INDUSTRIAL ECONOMICS

CHAPTER THREE
PRICING POLICY OF THE FIRM
 introduction
One of the important factors which assist the
company in realizing its profits through
targeted sales is the Pricing Policy, it
formulates.
As a result the method of the company's
Pricing Policy plays an important role in the
Managerial decision making. Price, in fact,
is the source of revenue which the firm
seeks to maximize.
 cont
The company should fix the price reasonably
because if the price is set too high, it may lead it
to loose its market share. On the other hand, if
the price is set too low the company may not
recover its cost.
so the right choice of the Price fixation would
depend on number of factors and wide variety of
conditions prevailing in the market. Moreover the
pricing decisions have to be reviewed and
formulated from time to time.
 cont
Some of the factors which affect the choice of the pricing policies are:
 Business Objectives: This relates to rate of growth, establishing and
increasing its market share and maintenance of control and finally profit
realization. All these concepts play an important role in pricing policy
formulation.
 Competition level: It is important for a company to offer the product which
satisfies the wants and desires of the consumer than the one which sells at the
lowest price.
 4P's: Pricing happens to be one of the core concepts of marketing but a firm
must consider it together with Product, Place & Promotion.
 Price sensitivity: Factors like variability in the consumer behavior consumer
income level, marketing effect, nature of product and after sales service
among others affect the price sensitivity.
 Available information: The demand supply gap goes a long way in affecting
the choice of the pricing policy determination for as company
Objectives of Pricing Policies
Pricing policies form an integral part of the company's
overall business strategy. Some of the important
objectives, which the company should take into
consideration, are:
- Profit maximization for the company's products
-Relation of long term goals of the company.
-Successfully thwart the competitors.
-Flexibility in pricing to meet the changes in the market.
- Achieving a satisfactory rate of return
Factors affecting Pricing Policies
The company should determine its pricing policies in such a way
that depending on the market trends, the company is able to
adapt itself to the changes occurring in the market.
 Few of the factors are enlisted below:
 Cost involved
 Demand elasticity
 Consumer psychology
 Price changes
 Type of product
 Competitors in the market
 Product segmentation and positioning.
 Market structure and promotional policies
Prospective supply and demand
In price forecasting a knowledge about the prospective supply
and demand conditions is also essential. In fact, besides
estimating the supply and demand conditions prevailing at
the time of the forecast it is imperative to find the probable
demand and supply conditions during the next six months.
Prospective Supply
The current value of production of commodity should be
compared with the total productive capacity in order to
ascertain the extent of excessive productive capacity in the
market. An excess of capacity creates a persistent tendency
towards over production and acts as a restraint upon a rise
in the price.
 cont
Prospective Demand
The prospective demand is determined by the nature of need
for that commodity and the willingness of the buyer to buy
the commodity and their purchasing power. An analysis of a
price movement of a commodity over a period of time will
reveal certain fluctuation.
These fluctuations and their relationships are helpful in price
forecasting. Some of the fluctuations observed are:
 Seasonal price variation: These are common in case of
number of commodities notably agricultural and food
products such variations would take place in markets having
seasonal cycles.
 cont
Cyclical price variation: During the business
cycle, price of all commodities would
generally record fluctuations. So it becomes
essential to realize this effect on the
commodities in different ways.
Cob -Web Cycle: These cycles occur on
account of the cumulative effect of the price
expectations of the millions of independent
producers.
 Pricing Methods
Before we proceed with the various pricing methods, it is
essential for us to understand the Life cycle concept. Many
products generally have a characteristic known as 'Perishable
distinctiveness.’ The product cycle begins with the invention of
a new product followed by patent protection and further
development to make it saleable.
This is usually followed by a rapid expansion in its sales as the
product gains its market acceptance. Then the competitor enters
the field with the imitation and the rival products and the
distinctiveness of the new product starts diminishing. The speed
of degeneration differs from product to product. The innovation
of new product and its degeneration into a common product is
termed as Life Cycle of the Product."
 cont
There are five distinct stages in the Life Cycle of the
product'. They are as follows:
Introduction stage
Research or engineering skills lead to the product
development. There are high promotional costs
involved, volume of sales is low and there may be
heavy losses.
Pricing Policies in Introductory phase largely depend on
the close substitutes available in the market. Generally
two kinds of pricing policies are suggested.
 cont
Skimming Pricing: This pricing strategy is adopted
when close substitutes of a new product are not
available in the market. To extract the consumer
surplus, setting up a very high price initially and then a
subsequent lowering of prices in a series of reduction.
