Pricing Methods and Policies in Business

In theory a purely competitive firm simply accepts the market price. In real business, however, a firm must actively decide the price of its product, balancing its costs, its competitors, and what buyers are willing to pay. This is the practical, decision-making side of the chapter, and it distinguishes pricing methods (how the number is arrived at) from pricing policies (the strategy a firm follows over time).

Objectives of pricing usually include earning a target rate of profit, achieving or protecting market share, meeting or preventing competition, ensuring survival, and stabilising prices. The chosen method flows from these objectives.

Common pricing methods:

• Cost-plus (mark-up) pricing — the firm computes the cost per unit and adds a fixed percentage margin (mark-up) for profit. Simple, widely used in retail and contracting, and it guarantees cost recovery, but it ignores demand and competition. Selling price $= \text{Cost} \times (1 + \text{mark-up rate})$.
• Marginal-cost / contribution pricing — price is set to cover marginal cost plus a contribution towards fixed costs; useful for extra or export orders when fixed costs are already covered.
• Competitive (going-rate) pricing — the firm sets its price at, slightly below, or slightly above the prevailing price of rivals rather than strictly on its own costs; common where products are similar and no firm wants a price war.
• Value-based pricing — price is set according to the value buyers perceive in the product rather than its cost.

Common pricing policies (strategies), especially for new products:

• Price skimming — launching at a deliberately high price to "skim" the maximum revenue from buyers willing to pay most (early adopters), then lowering it in stages. Suited to novel products with few substitutes and inelastic early demand (e.g. a newly launched electronic gadget).
• Penetration pricing — launching at a deliberately low price to enter the market quickly, capture a large share and discourage rivals, relying on high volume and later economies of scale. Suited to price-sensitive mass markets with elastic demand. …