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Transcript
Pricing policy What is price? • Market value, or agreed exchange value, that will purchase a definite quantity, weight, or other measure of a product or service. • The sum or amount of money at which a good or service is valued. • As the consideration given in exchange for transfer of ownership, price forms the essential basis of commercial transactions. • Price denotes what (1) a buyer is willing to pay, (2) a seller is willing to accept, and (3) the competition is allowing to be charged. Price and marketing objectives Some of the common broad based objectives are: • Increase market share • Increase sales • Increase profit • Combat competition • Project a particular image Pricing objectives (Focussed) • • • • • • • • • • Maximize long run profit Maximize short run profit Growth Discourage new entrants Enhance image of the firm and its products Create interest and excitement about its product Maintain price leadership Discourage others from cutting prices Desensitise customers to price Be regarded as “fair” by customers Major factors influencing price • The price of a product or service is the outcome of the interaction between the demand for the product/service and its supply • The three influencers on demand and supply are • Customers • Competitors • Cost Major factors influencing price Customers influence prices through their effect on demand. Customers •Perceive Quality from price. •Have a rough estimate of price in their mind Unexpectedly low price triggers fears that the product may be of low quality Unexpectedly high price make buyers doubt the worth of the product Major factors influencing price Competitors influence prices through their actions. • Alternative or substitute products of a competitor may affect demand and force a business to lower its prices. • Fluctuations in the exchange rates of different countries’ currencies also affect pricing decisions. Major factors influencing price Costs influence prices because they affect supply. • The lower the cost relative to the price, the greater the quantity of product the company is willing to supply. Other factors influencing price ??? Whether price should be based on marketing or cost considerations ??? Whether price should be based on marketing or cost considerations Relative importance of marketing and cost considerations Parameters Marketing considerations Finance & Cost considerations Time-frame Short and medium term Medium and long term Market condition Buyer’s market; intense competition Seller’s market; competition not so intense Primary marketing objective profitability Market share Consumer Impulsive, erratic, buying behaviour irrational Product characteristics Stable, predictable, rational When subjective features When objective features are predominant are predominant (perceived attributes) (physical attributes) Pricing based on mktg considerations • • • • • • • • • Penetration Pricing Skimming pricing Value pricing Loss Leader Psychological Pricing Going Rate (Price Leadership) Tender Pricing Price Discrimination Predatory Pricing Penetration Pricing • • • • Price set to ‘penetrate the market’ ‘Low’ price to secure high volumes. Typical in mass market products Suitable for products with long anticipated life cycles • May be useful if launching into a new market Example: Hotel Rooms, Promotional products – ‘Buy one and Get one free’ Skimming pricing • High price, Low volumes • Skim the profit from the market • Suitable for products that have short life cycles or which will face competition at some point in the future Example: New technology products – Televisions, Cameras, etc., Value pricing • Price set in accordance with customer perceptions about the value of the product/service • Examples include status products/exclusive products Example: Private Label products by retailers; Automobiles Loss Leader • Goods/services deliberately sold below cost to encourage sales of some other product • Typical in supermarkets • Purchases of other items more than covers ‘loss’ on item sold Example: Razor – with the intention that consumer will buy blades; Insurance policy – The agent sacrifices part of his / her income by way of paying premium for one or two months on behalf of subscriber. Subsequently, subscriber chooses the agent in the future Psychological Pricing • Used to play on consumer perceptions • Classic example – Rs. 99 or Rs. 990 instead of Rs. 100 or Rs. 1000 • Linked with value pricing – high value goods priced according to what consumers THINK should be the price Example: Bata pioneered pricing their foot-wear; Dollar stores prices any product for a USD Going Rate (Price Leadership) • In case of price leader, rivals have difficulty in competing on price – too high and they lose market share, too low and the price leader would match price and force smaller rival out of market • May follow pricing leads of rivals especially where those rivals have a clear dominance of market share • Where competition is limited, ‘going rate’ pricing may be applicable – banks, petrol, supermarkets, electrical goods – find very similar prices in all outlets Example: Pricing of cars by Maruti Suzuki: Suzuki Swift Dzire is priced in such a manner competitors are moving away from the product segment Tender Pricing • Firm (or firms) submit their price for carrying out the work • Purchaser then chooses which represents best value • Mostly done in secret Example: Government Tenders: this is to ensure impartial selection of vendors. Price Discrimination • Charging a different price for the same good/service in different markets • When each market to be impenetrable • When different price elasticity of demand exits in each market Example: MNC’s chose to price their products in India / China to gain initial market share. Air travel ticket price differs on the basis of time/day of travel Predatory Pricing • Deliberate price cutting or offer of ‘free gifts/products’ to force rivals (normally smaller and weaker) out of business or prevent new entrants • Anti-competitive and illegal if it can be proved Example: Microsoft sold MS Windows along with Internet Explorer. This made the customers to choose IE as their default browser. Pricing based on cost considerations • Full cost/absorption pricing • Marginal cost pricing • Contribution pricing Absorption/Full Cost Pricing • Most conventional and popular method. • Final price is determined after adding some mark up to the full cost covering both fixed and variable costs. • Suitable • when products are clearly differentiated between companies • custom made products • New products where market is not established Marginal cost pricing • Marginal cost – the cost of producing an additional unit of product • Necessarily a short-run pricing strategy • Existence of idle capacity is a necessary precondition. • Particularly relevant in industries where where fixed costs may be relatively high • Allows variable pricing structure • Suitable for export pricing, or one time special order Contribution pricing • Contribution = Selling Price – Variable (direct costs) • Prices set to ensure coverage of variable costs and a ‘contribution’ to the fixed costs • Similar in principle to marginal cost pricing • Break-even analysis might be useful in such circumstances Target pricing • Target price is the estimated price for a product (or service) that potential customers will be willing to pay. • The target price, calculated using customer and competitors inputs, forms the basis for calculating target costs. • Setting