Financial Implications of Strategy – Valutrics

In order to understand financial implications of a certain market strategy it is
necessary to analyse the revenue stream that is generated  besides the existing
strategy cost structure.

Setting the price of a product is a critical decision for business success. The
product and its price are the linkages between the buyer and the business. We
can therefore say that the price is the source of the revenue stream, and the
pricing policy has an enormous impact on it.

General pricing options and factors influencing the pricing decision making
process can be classified as follows:

– Cost plus profit pricing. The cost plus profit approach involves adding a
predetermined profit per unit to the cost of production to compute sale
price. The cost of producing a product is, of course, not a fixed number
but depends on the number of units produced. As production increases,
fixed costs are spread over more units of production, reducing the cost
per unit. In addition to just covering costs, the sale price includes in this
case a predetermined profit level or a return on investment in the
business.

– Target return pricing. The target return approach involves computing a
target rate of return on your investment in the business and adding this to
the sale price.

– Perceived buyer value pricing. With this approach, price is based on the
perceived value of the product in the eyes of the buyer. To use this
method, the market is segmented as explained in the previous Chapter to
identify the type of buyer who will value the product the most. The
market segment that values the product the most is known as the target
market on which you want to focus your marketing and promotional
efforts. Therefore it is important to identify the target market for the
product as well as the units of product that can be sold due to changes in
the selling price.

– Type of buyer pricing. Pricing decisions also depend on whether you are
selling to the ultimate consumer of the product or you are selling an
ingredient to a processor or manufacturer of the consumer product.
Intermediaries such as manufacturers are normally more sophisticated
buyers. They are looking for specific attributes and know what they are
willing to pay for them. In addition, competitor’s prices are more
important in the purchasing decision of intermediaries because of the
volume involved. In these cases the pricing decision will be more
dependent on the price levels of competitors. As a general rule,
consumers are less sophisticated in their purchasing decisions and more
likely to respond to the emotions of the moment. They are less sure of the
value of product attributes and are easier to influence as to their value.
Therfore pricing decisions, along with the promotion program, will differ
depending on whether you are selling to an intermediary or the final
consumer.

– Price of competitor’s products pricing. The importance of the price of
competitor’s products depends on whether you are producing a
commodity or a differentiated Product. Commodities where every unit of
production is the same are highly influenced by the competitors’ prices
because buyers see no difference between your product and those of
competitors. However, the degree to which you convince buyers that
your product is unique or different from those of competitors will
influence the degree to which competitor’s prices will impact your sales.
Differentiation can be expressed in the attributes of the product itself or
the services provided with the product;

– Value pricing. Buyers make an evaluation of your product by comparing
it to competitors’ products. This evaluation is based on quality and price.
In this instance, quality is defined as how closely the product meets the
needs of the buyer. It is important to note that quality doesn’t need to be
real, it can be imagined. The only thing that counts is that the buyer
believes it is different. Also note that price is also an important factor in a
buyer’s decision. Therefore buyers will prefer a low priced product to a
high priced product. So buyers informally take both of these factors into
account when evaluating a buying decision by determining a product’s
value. Value is computed by dividing the product’s quality by its price.
Because quality is a subjective assessment, companies try to influence
the buyers perception of quality. The buyer’s assessment of quality is
only relevant at the time of purchase.

In a variety of industries, from software to pharmaceuticals, specialised
chemicals to cars, aircraft to apparel, it is quite common for the premium
price brand also to be a market share leader. High market share and high
prices can be achieved if prices truly reflect high customer value.
Pricing options related to new products offer additional advantages and
challenges. Educating the buyers on what your product is and why they want to
purchase it is important. However, pricing your product when the buyer is just
learning about it and before you have competitors is unique. There are two
typical strategies that you may want to employ:

– Skimming. If you are bringing a new product to a target market, a price
skimming strategy may be employed. With this strategy you set your
price high with the intention of selling to a relatively small portion of
your target market – just those high end users who are willing to pay a
premium price for your product. Although you don’t sell a large quantity
of product, your profit margin on each unit is large. A danger of using
the skimming strategy is that competitors will enter the market and
undercut your price. A skimming strategy works best where your buyers
are relatively insensitive to the price level. In other words, demand is
inelastic. It also works best in situations where fixed costs are relatively
small because fixed costs are only spread over a small number of units.
Skimming is sometimes used during the business start-up phase where
only a small quantity of the product is produced. As production is
ramped-up, the price can be lowered to expand the number of buyers.

– Penetration Pricing. Penetration pricing is the opposite of skimming.
Penetration pricing involves setting your price low so you can penetrate
your target market with a large number of sales and garner a large market
share. Once market share is captured, price may be increased. An
advantage of penetration pricing is that it will make the industry less
attractive to competitors. Penetration pricing works well when the buyer
is sensitive to price. In other words, demand is elastic. It is also a good
strategy if your cost of production involves high fixed costs because
these costs can be spread over many units creating economies of scale.
Although this strategy might appear to work for small, value-added
enterprises, few will have the infrastructure and size to operate at
economies of scale.

Another issue to consider in pricing strategies is the markup pricing by
intermediaries. The price you set for your product may not be the price paid by
the consumer; the consumer’s price may be much higher. If you plan to use
intermediaries such as distributors, wholesalers and retailers to distribute and
market your product, they will mark up the price to cover their costs.
Finally, it is important to realise that pricing as a dynamic process
changes in environmental conditions, in marketing strategy, and in customer
needs can require changing selected elements of the pricing process, which in
turn can lead to a modification of the prices adopted. Also, and although the
objective of the pricing process is to determine a pricing strategy, which will be
a basis for profitable decisions in the medium and long term, pricing strategies
are always context-specific and thus bound to change. Even global companies,
such as DuPont, rarely adopt a truly global pricing strategy, as the specific
elements of profitable pricing decisions depend upon local market conditions
and country-specific marketing objectives. A profitable pricing strategy in one
country might be a marketing blunder in another country