Price Setting Setting the right price is important for any product. There are many different approaches, based on the different variables that can be considered. For a new product in the marketplace, getting the price right is all the more difficult, because there is no prior data to help gauge the strength of the current brand, the price elasticity of demand or other factors that might come into play when pricing an established product. However, there is always an opportunity to adjust prices if the price of a good is not delivering the optimal financial results for the company. Thus, it requires management to have an understanding of pricing strategy in order to determine the most suitable price in the marketplace.

The most important thing to keep in mind is that price is one of the five Ps of marketing. Thus, the pricing strategy must be aligned with the other aspects of the marketing strategy in order for it to be effective. If the pricing strategy is sending a different signal to the marketplace than the other elements of the marketing strategy, there is greater risk to the company. This is especially the case with a new product, because consumers do not have a lot of history with the product or industry to fall back on; they may have trouble deciphering the different signals that are being sent by the different aspects of the marketing plan.

Considerations

There are several different pricing strategies, deriving from a handful of different core pricing philosophies. The first guiding principle in pricing is that the product must cover the cost of production and sale. There is a pricing approach based on this, called cost-plus pricing, where the company sets the price of the good in line with its costs and does not take the competitive marketplace into account. Some companies that produce luxury goods take this approach, leveraging the lack of price sensitivity of the marketplace. Restaurants commonly take this approach -- everything on the menu might be three times ingredient cost, or whatever the local rule of thumb is. This approach just means that the cost of producing something is passed onto the customers, and that there is a guarantee that everything sold will cover variable costs and therefore contribute to the net profits.

Most pricing strategies are more sophisticated than the cost-plus approach, but they will build cost into the strategy. Usually, the variable cost is considered to be the lower limit of what price can be charged, even during a sale. The reason for this is basic managerial accounting -- if the product is covering its cost of production, then it is contributing to the profitability of the company, even if that contribution is minimal, and poor value. If you sell something for less than the cost to make it, there would have to be a very good reason. Usually, the reason is that the cost of exiting that business is very high, so that it costs less to continue in the business and lose money than it would cost to actually exit the business. But normally, whatever other approach a company takes with its pricing strategy, it will at least seek to cover costs.

Another basic principle of pricing is the demand curve (NetMBA, 2010). The demand curve can be known for established products. For newer products, it might be entirely unknown, known only by looking at the other products within the industry or it might be known mostly through focus groups or other market research. The demand curve reflects the demand for the product at any given price point. The demand curve is based on a few ideas, one being the concept of utility. This means that the product is only worth what somebody is willing to pay for it, which in turn more or less means the value that the person can derive from the product. If the customer does not receive the equivalent utility from the product that would they would otherwise receive from using that money a different way, the customer is not likely to be a repeat customer; they will dissatisfied. So the demand curve is related to this idea, and for most products, the lower the price the higher the demand will be. There are exceptions to this, such as luxury goods. A luxury good derives some of its value from its exclusivity and a high price is one way of rendering something exclusive. There are situations where a luxury good will have higher demand when the price is increased, because it will be perceived as better quality and more exclusive....

But for the most part, the demand curve says that the lower the price the higher the demand. This information is used along with the cost of production information to calculate the profit at each different price point. The point where the profit is highest is the ideal price that the company will want to set.
For many products, however, it is the market that sets the price. The reason is simple -- in most markets there is intense competition, and consumers have sufficient information on which to make their purchase decisions. So for most products, the price more or less reflects what the market will bear for that particular good. It does not have the right attributes to charge more, but charging less would be insufficiently profitable. The company has the opportunity to influence the demand for its goods, however. An example is Apple, which creates brand loyalty and simplifies the purchase process, both of which serve to increase demand over what might exist if consumers were only evaluating the products on their attributes and price. A company can convince consumers that it offers more than what it does, or that what it offers is a bargain for the price it is charging. There are different approaches to influence consumer decision-making processes, which in turn shift the market for a good, increasing or decreasing demand.

What this means for most companies, however, is that they must work hard to influence the market and try to shift their demand curve. Otherwise, the market will essentially dictate the price and how much the company can sell at that price. Furthermore, a company that is selling to another business will also have to contend with the bargaining power of that business. A manufacturer of a consumer good has to choose the channels by which it wishes to sell its products, and those channels will influence the price. Some channels are deep discounters, offering a high volume of throughput in exchange for tighter margins. Other channels allow the company to maintain margins, but might require more work because they lack the throughput. There are a number of channel decisions that most companies have to make for their goods, and ultimately those channel decisions will influence the amount of power that a company has over the price of its goods in the marketplace, and the price that it will receive. A company may take a lower price in order to win a customer, if it feels that there are long-run benefits. A company may also choose to use one product as a loss leader in exchange for maintaining margins on others. There are any number of different environmental factors that can influence the final price for a good.

Pricing Strategies

The company must weigh all of these different philosophies and environmental influencers, and determine the sort of pricing strategy that will fit best with its overall marketing strategy. There are a number of different pricing strategies from which to choose. Two are current profit maximization and current revenue maximization. These are slightly different. The point at which profit is maximized is not necessarily the point of maximum revenue. Instead it is the point where the marginal cost of new revenue meets marginal revenue. After this point, the company can still increase its revenue, but will spend more than the cost of this revenue to achieve that. Thus, the two strategies are quite different. Maximizing profit today means pricing at the point of optimal profit, which can be determined using the demand curve and the product's cost. Maximizing revenue is less profitable, placing more emphasis on bringing money into the organization. There are two main conditions where this is desirable. The first is for a company with high fixed costs. Maximizing revenue will provide more raw contribution to fixed costs than maximizing, even with a lower profit margin. That might be important if fixed costs are high and the company is unable to deal with them another way.

The other condition under which maximizing revenue makes sense is when the company needs to grow the business. Maximizing market share is a closely-related objective. The company may decide that it earns lower profits today with a lower price point, but can gain market share. There are a few reasons why this is desirable. First, in a new business it helps to build a customer base. Companies seeking to win smartphone market share away from Apple offered their products at lower…