Everything you need to know about the factors affecting pricing decisions. A company’s pricing decisions are affected by both internal and external factors.
Internal factors include the company’s marketing objective, costs and marketing strategy. External factors include the nature of the market, demand, competition and external factors.
The amount of money charged for product or service or the sum of the values that consumers exchange for the benefits of having or using the product or service.
Price is the amount of money at which consumer is ready to buy the product and seller is ready to sell the product.
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Some of the factors affecting pricing decisions are:-
A. Internal Factors Affecting Pricing Decisions – 1. Marketing Objectives 2. Marketing Mix Strategy 3. Cost 4. Organisational Considerations
B. External Factors Affecting Pricing Decisions – 1. Demand and Supply Situation 2. Competitors Costs, Prices and Offers 3. Economic Conditions 4. Government Policies 5. Social Concerns.
Factors Affecting Pricing Decisions: Internal Factors and External Factors Affecting Pricing Decisions
Factors Affecting Pricing Decisions – Internal and External Factors
The amount of money charged for product or service or the sum of the values that consumers exchange for the benefits of having or using the product or service. Price is the amount of money at which consumer is ready to buy the product and seller is ready to sell the product.
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Factor to consider when setting price:
1. Internal Factors Affecting Pricing Decisions:
(a) Marketing Objectives:
The clearer a firm is about its objective the easier it is to set prices.
Common objectives are:
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i. Survival
ii. Current profit maximisation
iii. Market share leadership
iv. Product quality leadership
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v. Partial or full cost recovery.
(b) Marketing Mix Strategy:
Price is only one of the marketing mix tools that a company uses to achieve its marketing objectives.
Price decisions must be coordinated with product design, distribution, promotion decisions to form a consistent and effective marketing programme.
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Decisions made for other marketing mix variables may affect pricing decisions, e.g., many intermediaries would mean larger reseller margins.
Price is a crucial product positioning factor that defines the product’s market, competition and design.
(c) Cost:
Costs set the floor for the price that the company can charge for its product.
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The company wants to charge a price that both covers all its costs for producing, distributing and selling the product and delivers a fair rate of return for its effort and risk.
(d) Organisational Considerations:
Management must decide who within the organization should set prices. Who have an influence on pricing would affect pricing decisions, e.g., who among the sales manager, production manager, finance manager or top management sets prices would change the entire pricing strategy. Finance manager would keep profit maximisation as the main consideration, while the sales manager may want greater sales. All these factors would affect pricing.
2. External Factors Affecting Pricing Decisions:
(a) Demand and Supply Situation:
There is a relationship between price and demand. This relationship varies for different types of markets and buyers. Perceptions of price affect the pricing decision.
Pricing in different types of markets:
i. Pure competition – A market in which many buyers and sellers trade in a uniform commodity. No single buyer or seller has much effect on the going market prices.
ii. Monopolistic competition – A market in which many buyers and sellers trade over a range of prices rather than a single market price.
A range of prices occur because sellers can differentiate their offers to buyers.
iii. Oligopolistic competition – A market in which there are a few sellers, all of whom are highly sensitive to each other’s pricing and marketing strategies.
Product can be uniform or non-uniform.
iv. Pure Monopoly – A market in which there is a single seller – it may be a Government monopoly, a private regulated monopoly or a private non-regulated monopoly.
Price can be set too low to enable everyone to buy it or price can be set too high to reduce competition.
(b) Competitors Costs, Prices and Offers:
Competitor’s price may form the basis for pricing strategy. At times marketers also imitate and learn from sales promotion offers given by competitors.
(c) Economic Conditions:
Economic conditions of the nation, like boom or recession inflation, interest rates etc. have a bearing on total cost of production which in turn affects the pricing strategy.
(d) Government Policies:
Tax sops, exemptions, subsidies, special schemes in terms of special economic zones, priority sectors etc. have tangible financial benefits which leads to reduction in cost. Government may also be a part of pricing decision makers by licencing or deciding quotas.
(e) Social Concerns:
Organization may take the pricing decision keeping in mind social welfare, for instance pricing of essential food items or lifesaving medicines may be such that the entire society can afford and get benefit from it.
(a) Cost plus pricing – Adding a standard mark up to the cost of the product.
(b) Break even analysis and target profit pricing –
Setting price based on buyers perceptions of value rather than on the sellers cost.
3. Competition Based Pricing:
(a) Going rate pricing – Setting price based largely on following competitor’s prices rather than on company costs or demand.
(b) Sealed bid pricing – Setting price based on how the firm thinks competitors will price rather than on its own cost or demand. This strategy may be used when a company bids for jobs.
