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Price being the monetary amount charged on a good or service that the customer has to give up in order to derive benefits in owning or using that specific good/service. Therefore, pricing involves decision making in determining the monetary value to be charged on a product (SlideShare Inc., 4).
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Customer perception of value is how a customer perceives the likely benefits or satisfaction that he/she will derive from a product/service compared to its price. Company costs are the expenses that a company incurs in the production, distribution, and selling of products including its share of fixed costs (Ulaga and Chacour 525).
In today’s business world it has become crucial for the management to be very keen when pricing of products and services. In pricing a firm should consider the value perception of the customers that is when attaching a price to a product then that price should reflect the value perception of that product. If a firm set a price that is higher than the value of a product; then that means, the demand for that product will go down which consequently will lead to decline in the volume of sales. If this happens then the contribution (sales less variable costs) and the gross margin of that product will decline leaving that firm lesser gross and net profits (Drew 1).
Alternatively, if a firm set a price that is less that its value this will lead to high demand since the customers can derive more satisfaction from the product at a lesser cost. When a customer feels satisfied with a given product this will tend to increase his/her expenditure and volumes in that product. The increase in sales of that product may not necessarily lead to increase in the product’s contribution or the firm’s overall profit since the value of that product is higher than its price (Drew 1). This may lead to a loss in that product and also contribute a loss to a firm’s overall profits. This means a firm may in the process spend more on production and expenditure and gain less in the sale of that product that is higher company costs than gains. Therefore, it is important for a firm to weigh carefully its decisions before their implementation. The price of any product should show a reflection of its value. Every time when a firm is setting a price it should ensure that neither it nor its customers loose from the decision made (Dodd 10).
It is of utmost importance for the management or the pricing team to consider both the customer-value perception and therefore, they are responsible for regular and timely review of a firm’s products prices and their quality. Comparing a firm’s products to other firms trading in similar products in the market which they operate in terms of quality and price is important for that firm if it will remain relevant in the market. The firm should be in a position to differentiate their products from others so that their customers can be in a position to totally distinguish them. This translates to customer loyalty since they will not be faced with confusion due to the products available thereby increasing sales volume and margins of that product. A firm’s product that has many substitutes available is at high risk of loosing its market share that is if the firm product doesn’t give the much needed satisfaction by the customer in both aspects of quality and price. Therefore, it is imperative for a firm to regularly review its products quality by redesigning to avoid being faced out of the market. Further, a firm should always offer competitive prices to its customer in order to compete favorably with other firms’ products. But in so doing they should not do it while disregarding the costs involved since after all it will determine their profitability (Dodd 14).
Other important internal and external factors affecting a firm’s pricing decisions
This is a situation in which the average cost (AC) declines as production of a product goes up because fixed costs (FC) are spread over more units of products. This means that a firm is likely to derive more benefits if it produces more units of a product and sell them since the cost per unit is reduced considerably (Kottler 10.17). Therefore, a firm can have the capacity to reduce its prices which would attract more customers.
The increase in production capacity of a firm therefore is an important factor to consider in pricing of a product since by exploiting it then a firm would stand to benefit considerably. In producing and selling more units of a product/service a firm will increase its profitability by being able to cover fixed costs more (NetMBA1).
The graph compares the unit costs of a product and its output; the more units it’s able to produce the lower the unit costs they incur. For instance, when the firm is producing only 10,000 units the unit cost is at US$1 while at 160,000 units production the unit cost stands at US$0.32. This is a considerable reduction in the costs incurred by the firm, US$0.68 a reduction by more than 50% (NetMBA1).
Marketing objectives of a firm
In determining prices of a product of a firm the management or the pricing team should adhere to that firm’s pricing objectives in order to retain its relevance. One of firm’s marketing objectives can be a survival tactic in the market which it operates in. A price set for a product by a firm can be based on other similar products in the market, in such a scenario a firm may set a lower price than that of its competitors so as top remain relevant in that market. Where there is a stiff competition in a market a firm may adopt this strategy for survival purposes failure to which the product will be faced out of the market (Gaurav 15).
Secondly, a firm may decide on setting a price in order to maximize its profits. This will mean setting high prices in order to realize high profits. In doing so a firm has to consider the likely consequences for that decision; both positives and negatives. Maximum profits may be realized in short term and in long term ruin the products market share (Gaurav 15).
Thirdly, a firm may decide to set prices at a certain level in order to retain leadership in that market. In reaching such a decision a firm should consider the likely impacts and also other factors. A firm may set prices in order to retain leadership but at the same time incur losses since it may not be able to cover its production, selling and distribution costs and its fixed cost share (Gaurav 15).
Finally, a firm may set prices that conform to its quality as its marketing objective. A firm may set its prices in order to retain its leadership that is some customers perceive high prices to mean high quality. Therefore, a firm may take this advantage to be its marketing tactic but in so doing that firm should be in a position to anticipate the likely impacts (Gaurav 15).
marketing mix strategies
In pricing a firm should consider other marketing mix elements that include promotion, place and product in order to achieve its objectives. A price determined by a firm should relate well with the other marketing mix elements, for instance a firm should not set high prices whereas it’s a period for its products promotion. That will mean contradiction. Further, a firm should not set high prices in low income areas while in high income areas at low prices. This will be inconsistent with marketing mix strategies (Gaurav 15).
