Pricing

PRICING POLICIES
Pricing is the source of revenue which every firm is trying to maximize.

It is also one of the most important tools in the hands of a firm which it
can use to expand its market share. The pricing of a product is
important because if the firm prices its products very high then it may
lose its customers to the competitors. On the other hand if it keeps its
prices very low it may not be able to make the profits required to keep
the business going. Whether to keep the price high or low depends
upon a lot of conditions. It is also necessary that the pricing be
reviewed from time to time because no firm works in isolation and the
activities of the competitors and the business environmental conditions
also influence the working of a firm.
The factors governing the pricing policies of a firm can be
A) Internal Factors : These are

1. the costs
2. management policies
B) External Factors
1. Elasticity of supply and demand
2. goodwill of the company
3. competition in the market and the trend in the market
4. the purchasing power of the buyers
CONSIDERATIONS FOR FORMULATING THE PRICE POLICY
1. Objective of the Firm: The fundamental goals of the company are

the main guide for formulating the pricing policy. One of the
fundamental goals is the survival of the firm. This broad objective
of survival or continued existence of the firm can be achieved by
having an objective related to growth, market share, profits or
maintenance and control of ownership of the firm.
2. Nature of competition in which the company is operating: the
nature of competition in which the company is operating will have
a great influence on the type of pricing policy the company
follows. For example if the company is operating in a perfect
competition, then the company has no control over the pricing. If
it is operating in an oligopoly, then it has to consider the pricing of
the competitors as well. Today, in this competitive environment,
companies to satisfy the wants and desires of the customers.
3. Product and Promotional Policies: a product’s pricing must be
viewed together with the promotional strategies of the company.
Sometimes in order to increase the sales, companies reduce the
prices. But before reducing the prices, it must be ensured that the
reason for not getting good sales is prices only. Sometimes, due to
wrong promotional strategies also sales suffer. In such a situation,
reduction in prices will not bring about the desired results.
4. Nature of Price Sensitivity: Very often undue importance is given
to price sensitivity of a product. But the many factors which can
reduce this price sensitivity are ignored. For example, an effective
marketing strategy can greatly reduce price sensitivity and allow
the firm to charge a higher price.
5. Conflicting Interests of Manufacturer and Middlemen: The
distribution channel which is responsible for delivering the
product to the customer is made up of many middlemen. These
middlemen work for some monitory benefit. Sometimes, there is
a conflict in the interest of the manufacturer and the middlemen.
The manufacturer may want the middleman to work at a lower
margin than what is prescribed resulting in a conflict between
them.
6. Active entry of non business Groups into the determination of
Prices: Sometimes the government may intervene in the pricing
process to protect the interests of the citizens. This has its effects
on the pricing decisions of a firm.
PRICING METHODS
The various methods usually employed by the firms are as follows
A) COST ORIENTED METHODS

1. Cost plus or full cost pricing
2. Target pricing or pricing for a rate of return
3. Marginal cost pricing
B) COMPETITION ORIENTED PRICING
1. Going rate pricing
2. Customary Prices
3. Sealed bid pricing
COST PLUS PRICING
Under this method the price is fixed to cover all costs (material, labour
and overheads) and a pre determined percentage of profits. The
percentage of profits differs from industry to industry and also depends
upon the nature of competition in the industry. In the event of a
oligopoly, the percentage of profit may also be decided by the trade
association. The profit margins may also be fixed by the government in
case of some products like life saving drugs.
Limitations of Cost plus Pricing method
1. It ignores demand. It does not take into consideration what

people are willing to pay for the product.
2. It does not give the correct picture of the forces of
competition in the industry.
3. Any method of allocating the overheads to a particular
product is arbitrary. This is particularly so in a multiproduct
company.
In spite of the above shortcomings, the cost plus pricing method is
widely used. Some of the reasons for its popularity are as follows
1. This method enables a fair and plausible pricing with ease and
speed no matter how many product the company handles.
2. Prices based on this method look factual and precise and thus
seem morally correct.
3. This method is used where cost of getting information is too high
and the process of trial and error is costly. Firms use this method
in times of uncertainties.
4. When firms are uncertain about the shape of their demand curve
and are not sure about the response to price changes, firms
normally stick to this type of pricing method.
5. It is difficult to identify and compute direct costs.
6. This type of pricing method covers fixed costs in the short run also
and the firms feel that if the fixed costs are covered in the short
run, they will be covered in the long run as well.
7. When products and production processes are similar, it is not
known how the rival firms will react to the price. In such a
situation, this method gives a pricing that is acceptable to all the
firms. Hence all the firms to be on the safer side stick to this type
of pricing.
8. This type of pricing takes into account the product costs and
management tends to know more about product costs than any
other factors which are relevant to pricing.
PRICING FOR A RATE OF RETURN
Under this method of pricing, the firm decides a rate of return it

