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Cost Based Pricing vs. Market Based Pricing:

Cost Based Pricing vs. Market Based Pricing Presented By: Akash deep Kushwaha (39)


Background Price control over drugs was first introduced in India in 1962-63. Thereafter, a series of price controls have been implemented on several occasions in 1966, 1970 (under the Essential Commodities Act), 1978, 1979 and 1987. All these policies were broadly based on the principle of effecting control over prices of key bulk drugs and their formulations. The present Drug Policy of 1994 was implemented through the DPCO in 1995 which brought a major change in the way in which the key drugs were identified for price control. The policy based the selection process on the market share of different companies in the context of total sales of various drugs. Thus, drugs with annual sales at a particular level where the market share of leading players was beyond a particular level were brought under the ambit of price control.

Dept of Pharma puts new Drug Pricing Policy up for debate Published on Fri, Oct 28, 2011 at 15:45 Source : CNBC-TV18 :

Dept of Pharma puts new Drug Pricing Policy up for debate Published on Fri, Oct 28, 2011 at 15:45 Source : CNBC-TV18

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Objective - To bring all essential drugs under price control. The new policy, which has been pending since 2006, will replace the 15 year old policy. The policy framework aims at widening the ambit of medicines under price control as it proposes to include all of the 348 essential drugs listed in the NLEM as compared to the 74 bulk drugs. New pricing policy will cover at least 60% of drugs from only 20% right now. It is estimated, that the new policy in its proposed form would bring approximately 60% of the Rs, 48,200 C rore domestic formulation industry under the pricing control compared to ~20% earlier.

PowerPoint Presentation:

The Pranab Sen Committee of 2006 had recommended that “Pricing policy for drugs should move out of cost pay system and should go to reference pay system especially in a market like India which is highly branded generics market.” Now, the new policy will move to the reference pricing. Earlier, it had come up for a policy review in 2007-08, after Pranab Sen Committee. Now, with all the other pending details been taken into consideration

Reduction In Price:

Reduction In Price

Impact on the Domestic Pharmaceutical Industry::

Impact on the Domestic Pharmaceutical Industry : Price reductions imminent but impact likely to be limited

What is Price?:

What is Price? Narrowly defined, price is the amount of money charged for a product or service. Broadly defined, price is the sum of all of the values that consumers give up in order to gain the benefits of having or using the products or service.

Influences on Price:

Influences on Price Customer demand, Competitors’ behavior/prices/actions, Costs, Regulatory environment – legal, political and image related. 9

Markets and Pricing:

Markets and Pricing 10

Factors to consider when setting prices:

Factors to consider when setting prices Customer perceptions of value - Value-based pricing - Cost-based pricing Other internal considerations - Marketing strategy, objectives, mix Other external considerations - Nature of the market and demand - Competitors’ strategies and prices

Alternative Long-Run Pricing Approaches:

Alternative Long-Run Pricing Approaches Market-Based: price charged is based on what customers want and how competitors react. Cost-Based: price charged is based on what it cost to produce, coupled with the ability to recoup the costs and still achieve a required rate of return. 12

Market-Based Approach:

Market-Based Approach Starts with a target price. Target Price – estimated price for a product or service that potential customers will pay. Estimated on customers’ perceived value for a product or service and how competitors will price competing products or services. 13

Value-Based Pricing Vs Cost-Based Pricing (Fig 9.2 p 260 Armstrong and Kotler, Marketing: An Introduction, 9th edition) :

Value-Based Pricing Vs Cost-Based Pricing (Fig 9. 2 p 260 Armstrong and Kotler, Marketing: An Introduction, 9th edition)

Customer perceptions of value:

Customer perceptions of value (a) Value-based pricing: Uses buyers’ perceptions of value, not the seller’s cost, as the key to pricing. Price is considered along with the other marketing mix variable before the marketing program is set. Pricing begins with analyzing consumer needs and value perceptions, and price is set to match consumers’ perceived value.

Customer perceptions of value:

Customer perceptions of value (a ) Value-based pricing: Types of value-based pricing: Good value pricing Value-added pricing Companies often find it hard to measure the value the customers will attach to its product. Assigning a value to satisfactions such as taste, environment, relaxation, conversation, and status is very hard. Values will also vary both for different consumers and different situations.

Customer perceptions of value:

Customer perceptions of value (b) Cost-based pricing: Setting prices based on the costs for producing, distributing, and selling the product plus a fair rate of return for its effort and risk. Fixed costs - Costs that do not vary with production or sales level. Variable costs - Costs that vary directly with the level of production.

