Pricing Policies of Public Enterprises | Economics

In this article we will discuss about:- 1. Principles of Pricing in the Case of Public Enterprises 2. Machinery for Price Fixation 3. Guidelines.

Principles of Pricing in the Case of Public Enterprises:

What pricing policy should a Public Enterprise (PE) adopt? It is a complex problem and is not possible to lays down, general principle of pricing that should be followed by all the PEs. The complexity of pricing problem arises because of the fact that some PEs are industrial and commercial undertakings; some PEs are promotional and developmental; and some PEs provide basic and essential infrastructure facilities.

Also, competitive environment—domestic and international—has got to be taken into account in the case of goods produced by some PEs. There is also to be considered the need for financial resources for investment purposes in a developing country like India. From all these considerations; it should follow that there cannot be just a single, principle of guiding of pricing that can be prescribed for or that should be followed by all PEs.

The following are some of the important principles of pricing which are suggested in the case of PEs:

1. Marginal Cost Basis:

Marginal cost is the cost of producing an additional unit of a product. The reasoning behind the ‘marginal cost basis’ of pricing policy, is that, if a consumer is willing to pay for an extra unit of a product, welfare of the community gets maximised when that extra or additional unit of product is made available to him.

It is argued that if a consumer is not willing to pay the cost of the additional unit (i.e. marginal cost), that additional unit should not be produced in the interest of maximising welfare of the community. It is also argued that if marginal cost basis is followed in pricing policy of PEs, resources of the community will automatically be allocated to the production of different goods that will lead to maximisation of the welfare of the community.

Marginal Cost:

While considering ‘marginal cost’ in the short run, capital cost is fixed and only variable cost is taken into consideration therefore, called ‘short-term marginal cost’. In the case of long-term marginal cost, even fixed capital becomes variable capital and marginal cost has in that case to take note of both fixed capital cost and variable cost.

Criticism:

One criticism against the marginal cost principle of pricing of products of PEs is that, if strictly applied, it would result in deficit in the case of industries experiencing increasing returns or decreasing costs. Such deficits may have to be met by imposing taxes on other consumers who are not purchasing that commodity and this could reduce their welfare.

Surplus Revenue:

The principle of marginal cost would mean, in the case of industries which are functioning under conditions of decreasing costs, an increase in the price of commodity with every increase in production of that commodity. This would result in large surplus revenue. This surplus revenue, apart from inviting public protests, might also result in a demand for a rise in wages and bonus by workers in that unit of the PE.

Practical Difficulties:

The marginal cost principle may also be found unworkable because of the practical difficulties of calculating, with any degree of accuracy, the marginal cost in public utilities such as electricity, State transport services, post and telegraph and so on.

2. Pricing on the Basis of Average Cost:

‘Average cost pricing principle’ refers to fixing the price of a commodity on the basis of the average cost of population of the commodity. In the case of average cost pricing, total revenue obtained by selling a certain amount of commodity will be equal to its total cost of production. Thus, average cost pricing principle ensures that the entire cost of production is absorbed in to the price of the commodity.

It may be noticed that while calculating total cost of production, along with various other costs, normal profits is also included. On account of this, the price of a commodity is a little higher than the price based on the principle of ‘No profit, No loss’.

Calculation Problem:

It is claimed that it is easy to calculate total costs and therefore, also the average cost of a commodity, whereas it is not always possible to accurately calculate marginal cost, and sometime it is even impossible to-do that. Thus, in the case of railways, electricity and other public utilities it is possible to calculate total costs and therefore, also the average cost of production of a commodity or service whereas it is not possible in their cases to calculate marginal cost.

Merits:

The following merits are claimed for the principle of average cost pricing of commodities or services of PEs:

1. Every consumer pays the entire cost of production of a commodity that he is consuming instead of only its marginal cost. This appears reasonable.

2. Since nobody pays more than the average cost of production of a commodity or what it has cost the commodity to be produced and no more, there is no question of anybody being exploited (by changing a price that is higher than what on an average the commodity has cost).

3. ‘No Profit, No Loss’ or ‘Break-Even’ Principle:

‘No profit. No loss’ or ‘Break-even’ principle of pricing of products or services of PEs maintains that the price should be fixed in such a way that there will be neither any profit, nor any loss for the concerned PE. In simple terms, price should just-cover all costs of production.

Marginal Cost Pricing:

It is noted that in the case of marginal cost pricing, in the case of decreasing cost condition, the concerned-PE will suffer a loss which will have to be subsidized by taxing people to the extent of the deficit suffered by the PE. There is thus cross subsidization.

In the case of No profit, No loss’ principle of pricing of products of PEs there is no question of any loss and, therefore, no subsidizing the PE out of the government treasury or by taxing the people.

This means that when ‘No profit, No loss’ principle of pricing is adopted by a PE non-consumers of the commodity in question are not forced directly or indirectly to bear a ‘burden for the benefit of those who consume the product.

Arthur Lewis has advocated this principle of ‘No Profit No loss’ on the ground that the principle will prevent either over- expansion or under-expansion of a PE and will thus help avoid either inflationary or deflationary tendencies.

