The right pricing strategy for one product can be wrong for others.
Pricing strategy is critical to both the firm and its customers. From the company's perspective, setting the right price plays a key role in generating sufficient revenue and profit. To consumers, price is a measure of quality and value, helping them determine how one firm's offering stacks up against the competition. There are four major factors influencing a firm's pricing strategy: demand, cost, stage in the product life cycle, and promotion strategy.
The Demand Factor
Demand is a measure of how much consumers will buy of a product or service at a specified price. While lower prices typically attract new purchasers, the effect of price over the long term depends on elasticity: in other words, the sensitivity of buyers of a particular product to changes in its price. When demand is highly elastic, purchases are strongly influenced by price: For example, restaurant patrons tend to switch from lobster to other entrees when the price of seafood goes up. When demand is inelastic, people will continue to buy the same amount regardless of price. This would be the case for most staples, like eggs and milk.
The Cost Factor
To make a profit, firms must price their products high enough to cover the costs of producing and marketing those products. A measure commonly compared to selling price is average cost per unit. This takes into account both fixed costs like rent, which stay the same no matter how many products are produced; and variable costs like raw materials, which change as the volume of production changes.
Stage in the Product Life Cycle
When a product is new, the firm may charge a high price to take advantage of the novelty appeal. As the product matures and attracts competition, prices will usually come down. A declining market share for an older or poorly performing product will usually force the firm to cut prices still further. But price will tend to stabilize as competitors exit the market.
Promotion Strategy
Price discounts can be an effective means of getting consumers' attention and stimulating demand. For example, people might be tempted to try a new cereal if they get a half-price coupon for it. On the other hand, a firm could choose a high price to reinforce a high-quality image and help convince consumers that it is selling an exclusive, luxurious brand.
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