Among the key elements of the marketing mix, price is fundamental both at the corporate strategy level and at the operational marketing level, as it represents the primary lever that generates revenue for the company. It is therefore the determining factor of business profitability while simultaneously influencing demand. For the consumer, it represents the economic sacrifice they are willing to make to obtain a product or service.
From the company's perspective, the price of a product or service is determined by production costs, marketing costs, and business objectives. In particular, production costs influence the minimum price at which a product can be sold, while marketing costs and business objectives affect the maximum price.
The process of determining price is called Pricing and is influenced by a range of factors both internal and external to the company: the market in which you operate, the level of demand, prices offered by competitors, and all costs incurred in producing the product or service.
How to Define Pricing
There are cases where the prices of goods and services are regulated by law, as with public utilities. The selling price of a product must, as a rule, cover the various costs associated with it: production, marketing, and so on.
Two elements have a profound impact on product pricing: differentiability and perishability.
The first relates to a product's ability to be considered irreplaceable, giving it a distinctive market positioning.
Perishability, on the other hand, refers to the product's availability over time.
There are four different pricing methodologies:
- Mark-up pricing method: applies a percentage markup to the production or purchase cost of a product to arrive at the final selling price.
- Cost-plus pricing method: also takes into account indirect costs and the expected return from each unit of product.
- Rate of return pricing method: determines the final price with the objective of recovering costs incurred and achieving a specific profit target.
- Break-even analysis method: much more precise because it involves identifying the production volumes or sales revenues needed to cover all production costs. In this case, the analyst needs three values: selling price per unit of product, fixed costs, and variable cost per unit of product.
Finally, there is the possibility that a "price war" may occur, when two or more competitors focus exclusively on price reduction to acquire and/or retain customers.
The risk is triggering a continuous race to the bottom that can have serious effects on profitability and the company's brand equity.
Important Notes
The most widely used method for determining price is certainly the first, namely mark-up pricing, which involves setting the price based on production cost plus a profit margin. This method is particularly suited to standardized products and those with inelastic demand. In practice, it is often overused because it is fairly simple to implement. But it exposes the company to many problems, first and foremost the disconnect between price and brand strength.
In this regard, an innovative tool for price determination is increasingly gaining traction: pricing based on perceived consumer value, which considers price not based on costs incurred by the company, but based on the value the product or service holds for the customer. This method is particularly suited to luxury products or products with elastic demand.
In a future article, we will dive deeper into individual pricing methodologies. Stay tuned!