Price definedPrice is the amount of money charged for a product or service, or the sum of the values consumers give up to gain the benefits of having or using a product or service. It is the sum of perceived value at the time of the transaction based on the amount of consumers expected satisfaction to be received from the good or service. Price is the only element of the marketing mix that produces revenue; all other elements are costs.

Major factors affecting pricing and major pricing decisions

The internal factors Companys marketing objectives: Survival or staying in business in hopes of making profits when conditions improve is the primary factor in marginal businesses. Current Profit Maximisation refers to emphasising short term results over longrun performance. MarketShare Leadership objective focuses on seeking dominant market share by the company. It generally involves charging low prices to increase demand so that later volume creates profit. ProductQuality Leadership is often linked to niching strategy; it tends to push prices high. Companys marketingmix strategy: Price conveys to consumer one kind of information about the product and as such, price decisions must be coordinated with product design, distribution, and promotion decisions to form a consistent and effective integrated marketing program. Costs: Set the pricing floor that the company can charge for its product. There are two types of costs that a company incurs and are overhead expenses. Organisation for Pricing: How the Organisation delegates the pricing function affects price. In small companies, prices are generally set by top management; however, in large companies, pricing decisions are typically handled by divisional or product line managers.

The external factors Market and Demand: an economic interaction between price supplier want and buyers are willing to pay, regulates the law of pricing. Competition and environmental factors: other firms interact with each other to form prices e.g. Monopoly, Oligopolistic and Monopolistic competition. As well as economics, governmental, environmental and other factors.

A consumers perception of value is determined by price positions a production within their mind, regarding its quality due to price and quality association.

Supply and Demand interact to form a suitable price and quality demanded.

The price elasticity of demand is the responsiveness of demand to changes in price. PED = % CHANGE IN QUANTITY / % CHANGE IN PRICE.

Analysing the PriceDemand RelationshipThe relationship between the price charged and the resulting demand level is shown in the demand curve below.

Types of costs

Costs set the pricing floor that the company can charge for its product. There are two types of costs: Fixed Costs (or overhead) are costs that do not vary with production or sales levels. Variable Costs vary directly with the level of production. Total Costs the sum of the fixed and variable costs for any given level of production vary with level of production. Price must cover the total cost. Higher cost will lead to a higher price and less profit, which results in a competitive disadvantage. Management must consider how costs will change at different levels of production as part of their overall demand management strategy.

The Economy: Economic conditions can strongly influence a firms pricing strategies. The global The Economy: Can have a strong impact on the firms pricing strategies and change consumers pricevalue equation. For example, many consumers have become more value conscious after the recent global financial crisis. Rather than cutting prices, many companies are shifting their marketing to focus on more affordable items in their product mixes. Remember, even in tough economic times, consumers do not buy based on price alone. The key is to offer great value for the money. The company must also consider what impact its prices will have on other parties in its environment, such as resellers and the government. Social concerns may have to be taken into account.Customervalue based pricingThis approach is based on the assumption that price of a market offering is a reflection of buyers perceptions of value of that offering NOT the sellers cost of making it. It begins with analysing consumer needs and value perceptions and the price is set to match consumers perceived value. Goodvalue pricing and valueadded pricing described below are the two commonly used types of valuebased pricing.Goodvalue pricing refers to offering just the right combination of quality and good service that customers want at a fair price. This approach often involves introducing less expensive versions of established brands, or redesigning existing brands to offer more quality for a given price or the same quality for less. Everyday Low Pricing [EDLP] offered in many retail outlets is an example of goodvalue pricing.Valueadded pricing, on the other hand, refers to the practice of adding valueadded features and services by companies to differentiate their offerings to supports higher prices rather than cutting prices to match competitors.

Costbased pricingAs noted earlier, costs set the floor for the companys price. Price must cover all costs for producing the product and marketing it as well as generate a fair rate of return for its effort and risk. Low cost and low price can generate great sales and profit: a low price leads to an increase in sales, increase in sales leads to increases in levels of production to satisfy demand, increased production decreases the cost and decreased cost enables the company to set further lower price. There are three different types of costbased pricing, namely the costplus pricing; breakeven pricing and target return pricing.

