Rajagopal. Marketing Dynamics: Theory and Practice

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Marketing Dynamics: Theory and Practice

PSYCHOLOGICAL PRICING

This approach makes the customer feel that he is paying a relatively lower price for the product. To

stimulate such a view the price is fixed in integral values very close to the round numeric values, e.g.,

prices of Bata shoes Rs.499/-, shirts in UK 3.99. Such a price structure gives the customer a

materialistic satisfaction in buying the product.

VALUE-ADDED PRICING

In this price determining process, the company takes care of the value of its by-products in the

principal product and prices them accordingly. Such approaches are generally applicable for evolving

price strategies of semi-processed products like meat, oilseeds, milk, chemicals etc.

COMPLEMENTARY PRODUCT PRICING

Prices of the principal products are dependent on the pricing pattern of associated products, and

vice-versa. It is logical that the prices of the complementary products should be lower e.g., film of

camera, battery of camera etc. or else the customers may withdraw the principal product from

use.

PRICE DISCOUNTS

This is one of the most popular strategies adopted by the private companies in order to attract the

consumer towards their stocks and increase sales by offering a discount on the price of the products

either on selected or all items in accordance with the business state of the organization. The discounts

are offered in terms of cash, kind or discount vouchers, facilitating the customers to buy the products

of the company for the amount discounted. The discounts offered by the government supported

organizations include:

• Cash discounts

• Quantity discounts

• Discount in kind

• Trade discounts

• Seasonal discounts

• Institutional discounts

• Grant-in-aid discounts

• Allowances

• Stock clearing discounts.

A company may offer a discount either by making the customer pays less than the prescribed

price of the product or set a strategy to provide additional quantity of products on the pre-set price.

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Such transactions refer to cash and quantity discounts. For example the policy of discount of a firm

in kind may be given to a customer, with high technology products for the principal product e.g.

memory storage devise with the computer. The trade discounts are incentives to the distributors for

the promotion of sales. The seasonal discounts on prices are related to the customers’ demand for

the product at a particular time. For example, during festivals, clothes are in high demand and are

generally offered at seasonal discounts, to boost sales. The Handloom societies patronized by the

Government of India, also offer seasonal discount subject to the availability of grant-in-aid for sales

from the Government. On the bulk procurement of products, an institutional discount on the set price

is offered by the companies to keep up the customer relationship. The company however may decide

to offer a clearance sale discount on prices to ease inventory blockade and expenditure. It also helps

an organization to refill the product-line with products or demand at par with fashion or time. The

sales personnel of the company also get some benefit as a token or recognition for the service

rendered in terms of price discount on selected products to keep their morale high in the future too.

DISCRIMINATE PRICING

A company modifies its pricing strategy for the products according to the customer-segments, product

forms, product image, location and time. These approaches are to be decided on the basis of the

competition prevailing in the market. However, a marketing manager has to keep his corporate

objectives in view before discriminating the price in several forms stated above.

PROMOTIONAL PRICING

Under specific circumstances, companies will temporarily price their products below the list price to

promote sales. In this process, sometimes, risk is taken by the companies to fix the price even below

the cost. There are many forms of promotional pricing strategy. They are:

1. Loss leader pricing

2. Special event pricing and

3. Low financing

In this strategy, there always remains a threat of copying down by competitors. Thus, such a

policy should not be recommended for a long period of time.

Pricing is a logical proposition keeping in view the competitive products in the market. A company

has to determine the price on the basis of internal economics pertaining to business objectives,

targets, marketing policies and profit targets and external forces like the demand and strategies of

competitive products.

MARK-UP PRICING

It is an elementary pricing method that is exercised by adding mark-up standard to the cost of the

product. There are considerable variations in mark-ups among the different products. Thus, this

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Marketing Dynamics: Theory and Practice

methodology is not considered to be scientific. However, mark-up pricing remains popular for several

reasons (i) it is a cost plus exercise and appears to be fairer for both customers and sellers (ii) sellers

opine that this approach is simple and (iii) price competition is minimised. The mark-up price may be

calculated using the formula as below:

1–

....(i)

Where, P

= Mark-up price, C

= Unit cost price, S

= Expected returns on sales

Unit cost of the product may be calculated from the following formula.

