There are number of factors which
affect the fixation of the price of a
product. Some of the important factors
in this regard are discussed as below:
1. Product Cost: One of the most
important factor affecting price of a
product or service is its cost. This
includes the cost of producing,
distributing and selling the product.
The cost sets the minimum level or the
floor price at which the product may
be sold. Generally all marketing firms
strive to cover all their costs, at least
in the long run. In addition, they aim
at earning a margin of profit over and
above the costs. In certain circumstance,
for example, at the time of introducing
a new product or while entering a new
market, the products may be sold at
a price, which does not cover all the
costs. But in the long run, a firm
cannot survive unless at least all its
costs are covered.
There are broadly three types of
costs: viz., Fixed Costs, Variable Costs
and Semi Variable Costs. Fixed costs
are those costs, which do not vary with
the level of activity of a firm say with
the volume of production or sale. For
example, rent of a building or salary of a sales manager remains the same
whether 1000 units or 10 units are
produced in a week.
Those costs which vary in direct
proportion with the level of activity are
called variable costs. For example, the
costs of raw material, labour and power
are directly related with the quantity
of goods produced. Let us say, if the
cost of wood for manufacturing one
chair comes to Rs.100 the cost of wood
for 10 chairs would be Rs. 1000.
Obviously, there will be no cost of wood
if no chair is produced.
Semi variable costs are those costs
which vary with the level of activity
but not in direct proportion with it.
For example, compensation of a sales
person may include a fixed salary of
say Rs. 10,000 plus a commission of
5 per cent on sales. With an increase
in the volume of sales, the total
compensation will increase but not in
direct proportion with the change in
the volume of sale.
Total Costs are the sum total of the
fixed, variable and semi-variable costs
for the specific level of activity, say
volume of sales or quantity produced.
2. The Utility and Demand: While the
product costs set the lower limits of
the price, the utility provided by the
product and the intensity of demand
of the buyer sets the upper limit of
price, which a buyer would be
prepared to pay. In fact the price must
reflect the interest of both the parties
to the transaction—the buyer and the
seller. The buyer may be ready to pay
up to the point where the utility from
the product is at least equal to the
sacrifice made in terms of the price
paid. The seller would, however, try to
at least cover the costs. According to
the law of demand, consumers usually
purchase more units at a low price
than at a high price.
The price of a product is affected
by the elasticity of demand of the
product. The demand is said to be
elastic if a relatively small change in
price results in large change in the
quantity demanded. Here numerically,
the price elasticity is greater than one.
In the case of inelastic demand, the
total revenue increases when the price
is increased and goes down when the
price is reduced. If the demand of a
product is inelastic, the firm is in a
better position to fix higher prices.
3. Extent of Competition in the
Market: Between the lower limit and
the upper limit where would the price
settle down? This is affected by the
nature and the degree of competition.
The price will tend to reach the upper
limit in case there is lesser degree of
competition while under conditions of
free competition, the price will tend to
be set at the lowest level.
Competitors’ prices and their
anticipated reactions must be
considered before fixing the price of a
product. Not only the price but the
quality and the features of the
competitive products must be examined
carefully, before fixing the price.
4. Government and Legal Regulations:
In order to protect the interest of
public against unfair practices in the
field of price fixing, Government can
intervene and regulate the price of commodities. Government can declare
a product as essential product and
regulate its price. For example, the
cost of a drug manufactured by a
company having monopoly in the
production of the same come to Rs 20
per strip of ten and the buyer is
prepared to pay any amount for it, say
Rs 200. In the absence of any
competitor, the seller may be tempted
to extort the maximum amount of
Rs 200 for the drug and intervene to
regulate the price. Usually in such a
case, the Government does not allow
the firms to charge such a high price
and intervene to regulate the price of
the drug. This can be done by the
Government by declaring the drug as
essential commodity and regulating its
price.
5. Pricing Objectives: Pricing
objectives are another important factor
affecting the fixation of the price of a
product or a service. Generally the
objective is stated to be maximise the
profits. But there is a difference in
maximising profit in the short run and
in the long run. If the firm decides to
maximise profits in the short run, it
would tend to charge maximum price
for its products. But if it is to maximise
its total profit in the long run, it would
opt for a lower per unit price so that it
can capture larger share of the market
and earn greater profits through
increased sales.
Apart from profit maximisation, the
pricing objectives of a firm may include:
(a) Obtaining Market Share Leadership:
If a firms objective is to obtain larger
share of the market; it will keep the
price of its products at lower levels
so that greater number of people are
attracted to purchase the products;
(b) Surviving in a Competitive Market:
If a firm is facing difficulties in
surviving in the market because of
intense competition or introduction
of a more efficient substitute by
a competitor, it may resort to discounting its products or running
a promotion campaign to liquidate
its stock; and
(c) Attaining Product Quality
Leadership: In this case, normally
higher prices are charged to cover
high quality and high cost of
Research and Development.
Thus, the price of a firm’s products
and services is affected by the pricing
objective of the firm.
6. Marketing Methods Used: Price
fixation process is also affected by
other elements of marketing such as
distribution system, quality of
salesmen employed, quality and
amount of advertising, sales
promotion efforts, the type of
packaging, product differentiation,
credit facility and customer services
provided. For example, if a company
provides free home delivery, it has
some of flexibility in fixing prices.
Similarly, uniqueness of any of the
elements mentioned above gives the
company a competitive freedom in
fixing prices of its products.