35 Pricing: Factors affecting pricing

Rajwant Kaur

1. Learning Outcome

After completing this module, the students will be able to:

Understand the concept and objectives of pricing
Explain the process of pricing
Understand the factors affecting pricing decisions
Describe the significance of pricing

2. Meaning

Price can be defined as the monetary considerations asked for or exchanged for a specific unit of goods or services offering some utility. For consumers or buyers, the price is a package of expectations and satisfactions. According to some authors, for consumers, price means a sacrifice of purchasing power as amount spent on purchasing one product will not be available for something else.

Role of price is important in production, exchange, consumption and distribution. Price is the base for consumer decision-making. Consumers compare the prices (among other things like product features) of alternative items and make a final choice.

Pricing is the act of determining product value in monetary terms before it is offered for sale. Prof. K C Kite defined pricing as a managerial task involving pricing objectives, identifying the factors influencing price, asserting their relevance, determining product value in monetary terms and formulating pricing policies and strategies.

Pricing decision is important as price of the product affects producers, sellers and consumers. Price is important variable as it determines firm’s sales volume, sales revenue, profitability and return on investment.

3. Pricing Objectives

Pricing of products cannot be done unless pricing objectives are set. These objectives act as benchmark for fixing price, framing policies and formulating strategies. These objectives also act as standards for measuring managerial performance in crucial areas. The pricing objectives should be consistent with the overall organizational objective and compatible with prevailing external environment. The firms can have variety of pricing objectives. However some of the common pricing objectives are described as below:

Profit Maximisation : This is the most common objective of every firm. Firms want to maximize profit through price under given set of marketing conditions. However, it can be a long term objective as in short run and in initial stages of product life cycle, profit maximisation objective can not be achieved. In the short run, some tactics including cut in prices may be required to increase sales or capture more market which will help in maximizing profits in the long run. In initial stages of product life cycle, market penetration is necessary which is possible only with low prices. Further, profit maximization objective is not set in relation to single product only but to whole product line.
Market Share : A firm may aim to achieve a particular market share called as target market share by using price as an input. Target market share, usually expressed as a percentage, implies that portion of industry sale which a firm wishes to attain. Market share as pricing objective is important for firms in developing countries as in such countries market share acts as a barometer for measuring economic development. Price is an important variable to increase or maintain market share but sometimes it is used to reduce market share so as to restrain a firm from becoming a ‘dominant undertaking’ under MRTP Act 1969. Thus, market share as pricing objective is important for firms desiring to attain a target market share.
Target return on investment : The pricing objective of the firm may be to achieve a certain rate of return on capital employed over a period of time. For this, prices are so fixed that overall sales revenue generated during the financial year will become sufficient enough to cover total cost and provide desired return on investment. This objective is relevant for firms which are selling in markets where currently there is little or no competition.
Meeting or Preventing Competition : The firm may aim at meeting competition or preventing the competition through the instrument of price. The objective of meeting competition is set by firm who is not price leader. Such firm will set prices at par or little less than the competitors to neutralize the competitive impact. On the contrary, the objective of preventing competition is set by the firm who has substantial control in the market and wants to restrict the entry of competitors by making drastic price changes. However, such practice is restrictive trade practice. Therefore, generally firms do not clearly set it as objective but their actions show their such intentions.
Resource mobilisation: Generating funds for expansion or development purpose can be another pricing objective. In such cases, prices will be fixed in such a manner that sufficient resources are made available for the desired purpose. Prices will be deliberately set high. Public sector undertakings usually have this pricing objective.
Maintaining the loyalty of middlemen : The pricing objective may be to maintain loyalty of middlemen in the chain of distribution. This is done by fixing price in a way that it will leave sufficient margin for middlemen. The price structure which will allow huge trade discounts will boost the morale of middlemen and they will be motivated to sell more of firm’s brand.
Enhance the image of firm : The firm may aim to maintain or enhance its image through correct pricing. The firm with reputation may sell high quality product at high price due to customer’s perception of reliability, better quality and better service. Thus, prices are set high for standardized and branded products ensuring same or higher level of customer satisfaction every time. This enhances the reputation of firm.

