2. Methodologies used in Price Research
Pricing methods describe the procedures used to arrive at prices that will hopefully satisfy the pricing objectives set by the firm. Among the key issues in this area are the various factors taken into account when setting prices (E.g. costs, competitors’ prices and customer expectations); the general types of pricing methods used (i.e. cost-, demand- or competition- oriented) and their specific implementation (E.g. full-cost versus conversion-cost versions of cost-oriented pricing); and the impact of external factors (E.g. trade association recommendations) on the adoption of particular methods in different industrial settings. Attention must also be given to the other two ‘pillars of price’, namely demand and competition; sound-pricing decisions must be based on all three. Cost, demand and competition must all come into play in the formulation of pricing policy, as must other factors. On the whole, it seems that cost-oriented methods predominate in practice, with cost-plus pricing being the most common form. Pricing at the ‘market’ level (i.e. what the market will bear) is the second most frequently observed method, while following the market leader appears to be the most frequent manifestation of competition-oriented pricing. No single pricing method is considered to be potentially applicable to all product groups. Different methods are perceived to be most suitable for different groups. These findings serve to emphasize the situation-specific nature of price setting and the existence of intra-company variation in pricing requirements, which is also reflected in the choice of pricing method. The degree to which a particular pricing method is thought to constitute the most effective procedure for setting prices is likely to depend on the particular market situation under consideration. The importance placed on different factors bearing upon price setting may have an effect. To identify differences that exists between the pricing methods. The problem of setting actual prices generates much more specific information needs than policy and strategy decisions. They tend to concentrate on narrower problems. Approaches to pricing can be grouped into four categories. These include cost-oriented pricing, market-oriented pricing, competition-oriented pricing, and combined cost and demand pricing. Each of these approaches is a different type of decision problem and leads to varying information requirements.
Cost-oriented pricing
Cost-oriented approaches to pricing tend to be one or two types. The most common involves the use of markups or some type of predetermined percentage increase, which is added to the cost of the product. The management problem in these cases is relatively simple, and the primary source of information is a standard percentage published either in a company guidebook or some trade source. Although the information involved in this type of pricing decision may seem overly simplified, the system is not without merit. The problem facing managers of certain types of businesses, such as retail food stores, is that they must price a very large number of items and change many of those prices frequently.
Break-even price is:
F + VQ
P= Q
Where:
P = Break-even price
Q = Quantity
F = Fixed cost
V = Variable cost
The information required to utilize this formula is available from internal secondary sources. Specifically, the accounting information system provides the fixed and variable costs, which a schedule of break-even points can be derived. Break-even pricing is a reasonable approach when there is a limit on the quantity, which a firm can provide, and particularly when a target return objective is sought. The obvious shortcoming of the break-even approach to pricing is the absence of any information concerning the demand for the product at the desired price. It would be necessary, therefore, to determine whether the desired price is in fact attractive to potential customers in the marketplace. It should be supplemented by additional information concerning customer perceptions of the relevant range of price for the product. The source of this information would most common be survey research, as well as a thorough review of pricing practices by competitors in the industry.
Market-oriented pricing
Managers are much more concerned with price-related information derived in the marketplace as an initial base for pricing decisions. This information is acquired from one or both of two sources, customers and/or competitors. Customer-based information provides estimates of the relationship between price and demand. Pricing which is based on competitive information can obviously rely on the going rate in the marketplace. A more difficult area of competitive pricing is competitive bidding. The differentiated oligopolistic environment is created when a firm is able to discriminate on a profit basis, customer basis, location basis or time basis.
(Demand)
Q = 400 – 2P Q = 150 - .5P
(Revenue)
R = 200Q - .5Q R = 300Q = 2Q
(Cost)
C = 10,000 + 2Q(q + Q )
Where:
Qi = Quantity in segments I for I = 1,2
Pi = Price in segments I for I = 1,2
Ri = Total revenue in segment I for I = 1,2
C = Total cost
Using the standard assumptions of the marginal analysis model, profits are maximized when marginal revenues in each segment equal marginal cost.
Firms who are faced with the prospect of price discrimination between segments must utilize both internal secondary sources of information (in order to develop appropriate cost functions) and demand analysis (to provide demand in the form of revenue functions). Some firms often faced with the dilemma of making pricing decisions when internal company records do not provide adequate cost information. This also applies to new firms, or firms which are entering a new area of business activity. One of the best sources of information for pricing decisions is the pricing activity of competitors. The assumption is that successful companies are selling products at prices, which are attractive in the market and yield a profit.
Combining Cost and Demand
At this point in most traditional discussions of pricing, reference would be made to marginal analysis. Simply put, marginal analysis is based on three assumptions: (1) the sole objective of a firm is to maximize profits, (2) profit is the difference between revenue and cost, and (3) demand and cost can be measured accurately for analysis. Given cost and revenue information, profit is maximized when marginal revenue equals marginal cost. When the cost of producing a unit of output equals the marginal revenue added by placing that unit on the market, the level of output has been attained at which profits are maximized. Marginal analysis relies primarily upon internal secondary data and market surveys to provide the cost and demand information respectively. The lack of attention devoted to techniques which combine demand estimates and internal cost information are relatively simple in their theoretical form, but extremely complex in their applied for. The development of marginal cost schedules requires extensive expense category definitions and policies concerning the handling of costs, which many firms are reluctant to reveal. Similarly, demand estimates tend to be proprietary information for individual firms.
‘Coarse-grained’ approach
This approach is used, aiming to familiarize the researchers with the company and its market. This involved a series of personal interviews with company officials (including the company secretary, the marketing manager and the cost accountant) and consultation of relevant company documents, such as catalogues and brochures.
‘Fine-grained’ approach
This approach was adopted, whereby attention was focused on the individual product groups. This involved initially conducting in-depth interviews with all product managers. At a later stage they were also asked to complete and eight-page questionnaires.
Attribute Pricing
Is perceived to be most appropriate in markets with low price sensitivity where non-price competition is intense and price competition is not as important. It is preferred when the degree of product sustainability is not very high, i.e. in cases where many of the products in the groups concerned do not face direct competition from identical product offerings. These findings make intuitive sense, bearing in mind the way that attribute pricing works, i.e. establishment of price differentials among products by concentrating on differences in physical attributes without explicit reference to market conditions.
Cost-plus pricing
Is thought to be the best method for product groups containing products with few close substitutes offered by competition and sold in markets where price competition is low and non-price competition moderate. This method appears to be preferred in ‘sheltered’ market situations, i.e. where competitive activity is not very intense.
Demand-based pricing and Competition-based approach
Are considered to be most suitable in rather price sensitive markets. These are those in which suppliers offer largely similar products and competition is intense (both in price and non-price terms). These patterns are not surprising, given the explicit reliance of these three methods on demand and competitive considerations for purposes of price calculation. Competition-based pricing is associated with an emphasis on competitive prices and concern with the demand implications of price decisions. Demand is the least important factor when cost-plus pricing is deemed to be the best method.
Competition-based pricing and attribute pricing
Are appropriate when emphasis is placed on objectives such as matching competition, avoiding price wars, building barriers to entry and maintaining dealer support (at least in the short-run). These methods are all differentiated from cost-plus pricing, an unsurprising finding given the nature of cost-plus pricing, with its prime focus on cost rather than market-based considerations. Attribute pricing is also seen to be the best method for achieving a rational price structure in the long-run, which is consistent with the mechanics of arriving at prices under this method and, together with cost-plus pricing, for avoiding government attention.
3. Questions that you would ask in Price Research
Studies can answer a series of vital types of pricing questions relating to customers, competitors and costs. These are a couple of questions that customers have used simulators to answer:
· At what price is my products market share maximized?
· At what price is my products revenue maximized?
· At what price is my products profit margin maximized?
· If my products share increases due to a price reduction, from which competitors does it gain the most share?
· What will happen to my share/revenue/profit if one or more competitors match my price reduction? If they exceed it?
· To which competitors is my product most vulnerable to losing share, should that competitor initiate a unilateral price reduction?
4. Analysis of Price Research data
Of the traditional four “P’s” of marketing, pricing is the most often overlooked in constructing a successful marketing strategy. Many marketing organizations devote extensive resources to product, promotion, and distribution efforts, leaving pricing as a last minute decision, all too often made for the wrong reasons or by the wrong people, or without adequate consideration and analysis. However, an intelligent, well-conceived pricing strategy – driven by insightful pricing research is often the key to achieving profitability for even the most brilliant marketing efforts. Too often, organizations set their prices in overly simplistic ways, either by simply matching or slightly undercutting the competition’s prices, or by applying a simple cost-plus formula to manufacturing costs. Even when they do employ pricing research to take account of customer’s price sensitivity and willingness to pay, they may simply set prices in such a way to meet a pre-determined market share objective. The key to successful price determination understands your customers’ elasticity of demand. Technically, elasticity of demand is the amount of change in demand for your product or service that is associated with a given change in its price. In practical terms, understanding elasticity means understanding the relationship between prices, sales volume, revenue, and profit. While lower prices generally lead to greater sales volume, they also mean less money with each sale that is made, and potentially lower overall revenue and profitability.
The question of how to price a product is always a critical issue and, in many ways, the key element of the marketing mix. Several research approaches attack the pricing issue, including conjoint analysis, traditional purchase intent analysis and van Westendorp analysis.
In conjoint analysis, various approaches (adaptive, Choice-based, Preference-based, etc) are used to force target customers to make tradeoffs between price and other product features. Target customers are asked to indicate their likelihood of purchase or preference for various versions of your product that are stated in terms of differing levels of the attributes of the product such as price. By analyzing the choices they make, we are able to estimate the relative values they associate with each attribute and with the levels of each attribute. These estimated values or utilities are used to optimize a product, segment the market and simulate market response to different product offerings.
Traditional purchase intent analysis relies on asking a sample of target customers to indicate their likelihood of purchasing a particular product. Often they are asked to state their likelihood at different price points. We use our intent translation model to adjust raw survey responses to provide estimates of actual sales.
In van Westendorp analysis we ask target customers a series of questions that permit us to identify an Optimal Price Point as well as points of marginal Expensiveness, Marginal Cheapness and an Indifference Point.