Introduction to Price

Defining Price

Price is both the money someone charges for a good or service and what the consumer is willing to give up to receive a good or service.

Learning Objectives

Define price and its relationship to cost

Key Takeaways

Key Points

  • When you ask about the cost of a good or service, you’re really asking how much you will have to give up in order to get it.
  • For the business to increase value, it can either increase the perceived benefits or reduce the perceived costs. Both of these elements should be considered elements of price.
  • Viewing price from the customer’s perspective helps define value — the most important basis for creating a competitive advantage.
  • There are two different ways to look at the role price plays in a society; rational man and irrational man.

Key Terms

  • value: a customer’s perception of relative price (the cost to own and use) and performance (quality)
  • benefit: an advantage, help or aid from something
  • bartering system: Barter is a medium of exchange by which goods or services are directly exchanged for other goods or services without using a medium of exchange, such as money.

What Is a Price?

Buying something means paying a price. But what exactly is “price? ”

  • Price is the money charged for a good or service. For example, an item of clothing costs a certain amount of money. Or a computer specialist charges a certain fee for fixing your computer.
  • Price is also what a consumer must pay in order to receive a product or service. Price does not necessarily always mean money. Bartering is an exchange of goods or services in return for goods or services. For example, I teach you English in exchange for you teaching me about graphic design.
  • Price is the easiest marketing variable to change and also the easiest to copy.

Even though the question, “How much? ” could be phrased as “How much does it cost? ” price and cost are two different things. Whereas the price of a product is what you, the consumer must pay to obtain it, the cost is what the business pays to make it. When you ask about the cost of a good or service, you’re really asking how much will you have to give up to get it.

An electronic price display on a clothes stand at a retail store.

Price: The price is what a consumer pays for a good or service.

Different Perspectives on Price

The perception of price differs based on the perspective from which it is being viewed.

The Customer’s View

A customer can either be the ultimate user of the finished product or a business that purchases components of the finished product. It is the customer that seeks to satisfy a need or set of needs through the purchase of a particular product or set of products. Consequently, the customer uses several criteria to determine how much they are willing to expend, or the price they are willing to pay, in order to satisfy these needs. Ideally, the customer would like to pay as little as possible.

For the business to increase value, it can either increase the perceived benefits or reduce the perceived costs. Both of these elements should be considered elements of price.

To a certain extent, perceived benefits are the opposite of perceived costs. For example, paying a premium price is compensated for by having this exquisite work of art displayed in one’s home. Other possible perceived benefits directly related to the price-value equations are:

  • status
  • convenience
  • the deal
  • brand
  • quality
  • choice

Many of these benefits tend to overlap. For instance, a Mercedes Benz E750 is a very high-status brand name and possesses superb quality. This makes it worth the USD 100,000 price tag. Further, if one can negotiate a deal reducing the price by USD 15,000, that would be his incentive to purchase. Likewise, someone living in an isolated mountain community is willing to pay substantially more for groceries at a local store than drive 78 miles (25.53 kilometers) to the nearest Safeway. That person is also willing to sacrifice choice for greater convenience.

Increasing these perceived benefits are represented by a recently coined term, value-added. Providing value-added elements to the product has become a popular strategic alternative.

Perceived costs include the actual dollar amount printed on the product, plus a host of additional factors. As noted, perceived costs are the mirror-opposite of the benefits. When finding a gas station that is selling its highest grade for USD 0.06 less per gallon, the customer must consider the 16 mile (25.75 kilometer) drive to get there, the long line, the fact that the middle grade is not available, and heavy traffic. Therefore, inconvenience, limited choice, and poor service are possible perceived costs. Other common perceived costs include risk of making a mistake, related costs, lost opportunity, and unexpected consequences.

Ultimately, it is beneficial to view price from the customer’s perspective because it helps define value — the most important basis for creating a competitive advantage.

Society’s View

Price, at least in dollars and cents, has been the historical view of value. Derived from a bartering system (exchanging goods of equal value), the monetary system of each society provides a more convient way to purchase goods and accumulate wealth. Price has also become a variable society employs to control its economic health. Price can be inclusive or exclusive. In many countries, such as Russia, China, and South Africa, high prices for products such as food, health care, housing, and automobiles, means that most of the population is excluded from purchase. In contrast, countries such as Denmark, Germany, and Great Britain charge little for health care and consequently make it available to all.