4. Pricing Procedure

After laying down the objectives, the price of the product is determined. It is the base price which is set initially and quoted to buyers. This price is subject to changes as per policies and strategies of firm to meet specific market situation. The pricing procedure consists of the following steps:

(i) Collecting the necessary information: First of all, a strong and upto date information base is developed to take an effective decision regarding price. Information about cost of production, government regulations, collaboration arrangements and industry practices is collected. The cost of production indicates the expenses incurred to make the product. Obviously the price should not be fixed below cost. It will lead to losses to firm. The price control measures of government should be studied. Upto date information about various laws affecting price or seller’s pricing policies is of utmost importance and needs to be collected. Restrictions imposed by foreign collaborators of the firm are required to be thoroughly studied. Sometimes agreements with suppliers also affect pricing decisions. So these should be considered to create a sound information base. Further, it is equally important to have knowledge about practices and methods of pricing adopted by other members of industry.

(ii) Selecting the target market: It is important to select the market where marketing manager wants to sell the product. The paying capacity, willingness to pay, buying pattern, buying motives, price sensitivity and attitude about firm of customers / consumers in the target market affect the pricing decision.

(iii) Estimating demand : Next step, is to estimate the demand of the product. For this, there is need to know the expected prices for which survey may be conducted of competitors’ price, potential buyer or even test marketing can be initiated. Then, there is need to determine the sales volume at different prices. So demand schedule is developed which indicates demand as reflected in sales volume at different prices. Thus, sales forecasts, intermediaries’ opinion and degree of market competition will help in determining total demand.

(iv) Anticipating competitive reaction : It is essential to anticipate the reaction of competitors at present and in future as it has great impact on pricing decision of the firm. The firm may face competition from similar products like car manufacturer faces competition from other car manufacturer; from close substitutes like motorcycle manufacturer face competition from scooter manufacturer; or even from unrelated product seeking same consumer’s disposable income.

Competitors’ reaction may be instant or delayed. In instant reaction, competitor changes price quickly so as to be at par with the firm or capture a large market share. In delayed reaction, competitor watches the market reaction and then reacts if he seeks any opportunity or feels threat.

To know the competitors’ reaction, it is essential to collect information about competitors regarding their cost structure, production capacity, market share, promotional strategies and various marketing policies.

(v) Understanding the internal environment: The next step is to study and understand the internal environment of the firm in terms of labour relations, production capacity, contracting facilities, ease of expansion and supply of inputs. Sometimes, inefficiencies in internal environment lead to more wastages or increased overheads due to idle plant, idle labour or penalties etc. These inefficiencies result in increased cost of production per unit. So prices are to be fixed higher in such circumstances to cover the cost.

(vi) Considering components of marketing-mix: In this stage, there is need to consider the other components of marketing mix such as product, distribution channels and promotion for determining price. The price of the product is influenced by the degree of perishability of product. Faster the perishability of product, lower will be the price. Thus, price is affected by nature of product i.e. whether product is durable or perishable, old or new, consumer product or industrial product. Apart from this, strength, composition and quality of product do affect its price.

The length of distribution channel affects the pricing decision. Longer channel would require higher list price so as to provide a sufficient margin for middlemen.

Likewise, more promotional efforts would require higher price to cover promotional expense.

(vii) Selection of pricing policies and strategies : Pricing policies and strategies provide guidelines for setting as well as varying the prices as per specific market need. There are number of pricing policies available and a firm can choose suitable policies. Keeping in mind the pricing objectives, a suitable pricing strategy should be selected. Skimming pricing strategy is characterized by high prices. It can be used if the new product is distinctive and consumers are not price sensitive. Penetrating pricing strategy is characterized by low initial prices. It can be used if consumers are price sensitive or there is possibility of high competition.

(viii) Price determination : For determining the price, the management should use all decision inputs and determine a suitable price. The price may be determined on the basis of cost of production, competitive prices or forces of demand and supply. It is necessary that the price should be checked against pricing objectives to determine the consistency of price with pricing objectives and narrow down their difference. It is also desirable to test market validity of price through test marketing for its wider acceptance in actual market.

Before quoting the price as list price to consumer, a feedback of consumers’ reaction (in test market) and intermediaries’ reaction should be taken and accordingly a realistic price should be fixed and quoted.

5. Factor Affecting Pricing Decisions

Pricing decisions play a significant role in designing marketing mix. These decisions interconnect marketing actions with financial objectives of the company. Marketing manager decides the price of the product keeping in mind the impact of various internal and external factors. Internal factors are within the control of marketing manager, however, he has no control over external factors.

