Pricing has traditionally been considered a me-too variable in marketing strategy. The stable economic conditions that prevailed during the 1960s may be particularly responsible for the low status ascribed to the pricing variable. Strategically, the function of pricing has been to provide adequate return on investment. Thus, the timeworn cost-plus method of pricing and its sophisticated version, return-oninvestment pricing, have historically been the basis for arriving at price. In the 1970s, however, a variety of events gave a new twist to the task of making pricing decisions. Double-digit inflation, material shortages, the high cost of money, consumerism, and Post-price controls behavior all made pricing important. Since then pricing continues to play a key role in formulating marketing strategy. Despite the importance attached to it, effective pricing is not an easy task, even under the most favorable conditions. A large number of internal and external variables must be studied systematically before price can be set.

For example, the reactions of a competitor often stand out as an important consideration in developing pricing strategy. Simply knowing that a competitor has a lower price is insufficient; a price strategist must know how much flexibility a competitor has in further lowering price. This presupposes a knowledge of the competitor’s cost structure. In the dynamics of today’s environment, however, where unexpected economic changes can render cost and revenue projections obsolete as soon as they are developed, pricing strategy is much more difficult to formulate. This article provides a composite of pricing strategies. Each strategy is examined for its underlying assumptions and relevance in specific situations. The application of different strategies is illustrated with examples from pricing literature.

REVIEW OF PRICING FACTORS Basically, a pricer needs to review four factors to arrive at a price: pricing objectives, cost, competition, and demand. This section briefly reviews these factors, which underlie every pricing strategy alternative.

Pricing Objectives Broadly speaking, pricing objectives can be either profit oriented or volume oriented. The profit-oriented objective may be defined either in terms of desired net profit percentage or as a target return on investment. The latter objective has been more popular among large corporations. The volume-oriented objective may be stated as the percentage of market share that the firm would like to achieve. Alternatively, it may simply be stated as the desired sales growth rate. Many firms also consider the maintenance of a stable price as a pricing goal. Particularly in cyclical industries, price stability helps to sustain the confidence of customers and thus keeps operations running smoothly through peaks and valleys.

Each firm should evaluate different objectives and choose its own priorities in the context of the pricing problems that it may be facing. The following list contains illustrations of typical pricing problems:

1. Decline in sales.

2. Higher or lower prices than competitors.

3. Excessive pressure on middlemen to generate sales.

4. Imbalance in product line prices.

5. Distortion vis-à-vis the offering in the customer’s perceptions of the firm’s price.

6. Frequent changes in price without any relationship to environmental realities. These problems suggest that a firm may have more than one pricing objective, even though these objectives may not be articulated as such. Essentially, pricing objectives deal directly or indirectly with three areas: profit (setting a high enough price to enable the company to earn an adequate margin for profit and reinvestment), competition (setting a low enough price to discourage competitors from adding capacity), and market share (setting a price below competition to gain market share). As an example of pricing objectives, consider the goals that Apple Computer set for Macintosh:

1. To make the product affordable and a good value for most college students.

2. To get certain target market segments to see the Macintosh as a better value than the IBM PC.

3. To encourage at least 90 percent of all Apple retailers to carry the Macintosh while providing a strong selling effort.

4. To accomplish all this within 18 months.

Cost Fixed and variable costs are the major concerns of a pricer. In addition, the pricer may sometimes need to consider other types of costs, such as out-of-pocket costs, incremental costs, opportunity costs, controllable costs, and replacement costs. To study the impact of costs on pricing strategy, the following three relationships may be considered: (a) the ratio of fixed costs to variable costs, (b) the economies of scale available to a firm, and (c) the cost structure of a firm vis-à-vis competitors. If the fixed costs of a company in comparison to its variable costs form a high proportion of its total costs, adding sales volume will be a great help in increasing earnings. Consider, for example, the case of the airlines, whose fixed costs are as high as 60 to 70 percent of total costs. Once fixed costs are recovered, any additional tickets sold add greatly to earnings. Such an industry is called volume sensitive. There are some industries, such as the consumer electronics industry, where variable costs constitute a higher proportion of total costs than do fixed costs. Such industries are price sensitive because even a small increase in price adds much to earnings. If the economies of scale obtainable from a company’s operations are substantial, the firm should plan to expand market share and, with respect to longterm prices, take expected declines in costs into account.

Alternatively, if operations are expected to produce a decline in costs, then prices may be lowered in the long run to gain higher market share. If a manufacturer is a low-cost producer relative to its competitors, it will earn additional profits by maintaining prices at competitive levels. The additional profits can be used to promote the product aggressively and increase the overall market share of the business. If, however, the costs of a manufacturer are high compared to those of its competitors, the manufacturer is in no position to reduce prices because that tactic may lead to a price war that it would most likely lose. Different elements of cost must be differently related in setting price.

Competition The information may be analyzed with reference to these competitive characteristics: number of firms in the industry, relative size of different members of the industry, product differentiation, and ease of entry. In an industry where there is only one firm, there is no competitive activity. The firm is free to set any price, subject to constraints imposed by law. As an Illinois Bell executive said about pricing (before the AT&T split): “All we had to do was determine our costs, and then we would go to the commission the Illinois Commerce Commission, and they would give us the allowable rate of return.”2 Conversely, in an industry comprising a large number of active firms, competition is fierce. Fierce competition limits the discretion of a firm in setting price. Where there are a few firms manufacturing an undifferentiated product (such as in the steel industry), only the industry leader may have the discretion to change prices.

Other industry members will tend to follow the leader in setting price. The firm with a large market share is in a position to initiate price changes without worrying about competitors’ reactions. Presumably, a competitor with a large market share has the lowest costs. The firm can, therefore, keep its prices low, thus discouraging other members of the industry from adding capacity, and further its cost advantage in a growing market. If a firm operates in an industry that has opportunities for product differentiation, it can exert some control over pricing even if the firm is small and competitors are many. This latitude concerning price may occur if customers perceive one brand to be different from competing brands: whether the difference is real or imaginary, customers do not object to paying a higher price for preferred brands. To establish product differentiation of a brand in the minds of consumers, companies spend heavily for promotion. Product differentiation, however, offers an opportunity to control prices only within a certain range. In an industry that is easy to enter, the price setter has less discretion in establishing prices; if there are barriers to market entry, however, a firm already in the industry has greater control over prices. Barriers to entry may take any of the following forms:

1. Capital investment.

2. Technological requirements.

3. Nonavailability of essential materials.

4. Economies of scale that existing firms enjoy and that would be difficult for a newcomer to achieve.

5. Control over natural resources by existing firms.

6. Marketing expertise. In an industry where barriers to entry are relatively easy to surmount, a new entrant will follow what can be called keep-away pricing. This pricing strategy is necessarily on the lower side of the pricing spectrum.

Demand based on a variety of considerations, of which price is just one. Some of these considerations are

1. Ability of customers to buy.

2. Willingness of customers to buy.

3. Place of the product in the customer’s lifestyle (whether a status symbol or a product used daily).

4. Benefits that the product provides to customers.

5. Prices of substitute products.

6. Potential market for the product (is demand unfulfilled or is the market saturated?).

7. Nature of nonprice competition.

8. Customer behavior in general.

9. Segments in the market. All these factors are interdependent, and it may not be easy to estimate their relationship to each other precisely. Demand analysis involves predicting the relationship between price level and demand while considering the effects of other variables on demand. The relationship between price and demand is called elasticity of demand or sensitivity of price. Elasticity of demand refers to the number of units of a product that would be demanded at different prices. Price sensitivity should be considered at two different levels: total industry price sensitivity and price sensitivity for a particular firm. Industry demand for a product is considered to be elastic if, by lowering prices, demand can be substantially increased. If lowering price has little effect on demand, demand is considered inelastic. The environmental factors previously mentioned have a definite influence on demand elasticity. Let us illustrate with a few examples. During the energy crisis, the price of gasoline went up, leading consumers to reduce gasoline usage. By the same token, since gasoline prices have gone down, people have again started using gas more freely. Thus, demand for gasoline can be considered somewhat elastic. Acase of inelastic demand is provided by salt. No matter how much the price fluctuates, people are not going to change the amount of salt that they consume. Similarly, the demand for luxury goods, yachts, for example, is inelastic because only a small proportion of the total population can afford to buy yachts. Sometimes the market for a product is segmented so that demand elasticity in each segment must be studied. The demand for certain types of beverages by senior citizens might be inelastic, though demand for the same products among a younger audience may be especially elastic. If the price of a product goes up, customers have the option of switching to another product. Thus, availability of substitute products is another factor that should be considered. When the total demand of an industry is highly elastic, the industry leader may take the initiative to lower prices. The loss in revenue due to decreased prices will be more than compensated for by the additional demand expected to be generated; therefore, the total dollar market expands. Such a strategy is highly attractive in an industry where economies of scale are achievable. Where demand is inelastic and there are no conceivable substitutes, price may be increased, at least in the short run. In the long run, however, the government may impose controls, or substitutes may be developed. The demand for the products of an individual firm derives from total industry demand.

An individual firm is interested in finding out how much market share it can command by changing its own prices. In the case of undifferentiated standardized products, lower prices should help a firm increase its market share as long as competitors do not retaliate by matching the firm’s prices. Similarly, when business is sought through bidding prices, lower prices should help achieve the firm’s objectives. In the case of differentiated products, however, market share can be improved even when higher prices are maintained (within a certain range). Products may be differentiated in various real and imaginary ways. For example, by providing adequate guarantees and after-sale service, an appliance manufacturer may maintain higher prices and still increase market share. Brand name, an image of prestige, and the perception of high quality are other factors that may help to differentiate a product in the marketplace and thus create an opportunity for the firm to increase prices and not lose market share. Of course, other elements of the marketing mix should reinforce the product’s image suggested by its price. In brief, a firm’s best opportunity lies in differentiating the product and then communicating this fact to the customer. A differentiated product offers more opportunity for increasing earnings through price increases. The sensitivity of price can be measured by taking into account historical data, consumer surveys, and experimentation. Historical data can either be studied intuitively or analyzed through quantitative tools, such as regression, to see how demand goes up or down based on price. A consumer survey to study the sensitivity of prices is no different from any other market research study. Experiments to judge what level of price generates what level of demand can be conducted either in a laboratory situation or in the real world. For example, a company interested in studying the sensitivity of prices may introduce a newly developed grocery product in a few selected markets for a short period at different prices. Information obtained from this experiment should provide insights into the elasticity of demand for the product. In one study, the prices of 17 food products were varied in 30 food stores. It was found that the product sales generally followed the law of demand: when prices were raised 10 percent, sales decreased about 25 percent; a price increase of 5 percent led to a decrease in sales of about 13 percent; a lowering of prices by 5 percent increased sales by 12 percent; and a 10 percent decrease in price improved sales by 26 percent. In another study, a new deodorant that was priced at 63 cents and at 85 cents in different markets resulted in the same volume of sales.

Thus, price elasticity was found to be absent, and the manufacturer set the product price at 85 cents. A recent study of the top 500 brands in the United Kingdom showed that a 10% price cut produced an 18.5% increase in sales. This excludes a small group of mainly luxury brands with a positive price elasticity whose sales increase when their price goes up. The study found wide variation across brands and categories. The household cleaning products were much less price-sensitive than, say dairy and bakery products. To conclude this discussion on pricing factors, it would not be out of place to say that, while everybody thinks businesses go about setting prices scientifically, very often the process is incredibly arbitrary. Packaged goods companies for example, have long recognized that pricing is a key lever in managing brands for profitability. Yet it is so neglected at present that improving price management can raise margins substantially. Companies seeking to capture this potential must make efforts to understand the behavior of consumers and find ways to apply this understanding to the thousands of frontline pricing decisions they make every year. Although businesses of all types devote a great deal of time and study to determine the prices to put on their products, pricing is often more art than science. In some cases, setting prices does involve the use of a straightforward equation: material and labor costs + overhead and other expenses + profit = price. But in many other cases, the equation includes psychological and other such subtle subjective factors that the pricing decision may essentially rest on gut feeling. For example, price sensitivity, visibility to competition, and strength of supplier relationships are used to rank various customers, allowing a different pricing strategy to be adopted for each customer to effectively achieve profit, share, and communication objectives. The following eight steps deal with the essentials of setting the right price and then monitoring that decision so that the benefits are sustainable.

1. Assess what value your customers place on a product or service.

2. Look for variations in the way customers value the product

3. Assess customers’ price sensitivity.

4. Identify an optimal pricing structure.

5. Consider competitors’ reactions.

6. Monitor prices realized at the transaction level.

7. Assess customers’ emotional response.

8. Analyze whether the returns are worth the cost to serve. The above eight steps assess the factors affecting price. Companies need to assess their customers to discover how a product or service is valued. Variations in the way customers value the same product may be turned to a company’s benefit through clever pricing.