Monday, 8 August 2011

Strategic Pricing (1)

In an earlier article, Tempering The Pursuit of Profits, I described how pertinent it is for profit and not- for-profit organisations to manipulate the profit equation. One component of that equation is price of outputs that determines revenue. Pricing can be the effect of the marketing mix of product, promotion, price, place, people, processes and physical evidence. Establishing a price is also a strategic exercise recognising both economic and non-economic factors.  Additionally, altering the price of a product will usually allow much faster changes to organisational performance than developing products or designing and running promotional campaigns. I will be looking at influences on prices and then in another article specific approaches to pricing.
The influences on prices can be summarised in the diagram above. These influences are likely to be iterative and interwoven as in all strategic planning processes. For example a marketing objective could be established but could not be achieved because of cost or competition issues, so the objective has to be revised. Certainly, pricing is a dynamic process since nothing remains constant. Influences like the economic environment, the taste of consumers, the innovative processes including competitor actions and reactions will continually change, often forcing prices to be revised.

Mission and Marketing Objectives
An organisation’s primary purpose of existence, its self perception, its position in the market and its culture and ethics cannot be separate from pricing of its goods and services. A not-for-profit organisation might have a zero price for its goods and services or heavily subsidised. Some organisations might see itself to be ‘up-market’ and charge high prices to project quality and exclusivity. Other organisations in specialised industries like pharmaceuticals face ethical issues when pricing their products both for the rich and poor markets. In rich markets the intention might be to make profits but for poor markets ethical and social responsibilities take centre stage.
Pricing Objectives
The variety of pricing objectives tends to be short term, whereas missions and marketing objectives are long term. A profit organisations have to at least break even so prices are set to allow for this. There is no point to enforce the impression of upmarket by having high prices and realising sales volumes are very low. At times, the need for survival and increase cash flows quickly will influence massive price cuts. At times, organisations might hope of forcing competitors to withdraw from the market by lowering prices and sustaining losses for a while.
Costs
To make a profit, revenue must exceed all costs. Variable costs, fixed costs and period cost are for the short term pricing decisions. The sales and production volumes are used to determine how much contribution a product or service makes to profits in the short term. This also determines the breakeven price and sales volumes. In strategic management, opportunity costs and exit cost are important for the long term decisions.
 A forgone revenue as a results of a decision is the opportunity cost of that decision. If a piece of land is used for dwelling, it cannot be used for cultivation. The sale price forgone is an opportunity cost of the decision to build. Exit costs arise when the decision is to abandon a strategy. Examples of exit cost include liabilities as a result of redundant employees, clean-up or reparation costs. It might be cheaper to carry on provided the marginal revenue just exceeds marginal costs. The organisation is likely to suffer great pressure from competitors if they are in this position.
Competition
There are four types of markets, perfect competition, oligopoly, monopoly and monopolistic competition, each giving rise to a particular type of competition. The descriptions of these are highly technical and beyond the scope of this article. Very often organisations that uses a cost leadership strategy adopts price competition where consumers are motivated primarily by price and the suppliers will have to lower prices to succeed.  Because costs are very low, prices can be low as well. Most laptop producers are using price competition because they all do the same things, with the same operating systems, run the same application software and have similar reliabilities.
In non-price competition consumers are attracted not only by the price of the goods or services but also influences by the other marketing mix variables like the quality, brand and features; promotion activities; place ( where the goods or services are obtained). Ideally, organisations following differentiation or focus strategies are essentially using non-price competition. They aim to make their products different so they are particularly attractive to consumers, who are willing to pay premium prices. Arguably, Apple is using non-price competition among the laptop producers. Its laptop looks different and unique, they have different a different operating system and run different (but compatible) software. This makes it more expensive than others. Nevertheless they sell so well and profitably too.
Consumers
Suppliers must keep in mind both what the end consumers are willing to pay and also the profits that would be expected by intermediaries in the supply chain. Most industries have ‘rules of thumb’ about the mark-ups to apply to their products.  It is widespread in markets segments according to wealth to have a value range of goods for poorer or thriftier customers who might respond to price change competition, and a more exclusive range for better-off customers, who might respond to non-price competition. It is possible to charge different prices for the same product for different groups, even if there are no different lines of goods for different customer groups. This is called price discrimination. It is mostly cheaper to buy electronic goods in the US than in Europe. Leakage of goods information from cheaper to expensive markets is prevented in some way that makes the products different. In the pharmaceuticals industry, leakage from one market to the other is reduced by giving the products different names (though pharmacologically they are identical) and by carefully controlling distribution through government agencies and hospitals.
The perceived value of goods is a concept which is related to non-price competition and, also price. The thought that a higher price implies goods of a higher value is something we have all experienced, even though we are often ignorant about the merits of such goods. Consumers’ reactions to prices and price changes are influenced by whether the good are a necessity or a luxury. Goods that are very sensitive to price changes on the quantity demanded are luxury products. Goods that less sensitive to price changes on the quantity demanded are likely to be necessities. This is known as elasticity of demand of a product which is beyond the scope of this article. There are exceptions to this rule however.
Controls
Some industries are heavily regulated by statute and regulation giving them little or no power to choose their own prices. Others are able to influence final prices charged to consumers. In the perfume and cosmetic industries for example, exclusive producers resist price competition by insisting in their supply contracts that their retailer do not discount their products. Also not all contractual arrangements are legal. Pricing cartels (competitors fixing prices) are frowned upon by most government by bringing in anti-competition laws.
I had been looking at influences on price from a strategic perspective. Prices are influence by and large by costs, competition, consumers and control. In the second part of this article I will be looking at specific approaches to pricing.
Further reading:

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