Setting Price: Part 1 Tutorial

Setting Price TutorialIn the Pricing Decisions tutorial we provided the foundation marketers use to make pricing decisions. We now turn our attention to the process by which marketers determine price with a two-part look at the process marketers follow when setting product prices.

The central point of theses tutorials is a five-step process for setting price. We want to emphasize that while the process serves as a useful guide for making price decisions, not all marketers follow this step-by-step approach. Additionally it is important to understand that finding the right price is often a trial-and-error exercise where continual testing is needed.

Like all other marketing decisions, market research is critical to determining the optimal selling price. Consequently, the process laid out here is intended to open the marketer’s eyes to the options to consider when setting price and is in no way presented as a guide for setting the "perfect" price.

In Part 1 we look at Steps 1 and 2 with our primary emphasis on the approaches to setting an initial price.

Image by Walmart Corporate

We view price setting as a series of decisions the marketer makes in order to determine the price direct and indirect customers pay to acquire the product. Direct customers are those who purchase products directly from the marketer. For example, consider the direct pricing decisions that take place when a new novel is sold:

  • Publisher of the book must decide at what price they will charge their immediate customers in the channel of distribution such as online booksellers (e.g., Amazon.com).
  • Booksellers must decide at what price they will sell the book to their immediate customers which are typically final consumers (e.g., website shopper).

As we see with the bookseller example, many companies also sell indirectly to the final customer through a network of resellers such as retailers. For marketers selling through resellers the pricing decision is complicated by resellers’ need to earn a profit and the marketer’s need to have some control over the product’s price to the final customer. In these cases setting price involves more than only worrying about what the direct customer is willing pay since the marketer must also evaluate pricing to indirect customers (e.g., resellers’ customers). Clearly sales can be dramatically different than what the marketer forecasts if the selling price to the final customer differs significantly from what the marketer expects. For instance, if the marketing organization has forecasted to sell 1,000,000 novels if the price to the final customer is one price and resellers decide to raise the price 25% higher than that price the marketer’s sales may be much lower then forecasted.

With an understanding that marketers must consider many factors (see the Pricing Decisions tutorial) when setting price, we now turn to the process by which price is set. We present this as a five-step approach. As we noted earlier, while not all marketers follow these steps, what is presented does cover the methods used by many marketers.

The steps we cover include:
1. Examine Company and Marketing Objectives
2. Determine an Initial Price
3. Set Standard Price Adjustments
4. Determine Promotional Pricing
5. State Payment Options

With the objectives in Step 1 providing guidance for setting price, the marketer next begins the task of determining an initial price level. We say initial because in many industries this step involves setting a starting point from which further changes may be made before the customer pays the final price.

Sometimes called list price or published price, marketers will often use this as a promotional or negotiating tool as they move through the other price setting steps. For companies selling to consumers, this price also leads to a projection of the recommended selling price at the retail level often called the manufacturer’s suggested retail price (MSRP). The MSRP may or may not be the final price for which products are sold. For strong brands that are highly sought by consumers the MSRP may in fact be the price at which the product will be sold. But in many other cases, as we will see, the price setting process results in the price being different based on adjustments made by the marketer and others in the channel of distributions.

Speaking of distribution channels, as we discussed in the Distribution Decisions tutorial, some marketers will utilize multiple channel partners to handle product distribution. When resellers are involved marketers must recognize that all members of the channel will seek to profit when a sale is made. If a marketer seeks to sell the product at a certain retail price (e.g., MSRP) then the price charged to the first channel member to handle the product can potentially influence the final selling price. To see how this can cause problems, assume a marketer sets an MSRP of (US) $1.99 for a product that sells through a distribution channel. This channel consists of wholesalers, who must pay the marketer $1.89 to purchase the product, and retailers who in turn buy the product from wholesalers. In this example it is unlikely the retailer will sell the product at the MSRP since the wholesaler will add to the $1.89 purchase price and most likely raise the price charged to the retailer to a point that is higher than the MSRP. The retailer in turn will add to their purchase price when selling to consumers. In this scenario it is possible the final price to the consumer will be closer to $2.99 than the $1.99 MSRP. As this example shows marketers must take care in setting the initial price so that all channel partners feel it is worth their effort to handle the product.

Marketers have at their disposal several approaches for setting the initial price which include:

  • Cost Pricing
  • Market Pricing
  • Competitive Pricing
  • Bid Pricing

As we discussed in the Pricing Decisions tutorial, marketing decisions including price are driven by the objectives set by the management of the organization. These objectives come at two levels. First, the overall objectives of the company guide all decisions for all functional areas (e.g., marketing, production, human resources, finance, etc.). Guided by these objectives the marketing department will set its own objectives which may include return on investment, cash flow, market share and maximize profits to name a few.

Pricing decisions like all other marketing decisions will be used to help the department meet its objectives. For instance, if the marketing objective is to build market share it is likely the marketer will set the product price at a level that is at or below the price of similar products offered by competitors.

Also, the price setting process looks to whether the decisions made are in line with the decisions made for the other marketing decisions (i.e., target market, product, distribution, promotion). Thus, if a company with a strong brand name targets high-end consumers with a high quality, full-featured product, the pricing decision would follow the marketer’s desire to have the product be considered a high-end product. In this case the price would be set high relative to competitors’ products that do not offer as many features or do not have an equally strong brand name.

Under cost pricing the marketer primarily looks at production costs as the key factor in determining the initial price. This method offers the advantage of being easy to implement as long as costs are known. But one major disadvantage is that it does not take into consideration the target market’s demand for the product. This could present major problems if the product is operating in a highly competitive market where competitors frequently alter their prices.

There are several types of cost pricing including:

  • Markup Pricing
  • Cost-Plus Pricing
  • Breakeven Pricing