What is Price? Objectives, Factors Influencing Pricing Decisions

What is the Price?

Managers can set prices in addition to what cost they have incurred in developing and marketing the product. In many instances, the price is the rupee equivalent of the value of the company’s product. It is also the money that the consumer is willing to pay for ownership of the product. Price has different connotations.

We will use the value-based model in which the price is equivalent to the value that the customer is willing to acquire by paying its rupee equivalence for ownership or the right to usage after the purchase.

Companies decide about prices in many ways depending on the cost structure, market structure, nature, stage of the product life cycle, and the nature of competition in the market. We will discuss some of the general considerations that managers follow while deciding on prices.

Pricing decision involves the following:

  • Decide the price objectives
  • Determine the demand
  • Estimate the costs
  • Analyze the competitor’s cost, prices, and offers
  • Select the final price

Objectives of Pricing

Pricing decisions are usually considered a part of the general strategy for achieving a broadly defined goal. While setting the price, the firm may aim at one or more of the following objectives:

  • Maximization of profits for the entire product line: Firms set a price, which would enhance the sale of the entire product line rather than yield a profit for one product only. In this process, it is possible to maximize the profit for the entire product line.

    Example: Starbucks raised the price of the tall size brew exclusively in order to persuade customers to purchase larger sizes. The goal of the company is to use price increases to guide the customer toward your most profitable product.
  • Promotion of the long-range welfare of the firm can also influence the pricing decision: The firm may decide to set a price, which looks unattractive to competitors, and hence, the entry of competitors can be discouraged for a long period of time.

    In this way, the firm can take a decision for the long-term welfare of the firm rather than short-term profit maximization.

    Example: The introduction of Low-priced burgers by McDonald’s has restricted the entry or success of many burger producers in India. Their prolonged strategy to remain stable in the market is not giving a boost to any other player.

  • Adaptation of prices to fit the diverse competitive situations: The Company may decide to go for different kinds of pricing strategies depending on the individual product’s product-market situation.

    The company will try to maximize the profit from a market where it has cash cows and invest in other markets where it has to stay put for long-term benefits. It may decide to follow different kinds of product strategies for product portfolio members.

    Example: HUL has launched its products at all price points to cater to every market segment. It has its products catering to every stratum of the market ranging from rural to urban and even for niches.

  • Flexibility to vary prices in response to changing market conditions: One cannot decide about prices in isolation, as the firm is only a member of the market. So it has to decide on prices in response to changing economic conditions. The macroeconomic conditions also influence the pricing decision.

    Example: Many airlines slash their prices when a dip in the market is observed. They come up with low-frill packages for flyers and special packages for frequent fliers in the market. Airline companies focus on gaining customers in their stride.

    When there is a festive season the prices of tickets soar very high even in advance bookings for say during the Christmas season.

Stabilization of Prices and Margins

The firm may decide to stabilize the prices and margins for long-term goals and price the products in a different way than they would have done with a profit maximization objective.

Firms may pursue additional objectives as mentioned by Kotler. We present a small list of these objectives to augment the above list:

  • Market Penetration: The firm may decide in favor of a lower price to penetrate deeper into the market and stimulate market growth and capture a large market share.

    Example: When telecom players like ‘Aircel’ and ‘MTS’ entered the Indian market, they found the market already saturated. Hence, they adopted a strategy of low tariffs to attract the potential customer base.

  • Market Skimming: The firm may decide to charge a high initial price to take advantage of the fact that some buyers are willing to pay a much higher price than others as the product is of high value to them.

    The skimming pricing is followed to cover the product development cost as early as possible before competitors enter the market.

    Example: When a new highway is constructed connecting two cities or states, during the initial few years tolls is charged to recover the cost of construction. Thereafter, either the tax or toll is slashed or removed when the invested amount is recovered.

  • Early Cash Recovery: This is an aggressive form of skimming pricing. Some firms try to set a price, which will enable them to recover the cash rapidly as they may be financially tight or may regard the future as too uncertain to justify a delayed and smooth cash recovery.

    Companies with novel products but with less technological complexity prefer to recover the cash before competitors enter this market.

    Example: Apple whenever comes up with a new launch of its products, it commands very high prices on its sales. By the time other mobile industry players when copy their introduced technology, Apple usually tries to recover the money it invested in the mobile’s R&D.

  • Satisfying: Companies may pursue a pricing strategy if it satisfies a satisfactory rate of return, although it is possible for another price level to give a higher return.

The pricing decisions depend on the motives of the manager. The motives of managers can be of different types. Executives may advance their personal positions at the possible expense of the firm’s profitability. Thus in a professionally managed firm, persons at the helm of affairs may not be motivated solely by a desire to obtain the maximum long-run profits for the firm.

Factors Influencing Pricing Decisions

Formulating price policies and setting the price are the most important aspects of managerial decision-making. Price is the source of revenue, which the firm seeks to maximize. It is the most important device a firm can use to expand its market share. If the price is set too high, a seller may price himself out.

