Selecting a Pricing Method

According to Kotler, a company should consider following factors before setting the final price or selecting the pricing method:

•  Product's demand curve
•  Product's cost structure
•  Competitor's price

Companies select a pricing method based on one or more of these considerations.

Given below are different price-setting methods.

i.Cost Plus Pricing

This is the most elementary method of setting up a price. Under this method, the company adds a profit margin to the cost of production and decides the price.The cost of production includes variable and fixed cost per unit of the product.Profit margin is generally higher in: seasonal products, products with inelastic demand and products which are slow moving (to cover risk of not selling). For example, the expected profit margin on ice-cream is higher than on loose milk as ice-cream is seasonal and there is risk of not selling it enough during off-season.

Other example is, the dairy unit procures milk from farmers, does some elementary processing in its processing unit, and transports it to market for final sales. Therefore,cost is added on actual and marginal profit is taken on the basic cost.

Variable cost: Procurement price paid to the farmer (Rs 10/ liter)

Fixed cost: Rent of the processing unit, transportation cost, manpower cost etc(Rs 15000/ month)

The dairy unit is expecting to sell 15000 liter per month. In such case, the fixed cost per liter is Rs 1 and variable cost is Rs 10. Therefore, the total cost of production is Rs 11. Suppose the unit wants to retain a profit margin of 27%. The final price would be: Cost of production / (1-desired profit margin) = 11 / 0.73 =Rs 14

Thus, the final price would be Rs 14/ liter.

As we can notice, with increase in sale of milk the fixed cost per liter decreased and the unit could earn higher profit margin or could reduce the price and maintain the same profit margin.

ii. Target Return Pricing
According to Kotler, in target return pricing a company decides the targeted return on capital invested in the business and then sets the price which would yield targeted return. For example, a diary units producing packed milk has invested Rs 10 lacs in the business and is targeting 20% return. The dairy unit estimates to sell about 50,000 units of milk packs in a year and the cost of production (fixed and variable both) per unit is Rs 15. Therefore to target a return of 20%,the unit would set the price as follows:

Targeted price = (Cost of production + (Capital invested × Targeted return ))/Estimatesd sales per year

= 15 + (10, 000, 00 × 0.2) / 50,000

= 15 + 4 = 19

Thus the dairy unit would set the price at Rs. 17 per unit of milk.

In case the actual sale is lower than the estimated, the actual return on investment would be lower and vice-versa. In products where competition is high and a company is using target return pricing, the company has to focus on reducing the capital invested in the business so that it is able to achieve targeted return despite reduction in price.

iii. Value Based Pricing

In value based pricing, the company offers a low price for a high quality product.To use this method, the company has to reengineer its production processes to reduce the cost of production such that it is able to pass the saving in cost of production to consumers on a sustainable basis. This approach creates a long- term competitive advantage for the company.

iv. Perceived Value Pricing

In this approach, the company tries to estimate the price the buyers would be willing to pay for the perceived value of the product. A company builds up the perceived value of the product through innovative use of advertising and sales promotion. This approach is most commonly used in high end products like perfumes, cars, designer clothes, jewelry, and watches etc.

v. Competitive or Going Rate Pricing

In this approach, the company sets the price very close to the price charged by the competitor. This approach is used in mature products where creating differentiation is difficult. This is quite a popular method of pricing which assumes that the price charged by competitor is a fair price and could leave some profit for the company. For example, when Mother Dairy launched packed milk in Mumbai, it set the price at the same level as that charged by Amul.

vi. Promotional Pricing
Companies use promotional pricing to drive various sales objectives. Some of these are given below:

 Buy One Get One Free: Companies offers the same product or some other product of the company to consumers if they buy their product. The objective here could be to induce trial of other product of the company, clear inventories and prevent consumer trying product of competing companies. For example,Amul uses this technique often with ice-creams. It gives a 500 gms pack of the same flavour or any other flavour free on purchase of one 500 gm pack.

 Cash Rebates: Companies use this technique to induce purchase during a specific period of time. Rebates can also help clear inventories without reducing the stated list price of the product.
 

 Special Event Pricing: Companies offer low prices, extended warranties etc.during a specific period of the year. The objective here is to cash on the preparedness of the consumer to spend during that period. Companies use this technique during festive season like Diwali by offering low prices or some promotional offers etc.

vii. Discriminatory Pricing

Companies can charge different price for the same product for different customer segments. Companies use positioning, packaging, and product information about the competitive landscape to differentiate the pricing. According to Kotler,Discriminatory pricing occurs when a company sell same product at two or more prices. They do not reflect a proportional difference in cost.

Differential pricing can be offered in several forms:

 Image pricing: Companies can position the same product differently to charge different pricing. Companies making perfumes use this technique very often.
 

 Product form: Different versions of the same product are priced differently but not in proportion to the definite cost structure. For example, Amul sells packed milk at Rs. 17 per litre and flavoured milk at 45-50 Rs. per litre.
 

 Location pricing: Companies sell same product differently at different locations even though the cost of offering the product is same at different locations. For example, Consumer durable companies use this technique very often while pricing the same products in different countries.