Limitations of Market Penetration Pricing

Limitations of Market Penetration Pricing

Penetration pricing strategy to get high market share by reducing price does not hold true in all circumstances. There are some limitations of this strategy i.e. high competition in the market, high growth opportunities, quality of product, and brand role.

1.    Competitor Will React

Penetration pricing strategy does not work in competitive market, because in high competitive market, competitor will react immediately, and thus desired market share cannot be attain by redacting prices.

2.    Growth Encourages Entry

Penetration strategy cannot stop the new entry in the market, because growth opportunities will encourage people to invest in the industry to get their share out of growing market. Therefore penetration strategy will not prevent new entry in markets which have high growth potentials or expectations.

3.    Quality Does Matter

Price is not the sole factor for capturing the market share. Quality of product is also an important factor, and people are ready to pay high price for improved quality.Therefore improved quality at lower price is the best strategy to capture the market share, instead of just focusing on price reduction.

4.    Brand Name Play Role

It is not easy to compete with the good brand by lowering the price. People are ready to pay more for brand reputation. competing with a reputable brand by lowering prices is not a suggested option.

Disadvantages of Market Penetration Pricing

Disadvantages of market penetration Pricing Strategy

1.    High growing market

This strategy will not work in high growing market and competitor will react accordingly. The new entry cannot be avoided with low prices if the market has a lot of growth opportunity for example the telecom sector almost in every country of the world four to five companies can get their share even by offering higher prices than competitors.

2.    Price is only one factor

The price is only one of the factors for capturing the market. There are also other factors for example a brand name if branded competitor enter in the market even with the high price there is fair chance that he will lead the market. The other factor is product quality and features for example if your competitor enters in the market with improved product with same price or relatively high price then competitor will get his share from the market.

3.    Low price may result in high loses

The lower prices are possible by keeping the profit margin low. This situation may result in heavy losses if there is fall in demand. The profit margin should be sufficient enough to cover the fixed cost as well. Some company’s takes into account only the marginal cost for pricing decision and this situation may lead for heavy losses if the due consideration is not given to fixed cost.

Advantages of Market Penetration Pricing Strategy

Advantages of Market Penetration Pricing Strategy

There are number of advantages associated with market penetration strategy. These advantages has been briefly explained below

1.    High Market Share

Main advantage of keeping the prices low is to attain high market share. People are psychologically attracted to buy the product. This strategy is very effective for launching of new product.

2.    Discourages Competition

Other advantages of market penetration pricing are to discourage the new entry in the market. Businessman loves to enjoy competition free market, because there are number of advantages are associated with competition free market.

3.    High profit are possible

Market penetration can get high profit due to establish relationship between volume of sales and profitability. We know that profitability rises with rise in volume of sales.

4.    Reduces stock obsoletes

High sales volume in market penetration pricing strategy reduces the chances of stock obsoletes. Stock obsoletes are critical for some industries like fashion industry.

5.    Customer Loyalty

Low prices can be a source of wining the customer loyalties. This can be easily done by offering quality product at lower prices.

6.    Future product Launch

High market share by reducing prices can be helpful for launching the future products. People knowledge about the reputation of the entity plays important role in introducing new products.

7.    Cost control is focused

Low price means low unit profit, and therefore management try to keep the cost under control, otherwise cost may jump higher than selling price, and such situation can bring disaster results for organization.

Disadvantage of skimming pricing strategy

Disadvantage of skimming pricing strategy

1.    Brand image is at stake

The charging very high prices will bring a bad image of the brand for charging unnecessary high price for the product.

2.    Future product launch problems

The charging very high prices and then lowering down with the passage of time will have negative impact on future launch of product. The customer will not willing to pay high price for next product with a view that prices will come down sharply after sometime.

3.    Not suitable for low price product

This strategy will not work for the lower price product where there are many options available to the customer and lower prices offered to public will not attract the customer as the prices difference is not going to be material for the customer.

4.    Not suitable in competitive market

This strategy will not work in high competitive market because in the high competitive market the competitor is going to react quickly .The competitor will get the maximum share by reducing the prices. This strategy will only work in the high competitive market if your product offers some additional features as well.