Various internal and external factors which impinge on the pricing decisions of a company/firm have been described as follows :

I. Internal factors : Internal factors affecting pricing decisions include cost of production, pricing objectives, product life cycle, marketing mix, pricing policies and product differentiation. A brief explanation of these factors is given as follows:

Pricing Objectives : A company lays down objectives which act as benchmarks against which the prices are fixed. These act as standards. So every pricing decision should consider various pricing objectives of the company which may be price stability, sales maximization, profit maximization, increased market share, meeting competition or earning a target rate of return. Prices should be fixed in such a way that pricing objectives are achieved as far as possible.
Cost of Production : Cost is an important consideration while fixing the price of product. Both cost and price have a close relationship. Many companies use cost plus method. While some companies use demand or competition based method for price fixation. Whatever may be the method of pricing, the aim should be to cover the cost of production and make some surplus. Therefore, product cost should be given due consideration at the time of determining its price.
Product life cycle: Every product passes through different stages i.e. introduction, growth, maturity and decline. Each stage of product life cycle has a great influence on pricing decisions. Prices should be consciously decided during each stage to achieve marketing objectives.

In the introductory stage, the prices are fixed low so that product can easily enter the market. During growth stage, the prices can be raised to some extent.

As the product reaches maturity stage, attempt is made to keep the same prices or lower down the prices to meet competition. In the declining stage, there is cut in prices to maintain demand.

However, in case of innovative products, high price can be fixed at the introductory stage which will be lowered down in subsequent stages of product life cycle.

Marketing Mix : Marketing mix is an effective blend of product, price, place and promotion. These four elements are well co-ordinated in marketing programme to have synergic effect. Price is an important component of marketing mix. Pricing decision will definitely have bearing on other elements of marketing mix.

An organization can raise price of product if it wishes to generate more funds or it can cut down price in case it wants to attract more customers. Price change in either way will not bring fruitful results if such price decision is taken, in isolation, without considering it a part of total marketing programme. For effective results, price decisions should be coordinated with product, place and promotion decisions. For example, a firm wishing to increase price may add new features to the product or increase promotional expenditure.

Pricing Policies : Pricing policies are the general guidelines which provide a framework to the marketing manager to fix prices in a way that will match market needs. Policies act as guide to thinking. So due to this obvious reason, pricing decisions should be taken as per the pricing policies of the organization.
Product differentiation : Product differentiation is the ability of manufacturer to create distinctiveness of product through design, shape, package, colour or brand name. Product differentiation allows a marketer to fix higher price when it is done better than competitors. Especially, product differentiation is good weapon in hands of manufacturers of consumer goods. They can set higher price for their unique product, better quality or attractive package. Customers are willing to pay more price for highly differentiated product.

II. External Factors : These are the factors which are beyond the control of company but have significant influence on its pricing decisions. These factors need careful analysis and interpretation. Some of the important external factors are described below :

Competition : No organisation can remain unaffected by its competitors. It has to plan its move and counter moves as per the level of competition prevailing in the market unless it has monopoly.

Competition affects the pricing decisions of management. Management has to consider the pricing policies, objectives, strategies, strengths and weakness of competitors while determining price of the product. The level of competitors’ reaction to particular price is also assessed while fixing price. Thus, prices are fixed high, low or same as that of competitors’ price depending upon the nature and intensity of competition. In monopolistic conditions, prices are determined by keeping in mind the competition with that of substitute products.

Economic conditions : Inflationary or deflationary conditions prevailing in the economy affect the pricing decisions. During inflation, high prices are fixed to meet the rising costs. In boom period, the prices are increased to cover increasing distribution and promotion cost and to earn sizable profit. However, during recession period, prices are reduced to a considerable extent.
Government regulations : Government regulations influence the pricing decisions of a firm. The firm has to set prices within the framework of government regulations. In case prices are fixed by government, it has no choice than to accept it. The Government has framed laws to restrict monopoly and unnecessary price hikes. Thus a firm cannot fix higher prices at its own.
Distribution Channel : The use of intermediaries (wholesalers, retailers, distributor, sole agent) for distribution of goods is an important factor that influences pricing decisions. Intermediaries facilitate the flow of goods from manufacturer to final consumer. They are rewarded with commission or trade discounts. To cover this commission or trade discounts, high prices are fixed. Thus, pricing decisions are affected due to channel structure. Longer the channel of distribution (distributor, wholesaler, retailer), higher will be the price and vice-versa. But it does not mean that shorter distribution channel should be used so as to fix low price of product. Rather a sound channel management is required.
Image of the company : Market image of an organisation in terms of reliability, quality, durability, after sale services, product mix and technology affects its pricing decisions. An organisation enjoying better image among customers can fix higher price as the customers will be willing to pay higher price for perceived better quality or better services of the organisation.
Consumer behaviour : Buying pattern of consumer has impact on pricing decision of an organisation. If consumers buy the product frequently, lower price may be fixed. It will result in more sales and high overall profit.
Composition and strength of buyers : Organised buyers have influence on the pricing decisions of an organisation. If the buyers are large in number but unorganized, they will do little to influence price. However, few buyers who place large orders or are large users will have impact on the pricing decisions. The pricing decisions are also affected by the composition or class of consumers i.e. industrial users or house hold users. The price will be different for both classes of consumers.
Suppliers : The price of product is directly affected by cost of raw materials or various fabricated parts. Obviously, the suppliers of these inputs will influence the pricing decisions. If suppliers raise the price, the manufacturers are forced to raise the price of final product.
Elasticity of demand : Price elasticity of demand has considerable influence on pricing decision. Price elasticity of demand implies a relative change in demand due to change in price. If the demand of product is elastic, then a firm has to fix lower price. On the contrary, if demand is inelastic, higher price may be fixed as customers are not sensitive to price.

