Impact of Pricing Policy on Profitability Level of an Organization

Impact of Pricing Policy on Profitability Level of an Organization

PRICING AND PRICING DECISION: OVERVIEW AND DEFINITION:  Many firms have no pricing problem why; becomes they produces products that are in competition with other similar products for which a market price already exist, customers will not pay more than the normal price. There by under this circumstance no price calculation is necessary. And any firm entering the market will simply charge the price the market directs it to accept. In most situations a firm is faced with the problem of pricing that is deciding on the appropriate price for its products and services. Thus, pricing decisions are considered as the most important decision that a manager has to make because it can make or mar the organization.

According to Stanton (1981) price is the amount (or possibly goods) that is needed to acquire some come bination of production. Price is value expressed in dollars, cent or any other monetary medium of exchange value is the quantitative measure of the worth of a product to attract other products in exchange. In summary, price is the amount of money that is eventually paid in other to buy goods and services.

Pricing is the act of setting or determining the price of a particular good or service. Pricing must be done when a firm develops or acquires a new product, when it introduces its regular product into a new distribution channel or geographical area and when it enters bid on new contract work.

According to marking (179) Pricing Policies are broad guidelines that allow the firm to approach its pricing decision consistently. He sustained that it is a guiding course of action designed to influence and determine pricing decision.

According to Osisioma (1996) Pricing means different thing to different people.

1. To a buyer of a product, the price is the cost factor representing his outlay for that purchase.
2. To a seller, price represents the cost of production plus a margin on profit and it is a source of revenue.
3. To a marketer, price is one of the 4P’S of marketing. Price in this sense becomes the exchange value of good or service in terms of money.
4. To a lawyer, price is money consideration given or received to affect a sole of good and or receive.

In a free market economy,

Price is a measure and indicator of the value and utility that a consumer expects to derive form a product or service.

5. To the economist, price is an equilibrium factor in the market, harmonizing the demand in that market with the supply, and is therefore selective tool for allocating scarce resources.
6. The accountants understanding of price is simply cost plus mark-up (on cost). In this sense, price is thus a factor that incorporates cost and profit.

According to him, there are two types of pricing decision. It includes: Those for sales external to the firm that is those relating to customers and those relating to prices internal to the firm. This refers to transfer pricing within the same organization.

2.2   THE IMPORTANCE OF PRICING

Pricing is considered to be the key activity within the capitalist system by free enterprise. Price is a basic regulator of the economic system because it influences the allocation of the factors of production. In its role as an indicator or allocator of scarce resources, price determines what will be produced (supply) and who will get how much of these goods and services (demand).

An individual firm’s price of a product or service is a major determinant of the market demand for the item. Price affects the firm’s competitive position and its share of the market. The prices at which a company offers its product has a direct relationship to the company’s revenue and not profit (see kotler and keller 2005.Drury 2000, Egbunike

2.3        OBJECTIVE OF PRICE

        The clearer a firm’s Objective the easier it is to set price. The following reflects what a firm’s objective is likely to be for it to survive. Companies pursue survival as their major objective if they are plagued with over capacity. Intense competition or changing consumer wants. Profits are less important with the survival objective but this (survival) is only a short run objective in the long run, the firm must learn to earn profit or short down (markin, 1979).

The following are the possible reasons or objectives that firm seek in setting their prices:-

1. To maximize Profit:- To achieve this objective firms try to estimate demand and cost associated with alternative prices and choose the price that produce maximum current profit, cash flow or return on investment.
2. To maximize or improve share of market sales:- Market share which is a firm’s sale in relation to the total industry sales is a very important bench mark of success.

Some companies believe that maximizing sales or increasing sales volume will lead to lower unit cost and higher long run profit. They may achieve this by setting the lowest price by assuming market, is price sensitive.

3. To achieve target return on investment or net sales:- A firm may price to achieve a contain percentage returns on investment or on net sales. The percentage markup is large enough to cover anticipated operating cost plus a desired profit for the year.
4. Stabilize price:- Price stabilization is often the goal in industries with a price leader. In industries where demand fluctuates frequently, considerably large companies will to maintain stabilization in the pricing price leaders means that there is some relationship between the leaders and those charged by other firms.

A major reason for seeking stability in prices is to avert price war whether demand is increasing or decreasing.

2.4   FACTORS INFLUENCING PRICE.

DETERMINATION

        The manager has the responsibility of establishing price for products already in existence, pricing decision are pose with little difficulty but with pricing for new product decisions are difficult.

Factors that management should consider according to Drury (2000) are:

1. Demand for the product:- This is the first stage in pricing of product this is easier to achieve for an established product than for a new one.

Two steps involved in demand estimation include:

(i)     To determine whether there is a price that the market expects.

(ii)    To estimate the sales volume at different prices

(a)    The expected price:- The expected price for a product is the price which customer consciously or unconsciously value it. It is what they think it is worth.

(b)    Estimate of sales at various prices:- By estimating the demand for its products at different prices, management is in effect determining the demand curve for the item and its demand elasticity.

2. Target share of market:- The market target by a company is a major factor to consider when determining the price of a product or services.

A company may price more aggressively (cover base price, larger discount) than a firm that wants to maintain the present share.

