STEPS OF PRICING

Systematic Approach to Pricing (8 Steps)

by Manoj Sharma Pricing

As price is one of the marketing-mix variables, it warrants a precise and logical method for price setting. Firms should be systematic in setting the prices. Optimal prices cannot be established and pricing remains an art with a host of factors to be evaluated for which there are no precise measures and weights.

Though, price setting is more an art, than a science, certain logical steps are involved in the appropriate approach to pricing. The most widely used pricing methods begin with costs. This cost-plus as a reasonable profit explanation of pricing is understandable.

However, pricing strategy must be based on consumer, just as product, promotion and place strategies are. The ultimate goal of the price fixing process is to set a price that is compatible with the rest of the marketing-mix.

This is not an easy task that makes possible proper placement of costs which can hardly be ignored and meeting other considerations than profit. A systematic approach to pricing involves eight steps.

These eight logical steps are narrated below: 

1. Identify the potential customers:

The ultimate purchasers are those who pay the price for a product or a service. They are therefore, focal point in pricing strategy. It is extremely short-sighted to select a pricing policy or strategy without first identifying those people whom the pricing plan is supposed to affect. Of course, the identification of such market components is not a new step in the market planning.

The users, purchasers and the purchase influencers who are important in pricing are exactly the same individuals whose needs and attitudes were explored in the development of the rest of marketing-mix. The novelty of identifying these individuals for pricing purposes lies not in the task of doing it but rather the role they play.

2. Estimate the demand:

Prices are seldom set for each user or a buyer. Rather, users are grouped together into market segments may be regional, economic, demographic or psychographic whose members are reasonably similar. For each market segment, it is necessary to determine the relationship of alternative prices to potential demand.

The discovery of these relationships may require a deep penetration by the market planner into the nature of the demand for the product and the factors that influence it. This demand analysis is the part of the research activity as the starting stage of planning empirical studies of demand to produce demand schedules for each market segment. This permits the planner to judge fairly and accurately the range of prices that might be charged and price elasticity of demand within that range. In absence of statistical analysis or controlled experimentation, subjective assessment of market is the only way-out.

3. Determine competitors’ prices:

The importance of pricing in relation to competition makes it mandatory for the market planner to know exactly what competitors are charging. It is not that easy to get such competitive pricing information as it is usually a closely guarded secret.

Though it is easier to get price-lists of competitors, the challenging task is that of actual pricing policy. In spite of this, there are several ways in which these obstacles to obtain the information can be overcome. Most sellers establish excellent rapport with a few key customers.

These customers find it useful to provide selected manufacturers with information about the prices quoted by the competitors. It is also possible to get information by comparative shopping. This type of shopping involves the observation of prices actually charged by the competitors.

4. Identify alternative basic prices:

After pin-pointing the market, estimating demand and discovering competitors’ prices, it is usually possible to identify the basic pricing alternatives. The basic price is the reference price. It is price from which actual prices can be determined by adding extras and deducting intras.

Actual prices deviate from the basic prices because of two reasons namely:

1. Product-line pricing requires price differentials with different products in a multiple line and

2. Differences caused by market structures, geographical location, competitive conditions and terms and conditions of individual dealings. The number of pricing alternatives will depend on the range of prices within which the company chooses to compete and price elasticity that exists.

The wider the range and greater the cross-elasticity of demand, the more will be the number of pricing alternatives that must be considered. If the range is narrow and the cross-elasticity is low, there should be only two or three distinct pricing alternatives.

5. Calculate manufacturer’s net price:

Assuming that the manufacturers use some middlemen, it is essential to calculate the amount of the basic price that will be paid to the manufacturer and the amount that will be retained by the channel member or the members. If the manufacturer sells direct to the final buyers, the basic price and the manufacturer’s net price will be the same.

If the basic price is Rs. 500.00 and 20 per cent is given to the middlemen, then the manufacturer’s net price will be Rs. 400.00. From this it follows that if the company wants to make profit; all other costs fixed and variable must be less than this net price of Rs. 400.00, taking the above example.

6. Estimate costs:

Other costs to be incurred may be fixed or variable. Fixed costs are those that do not vary in total with the changes in the sales. These are depreciation, rent interest and other general and administrative expenses. Although these costs do not vary in total, they do decline per unit as the sales expand.

On the other hand, variable costs are those that vary in total with output though they are constant per unit of output or sale. These are the items of direct material, direct labour, direct expenses and variable overheads.

Since there are some expenses which are neither hundred per cent fixed nor hundred per cent variable, we must account for such semi-variable or semi fixed costs too.

7. Calculate expected profit:

The expected profit is obtained by multiplying the costs per unit by expected volume and subtracting this amount from the total revenue anticipated by the manufacturer. The most convenient way of doing this is to use break even analysis because, the break even chart shows the relationship between the total costs and the total revenue at alternative price levels and volume of output and sales. Much depends on the managerial philosophy and the minimum rate of return on capital employed or sales.

8. Repeat the analysis for each major segment:

It might be necessary to develop separate pricing strategies for each segment, if the marketer has more than one major segment. It is common for markets that are homogeneous in all other respects to be segmented on a price basis.

Segmentation does not necessarily mean that the manufacturer must attempt to serve all, the segments. However, this is of particular significance as market price elasticity varies greatly from segment to segment in case of each individual firm.