What are the key internal factors and external factors to be considered in price decision making - Essay Example

?What are the key internal and external factors to be considered in price decision making? Why? Introduction While speaking in a simple and basic economics’ language, price of a product is determined by the demand for and supply of that product. The equilibrium point where demand curve intersects with supply curve is the deciding point at which price is determined. When price is considered in terms of demand and supply, it can be said that price has inverse relationship with demand and positive relationship with supply. In other words, when price increases demand decreases and vice versa, while price increases supply also increases. This is because, when price increases, the customers would like to reduce its consumption as the product seems to be more expensive. Likewise, when price increases, the firms will be encouraged to produce or supply more, as they expect more for their products. In another words, price has the tendency to be increased by the increased demand and to be decreased by the increased supply (Shapiro and Barbara, 1978). But in a real market, price is not solely determined by the equilibrium position of supply and demand, but some other factors also play crucial role in deciding the price of the products. Pricing is a more a complex and complicated process than a simple determination of demand and supply. Hence, pricing policies which are deliberately taken by the firm is the most important deciding factor which decides the price of a particular product. These pricing policies of the firm are influenced, in general, by two sets of factors- internal and external. Both the internal as well as external factors influence the pricing decisions of any enterprise or firm. These factors may be psychological, economical, quantitative or qualitative (Sawyer, 1981 and Kotler, 1997). 2. Internal Factors Pricing decisions are influenced by a number of internal factors which consist of profit margin, cost of production and other expenses, brand image and expectations of the company, suppliers’ and employees’ efficiency and responsiveness of the product to the price changes (Kotler, 1997). . These factors can broadly categorized under the following heads: 2.1 Corporate and marketing objectives of the firm. Corporate and marketing objectives of the firm mainly seek to recover the cost elements of all types, to make target returns and to maximize the profit. Coverage of the corporate cost of production as well as marketing should be an influential factor of pricing policy of the firm. Corporate objective of making specific return rates on the basis of internal cost factors is another important internal factor which play crucial role in an organization’s pricing strategy. Some important examples of other market objectives are survival of the firm in a high competitive atmosphere, current profit maximization, market share leadership and product quality leadership (Munroe, 1990). 2.2. Image sought by the firm through the price By setting a particular price or implementing a pricing policy, the firms seek a particular public image and this image plays a crucial role in the pricing policy. For example, premium prices are usually being charged for global brand. Likewise, a plant keep going by setting a low price in the hope that in future, the plant can increase the demand. In this case, survival is more important than price or profit maximization (Forman, 1998). 2.2 The Stage of the Production in its life cycle The stage of the production under which the firm goes through is an important factor in the price setting strategy. Whether the firm is going through increasing, decreasing or stagnant returns of scale and where the position of its average and marginal product curves stand, are the important things which decisively play role in the pricing policy of the firm. 2.3. Capacity Utilization and Market Contribution rates Capacity utilization has a positive influence on cost-based pricing strategies. Organizations operating at full capacity are capable of spreading the fixed cost to various units and thereby, achieving flexibility in setting the prices. Market contribution rate means the percentage of total firm profits in representation of one particular product. A product which accounts for a major chunk of the profit share to a firm affects the pricing strategy (Noble, 1995). 3. External Factors Government policies, competitor’s prices, cost of raw materials, consumers’ expectations etc. are the important external factors in the price setting strategy of a firm (Kotler, 1997). 3.1. Government Policies To save the interests of the borrowers and of some sellers, government may interfere in the price determination of the firm. Hence, government policies are taken very seriously into consideration while formulating pricing policies 3.2 Costs of raw material and other intermediary goods Prices of the raw materials and other intermediary goods are very critical in the cost of the product and hence, in the determination of the prices. 3.3 Elasticity of the demand for product Price elasticities at different levels of output determine the price of a particular product. If the product is a more or less a necessary thing, even with high price the customers would purchase it. That is, when there is nearly zero elacticity, the price changes can be possible. More prices are generally charged for products with high elasticity (Munroe, 1990). 3.4. Entry Barriers Entry barriers include the nontariff trade barriers, patents, or technological innovations or advancements. If the entry to barriers are high, firms will be in a better position to retain relatively high prices and profit without facing much competition (Neumann and Lincoln, 1991). 3.5 Switching Costs The differences in the switching cost of the customer affect the flexibility of the managers to set the prices. The differences in the switching costs can be capitalized by implementing appropriate pricing policies (Stango, 2002). 4. Why there exists pricing policy These external and internal factors influence the pricing policies of the firm to attain the following three important objectives: i) maximization of the profit: For maximizing the profit, each firm should have a pricing policy. I ii) Price stability: A stable price should be fixed in order to ensure the confidence of the customer as price fluctuating is not a good will of the firm iii) Ability to pay: The ability of the consumers has to be considered while formulating the pricing principle. Conclusion Several internal and external factors decide the pricing policy of a firm. The firm takes a decision on price by considering the above discussed factors in order to ensure, profit maximization, price stability and ability to pay of the customer Reference Kotler, Philip (1997). Marketing Management: Analysis, Planning, Implemenation and Control. Englewood Cliffs. Prentice-Hall. Monroe, Kent D. (1990). Pricing: Making Profitable decisions: New York. NY7 McGraw-Hill. Montgomery, Stephen (1988). Profitable Pricing Strategies. New York. NY7 McGraw-Hill. Naumann, Earl and Lincoln, Douglas J. (1991). Non-tariff barriers and Entry strategy alternatives: Strategic Marketing Implications. Journal of Small Business Management. 29(2).60-67. Noble, Peter and Gruca, Thomas, S (1999). Industrial Pricing: Theory and Managerial Practice. Marketing Science. 18(3). 435-454. Sawyer, M C (1981). The Economics of Industries and Firms. London. England 7. Croom Helm. Shapiro, Benson P and Jackson, Barbara (1978). Industrial Pricing to meet customer Needs. Harvard Business Review. 56(6). 119-127. Stango, Victor (2002). Pricing with Consumer Switching Cost: Evidence from the Credit Card Market. Journal of Industrial Economics. 50(4). 475-492. Read More