considers satisfactory and then sets the price that will allow them to
earn that rate of return when their plant is operating at a standard rate.
In other words, the firm decides standard costs at standard volumes
and adds the margin that will give the targeted rate of return.
In this way, pricing for a rate of return is a variant of the cost plus
pricing method.
MARGINAL COST PRICING
Unlike the full cost pricing which is based on total cost comprising of
the fixed and variable costs, the marginal cost pricing is on variable
cost only. It is clear therefore that whereas the full cost pricing is a long
term phenomenon, the marginal cost pricing is a short term
phenomenon. This type of pricing is based on the incremental cost of
production and the firms try to analyze the increase in cost as a result
of some significant amount of change in the output. The firm uses only
those costs that are directly attributable to the output of a specific
product..
We know that in a competitive market situation in the short run a firm

will shut down only if the price is below the average variable cost, while
in the long run the firm must cover its average total cost i.e. average
variable cost plus the average fixed costs. Thus in the case of marginal
cost pricing there is a guarantee that the firm does not shut down , but
since it does not cover the fixed costs, it does not guarantee that the
firm will operate at the breakeven point.
This pricing procedure is often adopted when the firm
a) Wants to introduce its products to new markets

b) faces stiff competition in the market
c) has unutilized capacity
d) when a foreign market is to be tapped to earn foreign
exchange
e) when the firm has already purchased large quantities
of raw materials
f) when employees cannot be retrenched
g) When goods are of perishable nature.
Advantages of Marginal Cost Pricing
1. It allows the firm to develop a far more aggressive pricing

policy than does the cost plus pricing.
2. It is quite useful for pricing over the life cycle of the product.
Limitations of Marginal Cost Pricing
1. It helps in short period pricing and can therefore be applied

successfully on a temporary basis. It does not provide a long term
stable pricing policy.
2. It does not guarantee that the firm will operate at the breakeven
point.
3. During recession, some firms may resort to marginal cost pricing
which may be followed by other rival firms thus leading to cut
throat competition.
GOING RATE PRICING
In this type of pricing, the emphasis is on the market rather than the
cost. Where costs are particularly difficult to measure, the firm adjusts
its its own price to the general price structure in the industry. This type
of pricing reflects the collective wisdom of the industry. It is also a safe
way of pricing because where price leadership is well established, it is
safe to charge according to what the competitors are pricing.
CUSTOMARY PRICING
Prices of certain goods become more or less fixed as a result of their

having prevailed for a considerable period of time. For such goods, if
there is a change in the costs, the quality or quantity is adjusted to
accommodate the change in costs.. Only if there is a substantial change
in the costs, the prices are changed.. As far as possible the existing
prices are maintained.
SEALED BID PRICING
This type of pricing is more prevalent in construction activities or in the

disposal of used products or in the sale of antique pieces or artifacts.
Here the prospective buyers are asked to quote their prices in sealed
covers and the covers are opened at a pre determined place and time
in the presence of all the bidders. The buyer who quotes the highest is
awarded the contract.

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PRICING POLICIES

Pricing is the source of revenue which every firm is trying to maximize.

The factors governing the pricing policies of a firm can be

A) Internal Factors : These are

CONSIDERATIONS FOR FORMULATING THE PRICE POLICY

1. Objective of the Firm: The fundamental goals of the company are

The various methods usually employed by the firms are as follows

A) COST ORIENTED METHODS

Limitations of Cost plus Pricing method

1. It ignores demand. It does not take into consideration what

Under this method of pricing, the firm decides a rate of return it

MARGINAL COST PRICING

We know that in a competitive market situation in the short run a firm

This pricing procedure is often adopted when the firm

a) Wants to introduce its products to new markets

Advantages of Marginal Cost Pricing

1. It allows the firm to develop a far more aggressive pricing

Limitations of Marginal Cost Pricing

1. It helps in short period pricing and can therefore be applied

GOING RATE PRICING

Prices of certain goods become more or less fixed as a result of their

SEALED BID PRICING

This type of pricing is more prevalent in construction activities or in the

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