Pricing

The pricing of goods and services is almost always determined by demand, which creates the market or confirms an offering as legitimate, by competition, which lowers prices when present and increases them by its absence, and, finally, by the cost of producing the item or providing the service. A good deal of mythology and mystification surrounds the subject of pricing, but these fundamental relationships enable the business owner to price his or her goods correctly without either gouging or leaving too much on the table.

At the most fundamental level a sale is the consequence of an auction in which the price is set by bidding. If the highest bid is not high enough, the seller will not sell. If no one bids, there is no price. The rarer and the more valuable an object is (i.e., the higher the demand relative to supply) the higher the price. The more common the good and the more sluggish the demand for it, the lower the price—but objects will not be sold below the seller's cost except under unusual circumstances.

Bidding for every little thing in an open auction is, of course, very inefficient. For this reason pricing methods have evolved but still represent, as it were, a kind of ritualized and very slow-motion auction. Prices will rise or drop depending on demand. Demand will rise and fall depending on supply. But while this happens instantly in live-auctions, it takes place almost imperceptively in normal commerce.

PRICING A GOOD

The price of a good or of a service (hereafter we'll mean both by simply saying "product") is its total cost for the seller plus a profit margin over and above this cost the purpose of which is to keep the business in business. The cost will be the cost, of course. The profit margin will depend on the strength of the demand and the intensity of the competition. To be sure, pricing is dynamic. If a seller discovers that consumers like a product but will not pay the price, this often acts as feedback. The seller will attempt to reduce the cost as much as possible while attempting to maintain quality high enough still to command consumer interest. One modern technique of cost-reduction is to buy goods from regions where labor costs are low—and this strategy has created the discounting and outsourcing phenomena so prevalent in the mid-2000s.

Ideally the seller will select a location and an "ambiance" appropriate to the products sold. Ideally the seller will understand his or her turnover of goods well enough to know which lines sell sufficient quantities to maintain the store in business and which products, even if slower-moving, provide the extra margin of profitability. Ideally the seller will be sufficiently aware of the effective competition, namely that likely directly to compete with him or her, and the prices charged by that competition.

Common mistakes in pricing arise from careless tracking of overhead costs, product mix, changing consumer preference, and competitors' behavior. If the out-of-pocket costs of products sold have been declining and the merchant is in the habit of marking things up by a standard percentage, the new pricing may not absorb the total overhead, especially if overhead has been growing. The merchant may also overprice if costs have been rising; a standard mark-up will now produce more than overhead costs and the usual profit—but customers may no longer buy as readily. In service operations where bidding on jobs is common, careless and mechanical methods of estimation may sometimes result in seriously underbidding difficult jobs because the owner or salesperson didn't want to bother getting the ladder out and climbing a roof—or an analyst has failed to make five preliminary phone calls to really understand how easy or difficult it will be to get the information a customer wishes to have collected.

Good pricing behavior is therefore dependent on—

• Detailed and up-to-date knowledge of costs beyond the cost of the actual item, i.e., overhead cost and how it is changing. Increases in rent, salaries, benefits, utilities, and services must be noted immediately and a running overhead rate must be available monthly in updated format.
• Product knowledge including, in some categories, the "service" costs a product is likely to demand after its sale. Selling a computer installation may require a certain number of hours spent on the telephone after installation just in holding customers' hands. This cost must be known in advance.
• Careful and detailed estimating of technical and services sales, sometimes including quick studies and tests and/or visits and close inspections in order to understand jobs fully.
• Current knowledge of competitor pricing.
• A deep understanding of the product mix sold with special attention to that mix of products which carries the business. A specialty grocer may "carry" the store by selling dairy products, bread, cereals, soups, and fresh produce. The expensive meat counter with expert butchers may simply be paying for itself but may be the very reason why customers put up with the limited parking. The real profit may come from the company's extensive line of wines for which its customers are willing to pay a premium. For good pricing strategy, all this must be known.
• Close and detailed knowledge of vendors' offerings to identify unusual opportunities.

PRICING STRATEIES

Pricing itself is a form of communication. Not surprisingly, many different kinds and flavors of pricing strategy exist. Major categories include the following.

Manufacturer's Suggested Retail Price

Many small businesses prefer to price their goods in accordance with the manufacturer's suggested retail price. In some cases this is forced on the business because the price is prominently printed on the packaging. Going below it is possible, but going above it is almost impossible. Where such pricing is literally suggested, not printed, the business adopting this approach without analysis can make mistakes.

Price Bundling

This is the practice of giving the customers the option of buying several items or services for a single price. A furniture retailer might offer customers a sofa and love seat combination at a price somewhat lower than the two goods would cost if bought separately. Similarly, a landscaper might lure customers by offering two free months of lawn maintenance with any major landscaping job. These approaches, all pricing approaches, depend on precise pricing, at least for internal purposes, of each item—and good ability to predict volume changes due to the strategy.

Multiple Pricing

Similar to price bundling, multiple pricing is the practice of selling multiples of a unit for a single price—two for the price of one, $10 for 10, and endless combinations. This sort of pricing is used for moving low-cost items in that few people will buy three cars for the price of two—even if offered.

Cost-Plus Pricing

This method is the standard method of pricing everything initially, as described above. It combines all direct costs, apportions overhead to each product, and then adds the necessary profit margin, the "plus." Cost-plus should be the foundation on which all else is based.

