Methods of pricing

1. Cost-based Pricing

Cost-based pricing refers to a pricing method in which some percentage of desired profit margins is added to the cost of the product to obtain the final price. In other words, cost-based pricing can be defined as a pricing method in which a certain percentage of the total cost of production is added to the cost of the product to determine its selling price. Cost-based pricing can be of two types, namely, cost-plus pricing and markup pricing.

These two types of cost-based pricing are as follows:

A) Cost-plus Pricing

Refers to the simplest method of determining the price of a product. In cost-plus pricing method, a fixed percentage, also called mark-up percentage, of the total cost (as a profit) is added to the total cost to set the price. For example, XYZ organization bears the total cost of Rs. 100 per unit for producing a product. It adds Rs. 50 per unit to the price of product as’ profit. In such a case, the final price of a product of the organization would be Rs. 150.

Cost-plus pricing is also known as average cost pricing. This is the most commonly used method in manufacturing organizations.

In economics, the general formula given for setting price in case of cost-plus pricing is as follows:

P = AVC + AVC (M)

AVC= Average Variable Cost

M = Mark-up percentage

AVC (m) = Gross profit margin

Mark-up percentage (M) is fixed in which AFC and net profit margin (NPM) are covered.

AVC (m) = AFC+ NPM

For determining average variable cost, the first step is to fix prices. This is done by estimating the volume of the output for a given period of time. The planned output or normal level of production is taken into account to estimate the output.

The second step is to calculate Total Variable Cost (TVC) of the output. TVC includes direct costs, such as cost incurred in labor, electricity, and transportation. Once TVC is calculated, AVC is obtained by dividing TVC by output, Q. [AVC= TVC/Q]. The price is then fixed by adding the mark-up of some percentage of AVC to the profit [P = AVC + AVC (m)].

The advantages of cost-plus pricing method are as follows:

• Requires minimum information

• Involves simplicity of calculation

• Insures sellers against the unexpected changes in costs

The disadvantages of cost-plus pricing method are as follows:

• Ignores price strategies of competitors

• Ignores the role of customers

B) Markup Pricing

Refers to a pricing method in which the fixed amount or the percentage of cost of the product is added to product’s price to get the selling price of the product. Markup pricing is more common in retailing in which a retailer sells the product to earn profit. For example, if a retailer has taken a product from the wholesaler for Rs. 100, then he/she might add up a markup of Rs. 20 to gain profit.

It is mostly expressed by the following formulae:

• Markup as the percentage of cost= (Markup/Cost) *100

• Markup as the percentage of selling price= (Markup/ Selling Price)*100

• For example, the product is sold for Rs. 500 whose cost was Rs. 400. The mark up as a percentage to cost is equal to (100/400)*100 =25. The mark up as a percentage of the selling price equals (100/500)*100= 20.

2. Demand-based Pricing

Demand-based pricing refers to a pricing method in which the price of a product is finalized according to its demand. If the demand of a product is more, an organization prefers to set high prices for products to gain profit; whereas, if the demand of a product is less, the low prices are charged to attract the customers.

The success of demand-based pricing depends on the ability of marketers to analyze the demand. This type of pricing can be seen in the hospitality and travel industries. For instance, airlines during the period of low demand charge less rates as compared to the period of high demand. Demand-based pricing helps the organization to earn more profit if the customers accept the product at the price more than its cost.

3. Competition-based Pricing

Competition-based pricing refers to a method in which an organization considers the prices of competitor’s products to set the prices of its own products. The organization may charge higher, lower, or equal prices as compared to the prices of its competitors.

The aviation industry is the best example of competition-based pricing where airlines charge the same or fewer prices for same routes as charged by their competitors. In addition, the introductory prices charged by publishing organizations for textbooks are determined according to the competitor’s prices.

4. Other Pricing Methods

In addition to the pricing methods, there are other methods that are discussed as follows:

A) Value Pricing

Implies a method in which an organization tries to win loyal customers by charging low prices for their high- quality products. The organization aims to become a low cost producer without sacrificing the quality. It can deliver high- quality products at low prices by improving its research and development process. Value pricing is also called value-optimized pricing.

