- Understand the factors that affect a firm’s pricing decisions.
- Understand why companies must conduct research before setting prices in international markets.
- Learn how to calculate the breakeven point.
Having a pricing objective isn’t enough. A firm also has to look at a myriad of other factors before setting its prices. Those factors include the offering’s costs, the demand, the customers whose needs it is designed to meet, the external environment—such as the competition, the economy, and government regulations—and other aspects of the marketing mix, such as the nature of the offering, the current stage of its product life cycle, and its promotion and distribution. If a company plans to sell its products or services in international markets, research on the factors for each market must be analyzed before setting prices. Organizations must understand buyers, competitors, the economic conditions, and political regulations in other markets before they can compete successfully. Next we look at each of the factors and what they entail.
How will buyers respond? Three important factors are whether the buyers perceive the product offers value, how many buyers there are, and how sensitive they are to changes in price. In addition to gathering data on the size of markets, companies must try to determine how price sensitive customers are. Will customers buy the product, given its price? Or will they believe the value is not equal to the cost and choose an alternative or decide they can do without the product or service? Equally important is how much buyers are willing to pay for the offering. Figuring out how consumers will respond to prices involves judgment as well as research.
Price elasticity, or people’s sensitivity to price changes, affects the demand for products. Think about a pair of sweatpants with an elastic waist. You can stretch an elastic waistband like the one in sweatpants, but it’s much more difficult to stretch the waistband of a pair of dress slacks. Elasticity refers to the amount of stretch or change. For example, the waistband of sweatpants may stretch if you pull on it. Similarly, the demand for a product may change if the price changes. Imagine the price of a twelve-pack of sodas changing to $1.50 a pack. People are likely to buy a lot more soda at $1.50 per twelve-pack than they are at $4.50 per twelve-pack. Conversely, the waistband on a pair of dress slacks remains the same (doesn’t change) whether you pull on it or not. Likewise, demand for some products won’t change even if the price changes. The formula for calculating the price elasticity of demand is as follows.
Price elasticity = percentage change in quantity demanded ÷ percentage change in price
When consumers are very sensitive to the price change of a product—that is, they buy more of it at low prices and less of it at high prices—the demand for it is price elastic. Durable goods such as TVs, stereos, and freezers are more price elastic than necessities. People are more likely to buy them when their prices drop and less likely to buy them when their prices rise. By contrast, when the demand for a product stays relatively the same and buyers are not sensitive to changes in its price, the demand is price inelastic. Demand for essential products such as many basic food and first-aid products is not as affected by price changes as demand for many nonessential goods.
The number of competing products and substitutes available affects the elasticity of demand. Whether a person considers a product a necessity or a luxury and the percentage of a person’s budget allocated to different products and services also affect price elasticity. Some products, such as cigarettes, tend to be relatively price inelastic since most smokers keep purchasing them regardless of price increases and the fact that other people see cigarettes as unnecessary. Service providers, such as utility companies in markets in which they have a monopoly (only one provider), face more inelastic demand since no substitutes are available.
How competitors price and sell their products will have a tremendous effect on a firm’s pricing decisions. If you wanted to buy a certain pair of shoes, but the price was 30 percent less at one store than another, what would you do? Because companies want to establish and maintain loyal customers, they will often match their competitors’ prices. Some retailers, such as Home Depot, will give you an extra discount if you find the same product for less somewhere else. Similarly, if one company offers you free shipping, you might discover other companies will, too. With so many products sold online, consumers can compare the prices of many merchants before making a purchase decision.
The availability of substitute products affects a company’s pricing decisions as well. If you can find a similar pair of shoes selling for 50 percent less at a third store, would you buy them? There’s a good chance you might. Recall from the five forces model discussed in Chapter 2 “Strategic Planning” that merchants must look at substitutes and potential entrants as well as direct competitors.
The Economy and Government Laws and Regulations
The economy also has a tremendous effect on pricing decisions. In Chapter 2 “Strategic Planning” we noted that factors in the economic environment include interest rates and unemployment levels. When the economy is weak and many people are unemployed, companies often lower their prices. In international markets, currency exchange rates also affect pricing decisions.
Pricing decisions are affected by federal and state regulations. Regulations are designed to protect consumers, promote competition, and encourage ethical and fair behavior by businesses. For example, the Robinson-Patman Act limits a seller’s ability to charge different customers different prices for the same products. The intent of the act is to protect small businesses from larger businesses that try to extract special discounts and deals for themselves in order to eliminate their competitors. However, cost differences, market conditions, and competitive pricing by other suppliers can justify price differences in some situations. In other words, the practice isn’t illegal under all circumstances. You have probably noticed that restaurants offer senior citizens and children discounted menus. The movies also charge different people different prices based on their ages and charge different amounts based on the time of day, with matinees usually less expensive than evening shows. These price differences are legal. We will discuss more about price differences later in the chapter.
