Generally, organizations produce more than one product in their line of production. Even a single product of an organization can differ in styles and sizes. For example, a refrigerator manufacturing organization produces refrigerators in different colors, sizes, and features. Similarly, an automobile organization manufactures vehicles in different colors, sizes, and mileage. The pricing in case of multiple products is called multiple product pricing.
Multi-Product Pricing, also called “Portfolio Pricing” and “Category Pricing”, offers a way to eliminate cannibalization and increase profitability without sacrificing market share. In other words, you can get more profit from the same customers.
“More Profit + Same Customers”
The demand curve for multiple products would be different. However, the MC curve of these products is same as these are produced under interchangeable production facilities. Therefore, AR and MR curves are different for each product. On the other hand, AC and MC are inseparable. Therefore, the condition of MR=MC cannot be applied directly to fix the prices of each product.
The solution of this problem was provided by E.W. Clemens who stated how the multi-product organizations fix prices of their products. Suppose there are four differentiated products. A, B, C, and D produced by an organization.
As shown in Figure-6, the AR (price) and MR curves for four products are shown as four different curves and MC curve is shown as the total of MC of all the products. Suppose the aggregate MR curve, which is the total of all individual MR curves, passes through point E on the MC curve.
Certain basic considerations involved in decision making are:
(i) Price and cost relationship in product line,
(ii) Demand relationship in product line
(iii) Competitive differences.
They are explained as follows:
(i) Price and Cost Relationship:
For evolving a price policy for any product, price and cost relationship is the basic consideration. Cost conditions determine price. Therefore, cost estimates should be correctly made. Although a firm must recover its common costs, it is not necessary that prices of each product be high enough to cover an arbitrarily apportioned share of common costs.
Proper pricing does require, however, that prices at least cover the incremental cost of producing each good. Incremental costs are additional costs that would not be incurred if the product were not produced. As long as the price of a product exceeds its incremental costs, the firm can increase total profit by supplying that product.
Hence decisions should be based on an evaluation of incremental costs. A price that offers maximum contribution over costs is generally acceptable but in multi-product cases, incremental cost becomes more essential to make such decisions.
A set of alternative price policies should be considered and they are:
(i) Prices of multi-products may be proportional to full cost. This price may produce equal percentage of profit margin for all products. If the full cost for all products are assumed equal then the pricing will be equal.
(ii) Pricing for multi-products may be proportional to incremental cost.
(iii) Prices of multi-products may be assessed with reference to their contribution margin as proportional to conversion cost.
(iv) Prices of multi-product may be fixed differently keeping into consideration market segments.
(v) Prices for multi-products may be fixed as per the product life cycle of each product.
(ii) Inter-relation of Demand for Multi-product:
Demand inter-relationships arise because of competition in which case they become substitutes or they may be complementary goods. Sale of one product may affect the sale of another product. Different demand elasticity of different consumers may allow the firm to follow policies of price discrimination in different market segments. Two products of the same price may be substitutes to each other with cross elasticity of demand due to high degree of competitiveness.
In such a situation, pricing of the multi-products will have to be done in such a long way that maximum return could be obtained from each market segments by selling maximum products. Demand inter-relationships in the case of multiple products make it clear that we should take into account a thorough analysis of the total effect of the decision on the firm s revenues.
(iii) Competitive Differences:
Yet another important point should be considered for making price decisions, for a product line is the assessment of degree of competitiveness. Such an assessment will set up market share for each product. A product having large market share can stand a high makeup and can contribute to bear the losses.
There is competition among a few sellers of a relatively homogeneous product that has enough cross elasticity of demand so that each seller must in his pricing decisions take account of rivals’ reaction. Each producer is actually aware of the disastrous effects that an announced reduction of his own price would have on the prices charged by competitors. The firm should also analyse whether the competitors have free entry to the market or not.
Marginal Technique for Pricing Multi-products:
Marginal technique for pricing multi-products is based on the logic that when the firm has spare capacity, unutilised technical resources, managerial and organisational abilities and capabilities, the firm enters into production of various other products with most profitable uses of alternatives.
The product is technically independent in the production process. For selecting these alternatives, the firm considers marginal costs of each such alternative and adopts those which offer higher margin on cost through sales.
Since each additional unit produced entails an additional cost as well as generates additional revenue, the logic of profit maximisation stresses that production should be stabilised at a point where MR just covers MC. ‘Marginal cost more accurately reflects those changes in costs which result from a decision. Marginal pricing is more useful because of the prevalence of multi-product firms.
A firm shall produce the multi-product to the level where MR from sales of all these products equals the MC. If MC is more than MR then the firm shall stop producing and selling one of the products which offer less MR than MC.
Pricing of Multiple Products or Joint Products:
Products can be related in production as well as demand. One type of production interdependency exists when goods are jointly produced in fixed proportions. The process of producing mutton and hides in a slaughter house is a good example of fixed proportion in production. Each carcass provides a certain amount of mutton and hide.
There is little that the slaughter house can do to alter the proportion of the two products. When goods are produced in fixed proportion they should be thought of as a ‘product package’. Because there is no way to produce one part of this package without also producing the other part, there is no conceptual basis for allocating total production costs between the two goods.