Although all are geared towards the goal of maximizing wealth, different businesses adopt different pricing strategies.
The main objectives in choosing and setting the price of a product include the following: 1.) maximize profit, 2.) meet target sales or market share, and 3.) maintain a price that is stable in relation to competitors' prices.
Internal Factors in Pricing a Product
The cost of producing and marketing the product is the main consideration in setting a price. Clearly, the company wants to make profits from the costs it incurred. Marketing strategies, such as product specifications, place of distribution, and ways or promoting the product are carefully considered.
The capacity of the plant is also to be taken into account. Companies may set higher prices when they are not operating at full capacity for them to recover fixed costs even if less units are sold. This is known as peak-load pricing.
External Factors in Pricing a Product
Market competition plays big role in product pricing. The type of market determines the ability of a company in setting prices. In industries under perfect competition, players have less to no control over price. It is set by the market. Under monopolistic competition, a monopoly virtually has the power to set prices since there are no competitors.
Legal factors are also considered. Generally, pricing strategies that kill healthy competition are prohibited by law. Predatory pricing involves setting prices so low to drive out competitors. Collusive pricing happens when companies conspire to set very high prices. Discriminatory pricing involves charging different prices from different customers. These pricing strategies are generally prohibited by law.
The law of demand and supply also determines price levels. Generally, the higher the demand, the higher the price sellers will charge. The higher the supply is, the lower the price. The sensitivity (elasticity) of price to changes in demand and supply, and vice versa, must also be studied.
1. Cost-based pricing - Price is set by adding a certain mark-up above the cost of producing and selling the product.
2. Value-based pricing - Rather than focusing on costs, price is based on the value of the product as perceived by the buyer.
3. Competition-based pricing - Prices are based on competitors' prices. This is most applicable in pure competition markets where there are many market players.
4. Penetration pricing - Low prices are set for a new product for it to enter the market easily. Once the product has established itself, higher prices may then be set.
5. Price skimming - involves setting high prices for new products. The goal of price skimming is to sell as many units as possible to customers who do not care much about price. Once substantial amounts of cost have been recovered, prices may then be lowered in order to expand sales.