....(ii)

Where, V

= Variable Cost, F

= Fixed Cost and S

= Unit Sales

Expected return price on sales may be computed from the projection stated in the following

equation.

CTY

pi r c

....(iii)

pi r c

C+T*Y

Where T

= Target Returns and Y

=Capital investment in marketing

Mark-up price can be calculated substituting the values of unit cost and expected returns

drawn from equation (ii) and (iii) in the equation (i).

PRICING FUNDAMENTALS

Fundamentals of global pricing are derived through the conventional practices followed in home

markets. The basic determinants for the pricing of products and services are production costs,

competitive factors, and break-even analysis and demand considerations. Domestic price is affected

by the considerations on pricing objectives, cost, competition, customer, and state regulations. These

considerations apply at home and in the host country. In addition to the conventional considerations

on pricing, multiple currencies, trade barriers, and longer distribution channels make the pricing decision

more difficult. The pricing objectives should be closely aligned to marketing objectives, which in turn

need to be derived from overall corporate objectives. Essentially, the pricing objectives of a foreign

firm intending to operate in the host country should be evolved in terms of profit or volume.

Cost factors play a significant role in determining the international prices of products and services.

The mark-up on cost or price or a target returns on investment may constitute the profit objectives of

pricing while anticipated volume of growth in sales may be considered towards the volume objectives

of the international pricing. The standard pricing procedure for exporting consists of a cost-plus

formula. The firm may evolve export prices by adding up the various costs involved in producing and

shipping the product (which refers to cost-based pricing) and then adding a mark-up (that refers to

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the concept of “plus”) to this amount to achieve a reasonable rate of return. The cost drivers of

pricing include production costs, administrative costs, allocated research and development

expenditures, selling costs, transport and warehousing charges, custom duties, and requisite fees

towards documentation etc. paid through various facilitating agencies. In practice most firms seem

to use full cost approach that includes direct costs and managerial costs in determining the international

prices. However, the emphasis varies with the company strategy and the market situation. For an

existing product entering a new market, direct costs tend to be a natural choice, since administrative

or overhead costs are already covered at home and investments have been recouped. Fixed costs

are those that do not vary with the scale of operations, such as number of units manufactured.

Salaries of the managerial staff, office rent, and other office and factory overhead expenses are

examples of fixed costs. On the other hand, variable costs include material and labor used in the

manufacture of a product; bear a direct relationship to the level of operations. Some fixed, short-run

costs are not necessarily fixed in the long run; therefore, the variable and fixed costs may be distinguished

only in the short-run. For example the salaries of the marketing staff of a firm in the home country

should be considered as fixed. Moreover, some costs that initially appear fixed may be viewed as

variable when properly evaluated.

Kimberly Clark’s sales for the fourth quarter of 2002 faltered as its personal care business,

mainly nappies, felt the pinch of a fierce price war, particularly strong in North America.

Disappointing results followed the company’s statement issued in December 2002. which

warned that increasing competition in North America and adverse economic conditions in

Latin America would impact 2002 revenues. Severe competition in nappies has been one of

the most prominent features of the disposable paper products industry in the last decade,

sparked by the two rival companies Procter & Gamble and Kimberly Clark. The impact of

price competition was compounded by a gradual decline of sales due to consistently

decreasing birth rates and the rise of improved private label offerings. In response to this

trend Procter & Gamble undertook an aggressive price cut offensive in 2002, most notably in

America. The strategy has been pursued on two fronts - through coupon campaigns, offering

savings of up to US$5 per pack in the US, as well as the rationalization of their range in

Europe, which saw the end of Pampers Premium and Sensitives sub-brands and the relaunch

of Pampers Baby Dry. Such was the price pressure from its rival Procter & Gamble that

Kimberly-Clark decided to abandon a planned price increase of its Huggies brand in 2002.

While Kimberly Clark remained leader in North America, its market share dropped by 0.3

percentage points in 2002 compared to the gain made by its competitor of 1.4 percentage

points. In Western Europe, there was a similar scenario with Procter & Gamble gaining 0.7

percentage points in share, while Kimberly-Clark’s stake shrunk by the same amount. The

declining pattern of birth rates in North America and Western Europe in the last three years

has resulted in a drop of new born nappy sales by 5% and 1% respectively. On the other

hand, a trend towards delaying toilet training has spurred sound demand for disposable

pants. Procter & Gamble, which used to lead the nappies sector with its Pampers and Luvs

brands, has started losing ground to Kimberly-Clark due to the increasingly popular training

and swim pants recently introduced by the latter.

