Market Structure and Pricing Practices

Managerial Economics

Outline

Introduction

Overview of Market Structure

Overview of Pricing

Relationship between Market Structure and Pricing Strategy

Market Structure Pricing Practices

· Pricing Practices for Monopolistic, Monopolistic Competition, and Oligopolistic Markets

· Pricing Practices for Perfect Competition Markets

· Price Matching

· Inducing Brand Loyalty

· Randomized Pricing

Conclusion

References

Market Structure Pricing Practices

Market structure is one of the major factors that shape decisions made by business owners and managers. Generally, business owners and managers do not make decisions in a vacuum as they consider various factors including market structure. Market structure is an important aspect of decision-making in businesses as it shapes decisions on how much output to produce and pricing of products/services (Baye & Prince, 2017). The consideration of these factors is essential to promote business success and profitability. Given its impact on pricing or products/services, there is a nexus between market structure and pricing practices. In this regard, decisions on pricing are influenced by consideration of the market structure. This research paper discusses the nexus between market structure and pricing strategies as well as market structure pricing practices.

Overview of Market Structure

Baye & Prince (2017) define market structure as factors like the number of businesses competing in a market, size of these businesses, demand conditions, technological and cost factors, and the ease of entry and exit. A market structure is a term used to refer to a tool used in business decision-making in relation to the external business environment. In essence, the market structure provides business owners and managers with insights regarding the external business environment. These insights in turn shape the decisions and strategies adopted by business owners to ensure and promote the profitability and success of their businesses. Without an understanding of the market structure, business owners and managers will be unable to make appropriate decisions to promote the effective operations and profitability of their businesses. Therefore, market structure is a core characteristic for the operations of a business entity.

As a key factor in determining economic efficiency, market structure comprises different variables that shape managerial decisions. One of these variables is firm size, which implies the considerable variations in the size of businesses operating in a particular market. Each market has firms of different sizes ranging from small to large companies. A firm’s relative position in the industry is affected by various factors including changes in strategies adopted by rivals and changes in market conditions. The differences in firm size contribute to variations in sales, profitability, and revenues.

The second variable in market structure is industry concentration, which refers to distribution of firms within an industry. Industry concentration is an important aspect of managerial decisions as it determines the level of competition a business is likely to face in a particular industry. Markets vary in terms of industry concentration since some industries comprise many small firms while others are dominated by a few large firms (Baye & Prince, 2017). Technological and cost factors are the other variables of the structure of the market and relate to the technologies and costs of production of goods and services. The variations in technology used to produce goods and services contribute to differences in production techniques and measures across industries. These techniques in turn shape cost factors, which are also affected by the labor required in production processes.

Industries also vary in terms of demand and market conditions as well as the potential for entry and exit. Industries with low demand are characterized by the existence of only a few firms, which are adequate to sustain the market. On the contrary, industries with high demand are characterized by the presence of many firms to produce the demanded quantity of goods and services. Additionally, some industries are characterized by ease of entry for new companies into the market while others have numerous barriers to entry. When making decisions, business owners and managers consider the ease of entry to and exit from an industry.

Overview of Pricing

Indounas (2018) states that pricing is an important element for the success of any business organization since it is the only element of the marketing strategy that directly relates to profits and revenues. Pricing practices involve setting pricing objectives, which provide direction for every part of the pricing process. Pricing objectives are sometimes classified into two broad categories relating to maximizing profits and revenues. On one hand, pricing objectives can be classified as those that focus on realizing maximum financial results such as profit maximization and sales maximization. On the other hand, pricing objectives can be classified as those that seek satisfactory financial results for the business. Maximization-related pricing objectives are relatively difficult to operationalize and accomplish in reality. As a result, many business managers emphasize satisfaction-oriented pricing objectives. Such objectives can be operationalized and are achievable in the real-world business environment. Some examples of satisfaction-oriented pricing objective include increasing market share by 5% within the next three years or increasing sales by 5% within a year.

Pricing is usually viewed as the simplest strategy in marketing since many business managers make pricing decisions based on intuition and their experience (Toni et al., 2017). The view of pricing as the simplest strategy in marketing is also influenced by the fact that many managers do not strategically think about it. However, as the modern business environment is increasingly competitive, business managers need to think about pricing in a strategic manner. They should also administer prices of products and/or services in a proactive way in order to establish favorable conditions that result in profits. This need demonstrates how the development and determination of prices is a complex and challenging, but important business decision.

When making pricing decisions, business managers need to understand customers’ perceptions regarding prices, the perceived value of products and/or services, the inherent and relevant costs, and the firm’s competitive position in the market (Toni et al., 2017). By considering these factors, business owners and managers ensure that they do not lose control over their pricing strategies. Companies that fail to manage these factors end up losing control over the prices of their products and services resulting in impaired cost-effectiveness and profitability. This implies that the consideration of these factors enhances the quality of pricing decisions made by business owners and managers. Businesses in today’s competitive environment need a sound pricing strategy in order to promote customer value creation, structure their pricing objectives and decisions, and earn a profit (Kienzler & Kowalkowski, 2017).

Relationship between Market Structure and Pricing Strategy

Existing literature demonstrates a nexus between market structure and pricing strategy on the premise that business owners and managers do not make decisions in a vacuum (Baye & Prince, 2017). Pricing objectives and strategy are usually influenced by the structure of the market. For example, an ideal pricing strategy for an automobile producer differs from that of a company operating in the IT industry. The difference in the pricing strategies between industries is attributable to the differences in operations and market factors. Industries have different market structures and conditions that play a critical role in determining key operational aspects such as pricing.

