Fundamentals of Pricing

Table of Contents

I. Microeconomic View of Demand

II. Aims of Pricing

III. Fundamentals of Pricing
1. Determinants for the Pricing Strategy
2. Questions involved in setting a pricing strategy
3. Price targets and price strategy
4. The process of pricing
5. Pricing strategies

IV. Bibliography

I. Microeconomic View of Demand

Nearly each customer regardless if consumer or industrial customer is an individual. The sum of each individual is the total demand for a good. But demand mostly is not constant, but is strong correlated with the price for a product. That is why suppliers should know about the microeconomic market view to take the congnitions into consideration: “Because there is a relationship between price and quantity demanded, it is important to understand the impact of pricing on sales by estimating the demand curve for the product.”^[1]

In general the demand curve is seen as a straight or convex curve that is determined by the price for a good and the market demand. The classical microecomonic science explains that the demand depends on the price (under the precondition of a constant income level): the lower the price for a certain good, the higher in general the demand. The curve then looks as follows:^[2]

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Figure 1: Classical Price-Demand-Curve, http://de.wikipedia.org/wiki/Nachfrage

Newer research, however, shows a different picture: the demand curve is not straight, but looks like waves. The “top” of the waves are so called “price points” that show a relatively high demand for a certain price. Below the price point the demand becomes higher, at the beginning with slow increase and a higher increase the nearer the price is to the next price point. Above a price point the demand falls relatively strong. The following picture shows the demand curve with three price points:^[3]

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Figure 2: price ponits on the demand curve, http://en.wikipedia.org/wiki/Price_point

For a company it is important to know where the price points on the curve lie to maximise the income: The price point is an equilibrium price where relatively most consumers are willing to buy the product. Under the precondition of a linear cost curve the profit is maximised if the price point price is taken. But not only the price – demand curve is taken into consideration for the pricing strategy of a company, but a number of different factors.

II. Aims of Pricing

Pricing is an important part of a company’s Marketing Mix. The Marketing Mix contains the four critical parts of a marketing strategy. They often are called “The four p”:^[4]

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Figure 3: Marketing Mix, own illustration based on: hhtp://en.wikipedia.org/wiki/Pricing

The pricing strategy directly influences the turnover and as result the profit. The price is a result of the demand-price-curve I introduced above and expresses an equilibrium between demand and product price. So it means an equlibrium between consumers demand (customers return for service) and the company’s supply (company’s performance). Pricing sets a framework for the customers return, the consumer has to pay the provider for the consumption of a certain product or service.^[5] Furthermore pricing should support the marketing and company aims and support their realisation.^[6]

III. Fundamentals of Pricing

1. Determinants for the Pricing Strategy

There are some important variables that set the basis for a pricing strategy. As most important Preißner and Engel name the costs, demand and competition. Further the authors mention that in daily company’s life one of these factors is overweighted. Beside the internal restrictions for price setting, external parameters have to be considered, like public regulation (law) and other interplant organisations (like consumer counselling).

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Figure 4: Determinats for Pricing, compare Preißner/Engel (1995), page 127

2. Questions involved in setting a pricing strategy

Beside the basic considerations for setting the pricing strategy a number of questions like the overall company’s stragegy, brand value and the economical environment should be taken into consideration. The following selection shows the most important questions that determine the pricing strategy:

- How much do customers value the product sold ?
- What are the pricing objectives ?
- Do we use the profit maximisation pricing ?
- Should there be a single or a multiple price ?
- Should prices change in certain different geographical areas ?
- Should different versions of the product been sold ?
- Should quantity discounts be offered ?
- What prices are competitiors charging ?
- Which image should the pricing strategy express ?
- How important are customer price sensitivity and elasticity issues ?
- Is price discrimination or yield management appropiate ?
- Do price points already exist for the product category ?
- How flexible can we be in pricing ?
- What is the chance of being involved in a price war ?
- How transparent is the market for potential buyers ?
- What is the target market ?
- Are there joint product pricing considerations ?^[7]

3. Price targets and price strategy

On the basis of the answers and the considerations belonging to the whole environment, the price targets are set. The price targets set the general framework for price management. They are an orientation for price formation, price enforcement and price monitoring. The targets further are an orientation for the operational management level for price implementation.

Price targets could by systematised into two cathegories: quantifiable and not-quantifiable. Due to this systematisation a number of aims could be counted:

Quantifiable price targets:

- Profit targets
- Mass targets
- Financial targets

Not-quantifiable price-targets:

- Relationship to competitors
- Relationship to customers
- Relationship to the public
- Achievement of company’s targets
- Other aims^[8]

“The pricing strategy determines they way how the price targets should be achieved. It is the theoretical setting of all coordinated management and operational activities that are seen as necessary by the price management for achieving the wished price targets in advance. It is a kind of framework which sets the base for several operational decisions on prices.”^[9]

There are many ways to price a product. The price that is choosen as “right” price for a certain product in a certain market depends on the environment and competition. A picture could show the four general possibilities for price segments due to the product:^[10]

illustration not visible in this excerpt

Figure 5: Price segments and strategy mix, compare http://marketingteacher.com/Lessons/lesson_pricing.htm

4. The process of pricing

For the process of pricing, setting the follwing steps is recommended:

1. “Develop marketing strategy – perform marketing analysis, segmentation, targeting, and positioning.
2. Make marketing mix decisions – define the product, distribution, and promotional tactics.
3. Estimate the demand curve – understand how quantity demanded varies with price.
4. Calculate cost – include fixed and variable costs associated with the product.
5. Understand environmental factors – evaluate likely competitor actions, understand legal constraints, etc.
6. Set pricing objectives – for example, profit maximization, revenue maximization, or price stabilization (status quo).
7. Determine pricing – using information collected in the above steps, select a pricing method, develop the pricing structure, and define discounts.”^[11]

5. Pricing strategies

Despite answering the questions above, one pricing strategy should be defined. The literature names a collection of different possible strategies, in the following lines I would like to introduce the important ones.