Characteristics of Market Skimming Pricing

Characteristics of Market skimming Pricing

1.    High Introduction Price

In market skimming strategy organization charge high price at the time of introduction, because some customer are ready to buy the product at high price.

2.    Price Gradually Decreases

In market skimming strategy prices are gradually decreases to capture market share.

3.    High Advertising Cost

In market skimming strategy, firm is required to spend a lot on the advertising to attract maximum high value customer (customer ready to pay high price).

Disadvantages of Marginal Cost plus Pricing

Disadvantages of Marginal Cost plus Pricing

In marginal cost plus pricing, only the variable cost is focused. There are number of disadvantages or limitation of using marginal cost plus pricing.

1.    Decision Making Needs

Marginal cost plus pricing is widely used for pricing decision. It is important to note that this pricing cannot be used for external reporting purposes i.e. in financial statements.

2.    Fixed Overhead cost is Material

Marginal cost plus pricing cannot be used in organization, where fixed overheads cost are material.

3.    Not Represent Actual Profit

Marginal cost plus pricing system does not reflect the actual profit from the product. Therefore marginal cost plus pricing may produce some misleading projections of profits.

4.    Market Factors are Important

Market factor are important for price determination. In this method demand & supply are not considered for price determination. it means that this pricing strategy ignores some fundamental factors.

5.    Competitor is Alive

Competitor prices in the market are not consider, which another great limitation of marginal cost plus pricing. In real business world prices cannot be decided without considering competitor prices in the market.

Advantages of Marginal Cost plus Pricing

Advantages of Marginal Cost plus Pricing 

1.    Variety of product

Marginal cost plus pricing system is suitable, where a number of products are being produced. A profit margin is added to the contribution.

2.    Suitable for lower fixed cost

Marginal cost pricing is suitable, where fixed production cost is at lower side, otherwise this system can bring huge losses to the organization. (Full cost may be more than selling price).

3.    Focuses Contribution

Marginal cost pricing system is based on contribution maximization concept i.e. by maximizing contribution profit can be maximized, because fixed cost are period cost.

Disadvantages of Full Cost Plus Pricing

Disadvantages of Full Cost plus Pricing

1.    Competitor is ignored

In full cost plus pricing system competitor prices are ignored, which is a key factor for determining the price. Ignoring competition can bring huge losses to the organization.

2.    Market conditions are ignored

Full cost plus pricing system does not take into account the market condition i.e. demand & supply of the product, which again a key consideration for price determination.

3.    Profit Margin Decision

Management takes the profit margin decision, which could be very biased decision. There is no mechanism for profit margin. Biased decision making in this regard can bring heavy damage to the product.

4.    Full cost is difficult task

In many cases there is not possible to calculate the full cost of the product i.e. very small products, or different variety of product is being produced under same roof.

5.    No incentive for Cost Control

Profit is guaranteed in this method, therefore there is no incentive to control the cost.

6.    More Wastage is Expected

Due to guaranteed profit, there is no incentive to control wastage in the production process.

Advantages of Full Cost Plus Pricing

Advantages of Full cost plus pricing

1.    All cost are covered

Under full cost pricing all cost are covered and therefore there is no loss condition.

2.    Profit is known

In full cost pricing the profit is known from the project. Therefore there is no uncertainty about the profitability; therefore organization can focus on project.

3.    Quality Good

In full cost pricing there is more focus on quality, because cost is to be charged to customer in full cost pricing method.

Limitations of Market Transfer pricing

Limitations of Market Transfer pricing

In market transfer pricing, the market price is used for internal transfers. The main advantage of using this method is fair price method. This method can only be used, when an external market exists. There are some limitations of market transfer pricing, which have been explained below

1.    Market Price Changes

First important limitation of market transfer pricing is its continuous fluctuation.Market price continuously changes over the period of time and therefore cannot be used as standard for transfer pricing.

2.    Market Price Non Availability

Second limitation of market transfer price is non availability of market price.Market price may not be available for many products (specially for technical Goods). Therefore market pricing cannot be widely used by the organization.

3.    More than One Market Price

There may be more than one market price for a product i.e. retail price, or wholesale price. It is difficult to establish that what market price is to be used as market price.

