Options are difficult to understand. what are some of the challenges faced when computing the prices of an option.

 

Answer:

Price is the only element of the mercantile combination that generates profits, the other elements generate costs. In addition, price is one of the most flexible elements of the merchant mix, since it can be changed quickly, unlike product characteristics and pipeline commitments. At the same time, setting and price competition are the main issues facing many marketing executives. On the other hand, many companies do not handle pricing well. The most common mistakes are: setting prices that are too cost-oriented, the price is not reviewed as often as necessary to capitalize on changes in the market, the price is set independently of the rest of the market mix rather than as an intrinsic element of the commercial placement strategy, and the price is not varied enough for different items, market segments and purchase occasions.

How prices are set.

Setting prices is a problem when a company must determine them for the first time. This happens when you develop or acquire a new product, when you introduce your regular product in a new market or a new distribution channel, and when you participate in a tender.

The company must decide where to place its product in quality and price. You can place your product at the midpoint of the market or three levels below or above the midpoint. The levels are as follows:

 

Supreme.

Luxury.

Special needs.

Intermediate.

Comfort / convenience.

Me too, but cheaper.

Only the price.

 

In many markets there is a supreme brand (the gold standard). Just below the supreme brands are luxury brands. Below these are the brands that satisfy a special need. In the middle part there are a large number of brands. A step below the intermediate marks are the marks that offer above all functional utility. Below are the cheapest, which still perform satisfactorily. At the bottom are the brands whose only attraction is the price.

 

This scheme suggests that the seven levels of product placement do not compete with each other, but only compete within each group. There may also be competition between price-quality segments.

The company must consider many factors when determining its pricing policy.

Pricing procedure:

1.- Selection of the objective of the price setting. The company first has to decide what it wants to do with a particular product. If you have selected your target market and your position in it, then your marketing mix strategy, including pricing, will be fairly straightforward. Pricing strategy is largely determined by market placement.

 

The clearer the objectives of a company, the easier it is to set the price. Each possible price will have a different effect on objectives such as profits, sales profits and market share.

 

A company can pursue any of the six fundamental objectives through pricing:

 

Survival: Companies pursue survival as the main objective if they are saturated by excessive capacity, intense competition, or changes in customer requirements. Companies remain in business as long as prices cover variable costs and some fixed costs. However, survival is only a short-term goal. In the long term, the company must learn how to add value or face extinction.

Maximum current profit: Many companies estimate the demand and costs associated with alternative prices and select the price that generates the maximum current profit, cash flow, or rate of return on investment. Maximizing current profit presents problems. It assumes that the company knows its demand and cost functions; in fact, it is difficult to estimate them. Furthermore, the company emphasizes current financial performance rather than long-term performance. Finally, the company ignores the effect of other variables in the business mix, the reactions of competitors, and legal price constraints.

Maximum current profit: it only requires calculating the demand function, since it is only intended to maximize sales profits.

Maximum sales growth: Other companies believe that higher sales volume will result in lower unit costs and greater long-term profit. They set the lowest price by assuming that the market is price sensitive. This is called pricing for market penetration. The following conditions favor the establishment of a low price: the market is very price sensitive and a low price encourages further market growth; production and distribution costs decrease with the experience of accumulated production; and a low price discourages actual and potential competition.

 

Market Skim Maximum: Many companies favor setting high prices to "skim" the market. With each innovation, you estimate the highest price you can charge given the comparative profits of your new product against available substitutes. The company sets a price that makes the new material worth adopting for certain market segments. As sales decline, it lowers the price to descend to the next tier of price-sensitive consumers. In this way, you get a maximum amount of profit from the various market segments. Skimming the market makes sense under the following conditions: A sufficient number of buyers have high current demand; Low volume unit production costs are not so high that they negate the advantage of bearing the traffic implications; the high starting price does not attract more competitors; the high price communicates the image of a superior product.

Product quality leadership: A company may want to be the market's product quality leader. The superior quality and superior price strategy, in many cases, has delivered a consistently higher rate of return than the industry average.

Other Goals: Nonprofits and political organizations can adopt many other goals.

