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Importance of Product Pricing


Importance of Product Pricing

One of the elementary considerations any business startup has to attend to immediately after it has been established is what price it will charge for its principal product, as this is the primary means to cover raw material or other input costs, generate revenues, cover expenses, attract consumers, pay employees, etc. – in brief, to become a sustainable and profitable enterprise. Even though it is a fundamental decision, few choices a company will ever make are so essential in determining the bottom line it will report, the number of consumers it will have, and the ultimate performance it records and mistakes or errors here could have potentially disastrous ramifications all across the board.

Determining the Pricing Objective – Profit Maximization or Sales Maximization

The tradeoffs here are self-evident – setting a lower price may attract more customers and thus fetch a larger market share for the firm’s product. But charging a higher price might reflect a high quality and prestige product. If generating income as such is deemed the more important goal, the former will be chosen. But if maximizing sales revenue and targeting high growth in product purchase and expansion is ideal, the latter course will be pursued.

Estimating the underlying total Demand for the Product

The existing demand for the product sets a ceiling price. The usage of penetration pricing occurs if the product has a highly elastic demand, and prevalent competition in the market is already strong. Under this policy, it fixes the prices below the competitive level in order to obtain a larger share of the market. As soon as the product takes off, is widely used or generally accepted, the price is increased. But when the demand for the product with respect to price is more inelastic, it charges higher prices for the product. This policy follows generally during the initial stages of the introduction of the new product.

Arriving at figures for Costs and Profits

Likewise, the floor price for a product is set by the costs incurred in producing or manufacturing it. Must cover the various costs involving in producing the product and in pricing the product. On a long term basis also the price must take into consideration the costs of doing business. This also includes sales forecasts and profit margins.

Factoring in the existing Competition for the Product

The base price around which approximate point one’s own price would be centred may be provided by the competitor’s prices as well as the price of substitutes. The number of competitors for the product in the market, as well as the policy followed by them, is also an important factor. The usage of competitive pricing occurs if the market is highly competitive, and not differentiating the product from that of the competitor’s.

Considering the Governmental Regulations – Sales Tax and Octroi

Government policies and incentives also need to be taken into account by companies that want to run a sustainable business. Prices are affected by various tax liabilities that a company and the product is subjected to. It includes excise duty, sales tax, and local taxes like octroi. Sales tax is levied on the sale of movable goods in India at the rates, which vary depending upon the type and nature of goods and the State in which sale has taken place. The Central and State governments have empowerment to impose a sales tax. The Central Sales tax deals with transactions in the nature of inter-state sales. While the State sales tax deals with intra-state sales. Octroi is a tax levied on the entry of goods into a municipality or any other specified jurisdiction for use, consumption, or sale. Goods in transit exempt from it.

Selecting a Suitable Pricing Method/Policy

The right price for the product can be determined through pricing research and by adopting test-marketing techniques. The various pricing methods are:-

  1. Value and Perceived value pricing – In the former, companies develop brand loyalty for their product by charging a fairly low price for a high-quality offering. In the latter, a firm sets its price in relation to the value delivered and perceived by the customer. Perceived value is made up of several elements like the buyer’s image of the product performance, warranty, trustworthiness, esteem, etc. Each customer gives different weightage to these elements. Some may be price buyers, others may be value buyers, and still, others may be loyal buyers. If either the price is higher than the value or the price is lower than the perceiving value, the company will not be able to make potential profits.
  1. Differential Pricing – In this method, more affluent customers can be charged a higher price for certain additional features, add-ons, and a more comprehensive product or service, whereas relatively less well-off consumers are charged less for a more basic variation of the product or service. Thus, both ends of customer affordability, as well as expected revenue maximization, are met.
  2. Going rate pricing – Following this process, only if it is difficult to ascertain the exact costs and the competitive response. Hence, firms base their price on a competitor’s prices by charging the same, more or less than the major competitor.
  3. Introducing a product at a premium price – When a product is innovative, and competition is low or non-existent, this policy can be applied. Thus profits are optimized. But when competition arises, prices are lowered.
  4. Ethical pricing – this model of pricing keeps the welfare of the society predominantly in mind. For many life-saving drugs, this particular policy is used. The product is sold at the lowest possible price with either a very reasonable margin or no profit at all. Profit may be earned from other products.
  5. Full Line pricing – If you are selling a range of particular products, for example, pickles, then you price the product in a particular range, this way, you may earn more profit in one flavour and less on the other. But, you cannot sell only the one that gives you maximum profit, or else a customer may switch over to another brand where he would be able to exercise an option for other flavours.

