Pricing
Read the following text and decide whether the following statements are true or
false.
Companies' pricing decisions depend on one or more of three basic factors: production
and distribution costs, the level of demand, and the prices (or probable prices) of current
and potential competitors. Companies also consider their overall objectives and their
consequent profit or sales targets, such as seeking maximum revenue, or maximum market
share, etc. Pricing strategy must also consider market positioning: quality products
generally require "prestige pricing" and will probably not sell if their price is thought to be
too low.
Obviously, firms with excess production capacity, a large inventory, or a falling market
share, tend to cut prices. Firms experiencing cost inflation, or in urgent need of cash, tend
to raise prices. A company faced with demand that exceeds its possibility to supply is also
likely to raise its prices.
When sales respond directly to price variations, demand is said to be elastic. If sales remain
stable after a change in price, demand is inelastic. Although it is an elementary law of
economics that the lower the price, the greater the sales, there are numerous exceptions.
For example, price cuts can have unpredictable psychological effects: buyers may believe
that the product is faulty or of lower quality, or will soon be replaced, or that the firm is going
bankrupt, etc. Similarly, price rises convince some customers that the product must be of
high quality, or will soon become very hard to get hold of, and so on!
A psychological effect that many retailers count on is that a potential customer seeing a
price of £499 will register the £400 price range rather than the £500. This technique is known
as "odd pricing".
Obviously most customers consider elements other than price when buying something: the
"total cost" of a product can include operating and servicing costs, and so on. Since price
is only one element of the marketing mix, a company can respond to a competitor's price
cut by modifying other elements: improving its product, service, communications, etc.
Reciprocal price cuts may only lead to a price war, good for customers but disastrous for
producers who merely end up losing money.
Whatever pricing strategies a marketing department selects, a product's selling price
generally represents its total cost (unit cost plus overheads) plus profit or "risk reward".
Overheads are the various expenses of operating a plant that cannot be charged to any one
product, process or department, which have to be added to prime cost or direct cost which
covers material and labour. Cost accountants have to decide how to allocate or assign
fixed and variable costs to individual products, processes or departments.
Microeconomists argue that in a fully competitive industry, price equals marginal cost
equals minimum average cost equals breakeven point (including a competitive return on
capital), and that a company's maximum-profit equilibrium is where extra costs are
balanced by extra revenue, in other words, where the marginal cost curve intersects the
marginal revenue curve. In reality, many companies have little idea what their optimal price
or production volume is, while most microeconomists are happier with their models than
actually talking to production managers, marketers or cost accountants!
EXERCISE 1
1. There are three basic factors potentially involved in all pricing decisions. TRUE/FALSE
2. When pricing a product, companies have to think of potential as well as existing
competitors. TRUE/FALSE
3. You are unlikely to sell high quality products at a low price. TRUE/FALSE
4. When demand exceeds supply, a company nearly always increases its prices.
TRUE/FALSE
5. A company faced with rising costs has to increase its prices. TRUE/FALSE
6. A company can only change a price if it is "inelastic". TRUE/FALSE
7. Pricing is often strongly influenced by psychological factors. TRUE/FALSE
8. A company can respond to competitors' price cuts by changing different elements of
the marketing mix. TRUE/FALSE
9. Prices generally take into account both direct and indirect costs. TRUE/FALSE
10. In theory, a product's price should equal its marginal cost and the company's
breakeven point. TRUE/FALSE
EXERCISE 2
Now complete the following word partnerships from the text:
1. Breakeven ___________
2. ___________capacity
3. Distribution ___________
4. ___________targets
5. ___________ positioning
6. ___________share
7. Odd ___________
8. Prime ___________
9. ___________ accountant
10. Variable ___________
Which of these three summaries most fully and accurately expresses the main ideas
of the text on pricing?
First summary
The prices companies charge for their products depend on many factors: their costs, the
level of demand, competitors' prices, financial targets, marketing strategies, market
positioning, production capacity, inventory size, inflation, and so on. Yet pricing strategies
are often unsuccessful because of the unpredictable psychological reactions of
customers. Consequently companies often concentrate instead on other elements of the
marketing mix: product improvement, service, communications, etc. Even so, companies
have to make sure they cover direct costs and overheads. This usually results in a price that
equals both marginal cost and breakeven point.
Second summary
The most important factors in pricing decisions are production costs (including overheads),
the level of demand, and the going market price. Yet broader company objectives, and profit
or sales targets, and market positioning, are also important. There are also lots of
circumstances that might cause companies to change their prices: excess production
capacity, large inventories, or a falling market share on the one hand, or cost inflation, an
urgent need for cash, or demand that exceeds supply, on the other. Yet perfectly logical
decisions regarding prices thought to be elastic can have unpredictable psychological
effects. It is also clear that customers are influenced by elements other than price, so
companies can equally modify other elements of the marketing mix. In a competitive
industry, price is generally not much greater than marginal cost and breakeven point.
Third summary
Companies' pricing decisions generally depend on factors such as production and
distribution costs, consumer demand, and competitors' prices. Yet a company's overall
objectives and profit or sales targets are also important. Of course there are situations in
which a company will raise its prices (e.g. excess production capacity, a large inventory, or
a falling market share) or lower them (e.g. excessive demand, cost inflation, a cash
shortage). In general, the lower the price, the greater the sales. Companies take account of
psychological effects and use techniques such as odd pricing. Companies can also change
other elements of the marketing mix, especially if this allows them to avoid a damaging
price war. Whatever happens, companies generally have to cover a product's total cost and
make a profit. This is difficult in a competitive industry, as here price will only equal
breakeven point.
