PRICING:Market-based pricing, Cost-based pricing

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Brand Management (MKT624)

Lesson 38

PRICING

Introduction

We have seen how a premium pricing model works, but then not all situations are conducive to

charging a premium pricing. Not all companies at all times can charge a premium or a decently

high level of pricing. There are different models that cope with different situations and this

lecture makes an attempt to explain those.

The pricing models are grouped into two pricing bases. The discussion centers on both the

bases of pricing market-based pricing and cost-based pricing.

Market-based pricing

Market-based pricing starts with the customer, competition, and company positioning. Keeping

in view customer needs, price sensitivity, and competing products, a price is worked out to

offer customers a superior value1. The price is worked out in the market.

This pricing model is just not possible without having a focus both on customer needs and

competition (market intelligence). Concentration on one to the exclusion of the other is not

going to enable you to come up with the right price.

Price, under this model, therefore is set in the market and not internally within the marketing

and finance departments2. Market-based pricing model can be executed with different strategies

relating product life-cycle stage. Those are briefly discussed for your renewed understanding3:

Skim Pricing: It works under the circumstances of high differentiation that gives you a

sustainable advantage in quality-conscious market. The business charges a premium for

delivering superior customer value until competition catches up.

Value-in-use Pricing: This model basically applies to consumer durables or industrial

products that stay with customers for a certain period. From the time the product is

bought to the time of the completion of the life-cycle of the product, the customers have

to incur certain costs. Those certain costs could be anything from installation to

maintenance to resale of the product.

If customers perceive that the economic benefit that they get out of buying such product

is higher than that of competition, they will be willing to pay premium for your product.

Examples are air conditioners and cars. Customers will pay more for brands they think

offer them better value-in-use.

Segment pricing: One of the goals of segmentation is market-based pricing. Different

customers in different segments have different product needs and different pricing

priorities and sensitivities. This pricing model offers opportunity to set different levels

of pricing for different needs. An example could be different packages offered by cell

phone companies.

One thing must not be overlooked that the concept of economic value remains in force

while working out pricing for your products belonging to different segments.

Strategic Account Pricing: Large customers are important customers to any business

and therefore taken in a strategic light. The underlying assumption is always to maintain

a long-term relationship with such customers with focus on meeting their needs. To

maintain the strategic relationship, you may offer a special price to such customers,

while general prices are on the higher side.

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By the same token, you may also make them pay you higher prices, while the overall

conditions generally slacken and prices register a fall. Since the objective is to serve the

customers with a long term perspective, offering them economic value that surpasses

the one that may be offered by competition, the model works well.

Plus-One pricing: This model applies in mature market conditions, in which all

products carry good benefits for customers. For those brands that are bent upon

differentiating themselves from the rest of the crowd, they position themselves as a

"plus-one" brand.

A "plus-one" position allows the business to charge a market-based premium price on

the basis of that one feature which competition does not offer. Examples are Volvo for

safety, BMW and Lexus for performance, and Mercedes for overall reputation of

performance, luxury, and dependability.

What is important is an understanding of all the cost drivers and the full value of the

product. Realizing the full value of the product that the customer perceives getting may

offer an opportunity to charge more than what the traditional cost-based mechanism may

present you. Attentions to product benefits and value for customer enable you to charge

more, earn more and hence achieve more.

Cost-based pricing

Cost-based is adding your desired margin to the actual cost, and then adding to that margin

of every member of the channel to arrive at the final selling price. Most businesses engage

in cost-based pricing for their products. You may end up doing that, but you must not start

with that.

Market-based pricing may look like the preferred approach to pricing, but it may not be

ideal in many situations that may call for cost-based pricing. A cost-based model starts at

the company with manufacturing costs in view. Desired margin is added and the product

goes through successive channels with the same mechanism of added margins at every

stage till it reaches the customer with the final price.

This pricing is applied mostly in the markets where differentiation is minimal. Let's discuss

a few models in practice.

Floor pricing: As the name suggests it is the lowest possible price a company can

charge. As a means for achieving certain financial objectives like margins or return on

investment, companies set to themselves certain benchmarks. For example, we have to

have 20% margin or 30% return on investment.

Such pricing is not a reflection of the reality of the market; it is a benchmark that

indicates that at the established price, the company will remain a viable concern by

achieving its basic goals. It should be avoided.

Cost-plus pricing: This is what is generally referred to as cost-based pricing. It is

essentially mark-up based. A mark-up is added at every stage of the cost. The channel

works on this basis and the final price is the consumer price. What is important for

businesses is to increase their volumes and lower their costs at the manufacturing end.

Reduced costs mean higher margins. However, the margins to other members of the

channel should stay the same.

Penetration pricing: This model is applicable in situations of growth. You want to

increase your volume and in a bid to do that you lower the price. High volumes bring

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the costs down. This model is workable in markets with minimal differentiation, price

sensitivities, a large number of manufacturers, a large number of substitutes, and easy

entry.

The one with the highest volume and share is in a position to cause a shake out and

hence discourage new entrants from coming in.

Harvest pricing: This model applies to products at the decline stage when volumes are

falling. You increase the price and try to reap higher margins on costs. When volumes

further slide, margins compensate for that until the product fades away and makes way

for another one.

We have seen that market-based pricing starts with the market, competitive situation, and

product positioning and from there it works backward to arrive at margins.

Cost-based pricing starts from the company and reaches its final stage by adding mark-ups at

every stage of the chain.

It is wonderful to command a premium price and make more margins, but volumes may not be

that high. Conversely, it is prudent to follow a conservative approach that generates

benchmarks for the company to charge prices almost bare minimum. But then, you may be

grossly under-pricing and denying yourselves the opportunity of charging the right price.

There is no one answer to a variety of situations you may find yourselves in while pricing your

brand. However, following are a few guidelines for you to be sensible in pricing your brand.

Differentiation: Level of differentiation does offer guidance into the kind of model you

should follow. Market-based model for differentiated products and cost-based model for

those with minimum differentiation seem to be one guideline.

Touch both the bases: Within the generalized guidelines, you should look into the

positive aspects relating both the bases while pricing your brands.

Don't forget contribution: One important factor that you must not lose sight of is that

of total contribution. You have to arrive at a combination of volume and margin that

increases businesses' total contribution.

High volume and low price affect contribution negatively: Going for high market

share and high volumes at the cost of price may not be a good strategy, for it affects

contribution negatively. However, if there is a pressing argument for doing so, then

consensus among marketing and other colleagues must be achieved to make the best

possible decision.

Assess the perceived value: The perceived value your brand offers to your customers

must neither be over-estimated nor under-estimated.

Stay within the mainstream price: Customers will never pay a price they think is

beyond what they assess as the added-value your brand carries. Staying within the

mainstream price is the answer. You should try to see how close or far off that is from

both the models and what kind of contribution that offers. Subsequent to that consider

the factor of contribution margin to have confidence in your decision.

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Summary

Both the models have their attractions and distractions. The objective should be to come up

with the optimal level of pricing that offers the brand value and the company decent

profitability. Based on your brand vision, you must come up with the model most

compatible with it.

Bibliography:

1. Roger J. Best: "Market-Based Management Strategies for Growing Customer Value

and Profitability", Prentice Hall (241)

2. Roger J. Best: "Market-Based Management Strategies for Growing Customer Value

and Profitability", Prentice Hall (241)

3. Roger J. Best: "Market-Based Management Strategies for Growing Customer Value

and Profitability", Prentice Hall (241-251)

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