Price fixing, which occurs when firms get together and agree to charge the same prices, is illegal. Usually, price fixing involves setting high prices so consumers must pay a high price regardless of where they purchase a good or service. Video systems, LCD (liquid crystal display) manufacturers, auction houses, and airlines are examples of offerings in which price fixing existed. When a company is charged with price fixing, it is usually ordered to take some type of action to reach a settlement with buyers.
Price fixing isn’t uncommon. Nintendo and its distributors in the European Union were charged with price fixing and increasing the prices of hardware and software. Sharp, LG, and Chungwa collaborated and fixed the prices of the LCDs used in computers, cell phones, and other electronics. Virgin Atlantic Airways and British Airways were also involved in price fixing for their flights. Sotheby’s and Christie’s, two large auction houses, used price fixing to set their commissions.
One of the most famous price-fixing schemes involved Robert Crandall, the CEO of American Airlines in the early 1990s. Crandall called Howard Putnam, the CEO of Braniff Airlines, since the two airlines were fierce competitors in the Dallas market. Unfortunately for Crandall, Putnam taped the conversation and turned it over to the U.S. Department of Justice. Their conversation went like this:
Crandall: “I think it’s dumb—to pound—each other and neither one of us making a [expletive] dime.”
Crandall: “I have a suggestion for you. Raise your—fares twenty percent. I’ll raise mine the next morning.”
Putnam: “Robert, we—”
Crandall: “You’ll make more money and I will too.”
Putnam: “We can’t talk about pricing.”
Crandall: “Oh, [expletive] Howard. We can talk about any [expletive] thing we want to talk about” (Jackson, et. al., 1983).
By requiring sellers to keep a minimum price level for similar products, unfair trade laws protect smaller businesses. Unfair trade laws are state laws preventing large businesses from selling products below cost (as loss leaders) to attract customers to the store. When companies act in a predatory manner by setting low prices to drive competitors out of business, it is a predatory pricing strategy.
Similarly, bait-and-switch pricing is illegal in many states. Bait and switch, or bait advertising, occurs when a business tries to “bait,” or lure in, customers with an incredibly low-priced product. Once customers take the bait, sales personnel attempt to sell them more expensive products. Sometimes the customers are told the cheaper product is no longer available.
You perhaps have seen bait-and-switch pricing tactics used to sell different electronic products or small household appliances. While bait-and-switch pricing is illegal in many states, stores can add disclaimers to their ads stating that there are no rain checks or that limited quantities are available to justify trying to get you to buy a different product. However, the advertiser must offer at least a limited quantity of the advertised product, even if it sells out quickly.
The costs of the product—its inputs—including the amount spent on product development, testing, and packaging required have to be taken into account when a pricing decision is made. So do the costs related to promotion and distribution. For example, when a new offering is launched, its promotion costs can be very high because people need to be made aware that it exists. Thus, the offering’s stage in the product life cycle can affect its price. Keep in mind that a product may be in a different stage of its life cycle in other markets. For example, while sales of the iPhone remain fairly constant in the United States, the Koreans felt the phone was not as good as their current phones and was somewhat obsolete. Similarly, if a company has to open brick-and-mortar storefronts to distribute and sell the offering, this too will have to be built into the price the firm must charge for it.
The point at which total costs equal total revenue is known as the breakeven point (BEP). For a company to be profitable, a company’s revenue must be greater than its total costs. If total costs exceed total revenue, the company suffers a loss.
Total costs include both fixed costs and variable costs. Fixed costs, or overhead expenses, are costs that a company must pay regardless of its level of production or level of sales. A company’s fixed costs include items such as rent, leasing fees for equipment, contracted advertising costs, and insurance. As a student, you may also incur fixed costs such as the rent you pay for an apartment. You must pay your rent whether you stay there for the weekend or not. Variable costs are costs that change with a company’s level of production and sales. Raw materials, labor, and commissions on units sold are examples of variable costs. You, too, have variable costs, such as the cost of gasoline for your car or your utility bills, which vary depending on how much you use.
Consider a small company that manufactures specialty DVDs and sells them through different retail stores. The manufacturer’s selling price (MSP) is $15, which is what the retailers pay for the DVDs. The retailers then sell the DVDs to consumers for an additional charge. The manufacturer has the following charges:
|Copyright and distribution charges for the titles||$150,000|
|Package and label designs for the DVDs||$10,000|
|Advertising and promotion costs||$40,000|
|Reproduction of DVDs||$5 per unit|
|Labels and packaging||$1 per unit|
|Royalties||$1 per unit|
In order to determine the breakeven point, you must first calculate the fixed and variable costs. To make sure all costs are included, you may want to highlight the fixed costs in one color (e.g., green) and the variable costs in another color (e.g., blue). Then, using the formulas below, calculate how many units the manufacturer must sell to break even.
The formula for BEP is as follows:
BEP = total fixed costs (FC) ÷ contribution per unit (CU)
contribution per unit = MSP – variable costs (VC)
BEP = $200,000 ÷ ($15 – $7) = $200,000 ÷ $8 = 25,000 units to break even
To determine the breakeven point in dollars, you simply multiply the number of units to break even by the MSP. In this case, the BEP in dollars would be 25,000 units times $15, or $375,000.
In addition to setting a pricing objective, a firm has to look at a number of factors before setting its prices. These factors include the offering’s costs, the customers whose needs it is designed to meet, the external environment—such as the competition, the economy, and government regulations—and other aspects of the marketing mix, such as the nature of the offering, the stage of its product life cycle, and its promotion and distribution. In international markets, firms must look at environmental factors and customers’ buying behavior in each market. For a company to be profitable, revenues must exceed total costs.
- What factors do organizations consider when making price decisions?
- How do a company’s competitors affect the pricing decisions the firm will make?
- What is the difference between fixed costs and variable costs?
Jackson, D. S., John S. Demott, and Allen Pusey, “Dirty Tricks in Dallas,” Time, March 7, 1983, http://www.time.com/time/magazine/article/0,9171,953755,00.html (accessed December 15, 2009).
What are the factors that affect pricing decisions in marketing? ›
Those factors include the offering's costs, the demand, the customers whose needs it is designed to meet, the external environment—such as the competition, the economy, and government regulations—and other aspects of the marketing mix, such as the nature of the offering, the current stage of its product life cycle, and ...What are the factors to be considered while making pricing decision? ›
- Costs. First and foremost you need to be financially informed. ...
- Customers. Know what your customers want from your products and services. ...
- Positioning. Once you understand your customer, you need to look at your positioning. ...
- Competitors. ...
Pricing strategy in marketing is the pursuit of identifying the optimum price for a product. This strategy is combined with the other marketing principles known as the four P's (product, place, price, and promotion), market demand, product characteristics, competition, and economic patterns.What major factors can affect pricing decisions quizlet? ›
What are the three major factors affecting pricing decisions? Customers, competitors, and costs influence prices through the demand and supply.What are the 4 main factors that influence a business pricing strategy? ›
These include: price skimming, price penetration, competitive pricing, loss leader and cost-plus. Candidates should be able to recognise the factors which might influence the pricing decision, eg the nature of the market, and the degree of competition.What are the 7 factors to consider when setting price? ›
- Market research. ...
- Value. ...
- Cost of goods. ...
- Labor. ...
- Distribution. ...
- Economies of scale.
Cost-Based Pricing. Value-Based Pricing. Competition-Based Pricing.What is the importance of pricing principles? ›
Why is pricing important? In markets with increasing volume and price pressure, the right pricing approach is essential to remain competitive. It brings you the value you deserve for your products and services offered and secures the profits you need to invest in change and growth.What are the 6 factors affecting decision making? ›
Significant factors include past experiences, a variety of cognitive biases, an escalation of commitment and sunk outcomes, individual differences, including age and socioeconomic status, and a belief in personal relevance. These things all impact the decision-making process and the decisions made.Which of the following is not a factor that affects pricing decisions? ›
Therefore, from the above explanation, consumer behavior for a given product is not an internal factor of pricing decisions.
What are the 5 factors that affect price? ›
- Product Cost.
- The Utility and Demand.
- The extent of Competition in the market.
- Government and Legal Regulations.
- Pricing Objectives.
- Marketing Methods used.
- Price Anchoring.
- Onboarding and Switching Costs.
- Perceived Value.
- Product or Service Type.
- Customer Income.
The six stages in the process of setting prices are (1) developing pricing objectives, (2) assessing the target market's evaluation of price, (3) evaluating competitors' prices, (4) choosing a basis for pricing, (5) selecting a pricing strategy, and (6) determining a specific price.What are the 12 elements of pricing? ›
These include price skimming, price discrimination and yield management, price points, psychological pricing, bundle pricing, penetration pricing, price lining, value-based pricing, geo and premium pricing. Pricing factors are manufacturing cost, market place, competition, market condition, quality of product.What are the 4 types of pricing methods? ›
There are many different pricing strategies, but Competitive Pricing, Cost-plus Pricing, Markup Pricing and Demand Pricing are four common methods for small business owners to use.What are the 3 C's of pricing? ›
The 3 C's of Pricing Strategy
Setting prices for your brand depends on three factors: your cost to offer the product to consumers, competitors' products and pricing, and the perceived value that consumers place on your brand and product vis-a-vis the cost.
- Cost-plus pricing. Calculate your costs and add a mark-up.
- Competitive pricing. Set a price based on what the competition charges.
- Price skimming. Set a high price and lower it as the market evolves.
- Penetration pricing. ...
- Value-based pricing.
What are the 4 major pricing strategies? Value-based, competition-based, cost-plus, and dynamic pricing are all models that are used frequently, depending on the industry and business model in question.What are the 5 reasons why pricing is very important? ›
- Attract customers. Price creates the first impression and may influence customers to purchase your brand. ...
- Portray value. Pricing portrays the value of your product. ...
- Aids in meeting customers expectations. ...
- Determines profitability.
The most important element of your pricing strategy is that it needs to sustain your business. Your selling price needs to be able to keep you in business. If products are set at a high price and potential customers don't buy, you'll lose market share.
Why is pricing so important in marketing? ›
Pricing is important since it defines the value that your product are worth for you to make and for your customers to use. It is the tangible price point to let customers know whether it is worth their time and investment.What are the 8 factors that affect decision-making? ›
Significant factors include past experiences, a variety of cognitive biases, an escalation of commitment and sunk outcomes, individual differences, including age and socioeconomic status, and a belief in personal relevance. These things all impact the decision-making process and the decisions made.What are the 7 elements of decision-making? ›
- Step 1: Identify the decision. You realize that you need to make a decision. ...
- Step 2: Gather relevant information. ...
- Step 3: Identify the alternatives. ...
- Step 4: Weigh the evidence. ...
- Step 5: Choose among alternatives. ...
- Step 6: Take action. ...
- Step 7: Review your decision & its consequences.
This study addresses the influencing factors that are related to decision making, and categorizes them under five captions: Personal factors, organizational factors, Social factors, Environmental factors and behavioural factors.What are the three ways that pricing affects promotion decisions? ›
It affects promotion decisions in terms of choice of medium, amount of money spent, and time allocated to promotion. It affects place decisions in terms of choice of transportation channels and where products are offered. Companies keep a variety of pricing objectives in mind when making pricing decisions.What are the 7 principles of marketing? ›
The 7Ps of marketing are – product, pricing, place, promotion, physical evidence, people, and processes. The 7 Ps make up the necessary marketing mix that a business must have to advertise a product or service.What are the 4 principles of marketing? ›
The 4 basic marketing principles are product, price, place and promotion.What are the 5 principles of marketing? ›
The 5 P's of marketing – Product, Price, Promotion, Place, and People – are a framework that helps guide marketing strategies and keep marketers focused on the right things.Why is 7Ps important in marketing? ›
Importance Of 7 Ps Of Marketing
The 7Ps model helps us to: Set objectives and provide a roadmap for your business objectives. Conduct SWOT analysis, and undertake competitive analysis. Review and define key issues that affect the marketing of its products and services.
- Fulfill a need. Your content should answer some unmet need or question for your customer. ...
- Stay consistent. ...
- Be human. ...
- Have a point of view. ...
- Step away from the sales-speak. ...
- Be the best of the breed.
What are the 6 types of pricing? ›
- Price skimming. Best for: Businesses introducing brand new products or services. ...
- Penetration pricing. ...
- Competitive pricing. ...
- Charm pricing. ...
- Prestige pricing. ...
- Loss-leader pricing.
- Competitor-based Pricing. Competitor-based pricing, also known as competitive pricing or competition-based pricing, is more like plagiarism. ...
- Value-based Pricing. ...
- Cost Plus Pricing. ...
- Dynamic Pricing. ...
- Key-value item Pricing.
The 4Ps of product, price, place, and promotion refer to the products your company is offering and how to get them into the hands of the consumer. The 4Cs refer to stakeholders, costs, communication, and distribution channels which are all different aspects of how your company functions.What are common marketing principles? ›
There are four original principles of marketing referred to as 4Ps or 4P marketing Matrix that companies use for their marketing strategy. These four basic marketing principles Product, Price, Place, and Promotion are interconnected and work together; hence, they are also known as Marketing Mix.What are the 4 P's of marketing and which activities define them? ›
The 4 P's stand for product, price, place, and promotion, the four primary factors that marketers need to consider when designing a campaign strategy. A marketing strategy should: Communicate what the product will provide the customer. Demonstrate why the product's value fits its price.What are the 10 principles of marketing? ›
- Insight comes before inspiration. ...
- Don't repurpose, re-imagine. ...
- There's no business without show business. ...
- Want control? ...
- It's good to play games with your customers. ...
- Products are the new services. ...
- Mobile is where it's at. ...
- Always keep surprises in-store.
A pricing strategy is a model or method used to establish the best price for a product or service. It helps you choose prices to maximize profits and shareholder value while considering consumer and market demand.What are the 5 A's in marketing? ›
Named by Dr. Philip Kotler, the five stages (Awareness, Appeal, Ask, Act and Advocacy) allow marketing and sales professionals to create a map of the customer's needs and priorities during the different parts of their purchase process.