Exhibit 16.1   Demand and profit curves — taking a pricing decision.

At What Price Should We Sell Our Product?

The answer to this question invariably depends on your objectives. For instance, considering the typical scenario portrayed in Exhibit 16.1, what price adjustment would you recommend?

If the objective is to maximize profit, you might consider raising price all the way up to $3.15. However, if you do this, your market share will plummet from about 60% to 40%, and your competitors’ collective share will soar to 60%. If the market size does not change and if their variable costs increase proportionately, the competitors gain 50% growth in volume, value and profit. You, on the other hand, will gain about 19% in profit, and lose considerably in volume and value. So, by maximizing your profit, you will be conceding competitive advantage to your competitors.

If the objective is to grow market share, you might consider reducing price. But if you do this, your profits will plunge, and you might trigger a price war.

Low-cost leaders might aggressively engage in price wars with the intent of squeezing competitors out of the market. Yet the outcome may not always be what they are hoping for.

For instance, when IBM, under competitive price pressures in 2005, sold off its PC business to Lenovo, the change in market dynamics did not favour Dell. Lenovo, which already possessed a low cost manufacturing base, got armed with the talent that came with the IBM business. Much of IBM’s customer relationships, and a lot of its brand equity, got transferred to the new owners. According to Gartner, with a share of 16.9% in 2013, Lenovo became the leader in the global PC market.

Price-fixing is illegal in most countries, but the temptation may be alluring for oligopolies. That particularly holds for categories like cigarettes where governments also want prices to go up to dissuade smokers. The three conglomerates that control the cigarette market in a number of countries might be tempted to raise prices to the levels that the governments are targeting. By doing so they could get to “keep the money”, rather than let it go to the government in the form of increases in excise duty.

Unless there are sustainable competitive advantages, high-price, high-margin tactics lower the barriers of entry for competitors. When cigarette prices were fixed upwards in a particular country, the market was soon flooded by imports from a Chinese manufacturer. The commotion that followed led ultimately to the sharpest increases in excise duties in that market.

As can be seen from some of the above examples, pricing decisions are fraught with hidden risks. The tendency quite often is to take a blinkered view to the problem, not foreseeing the impact on competitors and other industry players, and not anticipating the sequence of events that might follow a pricing decision.

The answer to the question posed above, hinges on several factors. You need to take into consideration company objective, price positioning, cannibalization, profit, revenue, market share, competitive scenario, competitive response, and where applicable, government’s response. You also need to make a clear distinction between pricing strategy and pricing tactics.

The above discussion emphasizes the intricacies and risks involved with pricing decisions. As is often highlighted, price is the variable in the marketing mix that generates revenue. Getting it right therefore warrants careful attention to marketing and financial considerations.

The following section, which pertains to the basics of pricing research, reflects on the notion of price elasticity of demand and the factors affecting it. It highlights, too, the importance of realism in pricing research.

This chapter is devoted mainly to pricing research methods including Gabor–Granger, Van Westendorp’s price sensitivity meter, brand price trade-off, conjoint analysis and discrete choice models. The applications and the strengths and weaknesses of these methods are reviewed.

The chapter imparts an understanding of the dynamics of price and volume, and of the issues, intricacies and risks in taking pricing decisions, so that you are better equipped to make those decisions.

The Yakult case study, at the end of Part V, facilitates the development of a deeper understanding of the application of pricing research, and the issues involved in taking pricing decisions.


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