Pricing is the process of determining what a company will receive in exchange for its products. Pricing factors are manufacturing cost

Manufacturing cost

Manufacturing cost is the sum of costs of all resources consumed in the process of making a product. The manufacturing cost is classified into three categories: direct materials cost, direct labor cost and manufacturing overhead.- Direct materials cost :...

, market place, competition, market condition, and quality of product. Pricing is also a key variable in microeconomic price allocation theory. Pricing is a fundamental aspect of financial modeling

Financial modeling

Financial modeling is the task of building an abstract representation of a financial decision making situation. This is a mathematical model designed to represent the performance of a financial asset or a portfolio, of a business, a project, or any other investment...

 and is one of the four Ps of the marketing mix

Marketing mix

The term "marketing mix" was coined in 1953 by Neil Borden in his American Marketing Association presidential address. However, this was actually a reformulation of an earlier idea by his associate, James Culliton, who in 1948 described the role of the marketing manager as a "mixer of ingredients",...

. The other three aspects are product, promotion, and place

Distribution (business)

Product distribution is one of the four elements of the marketing mix. An organization or set of organizations involved in the process of making a product or service available for use or consumption by a consumer or business user.The other three parts of the marketing mix are product, pricing,...

. Price is the only revenue generating element amongst the four Ps, the rest being cost centers.

Pricing is the manual or automatic process of applying prices to purchase and sales orders, based on factors such as: a fixed amount, quantity break, promotion or sales campaign, specific vendor quote, price prevailing on entry, shipment or invoice date, combination of multiple orders or lines, and many others. Automated systems require more setup and maintenance but may prevent pricing errors. The needs of the consumer can be converted into demand only if the consumer has the willingness and capacity to buy the product. Thus pricing is very important in marketing.

Questions involved in pricing

Pricing involves asking questions like:

• How much to charge for a product
  Product (business)
  In general, the product is defined as a "thing produced by labor or effort" or the "result of an act or a process", and stems from the verb produce, from the Latin prōdūce ' lead or bring forth'. Since 1575, the word "product" has referred to anything produced...
  
   or service? This question is a typical starting point for discussions about pricing, however, a better question for a vendor to ask is - How much do customers value the products, services, and other intangibles that the vendor provides.
• What are the pricing objectives
  Pricing objectives
  Pricing objectives or goals give direction to the whole pricing process. Determining what your objectives are is the first step in pricing. When deciding on pricing objectives you must consider: 1) the overall financial, marketing, and strategic objectives of the company; 2) the objectives of your...
  
  ?
• Do we use profit maximization pricing
  Profit maximization
  In economics, profit maximization is the process by which a firm determines the price and output level that returns the greatest profit. There are several approaches to this problem...
  
  ?
• How to set the price?: (cost-plus pricing
  Cost-plus pricing
  Cost-plus pricing is a pricing method used by companies to maximize their profits.The firms accomplish their objective of profit maximization by increasing their production until marginal revenue equals marginal cost, and then charging a price which is determined by the demand curve. However, in...
  
  , demand based or value-based pricing
  Value-based pricing
  Value based pricing, or Value optimized pricing is a business strategy. It sets selling prices primarily, but not exclusively, on the perceived value to the customer, rather than on the actual cost of the product, the market price, competitors prices, or the historical price.The goal of value-based...
  
  , rate of return pricing
  Rate of return pricing
  Target rate of return pricing is a pricing method used almost exclusively by market leaders or monopolists. You start with a rate of return objective, like 5% of invested capital, or 10% of sales revenue...
  
  , or competitor indexing
  Competitor indexing
  Competitor indexing is a price setting technique used by marketers. Generally, it involves using the price of competitors' products in determining the price of your own products.Variations of this strategy include:* matching competitors price...
  
  )
• Should there be a single price or multiple pricing?
• Should prices change in various geographical areas, referred to as zone pricing?
• Should there be quantity discounts?
• What prices are competitors charging?
• Do you use a price skimming
  Price skimming
  Price skimming is a pricing strategy in which a marketer sets a relatively high price for a product or service at first, then lowers the price over time. It is a temporal version of price discrimination/yield management...
  
   strategy or a penetration pricing
  Penetration pricing
  Penetration pricing is the pricing technique of setting a relatively low initial entry price, often lower than the eventual market price, to attract new customers. The strategy works on the expectation that customers will switch to the new brand because of the lower price...
  
   strategy?
• What image do you want the price to convey?
• Do you use psychological pricing
  Psychological pricing
  Psychological pricing or price ending is a marketing practice based on the theory that certain prices have a psychological impact. The retail prices are often expressed as "odd prices": a little less than a round number, e.g. $19.99 or £2.98. The theory is this drives demand greater than would be...
  
