Price and Pricing Decisions
In this article, we shall be covering the role of price in the marketing mix, for instance, what price is, how it can be used, and how it is set relative to such factors as product costs, market demand, and competitors’ prices. In particular, we will examine three major pricing, decision problems facing sellers. These involve how to: (a) set prices for the first time, (b) modify a product’s price over time and space to meet varying circumstances and opportunities, and (c) initiate and respond to price.
THE MEANING AND IMPORTANCE OF PRICE
Price is the amount of money and/or other items with utility needed to acquire a product (utility is an attribute that has the potential to satisfy wants). In this instance, therefore, price may involve more than money. Note that exchanging goods and/or services for other products in termed barter.
Prices can take on a number of assumed names as indicated in Table 1 below:
Table: Other Names Assumed By Price
|
Assumed name |
Where applied or operational |
|
Tuition |
Education |
|
Interest |
Use of money |
|
Rent |
Use of living quarters, or a piece of equipment for a period of time. |
|
Fare |
Taxi ride or airline flight |
|
Fee |
Services for a physician or lawyer |
|
Retainer |
Lawyer’s or Doctor’s Services over a period of time |
|
Toll |
Travel on some high-ways |
|
Salary |
Services of an executive or other white-collar work |
|
Wage |
Services of blue-collar worker |
|
Commission |
Sales person’s services |
|
Dues |
Membership in a union or a club |
|
Premium |
Services of insurance companies |
|
Rate |
Services of utilities |
|
Honorarium |
Service given by professionals. |
From the various assumed price names in the above table, you can see that price is significant to an economy, to an individual firm and in the mind of the consumer. We shall briefly examine each of these situations.
IMPORTANCE OF PRICE TO THE ECONOMY
A product price influences wages, rent, interests, and profits. This means that a product’s price influences the amounts paid for the factors of production, such as land, capital, and entrepreneurship. We can therefore say that price is a basic regulator of the economic system since it influences the allocation of the factors of production. For instance, high wages attract labour, high-interest rates attract capital etc. As an allocator of resources, price determines what will be produced (i.e. supply), as well as who will get the goods and services produced (i.e. demand).
IMPORTANCE OF PRICE TO THE INDIVIDUAL FIRM
The product’s price is a major determinant of the market demand for it. Hence price affects a firm’s competitive position and its market share. Consequently, the price has a considerable bearing on a company’s revenues and net profits. For example, it is through prices that money comes into an organization.
However, several factors can limit how much effect pricing has on a company’s marketing programme. For instance, factors such as differentiated product features, a favourable brand, high quality, convenience, or some combination of these may be more important to consumers than price.
IMPORTANCE OF PRICE IN THE CONSUMER’S MIND
In some cases, some consumers’ perceptions of product quality have a direct relationship with price. Hence, the higher the price, the better the quality is perceived to be. In actual fact, a lot of people hold this view, especial y when they are economical y okay. This is the reason why some shoppers make price-quality judgments particularly when they lack other information about product quality. In addition, consumers’ quality perceptions can also be influenced by such factors as store reputation and advertising.
THE ROLE OF PRICE IN THE MARKETING MIX
Price is the only element in the marketing mix that produces revenue. All other elements-product, promotion, and distribution are concerned with delivering value to the customer, and by so doing, they represent costs. Price is also one of the most flexible elements in the marketing mix. Unlike product features and channel commitments, the price can be adjusted quickly. At the same time, pricing and price competition is the number one problem facing many firms. Observations have shown that many firms do not handle pricing well enough. The most common mistakes include:
(i) Pricing that is too cost oriented;
(ii) Prices that are not revised often enough to reflect market changes;
(iii) Pricing that does not take the rest of the marketing mix into account; and
(iv) Prices that are not varied enough for different products, market segments, and purchase occasions.
We shall be looking at the factors that must be considered when setting prices and at general pricing approaches.
FACTORS TO CONSIDER WHEN SETTING PRICES
A company’s pricing decisions are affected both by internal company factors and external environmental factors
Internal factors: Marketing objectives Marketing mix strategy Costs
Organizational
Considerations
External factors
Nature of the Market and demand Competition
Other environmental factors (e.g. economy re-sellers, government)
Pricing
Decisions
INTERNAL FACTORS AFFECTING PRICING DECISIONS
As already shown in Figure 11.1, the internal factors affecting pricing include the company’s marketing objectives, marketing-mix strategy, costs, and organization. Let us examine each of these.
MARKETING OBJECTIVES
The first thing to be done by a company is to decide what it wants to accomplish with the particular product. For instance, if the company has selected its target market and market positioning carefully, then its marketing-mix strategy, including price, will be somehow straightforward. For example, if the Nigerian Bottling Company wants to produce a special fruit drink for the affluent-customer segment, this implies charging a high price.
In this instance, pricing strategy is largely determined by the prior decision on market positioning. The company may simultaneously seek additional objectives. The clearer these objectives are, the easier it is to set price. Each possible price will have a different impact on such objectives as profits, sales revenue, and market share. Examples of common objectives are survival, current profit maximization, market-share leadership, and product, quality leadership.
Let us look at these objectives, one by one:
Survival: Firms set survival as their major objective if they are troubled by over-capacity, stiff competition, or changing tastes of consumers. For instance, in order to keep a factory going, a firm may set a low price, with the hope that demand will subsequently increase. Thus, profits are less important than survival. In as much as their prices cover variable costs and some fixed costs, the firm can stay in business. However, you should note that survival is only a short-term objective. The firm must learn how to add value in the long run, otherwise, it would close shop.
Current Profit Maximisation: Many firms use current profit maximisation as their pricing goal. What they usually do, is estimate what demand and costs will be at different prices and choose the prices that will produce the maximum current profit, cash flow, or return on investment. Thus, the firms are emphasizing current financial performance rather than long-run performance.
Market-Share Leadership. Some other firms set market-share leadership as their objective. The belief here is that the firm with the largest market share will enjoy the lowest costs and highest long-run profit. Hence, in order to become the market-share leader, these firms set prices as low as possible. Product–Quality Leadership: A firm might adopt the objective of being the product-quality leader in the market. As should be expected, this normal y cal s for charging a high price to cover the high product quality and high cost of research and development (R & D).
Firms might also use price to achieve other more specific objectives. For instance, a firm can set Prices low to prevent competition from entering the markets, or set prices at competitor’s level in order to stabilize the market. In addition, prices can be set to keep the loyalty and support of re-sellers or to avoid government intervention. Prices can be reduced temporarily to create excitement for a product or to draw more customers into a retail store. Furthermore, one product may be priced to help the sales of other products in the firm’s line. It is thus very clear that pricing plays an important role in helping to accomplish the firm’s objectives at several levels.
MARKETING-MIX STRATEGY
You should realize that price is just one of the marketing-mix elements that firms use to achieve their marketing objectives. Price decisions must be coordinated with the remaining three elements to form a consistent and effective marketing programme. Decisions made for other marketing-mix variables may affect pricing decisions. For example, producers using many resellers who are expected to support and promote their products may have to incorporate larger re-seller margins into their prices. In addition, the decision to position the product on high-performance quality will mean that the seller must charge a higher price to cover higher costs.
It is common for firms to make their pricing decisions first and then base other marketing-mix decisions on the prices they want to charge. In this case, price is a crucial product positioning factor that defines the product’s market, competition, and design. Therefore, the intended price determines what product features can be offered and what production costs incurred.
Some firms often support such price-positioning strategies with a technique called target costing,which is a potent strategic weapon. What is done in target costing is to reverse the usual process of first designing a new product, determining its cost, and then arriving at an appropriate price. Instead, it starts with a target cost and works backward.
Other firms may decide to de-emphasize price and use other marketing-mix tools to create non-price position. Often, the best strategy is not to charge the lowest price, but rather to differentiate the marketing offer to make it worth a higher price.
Generally, the marketer needs to consider the total marketing mix when setting prices, for instance, if the product is positioned on non-price factors, then decisions about quality, promotion, and distribution will strongly affect the price. If it so happens that price is a crucial positioning factor, then price will strongly affect decisions made about the other marketing-mix elements.
COSTS
Costs basically set the floor for the price that the firm can charge for its product. Normally, a firm will want 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 efforts and risks. Hence, a firm’s costs may be an important element in its pricing strategy. Usually, most firms struggle to become the “low-cost producers” in their industries. This is based on the fact that companies with lower costs can set lower prices, which then results in greater sales and profits.
A firm’s costs generally take two firms, fixed and variable. Fixed costs (or overhead) are costs that do not vary with production or sales levels. For example, a company must pay monthly bills for rent, interest, salaries, whatever the company’s output.
Variable cost varies directly with the level of production. These costs tend to be the same for each unit produced.
Total costs are the sums of the fixed and variable costs for any given level of production. Usually, management wants to charge a price that will at least cover the total production costs at a given level of production. The firm needs to watch its costs carefully. For instance, if it costs the firm more than competitors to produce and sell its product, the firm will have to charge a higher price or make less profit, thus putting it at a competitive disadvantage.
ORGANISATIONAL CONSIDERATION
It is the responsibility of a firm’s management to decide who within the organization should set prices. Finns handle pricing in a variety of ways. In small companies, for example, prices often are set by top management rather than by the marketing or sales department. In larger companies, however, pricing is generally handled by divisional or product line managers. In the case of industrial markets, salespeople may be allowed to negotiate with customers within certain price ranges. Even then, top management sets the pricing objectives and policies, and it often approves the prices proposed by lower-level management or salespeople.
