have dealt with competitive pricing. Sometimes the store brand in a grocery store is side by side on the shelf with the known brand.

Cost-Based Pricing

Cost-based pricing is at least to some extent a common pricing approach. The most common application of cost-based pricing is cost-plus pricing.  How much does it cost to make this product?  How much profit do we want, and then you price the product based on knowledge?

There is a big question about how sensitive customers are to price.

If we raise the price by 5%, will we lose some of our customers? Or, if we drop our price, 3%? Will we pick up any more customers, or will they buy more? Because we lowered the price?

How much is too much, and how much of a drop in price makes a difference? The answer is, it all depends. It depends on many variables, including  Price Elasticity.

Pricing Variables

Price Elasticity

Price elasticity (E) is the responsiveness of customer demand to changes in the product’s price. When demand is elastic, the percentage change in demand is greater than the percent change in price, like sales, increased 5% when prices reduced by 3%.

Think of medicine’s cost if it is lifesaving and there is only one drug on the market.  A price increase may not make much difference.

The purchasers are insensitive to the increase or inelastic.

But we see changes in gasoline prices each day, and even a penny or two price increase might drive customers to another gas station down the street, which is one or two cents cheaper.

People are sensitive to the price increase or elastic.

How to Calculate Price Elasticity Of Demand

The boundary between elastic demand and any elastic demand is defined to be negative 1.0. At this point, the percentage change in demand is equal to the percentage change in price.

Consider a 5% decrease in price, resulting in a 5% increase in demand. That’s what this equation refers to.

E is equal to a 2.5 increase in demand, divided by a negative 0.5 decrease in price, equal to a negative one point elasticity.

In essentially all cases, elasticity is bound by an upper value of zero.

That is, products with an elasticity greater than zero are very rare. The difficulty and calculating the elasticity of demand is very difficult.

More experience and time in the market, with rising prices and lowering prices certainly help.

What elastic product could you imagine that would have an elasticity close to zero. If we could market the air we breathe, its elasticity may approach zero.

No matter how much we decide to charge, demand would likely remain relatively constant on a personal basis. Pharmaceuticals that can save your life may approach zero elasticity.

Can you imagine a situation where price elasticity is greater than zero? For some reason, there are several examples from the liquor industry.

For example, several years ago, Shiner Bock Beer in Texas was perceived as a low-quality beer.

Shiner raised the price significantly without any major marketing or product changes, and demand went up as the beer was now perceived to be more premium. Shiner has now achieved what some might call cult status in Texas.

Importance of Elasticity of Demand

This is a good reason that companies work so hard to create new products and features that are new, unique, or very differentiated.

Obviously, knowing our products’ price elasticity is key to maximizing market share, unit sales, sales revenue, and profitability.

But we also know that not many businesses have actually measured price elasticity.

Why is this? It’s too hard to do.

Approaches to Determining Price Elasticity.

The quasi and controlled experimental approaches refer to market research techniques used to determine elasticity.

Many companies use managerial judgment and analysis of previous sales data, which is more readily available.

Product Line Pricing

Product line pricing can be defined as setting prices for all items in a product line involving the lowest-priced product price, the highest price product, and price differentials for all other products in the line.

When considering the price of a new product, the new product and its price will likely impact perceptions about existing products and vice versa.

Considerations of where it fits in the product line will help with deciding its price, and in the absence of any other information, customers will determine quality levels from the price differences in the product line.

A macro look at your product line will need to be undertaken in pricing.

The new product, a new version of a phone, may have more features and a better-quality screen than the rest of the existing product line.

The marketer needs to know from the market research how much the customers value those features and how much more they’re willing to pay for those features versus a phone without those features.

Understanding the market, the customers, the cost of making the product and the prophet needed, and what the customers are willing to pay for these new features and what the competition is doing is information that the marketer must have to price the product correctly.

Creating a price for a new product is not easy, and it’s not for the faint of heart