Pricing

Pricing is a fundamental aspect of financial modelling, and is one of the four Ps of the marketing mix. The other three aspects are product, promotion, and place. It is also a key variable in microeconomic price allocation theory. Price is the only revenue generating element amongst the four Ps, the rest being cost centers. Pricing is the manual or automatic process of applying prices to purchase and sales orders, based on factors such as: a fixed amount, quantity break, promotion or sales campaign, specific vendor quote, price prevailing on entry, shipment or invoice date, combination of multiple orders or lines, and many others. Automated systems require more setup and maintenance but may prevent pricing errors.

Questions involved in pricing

Pricing involves asking questions like:

• What does fraction of the price mean? It refers to a really great discount off of the standard rate below 50% off
• How much to charge for a product or service? This question is that a typical starting point for discussions about pricing, however, a better question for a vendor to ask is - How much do customers value the products, services, and other intangibles that the vendor provides.
• What are the pricing objectives?
• Do we use profit maximization pricing?
• How to set the price?: (cost-plus pricing, demand based or value-based pricing, rate of return pricing, or competitor indexing)
• Should there be a single price or multiple pricing?
• Should prices change in various geographical areas, referred to as zone pricing?
• Should there be quantity discounts?
• What prices are competitors charging?
• Do you use a price skimming strategy or a penetration pricing strategy?
• What image do you want the price to convey?
• Do you use psychological pricing?
• How important are customer price sensitivity (e.g. "sticker shock") and elasticity issues?
• Can real-time pricing be used?
• Is price discrimination or yield management appropriate?
• Are there legal restrictions on retail price maintenance, price collusion, or price discrimination?
• Do price points already exist for the product category?
• How flexible can we be in pricing? : The more competitive the industry, the less flexibility we have.
  • The price floor is determined by production factors like costs (often only variable costs are taken into account), economies of scale, marginal cost, and degree of operating leverage
  • The price ceiling is determined by demand factors like price elasticity and price points
• Are there transfer pricing considerations?
• What is the chance of getting involved in a price war?
• How visible should the price be? - Should the price be neutral? (ie.: not an important differentiating factor), should it be highly visible? (to help promote a low priced economy product, or to reinforce the prestige image of a quality product), or should it be hidden? (so as to allow marketers to generate interest in the product unhindered by price considerations).
• Are there joint product pricing considerations?
• What are the non-price costs of purchasing the product? (eg.: travel time to the store, wait time in the store, disagreeable elements associated with the product purchase - dentist -> pain, fishmarket -> smells)
• What sort of payments should be accepted? (cash, check, credit card, barter) Pricing

What a price should do

A well chosen price should do three things:

• achieve the financial goals of the company (e.g., profitability)
• fit the realities of the marketplace (Will customers buy at that price?)
• support a product's positioning and be consistent with the other variables in the marketing mix
  • price is influenced by the type of distribution channel used, the type of promotions used, and the quality of the product
    • price will usually need to be relatively high if manufacturing is expensive, distribution is exclusive, and the product is supported by extensive advertising and promotional campaigns
    • a low price can be a viable substitute for product quality, effective promotions, or an energetic selling effort by distributors

From the marketer's point of view, an efficient price is a price that is very close to the maximum that customers are prepared to pay. In economic terms, it is a price that shifts most of the consumer surplus to the producer. A good pricing strategy would be the one which could balance between the price floor (the price below which the organization ends up in losses) and the price ceiling (the price beyond which the organization experiences a no demand situation).

Definitions

Pricing is the process of determining what a company will receive in exchange for its products. Pricing factors are manufacturing cost, market place, competition, market condition, Quality of product.

The effective price is the price the company receives after accounting for discounts, promotions, and other incentives.

Price lining is the use of a limited number of prices for all your product offerings. This is a tradition started in the old five and dime stores in which everything cost either 5 or 10 cents. Its underlying rationale is that these amounts are seen as suitable price points for a whole range of products by prospective customers. It has the advantage of ease of administering, but the disadvantage of inflexibility, particularly in times of inflation or unstable prices.

A loss leader is a product that has a price set below the operating margin. This results in a loss to the enterprise on that particular item, but this is done in the hope that it will draw customers into the store and that some of those customers will buy other, higher margin items.

Promotional pricing refers to an instance where pricing is the key element of the marketing mix.

The price/quality relationship refers to the perception by most consumers that a relatively high price is a sign of good quality. The belief in this relationship is most important with complex products that are hard to test, and experiential products that cannot be tested until used (such as most services). The greater the uncertainty surrounding a product, the more consumers depend on the price/quality hypothesis and the more of a premium they are prepared to pay. The classic example of this is the pricing of the snack cake Twinkies, which were perceived as low quality when the price was lowered. Note, however, that excessive reliance on the price/quantity relationship by consumers may lead to the raising of prices on all products and services, even those of low quality, which in turn causes the price/quality relationship to no longer apply.

Premium pricing (also called prestige pricing) is the strategy of consistently pricing at, or near, the high end of the possible price range to help attract status-conscious consumers. A few examples of companies which partake in premium pricing in the marketplace include Rolex and Bentley. People will buy a premium priced product because:

1. They believe the high price is an indication of good quality;
2. They believe it to be a sign of self worth - "They are worth it" - It authenticates their success and status - It is a signal to others that they are a member of an exclusive group;
3. They require flawless performance in this application - The cost of product malfunction is too high to buy anything but the best - example : heart pacemaker.

