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PROBLEMS OF PRODUCT-LINE PRICING

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					              PROBLEMS OF PRODUCT-LINE PRICING
                                           JOEL DEAN
                                       Columbia University

Source: Journal of Marketing, Jan50, Vol. 14 Issue 4, p518-528


                                                    nature of particular buyers or orders, (e.g.,
     ow should a manufacturer determine the         quantity discounts, trade status discounts,
best pattern of prices for a group of related       geographical discounts); and (2) product
products, e.g., similar products that differ in     differentials, i.e. price differentials which are
size, quality, style, or features; or dissimilar    tied solely to the characteristics of the product
products that are substitutes or complements?       and its use (e.g. quality spreads, size
My analysis of this problem, which is confined      differentials, and other dimensions of product-
to manufacturers who have enough pricing            line pricing).
jurisdiction to have pricing problems, has two
                                                    The problem of determining these product-
parts: (i) a brief exploration of a broad
                                                    price differentials should also be distinguished
approach to the problem of product-line
                                                    from the problem of setting the firm's price
pricing; and (2) an examination of selected
                                                    level or basic price (e.g., basic price versus
areas of application.
                                                    "extras" in steel pricing). Different pricing
                                                    analyses and criteria are needed for these two
I. APPROACH TO PRICING RELATED
                                                    problems.
PRODUCTS
                                                    Opportune Time for Overhaul
Character oj Problem
                                                    This is an opportune time for an overhaul of
The problem of product-line pricing is to find
                                                    product-line pricing. Recent violent changes in
the proper relationship among prices of
                                                    the price level, wage rates, the distribution of
members of a product group. This problem is
                                                    income, the structure of competition, and
here broadly conceived to include not only the
                                                    product improvement and innovation have
pricing of products that are physically distinct,
                                                    made many product-line price structures ob-
but also those that, though physically the
                                                    solete. Few manufacturers can hope to develop
same, are sold under demand conditions that
                                                    a pattern of price relationships and then walk
give the seller an opportunity to charge
                                                    away from it. Unless the original pattern was
different prices. Thus use-differentials (e.g.,
                                                    just right and unless none of the foregoing
fluid milk versus cheese milk), seasonal
                                                    changes affected it significantly, reappraisal of
differentials (e.g., morning movie specials),
                                                    the structure of product price differentials is
and style cycle differentials are all phases of
                                                    called for today. Price obsolescence that was
product-line pricing. The justification for this
                                                    obscured by conditions of boom demand may
heterodox approach is that the nature of price
                                                    become painfully conspicuous in a period of
discrimination is essentially the same
                                                    adjustment. A strategic time to correct
regardless of the source of the opportunity to
                                                    obsolete price relationships is during the
charge different prices.                            period of general decline in prices.
The dividing line between the kinds of price
differentiation that are here included in           Alternative Policies of Price Relationship
product-line pricing and those which are
                                                    A logical approach to product-line pricing is to
viewed as distribution discounts is of course,
                                                    start with a picture of the alternative kinds of
arbitrary.     But      a     convenient      and
                                                    policy regarding the relationships among
administratively useful distinction can be
                                                    prices of members of a product line. This
made between: (i) distribution discounts, i.e.,
                                                    assumes that it is desirable to have some kind
price differentials which are based upon the
                                                    of underlying system of relationship of product
prices, which is debatable. But before adopting                         and in present and potential competition.
a philosophy of chaos it is well to examine
systematic patterns, several of which are                               4. Prices that produce contribution margins
sketched below.                                                             that depend upon the elasticity of demand
                                                                            of different market segments.
1. Prices that are proportional to full cost,                           Buyers with high incomes are usually less
    i.e., produce the same percentage net                               sensitive to price than those that make up the
    profit margin for all products.                                     mass market, and it is often profitable to put
Under this scheme, each product assumes its                             higher profit margins on products for the
full allocated share of all common and                                  plushy "class" markets than for the rough-and-
overhead expenses, and each produces a                                  tumble "mass" markets. Variations in style and
uniform percentage profit over this full cost.                          features among models of a single product can
Relative prices are thus determined by the                              create a partial barrier to flow of demand
accounting conventions that govern the                                  between market segments. For example, the
allocations of common costs among products.                             de-luxe models of washing machines sold at
In practice these allocations are necessarily ar-                       about twice the price of the strip models before
bitrary from an economic viewpoint.                                     the war. Ignorance, snobbishness, and inertia
Moreover, this plan gives no consideration to                           are mainstays of the segmentation that makes
market factors.                                                         such price discrimination effective.
