PRICING DECISIONS
What do the following words have in common? Fare,dues, tuition, interest, rent, and fee. The
answer is that each of these is a term used to describe what one must pay to acquire benefits
from another party. More commonly, most people simply use the word price to indicate what it
costs to acquire a product.
The pricing decision is a critical one for most marketers, yet the amount of attention given to this
key area is often much less than is given to other marketing decisions. One reason for the lack
of attention is that many believe price setting is a mechanical process requiring the marketer to
utilize financial tools, such as spreadsheets, to build their case for setting price levels. While
financial tools are widely used to assist in setting price, marketers must consider many other
factors when arriving at the price for which their product will sell.
What is Price?
In general terms price is a component of an exchange or transaction that takes place between
two parties and refers to what must be given up by one party (i.e., buyer) in order to obtain
something offered by another party (i.e., seller). Yet this view of price provides a somewhat
limited explanation of what price means to participants in the transaction. In fact, price means
different things to different participants in an exchange:
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Buyers’ View – For those making a purchase, such as final customers, price refers to
what must be given up to obtain benefits. In most cases what is given up is financial
consideration (e.g., money) in exchange for acquiring access to a good or service. But
financial consideration is not always what the buyer gives up. Sometimes in a barter
situation a buyer may acquire a product by giving up their own product. For instance, two
farmers may exchange cattle for crops. Also, as we will discuss below, buyers may also
give up other things to acquire the benefits of a product that are not direct financial
payments (e.g., time to learn to use the product).
Sellers’ View - To sellers in a transaction, price reflects the revenue generated for each
product sold and, thus, is an important factor in determining profit. For marketing
organizations price also serves as a marketing tool and is a key element in marketing
promotions. For example, most retailers highlight product pricing in their advertising
campaigns.
Importance of Price
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When marketers talk about what they do as part of their responsibilities for marketing
products, the tasks associated with setting price are often not at the top of the list.
Marketers are much more likely to discuss their activities related to promotion, product
development, market research and other tasks that are viewed as the more interesting
and exciting parts of the job.
Yet pricing decisions can have important consequences for the marketing organization
and the attention given by the marketer to pricing is just as important as the attention
given to more recognizable marketing activities. Some reasons pricing is important
include:
FACTORS INFLUENCING PRICE
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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:
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For elastic markets – increasing price lowers total revenue while decreasing price
increases total revenue.
For inelastic markets – increasing price raises total revenue while decreasing price
lowers total revenue.
For unitary markets – there is no change in revenue when price is changed.
Costs
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 customers
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:
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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.
Variable Costs – These costs are directly associated with the production and sales of
products and, consequently, may change as 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.
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Elasticity of Demand
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:


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For elastic markets – increasing price lowers total revenue while decreasing price
increases total revenue.
For inelastic markets – increasing price raises total revenue while decreasing price
lowers total revenue.
For unitary markets – there is no change in revenue when price is changed.
Target market
The class of customers you are targeting will greatly influence the pricing of your
product. In the society, there are three classes of people. The rich, the middle class and
the poor or more preferably “low income earners,” who are always the majority in terms
of population. A product targeted at the rich will surely command a higher price than
those targeted at the middle class. If products targeted at the rich commands a low
price, it will be tagged valueless by the rich. So when devising your product pricing
strategy; consider the societal class of your targeted customers first. It’s very important.
For instance, there are cars for the rich and cars for the middle class; both can’t be can’t
be sold in the market place with the same product pricing strategy.
Government Regulation
Marketers must be aware of regulations that impact how price is set in the markets in which
their products are sold. These regulations are primarily government enacted meaning that there
may be 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.
Competitive and Other 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.
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Value
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For most customers price by itself is not the key factor when a purchase is being
considered. This is because most customers compare the entire marketing offering and
do not simply make their purchase decision based solely on a product’s price. In
essence when a purchase situation arises price is one of several variables customers
evaluate when they mentally assess a product’s overall value.
Value refers to the perception of benefits received for what someone must give up.
Since price often reflects an important part of what someone gives up, a customer’s
perceived value of a product will be affected by a marketer’s pricing decision. Any easy
way to see this is to view value as a calculation:
 Value = perceived benefits received
perceived price paid
For the buyer value of a product will change as perceived price paid and/or perceived
benefits received change. But the price paid in a transaction is not only financial it can
also involve other things that a buyer may be giving up. For example, in addition to
paying money a customer may have to spend time learning to use a product, pay to
have an old product removed, close down current operations while a product is installed
or incur other expenses. However, for the purpose of this tutorial we will limit our
discussion to how the marketer sets the financial price of a transaction.
Break-even price
Break-even price is the price a company must sell its product at given a particular volume of
production. Calculating the break-even price helps the company determine the price it will
need to charge for its products. It also helps the company plan its future production. To
calculate break-even price, the company needs to know its total fixed costs, the volume of
production and the variable costs per unit. The total fixed costs are costs that do not change
with the level of production. Variable costs, on the other hand, do change with the level of
production
Profit and sales objectives
Profit and market share objectives include:
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maximize long-run profit
maximize short-run profit
increase sales volume (quantity)
increase monetary sales
increase market share
obtain a target rate of return on investment(ROI)
obtain a target rate of return on sales
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PRICING STRATEGIES
PENETRATION PRICING
Penetration pricing involves the setting of lower, rather than higher prices in order to achieve a
large, if not dominant market share.
This strategy is most often used businesses wishing to enter a new market or build on a
relatively small market share.
This will only be possible where demand for the product is believed to be highly elastic, i.e.
demand is price-sensitive and either new buyers will be attracted, or existing buyers will buy
more of the product as a result of a low price.
A successful penetration pricing strategy may lead to large sales volumes/market shares and
therefore lower costs per unit. The effects of economies of both scale and experience lead to
lower production costs, which justify the use of penetration pricing strategies to gain market
share. Penetration strategies are often used by businesses that need to use up spare resources
(e.g. factory capacity).
A penetration pricing strategy may also promote complimentary and captive products. The main
product may be priced with a low mark-up to attract sales (it may even be a loss-leader).
Customers are then sold accessories (which often only fit the manufacturer’s main product)
which are sold at higher mark-ups.
Before implementing a penetration pricing strategy, a supplier must be certain that it has the
production and distribution capabilities to meet the anticipated increase in demand.
The most obvious potential disadvantage of implementing a penetration pricing strategy is the
likelihood of competing suppliers following suit by reducing their prices also, thus nullifying any
advantage of the reduced price (if prices are sufficiently differentiated the impact of this
disadvantage may be diminished).
A second potential disadvantage is the impact of the reduced price on the image of the offering,
particularly where buyers associate price with quality.
PRICE SKIMMING STRATEGY
The practice of ‘price skimming’ involves charging a relatively high price for a short time where a
new, innovative, or much-improved product is launched onto a market.
The objective with skimming is to “skim” off customers who are willing to pay more to have the
product sooner; prices are lowered later when demand from the “early adopters” falls.
The success of a price-skimming strategy is largely dependent on the inelasticity of demand for
the product either by the market as a whole, or by certain market segments.
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High prices can be enjoyed in the short term where demand is relatively inelastic. In the short
term the supplier benefits from ‘monopoly profits’, but as profitability increases, competing
suppliers are likely to be attracted to the market (depending on the barriers to entry in the
market) and the price will fall as competition increases.
The main objective of employing a price-skimming strategy is, therefore, to benefit from high
short-term profits (due to the newness of the product) and from effective market segmentation.
There are several advantages of price skimming
• Where a highly innovative product is launched, research and development costs are likely to
be high, as are the costs of introducing the product to the market via promotion, advertising etc.
In such cases, the practice of price-skimming allows for some return on the set-up costs
• By charging high prices initially, a company can build a high-quality image for its product.
Charging initial high prices allows the firm the luxury of reducing them when the threat of
competition arrives. By contrast, a lower initial price would be difficult to increase without risking
the loss of sales volume
• Skimming can be an effective strategy in segmenting the market. A firm can divide the market
into a number of segments and reduce the price at different stages in each, thus acquiring
maximum profit from each segment
• Where a product is distributed via dealers, the practice of price-skimming is very popular, since
high prices for the supplier are translated into high mark-ups for the dealer
PREMIUM PRICING
Use a high price where there is a uniqueness about the product or service. This approach is
used where a a substantial competitive advantage exists. Such high prices are charge for
luxuries such as Cunard Cruises, Savoy Hotel rooms, and Concorde flights.
CAPTIVE PRICING STRATEGY
Premium pricing levels applied to components of a product that consumers have already
purchased. The customer cannot avoid purchasing the components, such as replacement razor
blades, without sacrificing the value of the core product , such as the razor itself, enabling the
company to achieve much higher profit margins than are possible for regular product
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