Factors to Consider When Setting Prices

In the narrowest sense, price is the amount of money charged for a product or service. More broadly, price is the sum of all the values that consumers exchange for the benefits of having or using the product or service.

Price is the only element in the marketing mix that produces revenue; all other elements represent costs. Price is also one of the most flexible elements of the marketing mix. Unlike product features and channel commitments, price can be changed quickly. At the same time, pricing and price competition is the number one problem facing many marketing executive. Yet, many companies do not handle pricing well.

Factors to Consider When Setting Prices:

A company’s pricing decisions are affected by both internal and external environmental factors.

Internal Factors Affecting Pricing Decisions:

Internal factors affecting pricing include the company’s marketing objectives, marketing strategy, costs and organizational considerations.

1. Marketing Objectives:

Before setting a price, the company must decide on its strategy for the product. If the company has selected its target market and positioning carefully, then its marketing mix strategy, including price, will be fairly straightforward. For example, when Honda and Toyota decided to develop their Acura and Lexus brands to compete with European luxury-performance cars in the higher income segment, this required charging a high price. Pricing strategy, thus, largely determined by decisions on market positioning.

At the same time, the company may seek additional objectives. Common objectives include survival, current profit maximization, market share leadership, and product quality leadership. Companies set survival as their major objectives if they are troubled by too much capacity, heavy competition, or changing consumer wants. To keep a plant going, a company may set a low price, hoping to increase demand. In the long run, however, the firm must learn how to add value that consumers will pay for or face extinction.

Many companies use current profit maximization as their pricing goal. They estimate demand and costs will be at different prices and choose the price that will produce the maximum current profit, cash flow, or return on investment. Other companies want to obtain market share leadership. To become the market share leader, these firms set prices as low as possible.

A company might decide that it wants to achieve product quality leadership. This normally calls for charging a high price to cover higher performance quality and high cost of R&D. Fort example, Caterpillar charges 20 percent to 30 percent more than competitors for its heavy construction equipment based on superior product and service.

A company might also use price to attain other, more specific objectives. It can set prices low to prevent competitors from entering the market or set prices at competitors’ level to stabilize the market. Prices can be set to keep the loyalty and support of resellers or to avoid government intervention. Prices can be reduced temporarily to create excitement for a product or to draw more customers into retail store. One product may be priced to help the sales of other products in the company’s line. Thus, pricing may play an important role in helping to accomplish the company’s objectives at many levels.

Not-for-profit and public organizations may adopt a number of other pricing objectives. A university aims for partial cost recovery, knowing that it must rely on private gifts and public grants, to cover the remaining costs. A not-for-profit hospitals may aim for full cost recovery in its pricing. A not-for-profit theatre company may price its production to fill the maximum number of theatre seats. A social service agency may set a social pricing geared to the varying income situations of different clients.

2. 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, and promotion decisions to form a consistent and effective marketing program. 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 build larger reseller margins into their prices. The decision to position the product on high-performance quality will mean that the seller must charge a higher price to cover higher cost.

3. Costs:

Costs set the floor for the price that the company can charge. The company wants to charge a price that both covers all its cost for producing, distributing, and selling the product and delivers a fair rate of return for its effort and risk. A company’s costs may be an important element in its pricing strategy. Many companies, such as Southwest Airlines, Wal-Mart, and Union Carbide, work to become the “low-cost producers” in their industries. Companies with lower costs can set lower price that result in greater sales and profits.

4. Organizational Considerations:

Management must decide who within the organization should set prices. Companies handle pricing in a variety of ways. In small companies, prices are often set by top management rather then by the marketing or sales departments. In large companies, price is typically handled by divisional or product line managers. In industrial markets, salespeople may be allowed to negotiate with customers with a certain price ranges. Even so, top management sets the pricing objective and policies, and often approves the prices proposed by lower-level-management or salespeople.

In industries in which pricing is a key factor (aerospace, steel, railroad, oil companies), companies often have a pricing departments to set the best prices or help others in setting them. This department reports to the marketing department or top management. Others who have an influence on pricing include sales manager, production managers, fiancé managers and accountants.

External Factors Affecting Pricing Decisions:

External factors that affect pricing decisions include the nature of market and demand, competition, and other environmental factors.

1. The Market and Demand:

The seller’s freedom varies with different types of markets. Economists recognize four types of markets, each presenting a different pricing challenge.

  • Under pure competition, the market consists of many buyers and sellers trading in a uniform commodity such as wheat, copper of financial securities. No single buyer or seller has much effect on the going market price. A seller cannot charge more than the going price, because buyers can obtain as much as they need at the going price.
  • 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. Either the physical product can be varied in quality, features, or style or the accompanying services can be varied. Buyers see differences in sellers’ products and will pay different prices for them.
  • Under oligopolistic competition, the market consists of a few sellers who are highly sensitive to each other’s pricing and marketing strategies. The product can be uniform (steel, aluminum) or non-uniform (computers, cars). There are few sellers because it is difficult for new sellers to enter the market. Each seller is alert to competitors’ strategies and moves. If a steel company slashes its price by 10 percent, buyers will quickly switch to this supplier.
  • In a pure monopoly, the market consists of one seller. The seller may be a government monopoly (the US postal service), a private regulated monopoly (a power company), or a private non-regulated monopoly. Pricing is handled differently in each case. A government monopoly can pursue a variety of pricing objectives.
  • In a regulated monopoly, the government permits the company to set rates that will yield a “fair return”, one that will let the company maintain and expand its competitors as needed. Nonregulated monopolies are free to price at what the market will bear.  However, they do not always charge the full price for a number of reasons; a desire to attract competition, a desire to penetrate the marker faster with a low price, or a fear of government regulation.

2. Consumer Perception of Price and Value:

In the end, the consumer will decide whether a product’s price is right. Pricing decisions, like other marketing mix decisions, must be buyer-oriented. When consumers buy a product, they exchange something of value (the price) to get something of value (the benefits of having or using the product). Effective, buyer-oriented pricing involves understanding how much value consumers place on the benefits they receive from the product and setting a price that fits this value.

3. Competitors’ Costs, Prices, and offers:

Another external factor affecting the company’s pricing decisions is competitors’ cost and prices and possible competitor reactions to the company’s own pricing moves. A consumer who is considering the purchase of a Canon camera will evaluate Canon’s price and value against the prices and values of comparable products made by Nikon, Minolta, Pentax, and others. If canon follows a high-price, high -margin strategy, it may attract competition. A low-price, low-margin strategy, however, may stop competitors or drive them out of the market.

Canon needs to benchmark its costs against its competitors’ costs to learn whether it is operating at a cost advantage or disadvantage. It also needs to learn the price and quality of each competitor’s offer. Once canon is aware of competitors’ price and offers, it can use them as starting point for its pricing. If Canon’s cameras are similar to Nikon’s, it will have to price close to Nikon or lose sales. If Canon’s cameras are not as good as Nikon’s, the firm will not be able to charge as much.  If Canon’s products are better than Nikon’s, it can charge more. Basically, Canon will use price to position its offer to the competition.

4. Other External Factors:

When setting prices, the company also must consider other factors in its external environment. Economic conditions can have a strong impact on the firm’s pricing strategies. Economic factors such as boom or recession, inflation, and interest rates affect pricing decisions because they affect both the cost of producing a product and consumer perception of the product’s price and value. The company must also consider what impact its prices will have on other parties in its environment. How will reseller react to various prices? The company should set prices that give resellers a fair profit, encourage their support, and help them to sell the product effectively. The government is another important external influence on pricing decisions. Finally, social concerns may have to be taken into account. In setting prices, a company’s short-term sales, market share, and profit goals may have to be tempered by broader social considerations.

About Abey Francis

Abey Francis is the founder of MBAKnol - A Blog about Management Theories and Practices - and he's always happy to share his passion for innovative management practices. You can found him on Google+ and Facebook. If you’d like to reach him, send him an email to: [email protected]

One Comment

  1. This was a detailed and very informative article

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