Q. What factors do affect the price determination of a product? Briefly explain the process of price setting in practice.
Ans. Pricing is an art of translating the value of the product or service into quantitative terms (i.e. rupees) by the marketing manager before it is offered to target consumers for sale. Pricing decisions should be consistent with the marketing objectives of the company. For determination of prices of its products the management must have to take a number of factors into consideration. The influencing factors for a price determination/decision can be divided into two groups, such as:
FACTORS AFFECTING PRICING DECISIONS
A. INTERNAL FACTORS: Internal factors are those which are well within the control of the company. Internal/controllable factors are as follows:
1. Pricing objectives: The objectives set for pricing affect the decision regarding fixation of price for a particular product. Firms may have a variety of objectives such as price stability, sales maximisation, target return on investment, meeting the competition, survival, etc. Pricing decisions should be made only after proper consideration of pricing objectives.
2. Cost of production: Cost plays an important role in the pricing of the product as both have a close relationship. Cost of production serves as the base for price fixation. Whatever may be cost of production, the price is one at which the seller is prepared to sell and the buyer is prepared to buy.
3. Marketing Mix: Price is one of the important elements of marketing mix and therefore must be coordinated with the other elements: production, promotion and distribution. Any change in price will have an immediate effect on the other three elements.
4. Product Differentiation: The price of the product also depends upon the characteristics of the product. In order to attract the customers, different characteristics are added to the product, such as quality, size, colour change, attractive package, alternative uses, etc. Generally customers pay more price for the product which is of the new style, fashion, better package etc.
5. Organisational considerations: Pricing decisions are occur at two levels in the organisation. It is the top management which generally has full authority over pricing. The marketing manager’s role is to assist the top management in price determination and administer the pricing within policies laid down by the top management. The top management sets the guidelines within which the price is to be administered and determine the price range within which the actual price is dealt at lower level.
However, in some companies, some authority is granted to subordinate executives for setting prices, especially where pricing varies in different markets or where ther are numerous products and frequent pricing decisions are required.
6. Product life cycle: Pricing decisions are affected by the stages of product life cycle. As the product follows a number of stages i.e. introduction, growth, maturity, saturation and decline. The price which is relevant in one stage may not necessarily be relevant in the next stage and therefore it requires price administration during each stage.
In the introductory stage, the prices are kept low so that the product can easily penetrate the market. As the sales increases and the product reaches the growth stage, the prices can be raised to a certain extent. During the maturity stage, the prices are either kept at the same level or lower down to face the competition. In the declining stage, prices are further reduced to maintain demand.
B. EXTERNAL FACTORS: External factors are those which are generally beyond the control of the company. These are as follows:
1. Product Demand: Product demand has a great impact on pricing. Since demand is affected by many factors, such as: number of prospective buyers, their preferences, their capacity and willingness to pay, number of competitors, what they are charging for similar products, etc. Therefore, these factors must be taken into consideration while fixing the price.
2. Elasticity of demand: Price elasticity of demand also affects the pricing decision. Price elasticity means a relative change in demand due to certain percentage change in price of the commodity. If the demand of product is inelastic, high price may be fixed. Contrary to it, if demand is elastic, the firm cannot fix high prices rather it should fix lower prices than that of competitors.
3. Competition: No manufacturer is free to decide his prices without considering competition unless he has monopoly. Competition is a crucial factor in price determination. While determining the prices, a marketer must know the pricing objectives, policies and strategies, strengths and weaknesses of the competitors. This also helps to know the possibilities of raising or lowering the prices. Even in monopolistic conditions, the manufacturer has to consider the competition with that of substitute products while deciding the price of his product. For example, if price of scooter increases, the consumers will shift towards motorcycle. Number of competitors and their sizes also affect the price decisions.
4. Economic conditions: Economic environment of the country is an important factor affecting the pricing decisions. Inflationary and deflationary conditions affect the pricing. In recession period the prices are reduced to a sizable extent to maintain the level of turnover. On the other hand, the prices are increased during the boom period to cover the increasing cost of production and distribution. To meet the changing economic conditions, several pricing decisions are available, such as:
(i) Prices can be boosted to protect profits against rising costs;
(ii) Price protection system can we linked with the price on delivery to current costs;
(iii) Emphasis can be shifted from sales volume to profit margin and cost reduction, etc.
5. Government regulations: The government of the country influences the pricing policies in a number of ways. Government regulates the prices of the products, it makes available services it renders to the community like electricity, transport, railway, postal, etc. Government interference in the form of taxes and fixation of prices , influence the pricing decisions. Like other marketers, government also sells necessity goods through its fair price shops such as sugar, rice, kerosene oil, atta, etc.
Government happens to be the largest employer and the buyer in the economy affecting the pricing system. Government has framed different laws to restrict price hikes, artificial scarcity, consumer exploitation, and monopoly tendencies. These are MRTP Act, Essential Commodities Act , Consumer protection Act and so on. The prices cannot be fixed higher, as government keeps a close watch on prices in the private sector.
6. Consumer behaviour: The behaviour of the consumers and users for the purchase of a particular product, do affect pricing, particularly if their number is large. In other words, the composition and behaviour of consumers have a great impact on pricing decisions. For example, if the consumers are small users, though large in number as in case of daily needs consumer products, they do not have much influence on pricing decisions. On the other hand few consumers , but large users have considerable influence on the pricing decisions.
The pricing decisions are also affected by the fact Whether the consumer is an individual industrial user or a household user. The firm cannot have the same price policy for both the classes of consumers. Buying pattern of the consumers also plays an important role in prisoning of a product. If the purchase frequency of product is higher, lower prices may be fixed, resulting in higher sales along with the higher overall total profit.
7. Distribution channel: A number of intermediaries exist between the manufacturer and the final consumer. Each of them charges for their services, which ultimately adds up to the cost of the product. Therefore, longer the distribution channel, higher will be the price of the product and vice-versa. If due attention is not given on this factor, it might happen that the price of a product may become so high that the consumer might reject it.
8. Suppliers: Suppliers of inputs, especially raw materials and fabricated parts have great impact on the price of a product. If the suppliers raise the price, it will lead the manufacturer to increase the price of the product, which will ultimately affect the consumers. The scarcity or abundance of the raw material also has considerable influences on the final pricing decisions.
9. Market position of a company: Besides the above, there are a number of factors which directly or indirectly influences the pricing decisions. Such as: social and ethical considerations, consumers’ reactions towards rising prices, wage rates, productivity, trade customs, speculation, etc.
Thus, the above are some important factors which affect the pricing decisions of a company. The marketers obviously can exercise substantial control over the internal factors, while they have little control over the external factors.
PROCESS OF PRICE SETTING IN PRACTICE
There is no specific procedure applicable to all forms for price determination. Generally , the following procedure may be followed.
1. Select the target market: The very first step for determining the base price of a product is to select the segment or segments, where the marketer wants to pursue. The demographic and psychographic characteristics of the selected segment will effect the pricing decision.
2. Identify the potential customers: The potential customers are those who will pay the price for a product. They are therefore, the focal point in price determination. It is short-sighted (narrow or limited way of thinking) to select a pricing policy or strategy without first identifying those people whom the pricing plan is supposed to affect. The buying motives, paying capacity, location, price sensitivity, consumer’s prior attitude about the marketer and his brand, etc. of the potential customers will have considerable effect on price determination.
3. Estimate the demand: Each price level gives different levels of demand. Higher the price, lower will be the demand. Estimating the demand for an established product is easier than for a new product. There are two steps in estimation of demand:
(a) Knowing the expected prices.
(b) Determining the sales volume at various prices.
Expected price refers to price range. Surveys may be conducted of potential buyer or competitor’s prices may be studied or the product may be tested in limited area to know the expected prices. After knowing the price range, sales volume at different prices are estimated. The product with elastic demand will be priced lower than the product with an inelastic demand. For example, the increase in the price of convenience products say salt may not affect the demand. Contrary to it, the increase in price of speciality products say scooter may affect the demand level.
4. Anticipate competitive reactions: After estimating the demand of the product, competitive situation in the present and in future should be studied because present and potential competition also influences the price determination. Competition may come from three sources:
(i) Competition directly from the substitute products: For example, a scooter manufacturer has to face a competition from the other manufacturers of scooters.
(ii) Competition from the substitute products: For example, a scooter manufacturer has to face a competition from the manufacturers of motorcycle.
(iii) Competition from unrelated products: For example, a scooter manufacturer has to face a competition from the manufacturer of small cars, air-conditioners and consumer durable seeking the same consumer’s disposable income.
Estimating the future competitive situation is more important, when the production of the product can be started with low initial capital and the profit margin is quite attractive. The marketer should study the competitor’s product, price, promotional competition either by reducing the prices or by entering into new market segments.
5. Establish expected share of market: The next step is to determine the market share which a company will try to capture. Low priced products may capture a larger share of the market and a high priced product may capture a small share of market. Larger share of the market can also be captured by adopting promotional techniques and by going for non-price competitive strategy. For deciding the market share, the market share should not be fixed beyond the production capacity of the plant.
6. Select pricing strategy: Keeping in view the marketing objectives in mind, a suitable pricing strategy should be selected. There are two main pricing strategies for pricing the new product.
(I) Skimming Pricing: It is a strategy in which prices are kept high with a view to skim the cream of demand. It is possible when the product has distinctive features or when there is no competition and the consumers are not price sensitive. Later on, the firm can easily lower down the prices to attract other segments of the market.
(II) Penetration Pricing: It is a strategy in which prices are kept low with a view to capture large market share. This strategy is useful when consumers are price sensitive, there is a fear of competition and the cost of production goes down with the increase in sales of production.
Both these strategies have their own merits and demerits. The company has therefore, to select the best suitable strategy.
7. Consider company’s marketing policies: In the next stage of price determination process, the product policies, the distribution policies and the promotion policies of the company must be considered.
(i) Product policies: The price of the product is more influenced by the nature of the product, i.e., whether it is a new product or an old product, perishable product or durable product, consumer product or industrial product. Perishable products which cannot be stored for a long period are priced low to facilitate its easy disposal. The change in fashion also forces the marketer to price the products at a level so that they get disposed off before the fashion changes.
The composition of product, its quality, durability, resistance to heat, light, water, breaking strength, shrinkage, etc. also affects the prices. Product mix is also one of the consideration.
(ii) Distribution policies: The nature of channels used and the gross margin requirements of the middlemen influence the pricing decisions. The length and complexity of the distribution channel greatly influence the price. The long and more complex channel, higher will be the price and vice-versa.
(iii) Promotional policies: The more the promotional activities undertaken, higher will be the price. Because expenses incurred will have to covered from the price.
8. Select the specific price: After considering all the above facts ultimately a specific price is selected. The selection of a specific price vary under different market conditions. The price may be determined through the forces of demand and supply or by cost of production or on the basis of competition prices.
There is no readymade formula for fixing the prices. It requires a lot of experience to have a good pricing decision after following the procedure. The price must be fixed by watching the interest of all the parties i.e. a fair return on investment to manufacturer, a good profit margin to middlemen and a fair price to consumers.
