PRICING AND SALES PROMOTION:FOUR BASIC RULES FOR PRICING

7. FOUR BASIC RULES FOR PRICING

The four rules given below are intended to capture the essence of the analysis necessary to determine and evaluate pricing strategies. The order in which the rules are presented does not imply a hierarchy of importance; each rule is equally important.

Know Your Objectives

As demonstrated earlier, many firms stress the profit objective of return on investment. Other firms stress the objective of maintaining specified profit margins, while still other firms seek to achieve market-share goals. It is not necessary for each product to maintain the same profit margin in order to achieve a particular return on investment. Similarly, different margins on products may still produce an overall desired corporate profit goal. Finally, firms stressing market share may utilize the experi- ence curve factor and build profits by reducing prices.

The important point to remember is that differences in corporate profit objectives eventually will lead to differences in prices and the role of price in influencing actual profits. Ultimately, regardless of the financial goal, the pricing objective is behavioral in nature. That is, whether buyers buy more, whether nonbuyers decide to buy now, and whether buyers decide to purchase less frequently but in greater volume per order, or to pay earlier, are influenced by the prices and price structure of the seller. Further, the degree to which distributors and dealers are cooperative and motivated to sell the firm’s products depends largely on the financial incentives provided by the suppliers’ prices and price structure. Also, the sales force’s motivation to help the firm achieve its financial objectives depends on its understanding and acceptance of the pricing strategy being followed. Price has an important role in developing incentives for distributors, salespeople, and buyers to perform in ways that will be beneficial to the firm. Thus, it is important that the seller develop a positive attitude toward pricing, leading to a proactive pricing approach.

Know Your Demand

This prescription suggests that the firm understand fully the factors influencing the demand for its products and services. The key question is the role of price in the purchaser’s decision process. Price and price differentials influence buyer perceptions of value. Indeed, many companies have achieved positive results from differentially pricing their products and services.

Coupled with knowing how price influences buyers’ perceptions of value, it is necessary to know how buyers use the product or service. Is the product used as an input in the buyer’s production process? If so, does the product represent a significant or insignificant portion of the buyer’s manu- facturing costs? If the product is a major cost element in the buyer’s production process, then small changes in the product’s price may significantly affect the buyer’s costs and the resulting price of the manufactured product. If the final market is sensitive to price increases, then a small price increase to the final manufacturer may significantly reduce demand to the initial seller of the input material. Thus, knowing your buyers also means understanding how they react to price changes and price differentials as well as knowing the relative role price plays in their purchase decisions.

Further, the seller should also know the different types of distributors and their functions in the distribution channel. This prescription is particularly important when the manufacturer sells both to distributors and to the distributors’ customers.

Know Your Competition and Your Market

In addition to the influence of buyers, a number of other significant market factors influence demand. It is important to understand the operations of both domestic and foreign competitors, their rate of capacity utilization, and their products and services. In many markets, the dynamic interaction of supply and demand influences prices. Moreover, changes in capacity availability due to capital in- vestment programs will influence supply and prices. A second important aspect of knowing the market is the need to determine price–volume relationships.

Know Your Costs

It is important to determine the basic cost data necessary for the pricing decision. As stated earlier, it is necessary to know which costs vary directly with changes in levels of activity and the underlying causes of the changes in costs. It is also necessary to identify the costs that are directly related to the product or service being costed but do not vary with activity levels-direct period or fixed costs. Furthermore, marketing and distribution costs should be objectively assigned to the products and not simply lumped into a general overhead category.

Valid cost data provide an objective basis for choosing between pricing alternatives, determining discounts, and establishing differential pricing alternatives. Furthermore, objective cost studies that are completed before the pricing decisions provide the firm with a valid legal justification for its price structure.

8. SUMMARY

It is important to realize there is no one right way to determine price. Pricing simply cannot be reduced to a formula—there are too many interacting factors. Successful pricing requires considering all internal and external factors and adapting to changes as they occur. Successful pricing is adaptive pricing. Pricing decisions should be logically made and should involve rigorous thinking, with min- imum difficulty from human and organizational factors. Further, it should be recognized that judgment and prediction are needed about the future, not the past. Finally, pricing decisions should be made within a dynamic, long-run corporate and marketing strategy.