7.4 - Price

Price is a vital component of the marketing mix as it impacts on the consumer demand for the product. The pricing level will also 

• determine the degree of value added by the business to bought in components

• influence revenue and profit due to impact on demand

• reflect marketing objectives and help establish the psychological image and identity of a product

Factors determining the price

• costs of production

• competitive conditioner on the market 

• competitors’ prices

• marketing objectives

• price elasticity of demand

• whether it is a new or existing product

DIFFERENT PRICING STRATEGIES 

COST BASED PRICING

Cost-based pricing begins with an assessment of the costs involved in producing or supplying a product, and then adds a specific amount or percentage as profit. One of the simplest forms is cost-plus pricing, where a business calculates the unit cost of a product and adds a fixed markup to set the final price. Retailers often use this method, adjusting the markup based on factors like demand, competition, or product maturity.

Another cost-based method is marginal-cost pricing, which involves setting a price based on the additional cost of producing one more unit. For example, an airline might sell last-minute seats at a lower price, as long as the fare covers the marginal cost of carrying one more passenger. While this can boost sales, it must be used carefully, as publicizing such prices widely could lead to pressure for permanent discounts.

Contribution-cost pricing is another approach where prices are set above variable costs to make a "contribution" toward fixed costs and profit. This strategy is common in multi-product firms where fixed costs are difficult to allocate per product, or when firms want to attract new orders or sell off excess stock without making a loss on each unit.

Full-cost or absorption-cost pricing, where both fixed and variable costs are calculated for each product and a profit margin is added. This method ensures all costs are covered and is especially common in firms producing one main product. However, in companies with many products, allocating fixed costs can become complex.

COMPETITION BASED PRICING

Competition-based pricing looks outward rather than inward. Firms using this strategy base their prices on those of competitors. In price leadership, a dominant firm sets the standard market price, and others follow to remain competitive. This is common in oligopolistic markets, such as fuel or mobile services, where firms tend to avoid price wars by aligning with the market leader.

Predatory pricing is a more aggressive strategy where a company deliberately undercuts competitors, sometimes selling at a loss, with the intention of forcing weaker rivals out of the market. Though potentially effective, this tactic is illegal in many regions, including the EU, due to its anti-competitive nature. Companies using it may try to disguise it as a loss-leader strategy—offering one product at a loss to attract customers who will buy other, more profitable items.

Finally, going-rate pricing is based on the prevailing market conditions and average prices charged by competitors. This has become increasingly common with the rise of online shopping, where price transparency allows consumers to compare options easily. Firms that cannot justify higher prices with added value (like superior service or product features) often find themselves having to match or follow the going rate.

MARKET BASED PRICING

Market-based pricing strategies are guided by external factors—primarily consumer demand, competitor prices, and overall market conditions—rather than a company’s internal costs. These strategies are particularly useful when businesses aim to either enter new markets, build market share, or maximize profits from consumer willingness to pay.

Penetration pricing, where a business sets a relatively low price for a new product in order to attract customers quickly and gain a substantial share of the market. This is often supported by heavy promotion and is suited to products with mass appeal or in highly competitive markets. Once brand recognition is established and customer loyalty grows, firms often gradually raise prices. 

At the opposite end of the spectrum is market skimming, where firms set high prices for new or innovative products with unique features or brand prestige. This strategy is most effective when demand is price inelastic—where consumers are less sensitive to high prices. The goal is to maximize short-term profits before competitors enter the market with similar offerings. As competition and substitute products increase, the price is lowered over time.

Price discrimination, where different consumer groups are charged different prices for the same product. This is only possible when customer segments can be clearly separated, and when it’s impractical or impossible for products to be resold between groups. Airlines frequently apply this model, charging higher prices for business travelers and lower fares for early-booking tourists. Train companies also offer discounts to children or seniors based on age groups' differing demand elasticity.

Loss leader pricing involves selling certain products—often everyday essentials—at very low or even below-cost prices to attract customers into a store. The idea is that once consumers are inside, they will purchase other, more profitable items. Supermarkets frequently sell products like bread or milk as loss leaders. While effective, this strategy raises ethical concerns about the impact on smaller retailers who can’t afford such aggressive discounts.

Psychological pricing plays on consumer perceptions of value. This strategy often involves pricing items just below round numbers—for example, $999 instead of $1000—to make the price seem significantly lower. More subtly, it also considers what customers believe a product should cost based on its quality or image. For example, a luxury perfume priced too cheaply might damage its brand by appearing lower in quality, while pricing it too high might deter all but a niche audience. Successful psychological pricing requires careful market research and a strong understanding of consumer behavior.

Promotional pricing uses temporary price reductions to boost sales or clear excess inventory. This might include limited-time offers, discounts, or deals such as "buy one, get one free." This approach is commonly used during seasonal dips in demand or to support the launch of a new product or store location. Promotional pricing is not typically sustainable long-term, but it is a powerful tool to drive short bursts of demand or create urgency.

SUPPLY AND DEMAND IN PRICING 

Supply and Demand Basics

Supply is how much of a product producers are willing to sell at a given price. For example, if weather conditions improve and more farmers grow cocoa, there will be more cocoa available. This increase in supply usually pushes the price down, because there’s more to go around.

Demand is how much of a product consumers are willing and able to buy at a given price. If demand increases—for instance, if more people want chocolate because of a successful marketing campaign—the price of cocoa might go up, because more people are competing to buy the same amount.

So, prices change depending on how supply and demand interact.

Why it matters: If demand is elastic, businesses should lower prices to boost sales. If it’s inelastic, they can raise prices without losing too many customers—and increase revenue.

Price Elasticity of Demand (PED)

PED measures how much demand for a product changes when its price changes.

• If a price increase causes demand to drop a lot, the product is price elastic (e.g., luxury goods or many substitutes).

• If demand doesn’t change much after a price change, the product is price inelastic (e.g., gasoline or medicine).

Why it matters: If demand is elastic, businesses should lower prices to boost sales. If it’s inelastic, they can raise prices without losing too many customers—and increase revenue.

Income Elasticity of Demand (YED)

YED measures how much demand changes when consumer incomes change.

• Normal goods (like books or phones): Demand rises when incomes rise (positive YED).

• Luxury goods (like designer clothes or sports cars): Demand rises more than income (high positive YED).

• Inferior goods (like bus tickets or instant noodles): Demand falls when incomes rise (negative YED), because people switch to better alternatives.

Why it matters: Businesses can use YED to decide which products to promote in different economic conditions. In a boom, focus on luxury goods. In a recession, focus on value brands.

Cross Elasticity of Demand (XED)

XED shows how demand for one product changes when the price of another product changes.

• If two products are substitutes (like Coca-Cola and Pepsi), XED is positive. If Coke gets cheaper, Pepsi sales might fall.

• If two products are complements (like printers and ink), XED is negative. If printer prices go up, fewer people buy ink too.

Why it matters: Firms must watch rival pricing and bundle complements smartly.

Advertising Elasticity of Demand (AED)

AED tells us how responsive demand is to changes in advertising spend.

• If AED is high, a good ad campaign can boost demand significantly.

• If AED is low, more advertising may not help—especially if the product is poor quality or if competitors out-advertise you.

Why it matters: Businesses should monitor ad effectiveness. Spending more only works if other parts of the marketing mix (product, price, etc.) support it.