The term Goldilocks pricing is commonly used to describe the practice of providing a "gold-plated" version of a product at a premium price in order to make the next-lower priced option look more reasonably priced; for example, encouraging customers to see business-class airline seats as good value for money by offering an even higher priced first-class option. Similarly, third-class railway carriages in Victorian England are said to have been built without windows, not so much to punish third-class customers (for which there was no economic incentive), as to motivate those who could afford second-class seats to pay for them instead of taking the cheaper option. This is also known as a potential result of price discrimination.

The name derives from the Goldilocks story, in which Goldilocks chose neither the hottest nor the coldest porridge, but instead the one that was "just right". More technically, this form of pricing exploits the general cognitive bias of aversion to extremes. This practice is known academically as "framing". By providing three options (i.e. small, medium, and large; first, business, and coach classes) you can manipulate the consumer into choosing the middle choice and thus, the middle choice should yield the most profit to the seller, since it is the most chosen option.

Demand-based pricing is any pricing method that uses consumer demand - based on perceived value - as the central element. These include : price skimming, price discrimination and yield management, price points, psychological pricing, bundle pricing, penetration pricing, price lining, value-based pricing, geo and premium pricing. Pricing factors are manufacturing cost, market place, competition, market condition, quality of product.

Multidimensional pricing is the pricing of a product or service using multiple numbers. In this practice, price no longer consists of a single monetary amount (e.g., sticker price of a car), but rather consists of various dimensions (e.g., monthly payments, number of payments, and a downpayment). Research has shown that this practice can significantly influence consumers' ability to understand and process price information

The 9 Laws of Price Sensitivity

In their book, "The Strategy and Tactics of Pricing", Thomas Nagle and Reed Holden outline 9 laws or factors that influence a buyer's price sensitivity with respect to a given purchase:

1) Reference Price Effect
Buyer’s price sensitivity for a given product increases the higher the product’s price relative to perceived alternatives. Perceived alternatives can vary by buyer segment, by occasion, and other factors.

2) Difficult Comparison Effect
Buyers are less sensitive to the price of a known / more reputable product when they have difficulty comparing it to potential alternatives.

3) Switching Costs Effect
The higher the product-specific investment a buyer must make to switch suppliers, the less price sensitive that buyer is when choosing between alternatives.

4) Price-Quality Effect
Buyers are less sensitive to price the more that higher prices signal higher quality. Products for which this effect is particularly relevant include: image products, exclusive products, and products with minimal cues for quality.

5) Expenditure Effect
Buyers are more price sensitive when the expense accounts for a large percentage of buyers’ available income or budget.

6) End-Benefit Effect
The effect refers to the relationship a given purchase has to a larger overall benefit, and is divided into two parts:
Derived demand: The more sensitive buyers are to the price of the end benefit, the more sensitive they will be to the prices of those products that contribute to that benefit.
Price proportion cost: The price proportion cost refers to the percent of the total cost of the end benefit accounted for by a given component that helps to produce the end benefit (e.g., think CPU and PCs). The smaller the given components share of the total cost of the end benefit, the less sensitive buyers will be to the component's price.

7) Shared-cost Effect
The smaller the portion of the purchase price buyers must pay for themselves, the less price sensitive they will be.

8) Fairness Effect
Buyers are more sensitive to the price of a product when the price is outside the range they perceive as “fair” or “reasonable” given the purchase context.

9) The Framing Effect
Buyers are more price sensitive when they perceive the price as a loss rather than a forgone gain, and they have greater price sensitivity when the price is paid separately rather than as part of a bundle.

Approaches

Pricing as the most effective profit lever. Pricing can be approached at three levels.The industry, market, and transaction level.

Pricing at the industry level focuses on the overall economics of the industry, including supplier price changes and customer demand changes.

Pricing at the market level focuses on the competitive position of the price in comparison to the value differential of the product to that of comparative competing products.

Pricing at the transaction level focuses on managing the implementation of discounts away from the reference, or list price, which occur both on and off the invoice or receipt.

Tactics

Micromarketing is the practice of tailoring products, brands (microbrands), and promotions to meet the needs and wants of microsegments within a market. It is a type of market customization that deals with pricing of customer/product combinations at the store or individual level.

Pricing Mistakes

Many companies make common pricing mistakes. Bernstein's article "Supplier Pricing Mistakes" outlines several which include:

• Weak controls on discounting
• Inadequate systems for tracking competitor selling prices and market share
• Cost-Up pricing
• Price increases poorly executed
• Worldwide price inconsistensies
• Paying sales reps on dollar volume vs. addition of profitability measures

[1]

See also

• Price System
• Product life cycle management
• Value pricing
• Price elasticity of demand
• New Product Pricing
• Time based pricing
• Suggested retail price
• Purchasing power
• Psychological pricing
• Market-Adaptive Pricing
• Options pricing
• Group buy
• Cost the limit of price

External links

• Pricing using Monte Carlo simulation, a practical example, Giancarlo Vercellino
• Engineering New Product Success: the New Product Pricing Process at Emerson Electric. A case study by Jerry Bernstein and David Macias. As published in Industrial Marketing Management.