Costplus pricing (or markup pricing): Defined as adding a standard markup to the cost of the product, costplus pricing happens to be the simplest pricing method. Under this approach, you add together the direct material cost, direct labor cost, and overhead costs for a product, and add to it a markup percentage in order to derive the price of the product.Illustrative example 1: Consider the example of ST Inc. It has designed a product for which the variable cost is $47.00 (i.e., direct material costs + direct labor costs and other variable costs), fixed costs are $500,000 and expected unit sales volume is 20,000 units.However, from marketers point of view, this is NOT the correct price. Marketers use markup as a percentage of the selling price that is added to cost. In the case of ST Inc., if the company intends to earn a 20% markup on sales, then the computation will change. It would mean that if the selling price of the product is fixed at (pi) dollars, 20% of that amount will be the amount by which the cost ($72.00) has been marked up. In other words:$ (1 0.2) = $72.00; and $72.00/ (1. 02) = $90.00.The company applies a standard 20% markup to all of its products. To derive the cost plus price of this product for ST Inc., one will be tempted to add together the stated costs to arrive at a total per unit cost of [$47.00 + $500,000.00/20,000)] = $72.00 and then multiplies this amount by (1 + 0.20) to arrive at the product price of $86.40. Note that the price $86.40 has been based on costs and from a definitional point of view, it is correct.It is important to remember that retailers tend to use markup in terms of a percentage of the retail price (desired profit margin). Hence, unless otherwise stated, markup should always be calculated on sales; NOT on costs. For ST Inc. the price is $90.00; NOT $86.40.There could be situations when the price calculation will be based on cost rather than on sales. One must careful ly evaluate the particular context and decide what he/she should do.The highest markup always has the highest risk. Markups are smallest on some commodities such as milk and bread, whereas it is higher on seasonal items and perishable goods. There are no standard markups to set prices.Converting Markup on Sales to Cost (and from markup on Cost to Sales)Markup % on Cost =Markup on Sale .100% Markup on Sale

Markup % on Sales =Markup on Cost .100% + Markup on CostFormula (i)Formula (ii)Illustrative example 2: (i) If markup on sales is 20%, what is the equivalent markup on cost? If (ii) markup on costs is 25%, what is the markup on sales?(i) Based on formula (i) above, Markup % on cost = [0.2/(10.2] = 0.25 = 25% You can easily prove that your calculation is correct (see box below) (ii) Based on formula (ii) above, Markup % on Sales = [0.25/(1+ 0.25] = 0.20 = 20% Advantages and disadvantages of costplus pricing.Costplus pricing has several advantages as well as disadvantages. Biggest advantage is that it is simple to calculate, reduces risk and delivers a selling price that will cover production and marketing costs. Sellers are more certain of their costs than they are about demand. It ensures a profit for sellers for their valueadded activities and does not take advantage of consumers when demand is greater. As all firms in the industry use this method, prices tend to be similar and price competition is minimised. Customers perceive this method fair. Prices tend to be similar and price competition is minimised. Since company uses its own data for deciding cost, price adjustments may be made if necessary.However, this approach has some shortcomings. For example, it does not take into consideration factors such as the nature of the target market, consumer demand, type of competition, product life cycle or the products image. Also, it can result in company overestimating the price of a product because this method include sunk cost and ignores opportunity cost also while calculating cost and there is element of personal bias while deciding the profit margin which is to be added for a product.Breakeven pricing and targetreturn pricing: These are two variants of another costoriented pricing approach based on the concept of breakeven analysis which shows the total cost and total revenue expected at different sales volume levels. Let markup on sales be MSThen, based on the formula above; 0.25 = [MS/ (1 MS)] Or, 0.25 0.25 MS = MSOr, MS (1 + 0.25) = 0.25 = 0.20 = 20% The breakeven pricing is defined as setting the price to break even on the costs of making and marketing a product. At breakeven point (BEP), costs equal revenue and there is no profit or loss for the company.Expressed mathematically:Total revenue + Total costs [i.e., Fixed Costs (FC) + Variable Costs (VC)]If c is per unit variable cost, P is per unit selling price and Q is the breakeven quantity, then PQ = FC + cQ; or, PQ cQ = FC;or, Q(P-c) =FC; or, Q =FC/(P-c)(P c), i.e., per unit price minus per unit variable cost is the per unit contribution margin (CM). Sales ($)Breakeven Analysis Break-even pointBreak-even volumeTotal RevenueTotal CostVariable Costs Fixed CostsUnits Sold (#) The breakeven pricing is defined as setting the price to break even on the costs of making and marketing a product. At breakeven point (BEP), costs equal revenue and there is no profit or loss for the company.Expressed mathematically:Total revenue + Total costs [i.e., Fixed Costs (FC) + Variable Costs (VC)]If c is per unit variable cost, P is per unit selling price and Q is the breakeven quantity, then PQ = FC + cQ; or, PQ cQ = FC;or, Q(P-c) =FC; or, Q =FC/(P-c)(P c), i.e., per unit price minus per unit variable cost is the per unit contribution margin (CM).Illustrative Example 3: Consider the following data for Positron Inc.: (1) direct labor is $8.50 per unit, (2) raw materials are $3 per unit, (3) selling price is $24 per units, (4) advertising and sales force costs are $380,000, and (5) other relevant fixed costs are $120,000.ProfitofitPContribution per unit = Selling price Variable costs= $24.00 ($8.50 + $3.00) = $12.50Breakeven point in unitsBreakeven point in dollarsAlternatively BEP in dollars= __Total fixed costs__ Contribution per unit= [$380,000 + $120,000] / $12.50 = 40,000 units

