Key Factors Affecting the Pricing Decision

1. Market Structure – the number and size of competing firms and ease of entry.
2. Market conditions – general economic conditions
3. Competitive Behavior – collusion, price behaviors, price matching
4. Product – its perish ability; durability; stage of life cycle; type – producer or consumer good; cost of production and distribution; distinctive substitutes.
5. Customers – their urgency of need; ability to pay; location; potential number; purchase behavior; use of product – intermediate or ultimate; perception of seller or brands; susceptibility to promotion.
6. Goals or Objectives of Seller – desire for market share; target rate of return on capital; beating or matching competition; recapturing full costs; exploiting excess capacity; maximizing sales rather than profits; exploiting monopoly power; market leadership.

Pricing Formulas:

Many pricing formulas can be reduced to two basic approaches: (1) the cost approach and (2) the market or demand approach. The cost approach is easy to understand. Three commonly accepted price formulas are: (1) Prices are set equal to allocated total costs, plus a certain standard percentage markup. This is full-cost formula where price reflects the average total cost of each unit plus a margin of profit. (2) Prices are set equal to a certain percentage of product cost at each level of production and distribution. This method, the markup formula, is basic in the wholesaler and retail trade. (3) Prices are set equal to variable direct costs some amount added to cover allocated overhead and profit contribution. This is known as the profit margin formula and uses only variable costs as a starting point.

The Cost Approach:

Using the cost approach one must find answers to two key questions: (1) what should be used as the cost base? (2) What factors should be considered in planning the margin? If for example, a company prices its products based only on the variable costs of each unit produced, it is using incremental cost pricing. This method is viable only in the short run because overhead costs and return on capital investment must be covered in the long run.

A cost plus approach to pricing has certain inherent risks. Today’s price often outlasts the conditions that determine today’s costs. Forecasting future costs of key production factors such as wages, raw materials, purchased components, and capital are required for most pricing decisions. Here replacement costs are more vital than historical costs. Finally, a cost plus pricing formula should adequately reflect the competitive situation and the unit sales volume at various price levels. Average unit costs depend on sales volume but in certain markets sales volume depends on the price charged. Thus the marketing manager is faced with a modest dilemma. From a marketing management viewpoint the practical solution is to adjust cost to fit a predetermined price (“customary price”) which takes into account generic demand, competition, and advertising elasticity in each target market. It should be recognized that the prices for manufactured goods are “administered” prices which require a lot of planning around data supplied by accounting and marketing research.

The Demand Approach:

Since marketing is primarily a “demand management” activity, understanding how to price goods in relation to market forces is critical. For the economist, demand is an expression of willingness to buy. Economists often portray demand as a schedule of prices and quantities that will be bought at each price. Marketing enlarges upon this concept of demand. In the broadest sense of the term some authorities equate the demand with consumer behavior; however, given the known relationship between price and sales volume, the marketing manager must devise policies and strategies that allow price to be integrated with the other marketing mix elements promotion, product, and place.