Factors Affecting Pricing Decisions – Consumer Situation, Cost Consideration and Other Factors
1. Consumer Situation:
1. Utility to the buyer,
2. Return to the buyer,
3. Comparable and substitute products-actual and brand, Custom and customary prices,
4. Prestige position of the product and brand,
5. Presence of buying habits, motives, and
6. Psychological aspects.
2. Cost Consideration:
1. Cost of production – historical,
2. Cost of production – future, and
3. Volume anticipated.
3. Other Factors:
1. Stages in the Product Life Cycle –
i. Usually high price in introduction stage,
ii. Stable price in growth stage,
iii. Price decline in maturity stage,
2. Competition –
i. Distribution Strategy,
ii. Promotion Strategy,
iii. Price consciousness.
Factors Affecting Pricing Decisions – 2 Important Factors: Internal Factors and External Factors
In short, businessmen when setting the price of goods consider various factors like consumer demand, competition, political consequences, legal aspects and even ethical aspects of pricing. In addition, they must consider their own costs, the cost of channels they use to reach the market and the various activities they have to perform in connection with the sale (such as – advertisement and sales promotion, freight, handling costs, discount, etc.).
For convenience, the factors that influence price decisions may be divided into two:
1. Internal factors.
2. External factors.
1. Internal Factors:
Internal factors are generally within the control of the organization. They are sometimes referred to as built-in factors that affect the price.
These factors include:
i. Costs, and
ii. Objectives.
i. Costs:
The most decisive factor is the cost of production. The main defect in this approach is that it disregards the external factors, particularly demand and the value placed on goods by the ultimate consumer. Furthermore, finding the cost of production is not so simple today on account of various lines of production and distributing the overhead (indirect) costs among the various products is also difficult.
ii. Objectives:
Many companies have established marketing goals or objectives and pricing contributes its share in achieving such goals. These goals may together be termed as pricing policies.
Such pricing policies may be classified into:
a. Target rate of return (rate of return on investment or % on net sales).
b. Stability in prices.
c. Maintenance or increase of market share.
d. Meeting or preventing competition.
e. Maximizing profits.
2. External Factors:
External factors are generally beyond the perfect control of an organization.
They include:
i. Demand,
ii. Competition,
iii. Influence of distribution channel,
iv. Political consequences,
v. Legal aspects, etc.
i. Demand:
In consumer-oriented marketing, the consumers influence the price. If the customer does not consider the value of the product worth the price, they will refuse to buy. In pricing not only the total demand be determined but also the rate at which this demand must be met has to be included. It is here that marketing research is used as an effective aid, in providing answers to these questions.
ii. Competition:
No manufacturer is free to fix his price without considering competition unless, he has the monopoly. It is necessary to consider the availability of substitutes.
Sometimes a higher price may in itself differentiate the product. This is known as – “prestige” pricing. But this is possible only when the product is backed by perfect quality.
Sometimes, management may decide to price below cost, mostly in the initial stages. This is referred to as “markdown” prices.
iii. Distribution Channels:
It is necessary to compensate middlemen working in the channel of distribution. The compensation is included in the ultimate price the consumer pays.
Legal constraints, government interference such as – control of prices, and levying of taxes are other considerations which also affect the pricing of products.
Factors Affecting Pricing Decisions – Price Factors and Non-Price Factors
Price Factors in Pricing Decisions:
Pricing is like a tripod. Costs, demand and competition are its three factors. It is not possible to say that one or another of these factors determines price.
The significance of these factors in pricing is as follows:
It is a popular fallacy to believe that price depends upon costs. However, it is true that the price cannot be fixed below cost for long. Costs determine the floor price below which an exporter may not agree to sell the goods. But while an increase in costs may justify the increase in prices yet it may not be possible to do so because of the marketing conditions of demand and supply. On the contrary it is possible that any increase in demand may lead to an increase in price without an increase in costs.
(i) Cost-Price Relationship:
The cost-price relationship does not support the claim that costs determine the price. Sometimes the prevalent price may determine the cost that may be increased. The manufacturer exporter cuts the costs according to the prices current in the market. The product is tailored according to the needs of the target consumers and their capacity to pay for it. Hence declining costs often result in better quality at the same price and raising costs lead to deterioration in quality.
(ii) Difference in Costs of Producers:
The costs do not determine the price because costs of each producer differ substantially due to different internal and external factors while the prices of their products are close to one another. The price must also vary substantially. A firm would suffer a loss if costs are to determine the price.
(i) Adaptation:
Another leg of the tripod demand determines the prices in the international markets. Demand in international markets is also affected by a number of factors which are different from those operating in domestic market.
Customs and tastes of foreign customers may differ widely which the product must be adopted to the needs of the foreign customers. Then higher price may be fixed for the product as compared to competitors. In this way demand of the product depends upon how the product has been adopted by the supplier.
(ii) Elasticity:
If the demand of the product is elastic, a reduction in price may increase the sales volume. On the other hand, higher price may be fixed if the demand is inelastic and the supply is limited.
Competition in the target foreign market increases the elasticity of demand as it would have been otherwise. Sometimes may be so severe that the exporter has no other option except to follow the market leader.
(i) Brand Type Competition:
Competition may be either brand type or functional type. Brand type refers to competition amongst brands of a product which aims at satisfying the same need.
(ii) Functional Competition:
It means the type of competition where the manufacturer tries to differentiate the function of the product from its competitors. This he may do either by altering its packages or by adding attributes to the product. Both these types of competition have pressure on the company’s pricing decisions.
(iii) Discouraging Competition:
Sometimes a company determines a price of the product with a specific objective of discouraging competitors from entering a given foreign market.
Non-Price Factors in Pricing Decisions:
Following non-pricing factors play important roles in creating demand in foreign countries:
(1) Confidence:
Sometimes the importers of developed countries do not have much confidence in the quality of products manufactured in developing countries. Thus Indians and exporters of other developing countries find their products at a lower price than that of their competitors. Though the quality was comparable Indians had to sell their storage batteries 10 per cent lower in Saudi Arabia than U.S. and European batteries. Thus fixing lower price is inevitable to make our product acceptable in foreign markets.
(2) Brand Image:
If products are well-differentiated and have a brand image in the minds of foreign customers, their manufacturers may charge higher prices for their products. Brand names like Bata, GKW, Dunlop, HMT, Lucas, etc., which have already earned a good brand image are able to sell their products at higher price.
(3) Frequency of Purchase:
If consumers purchase the goods very often as in the case of non-durable consumer items, they think of the price. On the other hand price is not important if the item is durable consumer item, products having snob value or gift item. If a particular product appeals, the people are willing to pay very high price. Thus durable consumer items, artistic items or gift items are sold at much higher prices.
(4) Close Association of Price and Quality:
There is a close association between the price and the quality of the product. It is generally believed that lower priced goods do not carry adequate value while the higher priced goods carry a much greater conviction about quality. In periods of inflationary price rise, a reduction in price may lead to a reduction in demand because it has an adverse reaction on the consumers. Unless there are chances to increase sales by reducing the price, reduction in prices or fixing a low price for the product in comparison to others is not regarded a good strategy.
(5) Comprehensive Knowledge of the Product:
In industrial goods, the importer has a good knowledge of the quality of brands available in the world market. Therefore besides quality, he considers other factors like technical soundness of the product, steady availability at reasonable price and comprehensive after sale service offered by the manufacturer. Price is not the indicator of quality alone. It is a composite of all other related factors.
(6) Before and After Sales Service:
Before and after sales services count much more than a lower price in case of valuable industrial and engineering products.
(i) Before Sale Service:
In the case of engineering goods before sale, service covers:
a. Advising the importer about the relative suitability of competing products, and
b. Demonstrating the use of his product.
(ii) After Sale Service:
After sale service in case of sale of engineering goods and durable consumer goods includes:
a. Rectification genuine technical fault in the product,
b. Educating the users on the proper use of the product and providing training for its proper maintenance,
c. Free service during warranty period, and
d. Ensuring supply of spare parts and components after the warranty period.
Price may be fixed comparatively higher if these services are under taken by the exporter in the foreign markets.
(7) Continuity of Supply:
In foreign trade if regular supplies of the product or ancillary products are not maintained, the country may lose the markets. Developing countries substitute for a number of exporter products due to their failure to maintain regular supplies. However an uninterrupted supply of the product may assure better prices.
(8) Prompt Deliveries:
Prompt deliveries attract the foreign buyers to pay more. Most of the developing countries fail on this point. Delayed deliveries have affected India’s exports to Sri Lanka, Burma and Arab countries. While foreign importers want deliveries within three months from the date of order, Indian exporters of machine tools do not deliver the goods before 6 months. Studies made about generalised system of preferences reveal that the reliability of product quality and delivery dates are more important factors than price.
(9) Supply of Complete Range of Product:
Sometime the price of the product depends upon the fact that the producer (exporter) is in a position to supply complete range and in large quantities of the products. Here also, Indian exporters fail to come up to expectations. In developing countries, the exporters do not supply the products in huge quantities because of lack of resources.
