Responding to Market Changes

There are situations in which a company may need to decrease or increase the price.

i.Initiating Price Cut

There can be following circumstances when a company can cut the price:

•  Excess plant capacity: A company needs more business and the business is not generating even after increased sales efforts, product improvement, and other measures.
•  Declining market share: A company can cut the price if the market share is falling.
•  Dominating the market through lower cost: A company either introduces a product keeping the prices low comparative to other competitors or starts cutting the prices to gain the market share.

But a price cutting strategy can lead to traps like:

•  Low quality trap: A customer assumes that a lower priced product have lower quality.
•  Fragile-market share trap: A customer can shift to other company if offered a low priced product.
•  Shallow pockets trap: A higher priced competitor can cut the price and stay in the market because of having a good financial status.

ii. Initiating Price Increases

Profits may increase if the increase in price is successful. Circumstances that can lead to price increase are:

 Cost Inflation: If the increase in cost doesn't match with the productivity, a company may have fewer profits which can lead to increase in price.
 

Overdemand: As the demand increases it may become difficult to supply all the customers which can lead to increased pricing, rationing supplies to customers,or both. According to Kotler, companies can also respond to higher costs or overdemand without raising prices. The following possibilities can be included:

•  Shrinking the amount of product instead of raising the price.
•  Substituting less expensive materials or ingredients.
•  Reducing or removing product features to reduce cost.l Removing or reducing product services, like installation and free delivery.
•  Using less expensive packaging material or larger package sizes.
•  Reducing the number of sizes and models offered.
•  Creating new economy brands.

iii. Customer's Reaction

Change in price arises many questions in the consumer's mind. A consumer can take a price decrease in several ways:

•  Is the new model of a product coming in the market?
•  Is the product quality is not good because of which the product is not selling leading to reduced price?
•  Will the price come down further?
•  Is the company compromising with the product quality while decreasing the rate?
•  Is the company facing any financial crisis?

Increase in price normally decrease the sales but can have positive impact also.

For example a consumer may think that the new item is in fashion, or provides better quality. Mostly the customers are concerned about the prices if the product cost a lot or is bought frequently. Infrequently bought items price are not necessarily noticed by the customers.

iv. Competitor's reaction

Change in price of a company's product is a cause of worry because the competitor's reaction is unpredictable. Competitors mostly react:

•  If the number of companies are less
•  Buyers have much information about the companies
•  The product is identical.

The two assumptions that can be made to predict the competitor's reaction are:

•  the competitor reacts in a set way to price change
•  Or the price change is taken as a challenge to the competitor

According to Kotler, different interpretations that can be taken by the competitors on a price cut are:

•  The company is trying to steal the market.
•  The company is doing poorly and trying to boost its sales
• The company wants the whole industry to reduce prices to stimulate total demand.

v. Response to Competitor's Price Changes

When the competitor initiates a price cut, a company should consider the following points:

•  What is the reason behind price change by the competitor?
• Is the price change permanent or temporary?
•  What will happen to the company if the change in price will not take effect? Are other companies will respond to price change?
•  What will be the reaction of other competitors and firms?

A price reaction program is used if a competitor cuts the prices. According to Kotler, reaction programs for meeting price changes find their greatest application in industries where price changes occur with some frequency and where it is important to react quickly. below Fig shows a price reaction program.

Selecting the Final Price

Pricing methods help business to find out the final price. Other factors that help to set the final price are:

•  Psychological pricing
•  The influence of other Marketing-Mix elements
•  Company pricing policies
•  Impact of price on other parties.

Let us discuss each of them one by one.

i.Psychological Pricing

Many consumers feel high priced product offers high quality. If a consumer knows about the quality features of a product, price plays a less significant role in comparison to quality. When a consumer thinks of buying a product they keep some budget in the mind which is decided by the past prices, current prices, or the buying situation. Mostly high priced product is thought of to have a high quality. So at times increasing the rates of a product increases the sales also.

ii. The influence of other Marketing Mix Elements

The final price of a product depends on the other marketing mix elements also like the advertising, brand name etc.

iii. Company Pricing Policies

The price of any product set should be decided according to the company's pricing policies. In many companies a pricing department is set up to make sure that product price should be reasonable for the customers, and that should give profit to the company also.

iv. Impact of Prices on Other Parties

According to Kotler, Management must also consider the reactions of other parties to the contemplated price.

•  How will distributors and dealers feel about it?
• Will the sales force be willing to sell at that price?
•  How will competitors react?
• Will suppliers raise their prices when they see the company's price?
•  Will the government intervene and prevent this price from being charged? - In this case the marketers should know the laws regulating prices.

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.