Characteristics of Dual Transfer Pricing

Characteristics of Dual Transfer Pricing

1.    Seller not Willing to Sell

In dual transfer pricing selling division are not willing to sell the goods at price offered by buying department. Selling department is interested at higher price than offered price by the purchasing department.

2.    Buyer is not willing to Buy

In dual transfer pricing, buyer is not willing to buy, because the price charged by the seller is regarded is too high. Buyer is interested at lower price than offered price. No transfer can take place due to this conflict.

3.    Head Quarter Buy & Sell

In dual transfer pricing, selling department transfer the goods at desired price to the head office, and head office then transfer the good to purchasing department at willing price (acceptable price to buyer). It means two different prices are used for transfer.

4.    Head office take disadvantage

In dual transfer pricing, head office treat the selling department profit as head office expenses. It means the buying department and selling department performance is not affected.

5.    Autonomy is at stake

In dual transfer pricing the autonomy of decision making department is at stake. Autonomy of decision making at divisional level is one of the fundamental objective of transfer pricing, which is at stake under this method.

6.    Complicated Accounting

Dual pricing complicate the accounting process and a cost are charged to the head office against profit of selling department is difficult to explain. Expense in head office account creates a lot of confusion.

Limitations of Negotiated Transfer Pricing

Limitations of Negotiated Transfer Pricing

Under this method transfer prices between department and division are decided on the bases of negotiation between these departments. This type of pricing is regarded as fair deal, because both parties are satisfied.

1.    Conflict

First limitation of negotiated transfer pricing is conflict creation  between departments. failed negotiation between departments may result in conflict. This conflict situation is not favorable for organization, because conflict may bring disintegration within the organization.

2.    Use of Domination

Under negotiated pricing, the powerful or dominating division may influence the transfer price in its favor; therefore the advantage of fair deal may not be achieved in such circumstances.

3.    Time Consuming Job

Negotiation pricing is a time consuming effort and  would consume a lot time of management. This time can be used on an issue which can bring real profit to the organization.

4.    No Real Benefit

Negotiated pricing will not bring any real advantage or benefit to the organization because transfer pricing is just a method of measuring performance of divisional performance. It has no direct role in improving the profitability of organization.

Transfer Pricing Concept

Transfer Pricing Concept

Transfer pricing is a concept related to internal sales i.e. sales is made by one department to another department. The prices at which these transfer are made are known as transfer price. Transfer price does not affect the overall profit, because profit on division is cost of another division.

Transfer Pricing Objective

1.    Full autonomy

Transfer pricing is source of full autonomy of decision making to the divisional manager. It means divisional manager enjoys full authority of decision making and therefore is total responsible for investment center performance.

2.    Fair Performance Valuation

Transfer pricing ensures fair performance evaluations. Transfer pricing allows selling department to charge a fair price for its goods. Thus performance of selling department would not be negatively affected by such transfer.

Types of Transfer Price

Transfer can be made on cost and above cost (adding some profit) and market price.

1.    Transfer at Cost

Selling department may transfer the goods to purchasing department either on marginal cost or full cost. It means that transfer cost may be categorized into full cost and marginal cost method.

2.    Transfer at Cost Plus

Selling department may charge some profit to the purchasing department. Management will decide about the profit margin on the transfer.

3.    Transfer at Market Price

Selling department may transfer the goods to purchasing department at market price. This method can only be used where external market for good exists.

Price Influencing Factors

Price Influencing Factors

1.    Demand & Supply

Demand will rise with the decrease in price, while supply will rise with increase in price (supplier is more willing to supply more at higher prices). Price of product will be the equilibrium i.e. supply=demand. This is price where supplier interested to sell & customer is willing to buy.

2.    Size of the firm

Some large produce take the decision about the product prices and whole market follow that price. Those firms are known as price maker and small firm who follow or take the price set by large producer are termed as price taker.

3.    Cost

Third price influencing factor is product cost. Every organization make product for profit, therefore a certain margin is added to the cost for price determination. Therefore cost is one of the vital price influencing factors.

4.    Income of Customer

Fourth price influencing factor is income of customer. When income of customer rises, demand of the product increases, and there is tendency of increase in price due to shift in demand curve.

5.    Availability of Substitute

Fifth price influencing factor is availability of substitute product. In case of substitute product, customer may shift to another product and therefore unreasonable increae in price is not expected.