One manufacturer in developing countries does not manufacture the complete range of products but produces only one or two items of the range. For example, cycle manufacturers in India do not produce a complete cycle but only its components.
(10) Settlement of Claims:
The exporter and importer are not close to each other in foreign trade. Often they even do not know each other. The importer does not hesitate to pay higher price if there is an arrangement between them for prompt acceptance and settlement of claims.
(11) Terms of Credit:
In exports of capital goods such as machinery and equipment, availability of finance and terms of credit are the determining factors. Developed countries dominate in this respect. They supply goods on credit while exporters from developing countries, including India, cannot do so because of their limited resources. In India, the Export Import Bank of India offer such credit to importers and the ECGC also offer guarantee cover for the credit given to importers.
Thus there are a number of non-price factors which help to maintain the differential prices in the international markets. However, their influence varies from product to product and market to market. The price factors, such as – cost, demand and competition affect the prices and play important though limited roles in determining the price strategy.
Taking advantage of these non-price factors would also involve some costs though the returns are likely to cost be higher than costs if proper efforts are made. Thus, in comparison to cost factors non-price factors are more influential in pricing.
Factors Affecting Pricing Decisions – Objectives of the Business, Cost of the Product, Market Positions, Competitors Prices, Distribution Channels and a Few Others
There are several factors which affect the pricing decision; some of those have been given below:
1. Objectives of the Business – A pricing policy should be established only after proper consideration of the objectives of the firm.
2. Cost of the Product – Cost and price of a product are closely related, price cannot be fixed below its cost.
3. Market Position – A reputed concern may fix may fix higher prices for its products on the other hand, a new producer may fix lower prices for its products.
4. Competitors Prices – the Company considers the prices fixed and quality maintained by the competitors for their products.
5. Distribution Channels – The nature of distribution channels used, and trade discounts which have to be allowed to distributors and the distribution expenses also affect the pricing decisions.
6. Price Elasticity and Demand Elasticity of the product – Price elasticity affects the decisions of price fixation. If demand is elastic, the firm should not fix high prices rather it should fix lower prices than that of the competitors.
7. Product’s Stage in the Life Cycle of the Product – Pricing decision is affected by the stage of product in its life-cycle.
8. Product Differentiation – The price of the product also depends upon the characteristics of the product. In order to attract the customers different characteristics are added to the product such as quantity, size, colour, alternative uses, etc.
9. Buying Patterns of the Consumers – If the purchase frequency of the product is higher, lower prices should be fixed to have a low profit margin.
10. Economic Environment – In recession period, the prices are reduced to a sizable extent to maintain the level of turnover. On the other hand, the price and increased in boom period to cover the increasing cost of production and distribution.
11. Government Policy – Price discretion is also affected by the price control by the government through enactment of.
Factors Affecting Pricing Decisions – 2 Main Factors: Internal Factors and External Factors
Factor # 1. Internal Factors:
These are the factors that are internal to the company, and can he control by it:
i. Firm’s objectives – Firms have different objectives that help them in setting prices of their products. Firms, whose only objective is survival, just to maintain a respectable market-share rather than earning huge profit, will set lower prices that are sufficient enough to cover their variable and fixed costs. Firms, whose objective is maximisation of current profits, will charge higher prices for their products. Firms, whose objective is to become market leaders, will set lower prices for their products.
ii. Marketing mix – Price is one of the four elements of marketing mix and needs to be coordinated with the other elements, i.e., product, promotion and distribution.
iii. Cost of the product – Cost is the most important factor influencing price. It is important that the price should cover all costs including a fair return for undertaking the marketing efforts and risk.
iv. Management policy – It is the top management which generally has full authority over pricing. Marketing Manager and Branch Managers are given authority within the broad policy framework created by the top management.
v. Product differentiation – When the product is unique in terms of its design, size, colour, and package etc., its price can be higher than that of rival products.
vi. Quality and Service – An article may be sold at a higher price if the quality of the product is better than that of the other firms or if a firm provides better services to its customers.
Factor # 2. External Factors:
i. Demand – The nature and size of demand in relation to the supply of a product is another important factor affecting price. If demand is more than supply, even a high price might work well. On the contrary, when demand is less than supply, only a low price could attract the customers. Price elasticity of demand is also important while pricing a product. In case of inelastic demand, price may be fixed at a higher level.
ii. Competition – When a firm does not face any competition, it can enjoy complete freedom in fixing its price. That is, it becomes the price maker in such a situation. In case of competition, each seller will have to consider the price charged by the competitors because selling above the competition price becomes difficult.
iii. Government control – Sometimes the Government may announce a policy about pricing of goods or may specifically fix and control the prices of goods. Under such a situation, a seller has little or no control over the prices.
iv. Consumers’ buying capacity – Since under the modern marketing concept, a product is made according to the needs and preference of target customers, the pricing of the product must be done in a manner so as to suit the pocket of the target customers.
v. Suppliers – The suppliers of raw materials and other inputs exercise a significant influence on pricing. A firm generally raises prices of its products when the suppliers increase prices.
vi. Product-life stage – While pricing a product, the firm must pay attention to the particular stage of the product-life cycle, which a product is passing through. For example, price of a product must be kept low during introductory stage. It could be slightly raised once the product is established.
Factors Affecting Pricing Decisions – Internal and External Factors
A company’s pricing decisions are affected by both internal and external factors. Internal factors include the company’s marketing objective, costs and marketing strategy. External factors include the nature of the market, demand, competition and external factors.
1. Internal Factors:
Before setting price, the firm must decide on its strategy for the product. If the firm has selected its target market carefully, then its marketing-mix strategy including price will be quite clear. For example, if Tata decides to produce a new small car to compete with Maruti Zen, this suggests charging a competitive price. If a new hotel positioned itself as one that provides economical rooms for budget-minded tourists, this position requires charging a low price.
At the same time the company has other objectives like survival, current profit maximisation, market share maximisation and product-quality leadership.
i. Survival:
Firms set survival as the major objective if they are troubled by heavy competition. To keep the firm going, a firm may set a low price, hoping to increase demand. In this case, profit is less important than survival. In recent years, many automobile companies have kept prices below cost in order to survive. As long as the company’s price covers variable cost and some fixed cost, it can stay in business until conditions change.
ii. Current Profit Maximisation:
Many firms set prices that will maximise current profits. They estimate what demand and costs will be at different prices and choose the price that will produce the maximum current profit.
iii. Market-Share Leadership:
A company may want to obtain dominant market share. It is believed that the company with the largest market share will enjoy the lowest costs and highest long-run profit. To become the market share leader, the firm will set prices as low as possible.
iv. Product-Quality Leadership:
A company might want to have the highest-quality product on the market. The calls for charging a high price to cover such quality and high cost of research and development.
v. Preventing Competition:
A company can set the price low to prevent competition from entering the market. If a company charges too high a price and enjoys large profits it will tempt new firms to enter the market and as a result its position in the market will be weakened. The existing firms, therefore, set a price which will forestall competition. This price is known as entry prevention price. Price cuts are often followed not with a view to surviving in a competitive environment but to make matters worse for the rivals.
vi. Price Stabilisation:
One of the pricing goals of the firm is to maintain stable prices. Firms under this policy attempt to keep their prices stable within certain limits despite small changes in demand or in cost. Having earned a satisfactory return, big firms usually do not put up prices partly because of the fear of upsetting the market and partly because of the fear of damaging the goodwill of the firm.
Frequent price changes entail a cost as the product has to be advertised to the consumers and dealers as it creates some amount of uncertainty. Firms base their prices on long-run trends of costs and productivity. They disregard short-run changes in cost and demand. In other words, short-run fluctuations in cost and demand are borne by profits and not by prices.
vii. Marketing-Mix Strategy:
Price is only one of the marketing-mix tools that the firm uses to achieve its marketing objectives. Price decisions must be coordinated with product design, distribution and promotion decisions to form an effective marketing programme. Decisions made for other marketing-mix variables may affect pricing decisions. Companies often make their pricing decisions first and then base other marketing-mix decisions on the prices they want to charge.
viii. Costs:
Costs set the floor for the price that the firm can charge for its product. The firm wants to charge a price that covers all its cost for producing, distributing and selling the product and delivers a fair rate of return for its efforts and risk. Cost of a product is an important element in its pricing strategy. Many firms prefer to become the ‘low cost producers’ in their industries. Firms with lower costs can set lower prices that result in greater sales and higher profits.
A firm has two types of costs – fixed and variables. Fixed costs are costs that do not vary with production. On the other hand, variable costs vary directly with the level of production. Total costs are the sum of the fixed and variable costs for any given level of production. A firm will set a price that will at least cover the total production costs. Cost of production will be different at different levels of production.
2. External Factors:
External Factors affecting Pricing Decisions:
Whereas costs set the lower limit of prices, the market and demand set the upper limit. Consumers balance the price of a product or service against the benefits derived. Thus, before setting prices, the marketer must understand the relationship between price and demand for its product.
