EXTERNAL FACTORS AFFECTING PRICING DECISIONS

THE MARKET AND DEMAND

You were
made to understand that cost sets the lower limit (or the
floor) of prices. The market and demand set the upper limit (or the ceiling).
Both consumer and industrial buyers balance the price of a product or service against
the benefits of owning it. In this regard therefore, the marketer must understand the relationship between
price and demand for its product. It will thus be necessary to explain how the
price-demand relationship varies for different types of markets and how buyer
perceptions of price affect the pricing decision. We shall also be discussing
the methods for measuring the price-demand relationship.

Pricing In Different Types of Markets

The pricing freedom of sellers actually varies with different
types of markets. There are four types of markets recognized by economists, and
each poses a different pricing
challenge.

Under pure
competition, for
example, the market consists of many buyers and sellers trading in a
uniform commodity such as cocoa, maize, banking, or telephone services. No single buyer or seller has many effects on the ruling market price.

For instance, a seller cannot charge
more than the ruling price because buyers can obtain as much as they need at
the going price. Neither would sellers charge less than the market price
because they can sell all they want at the current ruling price. If prices and profits rise, new sellers can easily enter the market. In a purely competitive market, marketing research,
product development, pricing, advertising, and sales promotion play very little
or no role. Hence, sellers in these markets do not spend much time on marketing
strategies.

In the case of monopolistic competition, the market
consists of many buyers and sellers
who trade over a range of prices rather than a single market price. This is
because sellers can differentiate their offers from buyers. For instance, the physical product can be varied in
quality, features, or style, or the accompanying services can be varied. Since buyers can clearly
see differences in sellers’ products, they will be ready to pay different prices
for them thus, sellers try to develop differentiated offers for different
customer segments and, in addition to price, often use branding, advertising,
and personal selling to set their offers apart.

Under Oligopolistic competition, the market consists of a few sellers
who are highly sensitive to each other’s pricing and marketing
strategies. The product can be uniform or non­uniform. There are few sellers
because it is difficult for new sellers to enter the market.

Each seller is typically alert to
competitors’ strategies and moves. If a seller cuts its price by, say 10
percent, buyers will quickly switch to this supplier. The other suppliers must
also respond by lowering their prices or increasing their services. You should
note that an oligopolist is never sure that it will gain anything permanent
through a price cut. On the other hand, if an oligopolist raises its price, its
competitors might not fol ow this lead. In this instance, therefore, the
oligopolist might have to withdraw its price increase or risk losing customers to competitors. 

In a pure monopoly, the
market consists of just one seller. The seller may be a government monopoly, a
private regulated monopoly, or a private non-regulated monopoly. In each of
these, pricing is handled differently. For instance, a government monopoly can
pursue a variety of pricing objectives. It might set a price below cost because
the product is important to buyers who cannot afford to pay the full cost.
Alternatively, the price might be set either to cover costs or to produce good
revenue. It can even be set quite high to slow down consumption. 

In a regulated
monopoly, the government permits the company to set, one that will allow the
firm to maintain and expand its operations as needed. Non-regulated monopolies are
free to price at what the market will bear. Usually, they do not want to charge full price for a number of reasons: a desire not to attract competition, a
desire to penetrate the market
faster with a low price, or a fear of government regulation.

Consumer Perceptions Of Price And Value

At the end of
the day, the consumer will decide whether a product’s price is right.
Therefore, when setting prices, the company must consider consumer perceptions
of price and how these perceptions affect consumers’ buying decisions. You
should remember that pricing decisions, like other marketing-mix decisions,
must be buyer-oriented.

Why consumers buy a
product, they exchange something of value (the price) to get something of value
(the benefits of having or using the product). This situation can be represented by a value equation

V = B/P

Where: V =
Value

B = Benefits, and

P = Price.

Based on this
consideration, an effective, buyer — oriented pricing should therefore involve
understanding how much value consumers place on the benefits they receive from
the product and setting a price that fits this value. Analysing the Price —
Demand Relationship

Each price a firm
charges will lead to a different level of demand. The relationship between the
price charged and the resulting demand level is illustrated in the demand curve
in Figure 11.2

Figure
11.2 Demand Curves

The demand curve shows the number
of units the market will buy in a given time period, at different prices that
might be charged. For normal goods, demand and price are inversely related, the higher the price are
inversely related, the higher the price, the lower the demand. For
example, the firm would sell less if it raised its price from Pi to P2. In
the case of luxury goods, the demand curve sometimes slopes upward.

