Pricing by Geoff Lancaster©
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1 The importance of pricing
Price is the means whereby an organisation covers the costs of its research, manufacturing, marketing and other activities and in a profit making organisation, the surplus is profit. Price is also important in ‘not for profit’ organisations where services or products are sold or dispensed. Here, the organisation must work within budget constraints so any revenues that might be accrued from the sale or dispensation of services must be within the constraints of the agreed budget. Organisational goals and objectives are determined through market conditions, so price is a function of such conditions. These organisational objectives are sometimes compromised by the realisation that certain levels of profit cannot be achieved.
As an element of the marketing mix price is, of course, the source of revenue for the organisation, whereas the other elements incur costs. Its importance will vary according to market conditions and the type or product or service being marketed, but only in rare cases is price the only criterion when purchases are made. Other elements like the brand name, service and warranty considerations, the sales routine and sales promotion all have their part to play, but the final consideration usually rests upon price, so its importance should not be underestimated. As price directly determines the amount of profit (or loss) an organisation makes it is important that it is approached in a reasonably scientific manner.
Organisations should consider pricing in conjunction with marketing objectives and these too should be quantified in terms of reaching organisation goals through marketing planning. Therefore, pricing is the means through which marketing objectives are reached. However, prices should be set at a realistic level which infers that marketing (and pricing) objectives should be attainable through the organisation’s marketing efforts.
As individuals, the level of prices in the economy affects our individual standards of living as well as the functioning of the economy as a whole. In a market driven economy the goal must, therefore, be to provide products and services that we need, but at good value for money, which will be a reflection of prices charged. However, competition between providers of such goods and services will tend to drive prices down as purchasers look for value, and this principle is at the very heart of marketing thought.
2 Pricing perspectives
Pricing theory distinguishes three separate approaches and philosophies. As these approaches have been documented by marketing theorists, it tends to put marketing propositions as being the most sensible ones. However, marketing theories were the last to be developed, so it is perhaps not surprising that these are more sustainable than the others in a modern commercial environment. Each of these approaches is dealt with later in terms of the theories they deal with, but the general philosophy pertaining to each is dealt with now.
2.1 The economist’s approach
This approach contends that price is the means through which supply and demand are brought into equilibrium. The mechanism operates along a range of markets from perfect competition, through imperfect competition to monopoly. The assumption is that profit will be maximised and the only input to purchasing decisions is the relationship between demand and price.
2.2 The accountant’s approach
Here the thrust is upon recovering costs in order to make profits. This is often expressed as a required rate of return. The accountant’s approach thus emphasises the importance of identifying and classifying different costs. The principal disadvantage with this approach is the tendency to ignore the volume of demand and prevailing market conditions.
2.3 The marketer’s approach
The marketer’s approach emphasises the effect of price on the organisation’s competitive market position. This includes factors like level of sales, market share and levels of profit. Value is emphasised as well as price, and the notion is to set prices at ‘what the market will bear’.
These approaches have been briefly explained at this early stage in order to provide an understanding of the various views. Each philosophy is expanded and elucidated in detail later.
3 Pricing decisions
Prices play an important part in the buyer/seller relationship. As we edge towards the era of ‘relationship marketing’, the significance of price is perhaps reduced as factors like quality and reliability of delivery are emphasised as being of equal or even greater importance. There is a mutual trust between seller and buyer that contends that prices will be set at a ‘fair’ level. Indeed, there is a notion of what is termed ‘open accounting’ whereby in such long-term relationships, price bargaining does not enter into the negotiation equation. Here, suppliers typically provide component parts to a main manufacturer, and are then shown how this customer’s price is arrived at for the end product. Equally, these customers see their suppliers’ price make-up, and indeed their suppliers’ suppliers price calculations, in terms of labour, material, expenses and overheads that are attributed to the component parts in question. (The entire process is termed ‘supply chain integration’ SCI). An acceptable price is then agreed, based upon relative profit margins. However, open accounting is perhaps an idealistic situation that is appropriate for component manufacturers supplying large manufacturing plants, but not for the vast range of products on the market. In general commercial practice, the buyer will always view price as a cost which is paid for in return for a series of satisfactions, and the seller sees price as a means of cost recovery and profit.
The principal inputs to pricing decisions are customers, competitors, costs and company considerations. Under each of these four Cs each is now examined in terms of pricing considerations.
- Customers - what they will be willing which will be affected by price levels in the marketplace; the effect of price on long terms relationships; their loyalty to your particular product (brand loyalty in the case of fmcg)
- Competitors - the nature and extent of competition; their numbers - how many or how few for the type of market being supplied; how aggressive they are in terms of marketing activity which will include pricing; the prices they charge
- Costs - materials; labour; overheads; considerations as to whether, in a highly competitive market, the goods might be produced on a marginal cost basis - where overheads have been recovered on other product manufacture - and where the only costs in the equation are direct costs of materials, labour and a margin for profit
- Company - its objectives in terms of growth, whether it wishes to be the market leader or a market follower; company image; resources of the company
In addition to these four ‘C’ factors, there are also a number of macro considerations that will affect price including: legislation - corporation tax, sales tax, value added tax and excise taxes depending upon the country’s taxation policies; tariffs and duty where appropriate; the effect of Government on pricing (e.g. if the company is becoming a powerful player in the industry, perhaps through merger or takeover, any suspicion of prices that are, or might become, too high would probably attract the attention of the Restrictive Practices legislators.
4 Concepts of pricing
Economics is the starting point from which an understanding of pricing commences. Economic theory looks at the ideas of utility and value in relation to price. Utility means that aspect of a product or service which makes it capable of satisfying a want or need. Value is the term used to quantify utility and the price is the monetary unit that this value represents.
Accounting provides a more pragmatic approach which contends that costs, competition and demand are the prime factors that relate to pricing decisions, but that price should always recover a company’s fixed costs (e.g. rent, rates, heating) and variable costs (direct materials, labour and expenses) plus a margin for profit.
Marketing’s view holds that ‘prices shall be set at what the market will bear’ that is the cornerstone of marketing thought. In reality, this is not as stark as it seems, for factors like competition, costs, long term goodwill towards customers and even the potential for Government intervention have to be considered. Indeed, in the interests perhaps of gaining entry to a market, or maintaining a product line in times of intense competition, there might be situations when the company markets its products anticipating a loss in the short term.
We have put forward three views from the theoretical to the logical to the realistic. Each view is now examined in turn.
4.1 Economists’ approach
This approach commences with the notion of supply and demand where these are expressed as a demand and supply schedules or curves as in Figure 1(a) and 1(b):
|price per unit||price per unit|
|Figure 1(a) Demand curve||Figure 1(b) Supply curve|
In Figure 1(a) it can be seen that the lower the price, the greater will be the amount demanded and conversely, the greater the price the lower will be the amount demanded. Conversely, in Figure 1(b) the lower the price, the lower with be the amount that suppliers will be willing to produce and the higher the price, the more suppliers will be prepared to supply.
In Figure 2 we superimpose one over the other, and where the two curves intersect will be the market price.
|price per unit|
Figure 2 The law of supply and demand
In economic terms, where the two curves intersect will be the market price, so at price ‘P’, quantity ‘Q’ will be the amount demanded.
Elasticity and inelasticity of demand are terms used by economists to describe how price changes affect the level of demand. The term elasticity is better described as ‘responsiveness’. ‘Inelastic demand’ is less sensitive to price changes and ‘elastic’ demand is very responsive to price changes. The concepts are shown in Figures 3(a) and 3(b).
|price per unit||price per unit|
|Figure 3(a) Inelastic demand||Figure 3(b) Elastic demand|
In Figure 3(a) we can see that a large reduction in price from P to P1 will hardly affect demand that only moves from Q to Q1 and this is known as inelasticity of demand. In fact, when the demand curve is vertical then this is known as infinite inelasticity. In the case of Figure 3(b) a small reduction in price from P to P1 will have a big effect on demand which moves from Q to Q1.