The seller’s pricing freedom varies with different types of markets.
i. Under perfect competition there are unlimited number of sellers and buyers trading in an identical commodity. No single buyer or seller can influence the prevailing market price in a purely competitive market; marketing research, product development, advertising and sales promotion play no role. Thus sellers in these markets do not spend any time on marketing strategy.
ii. Under monopolistic competition the market consists of many buyers and sellers who trade over a range of prices rather than a single market price. A range of prices occurs because sellers can differentiate their offers to buyers. Buyers see differences in sellers’ products and will pay the different prices for them. Sellers try to develop differentiated offers for different customer segments and in addition to price, they freely use branding, advertising and personal selling.
iii. Under oligopolistic competition, the market consists of a few sellers who are highly sensitive to each other’s pricing and marketing strategies. There are few sellers and each seller is alert to competitors’ strategies.
iv. In pure monopoly, there is one seller in the market. The seller may be a government monopoly (railways) or a private monopoly. Pricing is handled differently in each case. A government monopoly can pursue a variety of pricing objectives. If the product is very important to buyers, the government might set the price below the cost of production. It can set the price quite high if objective is to reduce consumption.
Factors Affecting Pricing Decisions – Internal Factors and External Factors
The final price for a product may be influenced by many factors which can be categorized into two main groups:
1. Internal Factors:
When setting price, marketers must take into consideration several factors which are the result of company decisions and actions. To a large extent these factors are controllable by the company and, if necessary, can be altered. However, while the organization may have control over these factors making a quick change is not always realistic.
For instance, product pricing may depend heavily on the productivity of a manufacturing facility (e.g., how much can be produced within a certain period of time). The marketer knows that increasing productivity can reduce the cost of producing each product and thus allow the marketer to potentially lower the product’s price.
But increasing productivity may require major changes at the manufacturing facility that will take time (not to mention be costly) and will not translate into lower price products for a considerable period of time.
2. External Factors:
There are a number of influencing factors which are not controlled by the company but will impact pricing decisions. Understanding these factors requires the marketer conduct research to monitor what is happening in each market the company serves since the effect of these factors can vary by market.
Below we provide a detailed description of both internal and external factors:
1. Internal Factors:
The pricing decision can be affected by factors that are controlled by the marketing organization.
These factors include:
i. Company and Marketing Objectives:
Marketing decisions are guided by the overall objectives of the company. It is important to understand that all marketing decisions, including price, work to help achieve company objectives.
Corporate objectives can be wide-ranging and include different objectives for different functional areas (e.g., objectives for production, human resources, etc.). While pricing decisions are influenced by many types of objectives set up for the marketing functional area, there are four key objectives in which price plays a central role. In most situations only one of these objectives will be followed, though the marketer may have different objectives for different products.
The four main marketing objectives affecting price include:
a. Return on Investment (ROI):
A firm may set as a marketing objective the requirement that all products attain a certain percentage return on the organization’s spending on marketing the product. This level of return along with an estimate of sales will help determine appropriate pricing levels needed to meet the ROI objective.
b. Cash Flow:
Firms may seek to set prices at a level that will insure that sales revenue will at least cover product production and marketing costs. This is most likely to occur with new products where the organizational objectives allow a new product to simply meet its expenses while efforts are made to establish the product in the market. This objective allows the marketer to worry less about product profitability and instead directs energies to building a market for the product.
c. Market Share:
The pricing decision may be important when the firm has an objective of gaining a hold in a new market or retaining a certain percent of an existing market. For new products under this objective the price is set artificially low in order to capture a sizeable portion of the market and will be increased as the product becomes more accepted by the target market.
For existing products, firms may use price decisions to insure they retain market share in instances where there is a high level of market competition and competitors who are willing to compete on price.
d. Maximize Profits:
Older products that appeal to a market that is no longer growing may have a company objective requiring the price be set at a level that optimizes profits. This is often the case when the marketer has little incentive to introduce improvements to the product (e.g., demand for product is declining) and will continue to sell the same product at a price premium for as long as some in the market is willing to buy.
Marketing strategy concerns the decisions marketers make to help the company satisfy its target market and attain its business and marketing objectives. Price, of course, is one of the key marketing mix decisions and since all marketing mix decisions must work together, the final price will be impacted by how other marketing decisions are made.
For instance, marketers selling high quality products would be expected to price their products in a range that will add to the perception of the product being at a high-level.
It should be noted that not all companies view price as a key selling feature. Some firms, for example, those seeking to be viewed as market leaders in product quality, will deemphasize price and concentrate on a strategy that highlights non-price benefits (e.g., quality, durability, service, etc.).
Such non-price competition can help the company avoid potential price wars that often break out between competitive firms that follow a market share objective and use price as a key selling feature.