Competitive Pricing

Some small business owners choose to base their own prices on the prices of their principal competitors. Business owners who choose to follow this course, however, should make sure that they look at competing businesses of similar size and strength. Competitive pricing among service-oriented businesses is more difficult to achieve, first because competitive pricing is difficult to discover and second because service jobs are more more variable than identical products spat out three a second by an automated system.

Pricing Above Competition

Oddly enough this strategy is used both in very up-scale and in rather poor areas. In the first the high income of the population permits an upward bias and is in part justified by providing convenience and ambiance. In poor neighborhoods prices are frequently higher than in middle-class neighborhoods because accessible outlets are few, the population has less access to transportation, and the merchant can therefore use his or her presence alone as a wedge and leverage. "Ghetto" pricing tends often to be of this nature, alas.

Pricing Below Competition

Pricing below competition is the practice of setting one's prices below those of its competitors. Commonly employed by major discount chains such as Wal-Mart—which can do so because its purchasing power enables it to save on its costs per unit—this strategy can also be effectively used by smaller businesses in some instances (though not when competing directly with Wal-Mart and its ilk), provided they keep their operating costs down and do not spark a price war. Indeed, the smaller profit margins associated with this pricing strategy make it a practical necessity for participating companies to: exercise tight control over inventory; keep labor costs down; keep major operational expenses such as facility leases and equipment rental under control; obtain good prices from suppliers; and make effective use of its pricing strategy in all advertising.

Price Lining

Companies that engage in this practice are basically hoping to attract a specific segment of the community by only carrying products within a specified price range. Here, again, very high-end retail (Cartier, Furla, Tiffany & Company) and very low-end ("Dollar stores") ultimately use the same strategy. Advantages sometimes accrued through price lining practices include reduced inventory and storage costs, ease of merchandise selection, and enhanced status or large volume. Analysts note, however, that this strategy frequently limits the company's freedom to react to competitors' pricing strategies, and that it can leave businesses particularly vulnerable to economic trends.

Odd Pricing

Odd pricing is used in nearly all segments of the business world today. It is the practice of pricing goods and services at prices such as $9.95 (rather than $10) or $79.99 (rather than $80) because of the conviction that consumers will often round the price down rather than up when weighing whether to make a purchase. This little morsel of pricing psychology has become so universally employed that many observers rightly question its value. Everybody rounds up, not down. But the practice remains widespread and is practiced worldwide.

Other commonly used pricing policies include penetration pricing and skimming pricing (for manufacturers) and loss leader pricing (for retailers). Both subjects are discussed in more detail elsewhere in this volume.

REAL PRICE AND NOMINAL PRICE

For national accounting purposes and to help all sectors of the economy calculate adjustments to pensions, changes in prices for the same goods or services are calculated by using the Consumer Price Index (CPI), prepared and published at monthly intervals by the U.S. Bureau of Labor Statistics. CPI is calculated by systematically pricing all manner of goods and services in the dollars of the day, the actual dollars charged. This is then labeled the "nominal price." The nominal price today is compared with prices for identical "shopping baskets" of goods and clusters of services (e.g., rents, education, fuels, etc.) in an earlier period. If one basket is priced in 2006 and another in 1996, the total price will be different yet will have purchased the same goods and services. CPI data, therefore, can be used to calculate inflation or deflation between two periods. If a dollar's worth of purchases in 1996 cost $1.27 in 2006 (the actual change between the years), the inflation rate has been 27 percent. Thus a couple who received $40,000 in pensions in 1996 would have to have $50,800 in 2006 to have the same standard of living. Using simple arithmetic, it is thus possible to express prices at any time in the past in dollars comparable to any other time. This is called "real price," i.e., price with inflation removed. Real dollars are always associated with a year. Thus when people speak of real 2000 dollars, they mean that all values are expressed in values of the dollar as it had in 2000. Because inflation is increasing, someone earning $75,000 in 2006 earned only $64,500 in 2000 dollars because of the inflation between the two years.

RAISING PRICES

Small business owners are often reluctant to raise prices once a good baseline price has been established. They worry that a price increase will alienate customers and drive them to the competition. "Faced with such resistance, a lot of businesspeople are tempted to forgo price increases altogether, or at least put them off for as long as possible. If you do either one, however, you're making a big mistake," Norm Brodsky wrote in Inc. "Your profit margins will be shrinking…. You're gradually undermining the perceived value of your services or products." Brodsky noted that many of a small business's costs—such as payroll, insurance, and utilities—tend to rise every year, slowly cutting into profit margins. In addition, customers tend to associate price with quality. A business that does not increase prices to keep up with the competition risks being regarded as the cheap alternative in the marketplace.

When price increases are implemented gradually and cautiously, small businesses may be able to keep their customers happy while also keeping their profit margins intact. Customers typically base their purchase decisions on more than just price. Other factors influencing the decision process include quality, features, guarantees, and personal desires. In addition, people will always pay more for good, reliable customer service. In order to make an effective price increase, the business owner should be ready to explain the increase to the customer if asked. The more straightforward and justified the answer, the more effective it will be to cause a customer to nod—not with pleasure, to be sure.