2.-Determination of demand. Each price that the company may charge will lead to a different level of demand and, as a consequence, will have a different effect on its marketing objectives. The relationship between the current price being charged and the resulting current demand is captured in the common demand schedule. The demand program denotes the number of units that the market will buy in a given period at alternative prices that could be loaded during that period. In the normal case, demand and price are inversely related, that is, the higher the price, the lower the demand, and vice versa.

 

In the case of prestige goods, the demand curve sometimes has a positive slope. However, if a price is charged too high, the level of demand will be lower.

 

Factors Affecting Price Sensitivity: The Demand Curve Shows the Index of Market Purchases at Alternative Prices. Add together the reactions of many individuals who have different price sensitivities. The factors that affect this sensitivity are:

 

Single value effect: Buyers are less price sensitive when the product is more original.

Awareness effect of substitutes.

Difficult comparison effect: Buyers are less price sensitive when they cannot easily compare the quality of substitutes.

Total Spending Effect: Buyers are less price sensitive when their spending is lower.

Final profit effect: buyers are less price sensitive when the cost of the total finished product is lower.

Comparative cost effect: Buyers are less price sensitive when another party absorbs a percentage of the cost.

Sunken investment effect: Buyers are less price sensitive when using the product with previously purchased assets.

Price effect - quality: buyers are less price sensitive when the product is supposed to have more quality, prestige or exclusivity.

Inventory effect: Buyers are less price sensitive when product cannot be stored.

Demand program estimation methods: In demand program research, the researcher needs to make assumptions about competitive behavior. There are two ways to estimate demand. One is to assume that the prices of competitors remain constant regardless of the price charged by the company. The other is to assume that competitors charge a different price for each price the company could set.

 

Measuring a demand schedule requires varying the price. A study can be done in a laboratory setting by asking subjects to indicate how many units they would buy at different possible prices.

 

If a company increases its advertising expenses while lowering its price, we would not know what percentage of the demand was the result of the lower price compared to the higher advertising expenses. Economists demonstrate the impact of non-price factors on demand by changing the demand curve rather than by moving along the demand curve.

 

Price elasticity of demand: marketers need to know how much demand would respond if there were a change in price. If demand hardly changes with a slight change in price, it is said to be not elastic. If the demand changes considerably, it is elastic. The price elasticity of demand is obtained by the quotient between the percentage change in the quantity demanded and the percentage change in the price.

 

The less elastic the demand, the more profitable it will be for the seller to increase the price.

 

Demand is likely to be lower under the following conditions:

 

There are few or no competitors or substitutes.

Consumers do not easily perceive the highest price.

Shoppers are slow to change their buying habits and look for lower prices.

Buyers think that higher prices are justified by increases in quality, inflation and other relevant factors.

If demand is elastic, sellers will consider lowering the price. A lower price will generate a greater total profit. This makes sense as long as the costs of producing and selling more units do not increase disproportionately.

 

Price elasticity depends on the magnitude and direction of the contemplated price change. It can be negligible with a slight change in price and substantial with a considerable change in price. It may differ for a price reduction against a price increase. The difference between the short and long term elasticity implies that sellers do not know the full effect of their price change until some time has passed.

 

3.-Estimation of costs. Demand largely represents a ceiling for the price the company can charge for its product. And the costs of the company represent the minimum ceiling. The company wants to charge a price that covers its cost of production, distribution and sale of the product, including a fair return for its effort and risk.

 

2.- Analysis of the prices, costs and offers of the competition. While market demand could set a maximum cap and the firm's costs a minimum cap for pricing, competitor costs, pricing, and possible reactions help the firm identify where its costs could be set. The company can send comparison buyers to set the price and evaluate competitors' offerings. You can buy price lists from competitors and buy their product and take it apart. You can ask buyers how they perceive the price and quality of each competitor's offer.

 

Since the company is aware of the prices and offers of the competitors, it can use them as a point of orientation for its own pricing. However, the company must be aware that competitors may change their prices in response to the company's price. Basically, the company will use the price to place its offer inch by inch with that of its competitors.

 

3.- Selection of the method to set the price. Given the three "Cs" (the consumer demand schedule, cost function, and competitor prices), the company is now ready to set a price. The price will fall somewhere between one that is too low to generate a profit and one that is too high to not produce any demand.