For many for-profit companies, the starting point for setting a product’s price is to first determine how much it will cost to get the product to their customers. Obviously, whatever price customer’s pay must exceed the cost of producing a good or delivering a service otherwise the company will lose money.
When analyzing cost, the marketer will consider all costs needed to get the product to market including those associated with production, marketing, distribution and company administration (e.g., office expense).
These costs can be divided into two main categories:
a. Fixed Costs:
Also referred to as overhead costs, these represent costs the marketing organization incurs that are not affected by level of production or sales. For example, for a manufacturer of writing instruments that has just built a new production facility, whether they produce one pen or one million they will still need to pay the monthly mortgage for the building.
From the marketing side, fixed costs may also exist in the form of expenditure for fielding a sales force, carrying out an advertising campaign and paying a service to host the company’s website. These costs are fixed because there is a level of commitment to spending that is largely not affected by production or sales levels.
b. Variable Costs:
These costs are directly associated with the production and sales of products and, consequently, change has the level of production or sales changes. Typically, variable costs are evaluated on a per-unit basis since the cost is directly associated with individual items. Most variable costs involve costs of items that are either components of the product (e.g., parts, packaging) or are directly associated with creating the product (e.g., electricity to run an assembly line).
However, there are also marketing variable costs such as coupons, which are likely to cost the company more as sales increase (i.e., customers using the coupon). Variable costs, especially for tangible products, tend to decline as more units are produced. This is due to the producing company’s ability to purchase product components for lower prices since component suppliers often provide discounted pricing for large quantity purchases.
Determining individual unit cost can be a complicated process. While variable costs are often determined on a per-unit basis, applying fixed costs to individual products is less straightforward.
For example, if a company manufactures five different products in one manufacturing plant how would it distribute the plant’s fixed costs (e.g., mortgage, production workers’ cost) over the five products? In general, a company will assign fixed cost to individual products if the company can clearly associate the cost with the product, such as assigning the cost of operating production machines based on how much time it takes to produce each item.
Alternatively, if it is too difficult to associate to specific products the company may simply divide the total fixed cost by production of each item and assign it on percentage basis.
2. External Factors:
The pricing decision can be affected by factors that are not directly controlled by the marketing organization.
These factors include:
Marketers should never rest on their marketing decisions. They must continually use market research and their own judgment to determine whether marketing decisions need to be adjusted. When it comes to adjusting price, the marketer must understand what effect a change in price is likely to have on target market demand for a product.
Understanding how price changes impact the market requires the marketer have a firm understanding of the concept economists call elasticity of demand, which relates to how purchase quantity changes as prices change. Elasticity is evaluated under the assumption that no other changes are being made (i.e., “all things being equal”) and only price is adjusted.
The logic is to see how price by itself will effect overall demand. Obviously, the chance of nothing else changing in the market but the price of one product is often unrealistic. For example, competitors may react to the marketer’s price change by changing the price on their product. Despite this, elasticity analysis does serve as a useful tool for estimating market reaction.
Elasticity deals with three types of demand scenarios:
a. Elastic Demand:
Products are considered to exist in a market that exhibits elastic demand when a certain percentage change in price results in a larger percentage change in demand. For example, if the price of a product increases (decreases) by 10%, the demand for the product is likely to decline (rise) by greater than 10%.
b. Inelastic Demand:
Products are considered to exist in an inelastic market when a certain percentage change in price results in a smaller percentage change in demand. For example, if the price of a product increases (decreases) by 10%, the demand for the product is likely to decline (rise) by less than 10%.
c. Unitary Demand:
This demand occurs when a percentage change in price results in an equal percentage change in demand. For example, if the price of a product increases (decreases) by 10%, the demand for the product is likely to decline (rise) by 10%.
For marketers the important issue with elasticity of demand is to understand how it impacts company revenue.
In general, the following scenarios apply to making price changes for a given type of market demand:
(1) For elastic markets – Increasing price lowers total revenue while decreasing price increases total revenue.
(2) For inelastic markets – Increasing price raises total revenue while decreasing price lowers total revenue.
(3) For unitary markets – There is no change in revenue when price is changed.
ii. Customer and Channel Partner Expectations:
Possibly the most obvious external factor that influences price settings are the expectations of customers and channel partners. When it comes to making a purchase decision customers assess the overall “value” of a product much more than they assess the price. When deciding on a price marketers need to conduct customer research to determine what “price points” are acceptable. Pricing beyond these price points could discourage customers from purchasing.
Firms within the marketer’s channels of distribution also must be considered when determining price. Distribution partners expect to receive financial compensation for their efforts, which usually means they will receive a percentage of the final selling price.
