Factors to Consider When Determining Prices
Category: Marketing
A company’s pricing decisions are affected by many internal company factors and external environmental factors. Internal factors include the company’s marketing objectives, marketing mix strategy, costs, and organisation. External factors include the nature of the market and demand, competition, and other environmental factors.
Factors affecting price decisions:
Internal Factors Affecting Pricing Decisions
Marketing Objectives. Before setting a price, the company must decide on its strategy for the product. The company’s overall strategy will determine the marketing objectives to a high degree. If the company has selected its target market and positioning carefully, then the marketing mix strategy, including price, will be fairly straightforward. Pricing strategy is largely determined by past decisions on market positioning.
At the same time, the company may seek additional objectives. The clearer the company is about its objectives, the easier it is to set the price. Examples of common objectives are:
Survival. Companies set survival as their major objective if they are troubled by too much capacity, heavy competition, or changing consumer wants. In order to keep the plant going, a company may set a low price, hoping to increase demand. In this case, profits are less important than survival. This objective might make sense as a short-term objective.
Current Profit Maximising. Many companies want to set a price that will maximise profits. They estimate the size of demand and costs at different prices and choose the price that will produce the maximum current profit, cash flow, or return on investment. In all cases, the company wants current financial outcomes rather than long-run performance.
Market Share Leadership. Other companies want to obtain the dominant market share. They believe that the company with the largest market share will enjoy the lowest costs and highest long-run profit. To become the market share leader, they set prices as low as possible.
Product Quality Leadership. A company might decide to have the highest quality product on the market. This normally calls for charging a high price to cover the high product quality and high cost of R&D.
Marketing Mix Strategy. Price is only one of the marketing mix tools for the company to use in order to achieve its marketing objectives. The company often makes its pricing decision first and then bases other marketing mix decisions on the price it wants to charge.
The marketer must consider the total marketing mix when setting prices. If the product is positioned on non-price factors, decisions about quality, promotion, and distribution will strongly affect the price. If price is a critical positioning factor, the price will strongly affect decisions on the other marketing mix elements. In most cases, the company will consider all the marketing mix decisions together when developing the marketing programme.
Costs. Costs set the floor of the price to be charged by the company. The company wants to charge a price both covering all its costs of producing, distributing, and selling the product and delivering 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 work to become the «low-cost producers» of their industries. Companies with lower costs can set lower prices resulting in higher sales and profits.
External Factors Affecting Pricing Decisions
The Market and Demand. Costs set the lower limits of prices whereas the market and demand set the upper limit. Both consumers and industrial buyers balance the price of a product or service against the benefits of owning it. Thus, before setting prices, the marketer must understand the relationship between price and demand for his product.
Analysing the price-demand relationship. Each price that the company might charge will lead to a different level of demand. The relationship between the price charged and the resulting demand level is shown in the familiar demand curve. The demand curve shows the number of units the market will buy in a given time period at different prices that might be charged. In the normal case, demand and price are inversely related: That is, the higher the price, the lower the demand.
Price-elasticity of demand. Marketers also need to know price elasticity — how responsive demand will be to a change in price. If demand highly changes, we say the demand is elastic.
The price elasticity of demand is given by the following formula:
What determines the price elasticity of demand? Buyers are less price sensitive when the product they are buying is unique or when it ranks high in quality, prestige, or exclusiveness. They are also less price sensitive when substitute products are hard to find or when they cannot easily compare the quality of the substitutes. Finally, buyers are less price sensitive when the total expenditure of a product is low as related to their income or when the cost is shared by another party.
If demand is elastic rather than inelastic, sellers will consider lowering their price. A lower price will produce more total revenue. This makes sense as long as the extra costs of producing and selling more do not exceed the extra revenue.
This can be illustrated by two hypothetical examples:
| Example | A: Inelastic demand | B: Elastic demand | ||
| Before price change: | Price per unit | 10 | Price per unit | 10 |
| No. of units sold | 1,000 | No. of units sold | 1,000 | |
| Turnover | 10,000 | Turnover | 10,000 | |
| Cost per unit | 6 | Cost per unit | 6 | |
| Total cost | 6,000 | 6,000 | ||
| Total cost | ||||
| Profit | 4,000 | Profit | 4,000 | |
| After price change: | Price per unit | 9 | Price per unit | 9 |
| No. of units sold | 1,100 | No. of units sold | 1,600 | |
| Turnover | 9,900 | Turnover | 14,400 | |
| Cost per unit | 6 | Cost per unit | 6 | |
| Total cost | 6,600 | Total cost | 9,600 | |
| Profit | 3,300 | Profit | 4,800 | |
| Change in profit: | -700 | +800 | ||
Other External Factors. When setting prices, the company must also consider other factors in its external environment. Economic factors such as inflation, boom or recession, and interest rates affect pricing decisions because they affect both the costs of producing a product and consumer perceptions of the product’s price and value.
The company must consider what impact its prices will have on other parties in its environment. How will re-sellers react to various prices? The company should set prices that give re-sellers a fair profit, encourage their support, and help them to sell the product effectively. The government is another important external influence on pricing decisions. Marketers need to know the laws affecting price and make sure their pricing policies are legal.