“Price is the only element in the marketing mix that creates sales revenue; the other elements are costs” (Kotler). Price also happens to be a major element of the marketing mix. Pricing is a very critical decision in marketing management. It is one variable that is very important to both seller and buyer.
The main objective of the firm, that is, to earn a profit very much depends upon the correct price decision. After meeting all the costs involved, the sales revenue generated must yield a surplus before there can be profits. The sales revenue figure is however affected by the price charged for the product.
The importance of price has always been recognized. What price should be charged for the product is a very crucial question. Several factors like economic, social, political and other factors influence the pricing decisions. Sometimes one price is fixed for the product but in some cases, different prices are set for different persons.
Pricing decision is handled in various ways in different companies. In small companies, price decision is taken by the top management. In some larger companies, it may be in the hands of divisional and product line managers but here also top management sets the general pricing policy and objective. In other big companies where pricing is a crucial factor (as in railway, airways, oil companies, etc.), price decisions are taken by a separate pricing committees or commission. Prices proposed by the commission may be subject to approval of top management who may seek advice of the sales or marketing managers.
What is Price?
For the ordinary man price is an amount of money paid by the buyer to seller of a product or service. That is, price is the money value of a product or service as agreed upon in a market transaction. Therefore, price is the exchange value of goods or services, and the value of an item is what it can be exchanged for in the market place. Price, therefore, can be defined as value expressed in terms of Naira and Kobo, or any other monetary medium of exchange. In earlier times, the price of an acre of land might have been 30 yam tubers, and 6 goats. That was during the barter era which has been abandoned in favour of a monetary system. Price came to mean the amount of funds required to purchase the item. As one writer has pointed out, contemporary society uses a number of names to refer to price: price is all around us. You pay rent for your apartment, tuition for your education, and a fee to your physician.
The airline, railways, taxi, and bus companies charge you a fare; the bank charge interests for the money you borrow.
The price for driving your car from Port Harcourt to Aba expressway is a toll, and the company that insures your car charge you a premium.
The guest lecturer charge an honorarium for the lecture, the businessman gives bribe for a favour.
Dues for membership of a trade association, a retainer to cover a lawyer’s professional service, salary for an executive’s services, a commission for a salesman’s extra service and a wage for a worker’s services.
Factors Affecting Pricing Decisions
The following factors may be considered important while taking a decision for pricing the product:
1. Objectives of the Business: There may be various objectives of the firm such as getting a reasonable rate of return, to capture the market, maintenance of control over sales and profits etc. A pricing policy thus should be established only after proper considerations of the objectives of the firm.
2. Cost of the Product: The cost and price of a product are closely related. Normally, the price cannot or shall not be fixed below its cost (including the production, administrative and selling costs). The product ultimately goes to the public and their capacity to pay will fix the cost. Price also determines the cost.
3. Market Position: The prices of the products of different producers are different either because of difference in quality or because of the goodwill of the firm. A reputable concern may.fix higher prices for its products and on the other hand, a new producer may fix lower prices for its products.
4. Competitors’ Prices: Competitive conditions affect the pricing decisions. The company considers the prices fixed and quality maintained by the competitors for their products. It can fix the price equal to or lower than that of the competitors provided the quality of the product is not lower than that of the competitors. Number of competitors also affect the price decisions. If they are few, they can form an association, to fix the prices which may 1)6 reasonable.
5. Channels of Distribution: The nature of distribution channels used, and trade discounts which have to be allowed to distributors and the distribution expenses also affect the pricing decision. If channel of distribution is lengthy, the prices will be fixed higher making an allowance for the distribution expenses made by each middleman. If on the contrary the channel is short, prices may be fixed lower.
6. Price Elasticity and Demand Elasticity: Price elasticity affects the decisions of price fixation. Price elasticity means the consequential change of demand for the change in the prices of the commodity. If the demand of the product is inelastic, high prices may be fixed. On the other hand, if demand is elastic, the firm should not fix high prices rather it should fix, lower prices than that of the competitors. If the demand is highly elastic, the price reduction strategy would pay.
7. Stage of Production Life Cycle: Pricing decision is affected by the stage of product in its life cycle. As the product move from one stage of the product life cycle to another, so are prices set and changed to reflect competitive pressure.
8. Buying Patterns of the Consumer: If the purchase frequency of the product is higher, lower prices should be fixed to have a low profit margin. It will facilitate increasing the sales volume and the total profit of the firm. All consumer items of daily use have high purchase frequency. Low purchase frequency products are sold at high profit margin and therefore at high prices. Durable consumer items like Televisions and Refrigerators are priced higher.
