UNIT 13 PRICING STRATEGIES

CONCENTRATION RATIOS, HERFINDAHL INDEX AND CONTESTABLE MARKETS

·         The degree by which an industry is dominated by a few large firms is measured by Concentration ratios.

·         Another method of estimating the degree of concentration in an industry is the Herfindahl index (H). The higher the Herfindahl index, the greater is the degree of concentration in the industry.

·         In fact, according to the theory of Contestable markets developed during the 1980s, even if an industry has a single firm (monopoly) or only a few firms (oligopoly), it would still operate as if it were perfectly competitive if entry is 282 Pricing Decisions “absolutely free” (i.e. if other firms can enter the industry and face exactly the same costs as existing firms) and if exit is “entirely costless”

PRICE DISCRIMINATION

Price discrimination refers to the situation where a monopoly firm charges different prices for exactly the same product. The monopoly firm (a single seller in the market) can discriminate between different buyers by charging them different prices because it has the power to control price by changing its output. The buyers of its product have no choice but to buy from it as the product has no close substitutes.

There are three types of price discrimination – First Degree price discrimination, Second Degree price discrimination, and Third Degree price discrimination.

First degree price discrimination refers to a situation where the monopolist charges a different price for different units of output according to the willingness to pay of the consumer.

Second degree price discrimination refers to a situation where the monopolist charges different prices for different set of units of the same product.

When the monopolist firm divides the market (for its product) into two or more markets (groups of buyers or segments) and charges different price in each market, it is known as third degree price discrimination.

PEAK LOAD PRICING

Peak load pricing is a type of third-degree price discrimination in which the discrimination base is temporal.

BUNDLING

Bundling is the practice of selling two or more separate products together for a single price i.e. bundling takes place when goods or services which could be sold separately are sold as a package.

TWO-PART TARIFFS

The techniques requires buyers to pay a fee for the right to purchase the product and then to pay a regular price per unit of the product.

Transfer Pricing

Transfer pricing is setting the price for goods that are sold between these related legal entities (branches, subsidiary etc.)

Purpose of transfer pricing

 · Profits of different units can be ascertained separately and this helps in separate performance evaluation of each unit of an organization.

· Transfer pricing also impact resource allocation among different units of an organization.

Traditional Transaction Methods and Transactional Profit Methods.

Traditional Transaction Methods

· Comparable Uncontrolled Price (CUP) method Under these methods, comparison is done between the terms and conditions of uncontrolled transactions (with unrelated parties) and controlled transactions (related parties). This requires high standard comparable data to ensure that transaction has been done on the basis of ALP.

· Resale price method In this method, selling price of a product is used which is known as resale price. Margin amount and different costs (determined by comparing to unrelated transactions) are deducted to determine resale price.

 · Cost Plus method Under this, a markup (profit) amount is added in the total costs incurred by the supplier unit of the organization.

Transactional Profit Methods

· The Comparable Profits Method Under this method, basis of the transfer price is net profit of controlled transaction.

 · The Profit Split Method This pricing method is used where companies are engaged in interconnected transactions and profits are separated by examining how unrelated parties would split profits in similar transactions.

Other Pricing Practices

Prestige Pricing

Prestige pricing is a type of pricing strategy, where a product is placed at a higher price, because consumers associate higher price with higher quality and a prestige is attached to the ownership of the product. This is also known as Image Pricing. NIKE is one of the best examples of prestige pricing.

Price Skimming

It is a strategy where a company charges high prices from consumers at first and earn substantial profits, later reduces the prices gradually to attract other customers who are price sensitive. APPLE is the best example of this type of pricing strategy.

Penetration Pricing

Companies charge relatively lower prices for their product to attract customers and increase market share. This pricing strategy is to lure customers away from competitor’s products.

Psychological Pricing

Psychological pricing involves pricing that has impact on the psychology of the consumers. E.g., Companies set prices such as ` 499 etc. which consumers perceive as lower prices than they actually are.

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