Pricing

Topic Gateway Series

Pricing Topic Gateway Series No. 18

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Prepared by Liz Murby and Technical Information Service

Revised November 2008

Pricing

Topic Gateway Series

About Topic Gateways Topic Gateways are intended as a refresher or introduction to topics of interest to CIMA members. They include a basic definition, a brief overview and a fuller explanation of practical application. Finally they signpost some further resources for detailed understanding and research. Topic Gateways are available electronically to CIMA members only in the CPD Centre on the CIMA website, along with a number of electronic resources.

About the Technical Information Service CIMA supports its members and students with its Technical Information Service (TIS) for their work and CPD needs. Our information and accounting specialists work closely together to identify or create authoritative resources to help members resolve their work related information needs. Additionally, our accounting specialists can help CIMA members and students with the interpretation of guidance on financial reporting, financial management and performance management, as defined in the CIMA Official Terminology 2005 edition. CIMA members and students should sign into My CIMA to access these services and resources. The Chartered Institute of Management Accountants 26 Chapter Street London SW1P 4NP United Kingdom T. +44 (0)20 8849 2259 F. +44 (0)20 8849 2468 E. [email protected] www.cimaglobal.com

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Definition Pricing is defined as the: ‘Determination of a selling price of the product or service produced.’ CIMA Official Terminology, 2005 There are a number of different pricing methodologies and strategies which may be used in pricing. The strategy chosen depends on the individual organisation producing the product or service.

Context In the current syllabus, CIMA students will learn and may be examined on this topic in Paper 5, Integrated Management.

Related concepts Transfer pricing refers to the pricing of goods and services within a multi-divisional organisation. For example, goods from the production division may be sold to the marketing division. Equally, goods from a parent company may be sold to a foreign subsidiary.

Overview The price of an offering is a key element of an organisation’s marketing mix. The mix comprises price, product or service, place of distribution and promotion factors. These factors communicate with potential customers and influence the consumer’s perception of the offering. In determining price, organisations should be aware of their mission and objectives, together with costs and constraints. Organisations may adopt one of several pricing strategies. These include cost-plus pricing, discount pricing, penetration pricing, pre-emptive pricing, prestige pricing, price skimming and target pricing. (See table in Application for further details). The price, once set, should support the achievement of the organisation’s mission. The price(s) set and pricing practices may vary between markets, market segments and geographical regions. They also vary over time, according to customer wants and organisational objectives.

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In the case of transfer pricing, the choice of price affects the division of total profit among different parts of the company. It can be advantageous to choose transfer prices so that, in book keeping terms, most of the profit is made in a low tax country. However, most countries have tax laws and regulations that limit how transfer prices can be set.

Application In setting price, producers of goods and services need to take a number of different issues into account. The key factors to consider include: •

production costs (labour, materials, overheads)

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distribution costs

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marketing costs

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competition pricing and activity

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perceived value (by the customer)

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government influence

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trade requirements

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volume targets (high price/low volume versus low price/high volume).

There are a number of tried and tested pricing strategies: Penetration pricing

Enter market with special offer pricing to get market share quickly. This was used by utilities entering deregulated European markets.

Discount pricing

Tactically reducing price occasionally to steal competitor share.

Skim the cream

Start with a high price to get the early adopters and then gradually reduce. This happens in technology markets such as PCs and Hi-Fi.

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Premium pricing

Adopt a platform of high prices and stick to it, for example, Rolex watches.

Cost plus pricing

Doesn’t work in a dynamic market but sometimes used in government contracts or controlled economies.

Going rate

Fitting the market price of competitors with like-for-like comparison.

Target pricing

Fixing price by market segments or distribution channels.

Price discrimination

For example, fixing a price too high (or too low) to exclude certain customers. For instance, some airport customers will pay extra to park in the short term or business car park while others won’t.

Quantum pricing

Fix price high and lowering until sales occur. For instance, Amazon Internet model.

Odd number pricing

Psychologically, ending a price with a nine makes it appear disproportionately cheaper. For example, £4.99 seems considerably cheaper than £5.00.

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In the supply chain, there is great flexibility in pricing if the customer is not the end user. One example is the traditional retailer model where the seller can discuss discounts, margins, buy-in incentives, promotions and offers to influence stocking levels.

Pricing and the internet For many organisations, the growing acceptance and implementation of B2B commerce and web enabled trading has had a dramatic effect on pricing. The length of the supply chain, from manufacturer to customer, via wholesalers and retailers, has become shortened. Customers are now increasingly able to deal directly with the manufacturer. Both customers and potential competitors can benefit through increased price transparency and comparability. This has come about through the use of search engines and dedicated price comparison sites. Where there are low barriers to market entry, the speed of price changes, including reductions, is likely to increase. The benefits of these changes are two-fold. Customers may gain from the opportunity of direct price comparison. Suppliers have the opportunity to exploit the benefits of increased market segmentation.

Further information Articles Full text for Business Source Corporate available through My CIMA www.cimaglobal.com/mycima [Accessed 11 November 2008] Anderson, E. and Simester, D. Mind your pricing cues. Harvard Business Review, September 2003, Volume 81, Issue 9, pp 96-103 Bidaud, H. Culture must drive a winning policy. International Tax Review, October 2006, Volume 17, Issue 9, pp 27-29 Brennan, R., Canning, L. and McDowell, R. Price-setting in business-to-business markets. Marketing Review, Fall 2007, Volume 7, Issue 3, pp 207-234 Eyink, C., Marn, M. and Moss, S. Pricing in an inflationary. McKinsey Quarterly, 2008, Issue 4, pp 100-103 Hansen, F. Transfer pricing front and center. Business Finance, April 2006, Volume 12, Issue 4, pp 49-53 6

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Lawrence, B. Calculating pricing optimization. Industrial Distribution, August 2006, Volume 95, Issue 8, pp 26-27 Norton, C. and Burns, P. Transfer pricing for intangible development: costsharing alternatives. International Tax Review, December 2006, Intellectual Property, pp 47-51 Pass, C. Transfer pricing in multinational companies. Management Accounting, September 1994, Volume 72, Issue 8, pp 44-50 Robertson-Kellie, J. and Mahalingham, S. How transfer pricing strategy can contribute to value leakage. International Tax Review, May 2006, Volume 17, Issue 5, pp 51-52 Stamer, H. and Diller, H. Price segment stability in consumer goods categories. Journal of Product and Brand Management, 2006, Volume 15, Issue 1, pp 62-72 Sodhi, M. and Sodhi, N. Six sigma pricing. Harvard Business Review, May 2005, Volume 83, Issue 5, pp 135-142 Unwin, M. Transfer pricing documentation fails harmony test. International Tax Review, July/August 2006, Volume 17, Issue 7, pp 37-40

Articles Abstract only from Business Source Corporate through My CIMA www.cimaglobal.com/mycima [Accessed 11 November 2008] Carson, D. et al. Price setting in SMEs: some empirical findings. Journal of Product and Brand Management, 1998, Volume 7, Issue 1, pp 74- 86 Hogan, J. and Lucke, T. Driving growth with new products: common pricing traps to avoid. Journal of Business Strategy, 2006, Volume 27, Issue 1, pp 54-58 Indounas, K. Making effective pricing decisions. Business Horizons, September 2006, Volume 49, Issue 5, pp 415-424 Krishnakumar, D., Markowitz, P. and Nagi, J. The pricing opportunity: discovering what customers actually value. Strategy and Leadership, 2006, Volume 34, Issue 3, pp 23-30 Romani, S. Price misleading advertising: effects on trustworthiness toward the source of information and willingness to buy. Journal of Product and Brand Management, 2006, Volume15, Issue 2, pp 130-138 Simon, H. Pricing opportunities and how to exploit them. Sloan Management 7