9. Economic Environment: In recession period, the prices are reduced to maintain the level of turnover. On the other hand, prices are increased in boom period to cover the increasing cost of production and distribution.
10. Government Policy: Price decision is also affected by the price control of government through enactment of legislation, when it is thought proper to arrest the inflationary trend in prices of certain commodities or products. So, the prices cannot be fixed higher due to the fear of government action.
The pricing objectives (which is but a part of the total company objectives) need to be clearly stated. Pricing objectives are very important because they do influence the firm’s pricing policies and the methods to be used towards the determination of the prices at which the company’s products need to be sold. The firm’s pricing objective do not remain stagnant. It changes to take care of the prevailing marketing condition.
The pricing objectives of all profit-oriented firms may be either one, or a combination of the following at any point in time.
1. To maximize profit
2. To achieve or maintain market share
3. To achieve target return on investment
4. To meet or prevent competition
5. To maintain stable prices
6. To maintain long run welfare of the firm
7. To maintain customer welfare
8. To achieve increase in sales
1. To Maximize Profit: Profit maximization objectives are commonly found among firms. The desire of companies that, do utilize profit maximization is usually to achieve profit growth and rapid return on investment in the short run instead of the long-run. Profit maximization is usually looked at as profiteering on the part of the organisation by the public.
In trying to follow a profit maximization objective, it will be to the interest of the firm to let his profit maximization be based on the long-run. There is nothing wrong with an organisation by making un-reasonable profit in the shortgun provided, the firm will show a better profit picture in th§ long-run. So, the pricing decision should be taken with a view to maximize the profits for long.
2. To Achieve or Maintain Market Share: Pricing objectives based on either achieving or maintenance of market share is more desirable, than, the objective of profit maximization. A pricing objective- whose major aim is to achieve or maintain a particular share of. the market (if achieved) serves a better indicator of company’s growth than what management may consider as a reasonable return on investment because, profits can still be increasing white the firm may be losing a reasonable percentage of its market share to their competitors. Sometimes, prices are fixed at the lowest ebb which may calculate a loss to the business but the main aim is to capture or maintain the market even at a loss at the initial stage, Such type of pricing is possible in a price sensitive market.
3. To Achieve Target Return on Investment: More companies are known for utilizing target return on investment when pricing their products. It was estimated that, about 80 percent of corporations world-wide price to achieve a specific return on investment (ROI) or sales.
Due to the heavy investment incurred in the research and development stage of new products, the firm may at the introduction of the new product in the market set a predetermined rate of return expected to be achieved before competitors starts coming into the market with their own brands.
4. To Meet or Prevent Competition: One of the objectives of the price decision is to face the competitive situation in the market. A firm can fix its price either with the objectives of meeting the competition; or to prevent or discourage other firms from making an in-road into the market.
If the objective is to meet up with competitors, a firm that is trying to venture into a new market may do so by entering the market with price reasonably lower than the prices of firms already in the market.
For a firm whose objective is to prevent other firms from entering a market, the organisation may reduce prices in such market. This action may make it unprofitable to new entrants into such markets.
5. To Maintain Stable Prices: In situations where an industry do experience frequent fluctuation in demand, it may be to the interest of the firms making up the particular industry to work towards maintenance of stable prices for their products. As far as possible, prices should not fluctuate too’ often. Firms should work towards price stability within the market. A stable price policy above all can win the confidence of the consumers.
6. To Maintain Long-run Welfare of the Firm: The main aim of some firm is to fix the price of the product which is in the best interest of the firm in the long-run keeping the market conditions and economic situations in mind.
7. To Maintain Customer Welfare; Sometime, a public spirited company may seek to promote customer welfare through price. This would mean setting a price which is fair and within the reach of many present and potential customers. This pricing objective is most likely to be found among government owned companies and public enterprises such as NEPA, and Water Board.
8. To Achieve Increase in Sales: Sales volume is close to the heart of every marketer. Although an increase in sales does not necessarily imply an increase in profitability, however, every firm seems to pursue sales increase as an objective. Sales maximization as an objective is an attempt made to select that price that will generate the highest level of sales-possible for the firm.
Methods of Pricing
Various methods have been used to determine prices of goods or services. Pricing methods are the techniques by which the company decides on how much to sell its products. Three basic methods shall be discussed:
1. Cost-Oriented Pricing
2. Demand Oriented Pricing
3. Competition Oriented Pricing
1. Cost – Oriented Pricing: Cost oriented pricing is very commonly used in Nigeria. With this method, cost is used as a base for determining the price of a product or service. The assumption is that all costs must be covered and some margin added as a reward for doing business.