Salt or soap has inelastic demand and colour televisions or hi-fi units has elastic demand.
It can then be seen that the incline of the demand curve, or the elasticity of demand for the product, will very much affect pricing decisions. However, in practice measures of total elasticity or inelasticity of demand are unrealistic. Even when demand is elastic, there is usually some point on the demand curve where a further price reduction makes little or no difference to demand. Determining the exact position of this point is important in demand analysis, because it would make little sense to reduce the price if this would not result in an increase in sales sufficient to offset this price reduction.
Companies market their products in a market situation which ranges from what economists call ‘perfect competition’ to ‘monopoly’ - each representing an extreme on the continuum. Perfect competition is a market in which there are a large number of fully informed buyers and sellers of similar products, and where there are no obstacles to exit or entry on the part of companies. Monopoly is where there is a single producer of a product for which there are no substitutes.
A theory developed by economists that has great relevance to marketers is the notion of ‘oligopoly’ which falls between the extremes of monopoly and perfect competition - towards the monopoly end of the scale. This concept has particular relevance for marketers of fast moving consumer goods (fmcg). Here we find a market dominated by a few sellers where each company must weigh the effects of its own policies on the behaviour of its rivals.
More specifically, the theory maintains that these few sellers are interdependent and the goods they produce are basically similar (or homogeneous). Companies competing in this situation are very sensitive to price changes between the various players. Since goods are similar, then customers will tend to purchase at the lowest price, so if one company lowers prices then the remaining players have to do the same in order to market their products. Therefore, price as an instrument of competition tends to be less effective than competition that is based upon such non-price factors as branding through advertising and sales promotional activities. All players produce below their maximum. The price of entry to the system can be prohibitively high through either the amount of promotion that must be done to establish a foothold or because of the costs of setting up manufacturing activities in terms of investment in plant and machinery and research and development costs. Therefore, in perfect competition, which is typified by a preponderance of small companies, each player is striving to perform at a personal best, whereas in oligopoly the actions of each player very much depends on the actions of other players.
Although the views put forward by economists are sometimes difficult to envisage in reality, they are useful in terms of being able to relate to in marketing terms because these theoretical positions tend to relate to certain kinds of marketing behaviour. With this background in mind, an industry or service provision that more or less equates to perfect competition, oligopoly and monopoly is:
- Perfect competition - the restaurant trade
- Oligopoly - motor cars
- Monopoly - the coal industry
Figure 4 explains the theory of oligopoly:
|price per unit|
Figure 4 Oligopoly
At price P the law of demand states that quantity Q will be demanded. If the price is then reduced to P1, then Q1 will be demanded, so Q-Q1 will be the additional amount demanded. However, in a situation of oligopoly where price as an instrument of competition is less effective, then the demand curve will kink to D1 and the dark area covered by Q-Q2 will be the additional amount demanded. A price reduction in these circumstances is less effective as customers will have been ‘pre-sold’ their existing products through non-price factors like advertising and branding, and indeed this is termed ‘non-price competition’.
The subject of economics is vast, comprising the entire structure matter of many first and higher degrees with hundreds of books having been written on the subject. In this very brief section we have attempted to put the economist’s view of pricing. The view is devoid of sociological and psychological influences that might influence purchasing decisions, but it is an essential starting point when attempting to understand the market. The next approach to pricing that we investigate is the accountant’s approach.
4.2 Accountants’ approach
The philosophy underlying the accountants’ approach to pricing is to achieve a targeted rate of return on investment from a given level of sales. Once total costs have been determined, the company then decides on the percentage of profit it requires. To accomplish this objective consistently, the company must be a market leader, otherwise fluctuations in demand will affect the value of profits made. In such a situation, companies have a clear idea of the volume of surplus they wish to achieve and can then estimate the profit margins needed to realise this. This approach is termed ‘cost plus’ pricing.