6. Role of Pricing

Pricing is important marketing function and it affects consumers, middlemen and manufacturers. Proper pricing contributes to the success of marketing strategy. Pricing helps in number of ways as discussed below:

Regulating demand: Price is used as an instrument to influence and regulate demand. In case of surplus production, price may be reduced to create more demand. Similarly, when there is insufficient production, price may be increased to discourage demand. In developing countries, price plays a special role in regulating demand.
Facing competition : Each firm in the market is affected by moves or actions of its rival firms. When rival firms use tactics such as price reduction to capture more market share, the firm has to react to such situation to stay in market. Price reduction or adjustments in price structure are made to meet competitive manoeuvres.
Increase in profitability : Price affects the profitability of a firm through sales revenue. It is used as a weapon to increase profitability. In case of competition, a small change in price may result into increased profitability provided other things remain constant.

Summary

Price can be defined as the monetary considerations asked for or exchanged for a specific unit of goods or services offering some utility. Pricing is the act of determining product value in monetary terms before it is offered for sale. Pricing decision is important as price of the product affects producers, sellers and consumers.

Pricing of products cannot be done unless pricing objectives are set. These objectives act as benchmark for fixing price, framing policies and formulating strategies. Common pricing objectives of different firms can be profit maximization, target market share, target return on investment, meeting or preventing, competition, resource mobilization, maintaining the loyalty of middlemen and enhance the image of firm. After laying down the objectives, the price of the product is determined. The price determination process consists of the various steps such as (i) Collecting the necessary Information (ii) Selecting the target market (iii) Estimating demand (iv) Anticipating competitive reaction (v) Understanding the internal environment (vi)Considering components of marketing-mix (vii)Selection of pricing policies and strategies and (viii) Price determination.

Pricing decisions play a significant role in designing marketing mix. These decisions interconnect marketing actions with financial objectives of the company. However, these decisions are affected by various internal and external factors like pricing objectives, cost of production, product life cycle, marketing mix, pricing policies, product differentiation, competition, economic conditions, government regulations, distribution channel etc. Pricing is important marketing function. It helps in regulating demand, facing competition and increasing profitability. Hence, pricing decisions should be taken very carefully by considering various factors to achieve desired results.

Learn More

Few important sources to learn more about pricing methods and strategies:

Baker,J.Michael (2000). Marketing Strategy and Management, Macmillan Press Ltd., London
Bearden, Ingram, Laforge (1995). Marketing: Principles and Perspectives, Irwin Inc.
Blois Keith (2000). The Oxford Textbook of Marketing, Oxford University Press Inc., New York
Gandhi,C J (1998). Marketing- A Managerial Introduction, Tata McGraw Hill, New Delhi
Kotler, Philip; Keller, Kevin; Koshey, Abraham; and Jha Mithileshwar, (2009). Marketing Management: South Asian Perspective. 13th Edition. Pearson Education, New Delhi.
Nagle, T.T. and Holden, R.K.(1995). The Strategy and Tactics of Pricing:A Guide to Profitable Decision Making, (Englewood Cliffs, NJ: Prientice-Hall)
Sherlekar,A.S.(2006). Marketing Management, Himalaya Publishing House, Mumbai
Still, Cundiff and Govoni. Sales Management: Decisions, Strategies and Cases, 5th Edition, Prentice Hall of India Private Limited, New Delhi.

Points to Ponder

Administered price is the price set by marketing manager or authorized company official.
Regulated price is the price set as per government regulations.
Strategy is a competitive policy.
A firm can choose high price strategy or low price strategy as per the nature of product, its distinctiveness and other prevailing conditions.