This percentage or margin between what they pay the marketer to acquire the product and the price they charge their customers must be sufficient for the distributor to cover their costs and also earn a desired profit.
iii. Competitive and Related Products:
Marketers will undoubtedly look to market competitors for indications of how price should be set. For many marketers of consumer products researching competitive pricing is relatively easy, particularly when Internet search tools are used.
Price analysis can be somewhat more complicated for products sold to the business market since final price may be affected by a number of factors including if competitors allow customers to negotiate their final price.
Analysis of competition will include pricing by:
a. Direct competitors,
b. Related products and
c. Primary products.
a. Direct Competitor Pricing:
Almost all marketing decisions, including pricing, will include an evaluation of competitors’ offerings. The impact of this information on the actual setting of price will depend on the competitive nature of the market. For instance, products that dominate markets and are viewed as market leaders may not be heavily influenced by competitor pricing since they are in a commanding position to set prices as they see fit.
On the other hand in markets where a clear leader does not exist, the pricing of competitive products will be carefully considered. Marketers must not only research competitive prices but must also pay close attention to how these companies will respond to the marketer’s pricing decisions.
For instance, in highly competitive industries, such as gasoline or airline travel, competitors may respond quickly to competitors’ price adjustments thus reducing the effect of such changes.
b. Related Product Pricing:
Products that offer new ways for solving customer needs may look to pricing of products that customers are currently using even though these other products may not appear to be direct competitors. For example, a marketer of a new online golf instruction service that allows customers to access golf instruction via their computer may look at prices charged by local golf professionals for in-person instruction to gauge where to set their price.
While on the surface online golf instruction may not be a direct competitor to a golf instructor, marketers for the online service can use the cost of in- person instruction as a reference point for setting price.
c. Primary Product Pricing:
Marketers may sell products viewed as complementary to a primary product. For example, Bluetooth headsets are considered complementary to the primary product cellphones. The pricing of complementary products may be affected by pricing changes made to the primary product since customers may compare the price for complementary products based on the primary product price.
For example, companies that sell accessory products for the Apple iPod may do so at a cost that is only 10% of the purchase price of the iPod. However, if Apple were to dramatically drop the price, for instance by 50%, the accessory at its present price would now be 20% of the of iPod price. This may be perceived by the market as a doubling of the legal ramifications if the rules are not followed.
Price regulations can come from any level of government and vary widely in their requirements. For instance, in some industries, government regulation may set price ceilings (how high price may be set) while in other industries there may be price floors (how low price may be set). Additional areas of potential regulation include – deceptive pricing, price discrimination, predatory pricing and price fixing.
Finally, when selling beyond their home market, marketers must recognize that local regulations may make pricing decisions different for each market. This is particularly a concern when selling to international markets where failure to consider regulations can lead to severe penalties. Consequently, marketers must have a clear understanding of regulations in each market they serve.
Factors Affecting Pricing Decisions
Pricing is the process of determining what a company will receive in exchange for its products. Pricing decisions are of strategic importance to any enterprise. Pricing is the only element in marketing mix accounting for demand and sales revenue. Price is the only factor which determines the income, rest all are cost factors. A lot of economic and social objectives matter in many pricing decisions. Price determination involves many relevant internal and external factors. These influence pricing decisions of an enterprise.
1. Internal Factors:
Many internal factors are involved during the many stages of price determination. Each firm has certain objectives in its pricing decisions like manufacturing cost and marketing. It obviously will look to recover these costs. Firm might also be buying for a particular public image through its pricing policies. It may have a basic philosophy on pricing. Pricing decisions have to be consistent with its core philosophy. All these constitute the internal factors that influence pricing. Also this pricing strategy has to fit into the overall marketing strategy. It can exist independently.
Thus, internal factors affecting the pricing policy can be as following:
a. Marketing Objectives.
b. Public image sought by the firm.
c. Basic characteristic of the product and the stage of the product on the product life cycle.
d. Product cost and Marketing Cost.
e. Marketing Mix strategy.
f. Organizational Considerations.
g. Use pattern and turn round rate of the product.
2. External Factors:
Pricing decisions of a business firm are influenced by certain external factors. First of all the nature of economy of the country and the world and the nature of the competition in the market. Purchasing power of the consumer as well as consumer behavior also needs to be taken into consideration.
Thus the external factors affecting pricing decisions could be:
a. Market Demand.
b. Buyer behavior.
c. Competitors pricing policy.
d. Government controls/regulations on pricing.
e. Other relevant legal aspects
f. Social Considerations.