SURVIVING COMPETITORS' DISCOUNT PRICING STRATEGIES

Major discount stores such as Wal-Mart, Sam's Club, Target, Kmart, Office Depot, Staples, Best Buy, and Circuit City have gained control of large blocs of the American business world over the last several years on the strength of their one-stop shopping and discount prices, the latter a result of their ability to buy goods at bulk rates. Many small business owners have felt the impact of these stores—indeed, cautionary tales concerning the impact that such stores can have on formerly vibrant downtown shopping areas have proliferated in recent years.

Surviving such assaults may not always be possible for the small business. A fundamental rule of pricing is that no one who is sane continues to sell below cost. When the "Big Box" moves in next door, the small business can only survive by changing—and sometimes only by changing radically. Hopeful observers suggest that small businesses innovate their way out of such competitive difficulties. They should offer more personal service, develop a niche the "Big Box" has neglected, segment the market more effectively, and/or adopt similar strategies. Yes, change is possible—but difficult if the small business cannot extract the assets invested in the business or if it was not wildly profitable and thus doesn't have reserves of cash. The best defenses are alertness, anticipation, and action before the inevitable happens. On the first news of the "Invasion of the Boxes," the business owner should be dusting off contingency plans and getting ready to liquidate, to move, or to change the business into something very different. The big retailers greatly increase traffic in and around their operations. One possibility of radical response may be to put up something nearby to tempt the masses drawn by low prices produced by Chinese labor. An ice cream shop, perhaps? It's a big change from running a family lumberyard, but entrepreneurs are endlessly creative!

see also Loss Leader Pricing; Penetration Pricing

BIBLIOGRAPHY

Baker, Michael. The Marketing Book. Butterworth-Heinemann,

2003. Brodsky, Norm. "Street Smarts: Raising Prices." Inc. May 2000.

Campanelli, Melissa. "Price Point: Score with a pricing strategy that keeps customers coming back." Entrepreneur. November 2005.

Hitt, Lorin M., and Pei-yu Chen. "Bundling with Customer Self-Selection: Simple approach to bundling low-marginal-cost goods." Management Science. October 2005.

Perryman, Bruce. "Business Sense: Pricing Products for Profit." Stitches Magazine. 22 February 2006.

Plack, Harry J. "Price Hikes Not Always a Bad Thing." Baltimore Business Journal. 14 July 2000.

U.S. Bureau of Labor Statistics. "Consumer Price Indexes." Available from http://www.bls.gov/cpi/home.htm. Retrieved on 1 May 2006.

                                  Hillstrom, Northern Lights

                                   updated by Magee, ECDI

PRICING

Price is perhaps the most important of the four Ps (product, promotion, and place being the others) of marketing since it is the only one that generates revenue for a company. Price is most simply described as the value exchange that occurs for a product or service. Broadly, price is the total of all values exchanged for a product or service. Price is dynamic. When establishing a price for a product or service, a company must first assess several factors regarding its potential impact. Commonly reviewed factors include legal and regulatory guidelines, pricing objectives, pricing strategies, and options for increasing sales. Advances in Internet technology have resulted in the increased use of dynamic pricing by some sellers.

LEGAL AND REGULATORY GUIDELINES

The first major law influencing the price of a company's product was the Sherman Antitrust Act of 1890, passed by the U.S. Congress to prevent a company from becoming a monopoly. A monopoly occurs when one company has total control in the production and distribution of a product or service. As a monopoly, a company can charge higher than normal prices for its product or service, since no significant competition exists. The Sherman Antitrust Act empowers the U.S. Attorney General's Office to challenge a perceived monopoly and to petition the federal courts to break up a company in order to promote competition.

Another significant piece of legislation that has a major effect on determining price is the Clayton Antitrust Act of 1914, passed by Congress in order to prevent practices such as price discrimination and the exclusive or nearly exclusive dealing between and among only a few companies. Like the Sherman Antitrust Act, this act prevented practices that would reduce competition. The Robinson-Patman Act of 1936, which is technically an extension of the Clayton Act, further prohibits a company from selling its product at an unreasonably low price in order to eliminate its competitors. The purpose of this act was to prohibit national chain stores from unfairly using volume discounts to drive smaller firms out of business.

To defend against charges of violating the Robinson-Patman Act, a company would have to prove that price differentials were based on the competitive free market, and not an attempt to reduce or eliminate competition. Because regulations of the Robinson-Patman Act do not apply to exported products, a company can offer products for sale at significantly lower prices in foreign markets than in U.S. markets.

Another set of laws influencing the price of a company's product are referred to as the unfair-trade laws. Passed in the 1930s, these laws were designed to protect special markets, such as the dairy industry, and their main focus is to set minimum retail prices for a product (e.g., milk), allowing for a slight markup. Theoretically, these laws would protect a specialty business from larger businesses that could sell the same products below cost and drive smaller, specialty stores out of business.

Fair-trade laws are a different set of statutes that were enacted by many state legislatures in the early 1930s. These laws allow a producer to set a minimum price for its product; hence, retailers signing pricing agreements with manufacturers are required to list the minimum price for which a product can be sold. These acts prevent the use of interstate pricing agreements between manufacturers and retailers, grounded in the belief that this would promote more competition and, as a result, lower prices. An important aspect of these acts is that they do not apply to intrastate product prices.

PRICING OBJECTIVES

A critical part of a company's overall strategic planning includes the establishment of pricing objectives for the products it sells. A company has several pricing objectives from which to choose, and the objective chosen will depend on the goals and type of product sold by a company. Four pricing objectives are competitive, prestige, profitability, and volume pricing.

