Types of Pricing Class 12
Firms, always aim at profit maximization and long-term growth. For making a unique pricing policy for their product they have to analyse the market situations.
Generally pricing is put into following four categories:
- Demand-oriented pricing
- Cost-oriented pricing
- Competition-oriented pricing (market driven pricing)
- Value- based pricing
Types of Pricing Class 12
1. Demand-oriented pricing
Demand-oriented pricing sets the price based on customer demand. There's an inverse relationship between price and demand. Higher prices mean lower demand, and lower prices mean higher demand. The equilibrium price is where quantity demanded equals quantity supplied.
If demand increases, prices rise; if supply increases, prices fall. This is due to price elasticity of demand. ‘Necessity’ goods have inelastic demand, meaning their demand isn't affected by price changes. This method helps firms optimize prices effectively e.g. bread and milk prices don’t fluctuate much because they are ‘necessity’ items.
Some Demand based methods of pricing are given below:
1) Perceived value pricing
Perceived value pricing sets the product price based on how customers value it, not on the cost to the seller. This involves using non-price factors like product quality, features, color, size, durability, and looks to build perceived value in buyers' minds.
Different buyers perceive the same product differently e.g. a cup of tea costs differently in a five-star hotel compared to a local cafe because of perceived value.
Key to this pricing strategy is accurately determining the value buyers see in the product. Mistakes in assessing perceived value can lead to wrong pricing decisions e.g. Coca-Cola is priced differently in various settings like family restaurants, five-star hotels, cinemas, and fast-food stalls based on perceived value.
2) Differential Pricing
Different customers have different desires and wants. So, the demand for the product would also be different. Following factors affect the differential pricing method.
a) Time of Purchase:
Prices can vary based on the time of day or season e.g. taxi fares have day and night rates, and hotels charge differently depending on the season.
b) Location:
The same product can be priced differently in various locations. Buyers might have to travel to get a lower price, which can be inconvenient.
c) Product Version:
Variations in product versions, like a leather-bound book versus a regular one, can lead to different prices. A slight cost difference in production can result in a significant price difference.
d) Customer:
Different classes within a theater show the same film but at different prices. Some customers are willing to pay more for a comfortable seat, while others are not.
e) Bargaining Ability:
Customers with better bargaining skills can get products at lower prices, while others may pay more for the same item.
f) Level of Knowledge:
The customer's knowledge about product features can affect the price they pay.
g) Availability of a Product:
If demand is high for a limited product, the seller can charge a higher price. The one willing to pay more gets the product.
3) Skimming Pricing:
Skimming sets a high initial price for a new product, which is reduced gradually as competition increases. This helps in market segmentation based on price sensitivity e.g. Textbooks start with a high price for the first edition, and later editions are priced lower.
The high initial price targets customers less sensitive to price, capturing maximum revenue before reducing the price to attract a broader market.
This strategy works well when a product is unique and its optimal price isn't clear. It allows for experimental pricing, starting high and adjusting downwards, rather than starting low and missing potential revenue.
Effective Conditions for Skimming Pricing
a) Inelastic Demand:
Demand doesn't change much with price changes; customers know little about the product and there are few competitors.
b) Segmented Market:
Market can be divided into segments with different price sensitivities.
c) Unknown Price Elasticity:
Little information about how price changes affect demand.
d) Low Risk:
Minimal risk allows for gradual price reductions.
e) Upmarket Efforts:
Firm aims to improve product quality, services, and marketing efforts, and capitalizes on these improvements.
4) Penetration Price Policy:
Penetration pricing involves setting a low initial price to quickly enter and establish a product in the market. The purpose is to attract customers and gain market share, pushing out competitors by offering a more affordable option.
Over time, as the product gains acceptance, the price may remain stable or increase.
Price penetration is ideal when:
- Sales Volume Sensitivity: Products sensitive to price changes benefit from this method.
- Large Sales Volume Needed: Aims for high sales volume to capitalize on economies of scale.
- Competitive Threat: Effective when facing significant competition.
- Price Stability Desired: Maintains low prices for market stability.
Using penetration pricing can keep the competitors away as It discourages new entrants. Thus, It can help the firm achieve long-term growth through increased market share and sales.
Effective Conditions for Penetration Pricing:
- High Price Elasticity of Demand:
Low prices attract more customers due to high sensitivity to price changes.
- Economies of Scale:
Larger sales volume reduces the cost per unit.
- Strong Competition:
Low prices can deter new competitors from entering the market.
- Utilized Capacity:
The firm can meet increased demand without extra costs.
- Non-Segmented Market:
High prices may not be accepted; low prices ensure broader acceptance.
- Substitute Products Available:
Low prices help compete against alternatives in the market.
These conditions make penetration pricing effective for capturing and expanding market share quickly.