1 Marzena Moglia : Nappies Feel the Pinch of Competitive Pricing, The Euro Monitor International, February

10, 2003,

www.euromonitor.com

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Impact of costs on pricing strategy can be studied by considering the ratio of fixed costs to

variable costs, the economies of scale available to a firm, and the cost structure of a firm and

competitors. If the fixed costs of a company in comparison with variable costs form the higher

proportion of its total costs, adding sales volume will be a great help in increasing earnings. A foreign

firm needs to consider the anticipated decline in costs while evolving the price for the goods and

services, which may be described as the process of lowering the prices in order to gain higher market

share in the long run. The concept of obtaining lower costs through economies of scale has often

been referred to in the literature as experience effect, which explains that all costs go down as

accumulated experience increases.

Titan Industries Ltd, a joint venture between the Tata group and Tamil Nadu Industrial

Development Corporation (TIDCO), is faced with the first serious threat of competition since

it started (in 1987), in the Indian Market for watches. The action began three years ago, when

quantitative restrictions (QRs) on watch imports were lifted. Since then, swiss brands have

entered at the prestige end, with Citizen just one rung below, even as Swatch, Espirit and

others start wooing the youth. The Mid-priced zone has been less exciting :HMT and Maximal

have been crawling along, while Timex struggles to recover. But as all the branded players

have discovered, the real action is at the voluminous lower end – where the unorganized-

sector and grey-market players have been having a blast. Smuggled Citizen movements, for

instance, are hugely popular with tinted watch assemblers. In contrast, recognized brands

have had it tough. Burdened by taxes, these account for less than half the total market,

estimated at 45 million units in 2000-01 (including everything). And that was just the prologue:

now comes the big monster. Chinese watches, at Rs 150-250 apiece, are here at half the price

of local equivalents. And they threaten to crunch through the low-end. Perhaps even the

middle. With sales of 6.9 million watches (estimate for 2000-01), Titan is still the undisputed

leader of the Indian market. It is also India’s most admired durables marketer. Yet, Titan is

losing shelf space at the retail level. In fact, if equity analysts have ever worried about the

firm’s prospects, it is now. Aware that Titan’s growth space is getting cramped from both

ends, they are pouring over Titan’s performance figures with grim diligence. Sales for the half

year ended 30 September 2000 are up 18.6 percent to US$66.1 million, and PAT has more than

doubled to US$2.16 million. But this includes the US$ 2.15 million Titan got for selling its

share in RDI Print & Publishing. Of course, watches and jewellery are seasonal businesses,

and the second-half will be much brighter, festive season and all. But that still doesn’t

reassure investors. Analysts have been wondering whether Titan would be better off

offloading its watches business to some global player, and selling only jewelry. Though it’s

a high working-capital business, Tanishq is an unrivalled brand, and could see the company

through. The brands Citizen, Omega and the like have been more visible than saleable. If

anything at all, the Swiss brands’ presence has helped create a segment of luxury watches for

Titan. (This business may soon be brought under a new brand). People exposed to watches

for US$2000 a piece are likely to find a Titan Insignia for US$ 220 or a solid gold Nebula for

US$ 800 reasonable. Titan is also using smart new designs under Fastrack (for men and

women) to counter Swatch and Esprit, which have undeniably won the admiration of the

style – conscious Indian youngster.

As for the middle-market, Titan can count on its ‘strong grip on distribution’. The retail

network is a formidable barrier to competition.”Its strength here has helped Sonata, a relatively

low-priced brand (about US$10 apiece), achieve annual sales of almost 3 million units within

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just four years of launch. Indeed, it was because of this success that Titan needed to churn

out 300,000 units more than the capacity of its Ho-sur plant (built in 1987 at an investment of

US $100 million). Today, Titan sells in over 40 countries, and claims to be the ‘world’s sixth

largest manufacturer watch brand’, after Casio, Citizen, Timex, Swatch group and Seiko. The

vision was always to be a globally significant player in watches and jewellery, adding that

the company’s core strength is its ability to anticipate change. The Chinese industry is

tormented by overcapacity, and watch-makers are flailing their hands about for any high-

volume deal. In fact, given that Titan is currently at full capacity, this is the best way to take

volumes up (to 10 million units in a couple of years). Titan is more a marketer than a

manufacturer. Where the watches actually come from is immaterial, so long as the brand

stands guarantee. The strategy has theoretical backing: as products reach parity and people

gain enough money to satisfy more than their basic needs, the most prized assets start

shifting from manufacturing know-how and factory machines towards the consumer

relationship section of the chain. This puts the emphasis on need-identifying, product

designing and brand communication skills, with which there’s greater scope to stand apart.

