12.1. Importance Of Price

Pricing is considered by many the key activity within the capi­talistic system of free enterprise. Price becomes a hub around which the system revolves; it is the balance wheel which keeps the system operating on an even keel. Imperfections in pricing are an indication of imperfections in the system.

The market price of product influences wages, rent, interest and profits. That is, the price of a product influences the in­come earned by, or the price paid for, the factors of production labor, land capital and enter preneurship. In this way, price becomes a basic regulator of the entire economic system because it influences the allocation of these resources. High wages attract labor, high interest rates attract capital and so on. Conversely, low wages, low rent or low profits reduce the availability of labor, land and risk takers.

The price of a product or service is a major determinant of the market demand for the item. Price will affect the firm's competitive position and its share of the market. As a result, price has considerable bearing on the company's revenue and net profit. The revenue is equal to unit price times the volume of units sold. The volume itself, that is, the quantitative measure of demand, is affected by the price. The profit is equal to revenue minus costs. To some extent, costs are a function of volume and costs themselves are measured by their price. Price affects the market segment that will be reached by a firm. Because a person's income so often determines his other socioeconomic characteristics, the price may influence the qualitative nature of the company's market as well as its quantitative limits.

The price of a product also affects the firm's marketing program. In product planning, for example, if management wants to improve the quality of its product or add differen­tiating features, this decision can be implemented only if the market will accept a price high enough to cover the costs of these changes. In the channels of distribution, a properly priced product not only helps to attract the general types of middlemen needed, but it can also attract desirable individual whole sales and retailers. The pricing structure will determine whether the manufacturer or his retailers will be expected to finance the bulk of the promotional program. Unless a price can be set high enough to pay for the advertising or personal selling, these efforts will have to be curtailed or omitted.

To put the role of pricing in a company's marketing program in its proper perspective, then let us say this price is important, but not all-important in explaining marketing strategy and marketing success. One study among manufacturing compa­nies, for example, identified product-related activities and sales effort as the most important factors contributing to marketing success in a firm; one-half of the respondents did not even list price as one of the top five factors.

Three situations may account for this relatively low ranking of pricing:
1-   Because supply generally exceeds demand, most sellers must be highly competitive (or collusive) in their pricing;
2-     Today's relatively affluent customer is interested in more than just price;
3- A   seller   may   achieve   some   pricing   freedom   through successful product differentiation.

12.2. Price in the Marketing Mix

Every successful product offers some utility or want satisfying power. However, individual preferences determine how much value a particular good or service. One person may value with leisure-time pursuits while another assigns a higher priority to acquiring property and automobiles. However, all consumers have limited amounts of money and a variety of possible uses for it. Therefore, the price (the exchange value of a good or service) becomes a major factor in consumer buying decisions.

Prices also help to direct activities throughout the overall eco­nomic system. A firm uses various factors of production such as natural resources, labor and capital, based on their relative prices. High wage rates may cause a firm to install laborsa-ving machinery, just as high interest rates may lead manage­ment to postpone a new capital expenditure. Prices and volu­mes sold determine the revenue and profits a firm receives.

12.3. 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 regularly enters bids on new contract work.

                                               Price

                Hight                 Medium                Low

Figure 6 Nine Marketing-Mix Strategics on            Price/Quality

The firm must decide where to position its product on quality and price. Figure 6 shows nine possible price-quality strategies The diagonal strategies 1, 5, 9 can all coexist in the same mar­ket; that is, one firm offers a high-quality product at a high price, another firm offers an average-quality product at an ave­rage price and still another firm offers a low-quality product at a low price. All three competitors can coexist as long as the market consists of three groups of buyers, those who insist on quality, those who insist on price and those who balance the two considerations.

Positioning strategies 2, 3, 6 represent ways to competitively attack the diagonal positions. Thus strategy 2 says, "Our pro­duct has the same high quality as product 1, but we charge less". Strategy 3 says the same thing and offers an even greater saving. If quality-sensitive customers believe these competi­tors, they will sensibly buy from them and save money (unless firm 1 's product has acquired snob appeal).

Positioning strategies 4, 7, 8 amount to overpricing the product in relation to its value. The customers will feel "taken" and will probably complain or spread bad word-of-mouth about the company. These strategies should be avoided by professional marketers.

