Pricing depends on the business objectives set by the enterprise. While price is a major factor for the customer in buying a product, it is not the only factor such as in the case of buying premium products. Non-price factors outweigh the price factor whenever a customer is buying a premium item because he or she is more particular about the ‘premium-ness’ in terms of quality, the status or image that the product brings, shorter waiting time or immediate delivery, and other such decision criteria.
Finding the right price for a product is, therefore, not a simple matter of adding a mark-up on the cost of a product or service, as some companies do.
The enterprise should set the prices of its products or services based on its business objectives such as the following:
- Profit maximization
- Revenue maximization
- Market share maximization
- Attainment of the desired prestige or quality leadership
- Penetration, survival, or liquidation
- Scarcity pricing or market skimming
- Cost recovery
- Subsidy pricing
- Marginal pricing
The first three pricing strategies pertain to the related dynamics of the different price ranges applied across different product volumes or quantities while considering the product costs incurred as these products are bought or sold. For a better appreciation, let us take a look at the table below.
*Assumes the following: Fixed Costs equal ₱300; Variable Costs equal PS per unit
The table above shows an example of a profit, revenue, and market share maximization pricing strategies. Prices ranging from ₱10 to ₱18 per unit have been market tested as shown in the first column. These prices have resulted in volumes (see second column) ranging from 50 units at the price of ₱18 per unit to 100 units at the price of ₱10 per unit.
The total revenues are computed by multiplying price with quantity as provided in the third column. The total costs are computed in the fourth column, assuming fixed costs of ₱300, irrespective of the volume level, and variable costs of ₱5 per unit. The fifth column calculates the total profits.
At the price of ₱14 per unit, the profits are maximized at ₱375, compared to the other price levels which yield lower profits. Unit cost is computed in column six in order to illustrate its decline as volume goes up. The revenue-maximizing price is derived by multiplying the different prices by their expected demand volumes. As shown in the table, the revenue-maximizing price is ₱12, generating total revenues of ₱1,080.
The revenue-maximizing price model is easier to derive than the profit-maximizing price. It should be used when the total costs are mainly fixed (little change over a wide volume range).
Market share maximization is achieved by the price that obtains the highest volume of sales possible without sacrificing too much profitability. In the same table, this market share-maximizing price is ₱10, with a volume of 100 units. At this low price, profits are still realized. Perhaps a bigger volume can be obtained at the lower price of ₱8 per unit. At this price level, a possible demand for 110 units would produce revenues of ₱880 and total costs of ₱850, yielding a miniscule profit of only ₱30. At this point, going for market share might be sacrificing profits too much.
One market research approach in estimating the demand, given the different price levels, is to conduct a price tolerance survey of randomly selected respondents.
Assuming that 100 respondents are chosen (at 90% confidence level), the respondents should be asked whether they would buy a product at, say, ₱10 a piece. After securing their answers, the respondents should be queried if they would still buy at ₱12 a piece. The surveyor should, subsequently, move up to the higher price levels. There would be less and less respondents answering “yes” to the question. The percentage of respondents answering “yes” at the different price levels could be multiplied by the estimated population of the target market to obtain the size of the demand.
As mentioned earlier, prices could be set at a premium to project a quality image and to distance the product from its inferior competitors. The idea is to attract customers who are willing to pay extra for the quality difference.
At the other end, prices can be set very low to survive in a competitive market or to get rid of mounting inventories and convert them into cash. The other objective of a low pricing strategy is to penetrate the market fully and overtake the competition.
Products that are very scarce or rare would appeal to wealthier customers who wish to belong to an exclusive club of owners.
Cost recovery pricing charges a price that allows the organization to merely recover its full costs. The purpose is to reins., est the sales proceeds to produce additional products and reach out to more people.
Marginal pricing sets the price higher than the variable costs of a product but lower than the full costs in order to increase overall profitability. This practice is done to utilize excess production capacity that would otherwise be unused.
There are other pricing objectives which the enterprise may have. It may offer introductory or promotional pricing to launch a new product. It may charge different prices in different geographical areas to take care of additional logistics costs in farther locations or to accommodate the lower purchasing power in poorer geographic areas. Discount pricing may be given to loyal and regular customers to maintain their patronage.