Tuesday, January 29, 2013

Pricing


What is given in exchange for a product or service is its price. In the process of this exchange, the seller or producer and the buyer or user agree on the price. The meeting of those who supply or sell with those who demand or buy is how market prices are determined.


                                                                                                                      
                                                                                                                         


In any particular region at a particular time, similar goods tend to have the same market price because the costs of producing and marketing them tend to be similar. Even before goods reach the market, buyers and sellers are generally not too far apart in their ideas of what prices should be. They are aware of the range of prices in the past and have a notion of what they will be in the future, based on producers’ costs sad consumers’ needs. This awareness produces a "normal price" with little variation. This average norm is the price toward which market prices theoretically move.
 
According to the law of supply and demand, formulated by the British economist Thomas R. Malthus, for each commodity some price must exist that will cause its supply and demand to be equal. In other words, the willingness of buyers to buy and of sellers to sell generally reveals some price at which the two activities intersect to create the equilibrium, or normal price. If sellers cannot find buyers, they will cut prices. Buyers who are looking for sellers will offer to pay higher prices. Thus any variation from the equilibrium price seems to automatically correct itself by market forces which push toward the norm. At least, this is the theory. Speculation and price controls are inhibiting factors to this natural process. When goods are considered in the aggregate, with the complex issues of unemployment, the international balance of trade, and national priorities, the equilibrium will still be reached, but in an altered, controlled form.
 
 
 
The effect of supply on price depends on the number and size of the suppliers. When there are many suppliers of a standard product, the amount offered by any one of them has little or no effect on the market price. This condition allows for a stable, competitive market. The price is kept stable— and usually low—by the availability of the product. In an abnormal atmosphere, such as war or famine, prices may vary widely in spite of the number of producers. A less-than-perfect competitive market occurs when the number of producers is so small that the output of any one of them can cause a change in price. This competition, or oligopoly, allows producers to set prices higher than they could in a more competitive market.
 
The producers must still contend with some competition, so prices cannot be too high unless there is a unique feature or quality.
 
 
When a few large producers furnish the entire supply of a given product monopoly exists. If they establish a fixed price among themselves, they can be fined or, in extreme cases, closed down. Even though price fixing is illegal, it is relatively easy to do and, therefore, quite common. Where a single producer has the entire market, the price of a product can be high. If it goes too high, however, the noticeably large profit will encourage others to enter the market. Monopolists often set different prices for markets separated by distance and in those markets which are least responsive to price change. This increases profitability. However, the Robinson-Patman Act of 1936 makes any price discrimination illegal, that is selling the same goods to different buyers at different prices. There must be "like price for like quality and quantity." The only differences permitted must be based on cost differences or the need to meet competition.
 
 
In some cases, producers or distributors of certain goods want to protect the retail sales of their products against price cutting. They set a price below which their product cannot be sold, by printing the price on the package or announcing the price through advertising. Usually these measures involve well-known brands or trademarked goods. These price maintenance procedures are regulated by law in most countries.
 
In the strict theory of competition, price policy has no role and individuals do not put prices on their products. Prices are assumed to be determined by that automatic mechanism which adjusts prices to bring supply and demand into equilibrium. Price policy is therefore associated with imperfect competition since marketing-conscious producers will set prices at the lowest unit cost of the most efficient production method to insure the widest market.
Price, along with product, place, and promotion, are the variables that the marketing manager controls. Pricing is extremely important since it so directly affects an organization's sales and profits. Naturally, profit objectives will guide pricing decisions. The marketing manager has to decide whether to maximize profits or establish a target return. A particular target might be a certain percentage return on sales or a certain percentage return on investment or, for a small family operation, the return might be a fixed dollar amount of profit to cover overhead and living expenses. With any objective, the time factor is crucial. What is an appropriate objective for the short-term may not be for the long-term and vice-versa.
 
 
Marketers are concerned with all the factors affecting price, in order to keep their products from faring poorly in a widely variable atmosphere. Even in service areas such as passenger fares and freight rates, where detailed prices are printed and distributed, influences may cause fluctuation. The marketing manager knows that the costs of the separate elements of the marketing mix can be recovered by proper pricing. The cost of the product itself—the promotion and selling associated with it, the distribution expenses, and profit — are all directly related to price. Thus price knits together the elements of the marketing mix and pays for their respective contributions. The marketing manager must analyze and reconcile the various elements of those variables which influence price, and must then decide on an optimal price policy.
 
