Pricing policies. (Threshold, Unit 3)

Market prices are determined by the interaction of supply and demand. Companies’ pricing decisions depend on one or more of three basic factors: production and distribution costs, the level of demand, and the prices (or probable prices) of current and potential competitors. Companies also consider their total objectives and their consequent profit or sales goals, such as obtaining maximum income, or maximum market share, etc. Pricing strategy must also consider market positioning: quality products generally require “prestige pricing” and will probably not sell if their price is thought to be too low.

Firms with excess production capacity, a large stock, or a falling market share, tend to cut prices. While firms experiencing cost inflation, or in urgent need of cash, tend to raise prices. A company faced with demand that exceeds its possibility to supply is also likely to raise prices.

Demand is said to be elastic if sales respond directly to price variations. When sales remain stable after a change in price, demand is inelastic. Although it is an elementary law of economics that the lower the price, the greater the sales, there are numerous exceptions. For example, price cuts can have unpredictable psychological effects: buyers may believe that the product is faulty or of lower quality, or will soon be replaced, or that the firm is going bankrupt, etc. Similarly, price rises convince some customers that the product must be of high quality, or will soon become very hard to get hold of, etc! A potential customer seeing a price of $499 will register the $400 price range rather than the $500. This is a psychological effect that many sellers count on. Such technique is known as “odd pricing”.

Actually most customers consider elements other than prices when buying something: the “total cost” of a product can include operating and servicing costs, and so on. Since price is only one element of the marketing mix, a company can respond to a competitor’s price cut by modifying other elements: improving its product, service, communications, etc. Reciprocal price cuts nay only lead to a price war, good for customers but disastrous for producers who merely end up losing money.

Whatever pricing strategies a marketing department selects, a products selling price generally represents its total cost (unit per cost plus overheads) plus profit or “risk reward”. Overheads are the various expenses of operating a plant that cannot be charged to any one product, process or department, which have to be added to prime cost or direct cost which covers material and labour. Cost accountants have to decide how to allocate or assign fixed and variable costs to individual products, processes or departments.

Microeconomists argue that in a fully competitive industry, price equals minimum average cost equals break-even point.

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