  ?
• How important are customer price sensitivity (e.g. "sticker shock") and elasticity
  Price elasticity of demand
  Price elasticity of demand is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price. More precisely, it gives the percentage change in quantity demanded in response to a one percent change in price...
  
   issues?
• Can real-time pricing be used?
• Is price discrimination
  Price discrimination
  Price discrimination or price differentiation exists when sales of identical goods or services are transacted at different prices from the same provider...
  
   or yield management appropriate?
• Are there legal restrictions on retail price maintenance, price collusion, or price discrimination?
• Do price points already exist for the product category?
• How flexible can we be in pricing? : The more competitive the industry, the less flexibility we have.
  • The price floor
    Price floor
    A price floor is a government- or group-imposed limit on how low a price can be charged for a product. For a price floor to be effective, it must be greater than the equilibrium price.-Effectiveness of price floors:...
    
     is determined by production factors
    Production, costs, and pricing
    The following outline is provided as an overview of and topical guide to industrial organization:Industrial organization – describes the behavior of firms in the marketplace with regard to production, pricing, employment and other decisions...
    
     like costs (often only variable costs are taken into account), economies of scale, marginal cost, and degree of operating leverage
  • The price ceiling is determined by demand factors like price elasticity and price points
• Are there transfer pricing
  Transfer pricing
  Transfer pricing refers to the setting, analysis, documentation, and adjustment of charges made between related parties for goods, services, or use of property . Transfer prices among components of an enterprise may be used to reflect allocation of resources among such components, or for other...
  
   considerations?
• What is the chance of getting involved in a price war?
• How visible should the price be? - Should the price be neutral? (i.e.: not an important differentiating factor), should it be highly visible? (to help promote a low priced economy product, or to reinforce the prestige image of a quality product), or should it be hidden? (so as to allow marketers to generate interest in the product unhindered by price considerations).
• Are there joint product pricing
  Joint product pricing
  Joint Products are two or more products, produced from the same process or operation, considered to be of relative equal importance.Pricing for joint products is a little more complex than pricing for a single product. To begin with there are two demand curves. The characteristics of each demand...
  
   considerations?
• What are the non-price costs of purchasing the product? (e.g.: travel time to the store, wait time in the store, disagreeable elements associated with the product purchase - dentist -> pain, fishmarket -> smells)
• What sort of payments should be accepted? (cash, check, credit card, barter
  Barter
  Barter is a method of exchange by which goods or services are directly exchanged for other goods or services without using a medium of exchange, such as money. It is usually bilateral, but may be multilateral, and usually exists parallel to monetary systems in most developed countries, though to a...
  
  ) Pricing

What a price should do

A well chosen price should do three things:

• achieve the financial goals of the company (e.g., profitability)
• fit the realities of the marketplace (Will customers buy at that price?)
• support a product's positioning
  Positioning (marketing)
  In marketing, positioning has come to mean the process by which marketers try to create an image or identity in the minds of their target market for its product, brand, or organization....
  
   and be consistent with the other variables in the marketing mix
  Marketing mix
  The term "marketing mix" was coined in 1953 by Neil Borden in his American Marketing Association presidential address. However, this was actually a reformulation of an earlier idea by his associate, James Culliton, who in 1948 described the role of the marketing manager as a "mixer of ingredients",...
  
  
  • price is influenced by the type of distribution channel used, the type of promotions used, and the quality of the product
    • price will usually need to be relatively high if manufacturing is expensive, distribution is exclusive, and the product is supported by extensive advertising
      Advertising
      Advertising is a form of communication used to persuade an audience to take some action with respect to products, ideas, or services. Most commonly, the desired result is to drive consumer behavior with respect to a commercial offering, although political and ideological advertising is also common...
      
       and promotional campaigns
      Promotion (marketing)
      Promotion is one of the four elements of marketing mix . It is the communication link between sellers and buyers for the purpose of influencing, informing, or persuading a potential buyer's purchasing decision....
      
      
    • a low price can be a viable substitute for product quality, effective promotions, or an energetic selling effort by distributors

From the marketer's point of view, an efficient price is a price that is very close to the maximum that customers are prepared to pay. In economic terms, it is a price that shifts most of the consumer surplus

Economic surplus

In mainstream economics, economic surplus refers to two related quantities. Consumer surplus or consumers' surplus is the monetary gain obtained by consumers because they are able to purchase a product for a price that is less than the highest price that they would be willing to pay...

 to the producer. A good pricing strategy would be the one which could balance between the price floor (the price below which the organization ends up in losses) and the price ceiling (the price beyond which the organization experiences a no demand situation).

Line Pricing

Line Pricing is the use of a limited number of prices for all product offerings of a vendor. This is a tradition started in the old five and dime

Five and Dime

Five and Dime is a cartoon short by Walter Lantz which features Oswald the Lucky Rabbit. It is the 74th Oswald short produced by Lantz and the 125th overall. It also is among the number of shorts that feature Oswald in his fully clothed appearance....

 stores in which everything cost either 5 or 10 cents. Its underlying rationale is that these amounts are seen as suitable price points for a whole range of products by prospective customers. It has the advantage of ease of administering, but the disadvantage of inflexibility, particularly in times of inflation

Inflation

In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...

 or unstable prices.

Loss leader

A loss leader

Loss leader

A loss leader or leader is a product sold at a low price to stimulate other profitable sales. It is a kind of sales promotion, in other words marketing concentrating on a pricing strategy. A loss leader is often a popular article...

 is a product that has a price set below the operating margin. This results in a loss to the enterprise on that particular item in the hope that it will draw customers into the store and that some of those customers will buy other, higher margin items.

Price/quality relationship

The price/quality relationship refers to the perception by most consumers that a relatively high price is a sign of good quality. The belief in this relationship is most important with complex products that are hard to test, and experiential products that cannot be tested until used (such as most services). The greater the uncertainty surrounding a product, the more consumers depend on the price/quality hypothesis and the greater premium they are prepared to pay. The classic example is the pricing of Twinkies, a snack cake which was viewed as low quality after the price was lowered. Excessive reliance on the price/quality relationship by consumers may lead to an increase in prices on all products and services, even those of low quality, which causes the price/quality relationship to no longer apply.

Premium pricing

Premium pricing (also called prestige pricing) is the strategy of consistently pricing at, or near, the high end of the possible price range to help attract status-conscious consumers. The high pricing of premium product is used to enhance and reinforce a product's luxury image. Examples of companies which partake in premium pricing in the marketplace include Rolex

Rolex

Rolex SA is a Swiss watchmaking manufacturer of high-quality, luxury wristwatches. Rolex watches are popularly regarded as status symbols and BusinessWeek magazine ranks Rolex No.71 on its 2007 annual list of the 100 most valuable global brands...

 and Bentley

Bentley

Bentley Motors Limited is a British manufacturer of automobiles founded on 18 January 1919 by Walter Owen Bentley known as W.O. Bentley or just "W O". Bentley had been previously known for his range of rotary aero-engines in World War I, the most famous being the Bentley BR1 as used in later...

. As well as brand, product attributes such as eco-labelling and provenance (e.g. 'certified organic' and 'product of Australia') may add value for consumers and attract premium pricing. A component of such premiums may reflect the increased cost of production. People will buy a premium priced product because:

1. They believe the high price is an indication of good quality;
2. They believe it to be a sign of self worth - "They are worth it;" it authenticates the buyer's success and status; it is a signal to others that the owner is a member of an exclusive group;
3. They require flawless performance in this application - The cost of product malfunction is too high to buy anything but the best - example : heart pacemaker.

Demand-based pricing

Demand-based pricing is any pricing method that uses consumer demand - based on perceived value - as the central element. These include: price skimming

Price skimming

Price skimming is a pricing strategy in which a marketer sets a relatively high price for a product or service at first, then lowers the price over time. It is a temporal version of price discrimination/yield management...

, price discrimination

Price discrimination

Price discrimination or price differentiation exists when sales of identical goods or services are transacted at different prices from the same provider...

 and yield management

Yield management

Revenue management is the process of understanding, anticipating and influencing consumer behavior in order to maximize yield or profits from a fixed, perishable resource...

, price points, psychological pricing

Psychological pricing

Psychological pricing or price ending is a marketing practice based on the theory that certain prices have a psychological impact. The retail prices are often expressed as "odd prices": a little less than a round number, e.g. $19.99 or £2.98. The theory is this drives demand greater than would be...

, bundle pricing

Product bundling

Product bundling is a marketing strategy that involves offering several products for sale as one combined product. This strategy is very common in the software business , in the cable television industry Product bundling is a marketing strategy that involves offering several products for sale as...

, penetration pricing

Penetration pricing

Penetration pricing is the pricing technique of setting a relatively low initial entry price, often lower than the eventual market price, to attract new customers. The strategy works on the expectation that customers will switch to the new brand because of the lower price...

, price lining, value-based pricing

Value-based pricing

Value based pricing, or Value optimized pricing is a business strategy. It sets selling prices primarily, but not exclusively, on the perceived value to the customer, rather than on the actual cost of the product, the market price, competitors prices, or the historical price.The goal of value-based...

, geo

Geo (marketing)

As a general term, Geomarketing is the integration of Geographical intelligence into all marketing aspects including sales and distribution. Geomarketing Research is the use of geographic parameters in research methodology starting from sampling, data collection, analysis, and...

 and premium pricing. Pricing factors are manufacturing cost, market place, competition, market condition, quality of product.

Multidimensional pricing

Multidimensional pricing is the pricing of a product or service using multiple numbers. In this practice, price no longer consists of a single monetary amount (e.g., sticker price of a car), but rather consists of various dimensions (e.g., monthly payments, number of payments, and a downpayment). Research has shown that this practice can significantly influence consumers' ability to understand and process price information

Nine Laws of Price Sensitivity & Consumer Psychology

In their book, The Strategy and Tactics of Pricing, Thomas Nagle

Thomas Nagle

Thomas Alexander Nagle was an Irish Labour Party politician. He was elected to Dáil Éireann as a Labour Party Teachta Dála for the Cork Mid, North, South, South East and West constituency at the 1922 general election. He was re-elected at the 1923 general election for the Cork North constituency....

 and Reed Holden outline 9 laws or factors that influence how a consumer perceives a given price and how price-sensitive s/he is likely to be with respect to different purchase decisions:

1. Reference Price Effect Buyer’s price sensitivity for a given product increases the higher the product’s price relative to perceived alternatives. Perceived alternatives can vary by buyer segment, by occasion, and other factors.
2. Difficult Comparison Effect Buyers are less sensitive to the price of a known / more reputable product when they have difficulty comparing it to potential alternatives.
3. Switching Costs Effect The higher the product-specific investment a buyer must make to switch suppliers, the less price sensitive that buyer is when choosing between alternatives.
4. Price-Quality Effect Buyers are less sensitive to price the more that higher prices signal higher quality. Products for which this effect is particularly relevant include: image products, exclusive products, and products with minimal cues for quality.
5. Expenditure Effect Buyers are more price sensitive when the expense accounts for a large percentage of buyers’ available income or budget.
6. End-Benefit Effect The effect refers to the relationship a given purchase has to a larger overall benefit, and is divided into two parts: Derived demand: The more sensitive buyers are to the price of the end benefit, the more sensitive they will be to the prices of those products that contribute to that benefit. Price proportion cost: The price proportion cost refers to the percent of the total cost of the end benefit accounted for by a given component that helps to produce the end benefit (e.g., think CPU and PCs). The smaller the given components share of the total cost of the end benefit, the less sensitive buyers will be to the component's price.
7. Shared-cost Effect The smaller the portion of the purchase price buyers must pay for themselves, the less price sensitive they will be.
8. Fairness Effect Buyers are more sensitive to the price of a product when the price is outside the range they perceive as “fair” or “reasonable” given the purchase context.
9. The Framing Effect Buyers are more price sensitive when they perceive the price as a loss rather than a forgone gain, and they have greater price sensitivity when the price is paid separately rather than as part of a bundle.