Customer perceptions of value:

Customer perceptions of value Types of cost-based pricing: Cost-plus pricing-Adding a standard markup to the cost of the product. Break-even pricing-Setting price to break even on the costs of making and marketing a product. Target-profit pricing-Pricing that starts with an ideal selling price, then targets costs that will ensure that the price is met.

Cost-Based (Cost-Plus) Pricing:

Cost-Based (Cost-Plus) Pricing The general formula adds a markup component to the cost base to determine a prospective selling price. Usually only a starting point in the price-setting process. Markup is somewhat flexible, based partially on customers and competitors. 19

Forms of Cost-Plus Pricing:

Forms of Cost-Plus Pricing Setting a Target Rate of Return on Investment: the Target Annual Operating Return that an organization aims to achieve, divided by Invested Capital Selecting different cost bases for the “cost-plus” calculation: Variable Manufacturing Cost Variable Cost Manufacturing Cost Full Cost 20

Common Business Practice:

Common Business Practice Most firms use full cost for their cost-based pricing decisions, because: Allows for full recovery of all costs of the product Allows for price stability It is a simple approach 21

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Pragya Misra (48)

NPPP 2011:

NPPP 2011 The drug policy has only 18 per cent of the Rs 62,000-crore drug market under price control, the proposed one will cover over 60 per cent of the domestic drug market. The new policy will see all medicines on the National List of Essential Medicines (NLEM)-2011 under price control. According to industry estimates, the NPPP will result in a dip of up to Rs 3,000 crore in the industry’s net profits.

Price fixing :

Price fixing Disadvantages of COST BASED PRICING: Detailed drug prices calculated every year. Requires complex variety of data. Manufacturers required to provide detailed pricing data, making it intrusive and so resisted by individual manufacturers. Results in possible manipulation and delay.


CURRENT vs. NEW POLICY In the existing policy, the prices of non-controlled drugs are monitored and in case the prices rise beyond 10% in a year, the NPPA steps in and regulates the same. In the new policy, all essential drugs will come under price control, and to keep a tab on the prices of non-essential drugs, if these exceed 15% per year, the NPPA can regulate them.


MARKET BASED PRICING In such an approach, the ceiling price is fixed as listed by the Government. This ceiling price will be decided on the basis of the weighted average price of the top three brands by value of a single ingredient drug belonging to the national list of essential medicines. The prices of formulations will be decided by fixing a ceiling price and manufacturers will be allowed to fix any price which is equal to or below the ceiling price.

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ANOMALIES OF THE NPPP DRAFT ( w.r.t . pricing)


ANOMALY 1: There is no logic in restricting the formula to just three brands. Why not five? Why not 10 to arrive at a more representative and reasonable figure ? Besides why base on sales figures? In any pricing policy the parameter should be the price.


ANOMALY 2: Market Based Pricing (also called competition based pricing) is applicable to only those items (such as TV set, shoes, clothes etc.) . In such cases, the consumer is the decision maker capable of assessing the relative merits of various brands on sale and voluntarily decides to buy one or the other product in his best interest suiting his pocket.


CONTD… In the field of pharmaceuticals, the paying consumer has no say and has no alternative but to buy as directed by the doctor. All decisions are taken by doctors who “do not pay” but often “get paid.” Due to aggressive, incentive based promotion, the top selling three brands are nearly always the more expensive brands. Due to the government-sanctioned legitimacy for such high pricing, manufacturers of lower priced equivalents will be induced to push up the prices and simultaneously increase expenditure on promotion.


ANOMALY 3: There are many products where there is just one brand (example: Revital). In such cases, the producers will be free to charge at will and immensely benefit from a faulty policy.


ANOMALY 4: Under the proposal, all drugs being sold for Rs. 3 or less per unit (tablet, capsule) will be exempted from price regulation in addition to being automatically eligible for hike in pricing based on WPI for manufactured goods year after year. One out of every three medicines sold in India is priced below Rs. 3 per unit. Thus Crocin brand of paracetamol which is currently sold for Rs. 20 for 15 tablets will be free to increase the price to Rs. 45 even though the cost of production is pretty less. The new policy, if implemented will mean that the price of Crocin can reach Rs. 65 for 15 tablets based on average WPI-linked hike of 7.5% compounded in the next five years.

Thank you !!!:

Thank you !!!

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