Advantages of Demand Based Pricing:
- Considers how customers react to price changes and their preferences.
- Helps identify inefficiencies, optimize the product mix, and set prices for new products.
- Eliminates the challenge of joint cost allocation.
- Improves the firm's ability to find ideal prices using predictive models.
Disadvantages of Demand Based Pricing:
- Does not ensure competitive harmony.
- Not safe from a company’s side.
Types of Pricing Class 12
2. Cost-oriented Pricing
Cost-oriented pricing is setting the prices that considers the company's profit objectives and covers its costs of production. Costs is the key factor for determining the initial price but the target market’s demand for that product is ignored.
Cost-oriented pricing is of three Types:
- Cost plus Pricing
- Markup Pricing
- Break-even Pricing
- Cost Plus Pricing
The price is set by adding a profit margin to the total cost of producing a product.
Formula: Selling Price = Unit Total Cost + Desired Unit Profit.
It tells firms about competitor prices but ignores replacement costs.
- Markup Pricing
This pricing is used by resellers who add a percentage increase on the product cost to determine the price e.g. during annual sales, firms adopt markup pricing. It helps combat inflation by passing increased costs to customers, ensuring profit. However, setting prices too high or low can miss profit opportunities.
- Break-Even Pricing
A price is set to cover all production costs, resulting in zero profit.
Formula: BEP = Total Fixed Cost / (Selling Price per Unit - Variable Cost per Unit).
The equilibrium is reached when total revenue equals total cost, resulting in no profit or loss.
The equilibrium establishes at a point where total revenue is equal to total cost and the firm enters into ‘Break-even’ a situation of ‘no profit, no loss’.
Example: If Fixed expenses in a production unit are ₹72,000, variable cost per unit is ₹16 and selling price per unit is ₹20; find out BEP quantity. What should be the selling price if Break-even output is brought down to 12,000 units?
Solution: (a) BEP = Total Fixed Cost / Selling Price per unit – Variable cost per unit
OR . BEP = Total Fixed Cost/ Contribution per unit
(Contribution per unit = Selling Price per unit – Variable cost per unit)
= 72,000/ 20 – 16
Break-Even Point = 18,000 units
(b) BEP = Total Fixed Cost/ Contribution per unit
(Contribution per unit = Selling Price per unit – Variable cost per unit)
12,000 = 72,000 / Contribution per unit
Contribution per unit = 72,000 / 12000 = 6
Contribution per unit = Selling Price per unit – Variable cost per unit
6 = Selling Price per unit – 16
Selling Price per unit = ₹22
Types of Pricing Class 12
3. Competition-Oriented Pricing
Competitive Pricing involves setting product prices based on what other firms charge. This is typical in a competitive market where products are similar and market prices are well-known. Sellers must adapt to market-driven prices, often lowering costs to stay competitive. For example, Airtel reduced its prices when Vodafone, Idea, and Reliance Jio entered the market.
Competition-Oriented Common Methods:
a) Going Rate Pricing:
Prices follow market trends without deep analysis of demand or cost.
Popular among retailers for homogeneous products.
Prevents price wars by aligning with industry leaders.
b) Sealed Bid Pricing:
Used in bidding scenarios, firms set prices competitively to win contracts.
Balances between not underpricing (below cost) and avoiding overly high prices.
Relies on expected profit calculations.
c) Discriminatory pricing
Discriminatory pricing means selling the same product at different prices without a proportional difference in costs. It includes various forms:
- Customer Segment:
Different prices for different groups (e.g., Indian Railway charges lower fares for students).
- Product Form:
Different versions of the same product sold at varied prices (e.g., a bathing soap priced at ₹2 and ₹50 based on packaging).
- Location:
Different prices at different places (e.g., cinema seats priced differently based on location).
- Time:
Prices vary by season or time of day (e.g., higher taxi fares at night).
- Image:
Same product priced differently based on image (e.g., perfume priced at ₹500 in an ordinary bottle and ₹1000 in a fancy bottle).
Differential Pricing strategy leverages different factors to adjust prices according to market segments, maximizing profit by targeting various customer preferences and behaviors.
Types of Pricing Class 12
4. Value-based Pricing
Value-based pricing sets prices based on the perceived value to the customer rather than the cost. Companies analyze consumer needs and value perceptions, then set target prices and design products accordingly. This is opposite to cost-based pricing, where prices reflect production costs.
Higher perceived value, influenced by brand image and marketing, justifies premium pricing. For example, Fab-India and Forest Essentials cosmetics are considered high-end and priced accordingly.
Value-based pricing strategy benefits firms by aligning prices with what customers are willing to pay, ensuring the product meets consumer expectations and maximizing profit potential.
Major Pricing Methods Followed by Business Enterprises Class 12