Titan has already made some admirable breakthroughs in brand-building. As a brand, Titan

sought ownership of the ‘style’ portion of the target consumer’s mind. That may be fine at

the upper-end, but what about the huge price-sensitive segment? The answer is brand

sensitization. Anyhow, crushing costs is a Titan priority. Titan is highly cost-competitive on

‘day’ and ‘date’ movements. Watches are being redesigned with fewer parts (the quartz

revolution cut the component count from 150 to 50, and now further reductions are being

made) and gold-plating costs are being slashed. Meanwhile, an ERP system has reduced

working-capital needs by some 20 percent this year, as lean processes deliver their magic,

vaporizing inventories and speeding up the cycle. The average Titan that sells overseas is

priced at $125, which is lower than Swiss brands but higher than the Japanese. However,

what really counts is Europe, where Titan is striving hard to get past the 100,000-units mark.

It must make some headway with the demanding European consumer before it can attain

genuine global stature.

Titan was virtually unknown in Europe, but even here, Titan decided to use one monster to

destroy another -by turning anonymity to its advantage. For, the flipside is that there is no

nation with which anyone associates the brand. This gives it a chance to strike a truly global

posture. Timex is American, Seiko is Japanese and Omega is Swiss. ‘No one country could

have made faces this beautiful’ expresses the advertisement, juxtaposing a woman’s face

with an equally stunning watch dial, with the hands in perfect symmetry at 10 past 10. The

idea is to show how the creative blending of diverse West Asian markets, where Titan is

ranked either 2nd or 3rd position, accounts for more than half the figure. And the brand is

doing fine in Myanmar, Sri Lanka and other markets under the Indian subcontinent’s satellite-

TV footprint. The crucial thing is that Titan is actually trying to build a global brand (an ad

campaign was developed for the purpose some four years ago). It’s obvious that on a dollar-

to-dollar scale, the odds are stacked against Titan. And one might imagine that the depth of

pockets is the issue. After all, what has worked to differentiate the brand in India is no big

deal overseas. But brand building can be done cheaply too, so long as Titan is able to single-

mindedly convey a point of differentiation that strikes the consumer. The general framework

- Indian and Japanese can result in such extraordinary beauty. As an idea, it holds immense

potential. The concept can be stretched to take Titan to a position of global uniqueness: a

brand that knows how to bring information and ideas together from around the world, to

fulfill human needs in novel ways. The campaign has a touch of classy understatement.

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Marketing Dynamics: Theory and Practice

Use of a cost-based price has been observed as a common practice with the multinational firms

after the concept of the experience curve pricing effect was regarded as an effective tool in

pricing strategy. The experience curve describes the relative movement of unit cost and volume of

production as how unit costs go down successively with the production of more units of a product.

Through the “learning by doing” that comes from experience, the company’s employees develop

skills and capabilities that translate into lower costs. Hence, firm entering new foreign markets will

gain in capabilities and economies of scale from accumulated production and market experience. In

tune with the new market providing a chance for increased output and thus lower unit costs, the

anticipated gains might be passed along to the customers in the form of low introductory prices or

“penetration” prices in the introductory stage of the product life cycle. Whether the introductory

price will be raised later or not depends directly on the correctness of the anticipated cost declines.

Experience curve pricing has been adopted primarily by companies entering an existing market in the

maturity stage. Many Japanese firms operate with this strategy, since it allows them to maintain a

penetration price level in foreign markets. Companies habitually charge less than they could for new

products, especially with revolutionary offers. Underestimating a product’s value can be a costly

mistake, since the introductory price often fixes its worth in the buyer’s mind. Good pricing decisions

take an expansive, rather than an incremental, approach to new products. Companies should construct

a range of possible prices based on the new offer’s value to customers and the competitive landscape.