= _ $500,000__1 $11.50/24.00= _$500,000_ 1 0.479167= $960,000= 40,000 x $24.00 per unit= $960,000CM/P is the contribution margin expressed as a fraction or ratio of P and is known as Contribution margin ratio. This shows what percentage of sales is made up of the contribution margin. Simplifying the above equation:Contribution margin ratio = 1 In illustrative example 3, (1 $11.50/$24.00) = (1 0. 0.479167) = 0.5208 is thecontribution margin ratio.The target profit pricing is defined as setting the price to make the desired profit. A given profit on investment is a main purpose for companies, such as importers and public utilities, to use this tool. The calculation involving the determination of the required BEP with a targeted return is very similar to BEP calculation explained above. The formula used in this case is:Breakeven point with targeted return in units = Total fixed costs + Target profit__ Contribution margin per unitIllustrative example 4: Suppose Positron wants to achieve a profit goal of $100,000. How many units should they sell?Contribution margin per unit may be expressed differently as:Dividing both sides by P, i.e., unit selling price, we have: (CM/P) = (P/P) (c/P)CM = P c

Variable cost per unit Selling price per unit Breakeven point in units =(With target return)= =Breakeven point in dollars = =Total fixed costs_+ Target profit_ Contribution margin per unit[$380,000 + $120,000 + $100,000]/ $12.50 48,000 units. $600,000__1 $11.50/24.00_$600,0001 0.479167= $1152, 000.00Alternatively, BEP in dollars = 48,000 x $24.00 per unit = $1152, 00.00Competitionbased pricingCompetitionbased pricing involves setting prices based on competitors strategies, costs, prices and market offerings. Deciding what price to charge relative to those of competitors is difficult in practice. Most firms in a competitive market lack sufficient power to be able to set prices above their competitors. They tend to use "goingrate" pricing i.e. setting a price that is in line with the prices charged by direct competitors; they must accept the going market price as determined by the forces of demand and supply. However, the company must give customers superior value for the price.An advantage of using competitive pricing is that selling prices should be in line with rivals, so price should not be a competitive disadvantage. The main problem is that the business needs some other way to attract customers. It has to use nonprice methods to compete e.g. providing distinct customer service or better availability.Newproduct pricing strategiesThe price of a product/service changes along with its life cycle. It is more challenging and more difficult for setting price for new products at the introductory stage. Two newproduct pricing strategies are popular with marketers. These are the market skimming pricing and market penetration pricing. Marketers often combine pricing with promotion to have rapid/slow skimming pricing strategy or rapid/slow penetration pricing strategy.Marketskimming pricing (or price skimming) refers to setting high initial prices to skim revenues layer by layer from the market. This strategy makes sense under the following conditions.The quality and image of the market offering must support its higher price and enough buyers must want the product at that price. The costs of producing a smaller volume cannot be so high that they cancel the advantage of charging more. Competitors should not be able to enter the market easily and undercut the high price. Marketpenetration pricing, on the other hand, involves setting a low initial price in order to penetrate the market quickly and deeplyto win a large market share by attracting a large number of buyers quickly. Conditions that must be met for this for this strategy to work include the following.The market must be highly pricesensitive so that a low price produces more market growth. Production and distribution costs must fall as sales volume increases. The low price must help keep out the competition, and the penetration price must maintain its lowprice position. Productmix pricing strategiesWhen the product or service is part of a mix or portfolio, marketers may use any of the following five productmix pricing situations to maximize their profit over the product mix.Productline pricing: This refers to setting the price steps between various products in a product line, based on cost differences between the products, customer evaluations of different features, requirements and competitors prices. For example Dell the PC manufacturer makes a lot of different versions of its Pcs which then range from $269 to $25000.Optional product pricing: This is defined as the pricing of optional or accessory products together with a main product. It is popular among electronic companies such as Dell. Whenever a consumer buys a Dell he/she gets the option to buy other accessories such as mice, speakers, keyboards, storage devices, flash drives, printers, etc. Car manufacturers also