In addition to the variations between industries, pricing strategies also differ between companies within the same industry. These differences are attributable to market factors and conditions that shape a specific market structure. This implies that companies within the same industry employ different pricing strategies based on the level of competition in the market. Moreover, an organization’s internal operational environment and capacity influence its pricing strategy, which results in variations in pricing practices between companies in the same industry or market. Companies operating in the same market are faced with different challenges and have different operations and objectives, which contribute to differences in pricing practices.

Market structure affects pricing strategies and practices adopted by business organizations. A market with a small number of players is characterized by high market prices if all other factors remain equal (Labaj et al., 2017). The effect of market structure on pricing is also attributable to the fact that market structure entails individual aspects in the market that shape the behaviors of buyers and sellers. The nature of the market structure has a significant impact on the behaviors of producers and buyer behavior. By affecting the behaviors of producers, market structure affects the level of production of goods and services. This in turn affects the price of a specific good or service in the market. Indounas (2018) contends that different conditions in the market, which are attributes of the market structure, result in different pricing objectives. Business managers consider market conditions when making decisions on pricing to ensure that their pricing decisions are effective and suitable for the particular market.

Market Structure Pricing Practices

As evident in the above discussion, there is a strong link between market structure and pricing strategies adopted by businesses. Market structure has a significant impact on pricing strategies since it entails the prevailing market conditions that could affect a firm’s operations and profitability. As previously indicated, business managers examine the nature of the market structure and its conditions when making decisions on pricing. To this extent, there are different pricing practices embraced by business managers depending on the specific market. Market structure can be classified into four i.e. perfect competition, monopoly, monopolistic competition, and oligopoly.

Perfect competition refers to a competitive market in which many companies sell identical products and act as price-takers amidst the rivalry. Since they act as price takers, companies in such a market structure have no market power and simply have to embrace the price for their products or services as given. On the contrary, monopoly refers to a market structure in which a single company is dominant. The single firm sells its products/services for which there are no close alternatives (Baye & Prince, 2017).

Monopolistic competition is a market structure characterized by the presence of numerous competing businesses that offer products that are not identical. Such markets are also characterized by free entry and exit of companies from the industry. While firms in such markets have close substitutes for their products, their products differ from those offered by rivals. These products are close, but imperfect substitutes. In contrast, an oligopoly is a market structure where a small number of large firms dominate the market. Since these markets are dominated by a few large firms, a change in pricing or marketing strategy by one firm affects other companies in the industry or market.

The four different types of market structures are characterized by different levels of competition and operations. The differences in the level of competition contribute to variations in pricing practices. Businesses adopt different pricing practices based on the market structure because there is no one-size-fits-all pricing strategy that is applicable to all markets.

Pricing Practices for Monopolistic, Monopolistic Competition, and Oligopolistic Markets

The first strategy employed in these market structures is price discrimination, which involves charging different prices for the same product or service (Baye & Prince, 2017). It is divided into three categories i.e. first-, second-, and third-degree price discrimination. First-degree price discrimination involves charging customers the maximum prices they are willing to pay for each unit of the purchased product. Examples of industries where firms adopt this form of price discrimination include automobile and law industries. Second-degree price discrimination is a practice is where a firm posts a separate schedule of decreasing prices for various ranges of quantities. This type of price discrimination strategy is commonly employed in the electric utility industry. Third-degree price discrimination is where companies make profits by charging different groups of customers different prices for the same commodities. An example of this pricing practice is student discounts offered in restaurants and hotels.

Two-Part Pricing is the second pricing practice in these markets and involves charging a fixed fee for the right to buy goods and a per-unit price for each unit purchased. Health clubs and golf clubs commonly use this pricing strategy to enhance their profits (Baye & Prince, 2017). The third pricing practice for these markets is block pricing, which entails packaging units of a product and offering them to customers as one package. Through this pricing practice, a company earns more than by offering a simple per-unit price. It increases profits by forcing customers to decide whether or not to purchase units of a product. Companies operating in these market structures use commodity bundling, which involves bundling at least two different products together and offering them to customers at a single bundle price. It is commonly employed by travel companies to extract surplus from customers.

Firms operating in these markets also employ peak-load pricing, which is used because markets have seasons of high and low demands. Using this strategy, firms increase the prices of their products during peak times when the demand is high and lower them during off-peak. The other pricing practice in these markets is cross-subsidies, which is used when a company has cost complementarities and an interdependent demand for a group of products by customers. In such situations, cross-subsidies are employed to allow the use of profits generated from one product to subsidize the sales of another commodity. The final pricing strategy employed in these market structures is transfer pricing, which is a practice in which a company optimally establishes the internal price at which an upstream department should offer its inputs to a downstream department. It is an important pricing strategy since many departmental managers are offered incentives to maximize the profits of their own divisions.

Pricing Practices for Perfect Competition Markets

Companies operating in perfect competition market structures adopt different pricing strategies depending on their competitive advantage (Farm, 2019). Those with a competitive advantage adopt pricing practices that seek to maximize profits (Indounas, 2018). Profit maximization is key in pricing decisions for these firms because of the competitive advantage they possess. In contrast, companies that do not have a competitive advantage focus on setting fair prices for their customers. In this regard, these firms embrace a customer-centered approach when making pricing decisions due to lack of competitive advantage and intense rivalry. Some of the most commonly used pricing practices by companies in such market structures include: