Pricing Strategies in Business

***********************************************************************************
ACKNOWLEDGEMENT

This article was published in the New Straits Times on January 18, 2003

as a CIMA Business Talk article.

Reproduced here with permission from
The Chartered Institute of Management Accountants (CIMA Malaysia).
************************************************************************************

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/

Exporting Retail Brands to New Markets

With the advent of globalization brought about by the new economy and technological advances, the once demarcated business world has suddenly become a large borderless and continuous market. While this may not be news to large manufacturers such as Cola-Cola and Pepsi-Co, who prior to the dawn of the new economy had already established manufacturing facilities in low cost producing Asian countries such as China, Malaysia, Thailand and Taiwan, it is still relatively new to large retailers.

So, what issues and challenges do large retailers face when they expand or introduce their products or brands into international or regional markets?

In “Retailers to the World,” Incandela, McLaughlin & Smith Shi identify five ways for retailers to expand across borders. The five ways are:

• Choose your sliver
• Get comfortable partnering
• Invest in intangible assets
• Keep expenses and capital requirements low
• Exploit opportunities to arbitrage

Choose your sliver
In the manufacturer to retailer to consumer value chain, retailers should identify where their core strength lies and capitalize on those strengths. They do not need to own all the parts or slivers of the value chain. For e.g. Carrefour and Tesco, recognizes that their strength lies in store operations i.e. product inventory and logistics management. Hence, they focus on offering a vast assortment of everyday products and rely on their suppliers to develop and brand most of the products they sell.

Get comfortable partnering
While many retailers may be adverse to the idea of partnerships and joint ventures with foreign companies for fear of losing management control, leading global companies have shown possible ways of forging successful partnerships. For e.g. Coca-Cola who has a global presence yet do not own majority interests in the foreign companies. Coca-Cola is able to create new ownership and capital structures to control their alliances with their foreign partners.

Invest in intangible assets
Brands and reputation; proprietary technology, know-how and tools; and people, talent and skills are the key intangible assets. “A global platform is built on powerful brands,” says Incandela, McLaughlin & Smith Shi. The key arguments about brands are – brands must have a customizable value proposition appealing to a variety of consumers at certain price points. Next, brands must have identifiable personalities relevant to consumers, and these personalities must be continuously reinforced with consumers. Thirdly, brands must be totally visible in the marketplace.

Keep expenses and capital requirements low
The business structure and processes should be kept at low operating cost, as high overheads will cause retailers to become uncompetitive. Centralization and computerization can help contribute to efficient and cost-effective operations.

Exploit opportunities to arbitrage
Market factor cost varies globally, hence retailers should exploit arbitrage opportunities to source from suppliers in low manufacturing cost countries and sell at premium prices in mature markets.


Furthermore, note that the above five approaches results in one objective – the success of the retailers in new foreign markets, which means building and establishing its identity – its brand name. For e.g. most consumers will remember Carrefour, but not the name of the packet of sausages.

However, according to Child, Heywood & Kliger in “Do Retail Brands Travel?” presenting a strong brand image is not sufficient to assure success for retailers in a new foreign market: “But retail chains have found that although they can hang out their signs anywhere, consumers respond differently in every country. Understanding those differences is the key to building a successful retail brand across borders.”

So, in addition to having a strong brand identity, that brand must be able to appeal to a cross-section of consumers in different countries. Again using Carrefour as an example, it would need to be able to appeal to affinity customers in one market and service/quality customers in another market.

For affinity customers, the social association of shopping at Carrefour instead of the neighbourhood grocery store is an important consideration, while variety, product performance and service levels will appeal more to service/quality customers. In markets where consumers are concerned about spending their money wisely, retailers could position their products with attractive price/value propositions.

In “Brand Building in Emerging Markets,” De Abreu Filho, Calicchio & Lunardini argue that: “companies perform best in the vast low-income segment by adopting local branding and organizational strategies.”

For e.g. a retailer like Tesco to enter a new emerging market, it could consider acquiring the local competitor. In essence, Tesco is buying access to established local supply and distribution channels and existing value chains, which Tesco can grow upon.

Having immediate access to established local brand name products can maintain the associative and comfort levels with consumers. Later, the strategic introduction of Tesco’s own brands or even other foreign brands can build upon consumers’ associative and comfort levels to try other products by Tesco, since the consumers’ trust is acquired.

Hence, global companies should develop two different marketing strategies to approach emerging markets. In high-income emerging markets, it should pursue premium brand building strategies to achieve high profitability. Whereas in low-income emerging markets, it should position itself to meet local standards of quality, technology and pricing defined by the purchasing patterns and purchasing power of the local consumers.

Two other factors to consider in order to win in the new emerging markets are (a) acquiring or retaining the best local managers and (b) avoiding full integration with the locally acquired company or competitor if acquisition was the mode of entry used.

Employing the best local managers i.e. homegrown management help ensure closeness to and understanding of the local consumers’ behaviour, instead of importing managers from advanced markets who lack the local market knowledge. Avoiding full integration with the locally acquired company enables the global parent company to focus on the group’s core strengths, for e.g. international sourcing and logistics functions, as argued by Incandela, McLaughlin & Smith Shi in “Retailers to the World.”

In conclusion, global retailers must be able to adopt the right business structure and strategies for a particular country or market in order to be able to build and position their brands to appeal to consumers around the world, and profit handsomely.


References:

Incandela, Denise; McLaughlin, Kathleen L. & Smith Shi, Christiana. (1999). "Retailers to the World." The McKinsey Quarterly. Number 3, pages 84 – 97

Child, Peter N., Heywood, Suzanne & Kliger, Michael. (2002, January 1). "Do Retail Brands Travel?" [Electronic Version] The McKinsey Quarterly

De Abreu Filho, Gilberto Duarte; Calicchio, Nicola & Lunardini, Fernando. (2003). "Brand Building in Emerging Markets." [Electronic Version] The McKinsey Quarterly. Number 2 – Organization