B) Target Return Pricing

Helps in achieving the required rate of return on investment done for a product. In other words, the price of a product is fixed on the basis of expected profit.

C) Going Rate Pricing

Implies a method in which an organization sets the price of a product according to the prevailing price trends in the market. Thus, the pricing strategy adopted by the organization can be same or similar to other organizations. However, in this type of pricing, the prices set by the market leaders are followed by all the organizations in the industry.

D) Transfer Pricing

Involves selling of goods and services within the departments of the organization. It is done to manage the profit and loss ratios of different departments within the organization. One department of an organization can sell its products to other departments at low prices. Sometimes, transfer pricing is used to show higher profits in the organization by showing fake sales of products within departments.

Types of Pricing

1. Market-Skimming Pricing

Many companies that invent new products set high initial prices to "skim" revenues layer by layer from the market. Sony frequently uses this strategy, called market-skimming pricing (or price skimming). When Sony introduced the world's first high-definition television (HDTV) to the Japanese market in 1990, the high-tech sets cost $43,000. These televisions were purchased only by customers who really wanted the new technology and could afford to pay a high price for it. Sony rapidly reduced the price over the next several years to attract new buyers. By 1993 a 28-inch HDTV cost a Japanese buyer just over $6,000. In 2001, a Japanese consumer could buy a 43-inch HDTV for about $2,000, a price that many more customers could afford. As entry-level HDTV set now sells for less than $500 in the United States, and prices continue to fall. In this way, Sony skimmed the maximum amount of revenue from the various segments of the market.

Market skimming makes sense only under certain conditions.

•  The prod­uct's quality and image 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.

2. Market-Penetration Pricing

Rather than setting a high initial price to skim off small but profitable market seg­ments, some companies use market-penetration pricing. They set a low initial price in order to penetrate the market quickly and deeply—to attract a large number of buyers quickly and win a large market share. The high sales volume results in falling costs, allowing the companies to cut their prices even further. For example Dell used penetration pricing to enter the personal computer market, selling high-quality computer products through lower-cost direct channels. Its sales soared when HP, Apple, and other competitors selling through retail stores could not match is prices. And Bank Alfalah Limited used penetration pricing for its credit cards to boost its success in the highly competitive credit-card market in Pakistan.

  Several conditions must be met for this low-price strategy to work.

• The market must be highly price sensitive 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 pricer must maintain its low-price position—otherwise, the price advantage may be only temporary.

3. Product Line Pricing

Companies usually develop product lines rather than single products. For example, Samsonite offers some 20 different collections of bags of all shapes and sizes at prices that range from under $50 for a Sammie's child's backpack to more than $1,250 for a bag from its Black Label Vintage Collection. In product line pricing, management must decide on the price steps to set between the various products in a line.

    The price steps should take into account cost differences between the products in the line. More importantly, they should account for differences in customer perceptions of the value of different fea­tures. For example, Bata offers an entire range of footwear in India, from the premium European Collection and Hush Puppies brands that are priced at about Rs. 2,499 to ordinary leather shoes for Rs. 749. Bata also has a collection of chappals and sandals. For women, it offers a wide range of footwear, from fashionable footwear for parties to the regular ones for everyday use. The children's section has several varieties for children of different age groups and at various prices, from economy to premium.

4. Optional-Product Pricing

Many companies use optional-product pricing—offering to sell optional or accessory products, with their main product. For example, a car buyer may choose to order a GPS navigation system, Bluetooth wireless communication. Refrigerators come with optional ice makers. And when you order a new PC, you can select from a bewildering array of hard drives, docking systems, software options, service plans, and carrying cases.

Pricing these options is a sticky problem. Automobile companies must decide which items to include in the base price and which to offer as options. Until recent years, General Motors' normal pricing strategy was to advertise a stripped-down model at a base price to pull people into showrooms and then to devote most of the showroom space to showing option-loaded cars at higher prices. The economy model was stripped of so many comforts and conveniences that most buyers rejected it. Then, GM and other U.S. automakers followed the examples of the Japanese and German companies and included, in the sticker price many useful items previously sold only as options. Thus, most advertised today represent well-equipped cars.

5. Captive-Product Pricing

Companies that make products that must be used along with a main product are using captive product pricing. Examples of captive products are razor blade cartridges, video games, and printer cartridges. Producers of the main products (razors, video game consoles, and printers) often price low and set high markups on the supplies. For example, Gillette sells low-priced razors but makes money on the replacement cartridges. You can buy a Gillette Mach3 razor”  with a replacement cartridge and storage case for under Rs. 200. But you've bought the razor, you're committed to buying replacement cartridges at about Rs. 750 an eight-pack. Companies that use captive-product pricing must be careful—consumers trapped into buying expensive supplies come to resent the brand that ensnared them.

6. By-Product Pricing

Producing products and services often generates by-products. If the by-products have no value and if getting rid of them is costly, this will affect the pricing of the main product. Using by-product pricing, the company seeks a market for these by-products to help offset the costs of disposing of them and to help make the price of the main product more competi­tive. The by-products themselves can even turn out to be profitable. For example, papermaker MeadWestvaco in the United States has turner what was once considered chemical waste into profit-making products.

MeadWestvaco created a separate company, Asphalt Innovations, which creates useful chemicals entirely from the by-products of Mead Westvaco’s wood-processing activities.  In fact, Asphalt Innovations has grown to become the world's biggest supplier of specialty paving industry. Using the salvaged chemicals, paving companies can pave roads at lower temperature, create longer-lasting roads, and more easily recycle road materials when roads need to be replaced. What's more, salvaging the by-product chemicals eliminates the costs and environmental hazards once associated with disposing of them.

7. Product Bundle Pricing

Using product bundle pricing, sellers often combine several of their products and offer the bun­dle at a reduced price. For example, fast-food restaurants bundle a burger, fries, and a soft drink at a "combo" price. Resorts sell specially priced vacation packages that include airfare, accommoda­tions, meals, and entertainment. Price bundling can promote the sales of products consumers might not otherwise buy, but the combined price must be low enough to get them to buy the bundle.

8. Discount and Allowance Pricing

Most companies adjust their basic price to reward customers for certain responses, such as early pay­ment of bills, volume purchases, and off-season buying. These price adjustments—called discounts and allowances—can take many forms.

The many forms of discounts include a cash discount, a price reduction to buyers who pay their bills promptly. A typical example is "2/10, net 30," which means that although payment is due within 30 days, the buyer can deduct 2 percent if the bill is paid within 10 days. A quan­tity discount is a price reduction to buyers who buy large volumes. Such discounts provide an incentive to the customer to buy more from one given seller, rather than from many different sources.

A functional discount (also called a trade discount) is offered by the seller to trade-channel members who perform certain functions, such as selling, storing, and record keeping. A sea­sonal discount is a price reduction to buyers who buy merchandise or services out of season. For example, lawn and garden equipment manufacturers offer seasonal discounts to retailers dur­ing the fall and winter months to encourage early ordering in anticipation of the heavy spring and summer selling seasons. Seasonal discounts allow the seller to keep production steady during an entire year.

Allowances are another type of reduction from the list price. For example, trade-in allowances are price reductions given for turning in an old item when buying a new one. Trade-in allowances are most common in the automobile industry but are also given for other durable goods. Promotional allowances are payments or price reductions to reward dealers for participating in advertising sales support programs.

9. Segmented Pricing

Companies will often adjust their basic prices to allow for differences in customers, products, and locations. In segmented pricing, 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.

Segmented pricing takes several forms. Under customer-segment pricing, different customers pay different prices for the same product or service. Museums, for example, may charge a lower admission for students and senior citizens. Under product-form pricing, different versions of the product are priced differently but not according to differences in their costs. For instance, a 1-liter bottle of mineral water may cost Rs. 13 at your local supermarket. A 5-liter bottle of the same mineral water brand sells for a suggested retail price of Rs. 55, and its half-liter easy-to-carry bottle is available at about Rs. 10. The water is all from the same source, but the price varies disproportionately with the quantity.

Using location pricing, a company charges different prices for different locations, even though the cost of offering each location is the same. For instance, theaters vary their seat prices because of audience preferences for certain locations and state universities charge higher tuition for out-of-state students. Finally, using time pricing, a firm varies its price by the season, the month, the day, and even the hour. Some public utilities vary their prices to commercial users by time of day and weekend versus weekday. Resorts give weekend and seasonal discounts.

For segmented pricing to be an effective strategy, certain conditions must exist. The market must be segmentable, and the segments must show different degrees of demand. The costs of segmenting and watching the market cannot exceed the extra revenue obtained from the price difference. Of course, the segmented pricing must also be legal.

Most importantly, segmented prices should reflect real differences in customers' perceived value. Consumer in higher price tiers must feel that they're getting their extra money's worth for the higher prices paid. By the same token, companies must be careful not to treat customer lower price tiers as second-class citizens. Otherwise, in the long run, the practice will lead to customer resentment and ill will. For example, in recent years, the airlines have incurred the wrath of frustrated customers at both ends of the airplane. Passengers paying full fare for business or first class seats often feel that they are being gouged. At the same time, passengers in lower-priced coach seats feel that they're being ignored or abused.

10. Psychological Pricing

Price says something about the product. For example, many consumers use price to judge quality. A bottle of perfume that costs Rs. 4,000 may contain only Rs. 400 worth of scent, but some people are willing to pay the Rs. 4,000 because this price indicates something special.

In using psychological pricing, sellers consider the psychology of prices and not simply the economics. For example, consumers usually perceive higher-priced products having higher quality. When they can judge the quality of a product by examining it or by calling on past experience with it, they use price less to judge quality. But when cannot judge quality because they lack the information or skill, price become an important quality signal.

Another aspect of psychological pricing is reference prices—prices that buyers carry in their minds and refer to when looking at a given product. The reference price might be formed by noring current prices, remembering past prices, or assessing the buying situation. Sellers can influence or use these consumers' reference prices when setting price. For example, a company could display its product next to more expensive ones in order to imply that it belongs in the same class. Department stores often sell women's clothing in separate departments differentiated by price: Clothing found in the more expensive department is assumed to be of better quality.

For most purchases, consumers don't have all the skill or information they need to figure out whether they are paying a good price. They don't have the time, ability or inclination to research different brands or stores, compare prices, and get the best deals. Instead, they may rely on certain cues that signal whether a price is high or low. Interestingly, such pricing cues are often provided by sellers.

11. Promotional Pricing

With promotional pricing, companies will temporarily price their products below list price and sometimes even below cost to create buying excitement and urgency. Promotional pricing takes several forms. A seller may simply offer discounts from normal prices to increase sales and reduce inventories. Sellers also use special event pricing in certain seasons to draw more customers. Thus, the last night of the year offers an opportunity to many marketers to create special events to draw more customers.  Essel World offers a number of attractions and special events to attract more vis­itors on 31 December every year. Linens are promotionally priced every January to attract weary Christmas shoppers back into stores. Manufacturers sometimes offer cash rebates to consumers who buy the product from dealers within a specified time; the manufacturer sends the rebate directly to the customer. Rebates have been popular with automakers and producers of durable goods and small appliances, but they are also used with consumer-packaged goods. A Many retailers, such as the Future Group, organize "shopping festivals" that offer lucrative assured gifts to shoppers who shop at their retail outlets during given periods. Gul Ahmed Textile offers promotional prices to create buying excitement and urgency. Some manufacturers offer low-interest financing, longer war­ranties, or free maintenance to reduce the consumer's "price." This practice has become another favorite of the auto industry.

Promotional pricing, however, can have adverse effects. Used too frequently and copied by competitors, price promotions can cre­ate "deal-prone" customers who wait until brands go on sale before buying them. Or, constantly reduced prices can erode a brand's value in the eyes of customers. Marketers sometimes become addicted to promotional pricing, using price promotions as a quick fix instead of sweating through the difficult process of developing effective longer-term strategies for building their brands. The use of promotional pricing can also lead to industry price wars. Such price wars usually play into the hands of only one or a few competitors— those with the most efficient operations. For example, in the face of intense competition with Intel, computer chip maker Advanced Micro Devices (AMD) began to aggressively reduce its prices. Intel retaliated with even lower prices. In the resulting price war, AMD has seen its margins and profits skid against those of its larger rival.10 The point is that promotional pricing can be an effective means of generating sales for some companies in certain circumstances. But it can be damaging for other companies or if taken as a steady diet

