7: Pricing Policies and Strategies
Price has always been of principal importance to the buying decision. For many products and services, it is presumed that buyers will select the cheapest available. While some customers will pay a higher price for a "better" product in some categories, there is limited elasticity of demand for the majority of the market, and price remains a critical factor even for luxury goods.
The Economics of Pricing
The author attempts a quick-and-dirty stab at basic economic principles:
- In general, demand for a good decreases as its price increases
- The rate at which demand decreases is referred to as elasticity of demand (the greater the decrease in demand per unit of increase in price, the less the elasticity), meaning that customers are more price-sensitive about some products than others (generally due to competition, the availability of substitutes, the necessity of the good, etc.)
- There is also a suggestion that a producer can affect the demand curve by advertising quality (making buyers willing to pay a higher price for the same quantity) or advertising utility (causing buyers to wish to consume more at the same price). (EN: economists would debate whether the company is actually changing the demand curve, or merely choosing a point for its products along the existing cure, or stealing market share - it's tricky to prove either way, as it's purely theoretical.)
- The supply curve is affected by the number of competitors in a market and the profit margin on the sale of the good. The greater the potential profit, the more competition, and the more competition, the more pressure to lower prices.
- Costs also influence the amount that sellers are able to charge: the product must be priced to cover total costs (variable costs, fixed production costs, and overhead costs) in order for sellers to remain in business as well as providing sufficient return on investment, in consideration of the level of risk, for investors
Given the economic realities, the basic economic pricing approaces are:
- Cost-plus pricing - In which a business sets a desired amount of profit and prices the items to cover the costs plus the desired profit.
- Markup pricing - Common in retailing and wholesaling, markup pricing adds a fixed percentage to the cost of purchasing inventory to determine the selling price.
- Marginal pricing - Considers the per-unit cost of production and seeks to set a price that will generate specific level of demand at which the firm can operate profitably.
- Yield management pricing - considers the demand curve and seeks to price products at the most profitable level, (quantity times price, minus cost, is greatest)
Setting Prices
The author asserts that cost considerations should not dominate pricing decisions. While it remains true that a product must be sold at a certain minimum price to cover the costs of productions, additional factors must be considered, including:
- The price sensitivity of the target market (as opposed to the market as a whole)
- The impact on price on the desired brand image (desire to create a luxury brand means setting a higher price, just as a matter of esteem)
- The profit levels that are demanded by the distribution chain
- The impact of demand across complementary products (a producer might take a loss on one item to make a higher profit on another, whose demand is driven by the first)
- The current position of the product within its life cycle
- The lifetime value of customers (as opposed to profit on the current sale)
- The prices that competitors are charging
- The potential to maximize profit given market conditions
- The desire to maintain or improve market share
Price and the Product Life Cycle
The author provides a bit more detail on the impact of product life cycle on pricing decisions. Generally speaking, there is a high premium for "new" products that decreases as the product moves through the product life cycle.
During the introduction stage, the marketer is faced with a choice of skimming (setting a high price to take advantage of those who are willing to pay to be the "first") or penetration (setting a lower price to onboard as many customers as possible early in the game, and establish market share before competitors enter the market).
Pricing strategy must shift during the growth stage to react to competitors who enter the market. Especially if the company begin with a skimming strategy, it is likely that competitors have entered with a strategy of under pricing to attract a larger number of consumers who are willing to pay a lower price.
During maturity, there is increased competition and market demand becomes elastic due to the willingness (or need) of competitors to compete on price. Generally, this occurs in cycles: firms gravitate toward a common price to maximize profits, then a few players attempt to seize market share by lowering price (sacrificing some profit), then the other competitors match price, then the price holds. This continues until only the competitors that have the lowest cost structure and/or profit requirements can afford to remain in the market.
During the decline stage, competitors are generally attempting to squeeze out the last bit of profit before a product becomes obsolete. Some firms stubbornly continue to cling to a historical product in order to cover capital expenses for producing it while others plan a clean exit from the market, liquidating inventories and re-gearing production capacity toward newer or more profitable product lines.
Pricing Practices
A few other practices are detailed (EN: seems like odds and ends).
In some instances, a price is set that is higher than the market will bear, with the plan of offering incentives to customers. Some of the reasons for offering incentives are:
- A psychological benefit (customer feels they are getting a special deal)
- An incentive to pay bills promptly (particularly wholesalers offering a discount for prompt payment)
- Cost incentives for intermediaries (bulk discounts , co-op advertising dollars, stocking fees, etc.)
- An incentive to make a purchase at a specific time (a seasonal "sale")
- Cost of ancillary services that are provided (including trade-in discounts)
- Cash rebates to consumers
- Pricing that accounts for the cost of shipping and delivery
- Promotional pricing to attract buyers (for various reasons, including introducing a new product, liquidating old inventory, etc.)
Regulation of Pricing
Government regulations periodically impact pricing decisions. In general, regulators have to purposes in mind: to ensure that suppliers are not colluding and to protect consumers against unfair trade practices.
(EN: I would add that these are the two legitimate purposes. Politicians often use their power to influence pricing to gain political support from voters or by levying additional taxes on certain products to generate revenue. There is no end to the influence/damage that a political body can do to the economy by interfering in the markets.)
The author refers to then Sherman Act of 1890 as the first major foray into the market, which was an early attempt to prevent monopolies from forming without government consent. Later, the Federal Trade Commission was established to provide greater control.
Some of the practices forbidden by law are:
- Price-fixing (colluding with competitors to set a price)
- Predatory pricing (selling at a loss to drive competitors out of business)
- Price gouging (charging an inflated cost in times of shortage)
- Price discrimination (based on race, gender, age, or certain other factors)
The author says a bit more on the last topic, in terms of indicating that price discrimination by other factors may be completely ethical or legal. In general, the FTC will abide charging different prices to different customers if the vendor can provide an objective reason for doing so.