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LEAN MANAGEMENT GUIDELINES FOR CHECK POINT 88

PRICE

Business owners and marketing managers must have a good understanding about various price strategies to ensure effective implementation of the marketing plan within the organization.

Price can be defined as the value assigned to the benefit one receives from products or services. Usually, price is the amount of money that is spent to acquire a specific quantity of goods or services. (27)

The concept of price is an integral part of the Product-For-Money Exchange Process and is an inherent part of marketing management. All parties involved in the exchange process are expected to establish a suitable price for products or services in order to satisfy both buyer and seller.

The Buyer must feel that the price paid for products or services is a fair one. The Seller, on the other hand, must believe that the price received from the buyer is sufficient to cover the initial expense and produce profit commensurate with the risk involved.

Price is an important Marketing Tool for offering products or services in the marketplace. Only if buyers feel that they are getting a good deal, will the product or service be purchased. The "right price" concept can, therefore, be an effective marketing tool that determines who purchases what. Moreover, price determines what will be produced by the sellers, and regulates the quantity of products or services purchased by the buyers.

ADDITIONAL INFORMATION ONLINE

Price is one of "The Four P's" elements of the Marketing Mix as illustrated below.

MARKETING MIX (“THE FOUR P")

PRICING PROCEDURE

The Price-Setting, or Pricing, represents one of the critical tasks in the marketing management process. Some studies indicate that pricing is considered the most important marketing variable.

Business owners and managers can use several methods to price products or services. Some of the Pricing Methods are discussed in detail in Tutorial 3. Although suppliers must consider basic costs, potential demand, and competitive prices charged for similar products or services, the ultimate pricing procedure must combine seasoned executive judgment and an analytical approach.

The Pricing Procedure in a small or medium-sized organization requires coordination of efforts of marketing, operations, and financial employees. Pricing of products or services must be carried out in accordance with the overall financial and marketing objectives of the company. Pricing may present a challenge in certain types of situations outlined below.

The ultimate consideration in the price-setting procedure should be whether a particular product or service contributes to the overall profitability of the company, and the extent of that contribution. It is obvious that if a particular product or service can’t contribute to the company’s overall profitability, then the viability of such product or service should be questioned immediately.

REASONS FOR PRICE-SETTING

THE MAIN OBJECTIVE OF THE PRICING STRATEGY

The main objective of the Pricing Strategy is to determine a suitable price, and price fluctuation through time, in order to support the product or service in the marketplace and to meet the sales and profit objectives of the organization. Most companies establish their pricing strategy in accordance with one of the following factors illustrated below.

PRICE-SETTING FACTORS

ADDITIONAL INFORMATION ONLINE

COST

Cost represents one of the basic parameters used throughout the ordinary pricing procedure. All costs are classified in Tutorial 3 as either Direct Costs or Indirect Costs as illustrated below.

BASIC CLASSIFICATION OF COSTS

Both, Direct Costs and Indirect Costs differ, depending upon the nature of the company's activities, as illustrated below.

TYPES OF COMPANY ACTIVITIES

A Detailed Classification Of Direct Costs And Indirect Costs in various types of companies is illustrated below. This classification also applies in a similar manner to Project Management Companies and Contractors.

DETAILED CLASSIFICATION OF COSTS

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PRICING STRATEGY

The actual pricing of products or services is normally carried out by the financial department employees using information provided by the operations and marketing departments.

From the strategic marketing point of view, the Pricing Strategy is particularly important when new products are introduced into the marketplace. Three basic types of pricing strategies may be adopted at this stage by the marketing manager. These strategies are illustrated below. (28)

THREE BASIC PRICING STRATEGIES

Each strategy is described in details next. However, irrespective of a particular price-setting strategy which may be used, business owners and marketing managers should always remember that:

It is always easier to reduce a discount than to increase price!

There are additional pricing strategies which are often used by business owners and marketing managers. These strategies include:

All the above mentioned pricing are presented below. Information about additional Pricing Strategies is available online.

ADDITIONAL INFORMATION ONLINE

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PENETRATION PRICING STRATEGY

Penetration Pricing Strategy is the strategy of entering into the market with new products or services at the lowest possible prices. This will allow the company to capture a significant portion of the existing market and to attract valuable customers. 

Since the Low Price means lower profit margins for the company, it may discourage competitors from entering the market. Low pricing of products or services can be used as a prime advantage, provided, of course, that the quality is maintained on an acceptable level. 

Once the company is successful in establishing itself in the marketplace, the price should be adjusted and raised accordingly. The Price Increase, however, should not exceed the price level imposed by competitors. At a later stage, if circumstances allow, the price could be increased more in order to maximize the company's level of profitability. 

Many organizations, small and large, use the penetration pricing strategy as an effective tool in developing a strong business momentum, and opening additional markets for their products or services.

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MEET-THE-COMPETITION PRICING STRATEGY

Meet-The-Competition Pricing Strategy directs that new products or services enter the marketplace at the existing price level established by competitors. In order to ensure successful implementation of this strategy, it is necessary to offer additional advantages to potential customers. 

Such advantages, for example, could be a simplified functional application, improved quality, or reduced weight of a particular product, or a specific service improvement.  All additional benefits should be clearly explained to potential customers and used to Stimulate New Business in the competitive environment.

Once the company is successful in implementing the meet-the-competition pricing strategy, the price of products or services could be adjusted in order to maximize the level of profitability. The price adjustment, however, should be carried out with  particular care to ensure that the company's market share is maintained.

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PRICE-SKIMMING STRATEGY

Price-Skimming Strategy prescribes the use of a high price for new products or services in a developing market environment. This strategy is frequently used by manufacturers and suppliers, who are the first to introduce a brand new product or service into the market. The prime purpose of the price-skimming strategy is to maximize the profits from the very beginning while there is no competition in the marketplace.

If the new product or service proves to be a success, the company should expect competition in the future. In the meantime, however, the company should attempt to sell as many products, or provide as many services, as possible and accumulate additional funds. These funds should be used for advertising and promotion to strengthen the company's position in the marketplace.

When the product's or the service's novelty is gone, and other organizations enter the market, it will be necessary to lower the price to ensure that the company's market share is maintained. Price-skimming is considered a safe strategy since the company is constantly reducing the price of a particular product or service and accommodating the ever-changing needs of customers.

DISCOUNTS

Another important aspect of pricing strategy relates to discounts which are frequently offered to selected customers.

A Discount is a reduction in a defined selling price.

Different types of discounts can be offered to customers for several reasons as outlined below.

REASONS FOR OFFERING DISCOUNTS TO CUSTOMERS

In order to accommodate different situations in a competitive business environment, it is essential to develop a suitable Discount Structure. Several types of discounts should be considered by the marketing manager as illustrated below.

TYPES OF DISCOUNTS

ADDITIONAL INFORMATION ONLINE

TRADE DISCOUNT

A Trade Discount is a reduction in a nominal list price which is offered to regular customers. 

List Price, or Suggested Retail Price, is the final price attached to a particular product or service.

Sometimes wholesalers and retailers may decide to reduce the level of slow moving inventory and to make space for new merchandize. In this case, the list price of existing inventory is "marked down" by a sales discount and the sales price is calculated as follows

List Price - Markdown (Or Sales Discount) = Discounted Sales Price

Manufacturers often use a Chain Discount, or a series of trade discounts offered to customers as illustrated below.

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CHAIN DISCOUNT STRUCTURE

For example, if the product's Suggested Retail List Price is $100 per unit and the Chain Discount from the manufacturer is "40/20," this means that:

• • The wholesaler's price to a retailer is $100 - 0.40 x $100 = $60 per unit.
• • The manufacturer's price to a wholesaler is $60 - 0.20 x $60 = $48 per unit.

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QUANTITY DISCOUNT

A Quantity Discount, or a Volume Discount, is a reduction of the purchase price based on the quantity of purchased products or services, measured either in units or dollars. 

Quantity discounts may be offered to customers on non-cumulative or cumulative basis as illustrated below.

TYPES OF QUANTITY DISCOUNTS

A typical structure of a non-cumulative and cumulative quantity discounts is illustrated below.

QUANTITY DISCOUNT STRUCTURE

Non-Cumulative Quantity Discount:

A supplier may offer a 1 percent discount on the purchase of 10,000  units and a 2 percent discount on the purchase of 20,000 units. 

Cumulative Quantity Discount:

A supplier may offer cumulative quantity discount to customers as described below.

Non-cumulative quantity discounts usually stimulate customers to place larger orders on a less frequent basis. This, in turn, helps reduce the supplier's administration, operation, and distribution costs.

Cumulative quantity discount does not encourage customers to place larger orders, so it causes higher administrative, operation, and distribution costs. It does, however, stimulate customer loyalty and development of friendly long-term customer-supplier relations.

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CASH DISCOUNT

A Cash Discount is a reduction in the purchase price when a bill is paid on time or in cash upon the delivery of products or services.

Cash discounts are usually offered to customers in addition to any trade discounts or quantity discounts. A typical Cash Discount Structure is illustrated below.

CASH DISCOUNT STRUCTURE

A manufacturer may quote "2/30, Net 60" terms to a customer. This means that the customer can deduct 2 percent of the purchase price if the invoice is paid within 30 days from the issue date. Otherwise, the full price must be paid within 60 days.

Although 2 percent may appear insignificant at first, cash discounts should not be disregarded. If the invoice is paid within 60 days, this results in borrowing an amount equal to the purchase price at:

(60 days - 30 days) x 2 percent x 12 months = 24 percent per year.

It is advisable, therefore, for management to take full advantage of cash discounts, since they may help reduce the overall cost of purchases. Sellers, on the other hand, are also encouraged to offer meaningful cash discounts to customers in order to improve their cash flow.

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PROMOTIONAL DISCOUNT

A Promotional Discount is an allowance to customers for promoting new products or services during a limited period of time.

By offering promotional discounts on a limited-time basis, suppliers create a sense of urgency in the minds of their potential customers to purchase their products or services at lower prices. Manufacturers, for example, may use promotional discounts when launching new products in the marketplace. Wholesalers and retailers use a promotional discount as an additional incentive to market new products in a particular market segment.

Promotional discounts may also be offered in other forms of incentives as illustrated below.

TYPES OF PROMOTIONAL INCENTIVES

The magnitude of promotional discounts and incentives is normally determined by the marketing manager well in advance and according to the promotional strategy.

ADDITIONAL INFORMATION ONLINE

PRICE CHANGE MANAGEMENT

Business owners and marketing managers often face situations when prices must be adjusted in accordance with the changing conditions and price fluctuations of products and services in the marketplace. It is important, therefore, to have a clear strategy under these circumstances and accommodate such changes in a timely manner.

The basic guidelines related to the Price Change Management entail a number of steps, as outlined below. Monitoring and adjustment of prices related to the company's products or services represents an important managerial task. This task should be carried out by the marketing manager on a continuous basis to ensure the company's solid standing in the marketplace.

THE PRICE CHANGE MANAGEMENT PROCESS