ISSUES INVOLVED IN PRICING

Discussions of issues related to pricing of:

Aviation Industry Tariffs,
Rental for a multiplex at Worli seaface

Submitted by

R.M. CHATURVEDI
PhD Batch 2005

To
Dr. H Mankad

As part of economics course Delivered By

Dr. H Mankad, Ex Director NMIMS

In partial fulfillment of the requirements for the

DOCTORAL PROGRAMME IN MANAGEMENT (Ph.D.)

BUSINESS MODEL FOR SERVICE INDUSTRIES IN

COMPETITIVE ENVIRONMENT
(An analytic study for telecom sector)

Under the guidance of

Dr. Bal Chansarkar

Senior Professor, Middlesex University

Dr. Bindi Mehta

Chairperson, Research and Publications, NMIMS

At

NARSEE MONJEE INSTITUTE OF MANAGEMENT STUDIES

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 MAIN ISSUES INVOLVED IN PRICING

R M Chaturvedi
Ph D Batch
NMIMS Mumbai

Just as management, pricing is also an art and a science. Pricing

strategies for various products and services have been changing as economy
is changing. Price plays a much important role as price defers from the other
three marketing mix elements in that, it produces revenue while the other
elements create cost. And as such for a company to realize its maximum
profit potential, the most effective way for a company is to get its pricing
right. It is also to highlight that it may be a very difficult and lengthy
exercise to rectify the pricing wrongs. Once a bad price is established it can
be devilish to fix it. Importance of pricing right can be stated as, while poor
marketing can damage an organization; poor pricing can damage a market.
Because pricing decisions not only effect your own organization but they
also have a major impact on the whole market as other companies can not
ignore and have to respond to the marketing strategies of their competitors.
In this communication I am going to discuss various issues involved in
pricing along with the two examples for pricing strategies.

Various pricing methodology are used for deciding the price. Few
important ones are placed below:

1. Cost plus pricing.

Cost plus pricing and its variants will provide for calculation of
the cost of a product along with an additional mark up which
may be based on target ROI. This method is utilized for
services where what the cost is, may be calculated based on
activity based costing. Typical examples will include catering
and shared corporate services.

While this method has simple formula and standard mark up, it
has the disadvantage of ignoring the demand and the value
customer places, on the product as well as competition. While
calculating the cost there may be flawed procedures. This type
of pricing may result in overprice in weak markets and under
price in strong markets.

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 2. Market driven, competitive pricing.
In this case market and the competition determine or have
major influence on the price. i.e. the underlying personality of
the purchaser and characteristics of the products have major
influence on the price. Airlines and internet service providers
etc. have to use this method.

While this method is always competitive or near competitive on

price, it ignores the fact that price does not always drive the
purchase decision and ignores the value to the customer and
value of non price attributes.

3. Non linear / two part pricing.

This method provides for two separate charges for consumption
of a single product i.e. the total cost may constitute a fixed
component and a variable component and the fixed price paid
may determine the variable price paid. Amusement parks (entry
and per ride fee) and utilities such as telephone, gas, electricity,
water etc. use this pricing method.

This pricing method encourages greater usage, fixed cost covers

the cost of providing infrastructure and reduces churn by
creating switching cost. However, it requires complex decision
making with significant amount of data, and discounts for high
volumes become necessary as willingness to pay declines. The
communication of this pricing can also become complex and
difficult.

4. Dynamic pricing.
Industries like internet cafes, stocks and commodities, road
products etc. need continuous adjustment in pricing and as such
free and continuous fluctuations in prices in line with demand
and supply become a important characteristics of pricing
methodology. Dynamic pricing also includes revenue / yield
management and auction.

Dynamic pricing has the advantage of discovering the market

clearing price, minimizing the consumer surplus and is suitable

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 for highly uncertain markets. However, it generally requires
dedicated pricing resources and mistakes can be very costly.

5. Value based pricing.

One of the important methods evolving for the product and
services which provide value to the customer is to price a
product or service or a component of it according to the value it
delivers to the purchaser. The examples would include online
advertising and pay performance listings, in various search
engines.

The value based pricing is designed to capture more value and

not more sales and it is equitable. However, at times it can be
difficult to sell to customer, measurement of value has to be fair
and accurate, and it has to be known what customers value.

Supply and Demand:

While above considerations are based on marketing view point as far

as economics is concerned price is primarily decided by the functions of
demand and supply. As we all know the supply is a upward sloping curve
and demand is a downward sloping curve. The two intersect at an
equilibrium price point where supply equals the demand. As the price
increases the customers would be less willing to buy but at the same time
producers will be willing to produce more. The supply and demand will
further depend on some other issues placed below:

Marginal revenue and cost:

Marginal revenue from the sale should exceed the marginal cost to
produce and the enterprise would continue to produce until its M.R. = M.C.
as at this point of equilibrium the marginal profit on the next unit sold will
equal zero. And as such no profits are left on the table. Further the capacity
will also play a role as once a factory reaches capacity, the marginal cost of
producing one additional unit will be very high and increases beyond the
cost of the last unit produced.

However, marginal revenue concept can only be used for additional

business and the fixed or basic cost has to be recovered from the regular
customers. Hence marginal costs and revenues are critical in making
marginal pricing and production decisions but to evaluate profitability of an

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entire business rather than one transaction it is total revenue which must
exceed total cost to make a bottom-line company profit.

Price elasticity of demand:

Elasticity of demand i.e. buyers responsiveness or sensitivity to

change in price plays a important role in pricing decisions. Every company
wants to know how a price change will effect demand for their brand. When
consumers are not sensitive to prices the demand is stated to be inelastic.
Necessities such as medical services or cigarettes fall into this category.
Quantification of elasticity is done by calculation of elasticity coefficient.
Usually, a great deal of research is necessary to determine elasticity and use
of historical data with elimination of non price influences is used to calculate
elasticity. Further, elasticity is not constant at all price levels. For example at
lower price levels the demand may be relatively inelastic but at higher price
levels it may become elastic. Those with unlimited cash tend to be more
price inelastic and buy regardless of price.

For a company what really matters is not elasticity of quantity

demanded but elasticity of total revenue which are two different things. As
those who are willing to buy at higher prices, make up for the lost revenue of
higher sales volumes.

Competition:

Another important issue in making pricing decision is the competitive

environment which drives supply, demand and prices. The greater the
competition in a given market, the more sensitive the market prices are to
changes in supply and demand. To take an example, this is why diamond
prices remain high and relatively stable and predictable in contrast to gold
prices. Pricing decision will depend on the market structure of the product /
service i.e.
Pure monopoly.
Oligopoly.
Monopolistic competition.
Pure competition.

Organizational Strategy:
Pricing will also depend on company’s strategy as to whether the
company wants to follow the skimming strategy or penetration strategy.

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Skimming pricing strategy will set higher prices related to value, will focus
on margins rather than volume, and be used for products with short life
cycle, high barriers to entry, inelastic demand, clear competitive advantage
and well defined market segments.

Penetration pricing strategy would be used to penetrate the market at

large with low prices related to value, will focus on volumes rather than
margins and will be used for products with long product life cycles, low
barrier to entry, elastic demand and where economies of a scale or
experience plays a role. Penetration pricing strategy can undermine prestige
brands.

The Product Life Cycle:

Pricing decision will depend on the stage of the product in its life
cycle. i.e. infancy, growth, maturity or decline and also as per the innovation
adopting stage i.e. the price is set for innovators, early adopters, early
majority, late majority or laggards. It is to highlight that catching up is
cheaper than trailblazing as a second mover can see what works.

Traditional economic theory usually talks about two parties i.e. a

buyer and seller while in reality there are many more players. Further it
assumes and analyses as if the firms sell a single product only, while in
reality firms sell several products which may partially form substitute to
each other. The economic theory also assumes that the firm seeks to
maximize profits while in fact non profit objective may also exist. These
factors which differentiate pricing decision based on economic theory from
the pricing decisions based on marketing concepts have to be considered
while deciding prices for markets.

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 Issues related to pricing for Indian Airlines:

Indian Airlines is incumbent air transport service provider in India and

is now facing competition from various other private air transport service
providers. It provides full range of services and is a high cost schedule
airline, has a network for long and short haul travel, has multiple classes and
multiple distribution channels. The company has low to medium aircraft
utilization, uses large as well as small airports managed by Airport Authority
of India and has multiple aircraft types.

The airline is facing competition from airlines providing full service

as well as from low cost airlines and airlines operating in limited sectors.
The low cost airlines are using low tariff to attract customers, have point to
point short haul travel, provide no frills one class service, preferably use
direct sale through multiple channels and aim high aircraft utilization etc.

In view of this, Indian Airlines has to use pricing strategies which are
competitive in nature and focus on its competitive advantage to maintain its
competitiveness and profitability. It may consider and take following steps
while deciding its pricing strategies.

Maximum the load factor first and then the yield.

Offer competitive fares within market.
Benchmark for a minimum of half full service airline by providing
fully flexible fares.
Dynamic price according to demand, route, season etc.
Increase fares as flight departure approaches.
Not to sell flights out before day of departure.
Target excess seats with promotions.
Overbook where possible

Airline market has shifted from monopoly to oligopoly wherein there

are only a few suppliers for the services with practically no substitute. As
there are only few competitors’ prices can be maintained at high levels if the
service providers choose not to compete on prices. However, Indian Airlines
being an incumbent service provider and belonging to government sector has
a important role to play in benchmarking the prices as per government
policy. In case the market players are not able to settle to avoid competing
on price, price wars will break out. However, once it becomes clear that
nobody can win as happens in oligopoly; oligopolyst return prices to higher

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levels. We have been watching this for some time and the prices have been
fluctuating in past.

In the air transport market there have been clear segmentation of the
market based on time of purchase by Indian Airlines as well as other players.
There is wide range of fares to cover all market conditions.

Pricing issues for rental for a multiplex at Worli Seaface

Following issues need to be considered and kept in view while taking

pricing decisions for rental, for a multiplex at Worli Sea face.

Worli sea face is an important locality located about 10 kms from the
southern tip of Mumbai city and unlike Marine Drive which also provides a
nice sea face has a more active sea and the sea waves are much stronger.
Hence it is visited by many tourists and residents of Mumbai.

Worli sea face is situated away from any suburban railway station and
as such visitors are either staying in surrounding areas or visit the same by
their own vehicles which ascertain the class of persons visiting that area.

There is already a very popular mall named Big Bazar which is not far
from Worli and lot of further malls, multiplexes and residential complexes
are under construction and further planned for construction in the nearby
area of Parel / Lower Parel where the land has become available due to
closing of various textile mills.

However, Worli Sea face has a added attraction that the visitors can
have a nice view of sea in addition to visiting the multiplex which will
provide additional reason of entertainment and hanging around. In view of
this, the persons visiting can be clearly categorized as those visiting for fun
and will do impulse buying or those who will plan the visit, will belong to
higher middle or higher income group and will visit for repeated purchases.

As Worli Sea face provides a unique characteristic of availability of a

large well maintained sea face and a tourist attraction, this uniqueness can be
used to advantage in pricing which can be leveraged through increasing the
prospective customer base through advertising and increasing awareness
through multiple channels including Internet.

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 Thus we have seen and discussed important issues involved in pricing
relate to economic considerations as well as marketing considerations and
organizational strategy. Pricing has a very important role to play and must be
given due consideration as it effects not only profitability of the company
but market as a whole.

R M Chaturvedi
Ph D Batch II
NMIMS, Mumbai

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