 
 
The most fundamental part of any marketing analysis is the recognition of the competitive structure of the industry. Where there are many competitors offering the same type of product, price competition will be active. When there are great numbers of similar offerings, products tend to lose their individuality. Then differentiation becomes difficult, and marketers have little discretionary power to influence prices. It is in this circumstance that marketers and merchants alike look to sales techniques. Disposing of goods at reduced prices draws attention to the specific brand, in the hope that customers will continue to buy when prices return to "normal."
 
 
Another key input variable in making pricing decisions is industry demand. If the average price of a product is reduced, will there be large, modest, or no expansion of demand? When demand increases significantly as prices are lowered, the demand is said to be highly elastic, if demand is little affected by price, it is said to be inelastic. This price sensitivity or insensitivity is influenced by various factors, making precise forecasting of the impact of price changes difficult Occasionally, consumer response occurs after a time lag, so that elasticity of demand for a product may be greater over a longer time period.
 
Certain products are important to consumers because they are necessities- i e. rice to the Japanese cook or gas to the taxi driver Where this is true, the industry demand will be insensitive; as prices rise, consumers will be forced to pay more. On the other hand, there are many areas which are not so important, such as an extended vacation at the beach or a night at the opera. These less important items may be highly sensitive to price. There have been rare cases where consumers boycotted items in such numbers that they forced prices down, no matter why they had risen originally.
Other factors affect industry demand and elasticity. Some products have a derived demand, such as the need for tourist hotels only where there are sufficient numbers of tourists to warrant them. If the cost of zinc rises, industries which use it may substitute a plastic substance. Whenever substitute products are available, there is danger of losing customers if prices rise too much. The income level of the current customer is also a factor. Private planes are affordable only by the very rich, so a price rise or dip may not affect sales as much as a similar rise or dip in the cost of a color television set. Finally, there is the perceived saturation of need for a product. If Argentinians are already eating all the beef they want, it is unlikely that the beef industry will stimulate demand further by lowering the price. On the other hand, the demand for coffee in many countries seems far from satiated, and price reductions would reasonably accelerate sales.
 
 
Cost of production is one of the several inputs into the pricing decision. Marketers separate these costs into those which are fixed and those which are variable. The data is then used to compute various break-even points at various price assumptions. Break-even calculations provide a measure of the minimum sales required to avoid losing money. The same type of projection may be used to compute projected earnings at given sales levels. A particular level of profit may be built into the calculation as another fixed cost to be recovered.
Average-cost pricing, which consists or adding a "reasonable" mark-up to the average cost of an item, is typical in business. For the producer, costs do drop steadily as the quantity produced increases.
 
Therefore, the "average" cost, and subsequently the price, may vary with the quantity purchased. This is why large scale production and distribution are potentially more profitable.
Retailers mark-up their prices enough to cover their buying prices and overhead and make a profit at the same time, but not so high as to prevent sales and a turnover of merchandise. In an effort to keep goods moving and insure profits, retailers must continually decide when to cut prices, what to discount, and which items to market as loss leaders. Ultimately, to stay in business, profits must keep pace with sales.
 
 
Finally, marketing managers must take into account the goals, positions, and resources of their own firms. Large companies with large financial resources may absorb short-term losses in order to ultimately gain a secure position, or even leadership, in the market. Smaller firms may decide that the best pricing strategy is to stay close to the big competition, hoping not to suffer a price war retaliation. Whether the pricing policies involve active or passive roles, short-range tactics or long-range strategy, they must ultimately become part of the total marketing mix.
How can the best prices for a company's products be established? There is no current technique available for setting prices at an optimal level. Mathematically, it would be possible to choose the best price for a single product if all the variable factors were known. But that wishful thought is a contradiction in terms: variable factors, by definition, vary. The cost of raw materials and labor, consumer demand, plus other factors are all dynamic, ever-changing, and unstable. Pricing is not a one time decision. Changes in the competitive environment, changes in a product's cost structure, the pressures of inflation—these and many other factors demand continuing attention to pricing.

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