When develops a new product or introduces regular product into new distribution channel or geographical area. It is a six step procedure.
STEP 1: Selecting the Pricing Objective
Each firm operates with some objectives and sets its products price which aligns with its objectives.
Survival.
When intense competition exists, or consumer wants changes. Price only covers variable cost and some fixed cost and company stays in business. It is a short-run objective.
Maximum Current Profit.
Tries to produce maximum current profit or cash in-flows by estimating the demand and cost. Difficult in the long-run because of marketing-mix variables, competitors, and legal constraints.
Maximum Market Share. Market-penetration pricing. Mass production involves. Higher sales volume leads to lower unit cost and higher long-run profit. Benefits can be achieved:
(1) When the market is highly price sensitive and low price stimulates market growth.
(2) With mass production cost of production and distribution will decrease.
(3) Competitive advantage. Low price discourage actual and potential competition.
Maximum Market Skimming. Market-skimming-pricing. Monopoly. Higher price in the start and then low. In 1990 Sony introduced High Definition Television (HDTV) at $43,000. In 1993, 28" was of $6,000 and in 2004; 42" was in $1,200. Condition must exist:
- High current demand.
- Low unit cost at small volume.
- High initial price will discourage competition.
- Superior product image.
Product-Quality Leadership. Making the brand high quality and affordable by creating value and setting just high enough prices.
Other Objectives. Nonprofit or public organizations have different objectives, like nonprofit hospital aim to full cost recovery, or social agencies set a price according to client income.
STEP 2: Determining Demand
Price and demand has an inverse relationship. If price is high demand level will be fall and if the price is low demand will be ultimately high.
Price Sensitivity.
People have different price sensitivities. Customers are more prices sensitive to products that cost a lot or are bought frequently and less sensitive to low-cost items or items that buy infrequently. Companies prefer less price sensitive customers.
Estimating Demand Curves.
- Statistical analysis by statistical techniques gathering data from past prices, sale volumes.
- Price experiments by charging different prices for a product to see how sales affects.
- Surveys can explore what price consumer will accept.
Price Elasticity of Demand. Need to know the change in price brings how much change in demand.
STEP 3: Estimating Costs
Amount incurred on producing, distributing and selling the product
Types of Cost and Level of Production.
Management should know how costs vary with the different levels of production.
- Fixed cost that does not vary with production.
- Variable cost varies with the level of output.
- Total Cost = sum of fixed and variable costs for given level of production.
- Average cost = Total Cost / No. of Units Produced.
Accumulated Production.
With time experiences the production techniques become better, the methods improve and average cost falls with this accumulated production experiences. It is called the experience curve or learning curve. Some chains have different learning curves so profits. Activity-based cost (ABC) accounting should be used to estimate the real profitability.
Target Costing.
Set a target cost to be achieved through production scale, experience, and efforts by designers, engineers, and purchasing agents by reducing the current cost. Cost elements---design, engineering, manufacturing, sales---must be examined to bring down cost in target cost range.
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