In addition to costs, there are two other legs of market demand and competition. It is no more possible to say that one or another of these factors determines price than it is to assert that one leg rather than either of the other two supports a tripod. Price decisions cannot be based merely on cost accounting data which only contribute to history while prices have to work in the future.
Again it is very difficult to measure costs accurately. Costs are affected by volume, and volume is affected by price. The management has to assume some desired price-volume relationship for determining costs. That is why, costs play even a less important role in connection with new products than with the older ones. Until the market is decided and some idea is obtained about volume, it is not possible to determine costs.
Regarding the role of costs in pricing, Nickerson observes that the cost may be regarded only as an indicator of demand and price. He further says that the cost at any given time represents a resistance point to the lowering of price. Again, costs determine profit margins at various levels of output. Cost calculation may 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 costs determine is not the price, but whether the production can be profitably produced or not is very important. Though in the long run, all costs have to be covered, for managerial decisions in the short run, direct costs are relevant. In a single product firm, the management would try to cover all the costs. In a multi-product firm, problems are more complex. For pricing decision, relevant costs are those costs that are directly traceable to an individual product.
Ordinarily, the selling price must cover all direct costs that are attributable to a product. In addition, it must contribute to the common cost and to the realisation of profit.
If the price, in the short run, is lower than the cost, the question arises, whether this price covers the variable cost. If it covers the variable cost, the low price can be accepted. But in the long run, the firm cannot sell at a price lower than the cost. Product pricing decision should be lower than the cost. In pricing of a product, demand occupies a very important place.
The elasticity of demand is to be recognised in determining the price of the product. If the demand for the product is inelastic, the firm can fix a high price.
On the other hand, if the demand is elastic, it has to fix a lower price. In the very short term, the chief influence on price is normally demand. Manufacturers of durable goods always set a high price, even though sales are affected. If the price is too high, it may also affect the demand for the product. They wait for arrival of a rival product with competitive price.
Therefore, demand for product is very sensitive to price changes. Demand for the product depends upon the psychology of the consumers. Sensitivity to price change will vary from consumer to consumer. In a particular situation, the behaviour of one individual may not be the same as that of the other. In fact, the pricing decision ought to rest on a more incisive rationale than simple elasticity.
There are consumers who buy a product provided its quality is high. Generally, product quality, product image, customer service and promotion activity influence many consumers more than the price. These factors are qualitative and ambiguous.
From the point of view of consumers, prices are quantitative and unambiguous. Price constitutes a barrier to demand when it is too low, just as much as where it is too high. Above a particular price, the product is regarded as too expensive and below another price, as constituting a risk of not giving adequate value. If the price is too low, consumers will tend to think that a product of inferior quality is being offered.
With an improvement in incomes, the average consumer becomes quality conscious. This may lead to an increase in the demand for durable goods. People of high incomes buy products even though their prices are high. In the affluent societies, price is the indicator of quality. Advertisement and sales promotion also contribute very much in increasing the demand for advertised products.
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Pricing policies heavily consider competition with other firms in the market. Profit goals: You might choose a pricing policy to meet a specific profit goal for your company. Sales totals: Pricing policies directly affect how many people buy your company's product and how much they purchase. Firm health: The financial circumstances of your company may enable it to prioritize market strategy over immediate profit, or you may need to earn revenue as soon as possible to remain in business.
Flexibility: Companies often react to market shifts by changing prices. Your company might consider if your initial price enables you to respond to the market without losing profitability. Government regulation: To protect consumers, the government regulates the pricing of certain goods and services.
Depending on your industry, this may be irrelevant or a central concern in pricing policy. Method of price adjustment: Increasingly, companies that sell vast amounts of goods may automate pricing with specialized software. Pricing policies consider how your company intends to change prices.
Sales venue: If your company sells the same product in wholesale, retail or other venues, pricing policies may differ for each one. Objectives for pricing policies. Profit: The most basic business objective of making profit is still an important one. For some businesses, it might be critical to maximize profit in the immediate future. Firm survival: Sometimes the only available pricing policy is the one that enables your firm to continue operations.
Limiting competition: Your business may have structural advantages that enable it to produce a good at a price point no competitor can match. Businesses typically weigh the competitive consequences of any price point against profit potential. Gaining market share: Your pricing policy might aim at maximizing market share. Earning a large portion of market share provides both strategic and financial advantages.
Accessibility: If your company values offering its product to as many people as possible, your pricing policy might have to adapt. Consumer satisfaction: Consumers' expectations change depending on the price they pay for something. Your business might consider what expectations you want to meet and price accordingly. Types of pricing policies.
Cost-based pricing policy. Value-based pricing policy. Focusing on specific market segments: Value-based pricing policies attempt to be as narrowly focused on the relevant market segment as possible. For instance, if your company sells laptops, you would research laptops with the same dimensions, functional purpose and typical buyer rather than all laptops.
Studying existing competition: Value-based pricing succeeds when a company can make a meaningful and direct comparison to another product already on the market, just like an actual buyer would.
Your competitors are largely what determine consumers' ideas of value. Pricing for added value: Since your company is determining price from value, it clearly defines what makes your product different from the nearest competitor and researches the value of that difference in dollars.
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