Internal and external factors affecting pricing decisions

University Degree Business and Administrative studies

LEVEL 2 MANAGEMENT

ASSIGNMENT

ESSAY TITLE: Internal and external factors affecting pricing decisions

Primary SUBJECT AREA: Marketing

NAME: Evgueni Nod

MATRICULATION NO: 0007927

For Office Use only:

Submission Date:

Misc:

Introduction

“There are two fools in every market. One charges too much; the other charges too little.”

Russian proverb

“Pricing is the moment of truth – all of marketing comes to focus in the pricing decisions”

These words show the significance of the concept of price and how important it is to set prices of company’s products carefully in order not to be a ’fool’ in the market. Price is the only marketing-mix variable that earns revenue. All the other marketing-mix elements – product, place and promotion generate only costs. The product might be perfectly designed, efficiently distributed and well promoted but all these do not matter unless price covers all the costs. It is, therefore important that managers understand how to set prices and what factors to consider. In setting prices a manager first must consider the company’s overall marketing objectives and the role of price in the marketing-mix. Should he set prices to maximise current profits or to maximise long-run market share or to prevent competition from entering the market? He must also consider the costs as they set the floor for the price.

Beyond costs, managers must understand the relationship between price and demand for the product and must set prices to match the value that consumers receive from the product and consumer perception of the price. For example, if Orange, the leading UK mobile phone network, charges for a minute of talk more than the customers’ perceived value, its service will be poorly used and some of its customers will switch to competitive networks. Finally, competitors’ prices and offers must be considered.

Thus, a company (like Orange) sets its prices on the basis of numerous factors – overall marketing objectives, costs, competitors’ prices and offers, and consumer perception of the price and demand. But it is also important to adjust prices to account for different buyers and different market situation. Orange, for example, has a large range of different mobile phones models and accessories priced from £0 to £199,99 and various talk plans from 2p to 35p per minute in order to fit any consumer preferences and pocketbooks.

Acknowledgments

I want to thank one person who helped me in writing this work. Karen Laverly, the manager of Orange retail shop (128 Buchanan st., Glasgow, G1 2JW) agreed to answer my questions (see Appendix 1) about the company she worked for and provided me with practical information on my topic.

Internal factors affecting pricing decisions

Internal company factors that affect pricing decisions are company’s objectives, company’s marketing-mix strategy, its costs and organisation.

Company’s objectives

It is easier for a company to set prices if it is clear about its objectives. It may easily use price as a tool to achieve what it wants. The most common objectives are:

Survival. A company may set survival as its main objective because of the heavy competition or demand declines as a result of changing customer needs. In this case, profits are less important than survival and, therefore, low prices may be set to increase demand.
Current profit maximisation. If a company wants current financial results rather than long-run performance, it may estimate costs and demand at different price levels and set price that will produce the maximum profit.
Market-share maximisation. Some companies set prices as low as possible in order to obtain the dominant market share. As market-share leaders, they will have higher long-run profits in the future.
Market-share gain is a variation of the previous objective. If, for example, a company wants to increase its market share from 5% to 10% within a 2-year period, it sets market-share gain as its fundamental objective. In this case the company needs to search for the price that will achieve this goal.
Quality leadership. If a company wants to produce the highest-quality product or to provide the highest-quality service on the market, it may charge a high price for some reasons. Firstly, price of a product is always associated with its quality, therefore, high price may be charged to cover the quality. Secondly, higher costs that are due to higher quality must be covered.
Other objectives. A company may also use prices to achieve any other goals. It can set low prices to prevent the market from new entrants or avoid government intervention. Prices can be increased to slow down sales and increase inventories.

Sometimes, a company may decide that it wants to achieve two or more objectives at a time. Orange, for example, has set quality leadership and market-share maximisation as its main objectives. It is trying to provide the highest-quality services at the mobile phone market and at the same time it wants to be the most widespread network in the UK. And it may be two these efforts that have made the company a leader.

One might think that these two objectives are contradictory to each other by definition but if we think about the specificity of mobile phone industry ...

