Before going into the detail of factors affecting pricing decisions, let’s discuss some of the basic concepts of pricing, which are also important to know.
The money claimed against the offered product or service in the market is called price. In other words the value exchanged for use of the benefits of a certain product or service. The customer is called the price of that product or service. Price may take the following forms.
- Fare etc.
Price is an important element that serves as the basis for the choice of the customers in the purchase in the old days. However, now many other elements are considered as more determining than price alone in Consumer Behavior. Price is set by the negotiation between customers and the sellers. There are two main types of pricing which are as follows:
Fixed Price, in which single price is set for all customers.
Dynamic Price that contains different prices for different customers on the basis of the situation.
Factors Affecting Pricing Decisions
There are a number of factors affecting the pricing decisions and price is not determined simply. Moreover, there are many factors affecting pricing decisions. The reason is that the price is a very sensitive issue for the customers in their purchasing behavior. Following are the two main factors affecting pricing decisions:
1– Internal Factors
2- External Factors
Internal factors are those factors that are related to the internal environment of the business. This means that the issues that prevail within the business organization and upon which the organization has control are included in this category. Internal factors further include the following:
Price Adjustment Strategies For Small Business
- Marketing Objectives and Marketing Mix Strategies
- Organizational Considerations
Each of these is discussed one by one.
Marketing Objectives & Marketing Mix Strategies
The objectives of the business serve as a basis for the development of proper marketing mix strategy. Also, that includes in the price determination process. Those businesses that have kept clear objectives feel comfortable in setting an effective price for their products or services. Since, their prices are built on the ground of stated objectives. Following are some of the important objectives that are covered by most businesses.
In this objective the main purpose of the business is survival in the market. The profit maximization purpose becomes a secondary importance for such a business. Because its survival is at stake due to unfavorable market conditions like tough competition, changes in tastes of customers etc. In this case the business tries to keep its price low. So, that a sufficient proportion of its product or service should be sold.
Another important objective is the profit maximization that is employed by many businesses. Such businesses count the costs and demand of their products or services and set different prices. From these price combinations, a business chooses the price that can give maximum profit, return on investment or cash flow. This objective is beneficial for the short run and it neglects the long term future of the business. Some businesses try to increase their market share for the purpose of getting the highest profit. Because their management believed that higher market share leads to lower cost and hence higher profits. Businesses adopting such a strategy also keep their prices low.
Product Quality Leadership
A business can set its basic objective as the product quality leadership in the market. For this purpose, such a business keeps its price higher. To cover the higher performance of its product along with the costs incurred on research and development.
Price can be used to accomplish other objectives for a business. Examples include lowering of price to avoid increasing competition, keep prices competitive. To make the market stable and avoid government intervention. Also, to increase demand by lowering prices etc. In short, the decisions taken in respect of price affect other marketing mix variable decisions. So, all of these decisions should be consistent with one another to make a marketing program effective. The business should also keep its product as differentiated and set a relatively high price for the uniqueness of its product. In this way price is based on many non-pricing factors.
Cost is the fundamental element in setting prices for a product or service. There is simple rule of the business charges. Such prices that should not only cover all of the costs incurred in manufacturing, distribution and promotion of the product or service. However, also provide a fair return on the invested money. If a business has low costs, then it can increase its sales and profit by lowering the price of its product.
Kinds of Costs
Generally there are two major types of costs which are as follows:
a) Fixed Cost
b) Variable Cost
The fixed cost is such a cost that remains fixed and does not change with the changing level of production or sales. Since, the total fixed cost remains the same but fixed cost per unit may change. The example includes rent paid for the building, interest paid on loan, salaries to employee staff etc.
The variable cost is that kind of cost which changes with the change in the level of production and sales. Although the total variable cost changes but the unit variable cost remains the same. For example, each car produced includes the variable cost of tires, metal sheets, Misc. items etc. The change with the increase or decrease in the quantity of production and sales.
Management of the business should ascertain different levels of costs with respect to different levels of production and sales. So, that the lowest cost can be obtained for the determination of effective prices for the manufactured products or services.
This factor includes the fact that who should be given the responsibility to set the price within the organization. There are many ways to deal with such an issue. In smaller businesses, top management is responsible for setting the price of the product. On the other hand, in large organizations product line managers or divisional managers have the authority to set prices for the product or service. In case of industrial markets, salespersons handle the pricing of products by negotiating with the customers. If certain price sensitive industries have a separate pricing department that can either directly determine the best prices. In some firms, top management like the proposed prices of the lower level employees like salespersons etc.