practice this when they offer addons such as alloy wheels, cd changers, leather interior, spoilers, and other trim options.Captive product pricing: Involves selling products that must be used along with a main product. Examples include printer cartridges, video game cartridges, Razor blades, staples, computer software, memory cards etc.Companies sell captive products using a higher price compared with their main equipment and make profit on the servicing of the equipment. The price of the service is broken into a fixed fee plus variable usage rate, which is called twopart pricing. In many cases, the fixed amount should be lower and profit is made from variable usage or service fees.Byproduct pricing: Companies that produce byproducts in their production process use this pricing method to sell their byproducts in order to reduce the costs of main products and make their main products price more competitive.Productbundle pricing: This type of pricing is used by companies that intend to reduce price and attract more customers by offering product/service bundles. A typical example is an airline that provides a package ticket which includes free accommodation and breakfast. This may stop the customer switching to the competitors. However, the bundle pricing must be low enough to attract buyers.Priceadjustment strategiesOften marketers are required to adjust their prices for various reasons. Seven different price adjustment strategies are available to marketers (i) discount and allowance pricing; (ii) segmented pricing; (iii) psychological pricing; (iv) promotional pricing; (v) geographical pricing,; (vi) dynamic pricing; and (vii) international pricing.(i) Discounts and allowance pricing: These are reduction from the list price. Discounts include: Cash discount, a price reduction to buyers who pay their bills promptly. Quantity discount is a price reduction to buyers who buy large volumes. Functional discount (also called a trade discount) is offered by the seller to trade channel members who perform certain functions. Seasonal discount is a price reduction to buyers who buy merchandise or services out of season. Allowances are a reduction from the list price. Tradein allowances are price reductions given for turning in an old item when buying a new one. Promotional allowances are payments or price reductions to reward dealers for participating in advertising and sales support programs.(ii) Segmented pricing occurs when the company sells a product or service at two or more prices, even though the difference in prices is not based on differences in costs. Customersegment pricing: Different customers pay different prices for the same product or service. Productform pricing: Different versions of the product are priced differently but not according to differences in their costs. Location pricing: A company charges different prices for different locations, even though the cost of offering each location is the same. Time pricing: A firm varies its price by the season, the month, the day, and even the hour. (iii) Psychological pricing occurs when sellers consider the psychology of prices and not simply the economics. In the absence of information on actual prices of products many people judge the quality of the commodity price for taking a higher price as a sign of good quality. This type of behaviour requires sellers to increase prices of their products despite the fact that real prices are low. Sometimes prices are set at what seem to be unusual price points such as $9.99 or $14.99 with a view to help customers overcome the perceived price barriers that they may have. They will buy something for $9.99, but think that $10 is a little too much. In other words, a price that is one cent lower can make the difference between closing the sale, or not! The aim of psychological pricing is to make the customer believe the product is cheaper than it really is. Pricing in this way is intended to attract customers who are looking for value. One aspect of psychological pricing is reference pricesprices that buyers carry in their minds and refer to when looking at a given product. In order to obtain higher profits, sellers have to influence the reference price of the customers. (iv) Promotional pricing: Refers to promoting a companys products/services by temporarily cutting down the prices of their products below list price or costs using discounts, special event pricing and cash rebates. Promotional pricing can be dangerous for the organization, because it can ruin the reputation of the organization. Constantly reduced prices can erode a brands value in the eyes of customers. Price promotions can create dealprone customers who wait until brands go on sale before buying them. Also promotional pricing can lead to industry price wars. Loss leader pricing is a popular method of promotional pricing. A loss leader is a product priced below costprice in order to attract consumers into a brick and mortar shop or online store. While