If it is too low, his income may not cover costs, or at best, fall short of what it could have been. However, setting prices is a complex problem and there is no fixed formula for doing so. The decision to set a low price or a high price would depend upon a number of factors and a wide variety of conditions.

Moreover, the pricing decision is critical not only in the beginning but it must be reviewed and reformulated from time to time.

In this connection, it may be pointed out that in economic theory, only two parties are generally emphasized, i.e. buyers and sellers. In practice, however, certain other parties are involved in the pricing process, i.e., rival sellers, potential rivals, middlemen and the government. All these parties also exercise their influence in the process of price determination.

The factors governing prices may be divided into external factors and internal factors. The external factors include elasticity of supply and demand, goodwill of the company, the extent of competition in the market, the trend of the market, purchasing power of the buyers, and government policy towards prices.

The internal factors include the costs and the management policy toward gross margin and sales turnover. The following are the general considerations for formulating a pricing strategy.

Objectives of Business

Pricing is not an end in itself but a means to an end. The fundamental guide to pricing, therefore, is the firm’s overall goals. The broadest of these is survival or assured continued existence. On a more specific level, objectives relate to the rate of growth, market share, maintenance of control or ownership, and finally profit.

Very often companies fix a target rate of profit; whether the company will be able to achieve the target rate of profit will depend upon the forces of competition. The various objectives may not always be compatible and hence there is a need for reconciliation. A pricing policy should never be established without full consideration of its impact on the other policies and practices of the firm.

Example: Nirma wanted to gain a huge share of the market at the time when HUL was an established player in the area of washing powders. Hence it came up with a very low-priced detergent to woo the target market.

Competitive Environment

An effective solution to the pricing problem requires an understanding of the competitive environment. In perfect competition, sellers have no pricing problems because they have no pricing discretion. Pricing policy has practical significance only where there is a considerable degree of imperfection in competitive structures and where there is some room for managerial discretion.

Under the present competitive conditions, it is more important for the firm to offer the product which best satisfies the wants and desires of the consumers than the one which sells at the lowest possible price. As a result, pricing policy should be governed more by the relative than by the absolute height of prices.

Example: Samsung floated mobiles in the low-price segment as Nokia was generating good business from that segment. Samsung later launched android versions which had more features at less price and became an attractive option for customers, leaving Nokia behind in the competition.

Product and Promotional Policies of the Firm

Pricing is only one aspect of marketing strategy and a firm must consider it together with its product and promotional policies. Thus, before making a price change, the firm must be sure that the price is at fault and not its sales promotion program or the quality of the product, or some other element.

Example: Luxury suites of plush hotels are priced high for the ultra-rich class to attract them. This satiates their esteem and status needs and the pricing of suites is kept accordingly.

Nature of Price Sensitivity

Businessmen often tend to exaggerate the importance of price sensitivity and ignore many identifiable factors at work that tend to minimize their role.

The various factors which may generate insensitivity to price changes are variability in consumer behavior, variation in the effectiveness of marketing effort, nature of the product, the importance of after-sales service, the existence of highly differentiated products that are difficult to compare, and multiple dimensions of product quality.

Example: Prices of essential drugs and basic food items such as sugar, salt, wheat, etc. affect the pockets of consumers a lot if there is a slight change in prices. Whereas the price of diamonds and platinum doesn’t affect the pocket of consumers too much as only people who can afford them will buy them.

Conflicting Interests Between Manufacture and Intermediaries

The interests of manufacturers and middlemen (through whom the former often sell) are sometimes in conflict. This is called vertical conflict. For instance, the manufacturer would desire that the middleman should sell his product at a minimum markup, whereas the middleman would like his margin to be large enough to stimulate him to push up the product.

The manufacturer may like to control the middleman’s prices and even the retail prices, but the middlemen may seek to expand their sales through price cuts or obtain larger margins than allowed by the suggested prices.

Further, if the manufacturer reduces the price, the middlemen’s inventories may go down in value thereby causing resentment among them. So, pricing decision in the both short and long term is influenced by the nature of the relationship between the manufacturer and intermediaries.

Routine Pricing Decision

Pricing in practice is often routinized though its extent may differ from company to company and from product to product. For example, the management may prefer to depend on suggested prices, which is a mechanical formula for pricing decisions.

The degree of routinization depends on the following factors:

Number of Pricing Decisions

A firm may have to take thousands of pricing decisions on a wide range of products, none of which provides a substantial proportion of sales. In this case, it will find that the costs of separate analyses on each product are too high. It would, therefore, find it economical to adopt a relatively mechanical routine for pricing.

Speed in Making a Pricing Decision

Mechanical formulae, such as a pre-determined markup on the full cost, have the advantage of speed, though flexibility and adaptability to special conditions are lost.

Quality of Available Information

If the data on demand and costs are highly conjectural, the best the firm may be able to do is to rely on some mechanical formula such as cost plus formulation.