This, however, is a rather mechanistic approach that is not usually used in practice, although mark-up pricing which simply adds a fixed percentage onto the cost of goods and services, is still used a lot in the more traditional sectors of the retail trade. The reality is that the overall profit margin is normally the result of several pricing strategies applied to a variety of products in response to changes in the market place. Therefore, the percentage of ‘plus’ that is applied in respect of each contract or product line is a function of market conditions and individual customers which means that it is more a decision that marketing should make rather than for finance. However, the target rate of return that is expected in such circumstances should equate to the overall percentage that has been agreed with finance. If certain contracts are agreed with customers at less than this target rate of return, then this shortfall should be made up on other contracts which will be priced at more than this target rate of return. This technique is more flexible than simple cost plus pricing in that it allows marketing more flexibility when dealing with customers and for obvious reasons this pricing technique is termed ‘target pricing’.
In a manufacturing situation where the company has to make and perhaps install something that is unique and purpose designed a cost plus or target pricing approach might be appropriate. Such a product might be for the design, manufacture and commissioning of an oil refinery. Here the client is probably asking for tenders from a number of companies so what the company must do is to estimate the likely costs of such a project and then add a margin on top of this for profit.
The accountant also has to control the flow of cash in an organisation and there is normally a need to recoup the often high costs of development as early as possible in the life cycle of a product. However, it is through the financial function that a balance is kept between a variety of other demands on the company’s limited resources. This means that a fine balancing act has to be performed when attempting to meet the often conflicting demands and requirements of, for instance, production, research and development, training and marketing. In can then be seen that the accountant’s view of pricing is more governed by the internal workings of the company than with the vagaries of the market place.
In any manufacturing concern, there are fixed costs like depreciation and maintenance of plant and equipment, rent and rates for factory buildings and the costs of a minimum labour force which the company has to pay regardless of the level of output. Variable costs have also to be added and these are a function of the level of output that includes direct labour, materials and energy costs. The total costs are the sum of fixed and variable costs. This is explained in Figure 5 that explains the concept of break-even analysis:
|cost and revenue||total revenue|
Figure 5 Break-even analysis
In Figure 5 it can be seen that variable costs increase in direct proportion to the volume produced or sold, and the sum of these is total cost. The break-even quantity (BEQ) occurs when a certain number of units sold at a given price generates sufficient revenue to exactly equal total costs. Total revenue is of course the amount of money that the company receives and this will increase with output. Therefore, the gap between total revenue and total costs prior to the break-even point will represent a loss to the company and the gap between these after break-even will represent profit. Figure 5 then represents a straight ‘cost plus’ approach to pricing which assumes a balanced fixed and variable cost element and an unchanging profit margin. In reality things do not work as neatly as this, as there are elements of extra costs and reduced revenues that must be considered. As output and sales increase to a certain level there will be additional costs like the commissioning of a new production line which will incur a ‘step cost’. As sales grow there will be a tendency to trim profit margins in order to attract more customers. This is explained more fully in Figure 6:
|cost and revenue|
Figure 6 Break-even analysis showing step cost and revenue reduction with increased sales
In Figure 6 it can be seen that BEQ1 represents the normal break-even concept as seen in Figure 5 and after this point total revenue exceeds total costs. Between BEQ1 and BEQ2 there is a step cost which is a reflection of another production unit being established to cope with increased output and it is at this point that total costs exceed total revenue for a short period. At BEQ2 the second break even occurs and once again total revenue exceeds total cost. However, shortly after this, total revenue begins to tail off as a result of price reductions which have to be made in order to sustain increasing levels of sales, and ultimately this moves to a point where total revenue and total costs are again equal. What Figure 6 infers is that demand must be taken into consideration when deciding the amount of ‘plus’ in cost-plus pricing decisions.
Demand orientated pricing might be viewed as being preferable to cost-based pricing, but we should be aware of certain practical limitations when it is related to break-even analysis. It assumes that costs are static, whereas they can vary considerably (both up and down) in reality. Revenue is over-simplified as market conditions can change rapidly, and even if they return to the condition on which the analysis was originally based, the actual revenue may not be as predicted. With these provisos taken into account, break-even analysis related to demand can be an effective price computational technique, especially if costs and demand levels are comparatively stable, even if only in the short term. It should, however, be appreciated that accurate demand estimation is difficult to achieve despite an organisation’s best efforts when attempting to provide accurate forecasting.