  12.4. Price And Pricing Objectives

Markets attempt to accomplish certain objectives through their pricing decisions. Research has shown that pricing objectives vary from firm and many companies pursue by setting high prices, while others set low prices to attract new business. The four basic categories of pricing objectives are:
♦       Profitability,
♦       Volume,
♦       Meeting competition,
♦       Prestige.

12.4.1. Profitability Objectives

Most firms pursue some type of profitability objectives in their pricing strategies. Marketers know that:

Profit = Revenue = Expenses

Also, revenue is a result of the selling price times the quantity-sold:

Total Revenue = Price   X   Quantity Sold

Some firms try to maximize profits by increasing prices until sales volumes decline. This approach may or may not work.

Some marketers seem to believe that price consciousness is a personality trait that some people are "stingy" and others are "big spenders". In fact, however, price consciousness is the result of how much spending money (discretionary income) a consumer has and how much the consumer things the product is worth (value). Research suggests that price is the primal") consideration for only 15 percent to 35 percent of buyers in most categories. But marketers are increasing treating price as if it were the only consideration in consumer buying behavior. Far too often, low-price strategies compromise long-term plans.

Since price is an easily observed characteristics of competing products it represents a powerful marketing weapon. However, it is also one of the easiest product traits to match by competitors. In marketplace confrontations based on price cutting, the reduction in per-unit revenues or they will leave all firms worse off than before the changes. Creditcard companies are learning this lesson the hard way as they seek to entice cardholders to switch companies by offering below-average interest rales. They gain customers, all right, but as soon as the introductory rate period ends, savvy borrowers surf the financial web for another deal. In this promotion, credit-card marketers have succeeded only in creating a new, highly dislo­yal consumer group-card surfers .

The principle of profit maximization forms the basis of much of economic theory, yet its application often creates difficult problems in practice. Many firms have turned to a simpler pro­fitability objective the target-return goal. Most target-return princing goals state desired profitability levels as financial returns on either salers or investment.

12.4.2. Volume Objectives

In other approach to pricing strategy called sales maximi­zation, managers set an acceptable minimum level of profita­bility and then set prices that will generate the highest possible sales volume without driving profits below that level. This strategy views sales expansion as a more important priority than  short-run  profits  to  the  firm's  long-term  competitive position. In order to attract customers, stores may advertise certain products called loss leaders at or below costs. "

A second volume objective bases pricing decisions on market share the percentage of a market controlled by a certain company or product. One firm may seek to achieve a 25 Per­cent market share in a certain industry. Another may want to maintain or expand its market share for particular products or product lines.

Pricing objectives based on market share have become popular for several reasons. One of the most important is the ease of applying market share statistics as yardsticks for measuring managerial and corporate performance. Another is that increa­sed sales may reduce Per-unit production costs and boost profits.

12.4.3. Pricing to Meet Competition

A third set of pricing objectives seeks simply to meet compe­titors' prices. In many lines of business, firms set their own prices to match those of established industry price leaders. These types of objectives de-emphasize the price element of the marketing mix and focus competitive efforts on nonprice variables. Price is a highly visible component of a firm's mar­keting mix and an easily used and effective tool for obtaining and advantage over competitors. The ease of duplicating prices leads many marketers, to try to avoid price wars by favoring nonprice strategies, such as adding value, improving quality, educating consumers and establishing relationships. The air­line   industry's   recent  experience  exempli lies   competitors' actions and reactions to price cuts.

In markets characterized by competitive pricing, other marke­ting mix elements gain importance in purchase decisions. In such instances, overall product value, not just price, determi­nes product choice. In recent years, value pricing has emerged to emphasize benefits a product provides in comparison to the price and quality levels of competing offerings. Many marketens follow value-pricing principles to attract consumers who want more quality for their money. While value-priced pro­ducts generally cost less than premium brands, marketers point out thai value doesn't necessarily mean a cheap price.

12.4.4. Prestige Objectives

Another category of objectives, unrelated to either profitability or sales volume, encompasses the effect of prices on prestige. Prestige pricing establishes a relatively high price to develop and maintain an image of quality and exclusiveness. Marketers set such objectives because they recognize the role of price in communicating an overall image for the firm and its products.

12.5. 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.

We will examine six major business objectives that a company can pursue through its pricing, namely;

♦       Survival,

♦       Maximum current profit,

♦       Maximum current revenue,

♦       Maximum sales growth,

♦       Maximum market skimming,

♦       Product-quality leadership.

