17^th September 1998

Selecting the right price is one of the most critical decisions to be taken in the marketing mix. If Eurotunnel has set it’s price to high or too low then Le Shuttle may prove to be a very expensive failure.

The importance of price within the marketing mix varies from one market to another and between different segments in the same market. In low-cost non-fashion markets, price can be critical (e.g. in the sale of white emulsion and gloss paint for decorating). In fashion markets, such as fashion clothing, it can be one of the least relevant factors. Certain products are designed to suit a particular price segment (e.g. economy family cars) whilst others perform a specific function regardless of cost (e.g. sports cars). For consumers with limited budgets, price is a key purchasing criterion, whilst for others for whom ‘money is no object’, price is less important.

The price of products in international markets is crucial. The price that you charge needs to be:

• Competitive with the prices of similar products in international markets
• Set in such a way that you will not lose out dramatically as a result of small (or sometimes large) changes in international exchange rates

A number of situations can be identified in which pricing decisions have to be made. The most important of these are:

• When a price needs to be set for the first time – This can happen when a new product is launched on the market, when new outlets are used, when new contracts are made, or when businesses move into new international markets.
• When it becomes necessary to make a change in the pricing structure – This may be because of the development of competition (e.g. EU competitors selling into the UK after the creation of the Single Market), or a movement along the product life-cycle, or a change in demand or cost conditions

When selecting an appropriate price for a product, a business should take into account the objectives (being to maximise profits), strategies (e.g. to charge a low price) and techniques (e.g. to charge a very low mark-up cost, which maximises unit sales)

The starting point in pricing is to be clear about your goal or objectives. Some possible objectives are as follows:

A key assumption of many business theories is that profit maximisation is the most important pricing target. While it is true that unless businesses can make profits in the long run their future will be uncertain, studies of actual business behaviour reveal a wide range of alternative objectives rather than simple short-term profit maximisation

A competitive price is one that gives a competitive edge in the marketplace. It is not necessarily one that is lower than that of a rival because other elements of the marketing mix add to the competitive edge. For example. It is possible for the manufacturer of Gillette razor blades to argue that they are better quality than those of rivals, giving scope to charge a higher yet more competitive price than those applying to other blades.

A further element of competitive pricing is to set a price that deters new entrants in a particular market. Large firms with some degree of monopoly power may be inclined to keep prices relatively low in order to secure their long-term market dominance.

Any money that is allocated to a particular use bears an opportunity cost. Could this money be spent in a better way? What are the alternatives that are sacrificed? Investors usually have expectations of what they regard to be an appropriate rate of return on investment. This yield will then be an important factor in determining pricing decisions. Investors will quickly make their feelings known to managers if they feel that the wrong pricing decisions are being made.

If you generate a lot of sales then you can produce on a large scale. High sales also give you a good profile in particular market.

Sometimes organisations set out to generate high sales figures because it makes them look good. The sales manager who sells a lot will need to large a large sales team, thus embracing his or her own position and salary and bonus.

However, sales should be related to the cost of making those sales. For example, a sales division may be able to generate sales in Europe, Asia, North and South America, but the cost of making, distributing and organising sales in all these areas may be prohibitive.

There are many other possible objectives in establishing prices. In setting the objectives outlined above, it is essential to remember that it is not only customers that may respond unfavourably. Other groups that need to be considered include:

• Competitors, who may chose to match price cuts or not to match price increases
• Distributors, who may insist on high margins ands thus resist price-cutting
• Employees, who may ask for wage increases
• Government bodies, who may withhold contracts, certificates or grants
• Shareholders, by seeking higher dividends

Once a pricing objective has been established, it is necessary to establish an appropriate strategy. Three broad pricing strategies can be considered: ‘high-price’, ‘market-price’ and ‘low-price’. Before going on to look at each of these in turn, it is helpful to say a few words about the relationship between price and sales.

A demand curve shows the quantity of items of a product that consumers will be willing to buy at different prices.

Common sense seems to tell us that more of a product will be bought at a cheaper price than at a higher price. This demand for a product may be shown on what is named a demand curve. An individual demand curve can be likened to a snapshot taken art a particular moment in time showing how much of a product would be bought at different prices. At that moment in time, price is seems to be the only variable that can be altered which will influence the quantity purchased.

Most demand curves drawn from real situations will have a shape which is more of a squiggle than a straight line. However, the common factor of nearly all demand curves is that they slope down to the right, indicating that – assuming conditions of demand remain the same – more units will be bought at a lower price than at a higher price. This condition is simplified as a straight line demand curve above.

It is however, possible to increase sales or keep sales constant without lowering the price. This can be done by raising the demand for the product. An increase in demand for a product leads to a shift in the demand curve to the right, as shown below.

Factors which might cause an increase in the demand for a product include:

• An increase in the number of people (population) available in the market
• A change in tastes in favour of your product
• An increase in the price of competing products
• An increase in the incomes of people making up your market

The demand curve for most products is continuously shifting as a result of pressures such as changes in tastes and fashion. Most businesses can influence and shape these external factors by a careful use of the marketing mix (e.g. by changing their product, by advertising, and by sales promotion as well as adjustments in price)

A low-price strategy should be considered when consumers respond very positively to small downward changes in price.

In technical terms we can measure this response by calculating the elasticity of demand. This is the measure of changes in quantities purchased as a response to price changes.