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One might think that these two objectives are contradictory to each other by definition but if we think about the specificity of mobile phone industry and wire services. The product, mobile phones, and some services are uniform. Every company in the market offers the same products and services as their competitors. So, Orange must not set prices higher than the competition even if it provides higher-quality services. Moreover, it may set prices a little lower to attract more customers and increase the volume of sales (in this case it is the number of phones and the number of minutes of talk time) to cover the costs of higher-quality services. It also can use high quality as differential advantage over the competition.

Marketing-mix strategy

When setting prices, managers need to remember that price is one element of the marketing-mix. “Price should not be set in isolation”. It should be co-ordinated with product design, promotion and place. Decisions made for other marketing-mix variables may affect or might be affected by pricing decisions. Some companies follow the strategy of non-price positioning. Price in this case depends on the decisions made for other marketing-mix variables. These companies differentiate their marketing offers and, therefore, charge high price for that. But some companies set their prices first and then make their decisions for promotion, distribution, product design and quality on the basis of the price they want to charge. For example, Orange follows this strategy. Despite it provides high-quality services, it cannot charge higher price than the competition does for that. In wire industry price is the major factor that affects consumer buying decisions. If Orange charged more than the competition, it would lose some of its customers to main competitors. So, Orange has to set prices first and then decide on whether to provide high-quality services or not.

Costs

A company charges the price both to cover the costs of producing, distributing and selling its product or providing services and to earn some profits. Costs may be an important element here because they set the floor, the lowest price that the company may charge for its product or service. According to costs, the lowest price Orange can charge for one minute of talk time is 1p. But it does not. The minimum price Orange does charge is 2p, whereas the maximum is 35p. Why? The price of 1p could be set if survival was chosen as the company’s main objective. This price would only cover all the costs and would not deliver any profit. Profit is needed for the company’s growth and to support activities that the company does to achieve its goals.

Organisational consideration

It is very important to decide who within a company should set prices. Who handles pricing shows how important it is for an organisation to set prices carefully and how important price is considered to be. In small companies, pricing usually is handled by the top managers. In large companies prices are often set by divisional or product line managers. In some industries, where price is a major factor that affects consumer buying decisions, it is normally for marketing department to set the prices or to have a special pricing department that derives the best price for a particular product and then reports to the marketing department or top manager. Traditionally, these industries are: railways, aerospace, power companies, oil and gas companies. I can add to this list mobile phone industry because the decision of consumers on what company to choose is very much determined by prices these companies charge for their products and services. In Orange case, for example, setting prices is a duty of the marketing department. It derives the best price for the whole UK market but all Orange outlets are free to vary prices of mobile phones in a certain range according to the local market conditions.

External factors affecting pricing decisions

External or environmental factors that affect company’s pricing include the type of market in terms of competition, the nature of the demand, competitors’ pricing and other environmental influences.

Type of market

Companies’ pricing strategies vary with different types of market. Economists recognise four major types of market, each needs different pricing strategy. They are pure monopoly, pure competition, monopolistic competition and oligopolistic competition.

Under pure monopoly, the market consists of only one seller and many buyers. The seller may be a government monopoly, a private regulated or non-regulated monopoly. In each case, prices are set differently. Under government monopoly, the seller may try to achieve several pricing objective. It may set the price quite high to slow down the consumption of a particular good or to produce good revenue or, on the contrary, very low because the product is very important to buyers. In a regulated monopoly (a power company), the government permits the company to vary prices within a certain range, so that the price will deliver some profits and will let the company to maintain and expand its activities. Under non-regulated monopoly, the company may set whatever price it wants but it not always does so for a number of reasons: “a desire not to attract competition, a fear of government regulation” etc.

Under pure competition, the market consists of many buyers and sellers. A product is uniform (oil or gas). No single seller can charge less than the market price or more than the market price. In the first case, this would generate an infinite excess demand for its goods. In the second case, it would not be able to sell anything because buyers would be able to obtain as much as they need at the market price.

Under monopolistic competition, the market consists of many buyers and sellers. There is no single market price because sellers can differentiate their offers to buyers on either the physical product or the accompanying services. Under monopolistic competition, each company is not affected by the competitors’ marketing strategies.