Setting the Price/Quality/Value Equation

Value of a product or service in the mind of consumer is a function of perceived
quality of the product, perceived positioning of the product, perceived quality and positioning of competing products, and the difference in price of competing
products.
 

i.Differentiate Between Price and Value

Consumers may compare price of a company's product and the competing product and also compare the perceived difference in product quality to decide which products offers a better value to them. In products, where consumer has much alternative choice, the winning companies are striving hard to offer best value to the consumer. In the new products, the companies can charge high price until the consumers have enough choices to derive price-quality equation. For example - in ice-creams, Amul is perceived to be offering better value to consumer as it is perceived to be of better quality and lower price as compared to Walls or Mother Dairy etc. In Mumbai, an ice-cream brand called Naturals is able to charge a higher price and consumers are willing to pay the price. This is because the brand offers ice-creams with flavors of seasonal fruits and there is no competing brand with that positioning.

Offering best value on sustainable basis requires companies to reengineer their processes and build capabilities that can reduce the   cost and increase value for the consumer. Companies resorting to sales and promotion activities are the only means to offer value to the consumer, but may not be able to do it on long-term basis. In USA, a retail chain called Wal-Mart pioneered the concept of Every Day Low Prices (EDLP). Under this approach, the chain sells most of the brands at fairly low price on everyday basis. To offer such a value to consumer, Wal-Mart had to invest heavily in redesigning its logistics management, renegotiate prices with suppliers, and cut down on inventory. In a similar example - in India,Amul has developed a highly efficient milk procurement system wherein Amul provides technical assistance of milk producers and buys milk from them. Thesemilk producers are also the owners of Amul and the profit of Amul is distributed amongst them in form of higher milk prices.

ii. Relation Between Price and Value

Price of a product is determined by its value to the consumer. The phrase "you get what you pay for" is very common, but it's not always true. Sometimes you get much less than what you pay for, sometimes you get more than what you pay for, and sometimes you exactly what you pay for. Relation between price, quality and value can be defined as:

Value = Quality / Price

If the value comes to more than 1 then the product is good, if the value is less than 1 product is not at the satisfactory level, and when the value is equals to 1 the product is satisfactory.

Analyzing Competitor's Prices and Offers

Price of any product is determined by the demand of the market and the company'scost. A company should consider competitor's pricing, cost and possible reaction of the consumers to the price before pricing the product. A company should keep a track on the competitor's prices and the offers. There can be any of the three possibilities a company has to be taken care of i.e.

•  If a company's offer is similar to the competitor's offer, then the pricing should also be almost similar to the competitor's pricing.
•  If a company's offer is not up to the competitor's offer, then the company should keep the product pricing low.
•  If a company's offer is better than the competitor's offer the company can keep a price higher than the competitor's price.

Estimating Costs

For any company, planning is important, and budgeting is one of the important aspects of planning. Estimating a cost of product properly is essential for any company. Cost of any product increases if the demand of the product is more.

Cost of any product includes:

•  Production cost
•  Distribution and selling cost
•  Risk cost.

i.Types of Cost:

Cost is how much a company spends on a product to make it available to the end-user. There are two types of costs: fixed cost and variable cost.

i) Fixed Cost: Fixed cost does not change with production or profits, which means a cost which is fixed for any company to occur. It includes payment of bills for rent, electricity, salaries of the employees; interest etc. all this is must for a company to pay regardless of the output.

ii) Variable Cost: Variable cost varies with the number of unit produced by a company. For one unit the cost is fixed but the cost for a company varies as the number of unit varies. For e.g. for a milk pouch the cost of milk and packaging cost is fixed however depending on the number of milk pouches the cost changes.The other costs are Total cost and Average cost. Total cost is the sum of fixed and variable cost for any specified level of production.

Total cost = Fixed cost + Variable cost

Average cost is the cost per unit at the specified level of production. Average cost is equal to the total cost divided by the production cost.

Average cost = Total cost / Production

ii. Correlation Between Costs and Production Cycle 

Cost of any product is correlated with its scale of production. As the scale of
production increases, the fixed costs are allocated over more units of the product and also the production learning is embedded into the process thereby reducing variable cost per unit of the product. For example, Amul and Nestle launched packed curd in the market. In the initial stages itself Amul captured higher market share i.e., started selling more units of packed curd. This led to reduced cost of packaging per unit of curd and also reduced transportation cost per unit. While for Nestle the profitability of packed curd was reducing as the cost of production was high and the sales was declining. This led to Amul further increasing its market share.

iii. Target Costing

Target costing is a method by which a company determines the ways to achieve the success by planning the services provide, designing the products, processes and related cost structures that provide value to the customer. Cost of a product changes with the production, which can further be reduced by careful planning of the managers, engineers, and agents. The steps involved in Target costing method are shown in below fig.

The objective behind performing these steps is to find out whether the final cost comes in the target costing range. If it does not in that case a company may take the decision of not entering into that product market as the company will not earn profit in that case.