3. Competitive reaction:- Present and potential competition is an important influence in determining base price. The threat of potential competition is greater when the field is easier to enter and profit prospects are encouraging.

The more competitive a market is the more competitive will be the pricing policies pursed by the supplier, in that, the market will ultimately develop into a state which the economist call perfect competition. A perfect market competition is that market that leads to prices being established at a point where supply equates demand.

4. Cost consideration:- Cost are often an important element in price decision making. A price should be able to cover the cost of production if the product will continue. Two basic costs to be considered are fixed cost and variable cost and they determine the direction of pricing decision. The other set of factor are the external variable which are largely not controllable by firm. They include legal considerations, the nature of competition, the kind and characteristics of buyer’s price, elasticity of demand, kind of buyer’s economic condition and suppliers and so on. These two considerations are important in developing price policies and procedures.

According to Egbunike (2006:84) The following are the factors to be consider in pricing decisions.

(i)     The firm’s Objective

(ii)    The market in which the firm operates

(iii)   Demand for the firm’s product.

(iv)   Elasticity of demand for the product.

(v)    Cost structure of the firm and the product.

(vi)   Competition

(vii)  The Product

(viii) The relative position of the firm. (Market Share).

(ix)   Level of activity.

(x)    Government restrictions or legislation.

(xi)   Inflation.

ICAN (2006) maintained that the main factors in pricing decisions are as follows:

1. Pricing Objectives
2. Relationship between price and Output.
3. Selling price/demand relationship and
4. Other factors.
5. Pricing Objectives:-

The pricing objective of companies fail into three categories (Ican,   2006) These are

(a)    To achieve a target return on investment.

(b)    To stabilize price and output, and

(c)    To realize a target market share.

2. Relationship between price and output.

The element of price is always instrumental to level of demand. In most cases, the lower the selling price for an item, the higher is the quantity demanded. Therefore, a company should consider there relationship between price and demand when deciding on an efficient or optimal plan of action. However, the level of profit made by company is a function of the output levels agreed for the company products. It is reasonable to say that changes in output affect both total revenue and total costs, which are the determinants of the profit level to be made at a given point in time.

3. Relationship between selling price and demand.

The relationship between the selling price for a set of item and the quantity demanded at that price is influenced by a group of factors among which are:

(a)    Variation in quantity

(b)    Advertising and other promotional techniques

(c)    Buyers choice and the manner in which they overcome them. And

(d)    Pricing and advertising policy decisions comptitors.

4. Other factors

The other factors, among a host of factors, which interfere in pricing decision and at the same time exercise fundamental effect are

(a)    Overall company goals: These may include target objectives such as investment, sales or sales profitability and man-profit oriented objectives which may include increase in firm status or goodwill.

(b)    Costs:- These play and indirect role in that it secures the profitability of alternative price to be determined and also ensure a comparison of the profit margin at a present price with expected return. However, costs play a direct role in setting prices in tactical situation, that is contribution pricing.

(c)    Demand:- This factor cannot be over looked in the pricing decisions of a firm. It is based on two economics principles, that is the law of demand and supply, and the price elasticity of demand.

(d)    Legal:- This considered from the point of view of government interfering in price control, anti-monopoly measures, interest rates, taxation, and so on.

(e)    Social Responsibility:- The social impact of a firm who sells on national scale or basis is expected to be falt in the price changed on the goods.

2.5 THEORETICAL BACKGROUND TO PRICING

        Adeniyi (2004) argued that micro-economics has provided much of the theoretical back ground to pricing and while there are difficulties in applying these basic theories in practice, it serve as a starting point. The theory states that firms should seek the price which maximizes profit and will therefore obtain the most efficient use of economic resources held by the firm. This price is at that level of sales were the addition to total revenue from the sale of the last unit, that is the MR (Marginal Revenue) is equal to the addition to the total cost resulting from the production of that last unit, that is Mc (Marginal Cost).

Po = MR = Mc

Profit maximizing price can be determined using this formular.

LIMITATIONS OF THEORETICAL PRICING APPROACH

        theorecal model developed by economist in sound, is difficult to apply in practice. The model may be analyzed as follows: (see Adeniji 2002):

(a)The model assumes that firms are constraint influence by management desire for profit. Example stability for growth and security are also important goals to managers and may be obtained at the expense of profit maximization.

(b)    Economists also assume that a firm’s demand curve is known where as the precise quantification of the demand schedule of a firm’s product is extremely difficult to ascertain. Considering the possibility of any prediction on the exact sales demand by an organization that deal on multi-products.

(c) Marginal analysis assumes perfect knowledge of all the factors involved. The practical difficulties of finding such information are great, particularly relating to consumer behaviour at a particular point in time.

(d) Theoretical pricing models also assume that change in volume of sales are function of price change where as, there are other factors besides price influence on quantity demanded. Examples are advertisement, and sales promotion, income changes, design and packaging of product, channels of distributors, credit items offered.

(e)    Marginal analysis buttress their position further by assuming that all decision makers are rational and also guided by economic factors only. But decision makers in practice are influenced by moral, social, political as well as economic consideration.

2.6   PRICING APPROACHES

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