In determining the prices the nature of competition in each country also plays a key role. The

competition in an industry can be analyzed with reference to such factors as the number of firms in

the industry, product differentiation and ease of entry. In addition, competitive environment can be

categorized as privileged position, leadership, chaotic, or stabilized competition. The competitive

analysis should be done in order to reveal the global and domestic competitors in the particular

market in reference to the price they charge for their products. These prices tend to set the

“reservation” prices in the local market, that is, those limits beyond which the firm’s product will not

be considered and people will avoid buying. The analysis can go further and attempt to isolate the

differential advantages that the firm’s product might have over these existing offerings, so-called

perceived value pricing.

It is necessary for a company to conduct breakeven analysis of the current or proposed business.

A breakeven analysis examines the interaction among fixed costs, variable costs, prices, and unit

volume to determine that combination of elements in which revenues and total costs are equal. Fixed

costs are the expenses that must be made in business and are not impacted by sales. They will

include such things as rent, basic telephone expenses and utilities, ages for core employees, loan or

lease payments, and other necessary expenditures. A company should also include the wages as a

fixed cost. Variable costs include those expenses that change as a result of sales volume. In a

manufacturing business, the material cost of sales will be variable. Often utility expenses above

some base rates increase sales, including gas or electricity charges in the factory or telephone

expenses in the office. The labor component of production may be variable or fixed, depending upon

the obligations to its employees. In some cases employees need only be paid for hours worked

2 Michael V. Marn, Eric V. Roegner, and Craig C. Zawada : The Price Advantage, John Wiley & Sons, 2004.

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(variable expense), while in others, some minimum number of paid hours is required regardless of the

number of hours actually worked (fixed expense). By reducing the company to these three factors

for preliminary analysis, the company can avoid making serious mistakes and may discover significant

opportunities. The management challenge will be to design and implement the programs necessary to

achieve the desired results.

Another key factor in determining the price is customer demand for a product and it should be

analyzed in view of the many influencing variables. The price of the product is one of the variables

that influence the demand for the product. These considerations include the ability of customers to

buy, their willingness to buy, propensity to consumer, the place of the product in the customer’s

lifestyle (whether a status symbol or a daily-consumption product), prices of substitute products, the

potential market for the product (whether there is an unfulfilled demand in the market or if the

market is saturated), the nature of non-price competition, consumer behavior in general, and consumer

behavior in segments in the market. All these factors are interdependent, and it may not be easy to

estimate their relationships accurately. The process of demand analysis also includes the forecast of

relationship between price level and demand, simultaneously considering the effects of other variables

on demand. The relationship between price and demand may be described as elasticity of demand,

or sensitivity of price, which refers to the number of units of a product that would be demanded at

different prices. The industry demand for a product may be considered as elastic, if it can be

substantially increased by lowering prices. If lowering price has little effect on demand, it would be

considered inelastic. In case of the total demand of an industry being highly elastic, the industry

leader may take the initiative to lower prices. Environmental factors, which vary from country to

country, have a direct influence on demand elasticity.

COST-PLUS PRICING

Cost-plus looks inwards and examines the company’s cost and an expense structure to determine

how much has to be added to the cost of a product to achieve a desired level of profitability. Most

industries have rules of thumb that are often used to set prices. These rules of thumb are the cumulative

results of the performance of many industry participants over time and should not be dismissed

lightly. It is the rare company that can revolutionize the cost structure of a competitive market. Quite

often these rules of thumb are expressed in terms of a profit margin (the “plus”) to the cost of the

goods being sold. For a high tech start up, 80% gross profit margins are often necessary. This

means that if the product costs $20 to produce, the selling price for that product should be $100. It is

imperative to find out what these rules of thumb are for the particular industry.

Activity-based costing (ABC), also referred to as activity-based accounting and transaction-

based costing, is a concept that will probably be learned in a managerial accounting course and hear

about it in a production and operations management course. Basically, it is a method of allocating

costs to products and services. If ABC is used effectively, it is a great tool for planning and control.

