Pricing

Never has any class been so interesting in Marketing as the class on Pricing strategies by the inimitable Dr. Paul Prabakher. His teaching is stylish and he explains a very normal situation uniquely which makes me wonder every time - " why haven't I thought about it like this before?"

This is one of the best classes I have had till date and hence the length of this post may be excused. For those of you who are interested in pricing, this may be engaging. Before I start, this is a disclaimer that what I write here is not even a 0.01% substitute for his live teaching session. Those of you who have been fortunate to attend his classes will vouch for me.

The price that a customer wants to pay for a product is equal to the value that a customer accords to having/using it. Having said that, it is important to remember that a product "acquires" value only when it enters the customer environment. Till that point, it is just a physical creation. Hence, nobody can per se, "create value" in this world.

It is well known in economics that in case of perfect competition, all firms have Zero margin. This situation is the most natural for any market. So, creation of profit by itself is an unnatural action. In order for a firm to make profits, it has to temporarily half the functioning of a perfect market. Monopoly helps influence control in the market by means of Brand, Technology, Manufacturing quality etc. Hence, to make profits, a firm has to try to exert a monopoly in some possible way. Let us know look at 4 techniques firms use to price a product:

COST PLUS technique

The most simple and obvious: COST + MARKUP = PRICE

So how do we go about setting a price for a product? If you set ONE price, you will be losing the opportunity to exploit every other buyer's "willingness to buy". Financial statements of companies record only successful sales. It is a pity that we do not capture near successes or failures. When we sell a product, we DO NOT keep a record of all the buyers who walked away dissatisfied. We only keep track of successful transactions. Hence, the weakness in this technique is that you know that you are losing all the way around, but you don’t know where you lose it. This is considered a very myopic way of pricing.

New product pricing can in general can be done in 2 ways:

1. Giving it all away : creating a habit of buying initially by compromising on profit margin

2. Price skimming

Sophisticated Cost plus technique

In this method, a scientific way to calculate Markup price is arrived at. This is as follows:

COST + ( Internal rate of return * Capital invested ) / Number of units expected to sell this year.

In short, the markup is the aproportioning the amount of return required on all the units to be sold. This is explained in a very classic way by comparing GM and Toyota.

Saturn is GM's mid priced car ( they are closing now). Prof. Bala taught us today how Saturn's factory is fully automated requiring intervention of only 2-3 personnel. For Saturn, history speaks that for every 5 cars launched, 2 are very successful and 3 are averagely unsuccessful. That is, Saturn has a 40% success rate in product innovation.

For any project to be considered worthwhile to be funded and launched, its internal rate of return should be higher than an external rate of return.

In Toyota, 3 out of every 10 cars fail. Hence, its internal rate of return is lower as it is spread over a wide number. Historically, GM's IRR has been 24%. A small markup can yield 24%

Toyota can sell the same car that GM has for a lower price because of its innovation record which keeps its IRR low.

There are two more techniques to go : Block booking and Multipart, which I promise are more interesting than these ones and will be posted in the next few days.. So... watch this space!