External Factors include factors that are related to the external environment of the business. The business has less control over these variables of the external environment. Following are included in this category:
1) The Market and Demand
2) Costs, Prices and Offering of Competitors
The Market and Demand
We have already discussed that the lower limits of price are determined by the costs incurred. On the other hand the upper limits are determined by the demand and market elements. Price is balanced by the benefits of owning the relative product or service by consumer and industrial customers. For this purpose the price and demand relationship for a product is essential to be understood before setting its price.
Pricing in different Markets
Different market conditions require different sets of pricing strategies. Generally there are following four types of markets:
1) Pure Competition
2) Monopolistic Competition
3) Oligopolistic Competition
5) Consumer perception about value and price
6) Price Demand Relationship
In case of pure competition in the market, there are many buyers and sellers in the markets dealing with uniform commodities like wheat etc. There is one ongoing price in the whole market and no single buyer or seller can affect this price. Because the customers can easily obtain their required quantity at the ongoing price of the market. So, no seller can charge higher prices. Similarly, no seller can charge a lower price because he can sell all his offered quantity in the market. In case of the rise of the price or profit in the market, new sellers are attracted to enter the market. In pure competition, pricing, sales promotion, new product development and marketing research are not supported. Specifically, the sellers on the market do involve in preparation of marketing strategies.
In case of monopolistic competition there are many sellers and buyers who offer their products not at a single price but at a range of prices. The difference in the price range is due to the differentiated product or service offering by the sellers. Customers can feel the difference between the products and hence pay different prices for them. These differences can be in shape of features, quality or style etc. So in this kind of market businesses spend more time. Also, money on differentiating their product or services in the shape of sales promotion, advertising etc. A single business is not affected by the marketing strategies of its competitors because there are many competitors in the market.
Another factor affecting pricing decisions is oligopolistic. In an oligopolistic market, there are few sellers and buyers which are conscious about the pricing and other marketing strategies of competitors. The offered products are either uniform or differentiated. It is difficult for new sellers to enter the market. A certain change in the price of a single firm affects its own soil in a negative way. Even if a seller lowers its price; its competitors also decrease their price. This means that the benefits are only for a short while.
Another market condition is monopoly in which there is only a single seller who can offer its products or services at different rates. As the seller is single and the buyers are much more, therefore the seller charges a relatively higher price. Because there is no fear of competition. In case of regulated monopoly, the seller can charge only a fair price. However, in case of unregulated monopoly the seller has freedom to charge extra for its offering. Mostly the monopoly firm keeps its price low for a number of reasons like quick penetration in the market, government intervention etc.
Consumer Perception about Value and Price
The bottom reality in the pricing decision is that the customers are the final authority who determines the price of a product or service. It is obvious that the consumers pay the price for the exchange of the benefits that they avail by using the relative product. So businesses should focus on the pricing that is consumer oriented. While they try to determine how much the consumer would be willing to pay for how much benefit of a certain product.
Price Demand Relationship
Businesses should also consider the important relationship between the price of a product or service and its demand. Generally price and demand is inversely related. That means, the increase in the price would lead to the decrease in the demand for that product and vice versa. The reason behind this inverse relationship is that the customers have limited resources for the fulfillment of their demands.
In some cases the price and demand show the direct relationship. The increase in the price would lead to the increase in the demand of that product in the market. However, this only happens with the prestigious products where increased price means increased quality.
The business management should also consider the elasticity of the demand of their offering product while setting its price.
Costs, Prices & Offering of Competitors
There are some external factors affecting pricing decisions of the business. Such as the costs, price and offering of the competitors as compared to its own cost, price & offering. This means that the management of the business should take into account the change in the price. Although, offering of the competitors and take steps accordingly.
Other external factors affecting pricing decisions are also important to be considered. While determining a price for a product or service, like economic conditions of the country, government rules and regulations etc.
Hello everyone! This is Richard Daniels, a full-time passionate researcher & blogger. He holds a Ph.D. degree in Economics. He loves to write about economics, e-commerce, and business-related topics for students to assist them in their studies. That's the sole purpose of Business Study Notes.
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