Q.
(a) Explain three (3) factors affecting a firm’s pricing decision (15 marks)
(b) Elaborate the internal & external factors which affects a firm’s pricing decision for its product ( 10 marks)
(25 marks, 2022 Q5)
A.
Factors affecting pricing decision as well as internal & external factors were asked in:
(a) 3 factors affecting a firm's pricing decision.
Some of the major factors influencing pricing decisions of a company are as follows:
A company’s price level sends signals about the quality of its products to the customer. A customer always compares the company’s prices with those of its competitors. The competitors also keep an eye on the price levels of a company.
1. Price-quality relationship:
Customers use price as an indicator of quality, particularly for products where objective measurement of quality is not possible, such as drinks and perfumes. Price strongly influences quality perceptions of such products.
If a product is priced higher, the instinctive judgment of the customer is that the quality of the product must be higher, unless he can objectively justify otherwise.
2. Product line pricing:
A company extends its product line rather than reduce price of its existing brand, when a competitor launches a low price brand that threatens to eat into its market share. It launches a low price fighter brand to compete with low price competitor brands.
The company is able to protect the image of its premium brand, which continues to be sold at a higher price. At a later stage, it produces a range of brands at different price points, which serve segments of varying price sensitivities.
And when a customer shows the inclination to trade up, it persuades him to buy one of its own premium brands. Similarly, if a customer of one of its premium brands wants to trade down, it encourages him to buy one of its value brands.
But, it is not easy to maintain a portfolio of brands in the same product category. The company needs to endow each of its brands with an independent personality, and identify it with a segment.
A company’s brands should not be floating around, willing to grab any customer that they can, but they should be specifically targeted at segments—customers of the target segment should like the brand, but customers of other segments should not like it enough to buy it.
3. Explicability:
The company should be able to justify the price it is charging, especially if it is on the higher side. Consumer product companies have to send cues to the customers about the high quality and the superiority of the product.
A superior finish, fine aesthetics or superior packaging can give positive cues to the customers when they cannot objectively measure the quality of the offering. A company should be aware of the features of the product that the customers can objectively evaluate and should ensure superior performance of those features.
In industrial markets, the capability of salespeople to explain a high price to customers may allow them to charge higher prices. Where customers demand economic justifications of prices, the inability to produce cost arguments may mean that high price cannot be charged.
A customer may reject a price that does not seem to reflect the cost of producing the product. Sometimes it may have to be explained that premium price was needed to cover R&D expenditure, the benefits of which the customer is going to enjoy.
4. Competition:
A company should be able to anticipate reactions of competitors to its pricing policies and moves. Competitors can negate the advantages that a company might be hoping to make with its pricing policies. A company reduces its price to gain market share.
One or more competitors can decide to match the cut, thwarting the ambitions of the company to gamer market share. But all competitors are not same and their approaches and reactions to pricing moves of the company are different.
The company has to take care while defining competition. The first level of competitors offers technically similar products. There is direct competition between brands which define their businesses and customers in similar way.
Reactions of such competitors are very swift and the company will have to study each of its major competitors and find out their business objectives and cash positions.
Competitors who have similar ambitions to increase their market share and have deep pockets will swiftly reduce price if any one of them reduces prices. A telephone company offering landline services has all telephone companies offering landline services as its first level of competitors.
The second level of competition is dissimilar products serving the same need in a similar way. Such competitors’ initial belief is that they are not being affected by the pricing moves of the company.
But once it sinks in that they are being affected adversely by the pricing moves of a company that seemingly belongs to another industry, they will take swift retaliatory actions. The telephone company has the mobile phone operators as its second level of competitors.
The third level of competition would come from products serving the problem in a dissimilar way. Again such competitors do not believe that they will be affected. But once convinced that they are being affected adversely, swift retaliation should be expected.
The retaliation of third level is difficult to comprehend as their business premises and cost structures are very different from the company in question. Companies offering e-mail service are competitors at the third level of the telephone company. A company must take into account all three levels of competition.
5. Negotiating margins:
A customer may expect its supplier to reduce price, and in such situations the price that the customer pays is different from the list price. Such discounts are pervasive in business markets, and take the form of order-size discounts, competitive discounts, fast payment discounts, annual volume bonus and promotions allowance.
Negotiating margins should be built, which allow price to fall from list price levels but still permit profitable transactions. It is important that the company anticipates the discounts that it will have to grant to gain and retain business and adjust its list price accordingly. If the company does not build potential discounts into its list price, the discounts will have to come from the company’s profits.
6. Effect on distributors and retailers:
When products are sold through intermediaries like retailers, the list price to customers must reflect the margins required by them Sometimes list prices will be high because middlemen want higher margins.
But some retailers can afford to sell below the list price to customers. They run low-cost operations and can manage with lower margins. They pass on some part of their own margins to customers.
7. Political factors:
Where price is out of line with manufacturing costs, political pressure may act to force down prices. Exploitation of a monopoly position may bring short term profits but incurs backlash of a public enquiry into pricing policies. It may also invite customer wrath and cause switching upon the introduction of suitable alternatives.
8. Earning very high profits:
It is never wise to earn extraordinarily profits, even if current circumstances allow the company to charge high prices. The pioneer companies are able to charge high prices, due to lack of alternatives available to the customers.
The company’s high profits lure competitors who are enticed by the possibility of making profits. The entry of competitors in hordes puts tremendous pressure on price and the pioneer company is forced to reduce its price. But if the pioneer had been satisfied with lesser profits, the competitors would have kept away for a longer time, and it would have got sufficient time to consolidate its position.
9. Charging very low prices:
It may not help a company’s cause if it charges low prices when its major competitors are charging much higher prices. Customers come to believe that adequate quality can be provided only at the prices being charged by the major companies.
If a company introduces very low prices, customers suspect its quality and do not buy the product in spite of the low price. If the cost structure of the company allows, it should stay in business at the low price. Slowly, as some customers buy the product, they spread the news of its adequate quality.
The customers’ belief about the quality-price equation starts changing. They start believing that adequate quality can be provided at lower prices. The companies which have been charging higher prices come under fire from customers. They either have to reduce their prices or quit.
Ref:
Verbatim from https://www.yourarticlelibrary.com/product-pricing/9-factors-influencing-pricing-decisions-of-a-company/12953