Factors Influencing Pricing Decisions
Customers use price as an indicator of quality particularly for products where objective measurement of quality is not possible, such as drinks and perfumes. Price strongly influences quality perceptions of such products. If a product is priced higher, the instinctive judgement of the customer is that the quality of the product must be higher, unless he can objectively justify otherwise.
Product Line Pricing
Some companies prefer to extend their product lines rather than reduce price of existing brands in face of price competition. They launch cut-price fighter brands to compete with low price rivals. This has an advantage of maintaining the image and profit margins of existing brands. By producing a range of brands at different price points, companies can cover varying price sensitivities of customers and encourage them to trade up to more expensive higher margin brands.
The company should be able to justify the price it is charging especially if it is on the higher side. Consumer product companies have to send cues to the customers about the high quality and the superiority of the product. A superior finish, fine aesthetics or superior packaging can give positive cues to the customers when they cannot objectively measure the quality of the offering.
A company should be aware of the features of the product that the customers can objectively evaluate and should ensure superior performance of those features. In industrial markets, the capability of salespeople to explain a high price to customers may allow them to charge higher prices. Where customers demand economic justifications of prices, the inability to produce cost arguments may mean that high price cannot be charged.
A customer may reject a price that does not seem to reflect the cost of producing the product. Sometimes it may have to be explained that premium price was needed to cover R&D expenditure, the benefits of which the customer is going to enjoy.
A company should be able to anticipate reactions of competitors to its pricing policies and moves. Competitors can negate the advantages that a company might be hoping to make with its pricing policies. A company reduces its price to gain market share. One or more competitors can decide to match the cut, thwarting the ambitions of the company to garner market share. But all competitors are not the same and their approaches and reactions to pricing moves of the company are different.
The company has to take care while defining competition. The first level of competitors offer technically similar products. There is direct competition between brands who define their business and customers in similar way. Reactions of such competitors are very swift and the company will have to study each of its major competitors and find out their business objectives and cash positions.
Competitors who have similar ambitions to increase their market share and have deep pockets will swiftly reduce price if any one of them reduces prices. A telephone company offering landline services has all telephone companies offering landline services as its first level of competitors.
The second level of competition is dissimilar products serving the some problem in a similar way. Such competitors initial belief is that they are not being affected by the pricing moves of the company. But once it sinks into them that they are being affected adversely by the pricing moves of a company that seemingly belongs to another industry, they will take swift retaliatory actions. The telephone company has the mobile phone operators as its second level of competitors.
The third level of competition would come from products serving the problem in a dissimilar way. Again such competitors do not believe that they will be affected. But once convinced that they are being affected adversely, swift retaliation should be expected.
The retaliation of the third level is difficult to comprehend as the business premises and cost structures are very different from the telephone company in question. Companies offering E-mail service are competitors at the third level of the telephone company. A company must take into account all three levels of competition.
In some markets, customers expect a price reduction. Price paid is different from list price. In industrial goods this difference con be accounted for by order-size discounts, competitive discounts, fast payment discounts, annual volume bonus and promotions allowance.
Negotiating margins should be built which allow prices to fall from list price levels but still permit profitable transactions. It is important that the company anticipates the discounts that it will have to grant to gain and retain business and adjust its list price accordingly. If the company does not build potential discounts into its list price, the discounts will have to come from the company’s profits.
Effect on Distributors and Retailers
When products are sold through intermediaries like retailers, the list price to customers must reflect the margins required by them. Sometimes list prices will be high because middlemen want higher margins. But some retailers can afford to sell below the list to customers. They run low-cost operations and can manage with lower margins. They pass on some port of their own margins to customers.
Where price is out of line with manufacturing costs, political pressure may act to force down prices. Exploitation of a monopoly position may bring short term profits but incurs backlash of a public enquiry into pricing policies. It may also invite customer wroth and cause switching upon the introduction of suitable alternatives.
Earning Very High Profits
It is never wise to earn extraordinary profits, even if current circumstances allow the company to charge high prices. The pioneer companies are able charge high prices due to lack of alternatives to the customers. The company’s high profits lure competitors who are enticed by the possibility of making profits.
Charging Very Low Prices
It may not help a company’s cause if it charges low prices its major competitors are charging much higher prices. Customers come to believe that adequate quality can be provided only at the prices being charged by the major companies. If a company introduces very low prices customers suspect its quality, and do not buy the product inspite of the low price. If the cost structure of the company allows, it should stay in business at the low price.