Competitive Pricing

The concept behind this frequently used pricing objective is to simply match the price established by an industry leader for a particular product. Since price difference is minimized with this strategy, a company focuses its efforts on other ways to attract new customers. Some examples of what a company might do in order to obtain new customers include producing high-quality and reliable products, providing superior customer service, and engaging in creative marketing.

Prestige Pricing

A company may chose to promote, maintain, and enhance the image of its product through the use of prestige pricing, which involves pricing a product high so as to make it available only to the higher-end consumer. This limited availability enhances the product's image, causing it to be viewed as prestigious. Although a company that uses this strategy expects to have limited sales, a profit is still possible because of the higher markup on each item. Examples of companies that use prestige pricing are Mercedes Benz and Rolls-Royce.

Profitability Pricing

The main idea behind profitability pricing is to maximize profit. The basic formula for this objective is that profits equal revenue minus expenses (P = R − E). Revenue is determined by a product's selling price and the number of units sold. A company must be careful not to increase the price of the product too much, or the quantity sold will be reduced and total profits may be lower than desired. Therefore, a company is always monitoring the price of its products in order to make sure it is competitive while at the same time providing for an acceptable profit margin.

Volume Pricing

When a company uses a volume-pricing objective, it is seeking sales maximization within predetermined profit guidelines. A company using this objective prices a product lower than normal but expects to make up the difference with a higher sales volume. Volume pricing can be beneficial to a company because its products are being purchased on a large scale, and large-scale product distribution helps to reinforce a company's name as well as to increase its customer loyalty. A subset of volume pricing is the market-share objective, the purpose of which is to obtain a specific percentage of sales for a given product. A company can determine an acceptable profit margin by obtaining a specific percentage of the market with a specific price for a product.

PRICING STRATEGIES

Companies can chose from a variety of pricing strategies, some of the most common being penetration, skimming, and competitive strategies. While each strategy is designed to achieve a different goal, each contributes to a company's ability to earn a profit.

Penetration-Pricing Strategy

A company that wants to build market share quickly and obtain profits from repeat sales-generally selects the penetration-pricing strategy, which can be very effective when used correctly. For example, a company may provide consumers with free samples of a product and then offer the product at a slightly reduced price. Alternatively, a company may initially offer significant discounts and then slowly remove the discounts until the full price of the product is listed. Both options allow a company to introduce a new product and to start building customer loyalty and appreciation for it. The idea is that once consumers are familiar with and satisfied with a new product, they will begin to purchase the product on a regular basis at the normal retail price. Retailers with high sales volumes frequently use the penetration-pricing strategy. High sales volume allows retailers, in some cases, to reduce prices even more.

Price-Skimming Strategy

A price-skimming strategy uses different pricing phases over time to generate profits. In the first phase, a company launches the product and targets customers who are more willing to pay the item's high retail price. The profit margin during this phase is extremely high and obviously generates the highest revenue for the company. Since a company realizes that only a small percentage of the market was penetrated in the first phase, it will price the product lower in the second phase. This second-phase pricing will appeal to a broader cross-section of customers, resulting in increased product sales. When sales start to level off during this phase, the company will price the product even lower. This third-phase pricing should appeal to those consumers who were price-sensitive in the first two phases and result in increased sales. The company should now have covered the majority of the market that is willing to purchase its product at the high, medium, and low price ranges.

The price-skimming strategy provides an excellent opportunity for the company to maximize profits from the beginning and only slowly lower the price when needed because of reduced sales. Price adjustment with this strategy closely follows the product life cycle, that is, how customers accept a new product. Price skimming is a frequently used strategy when maximum revenue is needed to pay off high research and development costs associated with some products. This strategy is effective if product image and quality support the higher price and if an adequate number of customers exist at that price. Producers of high-definition televisions have used price skimming as a strategy to maximize revenue.

Competitive-Pricing Strategy

Competitive pricing is yet another major strategy. A company's competitors may either increase or decrease their prices, depending upon their own objectives. Before a company responds to a competitor's price change with one of its own, a thorough analysis as to why the change occurred needs to be conducted. An investigation of price increases or decreases will usually result in one or more of the following reasons for the change: a rise in the price of raw materials, higher labor costs, increasing tax rates, or rising inflation. To maintain an acceptable profit margin for a particular product, a company will usually increase the price. In addition, strong consumer demand for a particular product may cause a shortage and, therefore, allow a company to increase its price without hurting either demand or profit.

When a competitor increases its price, a company has several options from which to chose. The first is to increase its price to approximately the same as that of the competing firm. The second is to wait before raising its price, a strategy known as price shadowing. Price shadowing allows the company to attract those new customers who are price-sensitive away from the competing firm. If consumers do switch over in large numbers, a company will make up lost profits through higher sales volume. If consumers do not switch over after a period, the company can increase its price. Typically, a company will increase its price to a level slightly below that of its competitors in order to maintain a lower-price tactical advantage. The airline industry uses the competitive pricing strategy frequently.

When competitors decrease their prices, a company has numerous options. The first option is to maintain its price, since the company is confident that consumers are loyal and value its unique product qualities. Depending on the price sensitivity of customers in a given market, this might not be an appropriate strategy for a company to use. The second option is to analyze why a competitor might have decreased its prices. If price decreases are due to a technological innovation, then a price decrease will probably be necessary because the competitor's price reduction is likely to be permanent. Regardless of its competitor's actions, a company may decrease its price. This price reduction option is called price covering. This option is most useful when a company has done a good job of differentiating the qualities of its product from those of a competitor's product. On the flip side, the advantage of price covering is reduced when no noticeable difference can be seen between a company's product and that of a competitor.

OPTIONS FOR INCREASING SALES

Companies have several options available when attempting to increase the sales of a product, including coupons, prepayment, price shading, seasonal pricing, term pricing, segment pricing, and volume discounts.

Coupons

Almost all companies offer product coupons, reflecting their numerous advantages. First, a company might want to introduce a new product, enhance its market share, increase sales on a mature product, or revive an old product. Second, coupons can be used to generate new customers by getting customers to buy and try a company's product in the hope that these trial purchases will result in repeat purchases. A variety of coupon distribution methods are available, such as the Internet, point-of-purchase dispensers, and Sunday newspapers. Internet coupons may be found at the following Web sites: http://www.couponcraze.com, http://www.couponpages.com, http://www.couponsurfer.com, and http://www.dealcatcher.com.

Prepayment

A prepayment plan is typically used with customers who have no credit history or a poor one. This prepayment method does not generally provide customers with a price break, although sometimes it does. For example, the magazine industry widely uses the prepayment strategy. A customer who agrees to purchase a magazine subscription for an extended period normally receives a discount as compared to the newsstand price. Purchase of gift certificates is another example of how prepayment can be used to promote sales. For example, a company may offer discounts on a gift certificate whereby the purchaser may pay only 90 to 95 percent of the gift certificate's face value. This strategy has several advantages. First, consumers are encouraged to buy from the company offering the gift certificates rather than from other stores. Second, the revenue is available to a company for reinvestment prior to the product's sale. Finally, receivers will not redeem all gift certificates, and as a result, a company retains all the revenue.

Price Shading

One way to increase company sales is to allow salespeople to offer discounts on the product's price. This tactic, known as price shading, is normally used with aggressive buyers in industrial markets who purchase a product on a regular basis and in large volumes. Price shading allows salespeople to offer more favorable terms to preferred business buyers in order to encourage repeat sales.

Seasonal Pricing

The price for a product can also be adjusted based on seasonal demands. Seasonal pricing will help move products when they are least salable, such as air conditioners in the winter and snow blowers in the spring. An advantage of seasonal pricing is that the price for a product is set high during periods of high demand and lowered as seasonal demand drops off to clear inventory to make room for the current season's products. Pricing for seasonal holiday products, such as those connected with Thanksgiving and Christmas, are frequently reduced the day after the holiday to clear inventory.

Term Pricing

A company has another positive reinforcement strategy for use when establishing product price, term pricing. For example, a company may offer a discount if the customer pays for the product promptly. The definition of promptly varies depending on company policy, but normally it means the account balance is to be paid in full within a specified period; in return, a company may provide a discount to encourage continuation of this early payment behavior by the customer. This term pricing strategy is normally used with large retail or industrial buyers, not with the general public. Occasionally, a company will offer a small discount to customers who pay for a product with cash. For example, Gill Brothers, a furniture store located in Muncie, Indiana, occasionally offers additional discounts to customers who pay cash. During one promotional event, selected items were marked down as much as 40 percent; in addition, customers who paid by cash or check were given an extra 10 percent discount.

Segment Pricing

Segment pricing is another tactic a company can use to modify product price in order to increase sales. Everyday examples of segment-pricing discounts are those extended to children, senior citizen, and students. These discounts have several positive benefits. First, the company is appearing to help those individuals who are or are perceived to be economically disadvantaged, a perception that helps create a positive public relations image for a company. Second, members of those groups who ordinarily may not purchase the product are encouraged to do so. Therefore, a company's sales will increase, which will likely result in increased market share and revenue. Best Western and Marriott are examples of hotel chains offering discounts to senior citizens.

Volume Discounts

A common method used by a company to price a product is volume discounting. The idea behind this pricing strategy is simple: If a customer purchases a large volume of a product, the product is offered at a lower price. This tactic allows a company to sell large quantities of its product at an acceptable profit margin. Volume pricing is also useful for building customer loyalty. For example, Stacks and Stacks HomeWares often provides volume discounts to customers ordering $1,000 worth of any one item.

DYNAMIC PRICING

The strategy where price is negotiated between buyers and sellers, dynamic pricing, has been used throughout history, but its use waned when fixed pricing became popular during the later part of the nineteenth century. Dynamic pricing is a strategy where price is set based on the individual customer and situations.

Advances in technology such as the Internet have made modern dynamic pricing possible. Companies selling via the Internet can mine databases to determine customer characteristics and adapt products to match buying behavior and set prices accordingly. Companies selling via the Internet can also adjust pricing based on customer demand and product supply. The speed with which changes can be made on the Internet allows sellers to make pricing changes on a daily or even hourly basis. Buyers can even negotiate prices with sellers via the Internet. For example, buyers can negotiate prices on products such as hotel rooms and rental cars at the Web site Priceline.com (http://tickets.priceline.com).

see also Marketing ; Marketing Mix ; Supply and Demand

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Churchill, Gilbert A., Jr., and Peter, Paul J. (1998). Marketing: Creating value for customers (2nd ed.). New York: Irwin McGraw-Hill.

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Allen D. Truell

Michael Milbier

PRICING

Although the pricing of products and services may appear to be simple at face value, there actually are many different dimensions to pricing in the business world. Pricing is a major component of any business strategy, online or otherwise, and companies take a variety of strategic approaches to pricing depending on their particular goals. The objectives of pricing can include everything from gaining market share, eliminating competitors, and reinforcing the position of a brand's image to simply selling high volumes of a product or service.

Generally, consumers seek to buy more when prices are lower and less when prices are higher. However, things are rarely that simple. Emotions and status also play critical roles in the pricing process, and shrewd marketers are able to tap into the minds of buyers and charge more money for so-called luxury items or status symbols. They also employ different pricing tactics, including odd-number pricing (selling an item for $19.95 as opposed to $20.00), in their attempts to sell goods and services.

In the physical world, the majority of sales transactions occur in face-to-face situations. Although some negotiating may take place, prices for goods and services are often fixed for consumers, and sellers possess a great deal of control. Consumers make purchases with relatively limited capabilities for quickly comparing prices from other sellers. Such is not the case on the Internet, where new sets of variables affect pricing. Online, both individual and business consumers are able to quickly find pricing information for similar or identical items from many different sellers in a matter of seconds. Additionally, individuals can use different tools, including software programs called intelligent agents (also known as shopping bots), to search the Internet for the best price and report back results. In some cases, intelligent agents also negotiate terms and prices on behalf of users, taking the search process a step further. Chat rooms and online communities also work to quickly spread the word about where the best deals can be found online.

THE POWER OF COMPARISON

On the Internet, there are several different tools customers can use to comparison shop for just about any kind of product or service, all within a matter of seconds or minutes. Among the Web's largest comparison shopping sites in the early 2000s was mySimon. The company's service was powered by intelligent agent technology created by one of the company's founders. According to mySimon, "by using the power of next-generation intelligent agent and advanced parallel search technologies, mySimon automatically combs Web merchants' sites for product and price information and presents it so that it is easy to read and sort. mySimon's proprietary Virtual Learning Agent (VLA) technology takes a unique approach to create mass quantities of intelligent agents that mimic human behavior and can be 'trained' to extract specific information from any merchant Web site."

At mySimon.com, consumers could shop for products in many categories from more than 2,000 different sellers, and then make actual purchases at a seller's Web site. In addition to listing prices for new items sold by leading e-tailers, search results could include products listed in online classified ads and online auctions. Details about the availability of items and the merchants who sold them also were available. In late 2000, mySimon announced expanded capabilities that gave more power to consumers and extended the Internet's reach to the physical retail world. The company made it possible for consumers to access mySimon from a variety of wireless devices including personal digital assistants (PDAs), wireless phones, and radio-modem-powered handheld devices from eLink.

Another company that gave consumers the ability to comparison shop was NexTag—an online marketplace where both companies and individuals consumers went to buy and sell both new, used, and reconditioned items. As with mySimon, NexTag allowed visitors to search for an item in one of several different categories. However, buyers also could "choose from name brand retailers, small stores, or individual sellers and between new or used versions of the same item." The prices listed on the site included sellers' taxes and shipping costs, and reviews from other users were available to assist shoppers in the decision-making process.

Sites like mySimon and NexTag helped to create a challenging atmosphere for companies engaging in e-commerce. One of the ways companies sought to gain an advantage in a marketplace where competing on price alone became difficult was to focus more on the buying experience they delivered to customers, including the aesthetic appeal of their Web sites and site personalization options. Focusing on hard-to-compare items and services was another strategy used by online sellers. While the prices of some items (including stocks, cameras, and books) can be compared quite easily, others (such as houses, even within similar price ranges and geographic areas) are harder to compare side-by-side. In general, the more variables involved with a product or service purchase, the harder it is for consumers to engage in comparison shopping, and the more room companies have to levy higher prices.

Online, traditional seller-established pricing is similar to its counterpart in the offline world in that every product or service has an associated market range within which businesses must stay when they set prices. Some ranges are wider than other, allowing for varying degrees of markups. The trick for many retailers is finding the highest price the market will bear without affecting demand. This can be accomplished more easily online because feedback on the Internet is both immediate and measurable. Conducting analyses into consumer reactions to pricing is also much cheaper online. Companies don't have to wait weeks or months to analyze sales reports or have retail staff physically adjust prices on store shelves. E-commerce allows them to monitor sales and make price adjustments electronically. Companies must be careful how they test prices, however, because consumer dissatisfaction can result when identical items are sold for different prices to different customers. This is one potential pitfall for e-commerce companies, especially those that take a dynamic approach to pricing.

DYNAMIC PRICING

Although traditional pricing schemes are used online, e-commerce allows for exciting scenarios not found offline. One unique advantage the Internet offers is the ability to customize prices to individual consumers or business customers based on their purchase histories. This price segmentation approach is made possible through the power of databases. Based on customer data, companies are able to offer better deals to their best customers, or to strategically price items that are similar to those purchased in the past.

In many ways, the Internet shifts the balance of price-setting power. As Business Horizons explained, "The Net enables customers to become both price takers and price makers, and for firms to gain both buying advantages (by buying at good prices from their suppliers) and earn commissions on customer trades (by allowing and facilitating customers to trade with each other). IT, and in particular the Web, have made variable pricing an option for many firms, which now have the opportunity to change and disseminate prices as often as desired. Prices can be set with a single transaction or multiple interactions."

Variable, dynamic pricing is a key characteristic of e-commerce pricing, allowing for prices that change or fluctuate due to different variables, conditions, and situations. Being able to manage dynamic pricing strategies is a key ability for companies wishing to succeed in the world of e-commerce, according to professors at the University of California-Irvine Graduate School of Management. The forces of supply and demand are leading variables that dictate pricing. They cause some e-tailers to continually analyze supply and demand information and adjust prices accordingly. When demand for products or services increases, savvy e-tailers respond quickly by increasing their prices. Likewise, when demand begins to fall they adjust prices downward to stimulate more purchases.

In mid-2001, InfoWorld announced that IBM, Compaq, Hewlett-Packard, and Dell were all looking into dynamic pricing approaches for their e-commerce operations. Different factors were involved in each company's strategy. For Dell, the price of computer memory chips and processors was an influencing factor, while IBM's approach involved product life cycle and demand. Hewlett-Packard referred to its approach as "contextual pricing," as the number of total items being purchased as part of special promotions would affect what customers paid overall. As a consultant pointed out in the article, dynamic pricing must be handled carefully. Such approaches have been known to cause problems for companies if consumers feel as though they have not received a fair deal.

Some dynamic pricing scenarios are value-based, involving situations in which customers pay what they think a product or service is worth. Priceline.com is an excellent example of value-based pricing. From airline tickets, rental cars, and hotel rooms to long distance phone service, new automobiles, and even mortgages, buyers used Priceline.com to get deals they might not have ben able to obtain through traditional means. At Priceline.com, consumers were able to make offers for different goods and services in one of four categories (travel, personal finance, automotive, and telecommunications), which they guaranteed with a credit card. The company then attempted to find sellers willing to honor the offer. In order to make things work, buyers were required to allow a degree of flexibility concerning things like brand names, features, and time frames.

Although the concept behind Priceline.com was popular with consumers, its success has been somewhat limited for a number of reasons. After its initial launch, Priceline.com founded a licensee called Web-House and attempted to apply the name-your-price model to other product categories like groceries and gasoline. However, the new endeavor failed because of customer service problems, which attracted considerable media attention. The company's stock price suffered badly, several key executives left the organization, the Connecticut Better Business Bureau removed Priceline.com as a member in good standing, and it was investigated by that state's attorney general. Priceline.com later was reinstated as a member of the Connecticut Better Business Bureau after it improved its customer service and named consumer advocate and former New York State Attorney General Robert Abrams as an advisor. This goes to show that low pricing alone isn't always enough to guarantee success; customer service also is a critical facet of e-commerce.

Are one pair of blue jeans worth $46,532? They were to Levi Strauss & Co., which purchased a rare vintage pair for that price on online auction site eBay. Online auctions are another form of dynamic, value-based pricing. Founded in 1995, consumers and business across the world congregate on eBay to buy and sell just about every imaginable kind of product and service. In late 2001, 29.7 million users were registered on eBay. Additionally, Media Metrix ranked the auction as the Internet's most popular shopping site, in terms of total user minutes. On eBay, users had the ability to buy items at fixed prices, as well as via a traditional auction format. In 2000 alone, more than $5 billion worth of merchandise was traded on the site.

eBay wasn't the only online auction in the early 2000s. More specialized, business-oriented auctions involving high-priced items also existed. Additionally, reverse auctions also were an option. These involved buyers indicating what they were looking for and how much they were willing to pay. Auctions like these were useful to companies that needed to get rid of excess inventories. Instead of selling off such inventories at deep discounts to third party re-sellers, auctions provided them with a way to leverage the real value of their inventories by reaching interested parties directly in a cost-effective way.

One example of a specialized online business auction was IronPlanet, where interested parties bought and sold used heavy equipment. Unlike eBay, IronPlanet's auctions were not continuous; it held events at specific dates and times. In mid-2001, one of IronPlanet's auctions involved 37 pieces of equipment being sold for more than $1.8 million. Including the sales from that auction, IronPlanet had sold more than $17.4 million worth of used equipment since its first auction in April 2000.

FURTHER READING:

Fischer, Frank. "Using the Web to Sell Surplus Inventory." Office.com, July 20, 2000. Available from www.office.com.

mySimon. "mySimon Company Information." mySimon, September 3, 2001. Available from www.mysimon.com.

Pitt, Leyland F., Pierre Berthon, and Richard T. Watson. "Pricing Strategy and the Net." Business Horizons, March/April 2001.

Regan, Keith. "Harnessing the Power of Online Pricing." E-Commerce Times, March 22, 2001. Available from www.ecommercetimes.com.

Vigoroso. "Study: Winning at E-Commerce Requires Evolved Management Style." E-Commerce Times, July 20, 2001. Available from www.ecommercetimes.com.

SEE ALSO: Commoditization; MySimon; Product Review Services; Shopping Bots

Pricing

What It Means

Pricing is the process of determining and applying prices to goods and services. The price is the monetary cost of the product (the good or service) that is bought or sold, and the pricing process fixes the amount that a consumer pays for the product.