The key consideration in lowering price is to increase revenue. If the percentage increase in quantity demanded is proportionately higher than the percentage change in price that triggered the rise in demand, then revenue will increase.

There are situations where one or more of the following conditions exist:

• Products are bought frequently
• Competitive products are highly similar
• A few large companies dominate supply in a specific industry

In any of these situations, firms could quickly lose all their business if they set their prices above that of the competition. Conversely, is the lower their competitors may be forced to follow. Firms tend to set their prices at market-place level and the role of the price is therefore neutral. Neutral pricing will often exist for many standard products at supermarket chains.

This can be either a long-term or a short term policy. A long-term policy will mean that the firm seeks to sell a high-quality product to a select market. This is true of international car sales where Jaguars, Rolls Royce's and Lamborghini's are sold at exclusive prices. High prices are an essential feature of up-market products – it is essential to maintain an exclusive image, to be reflected by the price.

A short-term policy is based on advantages gained by a patented product, a heavy investment in new equipment, or some form of barrier to entry to a market by competitors. In these circumstances price has a negative role in the marketing mix.

In setting a price for a product, a business must consider the following factors which will affect the selling price of the product:

Since the price a product is sold must cover production, distribution and sales costs, it is obviously desirable to reduce these to the minimum. This does not mean that the product’s price will drop accordingly, however. An organisation with low production costs has the flexibility to decide whether to price it’s products as low as possible, or to keep its prices in line with those of the competition.

An important term is the price-value relationship, which refers to a consumers’ perception of the value of a product. If consumers believe that Product A is far better in quality and has more benefits than Product B they will be willing to pay more for it. Here, branding plays an important role as a strategic tool, and the investment in time and promotional activity to develop a brand identity has been shown to reap substantial rewards.

Another aspect of the price-value relationship is added value. The value of a pound of potatoes may be 20p, but this can be considerably increased by adding a few (inexpensive) additional ingredients and making up a recipe dish such as Potato Dauphinoise – potatoes and onion layered with cream. If this is then given a name of a typical French cuisine, the price can be increased to whatever the customers are willing to pay. This is the difference between price value/perception and cost/value reality.

Often people need to express the importance of a relationship, or to mark a special occasion, and certain product offerings have become associated with these. They are priced accordingly. Although it is generally known that the astringent effect of after-shave can be obtained from simple chemicals available over the counter of retail chemists, after-shave products sold as ‘fragrance’ are priced at anything from £3 to £100

The whole point of image-pricing is that the price is unimportant to the purchaser. The purchase motivations are to do with love, reward, appreciation. A gift bought at a discount destroys the image of generosity that underpins the purchase decision.

The only time when image-priced goods appear with discounts is when stocks of a replaced model, or a slow-selling product are reduced in price to clear them – but this is a price reduction, not a discount.

The competition has a strong effect on price and ‘the price setter must gauge the effect of price on the behaviour of current and potential competition. At some high price level new entrants are tempted into the market and customers are tempted to switch’ (O’Shaughnessy 1992)

If there is limited competition, or even a single supplier, then the latter can demand a high price. Competition is healthy since it encourages greater fairness in pricing. In terms of tactical pricing, an organisation must always consider how the competition will react to a price change since price wars can prove to be very costly.

Collecting data on the competitors’ prices (and costs if possible) for every alternative product makes for efficiency and this should occur both in the development stage and at each stage through the life-cycle. This data and information, along with a fairly flexible organisation, will enable optimal prices to be fixed and maintained.

A price war occurs when one competitor reduces the price of a product or service and another follows. Then the first reduces further and is again followed. A prolonged price war can only benefit the consumer since, while prices go down, costs remain much the same. Thus the overall level of profit across the industry is reduced as prices stabilise at their new lower level.

Dominant suppliers may use price as an aggressive weapon to force smaller competitors into line – or to block entry. But then the price war is of limited duration, with a clear tactical objective. It is in fact, more of a battle than a war.

To achieve a promotional impact, limited periods of price reduction are widely used – especially in the retail sales of petrol.

Some firms may have more room for manoeuvre when making pricing decisions than others for the following reasons:

The business in question may be small and with a small workforce, small management structure and an order book that allows for flexibility in the pricing decisions that are needed by the company.

Also, the business may be more or less flexible to pricing decisions depending on the production method employed within it. For example, a business who’s production is based around the characteristics defined by Job production will be more flexible which allows it to tailor it’s products more easier and make pricing decisions faster and invariably to greater economic benefit to the consumer. However, a business with Flow production will be less sensitive to manoeuvre when making pricing decisions and so it will find it difficult to adjust the price of products quickly.

If the business is in a Niche market, then it will have great manoeuvrability when making pricing decisions because it commands a single stronghold with less external influences such as competitors activity affecting pricing decisions than businesses who find themselves in oligopoly markets

The business may be a newly formed company, and if it has no traditional recipes, or formulas to conform to then the pricing decisions that will need to be undertaken within the business may be made quickly indicating that a business which does not need to produce a product in a certain way, shape or form will be more manoeuvrable in it’s pricing decisions

If a business has a new product range, then it is easily able to adapt the product (and if it is either the market leader or the price maker) then supposedly the market to suit the businesses pricing decisions.

If a business enters into a new market, then it will experience the manoeuvrability with pricing decisions which are exhibited by Niche markets. By this I mean, that the business will be entering a new market with a tight market hold and few external influences coming from competitors, which therefore increases it’s flexibility with pricing decisions.