Now that we have considered economists’ and accountants’ relatively disciplined views of pricing we are now in a position to look at the marketer’s approach. It should be emphasised here that what has been and is going to be put forward are relatively theoretical constructs, and the purpose of theory is to enable the world of reality to be viewed in a more ordered and disciplined manner. In reality, if an accountant and an economist were faced with price making decisions it would be unlikely that they would personally take their respective theories too literally.
4.3 Marketers’ approach
An organisation should have to hand as much information as possible to use when setting prices and this will depend on the overall marketing strategy. The pricing techniques we have examined pay less attention to demand and concentrate on cost. Marketing techniques place more emphasis on the combined elements of the marketing mix as well as aspects of consumer behaviour in relation to the way price is perceived.
Improvement or maintenance of market share is a common pricing objective and this is market-based. When a market is expanding, existing prices being charged by a company may not encourage a corresponding improvement in market share. A downwards price adjustment might increase sales in an expanding market to a level where the return-on-investment increases in monetary terms although the percentage return on each unit sold might have fallen. Market share is a key to profitability and this is an indicator of an organisation’s general health. Price levels and profit margins carry much of the responsibility in a marketing mix designed to maintain or improve market share.
Smaller firms generally have little influence over the level of prices in a given market and organise their businesses so that costs are at a level which will allow them to fall in line with the prices charged by the market leaders and price leaders. This is sometimes termed ‘going rate’ pricing. Prices tend to be market led with little scope for any deviation from the established price structures. As long as returns are considered to be adequate, there is justification for keeping things as they are by conforming with prices that have been established by the leaders. It should, however, be noted that price leadership does not equate to total authority in the market place. Many price leaders are not necessarily market leaders. Non-price competition can improve a company’s market share through manipulation of the marketing mix, so the group with the final influence in price setting are indirectly end consumers who react to a company’s manipulation of its marketing mix through their individual purchasing actions.
If a company desires a rapid growth in sales, then if clear product superiority cannot be sustained, price is the component of the marketing mix that must be manipulated. In such circumstances, the firm must appreciate the competitive conditions in which it is operating and a price cutting action should always be made with caution. This caution is not only in terms of competitors’ reactions, but a sudden price reduction might also affect the balance of other elements in the marketing mix and an example of such adverse reaction might apply in the case of a manufacturer of an exclusive line of strongly branded perfume.
Profit maximisation is a natural policy for any business organisation to pursue. However, market conditions can make it impossible to maximise profits on all products, in all markets, at the same time. For this reason, companies employ pricing techniques that can promote sales, but reduce profits on certain products in the short term. The overall objective is to maximise profits on all goods that are to be sold over a period of time. The company’s product mix should, therefore, be considered as a complete entity, rather than as a range of products whose profits have to be maximised individually. This idea might run counter to the product/brand manager system, with the premise being that each product or brand manager is in control of a specific Strategic Business Unit whose objective is to maximise profits. However, a more global view, like the one expressed here, sometimes has to be taken by the marketing manager which might mean that certain product lines be held back in the interests of maximising the overall profitability of the company.
Break-even analysis has already demonstrated that to ensure profitability, prices must ultimately exceed costs. It is logical then to consider cost as the first step when planning price levels. However, market based pricing strategy should begin with the consumer and then work backward towards the company. Pricing decisions must be consumer-orientated, for it is customers who will ultimately decide whether the product is purchased or not.
When making market based pricing decisions, a number of sequential steps should be taken:
- Customer or market identification is to focus the marketing decision-maker’s mind on the market from the beginning. It prevents price from being perceived separately from other marketing mix elements.
- Demand estimation or more technically speaking, sales forecasting, is a skilled process that should provide the company with a series of potential demand levels at different selling prices. The potential sales volume will directly affect costs, and the price necessary for profit maximisation can then be calculated. The price a company is able to charge will vary according to market conditions and the chosen market segments in addition to less tangible criteria like the value customers place on a given product.
- Assessing competitive reactions assumes great importance when products are easily inaugurated and markets are easy to enter. Even when a company’s products or services can be differentiated in some way, it is not usually too long before competitive offerings appear. This competition appears from three sources:
- Direct or ‘head-on’ competition from similar product offerings
- Competition from substitute products or services
- Competition from products that are not directly related, but which compete for the same funding sources or disposable income and example of which is expensive perfume manufacturers and jewellery manufacturers who might sometimes be in competition as these items are often purchased as gifts.
- Market share analysis is to consider production factors against the anticipated share of the market. If a large market share is envisaged then the price will probably need to be competitive. If production capacity is insufficient to meet the demand that the anticipated market share will produce then there is little point in setting a low price that will bring in orders that cannot be fulfilled.
We shall now examine two pricing strategies, backed up with appropriate diagrams. These approaches have been developed by marketers and reference is constantly made to them. The strategies are called ‘market penetration’ and ‘market skimming’ and they relate very much to new products that are being introduced to the market place. It is at the start of a product’s life cycle that such pricing decisions should be taken, for that decision will help to determine the volume of sales for that product over its life.
A market penetration strategy relies on the economies of large-scale production to allow the product to be introduced to the market at a price low enough to attract a large number of buyers as quickly as possible. This will tend to constrain possible competitors by creating a low price barrier to market entry. If product design and manufacture is costly to set up and operate and is also conducted on a large scale, then this too will deter competitors. The aim is to attain a high, or even total, initial market share and keep this share high during the later stages of the product’s life cycle.
Figure 7 explains this idea, and it can be see that the product is introduced at an attractively low ‘penetration’ price at the beginning of its life cycle. As a result, demand for the product is high at the early stages, whereas the product life cycle concept shows a slowly rising trend at the beginning which only begins to rise substantially during the growth phase. This policy is particularly suitable for products that have high demand elasticity and where reductions in unit costs can be attained through large-scale operations. Indeed, where a large volume of sales is essential from the outset in order to keep production levels high as high production is a function of the manufacturing process.
Figure 7 Penetration Pricing
An example of a type or class of product where a penetration pricing strategy tends to be used is new mass produced models of motor cars.
A market skimming policy infers that a company will initially charge the highest price that the market will bear, and promotional effort is directed at a small percentage of the potential market. These customers are likely to be the innovators who will purchase during the introduction stage of the product’s life cycle, followed closely by the early adopters who are also more receptive to new concepts and products. Their income levels and generally higher social status make them less sensitive to high initial prices.
To be able to reach a wider group of customers once the innovators and early adopters have purchased, the company reduces its prices progressively thus skimming the most advantageous prices from each successive adopter group. Price reductions are successively brought in as sales slow at each phase, until the product has reached all of the target market. Figure 8 illustrates market skimming and here it can be seen that individual ‘skims’ have been taken at certain times. The explanation that follows is for illustration purposes. The timing of skims does not necessarily relate to social class, for the ‘innovator’ categories for say a home computing system will be ‘technically minded people’ whereas the ‘innovator’ category for an expensive new brand of perfume might well be the ‘A’ and ‘B’ social grades.
Figure 8 Market skimming
In Figure 8 the new product is introduced at time T0 at a high initial price P1. The product is meant to appeal to the AB social grades or the innovators at this stage. They make their initial purchases and the market then begins to tail off, so prices are reduced to P2 that brings in the C1 social classes or early adopters at time T1. The same thing happens again at time T2 when the C2 social classes, or early majority are brought in by bringing down the price to P3. The final skim is brought in as price P4 at time T3 that brings in the DE social grades, or late majority and laggards and this is when the product has reached its maturity/saturation phase.
A product that has used market skimming as its pricing policy is personal computers and this is the obvious example. However, products like micowave ovens and pocket calculators have gone through this same process. A modification on the model described is to initially introduce a refined ‘de-luxe’ version of a new product, with simpler versions appearing later at appropriately reduced prices.
In order to be successful, a skimming strategy must relate to a product or service that is distinctive enough to exclude competitors who might be encouraged to enter the market in the early stages through the high prices being attained. Other elements of the marketing mix must assist this skimming strategy by advancing a good quality, distinctive image.
A skimming strategy is particularly relevant for new products because at the earlier phases of the product’s life cycle, competition is minimal and the uniqueness of the new product can create opportunities for non-price competition. In addition, as we have seen from the example, the market can be effectively segmented or ‘cherry picked’ on the basis of innovator characteristics who will be willing to purchase regardless of the initial costs. At a more practical level, high initial prices can lead to quicker recovery of research and development plus production set-up costs, and it can keep demand within the capacity of production whilst production levels are building up.
Three approaches to pricing have been examined and it has been demonstrated that it is the market place rather than the company that exerts the greatest influence in prices determination. Marketing may be faced with a general level of demand for a given product or product type, but inside this level of demand there are opportunities for tactics to be developed which centre principally on the customer. It is upon such tactics that the next section now focuses.
8.5 Tactical pricing issues
Some consumer goods purchasers attach a great importance to prestige when making purchases. This prestige element is rarely admitted, and in some cases it is never consciously acknowledged, for the buyer does not always realise that it forms part of the purchasing decision. It does, however, allow for psychological pricing techniques to be applied. In such cases, the customer sees value in exclusivity and if he or she has the ability to pay high prices, the image projected as a result of this kind of purchase might enhance that person’s lifestyle. When we consider prestige pricing this produces a demand curve as shown in Figure 9:
|normal demand curve|
|inverse demand curve|
Figure 9 Prestige pricing
Here it can be seen that price reductions below a certain level can decrease demand since the product loses its exclusive image if price becomes too low and this produces what is termed inverse demand.
In the case of certain products there are psychological price bands within which price reductions have little effect. If, however, the price is reduced so that it falls into the next psychological price bracket, then demand will increase, resulting in a step-like demand curve. This thinking is also at the basis of what is termed ‘odd/even pricing’. Here prices like 9.99 are applied which means one cent or one penny change out of 10.00 and it somehow looks a lot less expensive than 10.00 because this is a sum that is in the next psychological price band. ‘Price lining’ is a variation of this and this is used a lot in the USA by retailers who sell all of their products in a number of distinct price bands like $49.95; $59.95 and $69.95 for such merchandise as trainers.
A company’s discount structure is also a major factor in pricing decisions and in some industries a ‘trade discount’ for members who belong to a certain profession is the accepted norm. Such professions are usually the trade professions like building or plumbing. Customers who purchase in large volumes may also reasonably expect to pay a lower price than would be the case for smaller purchases. Discounts are sometimes offered to encourage large purchases. Discounts can also be offered to encourage sales of a new product or increase demand for a slow moving product. A rebate policy may also be applied to payment terms to encourage prompt payment.
In easily segmented markets, companies sometimes charge different prices to individual segments for a product which is basically the same and this is referred to as ‘price discrimination’. In such cases it often takes only a minor modification to allow a discriminatory price to be charged. Such a discriminatory price may even be based on the individual customer or the location in which the product is being marketed.
An example of price discrimination is reduced rates offered to students on loans and bank charges whilst they are students in the expectation that they will become permanent customers.
An organisation’s willingness to adapt and modify price levels according to the needs of its customers and the market conditions that prevail is a pointer to the level of marketing orientation that prevails. Marketing management has, therefore, to devise pricing strategies that are compatible with other elements of the marketing mix. A knowledge of economic and accountancy theory is an essential precursor to understanding the wider issues involved when making pricing decisions, and to this extent these approaches have been given full consideration. Marketing approaches have also been discussed, for it is recognised that price embodies more than simply money that is exchanged for a product or service. To this extent the psychological and behavioural implications of price have also been investigated as well as the more practical issues of market based pricing theory.