Price determine the total revenue and to a large extent the profitability of any business. The goals of pricing strategy are:
- to determine how much consumers are prepared to pay for a product;
- to ensure that the company covers all costs involved in manufacturing and marketing the products (direct and indirect);
- to ensure that an adequate profit is made, so as to earn a satisfactory return on investment.
The price strategy is directly affected by the factors that make up the competitive structure of the industry. Thus, in making any pricing decision, the following factors deserve consideration: pricing objectives, cost, competition, the customer, and government regulations.
The Strategic Value Of Price Structure
All pricing strategies are composed of two elements: price structures and price levels.
Price levels are the actual dollar prices that are set within the structure. Price structures exist whenever prices are set.
"What aspects of our product should we be pricing?" and "How should our prices vary for different products and customers?" These are questions of price structure..." (Andrew A. Stern ).
Price structures lay the foundation on which price levels will be set by defining how the characteristics of a product will be priced. For example, most taxi services have a three-part price structure: a price to get into the cab, a price per mile, and a price per minute.
There are many alternative taxi service price structures that have been or could be implemented: a fixed price for any trip within a given area, a price linearly proportional to mileage, a price per passenger, a price differential based on the time of day, and so on.
Managers who have explicitly developed price structures to support their business strategy are using those structures for three purposes:
- To respond to specific competitive threats or opportunities
A price structure that recognizes the primary determinants of competitive advantage allows a firm the flexibility to focus its response to competitive threats by reducing prices where it is less advantaged without leaving money on the table where its advantage is greater.
Companies should distinguish between those customers with whom companies is competitively threatened and those with whom it is secure. The trick to focusing competitive pricing responses is to identify the key determinants of differences in competitive advantage in serving various customers or providing various products.
For example, to design such a price structure, it is necessary to identify those factors that cause variations in relatively cost position for different customers. Relative cost position is the difference between a company's delivered cost to a customer and the lowest-cost competitor's delivered cost to the same customer.
A company's delivered cost advantage depends on order size and relative shipping distance. The appropriate price structure for this firm is one that takes into consideration relative shipping distance and order size. As markets become increasingly competitive, the flexibility imparted by more complex price structures can only grow in value.
- To enhance revenues while minimizing sales volume loss
Rarely all customers have the same valuation. Customer valuation means the value a customer places on the purchase of a product - the highest price he would pay. Some potential customers are willing to pay substantially higher rates that others.
For example, by building a mileage component into their price structure, rental car companies are able to distinguish between the two types of customers. In general, price structure can be used to realize higher revenues when three conditions hold:
- The firm is competitively advantaged in serving select market segments;
- Various customers groups place predictably differing valuations on purchases of the product and customer valuation can be determined by a particular characteristic of the purchase; and
- Customers are not fully able to arbitrage the firm's prices.
- To manage the cost of delivering their products or services
Price structures can be used to create incentives for customers to make their purchase in a manner that is most cost effective from the firm's perspective.
For example, phone companies provided switched service (regular phone company service) and private line service (a direct link on a separate line rented from the phone company) as alternative products that permit customers to communicate between two points. Customers who make fewer calls will chose switched service and customers who make more calls will choose private line - the most efficient services. Similarly, price structure is used to manage costs in other businesses.
Price structure is an important element of any business's strategy. However, price structure is of great value in businesses with short-lived , or "evaporating," inventories because if the product is not sold within some limited period of time, the revenue-generating capacity cannot be recaptured (e.g., if a minute of television commercial time remains unsold at the time program airs, its revenues-generating capacity cannot be captured).
Managers should consider whether they have adequately assessed the role of price structure in implementing their business strategies.