The advantages of the activity based costing in determining the pricing strategy is listed as under:

• Identify high overhead costs per unit and find ways to reduce the costs

• Avoid decreases in head counts due to inaccurate allocation of costs

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Marketing Dynamics: Theory and Practice

• Measure profitability with higher accuracy than traditional costing that used only direct-

labor hours as a cost driver

• Software packages can do simulations/calculations to see what are the costs for different

types of activities

• Used with a strategic intent, ABC could help determine whether a new product/service

should be added and/or an old product should be replaced

• Used in production planning, ABC could help to decide whether production should be

outsourced or produced in-house

• Measure pricing and profitability

A company should identify, the major activities in a process/ department/ operation/system.

Later, it may create cost pools, should groups of activities need to be allocated together. Selecting

cost drivers should follow. The number of cost drivers used will probably rely on trade-offs. Too few

may reduce accuracy while too many may increase complexity. After determining the cost drivers,

the rate should be calculated. The Table 4.1 exhibits the activities and cost drivers planning to

support the pricing decisions.

Table 4.1 Activity Based Costing

Total Total Rate (Overhead

Traceable Units cost per unit in

Activities Cost Drivers Costs (USD) USD)

Materials Handling Number of Components $ 100 50 $2/component

Machine Set-ups Number of Set-ups $ 200 100 $1/setup

Inspections Hours of Quality Testing $ 300 150 $2/hour

Administrative Activities Number of Forms/Permits $ 100 25 $4/form

Waste Disposal Frequency of Disposal $ 50 10 $5/occurrence

Rates are then applied to the respective cost drivers for each product/service that are under

consideration. The overhead cost per unit can then be derived when the total product units divide the

total cost for the product. The rates of the activities may be substituted accordingly to determine the

cost of the products and services as exhibited in Table 4.2.

Table 4.2 Determining the Cost of the Product

Rate (Overhead cost Product A Product B

Activities per unit in USD) Units Cost (USD) Units Cost (USD)

Materials Handling $2/component 30 $ 60 20 $ 40

Machine Setups $1/setup 25 $ 25 75 $ 75

Inspections $2/hour 50 $ 100 100 $ 200

Administrative Activities $4/form 10 $ 40 15 $ 60

Waste Disposal $5/occurrence 5 $ 25 5 $ 25

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Foreign firms mainly follow the cost approach and the market approach towards the pricing

orientation. The cost approach involves first computing all relevant costs and then adding a desired

mark-up to arrive at the sales price of any products or services. The cost approach is commonly used

by the multinational firms as it is simple to understand, apply and leads to fairly stable prices in the

market. A conservative attitude would favor using full costs as the basis of pricing. On the one hand,

an incremental-cost pricing could allow for seeking business otherwise lost. This method is an

improvement over the pure cost-plus method since mark-up is derived more scientifically. Nonetheless,

the determination of rate of return poses a problem. The percentage mark-up on cost of the product

to determine the price may be calculated with the formula as given below:

where, M

denotes percentage mark-up on costs, K represents the total invested

capital, Q

symbolizes the standard cost of annual normal production and Y

exhibits the percentage

desired returns on the invested capital.

On the contrary, the market approach of pricing proceeds in a reverse fashion. In this strategy

of price determination estimation of the acceptable price in the target segment is made. Later, an

analysis is performed to determine, if this price would meet the company’s profit objective. The final

price is based on the market rather than estimated production costs. Market approach is widely used

in Japan which may be illustrated as a Japanese firm first examines the likely competitors and their

products, and then estimates the unit cost necessary for viable entry into the market.

CUSTOMER EXPECTATION-BASED PRICING

Another approach is to price to the customer expectations. Experienced purchasers of products and

services have general ranges and frames of reference for pricing expectations. Prices that are

inconsistent with these expectations may be rejected without consideration. A low price may be

associated with an inferior product or service, thereby being unacceptable to particular customers. A

high price may be beyond what another buyer considers reasonable for his/her expectations of the

product’s benefits. Ultimately, prices should be set according to what the market will bear. This will

be influenced by competitive actions, customer expectations, and the company’s cost structure. No

final pricing decisions should be made until a breakeven analysis has been performed which considers

fixed costs, variable costs, and volume.

PRICING MODELS

Binomial Model

There are two main models used in the Australian market for pricing equity options: The Binomial

Model and The Black Scholes Model. For most traders these two models will give accurate results.

The binomial option pricing model was first proposed by Cox, Ross and Rubinstein in a paper published

in 1979. This solution to pricing an option is probably the most common model used for equity calls

and puts today. The model divides the time to an option’s expiry into a large number of intervals, or