                                                                        The applicability of this approach is somewhat
2. Prices that are proportional to incremental
                                                                        restricted. It is fully usable only for products
    cost, i.e., produce the same percentage
                                                                        that are sheltered from the full blast of
    contribution-margin over incremental
                                                                        competition. Moreover, it must be possible to
    costs for all products."1
                                                                        break the market into sectors that differ in
This pricing approach is largely, but not                               demand elasticity, without substantial leakage
entirely free from the defect of arbitrary                              among sectors, if full profit potentials are to be
allocation of common costs found in the first                           reaped.
plan. But this price pattern also takes no                              An extreme form of market segmentation is to
account of differences in demand and                                    charge different prices to different individual
competitive conditions. Incremental cost is a                           buyers. Such discrimination is possible only
handy tool for product line pricing; but its                            when the seller has complete control of a
usefulness is destroyed if it becomes the basis                         product which is substantially different from
for a mechanical cost-plus pricing formula.                             that of rivals. This kind of pricing policy is
                                                                        essentially an extension of discriminatory
3. Prices with profit margins that are pro-
                                                                        market segmentation, with each buyer viewed
    portional to conversion cost, i.e. that take
                                                                        as a separate segment.
    no account of purchased materials cost.                             Two kinds of individualized price
The original rationale for this policy was                              disrimination may be distinguished. One might
primarily that conversion costs (i.e., the labor                        be labeled the "ability-to-pay" type, which is
and overhead required to convert raw material                           exemplified by physicians' fees. It is based on
into finished products) reflect the firm's social                       the assumption that the richer the man the less
contribution, whereas purchased costs do not.                           elastic is his demand. The other kind of
The notion that some elements of cost are                               individualized discrimination might be labeled
more worthy of bearing a profit mark-up than                            the "benefits received" type.2 Royalty
others is hard to justify, particularly since this                      licensing of patents and "unit-charge" leases of
mechanistic approach to pricing ignores the                             equipment, where the rental de-pends upon the
differences in price elasticity among products,                         output of the machine, are examples. Film

1                                                                       2
  Incremental cost is the additional cost of added units. It is often     When the diminishing maipnal utility of money is taken into
moderately well approximated by those out-of-pocket costs that are      account these two categories are dmelf related. Fnun this Tiewpcnnt,
directly traceable to the product. Contribution margin is the spread    on appendectomy is worth mai« dollars to a ridi man because die
between price and incremental cost.                                     dollars have less utility.
rentals that are based on a percentage of the       demand relationships, structure of competition,
gate or of gross profits and may differ among       and costs of the products.
theatres also attempt to charge each buyer a
different price depending upon the service-         Demand Relationships
value of the product to him.
                                                    In essence, demand considerations that enter
In general, traditional cost guides have been       into the pricing of a productline are peculiar in
more harmful than helpful for this problem.         three important respects, "nxe first is the
The notion that each product should pull its        interdependence of the demand for various
own weight, in the sense of having a price that     members of the product line. Interdependence
yields a uniform percentage margin on full          takes many forms. Products may be
allocated cost, robs market segmentation of its     substitutes, e.g., different models of radios or
point and of its potential profitability. Margins   grades of tires. Products may be complements,
should be systematically different and              e.g., tabulators and punched cards. Products
inversely related to the demand elasticity of       may also be supplements in a more remote and
the market sectors. Moreover, incremental           subtle sense of augmenting one another's
cost, rather than full cost, is the proper bench    acceptability, e.g. in enhancing the reputation
mark for establishing such margins.                 of the firm.
5. Prices that produce contribution margins         Interdependence also has a time dimension.
     that are related to the stage of               Today's price of one product may affect
     development of the product.                    tomorrow's sale of another.
                                                    Striking examples are introductory models,
Under this policy the price differentials among
                                                    such as trial subscriptions and children's
products vary with the changing power of
                                                    editions of magazines, midget pencil
products to bear the common costs of the
                                                    sharpeners,       and     diminutive      sporting
enterprise. A continuous analysis of the
                                                    equipment, etc. But this aspect of relationship
shifting contribution abilities of products is
                                                    extends into any product group where the sale
required.
