Factors affecting price determination
Factors affecting price determination
Following are the important factors that affect the price of a product or services:
1. Product Costs
2. Value of the product to the buyer
3. Legal Considerations
5. Other elements of marketing.
While fixing the price, it is important and logic to ask some questions like: What is the cost? What profit should be earned on the sale of products? What can people pay for the product? etc., The third question is an important question for a marketer. However, many marketers fix the price in terms of total costs. Total cost is the total of Manufacturing cost, distribution cost and administration cost. They then add a reasonable profit to it. Selling products or services below the cost will be dangerous and it may bring loss for the business. To sustain in the business, you have to sell products above the cost. (There are exception for introducing a new product or in a new market, manufactures sell product below the cost for a short period.)
Types of costs: For fixing the price, costs can be classified in to two: They are:
1. Fixed Costs
2. Variable Costs
Fixed costs are those costs which will not vary with the volume of sale or production. The manufacturer has to bear some expenses whether he produces 100 pieces a month or 1000 pieces a month. Examples of fixed costs are: Rent for the land or building used for the manufacturing. Rent for the storeroom, interest for the borrowed capital etc. These costs also known as overhead costs. These costs are known as fixed costs and will not change as per the variation in the production or sales.
Variable Costs are those costs which vary with the level of production. Cost of labor, electricity, raw materials etc. are vary as per the level of production. These costs can be controlled by changing the production schedule.
The total of fixed and variable cost is the total cost. Average total cost is the total costs divided by the number of units produced. Increase in production means the lower the cost would be. At the same time decrease in production would increase the cost.
Value of the product to the buyer
A man's wants are unlimited but his purchasing power is limited. Hence, he buy those products which give him maximum satisfaction. Each consumer set a priority schedule for the goods and services which he purchase. Priority of different people vary from person to person and place to place and time to time.
Price also affect the demand. More goods will be demanded at a lower price than at a higher price. This is the law of demand. To a marketer to increase the demand, he has to reduce the price of the product/services. It will help more people to avail the service/product. Therefore, a marketer must set a price that will attract enough buyers to achieve expected sales volume. The marketer must ascertain as to how price sensitive the buyers are to the change in price. This sensitivity is measured by price elasticity of demand. Price elasticity is defined as the relative change in the quantity demanded caused by a relative change in price. It refers to the inverse relationship that exists between the price and the quantity sold . Price elasticity can be calculated by dividing the percentage change in the quantity demanded by the percentage change in the price changed.
If the demand for a product increase by 20% when the price is reduced by 5%, the price elasticity demand is 4 and the demand is said to be elastic. The negative sign indicates that there is an inverse relationship between the demand and the price. If the demand falls by 5% when the price is increased by 15%, then the elasticity of the demand is -1/3. In this case, the demand for the product is inelastic.
The demand for a product is said to be elastic if the percentage change in quantity is greater than the percentage change in price. Conversely, the demand for a product is said to be price inelastic if a percentage change in price cause a smaller percentage change in demand. In price elastic demand, a decrease in price would increase the total revenue. However, any increase in price would lead to a decrease in the total revenue.
Cost is an important consideration in price determination. At the same time consumer must get value/utility for the money paid. The proper function of cost is to set the lower limit on the initial price charged for a product, while value to the buyer indicates the upper limit of the price. The job of the marketing manager is to choose that price between these two limits which will help him better in achieving the overall objective of pricing.
If the demand for the product is inelastic, the company is in a better position to fix prices at a higher level. The demand for products which are purchased with discretionary income, such as luxury items, automobiles etc., is generally more elastic. The demand for necessities such as salt, sugar, food-grains, public transport services etc. is generally inelastic.
A marketing manager should be aware of the law of the country before fixing prices. Under the "Essential Commodities Act" prices of certain goods are restricted and fixed by the government. The seller does not have the freedom of charging more than the predetermined price of such commodities. An increase in price can attract public criticism and may attract legal restraint. Suppose a medicine which is an essential commodity costs $ 2 per unit, whereas the buyer is prepared to pay any amount in case of an emergency. In the absence of any competition, the seller will be tempted to charge very high price, say $20 per unit. However, the law of the land can restrain the unscrupulous seller from charging exorbitant price. Therefore, legal consideration is a factor which affect the pricing decision.
While the upper and lower limits of the price of a product is set by keeping in mind the value of the product to the buyer and the cost of the product to the seller. At the same time a marketing manager must taken in to consideration the prevalent price of the product at the market. Competition in the market will considerably influence the fixation of price of a product. Free and healthy competition will reduce the price and favorable for the consumer. No competition or negligible competion will attract price escalation. The price of the substitute products and the features and prices offered by the competitors will also affect the pricing decition of a product. Through analysis of the pricing and behavior of the competitor in the market might be helpful in fixing the right price for the product. Right pricing can prevent a new competitor from entering into the market.
Other elements of Marketing
Pricing decision of a product by the company is depended on the following elements:
Method of Marketing
Channel of Distribution
Quality of the product
After sales service
Amount and medium of Advertising
Efficiency of Sales person
Type of packaging used etc.
If a company is providing better services like money back guarantee or home delivery or selling through expensive air conditioned outlets, the selling price of the product will be on a higher side. If a product is considerably different from the competitors products, then the company has more freedom in fixing the price of the product.