In pricing process it will be important to ensure that organizational considerations are considered. These may include the responsibility of setting prices of products in a firm. In setting prices the relevant authority for that task should be left to execute its work. Like in small firms the chief executive officer (CEO) or the top management should set products prices. This will be beneficial to that firm since it will ensure optimal prices are set (Gaurav 15).
In other firms pricing departments may be put in place whose work will be careful negotiation of prices. These departments will ensure objective and timely prices are set. This may involve considering the costs incurred in raw materials, production and addition of fair rate of margin for the production department. On the total price set by the department then the company will add another portion of margin to it and then the total will be considered as the price of that product (Gaurav 15).
(a) Nature of market and demand
In setting prices a firm should consider the market in which it operates that is whether pure competition, monopolistic competition, oligopolistic competition or pure monopoly. If a firm is operating in a pure competition market then it cannot set prices at unfairly high prices and expect to remain relevant in that market since there are other firms producing similar products. In setting prices in such a market a firm should consider other firms’ products prices. If a firm operates in a pure monopoly market then it can set high prices and this will not cause much change in demand especially if it’s a product that many people cannot do without (Gaurav 17-18).
(b) Competitors’ costs and prices
In fixing prices a firm should almost at all times consider its competitors prices if it has to survive in that market. For instance if a firm set a price US$10 while its competitor is selling a similar product for US$6 then most of the customers will switch into buying the product of the other firm selling at a lower price. Further, if a firm set its prices without considering the costs incurred by its competitor it may end up making very low profits or even is faced out of the market (Gaurav 17).
Major strategies for pricing imitative and new products
(i) Market skimming
This is a practice in which a firm may set high prices for new products in order to maximize their revenues from a target market. This usually results in less but more profitable sales volumes where with time customers will come to adapt to that situation and increase sales. For instance, Moto RAZR was launched in the market at a price of Rs. 40,000 but currently an upgraded model is sold at Rs. 10,000 (Gaurav 39).
(ii) Market penetration
This involves setting low prices for a new product so as to attract more customers which translates to high sales volume. This will further lead into a higher market share for that product (Gaurav 39).
How companies find a set of prices that maximizes the profits from the total product mix.
(i) Product line pricing
This involves a process of coming up with a single price for all the products in a product line, for instance, setting a price of US$ 28 for the high-priced line of mattresses, US$ 21 for the medium priced line, and US$ 16 for the lowest priced line. If other firms offered price in their highly priced mattresses as US$ 22 then there will be very minimal demand. If a price of a complementary product for instance software has huge impact on the demand of the hardware that is used together with the software (Kottler 11.7).
(ii) Optional product pricing
This is a practice in which a firm offers additional accessories after the initial pricing of a product. Different firms offer a saving on a collection of accessories up on the purchase of product. This strategy is meant to increase sales volumes and at the same time offer samples which will in future be included in the consumption baskets of those customers and thus creating more demand and loyalty (Kottler 11.7).
(iii) Captive product pricing
This involves pricing of products that have to be used with a main product. Using this strategy a firm may decide to price their products at a high price or at a low price. By pricing them low this means they will end up buying more main products and therefore increased demand, sales and profits (Kottler 11.9).
How companies adjust their prices to take into account different types of customers and situations
A firm in order to expand its market in terms of its customers may design products of different quantities and prices. For instance, a firm may bake different sizes of bread like 2kg, 1.5kg, 1kg, 800gms, 400gms, 200gms, and 100gms in order to serve different sizes of households which mean increased sales. These different sizes will have different prices which mean a customer may buy a size of bread that she/he has enough money for (Kottler 11.18).
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A firm may offer lower prices during major seasons since the volume of sales are going to be high. This will increase the sales volume and also the total contribution and profits of that product (Kottler 11.27).
Alternatively, a firm may reduce prices when it has volume of its products not sold in order to dispose them. This will save them from loosing their raw materials, production and distribution costs if the price will be set equal to those costs (Kottler 11.18).
Key issues related to initiating and responding to price changes
When a firm has an excess capacity for production it can cut down prices. This mean that if a firm can be in a position to produce more then it can do so and take advantage on the reduced per unit cost to reduce that product’s price. Secondly, a firm can reduce its prices if it is being faced by falling market due to price competition. This will help such a firm to buy retain its market share and evade a possible eviction from the market. A firm can increase its prices if it aims at increasing its profits that is profit maximization. Also a firm can decide to increase its profits if it is faced by higher demand that it can be able to supply in the market (Kottler 11.27).
In responding to price changes a firm may offer discounts to those who buy in certain quantities that when that firm has increased its prices. If its competitors adjust their prices when they are dealing in uniform products and buyers are well informed then that firm should take some actions. It can asses its competitors reason for their price change and also asses the market to reveal, the reactions to that price change (Kottler 11.30).
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