Pricing

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Pricing is one of the four p's of the marketing mix. The other three aspects are product management, promotion, and place. It is also a key variable in microeconomic price allocation theory.

Pricing is the manual or automatic process of applying prices to purchase and sales orders, based on factors such as: a fixed amount, quantity break, promotion or sales campaign, specific vendor quote, price prevailing on entry, shipment or invoice date, combination of multiple orders or lines, and many others. Automated systems require more setup and maintenance but may prevent pricing errors.

Questions involved in pricing

Pricing involves asking questions like:

• How much to charge for a product or service? This question is a typical starting point for discussions about pricing, however, a better question for a vendor to ask is - How much do customers value the products, services, and other intangibles that the vendor provides.
• What are the pricing objectives?
• Do we use profit maximization pricing?
• How to set the price?: (cost-plus pricing, demand based or value-based pricing, rate of return pricing, or competitor indexing)
• Should there be a single price or multiple pricing?
• Should prices change in various geographical areas, referred to as zone pricing?
• Should there be quantity discounts?
• What prices are competitors charging?
• Do you use a price skimming strategy or a penetration pricing strategy?
• What image do you want the price to convey?
• Do you use psychological pricing?
• How important are customer price sensitivity and elasticity issues?
• Can real-time pricing be used?
• Is price discrimination or yield management appropriate?
• Are there legal restrictions on retail price maintenance, price collusion, or price discrimination?
• Do price points already exist for the product category?
• How flexible can we be in pricing? : The more competitive the industry, the less flexibility we have.
  • The price floor is determined by production factors like costs (often only variable costs are taken into account), economies of scale, marginal cost, and degree of operating leverage
  • The price ceiling is determined by demand factors like price elasticity and price points
• Are there transfer pricing considerations?
• What is the chance of getting involved in a price war?
• How visible should the price be? - Should the price be neutral? (ie.: not an important differentiating factor), should it be highly visible? (to help promote a low priced economy product, or to reinforce the prestige image of a quality product), or should it be hidden? (so as to allow marketers to generate interest in the product unhindered by price considerations).
• Are there joint product pricing considerations?
• What are the non-price costs of purchasing the product? (eg.: travel time to the store, wait time in the store, dissagreeable elements associated with the product purchase - dentist -> pain, fishmarket -> smells)
• What sort of payments should be accepted? (cash, cheque, credit card, barter)

What a price should do

A well chosen price should do three things:

• achieve the financial goals of the firm (eg.: profitability)
• fit the realities of the marketplace (will customers buy at that price?)
• support a product's positioning and be consistent with the other variables in the marketing mix
  • price is influenced by the type of distribution channel used, the type of promotions used, and the quality of the product
    • price will usually need to be relatively high if manufacturing is expensive, distribution is exclusive, and the product is supported by extensive advertising and promotional campaigns
    • a low price can be a viable substitute for product quality, effective promotions, or an energetic selling effort by distributors

From the marketers point of view, an efficient price is a price that is very close to the maximum that customers are prepared to pay. In economic terms, it is a price that shifts most of the consumer surplus to the producer.

Definitions

The effective price is the price the company receives after accounting for discounts, promotions, and other incentives.

Price lining is the use of a limited number of prices for all your product offerings. This is a tradition started in the old five and dime stores in which everything cost either 5 or 10 cents. Its underlying rationale is that these amounts are seen as suitable price points for a whole range of products by prospective customers. It has the advantage of ease of administering, but the disadvantage of inflexibility, particularly in times of inflation or unstable prices.

A loss leader is a product that has a price set below the operating margin. This results in a loss to the enterprise on that particular item, but this is done in the hope that it will draw customers into the store and that some of those customers will buy other, higher margin items.

Promotional pricing refers to an instance where pricing is the key element of the marketing mix.

The price/quality relationship refers to the perception by most consumers that a relatively high price is a sign of good quality. The belief in this relationship is most important with complex products that are hard to test, and experiential products that cannot be tested until used (such as most services). The greater the uncertainty surrounding a product, the more consumers depend on the price/quality hypothesis and the more of a premium they are prepared to pay. The classic example of this is the pricing of the snack cake Twinkies, which were perceived as low quality when the price was lowered. Note, however, that excessive reliance on the price/quantity relationship by consumers may lead to the raising of prices on all products and services, even those of low quality, which in turn causes the price/quality relationship to no longer apply.

Premium pricing (also called prestige pricing) is the strategy of pricing at, or near, the high end of the possible price range. People will buy a premium priced product because:

1. They believe the high price is an indication of good quality;
2. they believe it to be a sign of self worth - "They are worth it" - It authenticates their success and status - It is a signal to others that they are a member of an exclusive group; and
3. They require flawless performance in this application - The cost of product malfunction is too high to buy anything but the best - example : heart pacemaker

The term Goldilocks pricing is commonly used to describe the practice of providing a "gold-plated" version of a product at a premium price in order to make the next-lower priced option look more reasonably priced; for example, encouraging customers to see business-class airline seats as good value for money by offering an even higher priced first-class option. ^{[citation needed]} Similarly, third-class railway carriages in Victorian England are said to have been built without windows, not so much to punish third-class customers (for which there was no economic incentive), as to motivate those who could afford second-class seats to pay for them instead of taking the cheaper option. ^{[citation needed]}

The name derives from the Goldilocks story, in which Goldilocks chose neither the hottest nor the coldest porridge, but instead the one that was "just right". More technically, this form of pricing exploits the general cognitive bias of aversion to extremes.

Demand-based pricing is any pricing method that uses consumer demand - based on perceived value - as the central element. These include : price skimming, price discrimination and yield management, price points, psychological pricing, bundle pricing, penetration pricing, price lining, value-based pricing, geo and premium pricing.

See also

• Product life cycle management
• Price elasticity of demand
• Purchasing power
• Psychological pricing