Pricing Decisions & Price Skimming

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Price

There are 4 key factors that influence a business' pricing decisions. Costs and the product life cycle are internal factors affecting pricing. The nature of a product and the degree of competition are external factors.

Costs

Costs influence a business' pricing decisions because businesses usually aim to make a profit.
A business' price and costs determine how much profit the business will make. Businesses cannot afford to set a price lower than their costs forever.

Product life cycle

A product's position in the product life cycle helps to determine if a business will charge a high or low price for the product.
When a new product is launched, businesses may charge higher prices to take advantage of exclusivity.
When Apple launches new iPhones (like the iPhone X), they charge higher prices. The iPhone X cost $1,000 in Autumn 2017, but this price fell to $850 by February 2018.

Nature of product

The nature of a product affects pricing in 2 key ways:
- Whether a good is a luxury good or not, will affect how much a business charges.
- Whether the product is hard to differentiate from competitors affects how much a business can charge. If it is similar (homogenous), then businesses usually price at a similar level to competitors.
For example, in the crude oil market, oil is the same no matter who produces it. This means that there is a uniform price (same price for all businesses and customers) in the market.

Degree of competition

The degree of competition affects the pricing decision of businesses because the more competition a business faces, the more options customers have.
When customers have lots of options for similar products, businesses must compete to attract customers using a lower price.

Setting Pricing - Price Skimming

Price skimming is a pricing method where a business sets a relatively high initial price and then gradually lowers it over time. This is often used before a business faces competition in the market. Once competition arrives, there will be downward pressure on the price to fall.

Maximise revenue

Price skimming is used to try and maximise revenue.
Consumers who buy early on are willing to pay a higher price but the business can still attract other customers who can pay a lower price later on in the product’s lifecycle.

Cover fixed costs (research and development)

Price skimming can help to recover the costs of research and development, which can be expensive for technology products.
- For example, the Apple iPhone X reportedly cost over $1bn in research and development costs.

Slower unit sales growth

A disadvantage of price skimming is that it can slow down the growth of a product and this can give competitors more time to launch a competing product or service.
A business does not maximise the number of sales at the start so competitors can get more of a chance to enter the market.