Pricing DecisionsBasic Factors Influencing the Pricing Decision (the Three C’s) Customers•What do the customers want?•What is their demand for particular kinds of products?•How elastic is that demand?Competitors•Who are the existing competitors on a product line?•Are there potential competitors?•Are there substitutes for the product?Costs•What are the production costs?•What is the cost of serving each customer group?•What are the competitors costs?
Pricing DecisionsThe analysis underlying a pricing decisions is fundamentally the same as that underlying any other decision:Identify the goal that is to be achieved;andSelect the price that will best enable the firm to achieve its objective, after considering all of the relevant factors.
Short-run vs Long-run PricingShort-run•In the short-run the relevant costs that must be recovered are those that will change depending upon whether the product is produced or not, such as– Variable production costs– Set-up costs– Order and delivery costs– Any opportunity costs that might result from constraintsor externalities.Long-run•For the long-run, the set of relevant costs is larger.•Over its life, a product must recover all of its costs– both fixed and variable – and provide the firm with a reasonable return on its investment.
Long-run Pricing DecisionsMost pricing decisions are a combination of two extreme cases:1)Cost-Plus PricingCost-plus pricing is typically used when there is no established market for a product or service (e.g., when the product is “custom made”) or when there is relatively little competition in the product market.In these cases, the price is derived as:Price/unit = Cost/unit x Mark-up rate (%)orPrice/unit = Cost/unit + Profit/unit ($)For long-run price determination, it is best to apply the mark-up rate (%) to the full product-related costs (including marketing) To ensure that all costs are recoveredTo stabilize prices by preventing managers from reducing the price to variable costHowever, it is important to bear in mind that, for short-term pricing or for strategic purposes, full-cost-plus pricing may not be appropriate/desirable.
Determining the Mark-up Rate (Amount)The mark-up rate should be based on consideration of two factors: