The Language of Small Business Texts and Vocabulary Training (for students of Economics) Part 2. Учебное пособие

How to Set a Price

Of course, there may be various discounts offered on this

price.

The problem with this system is the difficulty of working out how much of the indirect costs and overheads should be added to each product to work out the cost. To be able to attribute a certain percentage to the product, you need to have:

−some idea or forecast of the total amount of overheads and indirect costs for the year, and;

−some idea of the total amount of your product you will sell during the year.

In other words, a pricing system based on cost is based on your best forecasts. Obviously, forecasts can be wrong. You may find that you have not sold at a price high enough to cover the cost of overheads, because either your sales are lower or your overhead costs higher than your forecast.

The problem is multiplied if you have more than one product or service. How do you decide how much of the indirect costs and overheads should be apportioned to each product? There is no clear-cut answer.

SETTING A PRICE

There are several influences which will determine how near the top or how near the bottom end of the price range your product should be placed. These are:

−how your product compares to competitive products;

−the lifecycle of the product, that is, how new or mature;

−how price sensitive are your customers;

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−what price conveys to your customers;

−what position in the market.

HOW YOUR PRODUCT COMPARES TO COMPETITIVE PRODUCTS

Assuming that you face competition in your chosen market, it is realistic to assume that the price you can place on your product will, to a certain extent, depend on the competition. This does not mean that if your competitors price is very low, you have to follow suit. But it does mean that you should analyse your product carefully in relation to the others. The sort of characteristics you should look at include:

−what your product looks like and how it performs compared to the others?

−how it is packaged and presented?

−what is the availability?

−is your delivery and after-sales service better or worse than competitors?

−how do customers pay? (easy payment terms are a form of price discount)

−has your product a better image or reputation?

If your product compares favourably with the others, you may be able to justify a higher price than the competition, even if you are relatively new into the market. Do not be afraid of putting a higher price than the competition. If your product does really have benefits, such as better delivery and service, or a better image, the marketplace may well accept that your price should be higher.

WHAT STAGE IN ITS LIFECYCLE?

If it is a new product, one not before produced, such as CD players a few years ago, there are two possible strategies to adopt. One possibility is a price-skimming policy which goes for an initial

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How to Set a Price

high price. The other possibility is to try to secure a very large share of the market for your product before the competition appears on the scene. This would be achieved by setting the price fairly low, known as penetration policy.

HOW PRICE SENSITIVE ARE YOUR CUSTOMERS?

If you put up your prices, do you have any idea how many of your existing customers would switch to another supplier? Or if you dropped your prices how many new customers would you acquire? How great an effect change in prices has on the amount you sell is called price sensitivity (or elasticity of demand). If customer response to price changes in your product is not that great, you can push nearer the upper end of the price range.

Broadly speaking, if your product is not bought that frequently, that is, one purchase will last quite a long time, the sales of it will not be so sensitive to price changes. On the other hand, if it is bought at regular intervals, sales may react much more strongly.

If it is difficult to differentiate one product from another in your market, this also implies that it will react much more strongly to price changes. If, on the other hand, your product can be differentiated from others by perceived benefits such as image, delivery and so on, sales will be more resistant to price changes.

WHAT PRICE CONVEYS TO YOUR CUSTOMERS?

Price alone can conjure up ideas about your product in your potential customers’ minds. The consumer often associates higher quality with a higher price; paradoxically, a high price can help the image or reputation of your product. If this applies to your market, a lower price will not generate more sales.

In general terms, a product which has the greatest market share is unlikely to be the cheapest. These products may generate high sales, because despite their high price they are thought

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by consumers to offer the best package of benefits (or best value for money).

WHAT POSITION IN THE MARKET?

Often, your ability to set prices may be limited by the market in which you operate. There may be a going rate established in the market, and unless your product becomes the market leader or is definitely a better product, it may be difficult to establish any other price.

The price of your product needs to fit the market position planned for it. This is the place that the product occupies, compared to competitive products, in the eyes of your existing or potential customers.

ASTEP-BY-STEP GUIDE TO SETTING PRICES

1.Analyse the position your product holds in the market. Are your target customers those who are looking for reliability? Has your product already achieved an established image in the eyes of the market? Do buyers view it as good quality, prompt service, stylish, say?

2.Analyse your product. Are you planning modifications or alterations which could alter its reputation or relative position in the marketplace?

3.Analyse the competition. How do their products rate against yours? What is the relative price structure in the market?

4.Decide your pricing strategy. Where in the price range are you going to pitch your price? Is it going to be average for the market, 5 per cent less than the average, 5 per cent above the average or a premium price, 25 per cent above the average?

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5.Choose some specific prices. Estimate volume of sales, profit margin and costs to forecast the level of profits for each price.

6.Choose your price.

7.Would you be able to test market the price in a small area of your market? This would allow you to gauge customer reactions.

PRICE NEAR THE TOP END OF THE RANGE

There are two possible reasons why you may be able to justify a price near the top end of the range:

−the product is market leader;

−the product is set apart from the competition by non-price benefits.

MARKET LEADER

The market leader will be the biggest selling product in the market. There are several advantages to being the market leader, and so it is a position worth aspiring to. The advantages include being able to charge a higher price than the average, making greater sales, having more power over your suppliers and competitors, and being less risky in poor economic conditions.

There is, of course, no easy way to become the market leader. Some of the guidelines to achieve the premier position include:

−try to be one of the first into the market;

−develop, by careful marketing, selling and advertising, what is different about your product or business;

−be ruthless about efficiency and costs;

−be sensitive to changes in the market;

−compete intensively on all sales;

−look for profits over a long period, not the short-term fast buck – so lengthen your horizon.

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NON-PRICE BENEFITS

The price you put on the product tells prospective customers something about it. On the whole, a higher price implies high quality, a lower price low quality. You are unlikely to build a business offering a low quality product at a high price; on the other hand, you are throwing away profits if you offer high quality at a low price. You have to decide where your product is placed in the market compared to competitors and price accordingly.

You will be able to justify a higher price, near the top end of the range, if you decide to offer a high-quality product. You must not be frightened into thinking that the only thing that matters to buyers is price; they are interested in other aspects of your product, too.

In your marketing and selling, build an image or reputation for quality, efficient service, reliability, prompt delivery, effective sales and technical literature. This will allow you to raise prices and generate higher profits.

PRICE NEAR THE BOTTOM END OF THE RANGE

There are three main reasons why your pricing policy might be near the bottom end of the range:

−fear (because you mistakenly believe that the main factor in buying is price – but see above);

−a strategy of grabbing market share;

−severe price competition.

MARKET SHARE

A legitimate strategy for a business is to sacrifice the level of profits in return for an increased market share. To achieve this, you would pitch the price near the low end of the possible price

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How to Set a Price

range (in marketing jargon, a penetration price) in return for selling more of the product. The intention in the strategy is to increase your market share, to consolidate your position, to increase your prices gradually while retaining the share you have established. Essentially, the aim is eventually to become the market leader with higher unit sales at a higher price.

There are a number of dangers inherent in this strategy:

−you may find it exceptionally difficult to raise your prices, without demonstrating an improvement in the product in compensation;

−you may find that your new customers do not remain faithful to your product when you move the price upwards; instead they return to their original supplier;

−you may trigger off a price war with your competitors.

The likeliest use of the strategy occurs when you are intro-

ducing a new product to the market, and the competition is weak. In this case, you can establish a large market share without attracting strong competition because of the large profits to be made.

Few small firms will have the financial and managerial resources available to achieve this strategy of establishing a large market share successfully; it is really too risky to be considered. Instead, they should look more closely at devoting the available resources to promotion or advertising.

FACING SEVERE PRICE COMPETITION

Low prices or a price-cutting war is an advantage to very few people: you do not want it, other small competing firms do not want it; in the long run, customers do not want it, if it means a reduced number of suppliers and less choice. It may only be in the long-term interest of a large company, if that is your main competitor. So whatever you do, try to avoid triggering it off.

If one of your competitors cuts prices, what should you do? Try to avoid the instant reaction of following prices downwards.

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Instead try to concentrate your customers’ minds on the non-price benefits of doing business with you. If you have carried out some market research you will know which are the non-price factors which buyers rate most highly, and these can be emphasized.

However, if you operate in a market which is very price sensitive and does not differentiate between products, there is little choice but to match the price cuts. In this case, your survival will depend on savage reduction in your costs.

PRICING WITH MORE THAN ONE PRODUCT

If you have more than one product, the sales could be interlinked if they are:

−competing with each other, or,

−complementary to each other.

You need to ensure that your pricing policy is consistent

across the range of your products. With competing products, the prices need to make sense. There needs to be a recognizable gap in the prices, if one is a high-quality product while the other is lower quality.

The pricing considerations are different if your products are complementary, that is, if you sell one, you are likely to sell the other. Once your customer is hooked, there will be lots of scope for charging high prices on a complementary item, as long as it is not so blatant that it puts off buyers from the starting product.

Definitions of terms

Price (1) ECON. THEORY – the rate at which a commodity can be exchanged for another commodity or for money. The exchange value of an economic good. (2) COM-the amount of money for which an article or commodity can be bought and sold. (3) STK. EXCH. – a value for a security quoted by a jobber at two levels, the

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lower or bid price, at which he is willing to buy, and the higher or offered price at which he is willing to sell.

Price war COM. – a market situation in which all suppliers are competing to gain a larger share of the market by cutting prices, often, without thought for the results. It may happen that, although one supplier may get a short-term advantage by cutting his prices, if the rest follow, all suppliers will suffer and the weakest may go bankrupt. To avoid this danger, most suppliers fix their prices at a reasonable level and refuse to reduce them further.

Elasticity of demand ECON. THEORY – the degree to which the demand for a commodity is sensitive to, or affected by, a change in price. If a small change of price results in a large change in demand, demand is said to be elastic; if a large change in price leads to only a small change in demand, demand is said to be inelastic.

Cost (1) COM. – the price paid for something. At cost – at the bare price paid, with nothing added for profit, etc. (2) ECON. – the real effort and sacrifice needed to produce goods and services. (Also costs, pl.) (3) ACCIS. – the value given for accounting purposes to the stock of an article or commodity at the end of an accounting period. In a retail business the cost is usu. taken to be prime cost, i.e. the price paid to the supplier, but other accounts to cover storage and transport are sometimes added. In a manufacturing business the cost is usu. prime cost or production cost.

Direct cost – one which is directly related to the production of a particular article or unit of output, and which therefore varies in proportion to the number of articles or units produced. Syn.: variable cost.

Indirect cost = fixed cost – one that does not vary with output (the volume of goods produced); a cost that has to be paid whether anything is produced or not.

Profit, n. (1) the amount by which the price received is greater than the cost; the difference between business income and expenses. Opp. – loss, deficit. Syn. -surplus. (2) ECON. THEORY –

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