Approaches

Pricing is the most effective profit lever

Lever

In physics, a lever is a rigid object that is used with an appropriate fulcrum or pivot point to either multiply the mechanical force that can be applied to another object or resistance force , or multiply the distance and speed at which the opposite end of the rigid object travels.This leverage...

.
Pricing can be approached at three levels.The industry, market, and transaction level.

Pricing at the industry level focuses on the overall economics of the industry, including supplier price changes and customer demand changes.

Pricing at the market level focuses on the competitive position of the price in comparison to the value differential of the product to that of comparative competing products.

Pricing at the transaction level focuses on managing the implementation of discounts away from the reference, or list price, which occur both on and off the invoice or receipt.

Pricing tactics

Micromarketing

Micromarketing

Micromarketing"Micromarketing" was first referred to in the UK marketing press in November 1988 in respect of the application of geodemographics to consumer marketing....

 is the practice of tailoring products, brands (microbrands), and promotions to meet the needs and wants of microsegments within a market. It is a type of market customization that deals with pricing of customer/product combinations at the store or individual level.

Pricing mistakes

Many companies make common pricing mistakes. Bernstein's article "Supplier Pricing Mistakes" outlines several which include:

• Weak controls on discounting
• Inadequate systems for tracking competitor selling prices and market share
• Cost-Up pricing
• Price increases poorly executed
• Worldwide price inconsistencies
• Paying sales representatives on dollar volume vs. addition of profitability measures

Methods

• Price System
  Price system
  In economics, a price system is any economic system that affects its distribution of goods and services with prices and employing any form of money. Except for possible remote and primitive communities, all modern societies use price systems to allocate resources...
  
  
• Product life cycle management
  Product life cycle management
  Product life-cycle management is the succession of strategies used by business management as a product goes through its life-cycle. The conditions in which a product is sold changes over time and must be managed as it moves through its succession of stages.Product life-cycle Like human beings,...
  
  
• Value pricing
• Product sabotage
  Product sabotage
  In marketing and retail, product sabotage is a practice used to encourage the customer to purchase a more profitable product or service as opposed to cheaper alternatives. It is also the practice where a company attempts to aim different prices at different types of customer...
  
  
• Price elasticity of demand
  Price elasticity of demand
  Price elasticity of demand is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price. More precisely, it gives the percentage change in quantity demanded in response to a one percent change in price...
  
  
• Time based pricing
• Suggested retail price
  Suggested retail price
  The manufacturer's suggested retail price , list price or recommended retail price of a product is the price which the manufacturer recommends that the retailer sell the product. The intention was to help to standardise prices among locations...
  
  
• Purchasing power
  Purchasing power
  Purchasing power is the number of goods/services that can be purchased with a unit of currency. For example, if you had taken one dollar to a store in the 1950s, you would have been able to buy a greater number of items than you would today, indicating that you would have had a greater purchasing...
  
  
• Psychological pricing
  Psychological pricing
  Psychological pricing or price ending is a marketing practice based on the theory that certain prices have a psychological impact. The retail prices are often expressed as "odd prices": a little less than a round number, e.g. $19.99 or £2.98. The theory is this drives demand greater than would be...
  
  
• Options pricing
• Group buy
• Cost the limit of price
  Cost the limit of price
  Cost the limit of price was a maxim coined by Josiah Warren, indicating a version of the labor theory of value. Warren maintained that the just compensation for labor could only be an equivalent amount of labor . Thus, profit, rent, and interest were considered unjust economic arrangements...
  
  
• Pay what you want
  Pay what you want
  Pay what you want is a pricing system where buyers pay any desired amount for a given commodity, sometimes including zero. In some cases, a minimum price may be set, and/or a suggested price may be indicated as guidance for the buyer. The buyer can also select an amount higher than the standard...
  
  

External links and further reading

• William Poundstone
  William Poundstone
  William Poundstone is an American author, columnist, and skeptic. He has written a number of books including the Big Secrets series and a biography of Carl Sagan...
  
  , Priceless: The Myth of Fair Value (and How to Take Advantage of It) Hill and Wang, 2010

Engineering New Product Success: the New Product Pricing Process at Emerson Electric. A case study by Jerry Bernstein and David Macias. As published in Industrial Marketing Management.