Pricing Objectives
by
Charles Lamson
Prices should relate to the objectives of the firm. The price needs to be weighed against the impact on the firm's other products, the need for short-term profits against longer-term market position, and 'skimming' as opposed to 'penetration' objectives. For example, in launching a new product, a company may decide that, as it is the first to market, there will be little competition and so it will be able to 'skim' the market at a relatively high price. Alternatively, it may decide to enter the market at a relatively low price so as to gain a high market share before competitors enter. This, in turn, will allow the firm to benefit from experience curve effects. Each decision rests on different sets of assumptions made by planners. On the other hand, pricing may be geared towards earning a particular rate of return on funds invested or, indeed, on making a profit on the product range as a whole. In the latter case, a strategy involving 'loss leaders' may be used whereby products are sold below their cost of production to encourage purchases of other more profitable products.
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Setting Pricing Objectives As with objectives in any area of management, pricing objectives must be clearly defined, time-specific and consistent with each other. The four types of objectives that pricing decisions can help achieve are:
Income Related Objectives
Price adjustments are an obvious way of increasing the flow of money coming into an organization. This method of income generation depends on the resilience of consumer demand to an increase in price. In other words, how many customers will go elsewhere or stop buying altogether if the price increases beyond a certain point? The question is what economists call price price elasticity.
Some firms have calculated that they can afford to lose some customers because those customers who remain loyal are willing to pay the higher prices. Japanese car manufacturers took this decision in the 1980s when they increased the price of cars in their European markets. While this resulted in fewer customers overall, those who remained generated higher income for the companies concerned.
Another reason why companies decide to focus on income rather than volume is when they are the first into the market with an innovation and want to recoup their research and development costs before competitors enter the market with similar products. This is known as price 'skimming' because the firm is aiming high at a limited number of customers whose need for the product is high enough to justify a high price. The practice is common among high-tech and pharmaceutical companies. Additional examples of price skimming can be found among high-priced products such as color televisions, pocket calculators, digital watches and cameras, all of which have been characterized by skimming prices when they were introduced.
Firms may decide to concentrate on the short-term money gains from price skimming when the company finds it is threatened by acquisition. In order to convince shareholders of the financial health of the organization, managers may increase prices to bolster profits. Prices often return to their former level once the threat of takeover has receded.
Volume-Related Objectives
Volume-related objectives are approached by what is known as penetration pricing. As the name implies, this pricing policy aims at penetrating the market as extensively as possible with the aim of recruiting the maximum number of customers. Often penetration pricing is found in manufacturing industries when production capacity needs to be fully utilized. Unless the firm has a large enough production capacity to cope with anticipated demand and can reduce costs, penetration is unlikely to succeed.
The success of penetration will vary according to market conditions. In a mature market where expansion has slowed, there may be little point in buying market share. A penetration policy is more suitable in a growing market such as health drinks.
Societal Objectives
Competition between firms battling for market share has the effect of driving prices down. But in some markets competition is limited by the sheer size of the enterprises concerned and it can be seen to be against the public interest. Statutory controls are brought to bear to prevent such situations from developing - such as antitrust law in the U.S. or the activities of the Monopolies and Mergers Commission in the UK. Certain industries such as broadcasting, transport and public utilities are subject to watchdog bodies with advisory or regulatory powers. For example, companies within the privatized UK power industry are required to keep the prices agreed with the independent regulator.
*SOURCE: FUNDAMENTALS OF MARKETING, 2007, MARILYN A. JONES AND JOHN DRESMOND, PGS. 268-269*
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