ACKNOWLEDGEMENT
This article was published in the New Straits Times on January 18, 2003
Reproduced here with permission from
The Chartered Institute of Management Accountants (CIMA Malaysia).
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The price of a good or service may be seen as a financial expression of the value of that commodity. For the consumer, the price is the monetary expression of the value to be enjoyed or benefits of purchasing a product or service (together these may be known as an “offering”), as compared with other available items.
Price and the Marketing Mix
For the producer or supplier of a good or service, the question of price (and of price setting) is of fundamental importance. As part of the marketing mix, price can make a critical contribution to the organisation's ability to achieve its ultimate objectives such as:
- Meeting a specific target return on investment
- Maintaining or enhancing market share
- Meeting or preventing competition
- Maximising profits; and
- Stabilising prices
The “marketing mix” of a product comprises:
Product – This term refers to the tangible and intangible elements, which combine to create the offering. It includes aspects such as branding and packaging.
Promotion – Refers to all means of communication with the potential market (including activities such as advertising, sales promotion, publicity, personal selling) about the offering and its position in the market.
Place – This refers to where and how the offering is made available to the consumer (for example, through dedicated retail outlets, through department stores, by personal order, via the Internet, etc).
Price – The price is the monetary value or financial charge that must be paid by the customer to secure possession of the offering.
For service offerings, three further elements should be added:
Process – The means by which the customer receives the offering. For example, in a transaction whereby a customer purchases a theatre ticket, this action is not the end of the process. To attain the benefits of the transaction, the customer is effectively involved in the process of delivery in that he secures the value of the transaction in attending the performance. All aspects of this process should be considered and managed to deliver maximum value to the consumer.
Physical – This refers to any physical attributes that may impact evidence of value for the consumer. In dining at a restaurant, for example, the physical surroundings of the restaurant (including aspects such as decor, lighting, physical space available) all form part of the physical evidence of the offering.
People – For service organisations, people are one of the most important elements of the marketing mix and often have the greatest impact on the value derived by the consumer.
Price as a Strategic Tool
To operate most effectively, all elements of the pricing mix should reinforce and support each other. Through small changes to any of the elements in the marketing mix, a different message may be communicated to the market, each with different implications for the organisation, and its position as a supplier in the market.
Thus (short- or long-term) variations in the price of its offerings, either as a single action, or together with changes to methods of promotion and place of availability can be expected to cause different outcomes. Where the effects of such manipulations of each aspect of the marketing mix are understood, each becomes a tool which can be used to implement the overall corporate strategy.
Price Strategies
Some of the more commonly used pricing strategies are outlined below.
1. Skimming
The practice of “price skimming” involves charging a relatively high price for a short time where a new, innovative, or highly improved product hits the market.
The success of price-skimming strategies is largely dependent on the inelasticity of demand for the offering either by the market as a whole, or by segments of it.
High prices can be enjoyed in the short term where demand is relatively inelastic. In the short term, the supplier benefits from “monopoly profits”, but as profitability soars new suppliers may be attracted to the market (depending on the capital costs required to enter the market) and the price will settle as competition increases. Hence, the objective of employing a price-skimming strategy is to benefit from high profits available in the short term (due to the newness of the product) and from effective segmentation of the market.
Advantages of Price Skimming:
- Where a highly innovative product is launched, research and development costs are likely to be high as are the costs of introducing the product to the market via promotion, advertising, etc. In such cases, the practice of price skimming allows for some return on the set-up costs.
- By charging high prices initially, a company can build a high-quality image for its product. Charging initial high prices allows the firm the luxury of reducing them when the threat of competition arrives – a lower initial price is difficult to raise without losing volume.
- Skimming can be an effective strategy in segmenting the market. A firm can divide the market into a number of segments and reduce the price at different stages in each, thus acquiring maximum profit from each segment.
2. Penetration pricing
Penetration pricing involves the setting of lower, rather than higher prices by the supplier, in order to achieve a large, if not dominant market share. This will only be possible where demand for the product is believed to be highly elastic, for example, demand is price-sensitive and either new buyers will be attracted, or existing buyers will buy more of the product as a result of a low price.
The successful implementation of a penetration pricing strategy may lead to large sales volumes/market shares and therefore lower costs per unit. The effects of economies of both scale and experience lead to greatly reduced cost, which justify the use of penetration pricing strategies to gain market share.
Before implementing a penetration pricing strategy, a supplier must be certain that it has the production and distribution capabilities to meet the anticipated increase in demand.
3. Expansionistic pricing
Expansionistic pricing is a more exaggerated form of penetration pricing and involves setting very low prices aimed at establishing mass markets, possibly at the expense of other suppliers. Under this strategy, the offering enjoys a high price elasticity of demand so that the adoption of a low price leads to significant increases in sales volumes.
Expansionistic pricing strategies may be used by companies attempting to enter new or international markets for their offerings. Low cost standardised models of a product may be offered at a very low price to gain recognition and acceptance of the offering. Once acceptance has been achieved, more expensive versions or models of the offering can be made available at higher prices.
This is an excerpt from a publication Pricing Strategies – An Overview by the Chartered Institute of Management Accountants (CIMA). For more information, please contact CIMA Malaysia at Tel: +603 – 7723 0230 or e-mail: kualalumpur@cimaglobal.com Website: http://www.cimaglobal.com/
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