                                                    of one product tends to tie the customer to
This approach to the product pricing problem
                                                    future purchases of other products, as
is free of the restrictions of cost theology and
                                                    exemplified by the new slow-speed
margin uniformity and it recognizes the
                                                    phonographs and their records.
dominant role of demand considerations in
                                                    A second peculiarity is the entity, from the
pricing. It also points up the dynamic nature of
                                                    standpoint of demand, of the product group as
the patterns of relative maturity and customer
                                                    a whole. The promotional advantages of a full
acceptance among members of a product line.
                                                    line often make the whole greater than the sum
However, to be applied to price setting, it must
                                                    of its parts. This calls for a strategic approach
fall back upon criteria of competitive intensity
                                                    to product-line pricing which takes account of
and price elasticity of demand, which are hard
                                                    the effect of individual product prices upon the
to measure.
                                                    long term customer acceptance of the entire
The foregoing classification of policy
                                                    product group. The tactical advantages of a
alternatives is not exhaustive. But a
                                                    full line of sizes, grades, and supplementary
background of analysis in terms of pure types
                                                    products in getting good deders and in
will serve to sharpen the issues and high-light
                                                    merchandising high margin specialties makes
the basic choices. As in other policies,
                                                    this kind of interrelationship of demand a
exceptions to the selected underlying scheme
                                                    prominent factor in productline pricing. Some
of relationship are expected. Moreover,
                                                    would go so far as to deny the validity of
different policies are likely to be appropriate
                                                    analyzing contribution margins for individual
for different product-lines, and a combination
                                                    members of a product group because they
of patterns is often desirable.
                                                    contribute to each other's sales and profits and
In selecting an appropriate pattern (or
                                                    because the economic unit of merchandising
combination), alternative policies should be
                                                    activities is the whole group of products.
evaluated in the light of the individual firm's
                                                    A third demand peculiarity of product-line
pricing arises from opportunities and problems       demand falls short of the company's
that stem from market segmentation and price         production capacity than when demand is in
discrimination. Market segmentation, as we           balance, or exceeds capacity. In depression
have seen, involves breaking up the market           periods the alternative is usually idleness; then
into sectors that differ in price elasticity of      incremental costs alone are relevant. It is the
demand so that different prices can profitably       marginal contribution of a product to common
be charged in different sectors. When feasible,      costs and profit that is the significant
market segmentation can increase total profits       consideration.
by expanding sales into mass markets, yet            Pricing should be designed to get back
preserving rich margins in the inelastic sectors     incremental costs and as much more as
of the market.                                       demand conditions will permit.
                                                     When demand exceeds capacity, the
Cost Estimates                                       alternatives are sharply different. The limited
                                                     factory capacity should in general be used for
The kind of cost concepts and estimates that
                                                     the most profitable products. In effect, it
are relevant depend upon the nature of the
                                                     should be auctioned to the highest bidder; and
product-line pricing problem. The distinction
                                                     selling activities and price strategy should be
made by economists between the long run and
                                                     directed toward this end. Products which make
the short run situation is useful here. Some
                                                     relatively small marginal contribution should
productline pricing decisions are long run in
                                                     be pushed out (insofar as long term strategy
the sense that expansion or replacement of
                                                     permits) in favor of products that make greater
plant and equipment and changes in the scale
                                                     contribution per unit of capacity absorbed.
of operations could result from the product-
price (and strategic) decision in question.
                                                     II. SPECIFIC PROBLEMS OF PRODUCTLINE
Setting the price for a permanent addition to
                                                     PRICING
the product line is an example of a long run
decision, in which fixed costs are relevant and      The philosophy of product-line pricing
estimates of future long run economies of            sketched above can be illustrated by applying
scale may be important. Such pricing decisions       it to a few sample problems.
often amount to the same thing as a decision to      Pricing Products that Differ in Size
add or not add the product in question, since        How should we determine price differentials
the offering price is tantamount to a decision       for members of a product-line that differ only
not to offer the product unless at least this        in size? The first ques-tion is whether price
price can be received.                               should differ at all with size. If buyers' benefits
The kind of cost estimates that are appropriate      do not vary and costs differ little (e.g. shoe
also depend upon the pricing objective.              sizes), a uniform price is sensible. Custom
Although it is usually assumed that                  may force uniformity even when costs differ
businessmen want to make as much money as            materially.
