Dada Adefolami

The methods of setting prices include the following.

Setting prices to maximize profits:
In theory, and as you might recall from earlier discuss, profits are maximized when:

Marginal cost = Marginal revenue

In practice, this is almost useless advice to most organizations. Although we might expect a well-controlled organization to have reasonable information about how its costs move, very few will have sufficiently detailed or stable information about how revenues move, as they are affected by faithless consumers, competitor action and economic confidence.

Setting prices to break even
The break-even volume is given by:

Fixed costs/(Selling price per unit – Variable cost per unit)
                                                                 or
  Fixed costs/Contribution per unit

Setting a high selling price per unit will generate a high contribution per unit and this would require a smaller volume to be sold before breakeven point is reached. The company could, therefore, evaluate various options of prices and volume and compare these to what it feels customers might find attractive and what competitors might be charging.

Cost-based pricing
Here the cost per unit is determined (either total absorption cost, marginal cost or relevant costs) and a set amount, or a set percentage, is added to that to give the selling price. If the forecast volume is sold at the price set, then the forecast profit would be made. However, although useful as a guideline, the method is not sufficient because it is entirely inward looking and pays no heed to competitors or customers. The resulting prices must always be looked at with some doubt, and the organization must assess how those fit in with the market. An inability to make a reasonable margin on sales must indicate that either costs are too high or demand for the product is too weak. Strategically speaking the organization would be ‘stuck in the middle’.
Competition-based pricing

By contrast, this approach is entirely outward-looking. It strives to match what competitors are charging and is the only option when in perfect competition. Goods should sell at that price, but there is no guarantee that sufficient profit will be made. This approach, therefore, places high importance on being able to achieve low costs, ideally cost leadership.

Marketing-orientated pricing
In this approach, the organization attempts to escape from the constraints of perfect competition and sells a product differentiated by features, quality, design, promotion, place and so on. Generally, higher prices are sought and are justified by products better matching a market segment’s needs. For example, consider a company which makes agricultural chemicals. In general, farmers will need to buy these in spring, but will get no income from their crops until harvest in the autumn, so farmers have a very adverse cash flow for around six months. Think how attractive it might be if the manufacturer gave farmers payment terms of six months to match their cash flow needs. The prices of the chemicals might be higher than those of competitors, but the convenience to farmers plus the apparent empathy shown with their problems could well outweigh the price differences.

Strategic approaches
It is important to note several ways in which price can be used with more strategic intent, here using the term ‘strategy’ to mean a ‘ploy’.

1. Price skimming. This approach is often seen when new technology is introduced. There are some consumers who will pay a very high price for new products, perhaps because they need them or perhaps because they have more money than sense. After the most desperate, the richest or the most profligate consumers have been satisfied, the price is reduced to skim off another layer. At some stage a longer-term stable price is reached.

2. Penetration pricing, the ambition it to use a very low price to capture a very high market share. Note that this very high market share could well give economies of scale that will allow low costs and hence low prices to be maintained in the long term. In fact, a large market share can be a barrier to entry as smaller new suppliers will have to match, what are to them, uneconomic low prices.

3. Product-line pricing. For example, Car manufacturers, offer ranges of the same model of car. This enables them to attract customers by advertising ‘Prices from N10m’, and then often to persuade the customer to move up the range. You can be sure that the additional price on upmarket models will be much greater than the additional costs incurred making them.

4. Related product pricing. We have probably all experienced this with inkjet printers. Many of these sell for about N2000, and when you come to renew the ink cartridges you have to pay about N1700. Here the organization makes most of its profits on after sales services that consumers feel committed to after the initial purchase.

5. Demand manipulation. This is frequently seen in train ticket and airline prices. Not only are the companies using price discrimination (charging business travelers more for peak-time travel) but they are also encouraging others to make use of the services at other, less crowded times. Another example can be seen in heating engineering businesses which can have a problem meeting demand in winter but have idle staff over summer. They could even-out demand (and lower their costs) by offering routine servicing over summer at a discount, or for which payment did not have to be made until much later.

Finally
1. Pricing is part of the marketing mix of both products and services and it can be changed very quickly.
2. After the marketing and pricing objectives have been decided, pricing has to then consider costs, competition, customers and controls.
3. In the long-run, prices must at least match all costs if profits are to be made, but sometimes exceeding marginal costs and relevant costs will be sufficient.
4. Competition can be based on price or can be non-price competition. In non-price competition the company is in some way differentiating its products or services so that price is not the only factor influencing purchasing decisions.
5. Consumers will react to prices and price changes. For example, luxury goods are likely to be more sensitive to price changes than necessities. Price discrimination can allow different prices to be charged for the same product in different markets.
6. Controls over prices can be set by governments and regulators.
7. The calculation of the selling price can be based on various approaches (such as cost plus). Unless a company is very lucky, it is unlikely to have full information about the demand that will be generated by any price and a ‘reality check’ is needed.
8. There are a number of strategic approaches to pricing such as price-skimming, related product pricing and demand manipulation.

Strategic planning is an organization’s process of defining its strategy, or direction, and making decisions on allocating its resources to pursue this strategy. It may also extend to control mechanisms for guiding the implementation of the strategy

Marketing effectiveness is the measure of how effective a given marketer’s go to market strategy is toward meeting the goal of maximizing their spending to achieve positive results in both the short-and long-term. It is also related to Marketing ROI and Return on Marketing Investment (ROMI).

A business plan is a formal statement of business goals, reasons they are attainable, and plans for reaching them. It may also contain background information about the organization or team attempting to reach those goals.

The strategic plan sets objectives that will be consistent with its values and mission as envisaged by the directors. In order to realise the objectives set down in the plan, it is necessary for each functional area of the business to create its own plan. Therefore, there will be a production plan, a human resources plan, a financial plan, and so on.

The marketing mix is a business tool used in marketing and by marketers. The marketing mix is often crucial when determining a product or brand’s offer, and is often associated with the four P’s: price, product, promotion, and place. In service marketing, however, the four Ps are expanded to the seven P’s or Seven P’s to address the different nature of services. In the 1990s, the concept of four C’s was introduced as a more customer-driven replacement of four P’s. There are two theories based on four Cs: Lauterborn’s four Cs, and Shimizu’s four Cs. In 2012, a new four P’s theory was proposed with people, processes, programs, and performance.

Marketing mix modeling (MMM) is a term of art for the use of statistical analysis such as multivariate regressions on sales and marketing time series data to estimate the impact of various marketing tactics (marketing mix) on sales and then forecast the impact of future sets of tactics. It is often used to optimize advertising mix and promotional tactics with respect to sales revenue or profit.

The marketing plan can then be formulated, setting specific objectives and detailed plans on how marketing resources will be applied to achieve them. For many organizations, the detailed plans may be structured around the various elements of the marketing mix.

Dada Suraju Adefolami, Professor of Finance, School of Business Administration, UNEM University, Costa Rica, is a Finance / Management Consultant and Certified Forensic Accountant. You can reach him via: [email protected]; 08052043855