Four Questions to Ask Before Making Product Pricing Decisions
It is never easy deciding what to charge customers for your product or service, but it's something that has to be done. After all, price is the only one of the four major marketing mix elements (product, price, place/distribution, and promotion) that brings in revenue. All the other elements represent costs/expenses.
In this Hub, I'm taking a look at price and some of the main factors that should be considered by marketers as they prepare to make pricing decisions. Four questions, specifically, will be addressed in this Hub:
1. What is price?
2. Is there a single "most important factor" affecting pricing decisions?
3. In addition to costs, what other internal considerations are vital to understanding how to set product prices?
4. What Is dynamic pricing and why is it important in today's marketplace?
Who Is Responsible for Setting Prices?
Type of Company
Pricing is Usually Set By:
Small-to-Medium Sized Company
Divisional or Product Line Managers (or Pricing Department, if pricing is a key factor)
Members of the sales force may be allowed to negotiate with customers.
Throughout most of history, the pricing of products and services was something that was set by negotiations between buyers and sellers. Today, however, most prices are fixed. That is, there is one "fixed" price for all buyers. Although this pricing model has been around a while, it is a relatively modern idea that came about when large-scale retailing emerged at the end of the nineteenth century.
#1. What is Price?
As consumers, when we think of "price," we think about the amount of money being charged, or the amount we end up paying, for a product or service. For marketers price is the monetary or non-monetary consideration that is exchanged for a product or a service. The consideration is something of value that transfers ownership, and it is the basis of all commercial transactions.
A lot of marketing executives view pricing as a problem, perhaps because a lot of companies do not handle pricing well. A common problem is that companies, in order to get a fast sale, are rather quick to reduce prices. Marketing executives, on the other hand, would rather convince buyers that their products are of such quality that they justify being sold at a higher price.
These executives often feel that being too cost oriented is a mistake, and that it would be better for the manufacturer to be more customer-value oriented. In either case, the pricing of products and services must take into account the other elements of the marketing mix (product, place/distribution, and promotion).
#2. Is There a Single "Most Important Factor" Affecting Pricing Decisions?
Most marketers, if they had to say there is a single most important factor that must be taken into consideration when making pricing decisions, would utter one word: Costs. All the costs involved in delivering a market offering (whether it is a product or a service), must be the foundation of pricing decisions. What it costs you, the marketer, to bring the offering to customers--that is, the sum of both overhead or "fixed costs," and variable costs (those that change based on different levels of production), has to be the "floor" from which pricing decisions begin.
Why Cost Must Be Considered
Pricing needs to be set to provide, for the company, an acceptable ROI (return on investment), and this can only be done after recovering the cost of producing, distributing, selling/promoting the offering. Depending on what it costs to produce the product/service (at different levels of production), the company will either accept lower profits, or set higher unit prices. Market share will be difficult and even costly to defend if there are viable competitive offerings being sold at lower prices.
It's important to note that average costs usually drop as manufacturers gain production experience. There is a "learning curve" associated with the production of every product, and as marketers learn more and more ways to cut costs while delivering the same quality and value to customers, the average cost of production usually falls.
Cost-Based Approaches to Pricing
The company's approach to pricing will be based on either costs or value. Cost-based pricing is internally driven, because it is product driven. Value-based pricing is the exact opposite because the company uses, to set its target price, externally driven customer perceptions of product value.
The simplest pricing method is called cost-plus pricing. It is done by adding a standard mark-up to the cost of the product. This method ignores demand and competitor's prices, and uses a formula to determine the price mark-up over costs. Markup pricing is popular for many reasons.
- Sellers are more certain about costs than about demand.
- By tying price to cost, pricing is simple and does not require frequent adjustments as demand changes.
When all firms in the industry use this cost-plus pricing, prices tend to be similar, and that minimizes price competition. This method seems fairer to both buyers and sellers, because are able to earn a fair return on their investment, and buyers aren't taken advantage of if/when demand increases.
Another cost-oriented approach to pricing is the break-even method. One form of this approach, called target profit pricing, allows the company to discover the price at which it will break even, and then begin making the target profit that's being sought.
#3. In Addition to Costs, What Other Internal Considerations Are Vital To Understanding How To Set Product Prices?
When setting prices for products and services, it is important to look at factors both internal and external to your company. At the end of this Hub is a link to another article where I look at external factors important to the making of pricing decisions.
Following are questions and answers related to some of the most important internal considerations.
What is the market "positioning strategy" for the product?
