Price still remains one of the most important elements determining company market share and profitability. Generally, prices were set by buyers and sellers negotiating with each other. Setting one price for all buyers is a relatively modern idea. Price is the only element in the marketing mix that produces revenue. Price is also one of the most flexible elements of the marketing mix. At the same time, pricing and price competition are the number-one problems faced by many marketing executives. Yet many companies do not handle pricing well. The most common mistakes are these: Pricing is too cost oriented; price is not revised often enough to capitalize on market changes; price is set independent of the rest of the marketing mix rather than as an intrinsic element of market-positioning strategy; and price is not varied enough for different product items, market segments, and purchase occasions.
Pricing Decisions in Industrial Marketing
Companies handle pricing in a variety of ways. In small companies, prices are often set by top management rather than by marketing or salespeople. In large companies, pricing is typically handled by division and production managers. Top management sets the general pricing objective and policies and often approves the prices proposed by lower levels of management. In industries where pricing is a key factor (aerospace, railroads, oil companies), companies will often establish a pricing department to set prices or assist others in determining appropriate prices. This department reports either to the marketing department, finance department, or top management. Others who exert an influence on pricing include sales managers, production managers, finance managers, and accountants.
Now let us examine three questions:
- How should a price be set on a product or service for the first time?
- How should the price be adapted over time and space to meet varying circumstances and opportunities?
- When should the company initiate a price change, and how should it respond to a competitor’s price change?
Setting the Price
Pricing is a problem when a firm has to set a price for the first time. This happens when the firm develops or acquires a new product, when it introduces its regular product into a new distribution channel or geographical area, and when it enters bids on new contract work. The firm must decide where to position its product on quality and price. A company can position its product in the middle of the market or at three levels above or three levels below the middle.
Selecting the Pricing Objective
The company first has to decide what it wants to accomplish with the particular product. If the company has selected its target market and market positioning carefully, then its marketing-mix strategy, including price, will be fairly straightforward. For example, if a recreational-vehicle company wants to produce a luxurious truck camper for affluent customers, this implies charging a high price. Thus pricing strategy is largely determined by the prior decision on market positioning.
At the same time, the company might pursue additional objectives. The clearer a firm’s objectives, the easier it is to set price. Each possible price will have a different impact on such objectives as profits, sales revenue, and market share. A company can pursue any of six major objectives through its pricing.
- Maximum Current Profit
- Maximum Current Revenue
- Maximum Sales Growth
- Maximum Market Skimming
- Product-Quality Leadership
Factors Affecting Price Sensitivity
The demand curve shows the market’s purchase rate at alternative prices. It sums the reactions of many individuals who have different price sensitivities. The first step is to understand the factors that affect buyers’ sensitivity. Nagle has identified nine factors:
- Unique-Value Effect. Buyers are less price sensitive when the product is more unique.
- Substitute-Awareness Effect. Buyers are less price sensitive they are less aware of substitutes.
- Difficult-Comparison Effect. Buyers are less price sensitive with they cannot easily compare the quality of substitutes.
- Total-Expenditure Effect. Buyers are less price sensitive the lower the expenditure is to their income.
- End-Benefit Effect. Buyers are less price sensitive the lower the expenditure is to the total cost of the end product.
- Shared-Cost Effect. Buyers are less price sensitive when part of the cost is borne by another parry.
- Sunk-Investment Effect. Buyers are less price sensitive when the product is used in conjunction with assets previously bought.
- Price-Quality Effect. Buyers are Jess price sensitive when the product is assumed to have more quality, prestige, or exclusiveness.
- Inventory Effect. Buyers are less price sensitive when they cannot store the product.
Selection of Pricing Method
Given the three Cs—the customers demand schedule, the cost function, and competitors prices—the company is now ready to select a price. The price will be somewhere between one that is too low to produce a profit and one that is too high to produce any demand. Customers’ assessment of unique product features in the company’s offer establishes the ceiling price. Companies resolve the pricing issue by selecting a pricing method that includes one or more of these three considerations. The pricing methods will then lead to a specific price. We will examine the following price-setting methods: markup pricing, target-return pricing, perceived-value pricing, value pricing, going-rate pricing, and sealed-bid pricing.
- Markup Pricing. The most elementary pricing method is to add a standard markup to the product’s cost. Construction companies 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 their cost plus a specified markup; for example, aerospace companies price this way to the government. Markups are generally higher on seasonal items (to cover the risk of not selling), specialty items, slower moving items, items with high storage and handling costs, and demand-inelastic items. Does the use of standard markups to set prices make logical sense? Generally, no. Any pricing method that ignores current demand, perceived value, and competition is not likely to lead to the optimal price.
- Target-Return Pricing. The firm determines the price that would yield its target rate of return on investment (ROI). This pricing method is used by public utilities that are constrained to make a fair return on their investment.
- Perceived-Value Pricing. Companies are basing their price on the product’s perceived value. They see the buyers’ perceptions of value, not the seller’s cost, as the key to pricing. They use the non price variables in the marketing mix to build up perceived value in the buyers’ minds. Price is set to capture the perceived value. The key to perceived-value pricing is to accurately determine the market’s perception of the offer’s value. Sellers with an inflated view of their offer’s value will overprice their product. Sellers with an underestimated view will charge less than they could. Market research is needed to establish the market’s perception of value as a guide to effective pricing.
- Value Pricing. In recent years, several companies have adopted value pricing by which they charge a low price for a high-quality offering. Value pricing is not the same as perceived-value pricing. The latter is really a “more for more” pricing philosophy. It says that the company should price at a level that captures what the buyer thinks the product is worth. Value pricing, on the other hand, says that the price should represent an extraordinary bargain for consumers. Value pricing is not a matter of simply setting lower prices on one’s products compared to competitors. It is a matter of re-engineering the company’s operations to truly become the low-cost producer without sacrificing quality, and to lower one’s prices significantly in order to attract a large number of value-conscious customers.
- Going Rate Pricing. In going-rate pricing, the firm bases its price largely on competitors prices with less attention paid to its own cost or demand. The firm might charge the same, more, or less than its major competitor(s). 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 cost changes. Some firms may charge a slight premium or slight discount, but they preserve the amount of difference. Going-rate pricing is quite popular. Where costs are difficult to measure or competitive response is uncertain, firms feel that the going price represents a good solution. The going price is thought to reflect the industry’s collective wisdom as to the price that would yield a fair return and not jeopardize industrial harmony.
- Sealed Bid Pricing. Competitive-oriented pricing is common where firms bid for jobs. The firm bases its price on expectations of how competitors will price rather than on a rigid relation to the firm’s costs or demand. The firm wants to win the contract, and winning normally requires submitting a lower price than competitors. Yet the firm cannot set its price below a certain level. It cannot price below cost without worsening its position. On the other hand, the higher it sets its price above its costs, the lower its chance of getting the contract.