12.5.1.   Survival

Companies set survival as their major objective if plagued with overcapacity, intense competition or changing consumer wants. Survival is only a short-run objective. In the long-run, the firm must find a way to add value in the market or face extinction.

12.5.2.   Maximum Current Profit

Many companies want to set a price that will maximum current profits. They estimate the demand and costs associated with alternative prices and choose the price that will produce the maximum current profit, cash flow or rate of return on investment.

12.5.3.   Maximum Current Revenue

Some companies will set a price that will maximize sales revenue. When the cost function is difficult to estimate because of joint and indirect costs, revenue maximization requires only estimating the demand function. This objective is also simpler to implement insofar as the sales force will be paid a commission on sales revenue. Many managers believe that revenue maximization will lead in the long run to profit maximization and market-share growth.

12.5.4.   Maximum Sales Growth

Other companies want to archive maximum sales growth. They believe that higher sales volume will lead to lower unit costs and higher long-run profit. They set the lowest price, assuming the market is price sensitive. This is called market penetration pricing.

The following conditions favor setting a low price:
■       The  market  is  highly  price  sensitive  and  a  low  price stimulates more market growth;
■       Production and distribution costs fall with accumulated pro­duction experience;
■       A low price discourages actual and potential competition.

12.5.5. Maximum Market Skimming

Many companies favor setting high prices to "skim" the market. The company sets a price that makes it just worthwhile for some segments of the market to adopt the new material. Fach time sales slow down. Company lowers the price to draw in the next price-sensitive layer of customers. In this way, company skims a maximum amount of revenue from the various segments of the market.

Market    skimming makes sense under the following condi­tions:
   √   A sufficient number of buyers have current demand;
   √  The unit costs of producing a small volume are not so much
higher that they cancel the advantage of charging what the
traffic will bear;
  √ The high initial price will not attract more competitors;
√ The high price supports the image of a superior product.

12.5.0. Product-Quality Leadership

A company might aim to be the Product-quality leader in the market. It will charge a high price to cover the high product quality and high R&D cost. Caterpillar is a prime example of a firm pursuing product-quality leadership. It builds high-quality construction equipment and offers excellent service, with the result that it is able to price its equipment at a premium.

12.6. Price Determination

The price determination procedure used here can be divided into six steps:
1.  Estimate the demand for the product,
2.      Anticipate the competitive reaction,
3.      Establish the expended share of market,
4.      Select the price strategy to be used to reach the market target,
5.      Consider company policies regarding products, channels and promotion,
6.  Select the specific price.

At this point we are concerned with determining only the basic or list price of the product or service. Later we shall deal with specific policies regarding discounts, freight allowances, price lines and other factors which may somewhat alter this basic price. Ordinarily the original price setter is a producer, although sometimes a large middleman sets or strangely influences the original price.

The same general steps are followed in pricing a product, whether it is a new article or an established one. Pricing an established product often offers very little challenge because the exact price or a very narrow range or prices may be dictated by the market. At the same time, some stages in the pricing procedure are particularly important and difficult for a new article. Consequently, any special conditions involved in pricing new products will be woven into the discussion where appropriate.


A product selling for $20 with a variable cost of $14 Per unit produces a $6 Per unit contribution to fix costs. If the firm has total fixed costs of $42,000, then it must sell 7.000 units to break even on the product. The calculation of the breakeven point in units and dollars is:

Figure 7 illustrates this breakeven point in graphic form. Marketers use breakeven analysis is determine the profits or losses that would result from several different proposed prices. Since different prices produce different breakeven points, marketers could compare their calculations of required sales to break even with sales estimates from marketing research studies. This comparison can identify the best price, one that would attract enough customers to exceed the breakeven point and earn profits for the firm. 

                             Breakeven Analysis

12.8. Including Consumer Demand in Breakeven Analysis

Breakeven analysis considers only costs; it does not indicate whether enough customers will buy the number of units the firm must sell at a particular price in other to breakeven on the product. Most firms develop estimates of consumer demand through surveys of likely customers, interviews with retailers who would be handling the product and assessments of prices charged by competitors. Then the breakeven points for several possible prices are calculated and compared with sales estima­tes for each price. This practice is referred to as modified brea­keven analysis. Marketers narrow down price alternatives in this way until they identify only those that appear capable of achieving at least breakeven sales.