In India, the Damodar Valley Corporation (DVC) follows the principle of ‘No profit No loss’ in pricing. Other PEs which follow this principle of pricing are Hindustan Antibiotics, Hindustan Insecticides, Export Guarantee Corporation, etc.

4. Profit-Making Principle of Pricing:

Profit-making principle of pricing of the products or services of PEs maintains that the price charged should be such as to get for the concerned PE some surplus after absorbing all the cost elements, including normal profit. It is maintained that in developing countries like India, PEs are expected to generate as much surplus as possible so that these surplus funds can be further invested in developmental projects.

In Developing Countries:

In many developing countries like India, PEs has been occupying a prominent place in the economy. Huge amounts (amounting to more than Rs. 1,13,234 crores on Central Government projects) have come to be invested in PEs. In developing countries, people being poor with an extremely low per capital income, there is limited scope for both direct and indirect taxation.

If the rates are raised abnormally, the yields might decline and people may also develop tax-resistances. It is, therefore, suggested that PEs should generate as much surpluses or profits as possible which will augment government’s financial resources which can be invested for further development purposes.

In countries, where PEs have come to occupy a commanding position, it would be easier and also practicable that the country’s financial resources for developmental purposes should be augmented by this way than by raising financial resources by taxation or deficit financing or borrowing from the public.

Pronouncements:

We observe the pronouncements of politicians and economists in India in favour of this principle of pricing of the products of PEs. Thus, Mrs. Indira Gandhi, then the Prime Minister of India, pronounced that Government advocated expanding the public sector so that the PEs can “provide surpluses with which to finance further economic development”.

Mr. T.A. Pai (once Union Minister for Industries) argued that 12 per cent return on investment in the public sector should be regarded as equitable Dr. V.K.R.V. Rao maintained that the pricing policy of PEs should be such as to promote the growth of national income… public enterprises must make profit and the larger the share of public enterprises in all enterprises, the greater is the need for their making profits.

Profits constitute the surplus available for savings and investments, on the one hand, and contribution to national social welfare programmes, on the other, and if public enterprises do not make profits, the national surplus available for stepping up the rate of investment and the increase of social welfare will suffer a corresponding reduction.

Taxation Committees Report:

The Taxation Enquiry Committee (1952) observed, “…in certain age where the State has made substantial investment a policy of regulating prices so as to secure an adequate return on the capital invested is not only unobjectionable but may indeed be desirable. This is particularly so, where public enterprise itself, fostered at State expense, may in turn play a role in financing the country’s development.”

The Industrial Policy Statement of 1948 observed. “It is to be expected that public enterprises will augment revenues of the State and provide resources for further development to fresh fields.”

Plans:

India’s Five Year Plans have also advocated the same principle. Thus, the Third Five Year Plan maintained. Substantial investments have been made in the public sector over the last ten years and every effort must be made to ensure that they yield an adequate surplus on the basis of which to plan further advance.

The Sixth Plan Observed:

“Almost all the Central and State enterprises would need to adopt appropriate pricing policies in order to achieve an adequate rate of return on capital employed.”

It is thus maintained that according to this principle, while particular PEs, such as Hindustan Insecticides and the Hindustan Antibiotics may operate on the principle of’ No profit, No loss.’ PEs which are essentially industrial or commercial in nature (and not concerned with matters like education, research, public health and so on) should generate surpluses and augment the pool of investment funds.

Comment on Profit-Making Principle of Pricing for PEs:

The following points of criticism are brought against the profit making principle of pricing for PEs:

1. It should be noted that a reasonable return on investment in a PE is not the same thing as making maximum profit or mopping up Maximum resources for further investment purposes. If PEs as a whole is considered, there is ground for argument that on the whole, the public sector should yield a ‘reasonable rate of return’ on investment by which we may say what a similar investment in the private sector yields.

Adverse Effect:

But if the Government aims at a higher than reasonable rate of return or profit, the State having an absolute monopoly in some of the essential services and commodities, the State can do that; but that will have an extremely adverse effect on the welfare of the people (as in the case of railway travel and electricity) and on other sectors of production, because many of the commodities produced by PEs (e.g. coal, electricity, iron and steel, chemicals, fertilizers, etc.) happen to be important inputs of some other industries.

2. Reasonable Rate:

In the case of PEs in India, it is possible to raise objection even against the principle of reasonable rate of profit on the basis of investment. In India, most PEs have an extremely long gestation period and that resulted in the escalation of costs and amount of investment. All this was often due to faulty project planning, wrong location of a project under political pressure, employing too many workers again due to political reasons, etc.

To expect the PEs to cover a reasonable rate of profit on this unnecessary heavy investment would only mean covering up inefficiency of the PEs. The reasonable rate of profit should be based on the efficient running of PEs.

3. Welfare Point of View:

In some cases like fertilizers, antibiotics, milk for poor school children and mothers, etc., from the welfare point of view, it is necessary to subsidise their prices.