in the store (physically or browsing online), these customers are likely to make purchase of other profitable goods in addition to the loss leader. If a business undercuts its competitors on price, new customers may be attracted and existing customers may become more loyal. So, using a loss leader can help drive customer loyalty. This is a reasonable and welltested approach for building traffic to a store or website, but the marketer must monitor it carefully to ensure that it is actually generating an incremental profit, rather than a substantial loss.Loss leader pricing could be a risky proposition as customers may take the opportunity to "bulkbuy". If the product is not perishable and price reduction is sufficiently deep, then it makes sense for customers to buy as much as they can. This would defeat the purpose of using the approach. Using a loss leader is essentially a shortterm pricing tactic for any one product. To ensure that customers do not get used to the tactic, it is necessary to change the loss leader or its merchandising every so often.(v) Geographical pricing involves pricing products differently for customers located in different parts of the country or world. If customers are living in remote areas, companies have to charge higher prices to cover the cost of delivery, but this will result in the loss of customers to competitors. Therefore it becomes difficult for the company the possibility to apply uniform prices across the country price or charge according to the geographical conditions in which the customers live. Various types of geographical pricing are briefly described below FOBorigin pricing: The goods are placed free on board (hence, FOB) a carrier. At that point the title and responsibility pass to the customer, who pays the freight from the factory to the destination. Uniformdelivered pricing: The opposite of FOB pricing. Here, the company charges the same price plus freight to all customers, regardless of their location. Zone pricing: Falls between FOBorigin pricing and uniformdelivered pricing. All customers within a given zone pay a single total price; the more distant the zone, the higher the price. Basingpoint pricing: The seller selects a given city as a basing point and charges all customers the freight cost from that city to the customer location, regardless of the city from which the goods are actually shipped. Freightabsorption pricing: Using this strategy, the seller absorbs all or part of the actual freight charges in order to get the desired business. (vi) Dynamic Pricing: Refers to a pricing strategy in which businesses set highly flexible prices for products or services based on current market demands and supply, type of customers being targeted, competitor pricing and other factors. This policy, which allows business to stay competitive by changing prices, is a common practice in several industries such as hospitality (e.g., hotels and resorts), travel (airlines, bus/train), entertainment (sports/concerts), online marketers (Amazon, eBay) and retail. Each industry takes a slightly different approach to repricing based on its needs and the demand for the product. One commonality, however, is the use of dynamic pricing to increase revenue and profits. (vii) International Pricing: Many organizations that operate in different countries have to decide what price the company should charge in a specific country depends on many factors, including economic conditions, competitive situations, laws and regulations, and development of the wholesaling and retailing system. Costs play an important role in setting international prices. Price Changes: Initiating Price Cuts and Price increaseCompanies often face situations which require them to change the price or respond to price changes by competitors. They may have to cut the price or raise it. However, in both cases the companies must anticipate possible buyer and competitor reactions.Companies might cut price to take care of excess capacity and falling demand in the face of strong price competition as well as to dominate the market. Price increase, on the other hand, is often a response to cost inflation. A second factor leading to price increases is to curb excess demand; when a company cannot supply all its customers' needs, it can raise its prices, ration supply products to customers, or do both.Reactions to Price Change: by buyers and competitorsPrice change, be it price cut or price increase, will affect not only buyers, but also competitors, distributors, suppliers and, occasionally, the government. Buyers reactions to price change, however, are not always predictable or rational. For example, they may view the pricereduced product as faulty and of poorquality. They might speculate further cut down in price and defer purchase. By contrast, when price is increased, one might develop a positive view of the product and perceive that the item is of very high quality and/or the product is highly demanded and may be unobtainable