possible, maximizing profits is not always the       When price should vary with size, the next
company's pricing goal.                              question is whether any kind of pattern of
If the objective is to make a specified, limited     systematic relationship in respect to size is
profit, then cost estimates play a quite different   desirable. Having a pattern has advantages.
role in pricing than when maximum earnings           Price determination is made easier when new
is the objective.                                    sizes are subsequently fitted into the line. The
Cost may then determine prices directly and          appearance of equity is given the buyer.
mechanistically, rather than indirectly through      Management's time is saved by a blanket
selection of optimum prices.                         decision which can be extended to individual
The sort of costs that are relevant for product      pricing decisions systematically.
line pricing and the way that they are used          Assuming that some kind of systematic
depend upon the seller's alternatives. The           relationship of prices is desired, a choice may
nature of these alternatives is different when       be made among several possible patterns.
Prices may be: (i) proportional to full average       estimate of the incremental costs of each type
cost, which produces a uniform percentage net         of fractional page advertisement in order to
profit for all products; (2) proportional to in-      estimate the marginal contribution to profits
cremental costs, which yields a uniform               and general overhead that each size of
percentage contribution margin for all                advertisement makes under present prices and
products; (3) proportional to some dimension          also under other possible price schedules; (2)
of size of the product, e.g. diameter of              some kind of estimate of the pulling power of
parachutes or weight of paper; (4) proportional       advertisements of various sizes in order to es-
to the service value of the product to the buyer,     timate the service value of different sized ads
e.g. capacity of refrigerators or labor-saving        to the typical buyer of space; (3) an
power of machines; (5) related to competitive         investigation of the hypothesis that advertisers
intensity and elasticity of demand of market          who buy eighth-page ads later grow up to full
segments tapped, e.g. eight cylinder deluxe           page ads. One magazine recently found that
models vs. six cylinder stripped models of            the number of eighth-page advertisers who
cars; or (6) related strategically to the long run    eventually became full-page advertisers was
profit contribution of the various members of         extremely small. The proportion of advertisers
the product line, e.g. junior models of com-          who would have to grow up to full-page ads in
puting machines. Quite diverse patterns of            order to justify the sacrifice in contribution
product prices are obtained by applying these         margin with the present eighth-page rate was
different size-pricing philosophies.                  several times the proportion of advertisers who
Prices that are proportional to some aspect of        had actually become full-page advertisers.
size and prices that are proportional to full         In selecting the pattern of relationship of price
costs are probably the two most common                to size much depends on whether the buyer
patterns. Except for volume savings on                typically has freedom to substitute one size of
popular sizes, these two philosophies often           product for another, so that two sizes are in
produce price ladders with rungs in the same          competition. If substitution is possible, then
order, but steps that are different distances         there is much to be said for lower prices per
apart. These two popular patterns have                service unit for larger sizes, so that they will
advantages in being easy to compute and to            induce the buyer to shift to the larger sizes.
justify; but neither of them is necessarily the       This is especially desirable when there are
most profitable or strategic method of size           important savings in making larger sizes, and
pricing. When the different sizes of products         when purchasing the bigger package will be
differ in competitive intensity and offer             more likely to form the habit of using the
opportunities        for    profitable      market    brand and will shelter the seller from
segmentation, then proportioning price to any         competition during such a longer consumption
dimension of cost or of size sacrifices potential     period.
profits, at least in the short run. Other strategic   The intensity of competition often varies with
considerations should modify the pattern of           size. Different sizes sometimes go into quite
prices. The demand for the various sizes is           different uses, so that the service value, as
usually interrelated, particularly in its future      compared with alternatives, bears little relation
dimensions. Low prices on small sizes may             to size or to the seller's costs. For example, po-
induce buyers to get acquainted with the              tential use of parachutes differs in different
product, which may lead to future sales of            sectors of the size range, from lowering whole
larger sizes.                                         airplanes to dropping caged carrier pigeons.
An example of the size-differential pricing           Competition from other parachutes, as well as
problem is found in the fractional page               from substitutes, is more intense in some
advertising rate of magazines. Often, eighth          sectors of this size-use range than in others.
page, quarter page, half page and full page
space is offered at prices that are not               Pricing Products that Differ in Quality
proportional to space. A decision as to this          How should we determine the relationship
pattern of prices should involve: (1) an              among prices of products that differ in quality?
Much depends upon the strategic objectives of        products. Hence, the margin over incremental
having quality differentials. Sometimes the          cost should normally be systematically
purpose of high-quality items is to bring            increased as quality steps up-.
prestige to the entire line (e.g., fifty-dollar      Price Lining. Price lining, i.e., a predetermined
cufflinks to glamorize a line of medium-priced       pattern of relationship in the price to the
men's jewelery). Then the price of the prestige      utlimate buyer, is a common example of
items should not be set with any view to its         quality differentials.
effect on sales of that product itself, but rather   The widespread use of price lining in retail
with the view of its effect upon attitudes of        establishments and its growing acceptance as a
customers toward the lower-priced, high              philosophv of product-line planning on the
volume members of the line. When the                 part of manufacturers, raises important
purpose of low-end articles is primarily to          problems of pricing the product line. But they
counter price competition by keeping some            are not solely pricing problems. Quite largely,
items in the line competitive with the lowest        from the manufacturer's viewpoint, it is a prob-
price product in the market, then an entirely        lem of product design and selection. This may
different pattern of quality-price differentials     involve inverted pricing, which starts with the
is needed. The main purpose of the "fighting         retail price goal and works back through
brand" may be to maintain the "never                 distributor margins and selling costs to
undersold" claim for the en-tire product line.       necessary manufacturing costs, and hence, to
Another kind of strategic objective of low-          the design and selection of a product that will
margin, stripped models is to ward off               fit into the product line strategically.
potential competition by capturing a mass            However, part of the impact of price lining is
market early in the game and attaining               absorbed by differences in margins. This
economies of large scale production. Entry of        occurs both in the distribution channels and at
new rivals is made less tempting and more            the level of manufacturing. The tailoring of the
costly than if exploitation were confined to the     design of the product to fit the retailers' price
plush markets with premium prices. Similarly,        lines must sometimes be supplemented by
low quality members of the line can serve to         variation of manufacturer's (and dealer's) profit
head off or contain the growth of distributor-       margins.
brand products, as occurred in tires and             Systematic Approach. In developing the policy
refrigerators before the war.                        of price-quality differentials which will
Another purpose of the low quality item in the       implement any of three strategic objectives,
line may be to take up the shock of cyclical         three factiws must be weighed quantitatively.
flexibility in pricing. Thus, third-grade            The first is an estimate of the incremental cost
gasoline is normally introduced and pushed in        (over the probable range of operation) of each
depression phases of the cycle and disappears        quality variant in the line. Economies of lot
in prosperity phases. Similarly, third-grade         size and of large-scale production will
tires appear and are emphasized when                 normally differ among items. These should be
competition      is    severe.     Under     such    reflected in the estimates of incremental cost.
circumstances, the price of the "fighting            Differences in marginal cost should, of course,
brand" is de-termined not by costs, but              not control differences in price, but they
primarily by the competitive prices it is            should be useful in setting lower limits to
designed to meet.                                    prices and they should aid in estimating the
Another objective of multiple-quality grades is      profitability of alternative patterns of price
to break the market up into sectors which            differentials. Such cost estimates are a key
differ in price elasticity of demand. For such       consideration in obtaining maximum profits
strategy it is usually assumed that demand           from market segmentation through quality
elasticity will be least in the group appealed to    spreads.
by the high-quality prestige article, and that       The second factor is a guess at demand
the demand elasticity will be greatest in the        elasticity for the market sector tapped by each
sector of the market tapped by the low-quality       different quality bracket. If there are
differences in competitive intensity, they also      product is worth to the buyer, the seller seeks
affect price elasticity, since it is usually cross   to be sure he accepts no business that will not
elasticity of demand that is relevant for this       produce the desired unit net profits over
problem. The third factor is the interaction of      "normal" cost. He may carry this concept
demand of various members of the product             further, and have a policy of "discouragement
line. Price charged for one quality bracket will     pricing" on special orders in order to channel
affect demand in other quality brackets, both        demand into purchase of his standard models.
today and in the future. Its effects cannot be       At the other extreme there are cases where the
estimated accurately, of course, but they must       maximum price is pretty definitely known, so
be considered in reaching a correct price            that the real problem is whether or not this
policy.                                              price is acceptable to the seller. Between these
Pricing Special Designs                              extremes lies a dim area where estimates of
In pricing special designs, it is common             buyers' benefits and alternatives and guesses at
practice to estimate "normal" full cost, then        rivals' bids may give some indication of the
add to cost a fixed percentage to represent a        upper limit.