4. And therefore, the principle under discussion cannot be a general criterion for all types of PEs.

5. Pricing Policies of Some of the PEs in India:

The PEs in India follows a number of practices while fixing prices of their products or services.

Following some of the important practices adopted by PEs in India:

(a) Administered Prices:

Administered prices or controlled prices are fixed by the Government, as in the case of steel, electricity, railways, cement, sugar, etc. While fixing their prices, the Government may follow any principles mentioned above, namely reasonable rate of return. ‘No profit, No loss’, subsidised prices and so on.

(b) Subsidised Prices:

As a matter of policy, some of the prices of products of the PEs charged by the government are below their cost of production, the Subsidy being paid by the Government. Government may do this to specially help a certain section of the community.

Thus, in India, fertilisers are subsidised to boost agricultural production; similarly certain sections of society are provided loans at lower rates of interest by nationalised commercial banks as they are too poor to pay the normal rate of interest charged for the public. With a view to reduce the birth-rate in India, prices of contraceptives produced by the Hindustan Latex are subsidised.

(c) Parity Prices:

In the case of products of some of the PEs that have to face competition in the open market with imported goods of similar types or close substitutes, party with the landed cost of the imported commodity is made the basis of fixing the prices. In India, this happens in the case of the Hindustan Shipyard which has a monopoly in shipbuilding. In this case, parity with prices of similar goods imported from the United Kingdom is aimed at.

(d) Cost-Plus Prices:

Cost-plus prices is the price fixed by the Government in the case of the products of certain PEs on the basis cost of production incurred plus a margin (around 10 per cent for profit) in addition to that. In India this is done in the case of PEs like the Indian Telephone Industry, Hindustan Aircrafts and Bharat Electronics Limited, which fix prices on the cost-plus basis.

The danger in following this principle is that since a margin over cost of production is permitted, this may breed inefficiency in the PEs leaving no incentive to increase efficiency and reduce cost of production.

In India, captive producers like Hindustan Aeronautics, Hindustan Cables, Bharat Dynamics, etc., follow this principle.

(e) Discriminatory Prices:

In the case of discriminatory prices, the PEs charge different prices for the same product of the PEs for different sections of the community. Thus, nationalised commercial banks in India charge different rates of interest in the case of the very poor, the agriculturists with small landholdings and big industrialists.

(f) Following the Leaders:

In this case, prices are fixed by PEs taking into consideration the prices of similar goods fixed by a leading undertaking in the same line of production. For example, Kerala Soaps and Oils, while fixing the price of its product, takes into account the prices fixed by Hindustan Lever, Tata Soap, and Mysore Sandal, etc.

(g) Trade Association Pricing:

In India, the Air India International fixes the price (i.e. airfares) on the basis of the recommendation, of the international Air Transport Association; and the Shipping Corporation of India fixes prices or rates of its shipping services on the basis of the recommendations of the Shipping Conference which is an international organisation.

(h) Competitive Prices:

In India, certain PEs like the Ashok Hotel fix their prices on the basis of competition Prevailing in the market (that is, prices or rates charged by other similar Five Star Hotels in the private sector).

(i) Dual Pricing Policy:

In the case of Dual Pricing Policy, a public sector enterprise charges one price for some sector of the economy and another price for other sectors of the economy. The dual pricing policy may be illustrated by the public sector steel units. In the case of public sector steel units, the Government has been following a dual pricing policy since 15th October, 1977.

According to this policy, steel is sold to priority sectors at a lower price, and in order to compensate for this loss Involved, the public sector steel plants are empowered to sell the balance of their production at higher prices to other sectors of the economy.

Machinery for Price Fixation:

By a resolution, Government setup in January 1970, the Bureau of Industrial Costs and Prices, (BICP) on the, recommendation of the Administrative Reforms Commission, the BICP undertakes investigations, if and where necessary, regarding prices to be charged by PEs and gives its advice in the matter. In this work, the BICP is assisted by the Bureau of Public Enterprises (BPE).

The principles and practices adopted for pricing their products or services would be different in the case of the following different categories of public sector undertakings:

1. PEs engaged in the production of public utilities and services;

2. PEs engaged in trading activities; and

3. PEs which are public financial institutions.

Guidelines on Pricing of PEs by the Bureau of Public Enterprises:

The Bureau of Public Enterprises (BPE) is intimately concerned with problems of pricing by PEs.

The BPE has issued in this connection the following guidelines:

1. In case PEs produces goods in competition with private enterprise, it is the normal market forces of demand that should govern prices of such products of PEs.

2. Government should invariably purchase goods from PEs, if available, to meet their requirements. Price preference not exceeding 10 per cent will be admissible to PEs. But this cannot be permanent or taken for granted. Every effort should be made to reduce the cost of production and prices to a competitive level.

3. In case PEs operates under monopolistic or semi-monopolistic conditions, the landed cost of comparable imported goods should be the ceiling limit. Within this limit PEs should fix prices at a suitable level. If the landed cost of similar goods that are imported is found to be artificially low, the matter of pricing under such circumstances should be referred to the Administrative Ministry, the PBE and the Ministry of Finance.