Pricing a cigarette rarely follows the normal characteristics of FMCG products.
Cigarette prices almost always increase due to increase in tax on tobacco products in the annual Budget of the Government of India.
Pricing generally has the following steps involved:
1. Selecting the price objective
2. Determining the demand
3. Estimating Costs
4. Analyzing competition
5. Selecting a pricing method
ITC follows the following pricing mechanism:
Price elasticity:
Depending on the size of the price increase, reduced consumption of tobacco products following increases in tobacco taxes can be quite substantial. In 1999, a World Bank review concluded that, all else being equal, price rises of about 10% would on average reduce tobacco consumption by about 4% in developed countries and about 8% in developing countries. In their 2003 meta-analysis reviewing 86 studies published to the year 2001 which examined the price elasticity of demand for tobacco products, Gallet and List (link) found a mean price elasticity of –0.48, meaning that, on average, a 10% increase in price will be followed by a decrease in consumption of 4.8%.
More than a decade later, the Policy Economics Group at KPMG Peat Marwick conducted a new analysis of the price elasticity of cigarette demand on behalf of Philip Morris(link). This study applied methods used in previously published studies of cigarette demand to updated data on cigarette sales, explored how elasticity had changed over time, and provided estimates from models applying an economic model of addictive behaviour(link) to cigarette demand. Based on their time series data, the authors estimated an overall elasticity of −0.60 for the period from 1947 through 1987. They noted that elasticity has changed dramatically over time: “The elasticity fell during the period from 1947 to 1957, then increased during the period from 1957 to 1987.” They went on to state: “The reasons for the current increasing trend are unclear, but the statistics indicate that the increases in recent years have been significant.” As with the econometric studies discussed above, the authors found that the long run price elasticity of demand after accounting for addiction is higher than that obtained when addiction is ignored.
Cigarette prices almost always increase due to increase in tax on tobacco products in the annual Budget of the Government of India.
Pricing generally has the following steps involved:
1. Selecting the price objective
2. Determining the demand
3. Estimating Costs
4. Analyzing competition
5. Selecting a pricing method
ITC follows the following pricing mechanism:
- FOB origin – The shipping cost from the factory or warehouse is paid by the purchaser.
- Uniform delivery pricing – The same price is charged to all
- Zone pricing – Price increase as shipping distance increase
- Basing point pricing – Certain cities are designated as basing points. All goods shipped from a given basis point are charged the same amount.
- Freight – absorption pricing – The seller absorbs all or part of the cost of transportation. This amounts to a price discount, and is used as a promotional tactic.
Price elasticity:
Depending on the size of the price increase, reduced consumption of tobacco products following increases in tobacco taxes can be quite substantial. In 1999, a World Bank review concluded that, all else being equal, price rises of about 10% would on average reduce tobacco consumption by about 4% in developed countries and about 8% in developing countries. In their 2003 meta-analysis reviewing 86 studies published to the year 2001 which examined the price elasticity of demand for tobacco products, Gallet and List (link) found a mean price elasticity of –0.48, meaning that, on average, a 10% increase in price will be followed by a decrease in consumption of 4.8%.
More than a decade later, the Policy Economics Group at KPMG Peat Marwick conducted a new analysis of the price elasticity of cigarette demand on behalf of Philip Morris(link). This study applied methods used in previously published studies of cigarette demand to updated data on cigarette sales, explored how elasticity had changed over time, and provided estimates from models applying an economic model of addictive behaviour(link) to cigarette demand. Based on their time series data, the authors estimated an overall elasticity of −0.60 for the period from 1947 through 1987. They noted that elasticity has changed dramatically over time: “The elasticity fell during the period from 1947 to 1957, then increased during the period from 1957 to 1987.” They went on to state: “The reasons for the current increasing trend are unclear, but the statistics indicate that the increases in recent years have been significant.” As with the econometric studies discussed above, the authors found that the long run price elasticity of demand after accounting for addiction is higher than that obtained when addiction is ignored.
The profit margins of free enterprise cigarette manufacturing is around 30% of net sales before taxes and for monopoly type organizations, 40% free of taxes. (link)
Even though cigarettes pursue a value pricing model, cigarettes are purchased primarily because of their addictive nature. Thus, cigarettes have a huge product value in terms of providing immediate satisfaction to the smoker. No amount of psychological, energy or monetary cost deter habitual smokers.
The only difference found in cigarette prices is perhaps due to the cost of import of cigarettes manufactured abroad.
One would expect different types of cigarettes to command different prices, however, they are usually priced very similarly because loss of revenue due to the price premium is not worth it to the retailers.
Another example of how pricing with respect to products works is how excise duty on a 64mm cigarette is Rs.0.67 against Rs.1.47 on a 69mm stick, according to data from the Central Board of Excise and Customs.
Thus, shortening the length of the cigarette from 69mm to 64mm. ITC’s move to shorten low priced cigarettes by 5 millimetres (mm) helped fourth quarter profit jump 18% as customers snapped up smokes small enough to qualify for a lower government tax rate.
Another example of how pricing with respect to products works is how excise duty on a 64mm cigarette is Rs.0.67 against Rs.1.47 on a 69mm stick, according to data from the Central Board of Excise and Customs.
Thus, shortening the length of the cigarette from 69mm to 64mm. ITC’s move to shorten low priced cigarettes by 5 millimetres (mm) helped fourth quarter profit jump 18% as customers snapped up smokes small enough to qualify for a lower government tax rate.
No comments:
Post a Comment