Pricing one of the four primary elements of product marketing. The other three are the product itself, which includes product development as well as packaging and branding; promotion, for example, advertising and publicity; and distribution, or how the product gets to the consumer. Together with pricing, these elements are called the “marketing mix.” Pricing is considered the most important element of the marketing mix, because it is one that directly affects a company’s profits. A product’s price also affects how that product is positioned, or located in relation to similar products, in the market. For example, an automobile that is priced high to appeal to consumers with money will position it in competition with other automobiles in the same price range.

Costs and the target market (the consumers the company hopes to attract) are crucial considerations in choosing the price of a product. A snowmobile, for instance, is fairly expensive to make, appeals only to certain kinds of consumers, and is in demand only in certain geographic regions. The price needs to be set high enough to offset the costs involved in the product, promotion, and distribution the snowmobile, and it needs to be appropriate for the people who might be interested in buying it.

More generally, prices have to take into account consumer reaction, or the willingness of consumers to pay the set price. In a market where consumers choose among competing products, prices are ultimately determined by the balance between supply (how much of a product a company is willing to produce over a range or prices) and demand (how much of a product consumers are willing to buy over a range of prices). A price must be set with a certain degree of confidence that consumers will pay it.

When Did It Begin

As American markets expanded in the early 19th century, companies generally were free from government intervention and regulation. Partly as a result of this freedom, some of these companies combined in ways that gave them the power to reduce or even eliminate competition in the marketplace. One ability of these consolidated companies, called trusts, was to set the price for the products in an industry. The prices were often set so low that other firms were driven out of business, and new firms could not enter the competition for consumers. The trust, if it so chose, could then raise prices for its products to increase its profits. The most famous example of this type of arrangement was the Standard Oil Trust, a conglomeration of companies that in the late 1800s controlled the production, distribution, and sale of petroleum in the United States.

In a reaction to Standard Oil and other large trusts, the United States Congress passed the Sherman Antitrust Act in 1890. The law’s purpose was the elimination of monopolies and their suppressive tactics. Individual states also passed their own antitrust laws, which in some cases were even stricter than the federal law. Another federal law, the Clayton Antitrust Act of 1914, specifically outlawed price fixing, a practice in which competing companies in a specific market secretly agreed to charge identical prices for the same product, thereby avoiding competitive pricing.

More Detailed Information

Although companies go about setting prices in a variety of ways, they generally begin by developing a marketing strategy for the product. In this step an analysis of the market in which the product will be sold is conducted. The state of the existing market plays an important part in determining where the price should be set most effectively. For example, a novel product that has the market all to itself (called a “new entrant”) can probably carry a higher price. On the other hand, a product entering a market in which many similar products are vying for consumers must have its price set to be competitive.

The next step in the pricing process is usually a careful analysis of the entire marketing mix in order to understand how the price interacts with the product, its promotion, and its distribution. For instance, because the price of a product is often directly related to its quality, setting a price influences the product’s design and manufacture. If a furniture ensemble is to be targeted at consumers who wish to spend relatively little money for it, production of the furniture will need to be inexpensive, which probably will result in a lower-quality product.

Not part of the marketing mix but still essential to pricing is a consideration of any legal issues connected with the price of the product. For example, there are occasionally government-imposed price controls that set a limit on the price of goods in order to prevent inflation. In addition, antitrust laws make it illegal to conduct so-called predatory pricing, in which a firm prices a product so low that competitor producers of similar products cannot survive. Another outside factor to consider is the pricing strategy of competitors. If, for example, one firm sets an extremely low price for its product, the result may be a price war with a competitor that damages consumer perception of both firms.

Another step in the pricing process involves anticipating the level of consumer demand for the product so that the product’s distribution can keep up with the demand. Still another step is calculation of the cost to the company of making the product. This production cost includes both fixed costs such as the rental of the factories in which the product is made and variable costs such as the salaries of the specialists who help design the product. The total production cost is used to find the unit cost to the company of each product unit. The unit cost establishes the lower limit on the price that the company might charge. It also allows the company to project the profit it might make from future product sales when the price is set at various levels. The amount that the price of an item is raised above the unit cost is called the price markup. The price markup can be represented either as a percentage or as a fixed amount.

Each time a company prices a product, it has a specific objective in mind for choosing that price. In some cases it may be to maximize the number of product units sold or the number of consumers served. In other cases the objective may be to use price as an indicator of quality so that stands out as the leader among its competitors. If the market for a product is saturated with competitors, a company may choose a price to cover its costs and simply allow it to survive in the market.

Recent Trends

Among the various aspects of marketing, pricing is probably the one most dramatically affected by the introduction of the Internet into the world of the consumer. The Internet allows a consumer to search easily for information about the price of products and share that information with others. Without leaving home an online consumer can spot-check the prices of different competitors’ products within a certain market. The Internet also has become an avenue for some companies, for example, consumer electronics businesses, to offer lower prices to buyers who choose to make their purchases online rather then in traditional (“brick and mortar”) stores. Travel websites such as Travelocity and Orbitz have been successful because they have offered lower prices on airfares than travel agencies and reservation offices.

At Internet auctions, run by online businesses such as eBay, buyers rather than sellers set the final prices for products. Similar to the operation of traditional auctions, online bidders offer to pay ever higher prices for a given product until a time limit expires. The supply and demand for the product at a particular time determines the price of that product. A great advantage of the Internet auction is that the size of the bidding audience can greatly exceed what it would at a physical auction. Although the sellers at Internet auctions are typically individuals, some manufacturers have used these sites as places to sell their goods.