unless it is purchased soon.Price change may also worry competitors. This is particularly true when a small number of firms are involved, the product is uniform, and the buyers are well informed. If the company faces one large competitor who tends to react in a set way to price changes, that reaction can be easily anticipated. But if the competitor treats each price change as a fresh challenge and reacts according to its selfinterest, the problem becomes complex. Like the customer, the competitor can interpret a price change in many ways. However, when there are several competitors, the company must guess each competitor's likely reaction and act accordingly.Responding to Price ChangesIn order to respond to a price change by a competitor, the company needs to consider several issues. To begin with, it might analyse whether the change was aimed at taking more market share, to use excess capacity, to meet changing cost conditions, or to lead an industry wide price change. It also needs to think whether the price change is temporary or permanent and what happens if the company maintains status quo and do nothing.The company must also undertake a broader analysis of the stage of life cycle of the product affected by price change as well as the product's importance in the company's product mix; the likely intentions and resources of the competitor, and the possible consumer reactions to price changes.It must, however, be noted that it may not always be possible for the company to make an extended analysis of its alternatives at the time of a price change, but it may have to react within hours or days. The only way to minimise the reaction time is to plan ahead for both possible competitor's price changes and possible responses.A company might assess and respond to a competitor's price cut in several ways. If a price reduction by a competitor is believed to be temporary and may not harm company sales and profits, it might simply decide to maintain status quo. It might decide to wait and respond when it has more information on the effects of the competitor's price change. But if the company decides that effective action can and should be taken, it might make any of four responses. It could reduce its price to match the competitor's price. If the market is price sensitive such an action would be necessary. The company might maintain its price but raise the perceived quality of its offer and communicate this to customers. The company could improve quality and increase price, moving its brand into a higher pricevalue position. The higher quality justifies the higher price, which in turn preserves the company's higher margin. The company could launch a lowprice fighting brandadding a lowerprice item to the line or creating a separate lowerprice brand. But this might ultimately hurt longrun market share. The company should try to maintain its quality as it cuts prices. When raising prices, the company must avoid being perceived as a price gouger. One technique for avoiding this problem is to maintain a sense of fairness surrounding any price increase. Public policy and pricing Companies are not usually free to charge whatever price they wish; companies must consider the state and federal laws governing price determination. Price fixing, price discrimination, deceptive pricing and predatory pricing are prohibited by law. These practices are reviewed by the ACCC in Australia under the auspices of the Trade Practices Act. Pricing within channel levels: Federal legislation on pricefixing states that sellers must set prices without talking to competitors. Otherwise, price collusion is suspected. Pricing strategies of petrol companies are regularly checked for possible price collusion. Sellers are prohibited from using predatory pricingselling below cost with the intention of punishing a competitor or gaining higher longrun profits by putting competitors out of business. Once competitors have been driven out, the firm raises its prices. The price set might even be free, or lead to losses by the predator. Whatever the approach, predatory pricing is illegal under competition law. Proving the use of predatory pricing in practice is difficult and expensive. Pricing across channel levels: The RobinsonPatman Act seeks to prevent unfair price discrimination by ensuring that sellers offer the same price terms to customers at a given level of trade. Laws prohibit retail (or resale) price maintenancea manufacturer cannot require dealers to charge a specified retail price for its product. Although the seller can propose a manufacturers suggested retail price to dealers, it cannot refuse to sell to a dealer who takes independent pricing action, nor can it punish the dealer by shipping late or denying advertising allowances. Deceptive pricing occurs when a seller states prices or price savings that mislead consumers or are not actually available to consumers. Other deceptive pricing issues include scanner fraud and price confusion.