Retailers, wholesalers and producers set-cost-oriented prices by using either cost-plus, the average cost, target return, long-run target return, break-even, marginal cost or incremental cost pricing.
(a) Cost – plus Pricing: This pricing method assumes that no product is sold at a loss since the price covers the full cost incurred. Definitely costs furnish a good point from which the computation of price could begin. Fixing a tentative price is easier under this method. But the criticism against this policy is that it ignores completely the influences of competition and market demand.
Cost plus pricing are often used by retailers, and manufacturing industries. This method of pricing is based on simple arithmetic adding a fixed percentage to the unit cost. This method is also known as the sum of margins method.
(b) Target Pricing: Another common method used under cost-oriented pricing is known as target pricing. This is invariably adopted by manufacturers who fix a target return on the total cost. Target pricing enables a rate of return on investment to be earned for a standard volume of production, which is the level of production a firm anticipates achieving.
Target return pricing can be determined mathematically by applying: the following formula:
P = AVI + F/X + RK/X
Where P is the selling price to be determined AVC is the average unit variable cost.
F is fixed cost
JC is the standard volume to be produced
R is the target return on investment (%)
K is capital employed or investment cost.
Consider: Average variable cost per unit is N35
Total fixed costs as N250,000
Projected standard volume of production 15,000 units
Target return on investment 50% Total investment costs N300,000
P = N35 + N250,000/15,000 + 0.50 x N300,000/15,000
(c) Break-Even Pricing: The break-even analysis helps a firm to determine at what level of output the revenue will equal the costs assuming a certain selling price. It seek to determine at what price the company will realize the level of profit it has expected. For this purpose the cost of manufacturing is divided into two: fixed costs and variable costs. Fixed costs are: rent, rates, insurance, etc; which remain constant over all levels of output, whereas, variable costs (labour, and material) vary with changes in output level. Fixed costs naturally decrease per unit when production increases. Variable costs, on the other hand change as production varies. That is, no production, no variable cost, more production, more variable costs.
The break-even point therefore, is a point where there is neither loss nor profit. It happens when total sales equals total costs.
Break-even point can be computed in units or Naira sales with the following equations:
Break-even point (units) = Total fixed costs
Margin of contribution
Margin of Contribution = Unit Selling Price – Unit Variable Costs
Break-even point (Naira sales) = Total fixed costs
Margin of contribution
1 – Variable cost (per unit)
To illustrate Break-even point (BEP) Let us assume that:
Fixed cost = N500,000
Variable cost = N250
Unit selling price = N500
Substituting the given values in the equations.
BEP (units) = N 500.000
N500 – N250
= 2.000 units
BEP (Naira sales) = N500.000
1 – N250
(d) Marginal Cost or Incremental Pricing: In this method, the price is fixed on the basis of additional variable cost, associated with an additional unit of output. The last unit is taken as the base for the pricing. The marketing manager must be able to calculate average total cost, marginal cost, and other types of costs to determine a price that results in the maximum profit.
2. Demand – Oriented Pricing: Demand oriented pricing is another method of pricing. The marketing concept stresses the importance of the consumer and no where should the consumer be in sharper focus than in pricing. While the cost -oriented method focuses on the seller, the demand – oriented method is concerned with the customer.
This method of pricing is based on the level of demand .for a product. Price is fixed by adjusting it to the market condition. When demand for a product is intense, high price is charged. Price discrimination is usually adopted under such market situations.
3. Competition Oriented Pricing: Many firms employ this method to meet competition. Companies set prices after $. careful consideration of the competitive price structure. Deliberate policies may be formulated to sell above, below, or generally in line with competition.
Decisions concerning price to be followed for a period of time may be called price policies. A pricing policy is a plan or course of action for achieving pricing objectives. So different pricing policies may be adopted to meet the different long term objectives; There are many pricing policies open to firms. Pricing policies may cover the areas of new product pricing, competitive and economic conditions or realization of pricing objectives.
1. Market Skimming Pricing: Under a skimming pricing policy a high initial price is charged in order to skim the ‘cream’ of the market. The strategy is to exploit product distinctiveness by charging the highest possible price that buyer who most desire the product will pay, and to lower the price when competitors introduce similar brands. Price skimming strategy can provide many benefits: Especially when the product is at the introductory stage of life cycle. It can generate the much needed cash flow to help offset sizeable developmental costs. The policy is a safer one for facing an unknown elasticity of demand.