In an oligopolistic competition, the market consists of many buyers and few sellers that are sensitive to each other’s pricing strategies. The product can be uniform (mobile phones) or non-uniform. It is very difficult for new sellers to enter such a market. Mobile phone companies in the UK compete in such kind of market. There are four major networks in the market that are alert to each other’s strategies and moves. Orange, for example, watches adverts and checks mobile news and prices of its competitors once a week. The physical product (mobile phones) is uniform as well as some services (sending text massages) but companies may differentiate their offers by another services. Different talk plans or offering one-hour delivery when buying a phone, for example. So, the description of the UK mobile phone market fits the definition of oligopolistic competition.

Price-demand relationship

When setting prices managers need to know the price-demand relationship. Each price a company may charge will lead to a different demand level. Very often price and demand are inversely related; that is the higher is price the lower is the level of demand. If, for example, all the companies providing wire services in the UK raised their tariffs for talk time, people would use their services more rare and, therefore, the demand for these services would fall. But it not always so that price and demand are inversely related. When new Nokia 3210 first came to the market under £100, there was a huge demand for that, everybody wanted it. Orange, as well as its competitors, did not discount the price for the first time. When the demand had fallen a little, Orange decreased the price a little but the demand did not raise. It stayed the same and even decreased a little more in some time. So, for some products price and demand are not necessarily inversely related. But, in general, Orange does decrease its prices for mobile phones in order to increase the aggregate demand. But that does not have great effect because the demand for mobile phones is not very elastic. Price elasticity of demand shows how responsive demand will be to a change in price. If demand is very elastic, then a small change in price will generate a big change in demand. For example, when Orange dropped its prices for just talk two years ago, there was one million increase in its just talk clients.

So, if demand is quite elastic, sellers may consider setting a lower price that will increase the volume of sales and produce more revenue.

Competitors’ costs, prices and offers

Competitors’ costs, prices and offers is another external factor that is to be considered when setting prices. If a consumer is considering a purchase of a mobile phone from Orange shop, he will compare Orange offers and comparable offers made by Vodafone, One to One and others. He will compare the value of these offers against their prices. Finally, he will decide which offer fits its price better and choose that one. That is why Orange is always aware of its competitor’s prices and offers. As I have mentioned earlier, Orange checks prices, services and offers of its competitors, watches the adverts and reads the mobile news once a week in order to know what is going on at the market. It has to adjust its prices sometimes according to competitors’ prices. When, for example, Vodafone reduced the price for Motorola T2288e to £79.99, Orange had to offer this phone for the same price in order not to lose consumers who were considering the purchase this model to Vodafone.

A company must also compare its costs with the competitors’ costs to know whether costs is the advantage or disadvantage of the firm. If company’s cost are higher than the competition’s, it is obviously the disadvantage.

Other external factors

There might be some other external factors affecting company’s pricing decisions. That might be economic conditions, governmental regulation or social concerns. For example, bad economic conditions in Russian Federation have a strong impact on consumer perception of the price. For most people in Russia purchasing of a mobile phone is a complete waist of money. Most of them cannot afford it, because an average price of a mobile phone is twice as big as their salary. Unfortunately, this obvious external factor is not taken into account by most of wire service companies in Russia. They are more aware of their costs and profits rather than overall situation in the country.

Summary

Thus, there are a lot of factors that affects decision of a company about prices for its products and services. They are overall marketing objectives, costs, marketing-mix strategy, type of market, competitors’ prices and demand.

There are two factors that set the boundaries for the price the company may charge: costs and demand. Company’s costs set the lowest level for the price. The company must charge the price that at least will cover the costs. The demand for company’s products and services set the highest level for the price.

All the other factors determine in what position within that range price is set. The company might charge the lowest price it can, if survival is the main company’s objective. This price will only cover all the cost of producing, distributing and selling the product or providing the service. A little higher than the lowest price may be charged if the company’s main objective is market-share maximisation. If the company wants to maximise its current financial results, it might derive and charge the price that will produce the highest profit.

If the firm competing in the poorly competitive market, it is not able to set its price higher or lower than the market price. “A seller cannot charge more than the going price because buyers can obtain as much as they need at the going price. Nor would sellers charge less than the market price because they can sell all they want at this price”. If the firm is a monopolist, it can charge whatever price it wants within set range. But it will not always charge the highest price for some reasons: to prevent the market from new entrants, to prevent government regulation, etc.

Managers also need to remember that price is only one of marketing-mix variables. It should be co-ordinated with product design, distribution and promotion. For example, the company may charge high price for high-quality product.

Finally, some other environmental factors are to be considered when setting prices. Inflation, interest rates, boom or recession affect consumer perception of the price and, therefore, consumer buying decisions. Managers need to take that into account as well.

References:

E. Raymond Corey, Industrial Marketing: Cases and Concepts (N.J.: Prentice Hall, 1962).

2 D. Jobber, Principles and Practice of Marketing, 2nd ed. (London: McGraw-Hill, 1998), p 292.

3 P. Kotler, Principles of Marketing, 2nd ed. (N.J.: Prentice Hall, 1999), p 691.

4 P. Kotler, Principles of Marketing, 2nd ed. (N.J.: Prentice Hall, 1999), p 690.

Bibliography

Nagle, T. Holden, K. (1995), The Strategy And Tactics Of Pricing.
Oliver, G. (1980), Marketing Today.
Kotler, P. (1999), Principles Of Marketing.
Armstrong, G. Kotler, P. (1994), Principles Of Marketing.
Jobber, D. (1998), Principles And Practice Of Marketing.
OECD (1996), Mobile Cellular Communication: Pricing Strategies And Competition.

Appendix 1

(Questions for an interview)

1. What is your product or service that you offer to your customers?

2. Do you offer products and services to fit any consumer preferences and pocketbook?

3. Do you have special offers for different group of people (students, housewives or business people)?

5. Do you have any discounts for different customer groups (pensioners, students …)?

7. What are your company’s objectives:

- survival

- current profit maximisation

- market-share maximisation

- market-share gain

- quality leadership

8. Any other objectives? (to prevent competition from entering the market or to prevent government intervention)

9. What do you pay for in order to sell products and provide services?

10. According to your costs, what is the lowest price you can charge for your services (for a minute of talk)?

12. Do you make your pricing decisions first and then make the other marketing-mix decisions on the basis of the price you want to charge?

13. If not, then how your pricing decisions are affected by the decisions made for other marketing mix variables (product design, distribution, promotion).

14. Who does set prices in your company (marketing department, sales department, top manager)?

15. How would you describe the type of market you are operating on, in terms of competition? Is it:

- pure competition (many buyers and sellers, uniform commodity, no single buyer or seller can affect the going market price)

- monopolistic competition (many buyers and sellers, range of prices rather than a single market price because the product is differentiated. Each company is not affected by the competitors’ marketing strategies)

- oligopolistic competition (a few sellers who are sensitive to each other’s pricing strategies. It’s difficult for new sellers to enter such a market)

- pure monopoly (one seller is free to set prices)

16. Any other comments on that?

18. How would you describe the relationships between the price and the demand for your products and services? Are they inversely related?

19. Is the demand for your products and services sensitive to the price change? (Do you know the value of the point price elasticity of the demand?)

20. How is your main competitor?

21. Are you aware of your competitors’ prices, costs and offers?

22. How do your competitors’ pricing decisions affect your own pricing? (Do you adjust your prices according to your competitors’ prices?)

23. Are there any other external factors that affect your pricing decisions (economic conditions or social concerns)?

Notes:

E. Raymond Corey, Industrial Marketing: Cases and Concepts (N.J.: Prentice Hall, 1962).

D. Jobber, Principles and Practice of Marketing, 2nd ed. (London: McGraw-Hill, 1998), p 292.

P. Kotler, Principles of Marketing, 2nd ed. (N.J.: Prentice Hall, 1999), p 691.

P. Kotler, Principles of Marketing, 2nd ed. (N.J.: Prentice Hall, 1999), p 690