How Are Prices Established?
Robert Menard, Certified Purchasing Professional, Certified Professional Purchasing Consultant
Don’t you wonder how prices are established? Pricing is the process of determining a dollar amount that a seller asks from a buyer. Pricing factors include tangible considerations such as production costs, geographical market place, competitive market place, quality, service, and delivery specifications. It is also affected by intangibles such as optimization, perceived value, and dynamics such as marketing and sales strategies.
Questions involved in pricing
The process of establishing a price evolves from answers to many questions such as these.
- How much are competitors charging for similar/identical goods and services
- How do customers “value” the products/services
- Should there be
- a single price
- multiple price points
- quantity discounts
- Should prices vary by geographical areas (zone pricing)
- Is a penetration pricing strategy appropriate
- What brand image should the price convey
- Is yield management appropriate
An efficient price is a price that is very close to the maximum that customers will pay.
There are numerous terms and strategies in the selling world. These are a few of the most well known.
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Nomenclature
- Effective price the price the seller receives after accounting for discounts, promotions, and other incentives.
- Price homogenization This strategy limits the number of prices for all of a supplier’s products. The old five and dime stores of yore in which everything cost either 5 or 10 cents have been replaced by “Dollar” stores but the principle is the same.
- Loss leader This has a price that is often below cost and would otherwise create a Robinson-Patman violation save for its retail consequences. It usually creates a loss to the seller on that particular loss leader but it draws customers who likely will buy other related and higher margin items. Think of hot dog buns and soft drinks on the fourth of July. The chips, dip, hot dogs and burgers bought more than offset the leader “loss”.
- Price/quality or “Perceived Value” Perceived Value refers to the perception by consumers that a higher price means greater quality. This method of pricing was established in the 1970s with the introduction of Zantac to compete with Tagamet.
- Premium or Prestige This is the strategy of pricing near the high end of the range to attract status-conscious consumers. Some well known examples of premium pricing are Rolex and Steinway. People will buy a premium priced product because of its perceived prestige.
- Goldilocks This is the practice of “gold-plating” a version of a product in order to make the next-lower priced option appear more reasonably priced; encouraging customers to buy business-class airline seats for their “value” compared to the pricier first-class fare.
- Funnie Munnie In this practice, price is not a single amount but consists of various choices such as monthly payments or number of payments. I like to use the example of private jet planes that are frequently priced in “per occupied seat per mile per trip” basis. Another example is the $x/month. This is a favored strategy of the dreaded car sales man. “What monthly payment could you afford?” That payment could cost you dearly.