Designing Product Pricing Strategies, Part 2

Proposed Conceptual Framework

After five years from the publication of the established theoretical framework on designing price strategies, we now propose a new conceptual framework that will accommodate advances or new points of view as a result of studies in product pricing. The following pages will detail these.

The 3 Cs

The Cost Function

In its most simple definition, pricing should be about the bottom-line or the costs to produce and deliver the product and service offering. By knowing the costs, the marketer will be able to identify alternatives or substitutes that can be used to control these costs. But there is actually more for the interested marketer.

Successful companies are more oriented towards long-term planning. The more long-term the direction, the more active companies become. These activities increase costs. Tracking the activities of competitors, monitoring costs and profitability, and revenue forecasting have significant correlation with profit before tax. But there is evidence that the costs don't increase proportionally with the heightened activities. Knowledge of consequences of any activity will decrease probability of misdirected efforts, wasted resources and economic loss. And it is because of these reasons that guesswork and rule-of-thumbs are discouraged.

In order to accurately consider all cost factors, cost accounting is used in identifying and isolating the cost of producing goods and service. Costs include direct materials, direct labor and overhead. And overhead costs include all indirect supplies and materials of inconsequential price, managerial, transportation, clerical salaries, cost to operate machineries, building depreciation, insurance, utilities and employee benefits.

There are two approaches to costing: job and process costing. In job costing, each job is given the status of a cost center and the materials and labor are charged directly to the item produced. In process costing, costs are accumulated and spread over the all units produced.

Costs are not incurred because of an organization's processes. It is a result of the organization's desire to satisfy both an explicit and implicit need. To understand the buyer's needs, especially the most implicit of requirements, the seller must build relationships. This would lead to improved profitability when serving customers differently becomes a possibility.

Customers can be of the direct marketing and supply chain contexts. Between these, there are several dimensions of differences in customer profitability models. In the supply chain context, purchasing, carrying costs and shipment costs borne by the distributor generally vary across the supply chain; Customer characteristics such as size, decentralization of purchasing, inventory holding have a significant effect on customer serving costs; And, the execution of orders and related costs are different depending on the type and size of order.

Inventory discrepancy problems are also faced by all manufacturers, retailers and service providers face. It has important implications in marketing because many managerial decisions like purchasing the appropriate raw materials, correctly pricing products, hiring good workers, and scheduling efficient production are based on current inventory levels. This may include unreported scrap, misreported labor and production counts, unrecorded engineering changes, substituted materials and inaccurate cost standards. Add this to shipping errors, inaccurate material usage, obsolescence and unreported internal use and the costs can be really high.

And lastly, the "financial leverage" factor, which includes the use of outside borrowed funds and searching for cheap sources of funds also reduces costs.

These costs can negatively influence profitability, thus a desire to unduly increase prices.

Customer's Demand Schedule

In connection to this, the factors that influence customer profitability are volume, price/gross margins, complexity factors and efficiency factors. Customer sales have a positive association with the total service costs as customer profit margins. When price differentials adjust for service cost differentials across customers, gross margins are likely to be positive. Customer characteristics like number of orders, number of items, degree of product mix customization, number of delivery locations, may result to higher service costs and lower customer profits. High level of efficiency generates lower customer costs and higher customer profits.

Competitor's Price, Cost and Offerings

Initially, or before the actual price computation and setting, and without much computation, the marketer can elect to: (1) Sell at a premium, (2) Sell at the going rate, and (3) Sell at a discount. The direction is dependent on the effects that the marketer determines appropriate for the company's market.

Benchmarking can help assess costs to improve profitability, ensuring return on investment and assessing the impact of pricing. Computing contribution margins also play a crucial factor in analysis and strategy formulation as basis for pricing products and/or services including relative pricing of substitute products, pricing and marketing strategies in markets having elastic demand. It can be used for evaluation of incremental sale.

In the next article, we would discuss the the practical application of pricing methods and adaptation strategies observed on the retail floor.

Roberto M. Bernardo, Jr. is the principal consultant and designer at Motive (a full-service marketing, design and manpower agency), and a senior Lecturer and former Academic Chairperson of the Industrial Design program of the De La Salle-College of St. Benilde's School of Design and Arts. He is currently completing his Doctor of Business Administration degree at the De La Salle University-Professional Schools, Manila.

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