price to ‘target’ a specified profit level • Estimates of the cost and potential revenue at different prices, and thus the break-even have to be made, to determine the mark-up • Mark-up = Profit/Cost x 100 Target costs Target sales price per unit minus Target operating income per unit = Target cost per unit Target Costing Characteristics •Contradicts the traditional approach - design product, determine cost, set price •Intense customer focus • What do they want? • How much will they pay for it? •Can we make a profit on it? Want answers to these questions before committing to the project Target Costing Characteristics • Cost control from the beginning- Focus on product and process design to engineer out costs from the beginning • Product design, manufacturing process, delivery process designed simultaneously • Cost control at all phases of the product life cycle• Design, Production, Delivery/setup, service and repair, Disposal and recycling Steps in developing target prices and target costs Develop a product that satisfies the needs of potential customers. Choose a target price. Derive a target cost per unit. Perform value engineering to achieve target costs. Cost-Plus Pricing • The general formula for setting a cost-based price is to add a markup component to the cost base. • Cost base Rs. X Markup component Rs. Y Prospective selling price Rs.X + Y What is the mark-up? • It could be a percentage of the cost base • It could be to earn a target rate of return on investment. Special pricing situations • • • • • New product pricing Pricing under recession Pricing of joint products/by products Export pricing Transfer pricing New product pricing • If the product is only a new pack or line extension, price can be based on marginal cost plus contribution approach. Once it gets accepted , the price could be progressively adjusted in line with the other products. • If the product is new to the company but not new to the country then extensive market survey should be conducted, and pricing should be based on total cost/marginal cost and competitor’s price. • If the product is absolutely new to the customers then price has to be fixed keeping in mind the recovery of research and development costs and to encash on the brand image of the company. Thus, the company may fix a relatively high price initially. Pricing under recession • Under normal conditions, optimizing profits is the guiding objective in pricing decision. Under recessionary conditions minimizing losses should be the guiding principle. • Effort should be to get some contribution towards recovery of fixed overheads. • Marginal costing and contribution pricing is the only relevant technique for determining pricing strategy during recession. Pricing of joint products •Joint products are those products that emerge out of processing the main products, but their importance as regards sale value or revenue earning capacity is more or less same. •When a joint product emerges from a main product, the joint cost upto the split-off point are allocated to the joint products on the basis of Relative weights/units Market value or sale value Net realisable value (market value less cost of further processing) Selling price acts as a determinant of costs instead of the reverse. Thus pricing of joint products tends to be based on the overall profitability expectation, state of competition, demand for the product and prevailing market prices of the different products. Export pricing Factors to be considered in export pricing are: • Factors which result in increase in costs special packing charges Freight, insurance, clearing and forwarding, shipping agent’s commission and port charges etc. Cost of market exploration, such as special advt, foreign representatives, exhibitions, fairs and other sales promotion exps. Additional cost of maintaining export quality • Factors which result in decrease in costs Subsidies received from Govt, duty drawback, market development rebate, Income tax exemptions etc. Deduction of selling and distribution expenses from export cost Transfer pricing • A transfer price is the price one sub-unit charges for a product or service supplied to another subunit of the same organization. • In decentralised organisations, much of the decision making powers rests in the individual sub-unit and each sub-unit is treated as a separate responsibility centre, whose performance needs to be evaluated. • Transfer price is essentially a tool to evaluate the sub-unit’s performance and to motivate their managers. Methods of determining transfer prices • Market based transfer price • Cost based transfer price • Negotiated transfer price Market based transfer price • It is the price in the intermediate market between independent buyers and sellers. • This method works well when there is a competitive external market for the transferred product. • Divisional performance is more likely to depict the real economic contribution of the division to the total company profit. Limitations of market based transfer price • Cannot be used if a competitive market does not exist for the intermediate product being transferred. • Internal selling expenses may be less than what would be incurred, if the product were to be sold to outsiders. Hence, the selling division would get more benefit by transferring the product at the market price. • The buying division is unnecessarily penalised in case the selling division is not working to full capacity. Cost based transfer price • When external market does not exist for the intermediate product being transferred, or when information about the external market price is not readily available, companies may decide to use cost based transfer price. • It could be based on variable cost, full cost, full cost plus profit or standard cost. Limitations of cost based transfer price • If variable cost method is used, the selling division will be burdened with the un recovered fixed costs. • If full cost method is used then the selling division does not realise any profit on the tranferred goods. • If cost plus profit method is used then the basic question is ‘what should be the mark up? Negotiated transfer price • This method is generally preferred as a middle solution to market based price and cost based price. • Negotiated price provides an opportunity to achieve the objective of goal congruence, autonomy and accurate performance evaluation. • It is also in line with the concept of decentralised decision-making. Limitations of negotiated transfer price • A great deal of management effort, time and resources can be consumed in the negotiation process. • The final emerging negotiated price may depend more on the manager’s ability and skill to negotiate than on other factors.. Transfer Pricing Law in India • Arm’s length price: In accordance with internationally accepted principles, any income arising from an international transaction or an outgoing like expenses or interest from the international transaction between associated enterprises shall be computed having regard to the arm’s length price, which is the price that would be charged in the transaction if it had been entered into by unrelated parties in similar conditions. • The arm’s length price shall be determined by one of the methods specified in Section 92C in the manner prescribed in Rules 10A to 10C that have been notified vide S.O. 808 E dated 21.8.2001. • Specified methods are as follows: a. Comparable uncontrolled price method; b Resale price method; c. Cost plus method; d. Profit split method or e. Transactional net margin method.