There are two different ways to look at the role price plays in a society; rational man and irrational man. The former is the primary assumption underlying economic theory, and suggests that the results of price manipulation are predictable. The latter role for price acknowledges that man’s response to price is sometimes unpredictable and pretesting price manipulation is a necessary task.

Terms Used to Describe Price

Depending on whether they are describing a good or a service and the product’s industry, people may use terms other than the word price.

Learning Objectives

Name the different terms used to reference pricing

Key Takeaways

Key Points

  • From a customer’s point of view, value is the sole justification for price.
  • The price of an item is also called the price point, especially when it refers to stores that set a limited number of price points. The words charge and fee are often used to refer to the price of services.
  • The transportation industry charges a fare for its services.

Key Terms

  • price: The cost required to gain possession of something.
  • price point: The price of an item, especially seen as one of a number of pricing options.

Introduction

We’ve been using the word “price” a lot. There are, however, other terms you may come across in your studies and daily life that serve as synonyms.

Price Point

The price of an item is also called the price point, especially where it refers to stores that set a limited number of price points.

For example, Dollar General is a general store or “five and dime” store that sets price points only at even amounts, such as exactly one, two, three, five, or ten dollars (among others). Other stores will have a policy of setting most of their prices ending in 99 cents or pence. Other stores (such as dollar stores, pound stores, euro stores, 100-yen stores, and so forth) only have a single price point ($1, £1, 1€, ¥100), though in some cases this price may purchase more than one of some very small items. Price is relatively less than the cost price.

Charge

When someone wants to know the price of a service, they may ask, “How much do you charge? ” In this context, the word “charge” is a synonym for price.

Value

From a customer’s point of view, value is the sole justification for price. Many times customers lack an understanding of the cost of materials and other costs that go into the making of a product. But those customers can understand what that product does for them in the way of providing value. It is on this basis that customers make decisions about the purchase of a product.

Fee

A double-decker bus in London.

London Bus: A “fare” is the price to ride a bus.

Service providers may present you with a fee list as opposed to a price tag if you ask for the price of their services.

Fare

You pay a price to fly, ride the bus and take the train. The price in these industries is expressed as a fare.

The Importance of Price to Marketers

Since pricing has a direct impact on a company’s revenue, and thus profit, setting the right price is essential to a company’s success.

Learning Objectives

Discuss how pricing impacts marketing and business strategy

Key Takeaways

Key Points

  • Price is important to marketers because it represents marketers’ assessment of the value customers see in the product or service and are willing to pay for a product or service.
  • Adjusting the price has a profound impact on the marketing strategy, and depending on the price elasticity of the product, it will often affect the demand and sales as well.
  • Pricing contributes to how customers perceive a product or a service.

Key Terms

  • value: a customer’s perception of relative price (the cost to own and use) and performance (quality)
  • marketing mix: A business tool used in marketing products; often crucial when determining a product or brand’s unique selling point. Often synonymous with the four Ps: price, product, promotion, and place.
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Pricing and the Marketing Mix: Pricing might not be as glamorous as promotion, but it is the most important decision a marketer can make.

Price is important to marketers because it represents marketers’ assessment of the value customers see in the product or service and are willing to pay for a product or service. The other elements of the marketing mix (product, place and promotion ) may seem to be more glamorous than price, and thus get more attention, but determining the price of a product or service is actually one of the most important management decisions. Here’s why.

  • While product, place and promotion affect costs, price is the only element that affects revenues, and thus, a business’s profits. Price can lead to a firm’s survival or demise.
  • Adjusting the price has a profound impact on the marketing strategy, and depending on the price elasticity of the product, it will often affect the demand and sales as well. Both a price that is too high and one that is too low can limit growth. The wrong price can also negatively influence sales and cash flow.
  • Problems occur if the marketer fails to set a price that complements the other elements of the marketing mix and the business objectives, as pricing contributes to how customers perceive a product or a service. A high price indicates high quality. The term luxury comes to mind. If, however, a firm wants to position itself as a low-cost provider, it will charge low prices. Just as they do with high-end providers, consumers know what to expect when they see low prices.