COMPETITORS’ COSTS, PRICES, AND OFFERS

The second set of
external factors affecting the firm’s pricing decision is competitors’ costs
and prices, and possible competitor reactions to the firm’s own pricing moves.
For instance, a consumer who is considering the purchase of a GSM phone from
NITEL will evaluate NITEL’s price and value against the prices and Value of
comparable products from ECONET and MIN. In addition, the firm’s pricing
strategy may affect the nature of the competition it faces. For example, if a
particular firm follows a high-price, high margin strategy, it may attract competition. However low-price, the low-margin strategy may stop competitors, or
drive them out of the market.

It is necessary for companies to benchmark
their costs against competitors’ costs so as to learn whether they are operating at a cost advantage or
disadvantage. You should remember that costs typical y set the floor for
the price a firm can charge.

Companies also need to learn the price and
quality of each competitor’s offer. This can be done in several ways. For
instance, a firm can:

(i) Send a comparison shoppers to price and compare
competitors’ products

(i
) Get competitors’ price lists and buy competitors’ products and dismantle it
for the purposes of thorough examination of the features they contain

(iii) Ask buyers how they view the price and quality
of each competitor’s products.

Once
a company is aware of competitors’ prices and offers, it can use them as
starting point for its own pricing. For instance, if its products are similar
to those of a particular competitor, it will have to place its price close to
that competitor’s price otherwise it will lose sales. If the company’s products
are not as good as those of the particular competitor in question, the company
will not charge less, then it can charge more. In essence, a company should use price to position its
offers relative to the competition.

OTHER EXTERNAL FACTORS

Companies also
need to consider other factors in their external environment when setting prices.
Economic conditions can have a strong impact on a firm’s pricing strategies.
For instance, economic factors such as boom, or recession, inflation and
interest rates affect pricing decisions because they affect both the costs of
producing a product, as well as consumer perceptions of the product’s price and
value.

It is also
very necessary for the marketer to consider what impacts its prices will have
on other parties in its environment. Of particular importance is the way re-sellers or marketing intermediaries will react to the company’s various prices. In
actual fact, the company should set prices that give these intermediaries a
fair profit, encourage their support and loyalty, and help them to sell the
product effectively. Finally, the company must also take social concerns into
serious consideration. Hence, when selling prices, a company’s short-term
sales, market share, and profit goals may have to be tempered by broader
societal considerations.

GENERAL PRICING APPROACHES

After
discussing the various considerations affecting pricing policies, it would be
useful to discuss the alternative pricing methods most commonly used. These methods are:

1. Cost-plus or Full-cost pricing
2. Pricing for a rate of return, also called target pricing
3. Marginal cost pricing
4. Going rate pricing, and
5. Customary prices.

The first three methods are cost-oriented as the prices are determined on
the basis of costs. The last two methods are competition-oriented as the prices
here are set on the basis of
what competitors are charging.

COST-PLUS OR FULL-COST PRICING

This is most
common method used in pricing. Under this method, the price is set to cover costs (materials, labour and
overhead) and a predetermined percentage for profit. The percentage
differs strikingly among industries, among members-firms and even among
products of the same firm. This may reflect differences in competitive intensity, differences in cost base
and differences in the rate of turnover and risk. In fact, it denotes
some vague notion of a just profit.

What determines the normal profit?
Ordinarily, margins charged are highly sensitive to the market situation. They
may, however, tend to be inflexible in the fol owing cases: (i) they may become
merely a matter of common practice, (ii) mark-ups may be determined by trade
associations either by means of advisory price lists or by actual lists of
mark-ups distributed to members, (iii) profits sanctioned under price control
is discontinued.

These margins are considered ethical
as well as reasonable. Its inadequacies are:

1.      It ignores demand:  there is no
necessary relationship between cost and what people
will pay for a product.

2.      It
fails to reflect the forces of competition adequately. Regardless of the margin of profit added,
no profit is made unless what is produced is actual y sold.