"fair" or desirable profit. Let us examine the       Where buyers are few and powerful and are
usefulness and adequacy of this cost-plus            also potential producers (e.g., automobile
procedure.                                           companies buying from parts producers),
To an important degree the price decision on         pricing on the basis of full current cost may be
special orders is really a decision as to whether    logical. Buyers' intimate knowledge of the
or not to produce the product. Hence, cost           seller's production processes and costs makes
plays a peculiar role in special-order pricing.      then sensitive to high unit margins and their
An essential foundation for special-order            ability to produce the product themselves may
pricing is therefore skill in estimating             make stay-out pricing on the part of the sellers
accurately the future cost of unfamiliar             a wise strategy. But even under these circum-
products. This calls for analysis of previous        stances it is not the seller's costs which are
cost experience in the kind of detail that can be    relevant but those that the buyer would incur if
focused on the estimating problem. In                he made the part himself, or the costs of some
applying these estimates to a particular order,      other potential supplier. The seller's costs are
conceptual problems arise: What cost concept         useful primarily as a guide in estimating these
is relevant, and what profit margin should be        pertinent costs.
added? The solutions depends largely on the          Acceptable Price. A second problem is to
seller's alternatives, which are usually different   determine the lowest price that the seller can
in depression than in prosperity.                    afford to accept, considering his alternatives.
The problem of how to price special designs          A useful concept for this purpose is "parity
can be usefully attacked analytically by             price." A parity price, as the term is used here,
seeking answers to these questions:                  is one which yields the same total
1. What price is required to secure the order?       contribution-profit as would have been
2. What is the lowest price that will make the       obtained from the available alternative uses of
business acceptable to the producer in the           the plant facilities (or of the bottle-neck factor,
short run, in the light of available alternatives?   e.g., skilled labor). The pricing action of the
3. What adjustments in the short run figure          firm should depend upon what these
should be made because of long run future            alternatives are. If the alternative is idleness,
benefits (or drawbacks) ?                            the parity price is incremental cost. Revenue
                                                     from a special order must exceed the
Business-Getting Price. To estimate what is          incremental cost if this business is to be
the' highest price than can be charged and still     acceptable. But this incremental cost does not
get the business is often a sheer guess. Partly      give price answers automatically and must, in
for this reason much of the quotation on             fact, be used with care.3
special orders is really a form of refusal
                                                     3
pricing. Bidding in the dark as to what the            The time periods of the revenue conjecture and the incremental cost
                                                     estimate must be the same since the effects of a short period volume
If, however, the alternative is the production of                       chance of potential competition; (2) whether it
regular lines, the parity price is quite different.                     is practical to segment the market and first
Then it is incremental cost plus the dollars of                         exploit the inelastic sectors where snob appeal
contribution (to profit and overhead)                                   and prestige pricing have a significant role in
obtainable from the displaced regular                                   developing demand; (3) whether demand
production, i.e., alternative uses of the                               elasticity increases progressively over the
production facilities (or in general the limiting                       course of the style cycle; (4) whether intensity
scarce factor, e.g., steel). If the alternative is                      of competition varies with the phase of the
the production of some other special order,                             style cycle; (5) whether elasticity of demand is
that should determine the "parity price." Long                          great at the early stage of market development
run considerations, such as the possibility that                        (for non-style goods); and (6) whether
the special business will become permanent,                             prospective economies of scale production or
the danger of spoiling the market, etc., should                         marketing are pronounced, and the investment
modify this first approximation.                                        required to attain them is a substantial barrier
Pricing Ephemeral Goods                                                 to entry.
An important practical pricing problem is                               Little of a quantitive nature is really known or
raised by the perishability of the popularity of                        can be known about these factors. However,
a product and of the distinctiveness of its                             study of the market situation against the
physical innovations.                                                   background of these pricing considerations
This perishablity results from several causes,                          provides a systematic approach to pricing
such as the gyrations of the style cycle, the                           ephemeral goods.
running out of patents, the progressive
imitation of patented or unpatented                                                     CONCLUSIONS
innovations, etc.
How should prices be determined in order to                             By way of epilogue my general approach to
develop a market rapidly and profitably and                             product-line pricing may be high-lighted by a
still get back development costs before the                             few baldly stated conclusions:
style demand or specialty advantage runs out ?
One solution is a policy of high prices at the                          1. The problem of determining the pattern of
outset, while the monopoly power of                                        product prices should be sharply
innovation or of style popularity is at its                                distinguished from the problem of setting
height, then gradual reduction of price as                                 and changing the company's general level
competitive innovation arises or cyclical popu-                            of prices. It should also be distinguished
larity dies out. But this pricing policy may                               from the problem of building the structure
encourage potential competition and thus                                   of price discounts for diverse conditions of
shorten the life of the company's monopoly                                 distribution.
advantage. An alternative policy is to set low                          2. Now is an opportune time for a reappraisal
prices at the outset, in order to discourage                               of the structure of productline prices.
prospective competitors and to develop the                                 Revolutionary changes in the basic
market rapidly, so as to bring economies of                                economic conditions that control demand
large scale production quickly.                                            and cost behavior have made many
Each of these solutions may be correct for a                               product-price structures obsolete. A period
particular situation. Which one is right                                   of downward adjustment of prices is a
depends on several conditions: (i) whether                                 strategic time to correct such product-line
mass-market pricing will in fact reduce the                                pricing obsolescence. Moreover, product
                                                                           price differentials that are appropriate for a
increase will differ from those of a long period increase. Short run
                                                                           boom are not always suitable in a period of
marginal cost is normally much lower than longer run marginal cost.        declining business activity.
The estimate of incremental cast should, in adxlition, make allowance
for the size of the volume increment For example, the acceptance of a   3. An examination of several alternative
large private brand or-der might involve increases in overhead or
much quicker utilization of excess capacity from normal volume             systems of product price relationship is a
growth than would be the case for a small additional volume.
   useful prelude to an overhaul of product-          the company's long range objectives.
   line pricing. Prices may be proportional to
                                                   7. Products that differ in size are commonly
   full costs, to incremental costs or to
                                                      priced in proportion to full cost or to some
   conversion costs, or may be related to
                                                      dimension of size. Both of these policies
   market segmentation, stage of product
                                                      may miss profit opportunities that stem
   development or competitive intensity.
                                                      from differences in competitive intensity,
4. The notion that the relationship among             elasticity of demand, and strategic
   product prices should be determined                overtones.
   mechanistically by differences in their
                                                   8. Products that differ in quality and design
   costs is fatal for sensible productline
                                                      offer unusual opportunities for high
   pricing. Unit profit margins over arbitrarily
                                                      margins in the elite market while
   allocated full cost may be tolerable in
                                                      exploiting the mass market with thinner-
   inflation when the problem of many firms
                                                      margin models.
   is to limit profits rather than maximize
   them. But during periods of declining           9. Pricing special designs presents problems
   business activity this policy is usually           of product-line pricing in which cost
   indefensible. The company's alternatives, if       estimates play an unusually dominant role.
   it does not get a full margin price on a
   particular product, are then sharply            10. Pricing goods whose demand is perishable
   different from boom periods.                        offers opportunities for profitable market
                                                       segmentation.
5. Cost must be used with sophistication in
   product-line pricing. Different cost
   concepts are needed for different problems.
   The main job of cost estimates is to help
   select the most profitable pattern of prices
   in order to implement policies that take
   advantage of differences among members
   of the product line in competitive
   conditions and in demand elasticity. For
   this job incremental costs of individual
   products rather than fully allocated costs
   are normally appropriate. Another
   important job of cost is in connection with
   new products. These long run price
   determinations, which often amount to
   deciding whether to acquire, develop or
   commercialize added products call for esti-
   mates of full cost (including fixed over-
   heads) and these should be projected into
   the future and take account of economies
   of scale and technology.
6. Interdependence     of    demand       and
   opportunities for profitable price dis-
   crimination are distinctive features of
   demand estimates for product-line pricing.
   Prices of individual products need to be
   aligned with competitive and substitute
   bench-marks to get the kind of buyers'
   action and market-share results that attain

				
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