Competitive Market

If a firm is selling its product in a highly competitive market, it will have little scope for pricing discretion. This will pave the way for routinized pricing.

Active Entry of Non-business Groups in Pricing Decisions

The government, acting on behalf of the public, seeks to prevent the abuse of monopolistic power and collusion among businessmen. There is a complex body of regulation and an even more confusing series of judicial decisions guiding pricing principles in every country.

Very often, the government elects to control certain prices. Collective bargaining and strikes by the labor unions, attempt to raise wages. The entry of the government into the pricing process, in alliance with farmers and labor interests, tends to inject policies in price determination.

Pricing is not an exact science. There is no infallible formula for determining of the right price for a product. Every pricing situation is unique and should be explored in its own right. The pricing decision should result from the balancing of a number of considerations. In fact, pricing is a matter of judgment.

But to be effective, judgment should be based on sound principles and the fullest information possible. A beginning has to be made by a trial and error method. No matter how logical the price may seem to be, if it attracts an insufficient number of customers, it is the wrong price.

Cost Factors in Pricing

Costs have to be taken into consideration like many other important factors. In fact, in the long run, prices must cover costs. If, in the long run, costs are not covered, manufacturers will withdraw from the market and supply will be reduced which, in turn, may lead to higher prices.

The point that needs emphasis here is that cost is not the only factor in setting prices. The cost must be regarded only as an indicator of the price, which ought to be set after taking into consideration the demand and the competitive situation. It must be noted, however, that cost at any given time represents a resistant point to lowering of price.

Again, costs determine the profit consequences of the various pricing alternatives. Cost calculations also help in determining whether the product whose price is determined by its demand is to be included in the product line or not. What cost determines is not the price but whether the product in question can be profitably produced or not.

But what are the relevant costs for pricing decisions? Problems are more complex in a multi-product firm. For pricing decisions, relevant costs are those costs that are directly traceable to an individual product.

Ordinarily, the selling price must cover all direct costs – manufacturing and non-manufacturing, variable and fixed – that are attributable to a product. In addition, it must contribute to the common costs and realization of profit. But it may not always be possible to do so.

For a short period of time, it is tolerable for the price of a product to do no more than cover its direct costs and even only the direct variable costs. This may be the case when a new product is introduced. The initial direct promotional cost is usually high in relation to the sales volume, and special price concessions are granted in connection with introductory offers.

In such a case, a negligible contribution or no contribution to common costs in the short run is accepted in anticipation of long-run profits. In other cases, a very low contribution for one or more products may be accepted for want of a more profitable alternative. A low contribution is better than none at all.

In the long run, the aggregate revenues from all products must cover not only direct costs but also contribute towards common costs. Ideally, each product should make a significant contribution to common costs; but it is not possible to state any general rule for determining satisfactory or unsatisfactory contribution.

If factors of demand and/or competition prevent a firm from setting a price for one of its products that will cover direct costs, there may be no alternative but to discontinue the product.

If a competitive price does cover direct costs and yield some contribution towards common costs, the question arises: ‘how high must that contribution be’ to justify the long-run continuance of a particular product in a company’s product line? The question can be answered in light of the available alternatives.

If the product is discontinued, are there others, which may be substituted for it so that there is a higher contribution to common costs? What effect will the discontinuance of this product have on the demand for other products in the line?

The elimination of one product from the line may cause the loss of sales of other complementary products. Product pricing decisions should, therefore, be made with a view to maximizing company profits in the long run.

An important question that arises at this stage is: ‘How can the common costs be covered if individual prices are set in consideration of direct costs only?’ The point to be noted here is that covering of directs costs is only a starting point in the pricing decision.

Factors of supply and demand and competition may permit prices, which will yield a very substantial contribution to common costs. Again, a low contribution from a single product does not necessarily mean that the price is too low or that the product ought to be discontinued.

If the economic determinants of price are such that the combined prices for all of a company’s products are insufficient to cover common costs in the long run, the conclusion is not that the individual prices are wrong but rather that the firm is economically inefficient. Such a firm must either improve its operating efficiency or cease operations and wind up.


Total cost of product = total variable cost + total fixed cost

= ₹ 200 + ₹  50 = ₹  250

Profit margin (Markup) = 25%

Selling price = Total cost of product + profit margin

= 250 + 250 (25/100) = ₹ 312.5

This ₹312.5 will be price floor. The price ceil will depend on the competitive status, company’s situation and perceived value of the product.

  • Tapan K Panda, Marketing Management, Excel Books.

  • Philip Kotler, Marketing Management, Pearson, 2007.

  • V S Ramaswami and S Namakumari, Marketing Management, Macmillan, 2003.

  • http://www.mktghelp.com/pdf/Pricing%20is%20the%20 Hardest%20Marketing%20Decision.pdf

  • http://www.uk.sagepub.com/upm-data/43169_1.pdf

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