So, as you can see, it is important that a company sets the right price. A company’s success can depend on it. However, with so many factors to consider along with the lack of a crystal ball that will show the effect of a price change, It isn’t so easy to do.

Value and Relative Value

Value is the worth of goods, and relative value is attractiveness measured in terms of utility of one good relative to another.

Learning Objectives

Discuss the different concepts of value and how it influences consumer buying decisions

Key Takeaways

Key Points

  • Value is the worth of goods and services as determined by markets.
  • Something is only worth what someone is willing to pay for it.
  • The utility for the seller is not as an object of usage, but as a source of income.
  • In term of pricing, prices of valued items undergo questionable fluctuations.

Key Terms

  • utility: The ability of a commodity to satisfy needs or wants; the satisfaction experienced by the consumer of that commodity.
  • marginal utility: The additional utility to a consumer from an additional unit of an economic good.
  • Surplus value: The part of the new value made by production that is taken by enterprises as generic gross profit.

What is Value?

Value is the worth of goods and services as determined by markets. Thus, an important part of economics is the study of policies and activities for the generation and transfer of value within markets in the form of goods and services.

Often a measure for the worth of goods and services is units of currency such as the US Dollar. But, unlike the units of measurements in Physics such as seconds for time, there exists no absolute basis for standardizing the units for value.

One of the most complicated and most often misunderstood parts of economy is the concept of value. One of the big problems is the large number of different types of values that seem to exist, such as exchange value, surplus value, and use value.

The Buyer’s Utility

The discussion of values all start with one simple question: What is something worth?

Today’s most common answer is one of those answers that are so deceptively simple that it seems obvious when you know it. But then remember that it took economists more than a hundred years to figure it out: something is worth whatever you think it is worth.

This statement needs some explanation. Take as an example two companies that are thinking of buying a new copying machine. One company does not think they will use a copying machine that much, but the other knows it will copy a lot of papers. This second company will be prepared to pay more for a copying machine than the first one. They find a greater utility in the object.

The companies also have a choice of models. The first company knows that many of the papers will need to be copied on both sides. The second company knows that very few of the papers it copies will need double- sided copying. Of course, the second company will not pay much more for this feature, while the first company will. In this example, we see that a buyer will be prepared to pay more for the increase in utility compared to alternative products.

So we can summarize this with the statement that the economic value of an item is set by the increase in utility for customers. This increase in utility is called marginal utility, and this is all known as the marginal theory of value.

The Seller’s Utility

But how does the seller value things? Well, in pretty much the same way. Of course, most sellers today do not intend to use the object he sells himself. The utility for the seller is not as an object of usage, but as a source of income. And here again it is marginal utility that comes in. For what price can you sell the object? If you put in some more work, can you get a higher price?

Here we also get into the utility for resellers. Somebody who deals in trading will look at an object, and the utility for him is to be able to sell it again. How much work will it take, and what margins are possible?

Subjective Value

Not only do the two different buyers have a different value on an object, the salesman puts his value on it, and the original manufacturer may have put yet another value on it. The value depends on the person who does the valuation–it is subjective.

Relative Value and Pricing

Relative value in the marketing context is attractiveness measured in terms of utility of one product relative to another.

In term of pricing, prices of valued items undergo questionable fluctuations. For example, even though housing provides the same utility to the individual over time, and supply and demand are relatively constant and stable, the relative price of housing fluctuates, even more so than with stocks, oil, and gold.

This price volatility appears to occur in cycles and is caused by a myriad of factors. Figure 1 is an attempt to overlay the prices of housing, stocks, oil, and gold by normalizing the price streams. Normalizing is achieved by applying a discounting formula which converts a price to the price it would be at a certain date, given a certain discount rate. This would normally be used to cancel the effects of inflation, in which case the inflation rate would be used.

A chart shows that commonly valued items of constant utility tend to vary in price over time (house, stocks, rents, gold, crude oil, house trend, stocks trend, and rents trend).

Value or Price: This chart shows that commonly valued items of constant utility tend to vary in price over time.