Pricing technique during rising prices

Pricing technique during rising prices

By

Amlan Ray; Dean, IIPM- Kolkata,

AQ-6, Sector V, Salt Lake, Kolkata- 700091

E mail: amlanray1@gmail.com

                       

Pricing technique during rising prices

Key words: Pricing, elasticity, inflation, cost

Abstract

Pricing is the key factor in marketing mix. The revenue of a firm is dependent on correct pricing. Pricing decisions become more complex in an inflationary situation. The rising input cost put pressure on marketing manager. Passing the input cost to the consumer may bring down the total sales, resulting in declining revenue. The price elasticity of a product and the income elasticity of the consumers are final determinant of the sales quantity. Marketers are always in search for the optimum price and quantity which can maximize the firm’s revenue. In our study, we have tried to understand which groups of commodities are affected more due to inflationary condition. We have analyzed the secondary data of different product group’s sales in the current inflationary situation in India. We have also made an attempt to understand the buying behavior of a homogeneous group in case of price increase. Our study establishes that while price has adverse effect on sales, non price factors like competition, macroeconomic environment play crucial role in the sales quantity of a commodity. It is also found that mostly people try to adhere to their original buying behavior. The consumers always want to stick to their own taste and preference. This urge of maintaining same lifestyle compels the consumers to raise their willingness to pay.

1. Introduction

When you get an increment of 10%, you are not very happy as the extra income does not bring you any material comfort; it gets vanished chasing the new prices in the market. When bank gives 10 % interest to a retired person, he is still not able to maintain his life style; again the culprit is the price rise. When nominal income rises, we are not sure about the real income, maybe it is falling. In a falling income state, how do the consumers behave? Does their consumption pattern follow a typical Engel’s curve? What strategy should a marketer take to maintain his top line unaffected from the clutch of falling demand? Even if he is able to maintain the top line, will the bottom line be unaffected? Who will bear the cost of rising interest or the increased input cost?

Out of the marketing variables, pricing is that component of the marketing mix which directly determines the firm’s revenue. In an inflationary situation, pricing decisions are even more important as the cost curve of the firm heads northwards.

Our basic question is during the inflationary situation how the buying behavior of the buyers is affected?

In case of inflation, the real income of the consumer may go down. It’s a possibility but not a necessity. In most of the countries, we find that there is GDP growth in spite of inflation. So, aggregate real incomes of the people are not reducing. But it is very much possible that certain sections of the people are having reduced income. In case certain sections of the population are having reduced income and a company targets the same segment then the company’s top line might be affected.

2. Literature Review

John Quelch ( 2008) questions ‘ How can marketers cope not just with inflation but with consumer sticker shock?’In his 7 point advice to marketers, he stresses on investment on market research to understand the attitudes and behavior in response to price inflation. Quelch further says that clearly all marketers are not equally affected by inflation and luxury brands do well regardless of price. Increasing relevance and redefining value are important marketing strategy during price rise.

David B Ridley (2011) writes that inflation regulation can have the launch price decrease and profit and efficiency increase. Rising price indicate consumers’ increased willingness to pay and it happens due to rational addiction or adoption and switching costs.

As per Mckinsey researchers (Eyink, Marn, Moss; 2008) Price sensitivity research and Market price tests need to be rerun in case of down turn in the market. Unsold stock, reduced demand, excess capacity and extra price sensitiveness of consumers make it more challenging for the marketers to set price. Studying industry micro economics becomes utmost important in this situation. Similarly in inflationary situation, the consumers perceive reduced income and firms face increased price pressure which make it difficult for the corporations to set correct prices.

Ogbuechi (2011) writes that countries with high inflation rate pose a different pricing challenge to the marketing manager than do countries with moderate inflation. Pricing involves many factors like competition, market demand, government regulations. These factors become compounded in a high inflation market. Firms need to understand these factors before price setting.

2.1 Pricing technique in different phase of product life cycle

Apart from the economic condition, the pricing techniques are very much depended on the product’s phase in the PLC curve. The marketer still can get a higher price in case of a unique product during its launch but this advantage will wane away faster during inflationary condition or downturn.

2.2  Revolutionary, Evolutionary or Me too

In launch stage a product can be Revolutionary. It can set its own price. It might be new concept or the usages were unknown earlier. Over a period of time, the product needs to be evolutionary, wherein suppliers bundle more benefit or offers extra to retain market share. When, there is entry of more competitors, the product might become me too and the company does not gain by differential pricing. Customers become extremely price sensitive and price elasticity may cross 1. Here is the challenge in front of the marketer to keep the product floating in the market.

2.3 Gosling effect; does it work during inflation?:  Dan ariely in his experiment with MIT students have shown how the initial pricing bears a lingering effect in the consumers mind. If we know a cup of coffee at Barista will cost us Rs 100, we are prepared to pay that but our canteen coffee cup price is expected to be Rs 10 even for an equally good offering. Dan has explained it through the concept of arbitrary coherence. “The basic idea of arbitrary coherence is this: although prices are “arbitrary”, once those prices are established in our minds they will shape not only present prices but also future prices (this makes them “coherent”). Now will Gosling effect hold true in an inflationary situation?

3. Pricing techniques

Marketers can set the prices during inflationary situation, depending on the consumers buying behavior. In today’s market place due to cut throat competition, there is very slim chance of adhering to cost plus pricing. The possibility of pricing technique of marketers remains confined within the spheres of value based pricing depending on the offers or Competition based pricing.

3.1 Cost Based pricing: In case of cost based pricing, the entire focus of the company is on the cost incurred in manufacturing and delivering the product. Here the price elasticity or income elasticity is not given importance. The prices are based on the company’s perception about product’s value and not the consumer’s perception of the value of the product.

3.2 Market based pricing: Here cost of the product is not the main determinant. Product prices are set on the basis of the price customers are willing to pay. The seller needs information on the price elasticity on product segment and market segment.

4. Objective

Our basic research question is ‘During inflationary situation how the buying behavior of the consumers is affected?’

Objective of this study is to understand buying behavior of people during inflationary situation and to recommend a pricing technique which will help the marketers. We will try to find out:

1. During price rise, which group of commodities sales are worst hit?
2. Does the buying behavior follow Engel’s curve in real life?

5. Methodology

In our study, we have detailed secondary research and review of the existing work on pricing and inflation.

If the real income of the people goes up, then as per Engel’s curve, normal goods consumption will rise proportionately. Essential consumer goods will have less elasticity and luxury goods will have more demand. If we believe that in today’s market, Engel’s curve is applicable, then Luxury goods market should be affected the most in case of inflation.

Here our null hypothesis is H₀                                         

= In inflationary situation the consumer goods follow perfectly Engel’s curve

Apart from secondary research, we conducted a study of buying behavior on a controlled group of respondents.

1) The group is given a budget of rupees ten thousand to spend on a large number of goods.

2) Next, we increased the price of all the goods in the range of 40 to 50 percents and asked the respondents to start buying again.

This way a simulated buying behavior data is collected.

The sample size is 50

We have measured correlation between the initial data and post price increase data.

6. Findings:

Let’s follow the following times of India report dated 13^th July, 2011 titled ‘Inflation, rates hit consumer demand’. We find in the article following table:

Table 1

Top Losers Products	% Decrease in productions Apr- May’ 2011	Mighty Losers Products	% Decrease in productions Apr- May’2011
Cement Machinery	78.59	Cements All kinds	1.7
Colour TV picture tubes	50.49	Colour TV sets	9.78
Battery charger	60.34	Cigarettes	4.42
Polythene bags	45.01	Gems and Jewellery	8.05
Squash, jams, jellies, ketchup etc.	40.48	Milk	0.97

Source: Govt. data

Here we can see that the industrial products are cutting down the production on the basis of negative forecasting of market demand. We find decrease in the production of the different consumers’ goods as well. Gems and Jewellery being in the luxury segment is hit 8.05 percent, milk being an essential consumer goods, its demand has gone down only by 1 percent. Colour TV sets demand is hit but we know that there is no substantial increase in the price of the white goods segment in recent past. So, probably, this is more due the income elasticity than price elasticity which has impacted the colour TV sets demand. Squash, jams, jellies, ketchup being the luxury amongst the food items, its sales are more affected due to inflation. The report studied 270 items that account for over 45% of the index of industrial production (IIP). It has shown that products ranging from apparel, cigarettes, milk, televisions sets are all at the top of the list of the losers during April to March.

We find following information about sales of Maruti Cars from their website.

The comparative sales figures till September for both 2012-13 and 2011-12 are given below:

Table 2.

Segment Models Till September 2012-13 2011-12 % Change  A: Passenger cars : Mini M800, Alto, A-Star, WagonR 185023 234900 -21.2% A: Passenger cars : Compact Swift, Estilo, Ritz 112617 100515 12.0% A: Passenger cars : Super Compact DZire 73150 45383 61.2% A: Passenger cars : Mid-Size SX4 2861 9909 -71.1% A: Passenger cars : Executive Kizashi 35 171 -79.5% TOTAL A: PASSENGER CARS 373686 390878 -4.4% B: Utility Vehicles Gypsy, Grand Vitara, Ertiga* 40366 3846 3846 C: Vans Omni, Eeco 59166 78365 -24.5% Total Domestic Sales 473218 473089 0.0% Total Export Sales 53054 60744 -12.7% Total Sales (Domestic + Export) 526272 533833 -1.4%

* Ertiga launched in April 2012.

We study the above figures in the context of inflationary situation in the country. We have considered that real incomes of the people are falling. The Maruti products have become more expensive due to the dual effect of absolute price rise as well as interest rate increase during the above time period. When we closely follow the sales figure of Maruti Suzuki, the top most automobile manufacturer of the country, we find their sales dropped by 71 percent in the sedan segment SX-4, whereas in case of small cars, it was dropped by 21 percent. But how do we explain the 61.2 percent rise in the Swift Dzire? Probably in the sedan segment, Dzire is not a luxury product but more of a comfort. That explains the rise in Dzire sales and fall in SX-4.

6.1 Primary Research:

We had 50 respondents for a simulated buying exercise. Goods were classified into four sections namely Food items, clothing, gadgets and household goods. There were total 64 items randomly selected. We have collected data of sales at original price and post price increase. We find the following correlation between sales in original price and at increased prices for respective sections:

Food: 0.861279

Clothing: 0.878807

Gadgets: 0.87947

Household: 0.70456

Combining all the sectors, the overall correlation is 0.843755

We have further compared sales with respect to price. We have taken the 13 highest priced items in one group and 13 lowest prices goods in another group. Post price increase, the sales have gone down in higher priced item in the ratio of 9/4, in lowest priced items in the ratio of 8/5.

The strong correlation in sales figures of two data sets shows that buyers are more dictated by their taste, preference, choice rather than price. When we compare the sales data of highest priced products and lowest priced products, we do not observe any significant difference.

7. Managerial implications:

First step in the pricing technique should be classifying the products into normal, essential or luxury group. Next, we require measuring the consumer’s income elasticity. Considering the price elasticity of the product and income elasticity of the target segment, we require determining the price.

P = f ( Ep, Ey, y)

Where P = price, Ep = price elasticity of the product and Ey= Income elasticity of the product) and y = real income of the consumer.

While pricing is a function of multiple variables, the revenue is determined as a net product of price and quantity. Keeping this in mind marketers require to set his target price and target quantity of a product. Target segment is again one of the crucial determinants. Income elasticity of the consumers will set the consumers budget. If the marketer can predict these two fundamental micro economics variables correctly, the challenges before the marketers during inflationary condition become much simpler.

8. Future scope/Limitations

Our primary data is limited within city of Kolkata and may not be able to catch the buying behavior at different corners of the country. The respondent group is homogeneous upper middle class youth. The buying behavior of this segment may have no relevance in case of rural consumers with different buying patterns. Future studies can focus on these areas.

We have considered the case of Maruti Cars to assess the price sensitivity. Apart from price, there may be effect of other factors influencing the sales of Maruti car. Competition and prevailing interest rate play large role in determining automobile sales. Future studies can find out the extent of these factors and assess price sensitivities after discounting these.

Times of India report has most relevant contemporary data covering 270 items but the report has mentioned only 5 consumer goods, rest all are industrial products. Effect of price rise on industrial products and consumers products are expected to be different. A more detail study of consumer goods can give us even a clearer picture.

9. Conclusion

Price is one of the key determinants of demand. The effect of price depends on the income of the target segment and product type. There can be different pricing strategies to combat the effect of inflation. Feedback from the consumer through proper market research is key in decision making. The marketers need to reach to the optimum quantity with optimum price to achieve maximum revenue. Effect of price will depend on the category of product, its usage and more importantly the target segment. Macroeconomic environment will also play a major role in this. In case of consumer durable interest rate may be a key point. Other macroeconomic factors like change in income level, unemployment are equally crucial.

Spotting the target market correctly and finding out their income elasticity in inflationary situation is critical. In case of a homogeneous group the variation in sales is expected to be less in spite of change in price. The consumer may stick to the product set if the perceived value is high for him and if he is able to afford his taste and preference. Depending on the product and target segment, the market can take the right pricing decision.

 Our primary data shows that there is strong correlation between the buying preference of the consumers before and after increase of price. We find price will have a bearing on the sales but still consumers try to adhere to their own taste and preference. While in macro level the products may follow typical Engel’s curve, in micro level for a homogenous group, it may not work. Perceived value of a product can increase the consumers’ willingness to pay for it.  We may conclude that for an established brand targeting a particular segment, price increase in an inflationary situation is viable in spite of challenges particularly when the competitors are also forced to increase price.

Reference

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(http://articles.timesofindia.indiatimes.com/2011-07-13/india- business/29768567_1_cement-   production-iip-data-consumer-goods)

6. ( 2011) http://www.marutisuzuki.com/monthly-sales.aspx

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9. Ogbuechi, O. Alphonso; ‘ Pricing strategies in High – Inflation Markets: Implication for the Multinational Corporation’ ; Journal of Applied Business Research, Volume 9, Number 1.