 

Companies resolve the pricing aspect by selecting a method that includes one or more of these three considerations:

 

Higher pricing: The most basic method is to add a standard markup to the cost of the product. Any method that ignores current demand, perceived value, and competition is unlikely to arrive at the optimal price. Higher pricing works only if that price actually provides the expected level of sales.

Companies introducing a new product often value it very high in hopes of recouping their costs as soon as possible. But a high overpricing strategy could be fatal if a competitor offers a very low price.

 

Higher pricing remains popular for several reasons. First, sellers are more certain about costs than about demand. Second, where all companies in an industry use this method, prices tend to be similar. Third, many people think that cost pricing is fairer for both buyers and sellers.

 

Pricing based on target return: The company sets the price that its rate of return would generate on the target investment. But much of this profitability depends on price elasticity and the prices of competitors. Pricing based on target profitability tends to ignore these considerations. The manufacturer must consider different prices and estimate their probable effects on sales volume and profits. You should also look for ways to decrease your fixed or variable costs, since lower costs will reduce your required break-even volume.

Pricing based on perceived value: An increasing number of companies see buyers' perceptions of value, not cost to the seller, as the key factor in pricing. They use non-price variables in the commodity mix to create perceived value in the minds of buyers. The price is set to capture the perceived value.

Pricing based on perceived value is well suited to product placement thinking. A company develops a product concept for a particular target market with planned quality and price. Management then estimates the volume it expects to sell at that price. The estimate indicates the plant's capacity, investment, and required unit costs. Then, management considers whether the product will generate a satisfactory profit with the planned price and costs.

Sometimes this operation is called pricing based on the value of the components. The customer may end up finding out some but not all of the added values.

 

The key to pricing based on perceived value is to accurately determine the market's perception of the value of the offer. Sellers with an inflated outlook on their offer value will overvalue their product. Sellers with an underrated prospect will charge less than they could. Market research is required to determine the market perception of value as a guide to effective pricing.

 

Value-based pricing: Several companies have adopted value-based pricing, whereby they provide a low price for a high-quality offering (more-for-less pricing philosophy). Pricing based on value is not the same as pricing based on perceived value. The latter is actually a "more for more" pricing philosophy. It indicates that the company should set its prices at a level that captures what the buyer thinks the product is worth. On the other hand, value-based pricing indicates that price must represent an extraordinary bargain for consumers.

Value-based pricing is not based solely on lower prices compared to those of competitors. It involves modifying the company's operations in order to become a low-cost producer without sacrificing quality, and to reduce prices considerably in order to attract value-conscious customers.

 

Selection of the final price. Pricing methods reduce the range from which the final price can be selected. When selecting the final price, the company must consider additional factors.

Psychological Pricing: Sellers must consider the psychology of their financial aspects. Many consumers use price as an indicator of quality. Image-based pricing is especially effective with ego-sensitive products like perfumes and expensive cars.

 

Sellers often manipulate reference prices by pricing their product. Buyers have a reference price in mind when searching for a particular product. The reference price may have been formed by knowing current prices, past prices or the context of the purchase. For example, the seller may place their product among very expensive products to express that it belongs to the same class. Reference price thinking is also created by setting a high manufacturer's suggested price, or by stating that the product was originally priced much higher, or by pointing to a competitor's price.

 

Many sellers think that prices should end in odd numbers. One explanation is that odd endings cover the notion of discount or bargain. But if a company wants a high-priced image rather than a low-priced image, it must avoid the odd number ending tactic.

 

Price adaptation.

 

Companies do not set a single price, but rather a pricing structure that reflects variations in geographic demand and costs, market segment requirements, purchasing schedules, order levels, and other factors. As a result of the offer of discounts, rebates and promotional support, a company rarely perceives the same profit from each unit of product it sells.

1. Pricing by geographic area. It involves the company deciding how to price its products to customers in different locations or countries. Should you charge higher prices to more distant customers to cover freight charges? Should you participate in counter-trade proposals?

2. Discounts and discounts on prices. Most companies will modify their base price to reward timely payment, volume of purchases, and off-season purchases.