Price Determination (I)
What are factors that determine the product/service price?
Posted: Jul 2009
Determination of the prices depends internal and external factors. Pricing goals represents internal policy. Also, price policy should be aligned on several other factors.
Demand is the key determinant for market oriented company. Demand is the starting point for all activities. Simply, the average customer will be demanding different product quantities, depending on price. Law of the market says that demand and price are counter proportional ( price increase leads to demand decrease and vice versa ).
Competition has a significant influence to price determination of market oriented companies. Prices need to be adjusted in order to address the competition. Every company should research market and competition, prior to launch of the new product. Survey should include direct competitors but also the substitutes. Based on market survey and the strength of the company the prices can be the same, lower or higher.
Costs – While demand and competition are external factor, the costs are internal. The costs must be embedded in every stage of price determination process. There are several methods of cost embedding into price:
1.) Costs Plus – company calculates the costs and increase price for the specific profit.
2.) Markup – price based on cost increased for amount of specific markup percentage.
3.) Target Return Method – calculated required markup, in order to achieve return on investment.
4.) Profit Maximizing is the price where the marginal profit equals marginal cost.
5.) Breakeven Analysis – is the number of units sold that generates profit that can cover cost. This point does not have profit nor lost.
Life Cycle pricing approach analysis the current phase of product life in market.
1.) Entering phase usually requires higher sales prices in order to payback initial development costs. Also customers are willing to pay more for a new product.
2.) Growth phase is bringing the market stabilization. Prices are more or less stabile.
3.) Saturation phase leads to price decline, due to competition entrance and loss of consumer's interest
4.) Declining phase is the last part of product life cycle. Prices are still going down.
Sales Channels have the different shopping occasion. Consequently the pricing is adjusted to sales channel. For example, the same products is cheaper in hypermarket than on petrol station.
Government is usually do not interfere into price determination. Exceptionally it may limit maximal prices for a certain products. Still, government is influencing pricing, since the taxes & custom duties are the part of the price.