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Review, 1992, Volume 33, Issue 2, pp 52-62 Smith, G.E. and Nagle, T.T. Financial analysis for profit driven pricing. Sloan Management Review, 1994, Volume 94, Issue 3, pp 71-84 Stamer, H. and Diller, H. Price segment stability in consumer goods categories. Journal of Product and Brand Management, 2006, Volume15, Issue 1, pp 62-72

Other recommended articles Avlonitis, G. and Indounas, K. The pricing opportunity: discovering what customers actually value. Journal of Services Marketing, 2005, Volume19, Issue 1, pp 47-57 Hinterhuber, A. Towards value-based pricing: an integrative framework for decision making. Industrial Marketing Management, 2004, Volume 33, Issue 8, pp 765-778 Shipley, D.D. and Jobber, D. Integrative pricing via the pricing wheel. Industrial Marketing Management, 2001, Volume 30, Issue 3, pp 301-314 Stitt, I. Transfer pricing for the next century. Accountancy, November 1995, Volume116, Issue 1227, pp 92-93

Books Baker, R. (2006). Pricing on purpose: creating and capturing value. New York: John Wiley and Sons Cram, T. (2005). Smarter pricing: how to capture more value in your market. Harlow: Financial Times Prentice Hall Dolan, R. and Simon, H. (1997). Power pricing: how managing price transforms the bottom line. Cambridge: Simon and Schuster Emmanuel, C. and Mehafdi, M. (1994). Transfer pricing. London: Academic Press in association with the Chartered Institute of Management Accountants Levey, M., Wrappe, S.C. and Chung, K. (2006). Transfer pricing rules and compliance handbook. Chicago: CCH Nagle, T. (2001). The strategy and tactics of pricing: a guide to profitable decision making. Harlow: Prentice Hall Phillips, R. (2005). Pricing and revenue optimisation. Palo Alto, CA: Stanford University Press Renneboog, L. (2006). Advances in corporate finance and pricing. Oxford: 8

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Elsevier Reynolds, P. and Lancaster, G. (2005). Management of marketing. Oxford: Butterworth Heinemann Zeithaml, V., Bitner, M.J. and Gremler, D.D. (2006). Services marketing: integrating customer focus across the firm. New York: McGraw Hill McKinsey and Company. (2004). The price advantage. New York: John Wiley and Sons.

CIMA publications Axelby, G. (2002). CIM course book 2002/03: Management information for marketing decisions. Oxford: Butterworth Heinemann Available from: www.books.elsevier.com/cima [Accessed 11 November 2008] Barnett, I., Dawkins, S. and Allan, W. (2005). CIMA exam practice kit: Decision management. London: CIMA Publishing Available from: www.books.elsevier.com/cima [Accessed 11 November 2008] Scarlett, R. (2005). CIMA Study System 06: Management accounting performance evaluation. London: CIMA Publishing Available from: http://books.elsevier.com/cima [Accessed 11 November 2008] Scarlett, R. (2005). CIMA Study System 05: Performance evaluation. London: CIMA Publishing Available from: http://books.elsevier.com/cima [Accessed 11 November 2008] Wilks, C. (2005). CIMA Study System 05: Decision management. London: CIMA Publishing Available from: http://books.elsevier.com/cima [Accessed 11 November 2008]

CIMA Mastercourses Effective transfer pricing: a practical introduction to transfer pricing: the management and operational issues. To book via www.cimamastercourses.com please go to Find and key in the course code TRPR. 9

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Accounting for marketing. To book via www.cimamastercourses.com please go to Find and key in the course code ACMK.

Websites Businesslink Offers practical advice for business. Available from: www.businesslink.gov.uk [Accessed 11 November 2008] An archive of individual articles from 1922 to the present can be accessed from Harvard Business Review using Business Source Corporate on MY CIMA. Available from: www.cimaglobal.com/mycima [Accessed 11 November 2008]

First published in 2006 by:

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