12. Geographical pricing

   A company also must decide how to price its products for customers located in different parts of the country or world. Should the company risk losing the business of more-distant customers  by charging them higher prices to cover the higher shipping costs? Or should the company change all cus­tomers the same prices regardless of location? We will look at five geographical pricing strategies

For the following hypothetical situation:

A paper-product company is located in Mumbai, India, and sells paper products to customers all over India. The cost of freight is high and affects the companies from whom customers buy their paper. The company wants to establish a geographical pricing policy. It is trying to determine how to price a Rs. 1,000,000 order to three specific customers: Customer A (Mumbai), Customer B (Bangalore), and Customer C (Kolkata).

One option is for the company to ask each customer to pay the transportation cost from the Mumbai factory to the customer's location. All three customers would pay the same factory price of Rs. 1,000,000, with Customer A paying, say, Rs. 10,000 for shipping; Customer B, Rs. 15,000; and Customer C, Rs. 25,000. Called FOB-origin pricing, this practice means that the goods are placed free on board (hence, FOB) a carrier at a specified place. At that point the title and responsibility pass to the customer, who pays the freight from the factory to the destination. Because each customer picks up its own cost, supporters of FOB pricing feel that this is the fairest way to access freight charges. The disadvantage, however, is that the company will be a high-cost firm to distant customers.

Uniform-delivered pricing is the opposite of FOB pricing. Here company charges the same price plus freight to all customers, regardless of their location. The freight charge is set at the average freight cost. Suppose this is Rs. 15,000. Uniform-delivered pricing therefore results in a higher charge to the Mumbai customer (who pays Rs. 15,000 instead of Rs. 10,000) and a lower charge to the Kolkata customer (who pays Rs. 15,000 instead on Rs. 25,000). Although the Mumbai customer would prefer to buy paper from another local paper company that uses FOB-origin pricing, the company that uses uniform-delivered pricing has a better chance of winning over the Kolkata customer. Other advantages of uniform-delivered pricing are that it is fairly easy to administer and it lets the firm advertise its price nationally.

    Zone pricing falls between FOB-origin pricing and uniform delivered pricing. The company sets up two or more zones. All customers within a given zone pay a single total price; the more distant the zone, the higher the price. For example, the paper-product company might set up an East Zone and charge Rs. 25,000 freight to all customers in this zone, a Midwest Zone in which it charges Rs. 15,000, and a West Zone in which it charges Rs. 10,000. In this way, the customers within a given price zone receive no price advantage from the company. For example, customers in Mumbai and Ahmedabad, being in the West Zone, pay the same total price to the company. The complaint, however, is that the Mumbai customer is paying part of the Ahmedabad customer's freight cost.

Using basing-point 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. For example, the company might set Nagpur, which is center of the country, as the basing point and charge all customers Rs. 10,000 plus the freight Nagpur to their locations. This means that a Mumbai customer pays the freight cost from Nagpur to Mumbai, even though the goods may be transported from Mumbai. If all sellers used the same basing-point city, delivered prices would be the same for all customers and price competition would be eliminated. Industries such as sugar, cement, steel, and automobiles used basing-point pricing for years, but this method has become less popular today. Some companies set up multiple basing points to create more flexibility: They quote freight charges from the basing-point city that is nearest to the customer.

Finally, the seller who is anxious to do business with a certain customer or geographical might use freight-absorption pricing. Using this strategy, the seller absorbs all or part of the actual freight charges in order to get the desired business. The seller might reason that if it can gain more business, its average costs will fall and more than compensate for its extra freight cost. Freight-absorption pricing is used for market penetration and to hold on to increasingly competitive markets.

13. Dynamic pricing

Throughout most of history, prices were set by negotiation between buyers and sellers. Fixed price policies—setting one price for all buyers—is a relatively modern idea that arose with the develop­ment of large-scale retailing at the end of the nineteenth century in the United States. Today, most prices are set this way. However, some companies are now reversing the fixed pricing trend. They are using dynamic pricing—adjusting prices continually to meet the characteristics and needs of individual customers and situations.

For example, think about how the Internet has affected pricing. From the mostly fixed pricing prac­tices of the past century, the Web seems now to be taking us back—into a new age of fluid pricing. The flex­ibility of the Internet allows Web sellers to instantly and constantly adjust prices on a wide range of goods based on demand dynamics. In many cases, this involves regular changes in the prices that Web sellers set for their goods. In others, such as eBay or Priceline, consumers negotiate the final prices they pay. Still other companies customize their offers based on the characteristics and behaviors of specific customers.

Dynamic pricing offers many advantages for marketers. For example, Internet sellers such as Amazon.com can mine their databases to gauge a specific shopper's desires, measure his or her means, and instantaneously tailor products to fit that shopper's behavior, and price products accordingly.

Many direct marketers monitor inventories, costs, and demand at any given moment and adjust prices instantly. For example, Dell uses dynamic pricing to achieve real-time balancing of supply and demand for computer components. By raising prices on components in short supply and dropping prices for oversupplied items, Dell actually reshapes demand on the go to meet supply conditions.

Dynamic pricing can also be controversial. Most customers would find it galling to learn that the person in the next seat on that flight from Kolkata to Mumbai paid 10 percent less just because he or she happened to call at the right time or buy through the right sales channel. Amazon.com learned this some years ago when it experimented with lowering prices to new customers in order to woo their business. When regular customers learned through Internet chatter that they were paying generally higher prices than first-timers, they protested loudly. An embarrassed Amazon.com halted the experiments.

Dynamic pricing makes sense in many contexts—it adjusts prices according to market forces, and it often works to the benefit of the customer. But marketers need to be careful not to use dynamic pricing to take advantage of certain customer groups, damaging important customer rela­tionships.

14. International Pricing

Companies that market their products internationally must decide what prices to charge in different countries in which they operate. In some cases, a company can set a uniform world-wide price. For example, Boeing sells its jetliners at about the same price everywhere, whether in the United States, Europe, or a third-world country. However, most companies adjust their prices to reflect local market conditions and cost considerations.

The price that a 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. Consumer perceptions and preferences also may vary from coun­try to country, calling for different prices. Or the company may have different marketing objectives in various world markets, which require changes in pricing strategy. For example, Samsung might introduce a new product into mature markets in highly developed countries with the goal of quickly gaining mass-market share—this would call for a penetration-pricing strategy. In contrast it might enter a less-developed market by targeting smaller, less price-sensitive segments; in case, market-skimming pricing makes sense.

Costs play an important role in setting international prices. Travelers abroad are often surprised to find that goods that are relatively inexpensive at home may carry outrageously higher price in other countries. A pair of Levi's selling for $30 in the United States might go for $63 in Tokyo and $88 in Paris. A McDonald's Big Mac selling for a modest $3.50 in the United States might cost S7.50 in Reykjavik, Iceland, and an Oral-B toothbrush selling for $2.49 in the United States may cost $10 in China. Conversely, a Gucci handbag going for only $140 in Milan, Italy, might fetch $240 in the United States. In some cases, such price escalation may result from differences in selling strategies or market conditions. In most instances, however, it is simply a result of the higher costs of selling in another country—the additional costs of product modifications, shipping and insurance, import tariffs taxes, exchange-rate fluctuations, and physical distribution.

References 

• http://kalyan-city.blogspot.in/2010/05/marketing-marketing-mix-4-ps-of.html

• http://marketingmix.co.uk/

• http://www.tutor2u.net/business/reference/marketing-mix-basic-4ps

• http://www.marketing91.com/marketing-mix-4-ps-marketing/

• http://www.marketing91.com/marketing-mix-duracell/

• https://www.thebalance.com/marketing-mix-what-is-it-and-how-to-use-it-1794425

• https://www.businessstudynotes.com/marketing/principle-of-marketing/product-classification-categories-of-products/

• https://www.toppr.com/guides/business-studies/marketing/product/

• https://www.marketing91.com/importance-marketing-mix/