Page 233 - DECO101_MICRO_ECONOMICS_ENGLISH

Micro Economics

Notes 14.2 Pricing-based on Firm’s Objectives

There are many different strategies companies adopt for accomplishing pricing objectives. Some
of the important ones and often used are discussed here.

14.2.1 New Product Pricing

The base price of a new product is easily adjusted in the absence of price control by government.
A pioneer can set the base price high to recover product development costs quickly. While
setting the base price, the company also considers how quick will be the entry of competition in
the market, what would be the strength of entry campaign, and what impact this will have on
primary demand. If the company concludes that competitors will enter with heavy campaign,
with limited effect on primary demand, then the company may opt for penetration pricing policy
and set a low base price to discourage competitors’ entry.
Price skimming refers to charging the highest possible price that a sufficient number of most

desirous customers for the product will pay. This approach offers the most flexibility to a pioneer

in the product’s introduction stage because the demand tends to be inelastic during most of
this period due to the absence of competitors. Skimming approach generates much needed cash

flows to offset high cost of product development. Most companies, who introduce successful
pioneering products, usually adopt price-skimming approach.
Price skimming can generate quick returns to cover up the product’s research and development
costs. This strategy restricts product’s market penetration because only the most desirous
customers buy the product. Possibility of earning large margins encourages competitors to enter
the market.
Penetration pricing approach requires the price to be set less than the competing brands and
aims at market penetration to capture large market share quickly. Companies adopt this strategy
when the demand tends to be elastic. Sometimes companies use penetration pricing to rapidly
capture a large market share. Increased demand makes it necessary to produce more and this
decreases per unit production costs. Low unit production cost puts the marketer in a position of
advantage to further decrease the price, and thereby make it difficult for aspiring new competitors

to enter the market. Besides, a low unit price is likely to be less attractive to competitors because

the lower per unit price results in lower per unit profits. With this approach it becomes diffi cult
to raise price subsequently. Some firms initially skim the market and later set a penetration price.

A lower price makes the market less attractive to potential new entrants.
14.2.2 Psychological Pricing

Psychological pricing approach is suitable when consumer purchases are based more on feelings
or emotional factors rather than rational, such as love, affection, prestige, and self-image etc. Price
sometimes serves as a surrogate indicator of quality. Technological advancements are making
product differentiation difficult and many companies attempt to differentiate their offers based

on non-functional product attributes, such as image and lifestyle etc. Psychological pricing is not
appropriate for industrial products.

Firms set artificially high prices to communicate a status or high quality image. This pricing
method is appropriate for perfumes, jewelry, autos, liquor, and ready-to-wear garments etc.

John C. Groth and Stephen W, McDaniel found that firms use prestige pricing and consumers
associate a higher price with higher quality.

Example: Acer and Sony have adopted this type of pricing for their range of Ferrari and
Vaio Lifestyle notebook PCs. Apple adopts this method of pricing for its high-end PowerBook

228 LOVELY PROFESSIONAL UNIVERSITY