MARKETING MATERIAL

9054 – Marketing Practice 13 Pricing

Chapter 13

PRICING

Finally, we come to price. Its late appearance is quite deliberate, since it has let you become accustomed to the idea that is only one of elements of the Product:Service Package - albeit often an important one. We have already seen its role within this package described a number of times, from different perspectives. These specific references should, indeed, be seen as the most practical description of pricing mechanisms.

This short chapter is, therefore, primarily designed as an antidote to the hype which has traditionally surrounded it. Its exaggerated importance may be seen to most obviously descend from the tradition set by the economic disciplines. Central to the writings of neo-classical economists are the 'laws of supply and demand', which describe one theory of how prices are set;

For most markets that now exist, however, a more practical demand curve might look rather different from this classical model;

Thus, the typical demand 'curve' of most products or services is much steeper than traditionally assumed. In essence the demand is relatively inelastic (with respect to price). At the same time the supply 'curve' is very elastic above the entry price (the price at which the market becomes attractive to new entrants). below this point, however, it is inelastic. In other  words, new entrants require a given price level before they will make the investment necessary to enter . Above it they will produce in ever larger quantities, but below it they will not even consider production.

In recognition of this 'entry' level price, the existing tenants will (or at least should, according to this theory) maintain the equilibrium price in the market somewhat below this level. The amount of this 'discount' can be described as the 'competitive insurance'; since it represents their uncertainty as to what is the exact level.

Contrary to much of economic theory, the evidence suggests that (except for those protected by patents) the monopoly price will be often be lower still; representing the 'monopoly insurance', which the monopoly-holder is willing to pay in order to avoid the monopoly being taken away (directly by competitive activity or indirectly by government regulation).

The problem is that these models describe price activity in only one context - that where only price counts, and 'commodity' prices obtain. On the other hand, when the operators within a market decide that its products or services should be treated as commodities, and be priced accordingly, then something like this holds. Fortunately, this applies to only a small minority of markets.

Much the same as you play Russian Roulette with a revolver, suppliers often play Pricing Roulette with the market. The odds are a little bit better - our research indicates that only a tenth of markets indulge in commodity pricing (where there is one live round out of six in the revolver). The end effect may be much the same, however, if your spin of the chamber lands you on a commodity based market - it is often tantamount to commercial suicide!

If the products or services are treated as commodities, and if prices reflect this, then you MUST do the same in order to survive, even in the short term. You have no pricing choice. You must hope that the situation changes at some time in the future, when you can make a reasonable profit, but in the short term you can only reduce costs to staunch the bleeding.

Fortunately, as mentioned above, 90% of the markets are not commodity based. You can heave a sigh of relief that you have survived the test and get on with the marketing described in the rest of this book.

So if, as is usually the case, the market is not commodity based, your should adopt price maximisation rules.

This is one of the very few situations in marketing where there are no grey areas, no spectrum of options.

Beware though! One of the great temptations in marketing, to which many succumb, is to think that a significantly lower price will improve your position. The odds show (9:1, as we saw above) that this is likely to be a mistake - and may switch the whole market to commodity-pricing (so that everyone loses, especially the initiator).

This is not to say that a drive for reduced costs, which is typically initiated by commodity-pricing, should be abandoned. There must always be an awareness that commodity-pricing may one day emerge into your market, even if this would be near suicidal for all involved. The organisation has (while making its investments in the future), therefore, to develop a cost structure which will enable it to survive even this eventuality - and in the meantime it will reap even higher levels of profit.

For the great majority of markets suppliers can, happily for them, count on achieving more than the base commodity price. The difference is known as the 'price premium';

This is a simple concept, but a useful one - not least because it acts as an antidote against the very strong temptation to indulge in price-cutting.

This diagram also indicates that, in general, the brand leaders are progressively placed to achieve such premiums (though they may choose to trade this off against higher volumes of sales).

The premium may be justifies by a variety of factors; including those such as image, quality, differentiation positioning etc, which have already bee discussed. The exact reason for the premium is not important, it will vary from situation to situation. What is crucial is that you recognise it as a possibility, and work to maximise it.

If you avoid the pitfall of commodity-pricing, along with that of the many 'guaranteed' techniques of pricing offered by academics and consultants, most pricing then turns out to be relatively simple. This is because most products or services are either existing 'products' with a know track record, or are new products entering markets where there already are similar products with known track records. This, therefore, signposts the two main alternative methods, both of which tend to be scorned by academics, but which (despite the shortcomings I will discuss below) are eminently sensible;

1) HISTORICAL PRICING

This is probably the most prevalent form of pricing.

The first caveat is that you must still be aware of how the price needs to change to reflect the consumer's changing needs and different competitive conditions - but most managers who are in touch with their customers and markets should already be well aware of such trends.

The second caveat is that it assumes the historical price was correct, and exactly matched the perceived value; the value which the consumer believes (perceives) the product or service holds (and hence what he or she is willing to pay for it). This, though, just what the positioning process, which is at the heart of the marketing processes described in this book, sets out to achieve. Pricing is just one of the variables involved in the positioning, but the process should be no less powerful for that (and, indeed, linking it to the other parameters should increase the validity of the decision).

2) COMPETITIVE PRICING

The one additional aspect which may modify historical pricing, and may sometimes replace it (and always will in the case of new products) is what competitors are doing. The positioning exercise, of course, takes full account of the relative position with respect to competitors - so, once again, this should be a natural part of the pricing process.

COST-PLUS PRICING

On the other hand, the other main approach, adding a fixed percentage (to show a 'profit') to costs, should NOT usually be considered. Costs should be minimised, but prices should be maximised, based upon what the customer is willing to pay - which is typically not directly linked to cost.

The one exception, where cost-plus pricing may be justified is that where a large number of items have to be priced; and logistics of making a large number of individual decisions become a significant factor. Here a guide price may be determined (on the basis of historical/competitive/perceived value pricing) for a group of products, and then extended to the individual products as a percentage uplift on their cost

Another area where cost-plus approaches may be required is that of new products entering new markets, where no track record of any kind is available.

Overall, then, the most productive approach to pricing is not a separate technique, but is to see it as the natural outcome of the POSITIONING PROCESS.

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