You need to know how you will position the product/service in the market before setting prices. Knowing your positioning strategy means you know not only who you are targeting (what group of consumers represent your best customer prospects), you also have determined how you want them to think about your product offering as compared to competitive offerings (that's positioning).
If your positioning strategy is in place, you should already know whether your product fulfills the desires/needs of those looking for a low-priced alternative, or those looking for a premium-priced market offering. The strategy you utilize in positioning your product will make it much easier to develop a pricing strategy.
What other marketing mix decisions have already been made?
Product design, distribution, and promotional plans will need to be considered when pricing decisions are being made for a new market offering. Decisions with regard to each of the other marketing mix variables will work to help determine the success or failure of the marketing program. For example, decisions made about product design will affect placement/distribution, promotional strategies used, and, of course, pricing decisions.
Some companies will sometimes take a somewhat different approach when it comes to pricing strategy. They will set a price for a product based on positioning strategy (covered next), and then will customize the other marketing mix variable (design and placement/distribution) to match what they have decided to charge.
"Non-price" factors, including product/service quality, placement/distribution, and promotional strategies all exert great influence on product pricing decisions. And, when price is major part of the positioning strategy for a new market offering, then pricing will exert great influence on the decisions made about non-price marketing mix elements.
Will the pricing strategy used help your company to maximize profits?
Current profit maximization is usually always any company's ultimate goal. For this reason, when it comes to pricing new market offerings, it is important to estimate both the anticipated consumer demand for the offering, and the costs involved in supplying the offering to the market. Might demand fluctuate if price was set at different levels? How will levels of pricing and consumer demand affect cash flow, return on investment, and company profit?
How will the price you choose affect market share?
With the new offering, are you hoping to become a "market leader" or a "premium quality" leader within the product/service category? If you're hoping the new offering will become a market leader, then you will need to use a strategy that allows you to set prices as low as possible. But, if premium quality leader is your goal, the cost of providing a higher quality product will necessitate setting prices higher.
What are some of the disadvantages of an “aggressive” pricing strategy as a competitive move?
While it might seem like a good strategic move to put all your eggs into the lower-price basket, doing so can risk making the market offering appear to be “cheap,” or of poor quality. Consumers are well aware of the old saying, "you get what you pay for." That's why it is important, if competing on price, that efforts are undertaken to make sure that prospective buyers are made aware of the quality of the product/service.
In addition, competing primarily on price, and not on product features/benefits or quality, might work only as long as competitors allow it to work. Remember, price is one of most flexible, and therefore most easily changeable, elements of the marketing mix. Competitors who desire to do so may find ways to lower their prices as well.
#4. What Is Dynamic Pricing?
"Dynamic" pricing is all about being flexible with pricing strategies. Price is one of the most flexible elements of the marketing mix, and smart Internet retailers use dynamic pricing as a way of adjusting and adapting pricing as they see fit. Dynamic pricing allows them to charge different prices for products and/or services, depending on individual customers and market situations.
E-commerce represents a vast market arena in which some very exciting things can happen, when it comes to pricing. Database technology equips the Internet for rapidly customizing and tailoring prices for consumer and business customers based on purchase history.
Supply and demand will always influence the direction (up or down) of price flexibility. And, since online retailers can gather supply/demand information rapidly, they can use the information they get to direct them as they change prices rapidly, to match current levels of supply/demand. Increases in demand call for increases in prices, and decreases in demand call for decreases in price.
Dynamic pricing offers marketers some advantages. Consumer and business product/service marketers can monitor inventories, costs, and demand for products and services, at any given moment, and then adjust prices instantly. The Internet allows marketers to utilize all kinds of simple or sophisticated databases and other tools to gauge a specific shopper’s propensity to buy, including past shopping behavior and product preferences.
Both buyers and sellers benefit from Web data collection. Sellers can use the information to offer products and prices that match a potential customer's profile. Buyers can use information they find to get the best possible price on any item they want to buy.
Thousands of Internet sites (priceline.com is a good example) offer "value pricing," providing updated product and price comparisons from thousands of vendors. In addition, for buyers, there are hundreds of online auction (ebay.com is a good example) or exchange sites that allow price negotiation.
The Hub's Author
Dr. Middlebrook is a former college professor of marketing and mass communications. She spent nearly twenty years behind the desk teaching courses in advertising, marketing, public relations, and journalism. In addition, she worked, for many years, as a consultant and as an employee in corporate marketing and communications.
© 2013 Sallie B Middlebrook PhD