Understanding The Logic
Pricing is one of the most crucial aspect in the overall marketing plan of an organisation. It depends on many aspects and most important of all is the Seller’s Objective. A few examples – which we see in our daily life – could be relevant at this stage to have an understanding on the logic.
- In the morning or in the evening, the cost of hiring a cab increases. It also increase in case of rain or any natural calamity. This primary happens due to lower supply than demand.
- During certain festive seasons, sellers of white goods offer high discount. Generally the reasons for such decisions are,
- Clearing old stock to make way for new material – which could be of new model, design or technology.
- Mopping up as much revenue as possible, even if it comes at lower margin.
- Products available in online stores are generally cheaper that the same product available in retail outlets. This happens due to,
- Lower cost structure of online retailers in view of short supply chain and
- Economic of scale.
- When price of onion increases in domestic market, government stops export or when oil price decrease in international market, the Organisation of Petroleum Exporting Countries (OPEC) start discussion on reducing production. Thus in both the cases, the approach towards price control is controlling supply.
- When a saloon comes up in a locality, they start with offering hefty discounts for certain period, to attract clients, even though this may affect their margin and cause financial loss for that period.
- Jio launched internet services at a highly competitive price adopting a different technology and bundle of other offerings as a part of their market penetration strategy.
- In the market, products of some of the manufacturers are charged at a premium than competing products with similar features.
It may be evident from the cases above, that multiple factors play vital role in pricing decision. While some of the factors are in the control of the seller, some are market driven.
Factors that contribute to pricing decision are,
- Demand supply condition and Historic price trend,
- Cost of production,
- Competitor’s approach towards pricing,
- Regulatory aspects,
- Seller’s objective.
Demand Supply Condition Historical Pricing
Demand – supply model is a subject of microeconomic that provides the base model for price determination in market economy. It defines that price parity is achieved at a point where supply curve dissect demand.
At fundamental level, the model defines that if,
- supply increases and demand remains constant, the market price will tend to decrease, as buyers will have more buying options and under that condition the sellers will not be able to sell their products at prevalent price.
- demand increases and supply remains unchanged, price will increase due to shortage in supply.
- both demand and supply increase or decrease, the price will set at a level, where it makes the equilibrium.
It is important to understand that this model of demand – supply equilibrium is applicable for every product, but more relevant for commodities.
To arrive at a price that is acceptable by customers, it is important to understand historical demand and supply. While future supply may be derived on the basis of increase in capacity and import trend, demand projection is assessed on the basis of consumption fundamentals and export trend.
Knowing historic price band and margins forms an important aspect in pricing decision. But, getting such information may not be easy and may also require detailed market research.
In the above figure, it may be seen that margin in case of both the products are shrinking over time. But in case of Product 1, even the price is in the falling trend, which is negative to investment. This kind of scenario is prevalent in case of many product lines, generic pharmaceutical products can be specially mentioned.
For technology products or white goods, it can be difficult to ascertain a past price trend, as brand image forms an important aspect in pricing.
For example, there may not be much variation in the price of a commodity like, steel or cement produced by a leading player and a small producer. The variation could be limited to 2 to 4% of sales price. However, in case of a technology product like, mobile phone, the difference in price for two brands for a product with similar feature could be very wide.
Cost of Production and Pricing Decision
Cost plus approach is followed by many and the logic behind this approach is to pass on the entire cost to a buyer after adding expected margin. The negative side of this approach is that it also transfer the inefficiencies to a buyer. Further, in market economy, the scope for self decided prices – specially if they are higher than market – generally becomes unsustainable.
To some extent, cost is in the control of a producer, yet there is huge amount of external dependency. Typical this cost includes, raw material, labour, wastages, maintenance, utility, logistics, interest etc.
Better understanding of cost helps in areas of improvement / cost reduction and thus can be help taking informed decision.
Present market place is no way different from a battlefield, where competitors plan to destroy each other, in order to survive and grow. In many markets and product lines the product differentiation is virtually non- existent and producers try to project some or the other features, which could be common among all the supplies.
It is also important to know that the intelligence system is so strong in case of many of the market leaders, that they come to know about new product launches and competitors well before actual release of the product.
Analysing competitor’s approach helps in,
- Identifying potential differentiators,
- Understanding the philosophy behind the pricing decisions of competitors and strategizing suitability.
Regulatory Aspects in Pricing
In India, several sectors are bound by price registration and planning pricing for products in those sectors or product lines, is meaningless. It becomes rather important to look internally at cost control to improve margins. Some of these sectors are,
- Pharmaceuticals: In generic pharma, close to 900 products / formulation are under Drug Price Control Order (DPCO) and National Pharmaceuticals Pricing Authority (NPPA) regulates their price. While the objective is to help patients access essential drugs during need at affordable cost, the producer’s plight in entering such product segment is evident.
- Fertilizer: In urea fertilizer, the production cost is higher than selling price, which is compensated by subsidy from government. The producer’s ability in managing lower operating cost can only help increase margins. The possibility of advancement in product quality is also impacted.
Sellers objective is an important aspect in pricing decision. A serious player will always have clearly on the ultimate objective, which my also change based on lifecycle. Such objectives could be,
- Market penetration,
- Price leadership,
- Profit Maximisation,
- Create entry barrier,
- Market Positioning,
- Market driven pricing,
- Mop-up high sales in a short span or clearance sale.
Price should be something that a client will be willing to pay, except under compulsion, where the gravity of need determines the willingness to pay. Thus, while planning pricing strategy, keeping market expectations above all is important, and can not be overlooked.
While strategy is important, its implementation is challenging and most of the failures happen due to failure in implementation of strategy.
Further, a strategy cannot be rigid and it often needs fine-tuning based on additional knowledge gained.