3.         
Any
method of allocating overheads is arbitrary and may be unrealistic. Insofar as different
prices would give rise to different sales volumes, unit costs are a function of
price, and therefore, cannot
provide a suitable basis for fixing prices. The situation becomes more
difficult in multi-product firms.

4.        
It
may be based on a concept of cost, which may not be relevant to the pricing decision.

(a)     
To illustrate marking pricing, suppose a jug manufacturer
had the following costs and
expected sales:

Variable cost                       N10

Fixed cost                            N300,000

Expected
unit sale         500,000

Then the manufacturer’s cost per jug
is given by:

F i x e d
C o s t N 3 0 0 , 0
0 0

UnitCost=VariableCost+ MO + Unit Sale  50,000

=N16

Now, suppose the manufacturer wants to earn a 20 per cent marketing on sales. The
manufacture’s marking price is given by:

Marking
Price =               Unit Cost                                   = 1416

I—Desired Return on Sales                    1
— 0.2

=N20

The manufacturer would charge dealers N20 a jug and make a profit of N4
per unit. The dealers, in turn, will mark up the jug. For instance, if dealers want to earn 50 per cent on sales price, they will mark up the jug to N40 (N20 +50%

of N40). This number is equivalent to a marking on cost of 100 percent (N20/N20)

The explanation for the Widespread use of
Full-cost Pricing

A clear explanation cannot be given for the widespread use of full-cost
pricing, as firms vary greatly in size, product characteristics and product
range, and face varying degrees of competition in markets for their products.
However, the fol owing points may
explain its popularity:

1.    Prices
based on full-cost look factual and precise and maybe more defensible on moral grounds than prices established by
other means.

2.     Firms preferring stability, use
full-cost as a guide to pricing in an uncertain

market where knowledge
is incomplete. In cases where coasts of getting information are high and the
process of trial and error is costly, they use it to reduce the cost of decision-making.

3.     In
practice, firms are uncertain about the shape of their demand curve and bout

the probable response to any price
change. This makes it too risky to move away from full-cost pricing.

4.     Fixed costs must be covered in the
long-run and firms feel insecure that if they

are
not covered in the long-run either.

5.     A major uncertainty in setting a
price is the unknown reaction of rivals to that

price. When products and production
processes are similar, cost-plus pricing may offer a source of
competitive stability by setting a price that is more likely to yield
acceptable profit to most other members of the industry also.

6.     Management
tends to know more about products costs than other factors which are

relevant
to pricing.

7.     
Cost-plus pricing is especially useful in the
following cases:

(a)       Public utilities such as electricity
supply, transport, where the objective

is to provide basic
amenities to society at a price which even the poorest can afford.

(b)       Product tailoring, i.e. determining
the product design when the selling

price is
predetermined. The selling price may be determined by the government, as in the case of certain drugs, cement, and
fertilizers. By working back from this price, the product design and the
permissible cost is decided upon. This approach takes into account the market
realities by looking from the viewpoint of the buyer in terms of what he wants
and what he will pay.

With marginal cost pricing, the firm seeks to fix its prices so as to maximize its total contribution to fixed costs and profit. Unless the manufacturer’s products are in direct competition with each other, this objective is achieved by considering each product isolation and fixing its price at a level which is calculated to maximize its total contribution.

Advantages:

1. With marginal cost pricing, prices are never rendered uncompetitive merely because of a higher fixed overhead structure. The firm’s prices will only be rendered uncompetitive by higher variable costs, and these are controllable in the short run while certain fixed costs are not.

2. Marginal cost pricing permits a manufacturer to develop a far more aggressive pricing policy than does full-cost pricing. An aggressive pricing policy should lead to higher sales and possibly reduced marginal costs through increased marginal physical productivity and lower input factor prices.

3. Marginal cost pricing is more useful for pricing over the life-cycle of a product, which requires short-run marginal cost and separable fixed cost data relevant to each particular state of the cycle, not long-run full-cost data. Marginal cost pricing is more effective than full-cost pricing because of two characteristics of the modern business: