Price: Meaning, Role, Steps of Price Setting Process

price meaningPrice is the sacrifice made by the consumers to get an item. They are very sensitive to what they sacrifice for a product. In price setting, marketers should consider consumers’ ability to pay, the demand for the product that exists, the cost involved in producing the item, and the costs, prices, and offers of their competitors.

Meaning of Price

The price is what the consumer must give up to get the product. It is a representation of value placed on the product for purposes of exchange. Partially, this value is established by the marketing executive. Marketers incur certain costs in making, handling, storing, and selling the product.

These costs are usually covered in the selling price except for certain expectations. Marketers seek some extra compensation over the actual costs, so they make some profits. Costs and profit expectations, then, become the value the marketing executive places on the product.

The marketer does not always set the value of the product. Buyers as well help determine value through their purchasing patterns. Buyers allocate their funds to the goods and services that maximize their short and/or long-run benefits.

Buyers thus, place a trade-off value on the company’s product by weighing the benefits of having the item against the cost of foregoing the purchase of other products or retaining their money.

The product’s price will be balanced between the seller’s value and the buyer’s trade-off value. Where these two are similar, the price will be appropriate. If they do not match, some changes in values must occur, or the product will fail in the marketplace, i.e., it will not sell well.

The nature of the value of the product determines the price related problems. In addition to the costs, the seller’s expectations of profit and the buyer’s trade-off values are variables.

Not all sellers have the same profit expectations, and not all buyers have the same perception of the benefits of having the product versus holding money or purchasing another product.

Generally speaking, a product’s price reflects the personal values of the seller and buyer. Specifically, the price has a somewhat different role, acting as a technical mechanism for negotiations between individuals and groups of individuals who have goods, services, or money to trade.

Price is the common denominator allowing sellers and buyers to make evaluations and complete their exchanges.

As a marketer, you should be in mind that price is a means for allocating the nation’s scarce resources. Raw materials, products, and services in relatively short supply tend to be more highly valued than those readily available. Through the pricing system, sellers and buyers can better arrange their priorities and better utilize the economy’s resources.

Price is a highly significant marketing variable that is directly affecting the company’s sales and profits. Price also has considerable symbolic value, conveying information about the company to potential buyers.

A marketer should realize that the prices of his products heavily influence his sales and profits. An increase or decrease in price can mean higher or lower revenues.

This assumption is not always realistic since price changes alter the buyer’s cost-benefit trade-off. Generally, when the price increases, consumer demand falls, and vice versa. But total taka sales can increase even though demand declines.

Similarly, total taka sales can rise when prices decline, and consumer demand greatly increases. Though consumers are sensitive to price changes, the degree of sensitivity depends on many factors such as consumer’s financial status, availability of new products, etc.

The price set by the marketing executive is also important as consumers relate a product’s price to such factors as quality, progressiveness, and social status, psychological satisfaction, and so on.

They usually equate higher prices with better quality, modern, and more fashionable products. This image carries over to a company’s other products and the company itself, affecting the company’s future.

Price Setting Steps – Stages for Establishing Prices

We have already examined the nature and importance of price. It is now time to move on to the stages followed in price setting. Setting price for the first time is a real challenge to a firm, and it faces this situation when it plans to launch a new product or introduce an existing one into a new distribution channel or area, or participates in a bid.

In setting its pricing policy, a firm must consider several factors and proceed following a logical process consisting of seven steps.

  1. selection of pricing objective;
  2. assessment of the target market’s evaluation of price and its ability to purchase;
  3. determination of demand;
  4. analysis of costs;
  5. analysis of competitors’ costs, prices, and offers;
  6. selection of a pricing method; and,
  7. determination of a specific price.

The following figure shows the stages involved in price setting.

price setting steps

1. Pricing objectives

Pricing of goods and services is often a critical factor in the successful operation of business organizations.

Although the basic pricing ingredients (costs, competition, demand, and profit) are the same for all firms, the optimum mix of these factors varies according to the nature of products, markets, and corporate objectives.

The manager’s job is to develop and implement a pricing strategy that meets a particular company’s needs at a certain point in time.

Many different ways of handing prices are observed.

Prices are often set by top management rather than by marketing or salespeople in smaller companies. In comparison, division and product-line managers handle larger companies’ prices following the top management’s general pricing policies and objectives.

Selecting the pricing objective means deciding in advance what the company wants to achieve through offering its product. The marketing mix strategy, including price, becomes easier if the company can select its target market and correctly position it.

A firm can easily set the price of its product if it can clearly set its objectives. Pricing objectives are overall goals that describe the role of price in an organization’s long-range plans. Pricing objectives will influence decisions in most functional areas.

The objectives must be consistent with the organization’s overall objectives. Because of the many areas involved, a marketer often uses multiple pricing objectives. Here we shall look at some of the typical pricing objectives pursued by the marketing executives.

One of the six major objectives can be pursued by a firm through its pricing, such as survival, maximum current profit, maximum sales growth, product quality leadership, maximize current revenue, or maximum market skimming.

Survival

A fundamental pricing objective is to survive. Most organizations will not tolerate short-run losses, internal upheaval, and almost any other difficulties necessary for survival.

Since price is such a flexible and convenient variable to adjust, it sometimes is used to increase sales volume to match the organization’s expenses. If a company is plagued with overcapacity, intense competition, or changing consumer wants, it can pursue the survival objective. It is a short-run objective pursued by different companies to ensure survival.

Companies here cut prices without considering profit margin to cover variable costs and some fixed costs to sustain.

Maximum Current Profit

It is another pricing objective being pursued by many companies, and they set a price that guarantees a maximum current profit.

This objective does not always guarantee a maximum profit, particularly in the long run, because it overlooks the effects of other marketing mix variables, legal restraints on price, and competitors’ reactions. The other problem associated with it is that a company set price here, considering the demand and cost functions, which can hardly be estimated accurately.

Maximum Sales Growth

Pursuing this objective means setting prices at the lowest level to ensure maximum sales to lower unit costs, thus maximizing long-run profit.

This can also be termed as market-penetration pricing, and consumers are here thought of as highly sensitive to prices. To pursue this strategy, three conditions must prevail.

The market is price-sensitive. Market growth is stimulated by low price; accumulated production experience reduces production and distribution costs; actual and potential competitions are discouraged by the low price.

Product-Quality Leadership

A company might have the objective of product quality leadership in the market. If a company aims to be the product-quality leader in the market, it can pursue this pricing objective.

Here the company sets prices at a higher level (compared to competitors) to give the market an idea that its product is superior in quality, durability, functional performance, etc. (it obviously produces a high-quality product).

The price is also charged high here to cover high product quality and high research and development costs.

Maximize Current Revenue

Here the price is set based on the demand function to maximize sales revenue. It is hoped that market share growth and profit maximization will be achieved in the long-run if this objective is pursued.

Maximum Market Skimming

In this objective, the price is set at a high level. This objective is pursued, particularly in new or innovative products hoping that some segments will buy the product because of the newness, even paying a higher price.

When these segments become sour, the company will lower prices to attract new segments and follow the same method as long as it is sold and thus skims the market.

Under the following conditions, the market skimming strategy works:

  • If a sufficient number of buyers have a high current demand.
  • If the unit costs of producing a small volume are not so high, they cancel the charge of charging what the traffic will bear.
  • If the high initial price does not attract more competitors to the market.
  • If the high price communicates the image of a superior product.

Other Pricing Objectives

There are some other pricing objectives, some of which are followed by business organizations and others by nonprofit, social, or public organizations.

They are: achieve a target market share, achieve a target return on investment, maximize cash flow, meet or prevent competition, stabilize prices, support other products, partial cost recovery (may be pursued by an educational institution), full cost recovery (may be pursued by a nonprofit maternity clinic), and social price geared to the varying income situations of different clients (may be pursued by a nonprofit theatre company).

Let us now have a short discussion on them:

Achieve a Target Market Share

Here, the marketing executive will estimate the total market potential and determine what share the product should obtain given the competition. The executive will then estimate how high (or low) the price should be set to achieve that market share.

Achieve a Target Return on Investment

A more realistic pricing objective is achieving a target return on investment. Here, the marketer first determines the total costs of making and selling a certain number of units, including variable costs and the fixed costs.

Thereafter, he decides on the desired return on that investment. From that point, the executive will calculate a price that will yield that level of profitability.

For example:

Total cost to produce and sell 1,000,000 units = $1,000,000
Desired return on investment =  15%
Target profits = $150,000
Selling price per unit (for 1,000,000 units) = $1.15

Maximize Cash Flow

Under this objective, the marketing executive may decide to price the product to maximize the cash flow. It is assumed that sales are synonymous with cash. But in many instances, purchases are made on credit.

If a company must pay its supplier before its customers pay, cash inflows will be slower than outflows of cash. To eliminate this problem, the marketing executive may have to induce consumers to either pay in cash or pay sooner than otherwise.

Here, a marketer can make the cash price more attractive to buyers than a credit price or what is available from other sellers.

Meet or Prevent Competition

There is a situation where a marketer may be more concerned about the competition in the marketplace than with the actual performance of the product.

In such situations, he may price the product to nullify price as a marketing variable or discourages potential competition from entering the marketplace.

Stabilize Prices

Here a marketer tries to create a consistent price for the product so that both the executive and potential buyers will know what price to expect and plan for.

To stabilize prices, the marketing executive will generally meet competitive price changes as they occur, reducing the benefits of price modification and resulting in a more stabilized price, which may help him to retain his customers.

Support Other Products

There are situations where a marketer will use a product as a loss leader in which a loss is taken on the product to enhance sales and profits of other products within the mix of the company’s products. He may do this with the hope of maximizing total company profits rather than profits for individual items. This objective is found to be effective when great consistency exists within the product mix.

2. Assessment of Target Market’s Evaluation of Price and Its Ability to Purchase

Although it is assumed that price is a significant issue for customers, the price depends on the type of product and the type of market the company targets.

By assessing the target market’s price evaluation, a marketer is better positioned to know how much emphasis to place on price. Information about the target market’s price evaluation may also help a marketer determine how far above the competition a firm can set its prices.

Understanding buyers’ purchasing power and knowing how important a product is to them compared to other products helps marketers assess the target market’s price evaluation accurately.

3. Determination of Demand

The level of demand for a product depends on the price set levels, thus having different impacts on the concerned firm’s marketing objectives. We can understand the relationships between price and demand through the demand schedule.

The demand schedule tells us how much a product will be demanded (sold) at various prices. It is known that the price-quantity relationship is inverse except for a few exceptions. That is, less will be demanded if the price is charged high, and more will be demanded if the price is charged less, which means that buyers are price sensitive.

In the case of specialty or prestige goods, a price increase may increase demand because buyers draw a price-quality relationship: they take the higher price to signify a better or more exclusive item. We shall now discuss the factors affecting the price sensitivity of buyers.

Factors Affecting Price Sensitivity

Nine factors affect price sensitivity, as identified by Nagle. They are:

  1. Unique value effect: When the product is considered more unique by the buyers, they will usually be less price sensitive.
  2. Substitute awareness effect: When buyers are less aware of substitutes, they are less price-sensitive.
  3. Difficult comparison effect: When buyers cannot easily compare substitutes’ quality, they are usually less price sensitive.
  4. Total expenditure effect: If the product’s expenditure is less than the ratio to buyers’ income, they are less price-sensitive.
  5. End-benefit effect: The less the expenditure is to the end product’s total cost, the less price-sensitive buyers are.
  6. Shared cost effect: When another party bears part of the cost, buyers are less price sensitive.
  7. Sunk investment effect: If the product is used in conjunction with assets previously bought, buyers will be less price-sensitive.
  8. Price-quality effect: When the product is assumed to have more quality, prestige, or exclusiveness, buyers are less price sensitive.
  9. Inventory effect: When buyers cannot store the product, then they are less price sensitive.

Methods of Estimating Demand Curves

Several methods can be used to measure the demand curve of a company’s product.

They are discussed below:

First, existing data on past prices, quantities sold, and other factors can be analyzed statistically.

Second, price experiments may be conducted either by estimating the demand curve based on in-store sales data of a product at various prices or selling products at various prices in various territories and see their effect on sales.

Third, buyers may be asked how much they will buy a product at various prices.

Price Elasticity of Demand

It is the relative responsiveness of changes in quantity demanded to changes in price. Price elasticity should be taken into consideration in setting prices.

If the change in price does not affect the demand position, we can call it an inelastic demand situation, and, elastic demand situation is where a slight price change considerably affects the demand position. A product, demand of which is elastic, marketers can ensure increased sales by lowering the prices.

The elasticity of demand depends on several conditions, and the demand for a commodity is likely to be less elastic if the following conditions are present:

  1. where the number of substitutes or competitors are few in number;
  2. where buyers do not readily notice the change (increase) in price;
  3. where buyers are relatively brand loyal; and,
  4. where buyers consider price increase as logical.

4. Analysis of Cost

In setting prices, a company considers its production, distribution, and other costs as demand elasticity.

To stay in business, a company has to set prices that cover all its costs.

Here we shall discuss;

  1. types of costs,
  2. cost behavior at different levels of production per period,
  3. cost behavior as a function of accumulated production,
  4. cost behavior as a function of the differentiated marketing offer, and,
  5. target costing, in understanding how costs are estimated.

Types of Costs

Costs are associated with the production of any good or service. Determining costs of production necessitates distinguishing fixed costs from variable costs.

The cost that does not vary with the quantity of production can be termed as fixed costs such as house rent, executives’ salary, etc. The cost of renting a factory, for example, does not change because production increases from one shift to two shifts a day.

Variable costs, on the other hand, are directly related to the quantity of production. They increase production and decrease with the fall of production, such as raw material cost. These costs are usually constant per unit. The average variable cost is the variable cost per unit produced.

It is calculated by dividing the variable costs by the number of units produced. Total costs are the sum of fixed and variable costs. In price fixation, a company normally charges a price that covers at least its total cost.

Cost Behavior at Different Levels of Production Per Period

Costs of production vary with different production levels because the utilization rate varies and fixed costs per unit also vary. Management should find the optimum production level to keep the fixed cost per unit at a minimum level.

Cost Behavior as a Function of Accumulated Production

A company’s per-unit production costs keep reducing as it increases its production up to a certain level because it accumulates experience as it progresses.

For example, if the company produces 50,000 units per unit, production cost maybe $15; if it produces 100,000 units per unit, production cost may come down to $12.

An experienced company may exploit this experience by reducing its price compared to competitors’ prices to drive a few of the competitors out of the race and significantly increase its market share.

Cost Behavior as a Function of Differentiated Marketing Offers

Since this is the era of extreme competition, companies try to satisfy their customers by fulfilling their requirements. It leads to the idea of offering different terms to different customers since they vary in their requirements, and as a result, marketer’s costs will differ with different customers.

Since marketers’ costs vary here, marketers should fix different prices for different customers, and in fixing prices here, they should rely on activity-based cost (ABC) instead of standard costing.

Target Costing

Here a company first determines the price of a product at which it must sell, and from there on, it deducts the desired profit margin to arrive at the target cost. Efforts are taken thereafter to keep the production cost and other costs limited to the target cost.

Target cost for this purpose is broken down to all of the costs involved with the commodity production and marketing so that measures can be taken to keep the cost of every item limited within the target cost.

5. Evaluation of Competitors’ Costs, Prices, and Offers

To set prices appropriately, a company should have a clear picture of competitors’ cost, prices, and reactions against the possible range of prices determined by market demand and cost. It is also imperative to know in detail about competitors’ offers regarding quality, price, and other variables.

If the company finds that its offer is more or less similar to competitors’ offers, it should price close not to lose sales. If it finds that it is in a superior position, it can charge a high price and charge a lower price than competitors if its offer is found inferior to competitors’ offers.

Becoming aware of competitors’ prices, particularly, is not always an easy task, especially in producer and reseller markets. Competitors’ price lists are often closely guarded.

Even if a marketer has access to competitive price lists, these lists may not reflect the actual prices at which competitive products are sold. The actual prices may be established through negotiation.

Therefore, marketers need to be cautious in utilizing competitive price information while reaching price decisions.

6. Selection of a Pricing Method

When a company has three Cs in hand, it is ready to select a price. The three Cs are customers’ demand schedule, cost function, and competitors’ prices.

In selecting a price, a company has to select a particular pricing method, including cost considerations, competitors’ prices, prices of substitutes; and, customers’ assessment of unique product features.

We shall now discuss different pricing methods, any of which may be selected by a company:

Markup Pricing

This is the easiest pricing method. Here marketers first find out various costs and add a standard percentage with it as profit.

For example, a particular item’s fixed and variable costs are $20, and the marketer decides to make a profit of 20%, then the product’s price will be $24/= $(20+4).

Target-Return Pricing

Here, the price is set at that level, which will yield the target rate of return on the company’s investment.

For example, a company has invested $1,000,000/- in its business and expects a sale of 100,000 units, and the per-unit cost is $10/-. The company wants to achieve a 20% rate of return on investment.

In this case, its target return price will be $12/-. The formula used to calculate target return pricing is as follows:

Target Return Price = Unit Cost + { ( Desired Return x Invested Capital ) / Unit Sales }

Perceived-Value Pricing

This is one of the contemporary pricing methods under which marketers set their prices do not consider their costs as a key consideration. Rather they see the buyers’ perception of value.

To build up perceived value in the buyers’ minds, marketers use non-price variables such as durability, reliability, service, etc. in their marketing mix. Perceived value is captured to set a price accordingly.

Value Pricing

This is also a modern pricing method where high-quality products are priced significantly low, i.e., high-value is offered to customers.

Value pricing is not a matter of simply setting lower prices compared to competitors. Rather it is a matter of re-engineering the company’s operations to truly become the low-cost producer without sacrificing quality and lowering one’s prices significantly so that a large number of value-conscious customers are attracted.

Going-Rate Pricing

It is a popular pricing method and used when costs and competitors’ responses are difficult to measure. Firms here do not consider their costs and demand positions to set prices rather than determine prices based on their competitors’ prices. They can charge similar, lower, or higher prices than their competitors.

Sealed-Bid Pricing

This type of pricing method is followed when a firm wishes to win a contract or job. Pricing here is done, keeping in mind the probability of winning the contract and expected profit, not the firm’s cost and demand position. If a firm wants to increase the probability of winning, it has to set a lower price.

7. Determination of a Specific Price

The final price may be selected easily based on the pricing methods discussed earlier. To select the final price, a few additional factors to be taken into consideration by a company.

These are psychological pricing, influences of other marketing mix elements on price, company pricing policies, and price impact on other parties.

Psychological Pricing

Price sometimes denotes psychological meanings such as high price means high quality or odd price means lower price range or may convey the notion of discount or bargain.

For example, a particular product priced at $200/- per unit may contain $150/- worth of that product, but the consumer will not mind paying $200/- for the product because it may communicate an image of $200/- worth. In the case of ego-sensitive products, higher prices may be charged.

Another example could be a product charged $199/- instead of $200/-. Customers may see this as a price in the $100/- range rather than the $200/- range.

The Influences of Other Marketing Mix Elements on Price

In selecting the final price, a company should consider the influence of other marketing mix elements such as the quality of the product, the advertising budget, etc. A particular brand could be priced high if its relative quality is average, but the advertising budgets are high.

Brands that are of high average quality and advertising budgets are high may also be priced high. If a product is in the later stage of its life cycle and occupies a major portion of market share may also be priced high.

Company Pricing Policies

The final price is also the outcome of the pricing policy being pursued by a company. For example, if a company emphasizes its sales force’s price recommendations, it may select the final price based on the salespeople’s price quotes.

Impact of Price on Other Parties

The final price is also selected considering its impact on other parties such as distributors’ reactions, sales people’s objections, government reactions, competitors’ policies, and the effect of legislation on prices.

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