Pricing Decisions & Price Skimming
Business Management: IB Diploma, topic 4.4.2
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.
Test yourself on Pricing Decisions & Price Skimming
Which of these things affect a business' pricing decisions?
Why can price skimming be good?
What is a disadvantage of price skimming?