Question

‘Blessy Ltd., decided to diversify into manufacturing vitamin enriched water apart from their original business of cold drinks. The finance and marketing department sat and decided to adopt either of these two pricing techniques - adding a certain percentage of profit to the cost of production or to sell at a lesser amount so as to capture huge market. They put forth their finding to the CEO. Identify the technique and state one advantage and one disadvantage for each pricing method.

Answer 1

The two methods are - cost plus production and price penetration. 

Advantages of cost plus pricing 

1. Biggest advantage of this is that company knows exactly the amount of expenditure that has incurred on making a product and therefore they can add profit margin accordingly which helps in achieving the desired revenue for a firm. 

2. It is the simplest method to decide the price for a product because one has just to add up all the cost and then add profit which you want to earn which will give the price for a product. 

3. Since company is using its own data for deciding cost which makes it easier for a company to evaluate the reasons for escalations in expenses and therefore it can take corrective action immediately.

Disadvantages of cost plus pricing 

1. This method does not take into account the future demand for a product which should be the base before deciding the price of a product and therefore a serious limitation of this method. 

2. It also does not take into account the competitor actions and its effects on pricing of the product. 

3. It can result in the company overestimating the price of a product because this method includes sunk cost and ignores opportunity cost also while calculating cost there is an element of personal bias while deciding the profit margin which is to be added for a product. added for a product. 

The advantages of penetration pricing to the firm are: 

1. It can result in fast diffusion and adoption. This can achieve high market rates quickly.This can take the competitors by surprise, not giving them time to react. 

2. It can create goodwill among the early adopters segment. This can create more trade through word of mouth. 

3. It creates cost control and cost reduction pressures from the start, leading to greater efficiency. 

4. It discourages the entry of competitors. Low prices act as a barrier to entry 

5. It can create high stock turnover throughout the distribution channel 

6. This can create critically important enthusiasm and support in the channel.

Disadvantages: 

1. The main disadvantage with penetration pricing is that it establishes long– term price expectations for the product and image preconceptions for the brand and company. This makes it difficult to eventually raise prices. 

2. Penetration pricing attracts only the switchers (bargain hunters), and that they will switch away as soon as the price rises.