Penetration Pricing: This pricing policy is generally
adopted in case of the availability of close substitutes
of the new product in the market. To penetrate in the
market, initially a lower price is designed, as soon the
product captures the market, price is gradually raised
up.
 cont
Growth
Due to the cumulative effects of introduction stage the
product begins to make rapid sales gain. High and
sharply rising profits may be witnessed. Consumer
satisfaction has to be ensured.
Maturity
Sales growth continue, but at a diminishing rate, because
of the declining number of the potential customers
who remain unaware of the product or have taken no
action. Profit margin slips despite rise in the sale.
 cont
During Maturity stage, firm should move in
the direction of Product improvement and
market segmentation.
Saturation
Sales reach and remain on a plate marked by
the level of the replacement demand. There
is a little additional demand to be
stimulated.
 cont
Decline
Sales begin to diminish absolutely as the customers
begin to tire of the product and the product is
gradually edged out by better products or the
substitutes.
The life cycle broadly gives the different stages
through which a product passes through. There are
changes taking place in the price and promotional
elasticity of demand as also in the production and
distribution cost of the product.
The other various Pricing methods are
Marginal cost pricing,
Full Cost method pricing,
Limit pricing
Mark-up and Mark-down pricing,
Rate of Return pricing,
Going rate pricing
Team pricing,
Value pricing,
Position based pricing
Cost-plus or full-cost pricing:
This is the most common method used for pricing. Under
this method, the price is set to cover the costs
(materials, labour and overhead) and a predetermined
percentage for profit. The percentage differs from
industry to industry.
This method ignores the demands -there is no necessary
relationship between the costs and what the people pay
for the product. Also it fails to reflect the forces of the
competition adequately.
Example: All the stationery products are priced in this
way.
 cont
Rate of Return pricing
It is a refined variant of full cost pricing. Under this
method a firm starts with a rate of return they
consider satisfactory and then set a price that
allows them to earn that return when there plant
utilization is at some standard rate.
In other words the company determines the standard
cost at standard volume and adds the margins
necessary to return a target rate of profit over the
long run.
This can be broadly grouped under the following:
 cont
Fixing prices to maintain constant percentage mark up
over the cost,
 Fixing prices to maintain the profit as constant
percentage of sale, and
 Fixing prices to maintain a constant return on the
investment capital.
Example: Most products are priced I this way for
instance Philips audio systems are currently priced
based on what the manufacturers estimate the returns
to be.
 cont
Marginal cost pricing
Both under the full cost pricing and rate of return
pricing, the prices are based on total cost comprising
fixed and variable cost. Under marginal cost pricing,
the fixed costs are ignored and prices determined on
the basis of marginal cost. The firm uses only those
costs that are directly attributable to the output of a
specific product.
With marginal cost pricing, the firm seeks to fix its
prices so as to maximize its total contribution to fixed
cost and profit.
 cont
Limit Pricing
firms over a long period of time were keeping
their price at a level of demand where the
elasticity was below unity, that is, they did
not charge the price which would maximize
their revenue. Traditional theory was
concerned only with actual entry of the
firms and not the potential entry.
cont
 cont
Going Rate Pricing
Here instead of cost, the emphasis is on the market.
The firm adjusts its own price policy to general
pricing structure in the industry. This may seem to
be a rational pricing policy when the costs are
difficult to measure.
Many cases of this type are situations of price
leadership. Where price leadership is well
established, charging according to what
competitors are charging, is the only safe policy.
 cont
Team pricing
According to this method, the companies
sometimes assign special roles to the various
products they sell. Some items may be used
as promotional items which are priced and
advertised with prime purpose of attracting
the customers and other may be intended to
make up for the low margin obtained on the
promotional items.
 cont
Mark-up and Mark - down pricing
When a retailer follows the practice of fixing
the price over the one at which he has
obtained the product, such that it covers the
cost and leaves a reasonable profit margin
he is said to follow the mark-up policy.
In case certain goods are not sold within a
reasonable time, the retailer pulls the price
down i.e. "marks down" the product price.
 cont
Peak Load Pricing
There are certain perishable products which
are being demanded in varying quantities at
different point of time. E.g. During evening
hours, restaurants face peak demand and
during day time, the demand falls. For these
kinds of products, a double pricing system is
adopted.
 cont
A higher price, called peak-load price is
charged during the peak-load period and a
lower price is charged during the off-peak
period.
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