Government Role

Because of all the concerns that may arise if poor quality products without assurance of credibility, or if exorbitantly high prices are charged for what should be available at a minimal cost, the Governments at both the local and national levels have an important role to play. In this connection, the Central and State Governments have passed various legislations in order to control production, supply, and distribution as well as the price of a number of commodities. The Essential Commodities Act, 1955, is one such important legislation. Under the Act, the State Governments/UT Administrations have issued various control orders to regulate various aspects of trading in essential commodities such as food grains, edible oils, pulses, kerosene, and sugar, etc. The Central Government regularly monitors the action taken by State Governments/UT Administrations to implement the provisions of the Act. The Government can enlist any class of commodity as an essential commodity as well as regulate or prohibit the production, supply, distribution, price, and trade in any of these commodities for the following purposes

  • Maintaining or increasing their supplies.
  • Equitable distribution and availability at fair prices of the commodities concerned.
  • Securing any essential commodity for the defence of India or the efficient conduct of military operations.

It states the list of commodities as “essential” under the Essential Commodities Act, 1955, is undergoing reviewing process from time to time in the light of changes in the economic situation and particularly with regard to their production and supply.  For example, keeping in view the production and demand of some of the commodities, it felt that removing these from the list of essential commodities. Hence, with effect from 15.2.2002, the Government removed 11 classes of commodities in full and one in part from the list of commodities declared as essential under the Essential Commodities Act, 1955. Similar efforts are underway to delete more commodities from the purview of the Act in order to facilitate free trade and commerce, for which alternative legal mechanism is being worked out for the protection of consumers interest etc.

The list of commodities declared essential under the Essential Commodities Act, 1955 (As on 15.12.2004):-

I. Declared under Clause (a) of Section 2 of the Act – Cattle fodder, including oil cakes and other concentrates; Coal, including coke and other derivatives; Component parts and accessories of automobiles; Cotton and woollen textiles; Drugs; Foodstuffs, including edible oilseeds and oils; Iron and Steel, including manufactured products of Iron & Steel; Paper, including newsprint, paperboard, and strawboard; Petroleum and Petroleum products; Raw Cotton either ginned or un-ginned and cottonseed; Raw Jute.

II. Declared as essential through notifications under sub-clause (xi) of clause (a) of Section 2 of the Act – Jute textiles; Fertilizer, whether inorganic, organic or mixed; Yarn made wholly from cotton; (i) seeds of food crops and seeds of fruits and vegetables, (ii) seeds of cattle fodder and (iii) jute seeds

In addition, the Government has set up a Price Monitoring Cell (PMC) in the Department of Consumer Affairs to monitor and analyze price data and trends of availability of essential commodities. The Economic Adviser in the Department of Consumer Affairs heads the cell and a Deputy Economic Adviser assisted by Assistant Economic Advisers, and Deputy Directors looks after the work of the cell. The fifteen essential commodities for which the cell monitors the prices are Rice, Wheat, Atta, Gram Dal, Tur(Arhar) Dal, Sugar, Gur, Groundnut Oil, Mustard Oil, Vanaspati, Tea, Milk, Potato, Onion, and Salt.

Receiving the information on retail prices on a daily basis from 18 centres of the country. Similarly, receiving information on wholesale prices from 37 centres of the country on a weekly basis. Accordingly, the price monitoring cell issues retail reports on daily and wholesale reports on a weekly basis.

The objective of such price and distribution controls are evident – the promotion of equity or distributive justice as a desirable end while simultaneously ensuring the quality of goods and services, the prevention of anti-competitive trade practices that are hindering the public interest, augmentation and increase of the quantities supplied, seeing to it that the widespread availability of necessary goods at affordable prices, especially to the poorer strata of society is ensured, etc

About the Author:

Nishant is an MBA graduate from IIM Lucknow. He has extensive experience in business and professional writing, having authored dozens of business articles and personally prepared hundreds of project reports. He has specialized in finance.

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