2. Penetration Pricing: Penetration pricing is a lower price designed to penetrate the market and produce a large volume of sales, gain a large market share quickly. It is possible for a marketer to use penetration policy after price skimming. After gaining entry and a large market share the price is adjusted upwards. Price penetration is useful when a marketer suspects that competitors could enter the market easily. Competitors might be discouraged to enter the market by lowering prices. Thus, entering the market may be less attractive since lower price mean lower profit.
3. Prestige Pricing: Prices are set at artificial high level to provide prestige or quality image. Consumer may also associate quality with high price. Prestige pricing is applied to luxury goods.
4. Leader Pricing: In a competitive market, some big firms assume the role of a leader in pricing. When a small company starts production in such competitive product, it follows the pricing policy of such leader firms. It fixes the prices near their prices which are generally lower than those of their leaders.
This policy is suitable when competitive situation exists in the market. Such pricing is successful when buyers are price conscious.
5. Psychological Pricing: This implies a price set to appeal to the psychology of the consumer. It is believed that the price of a product has an influence on the buyer’s psyche and thus influences his perception of, and behaviour towards, the product. In an attempt-to use these psychological realities to advantages, marketers may adopt a policy of prestige, odd or even pricing. This type of pricing is common at supermarkets and departmental stores where prices are fixed as: N295.00,14995.00, Nl,995.00, etc.
6. Geographic Pricing: One of the basic elements that influence the price of a product or service is place or location of the buyer. Cost of transportation or-delivery has to be covered. Thus the manufacturer sometimes adopt different prices in each area without creating any ill-will among customers.
7. Discriminatory Pricing: This is a policy of charging different prices to different groups of customers. It involves raising the price for some people and lowering it for others. Price discrimination is setting distinct prices to reach different market segments. It can be customer-based, product-based, time-based, or place-based.
8. Sealed Bid Pricing: This method is followed ‘in the case of specific jobs or works. Government contracts are: usually awarded through a system known as tenders. The expenditure anticipated is worked out in detail and the competitors offer a price (known as contract price). The lowest bidder may not get the contract. Some of the criteria often used in supplier selection include the reputation, experience and previous performance of the bidder.
9. Promotional Pricing: Promotional pricing is defined as the setting of a price on a temporary basis below the price normally charged for that commodity or service. The objective is to increase sales by attracting more customers.
10. Price Discount: A discount is the amount that is subtracted from a list price and it is expressed as a percentage of the list price. A discount is made available to channel members and customers for performing certain functions, paying cash, buying large amount, purchasing in off-seasons, or enhancing promotions. Various types of discounts are used to adjust base prices. These are:
(i) Cash discount
(ii) Trade discount
(iii) Quantity discount
(iv) Seasonal discount
(v) Leasing arrangements
Cash Discount: It is a reduction in price as compensation for paying bills before they are due. Or a reduction to buyer that make prompt or cash payment. An example is “2/10 net 30” which means that payment is due within 30 days but the buyer can receive a 2 percent discount if he pays within 10 days from the invoice date.
Trade Discount (Functional Discount): These are given to a certain class of customers because of their functional contribution in moving goods. Trade discount is provided to wholesalers and retailers as a compensation for performing various services. Trade discounts ranges from 5 percent to 30 percent in some traces.
Quantity Discount: This is the most widely used instrument for establishing price variations. It is an offer of a price reduction to buyers who purchase larger volumes. There are two types of quantity discount – cumulative and non-cumulative discounts.
Cumulative discounts are granted on the basis of total purchases over a specified period of time e.g. 2 percent discount to a buyer who purchases at least 100 units of a given commodity per annum.
Non-cumulative discount is a reduction from the base price for those customers buying specified quantities. The aim is to effect some change in the purchase pattern of the buyer; and to satisfy the demands of larger buyers for price concession.
Seasonal Discount: This is a price reduction to buyers who purchase items out of season. It is used to encourage off-peak purchases or advance orders. Seasonal discount allow the seller to maintain steadier production during the year. For example makers of rain coats or umbrella may offer seasonal discounts to retailers that purchase off-season.
Leasing Arrangement: When some products or services are very expensive to buy, leasing arrangements are made to provide such products or services. The buyer pays pre-determined rental fees for services rendered by the product for a specified period of time.
Allowances: Allowances are also reductions in price offered by a seller to a buyer, usually to increase sales.