The Four Big Inputs To All Pricing Decisions

Pricing is really important in marketing because often times prices are chosen really really arbitrarily. Just looking at your competitor’s pricing, and using it as a sole reference for your pricing decision to modify your pricing accordingly to create an illusion of offering some small value isn’t the right way to go. There are other factors that must be considered.

There are four big inputs to pricing. These inputs must be considered while pricing a product in order to have a strong pricing strategy.

1. Company issues:

The company that manufactures a product will have certain financial considerations. The marginal cost of the product forms the floor of the pricing decision. This implies the price can’t be kept lower than the floor since the company intends to not just break-even, but also go on to make some profit. The company will have a certain target margin and/or internal rate of return which it shall consider while pricing the product.

The company also needs to consider being consistent in pricing with the product line. This implies the prices of new products will be influenced by the prices of existing products in the product line.

The company also needs to be consistent in its image. Thus, when a pricing decision is being made, the company needs to ensure that the price does not make the product extremely high-end or low-end compared to the company’s existing image as a seller. As an instance, Walmart can’t sell very high priced products because of its low product price range.

2. Competitor issues:

The price at which your competitors are offering the same product as yours will give a good insight as to tentatively where you might want to price your product. Several considerations must be made here.

Competitor aggressiveness is an important one. It refers to the ability of a competitor to sustain a price-based response i.e., whether a competitor has “deep-pockets”. What this means is that if you launch your product at certain pricing, will a competitor likely offer their product at a lower cost than before so as to make their product offering seem more attractive, and yet be able to sustain the low profits it will make, given the competitor has deep pockets to fall back upon. Thus, having “deep pockets” is directly related to a propensity for “irrational behavior” among your competitor.

It’s also important to consider the various ways competitors might respond to said pricing of your company. Is the competitor more likely to respond by improving their advertising or product? Or will they respond by making their distribution system more robust and efficient to reduce costs? If not, will the competitor respond by lowering their prices? These questions must be worked out to see how a competitor may respond.

You must also consider the position of the competitor.

Market leaders are likely to initiate, and followers are likely to imitate.

Market leaders have, in some sense, a responsibility to keep the prices high. Thus, if you decide to want to go slightly against market norms, you might want to step back and think it through before going further with the pricing decision.

3. Collaborator issues:

It’s important to keep the price high enough to give money to distributors/resellers to motivate them to sell it. The higher the margins set for these distributors/retailers/resellers, the more they are likely to push the product further.

These collaborators shall assess a product offering via the margins and Return on Assets(Profits/Assets) it offers to them.

4. Customer issues:

This might just entail the most important considerations. The customer’s willingness to pay is the amount that forms the ceiling of the pricing.

Price sensitivity is an important factor to consider. To understand this, price elasticity must be studied.

So, for instance, if on increasing the price by 1%, demand goes down by 5%, the product is very price elastic and you might want to drop the price a little.
Similarly, if on increasing the price by 1%, demand goes down by just 0.2%, the product is very price inelastic and you might want to increase the price a little.

Psychological issues must also be considered as a part of customer issues. Since price sensitivity and psychological issues both form a large domain of study under customer issues, I shall do a dedicated blog post on these in detail soon.

Thus, we looked at the four big inputs to pricing decisions here. In conclusion, the pricing must lie between the floor (as set by the cost of making the product) and the ceiling (the maximum customer willingness to pay). Between the floor and the ceiling, the pricing decisions are influenced by collaborator and competitor issues largely. That’s how a wholesome pricing decision is made, with appropriate consideration of each of the factors that must be taken into account. This blog post forms a part of the bigger discussion on pricing I shall have on the blog, in my later blog posts. Pricing is an extremely important consideration to keep in mind, and it can truly make or break a product’s entire marketing strategy!