Pricing Strategies

Pricing Strategies
When we studied various market structures, to determine the price to be set by each firm we first find the point where MC = MR and then extend that point upto the AR curve. That would be the selling price of the equilibrium output.

Pricing Strategies
But in practice, there are numerous factors that do not allow the firm to set the price according to the method we used in the graphs of market structures. In markets which are imperfect, the firm has to understand factors like competition, comparative costs, promotion expenditure, the firms objectives etc. and then set the price. Also, in reality, it is difficult to find the marginal revenue and marginal cost easily. Hence the concept of Average is more acceptable than marginal. This is one limitation of micro economics.
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Pricing Methods
The firms overall objectives serve as guiding principle to pricing. The following are the commonly adopted major pricing objectives of a business firm 1. Survival 2. Rate of Growth and Sales Maximization 3. Market Share 4. Target Rate on Investment 5. Preventing Competition 6. Making Money 7. Service Motive 8. Regular Income 9. Price Stabilization
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Cost-plus Pricing
Cost plus pricing is the most commonly adopted method. Under this method cost of product is estimated and a margin of some kind of profit is added on the basis of which the pricing is determined. Empirical evidences have shown that a majority of the business firms usually set prices for their products on the basis of cost plus a fair profit percentage.
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Cost-plus Pricing
Cost plus Pricing = Cost + Fair Profit Cost plus pricing is essentially Mark-up pricing in practice. It is determined by adding a percentage to the average cost of the product. Thus: Price = AC + Mark-up Mark-up measured as X%. It is also referred to as contribution margin
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Cost-plus Pricing
For example, a firms AC is Rs. 50 and contribution margin (X%) is 10% (thus 0.1 of 50 = Rs. 5) Therefore; P = 50 + 5 = Rs. 55 In practice however, cost-plus pricing method is regarded as more suitable when the producers are uncertain about the market demand for their products and would prefer stability when rivals price strategies are unknown.
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Administered Pricing
Administered price for a commodity is the one which is decided and arbitrarily fixed by the government. It is not allowed to be determined by the free market forces of demand and supply. Administered prices in a market economy are the results of government intervention. They are prescribed by the government rather than determined by the market mechanism.
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Ethical Pricing

When the firms help the government in carrying out socio-economic programme like supply of medicine or school books or nutritions food etc., they follow the principle of Ethical pricing, i.e., reasonableness of pricing that would create a good image of the firm.
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Going- Rate Pricing

It emphasis the market conditions. The firm does have control over its own price and output. Where a price leader exists and he charges a price in keeping with what the followers are charging. A firm may accept a certain price as a going rate price and then adjust its costs by providing for a certain margin of profits.
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Experimental Pricing
In search of an optimum price, the firm takes some cognizance of the demand for the product, and proceeds, to fix a price by a trial and error method. This is experimental pricing. Usually a sample of test markets is selected, and price is varied to see the reactions. These reactions are observed and then a price that maximizes profits is fixed. This method is used for launching new products.

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Pioneering Pricing
Every product has a life-cycle: a product is new, it clicks and gets established, but after sometime stagnation and decline phases follow. Once this fact is accepted two possible approaches emerge for a pioneering price. They are Skimming Price. Penetration Price.
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Pioneering Pricing
Y

Skimming Price

Price

Penetration Price

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Pioneering Price
Skimming Price : The entry of a new product into the market is usually preceded by a great deal of research and promotional expenditure. For a new product, the demand initially is not likely to be price-elastic. A firm can decide to skim the cream of the market by charging a high price. Subsequently price can be reduced to reach lower income customers.
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Pioneering Price
Penetration Price : Alternatively a firm can begin by charging a very low price to penetrate the market. In the short-run the firm may make losses, but in the long-run profits can be earned. This is because, after capturing a large part of the market, the firm can gradually raise the price. Where large-scale production is likely to reduce costs considerably, this policy is helpful.
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Marginal Cost Pricing

Here, the firm does not consider the fixed costs as the fixed costs might have been recovered earlier from the all the previous units sold. To make the selling price more competitive, the firm considers only the marginal costs as the cost of production and quotes the rate which is always lower than the competitors.
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Transfer Pricing
Many a times it so happens that one corporation has two or more subsidiaries and these subsidiaries have to trade among themselves. Here the firm uses Transfer prices. It neither sells the product to its associate firm at a high price ( to take advantage of being a supplier of the same corporation) nor does it charge a very low price ( to have reasonable profit ). Price in this case is also referred to as Arms Length Price
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Price Discrimination
A Monopoly can discriminate between different buyers by charging them different prices because it has control over the price and customers have no choice. It is a situation when a firm charges different prices for the same product when the difference in price is not based on the difference in costs. The cost curves of the firm are same but the demand and revenue curves are different.
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First Degree Price Discrimination

This is a situation where a Monopolist charges a different price for each customer for each unit separately. Eg. In a town, if there is only one cardiac surgeon, he may charge different rates from different customers, may be based on their paying capacity, for a bypass surgery.

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Second Degree Price Discrimination

Here, the monopolist charges different prices for different batches or blocks of units of the same product. Eg. A monopoly electric company can charge one rate per unit for the first 1000 units and then decrease the rate per unit for the subsequent batches of 500 units. Here, the per unit price remains the same for all the units in one batch and changes batchwise.
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Third degree Price Discrimination

Here, the monopoly firm divides the entire market into two or more different groups and charges a different price for each different group. Eg. Indian Railways has different charges for senior citizens, kids below 12 years, cancer patients, sports teams etc. Electric companies have different rates for farmers, commercial users, domestic users etc.
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Profit-maximising output under third degree price discrimination

DX O O O

MRX

(a) Market X

Profit-maximising output under third degree price discrimination

DY DX O O MRY O

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(a) Market X

(b) Market Y

Profit-maximising output under third degree price discrimination

DY DX O O MRY O MRT

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(a) Market X

(b) Market Y

(c) Total (markets X + Y)

Profit-maximising output under third degree price discrimination

MC

DY DX O O MRY O MRT

MRX

(a) Market X

(b) Market Y

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Profit-maximising output under third degree price discrimination

MC

DY DX O O MRY O 3000 MRT

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(b) Market Y

(c) Total (markets X + Y)

Profit-maximising output under third degree price discrimination

MC

5 DY DX O O MRY O 3000 MRT

MRX

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(b) Market Y

(c) Total (markets X + Y)

Profit-maximising output under third degree price discrimination

MC

5 DY DX O 1000 O MRY O 3000 MRT

MRX

(a) Market X

(b) Market Y

(c) Total (markets X + Y)

Profit-maximising output under third degree price discrimination

MC

5 DY DX O 1000 O MRY 2000 O 3000 MRT

MRX

(a) Market X

(b) Market Y

(c) Total (markets X + Y)

Profit-maximising output under third degree price discrimination

MC 9 5 DY DX O 1000 O MRY 2000 O 3000 MRT

MRX

(a) Market X

(b) Market Y

(c) Total (markets X + Y)

Profit-maximising output under third degree price discrimination

MC 9 5 DY DX O 1000 O MRY 2000 O 3000 MRT

MRX

(a) Market X

(b) Market Y

(c) Total (markets X + Y)