In general it is important to know about the “right” pricing strategy (i.e. by market survey) – how should the service or product look like to be in line with the market, which means to meet the demand and customer expectations ?^[12] Further the choice of the pricing strategy depends on the objectives of the company. The options are as follows:

- “Penetration pricing: Where the organisation sets a low price to increase sales and market share.
- Skimming pricing: The organisation sets an initial high price and then slowly lowers the price to make the product available to a wider market. The objective is to skim profits of the market layer by layer.
- Competition pricing: Setting a price in comparison with competitors.
- Product Line Pricing: Pricing different products within the same product range at different price points. An example would be a video manufacturer offering video recorders with different features at different prices. The greater features and the benefit obtained the greater the consumer pay. This form of price discrimination assists the company in maximising turnover and profits.
- Bundle Pricing: The organisation bundles a group of products at a reduced price.
- Psychological pricing: The seller here will consider the psychology of price and the positioning of price within the market place. The seller therefore charge 99p instead £1 or $199 instead of $200
- Premium pricing: The price set is high to reflect the exclusiveness of the product. An example of products using this strategy would be Harrods, first class airline services, Porsche etc.
- Optional pricing: The organisation sells optional extras along with the product to maximise its turnover. This strategy is used commonly within the car industry.”^[13]
- Time based price differentation: The price is reliant on the time of consumption – a well-known example is the airline yield management.
- Local price differentation: In this case the geographical place of consumtion determines the exact price for a good.
- Personal price differentation: Certain customer segments get certain prices, i.e. special menu offers in fast-food branches for pupils.^[14]

Another source differentiates on the basis of the price calculation. First prices could be determined on the basis of costs:

illustration not visible in this excerpt

Figure 6: Price determination on basis of costs, Preißner/Engel (1995), page 130

On the other hand, prices could be fixed with consideration of demand. In this case, the following factors influence the price:

- Demand structure (overall demand for a product, substitutes, elasticity of demand and income)
- Customer value idea for the product
- Willingness to pay
- Different price levels
- Influence of quantity and image

Third, prices could be determined on the basis of competition (taret pricing). Through orientation on the price leader or the average of comparable products a “pilot price” is fixed. Special in this way of pricing is that the price is independent from the company’s costs. Further, if the pilot price changes, the determined price is likely to change, too (despite unchanged costs). On the other hand, if the costs change, the price remains on the same level (if the generated pilot price does not change).

In reality, the company has to consider all variables that influence the price level: Own costs, competition and demand.^[15] At least, it is important to weight the factors in the right way for the certain product and certain market environment.

A further aspect is the possibility of give-aways or price-bundling (compare above): Often sellers could better their finacial result,if they sell not only a certain product but a package.^[16]

IV. Bibliography

books

Bruhn, Manfred:

Marketng, 6th edition, Betriebswirtschaftlicher Verlag Dr. Th. Gabler GmbH, Wiesbaden 2002

Preißner, Andreas/Engel, Stefan:

Marketing, 2nd edition, R. Oldenbourg Verlag, München – Wien 1995

Weber, Jürgen/Florissen, Andreas:

Preiscontrolling – Der Weg zu einem besseren Preismanagement, WILEY-VCH Verlag GmbH & Co. KgaA, Weinheim 2005

web pages

http://www.4managers.de/themen/price-im-marketing-mix/ (October 28, 2006)

http://www.learnmarketing.net/price.htm (October 28, 2006)

http://www.marektingteacher.com/Lessons/lesson_pricing.htm (October 28, 2006)

http://www.netmba.com/marketing/pricing (October 28, 2006)

http://de.wikipedia.org/wiki/Nachfrage (October 28, 2006)

http://en.wikipedia.org/wiki/Pricing (October 28, 2006)

http://en.wikipedia.org/wiki/Price_point (October 28, 2006)

[...]

^[1] http://www.netmba.com/marketing/pricing

^[2] Compare http://de.wikipedia.org/wiki/Nachfrage

^[3] Compare http://en.wikipedia.org/wiki/Price_point

^[4] Compare http://en.wikipedia.org/wiki/Pricing

^[5] Compare Bruhn, Manfred (2002), page 167

^[6] Compare Weber, Jürgen/Florissen, Andreas (2005), page 11

^[7] Compare http://en.wikipedia.org/wiki/Pricing and http://www.netmba.com/marketing/pricing

^[8] Compare Weber, Jürgen/Florissen, Andreas (2005), page 20

^[9] Weber, Jürgen/Florissen, Andreas (2005), page 11

^[10] Compare http://marketingteacher.com/Lessons/lesson_pricing.htm

^[11] http://netmba.com/marketing/pricing/

^[12] Compare http://www.4managers.de/themen/price-im-marketing-mix/

^[13] http://www.learnmarketing.net/price.htm

^[14] Compare Bruhn (2002), page 174

^[15] Compare Preißner/Engel (1995), page 127ff.

^[16] Compare Bruhn (2002), page 169