GCSE Business Studies/Price
The price is what a firm charges for a product or service.
What influences the price?
The price is influenced by two types of factors, these are:
- Internal factors, such as the cost of production.
- External factors, such as what other firms are charging for similar products or services.
There are a number of strategies that firms will use to decide how much they should charge. Some of these are:
Cost-plus (full-cost) pricing
In this type of pricing strategy, a firm adds a given percentage (know as the mark up) to what it costs them to make a product, and sells it for this price. The formula for getting the sale price is therefore:
For example, if a firm was making pens at a cost $2 per pen, and they wanted to make 25% profit on them, the sale price would be worked out like this:
This is the simplest pricing strategy and is commonly used by small firms or sole traders.
- Very easy and fast to calculate.
- Ensures that all your costs are covered properly.
- Does not take into account what the customer is willing to pay for the product, which could result in reduced profit.
- Does not look at what competitors are charging - if competitors are charging lower prices, sales may be lost.
- Takes a lot of time to work out the cost plus of every single item in a business
With penetration pricing a firm charges a very low price for a product in order to attract lots of customers. While this low price is used, firms will usually make little or no profit. This is called loss leading. Once the product has gained customer loyalty the producer will start charging higher prices to increase their profit. This pricing strategy is often done when introducing a new product in a market, often when existing products have brand loyalty, in order to grab a large market share quickly. Magazines are a good example.
- Will attract customers to the product and make them want to try it.
- Good for increasing market share quickly.
- Does not help pay back research and development costs.
- Revenue is lost while the product is selling at a lower price.
- Not good for products with short product life cycles (e.g. fashion clothing).
Skimming is the opposite of penetration pricing. Firms charge a high price to begin with for an exclusive product. This helps to make the product desirable to consumers with large incomes. When the product has become established the firm will lower the price to help it become a mass market product. This pricing strategy is often done with products based on new technology that are only just appearing the market.
- High prices can give a product a good image, and give customers the impression that it is very high quality.
- Will give firms high profits while the price is high, helping to pay back research and development costs.
- Competitors may bring out a lower-priced product, taking away your market.
- Some sales may be lost because customers are not willing to pay the higher price.
- Can put some potential customers off because of the high price.
With competition pricing a firm will base what they charge on what other firms are charging. This is used when there is lots of choice but not much product differentiation, like petrol.
- Avoids price competition which can damage the company
- It can change customer's opinions on different companies
- Businesses have to attract the customers in other ways, since the price will not grab the customer's interest.
- May only just cover production costs, resulting in low profits.
Promotional pricing means temporarily reducing the price of an established product in order to increase interest in customers. This is usually done because:
- The sales of the product are falling and the firm wants to renew customer's interest in it.
- The product has gone out of fashion, and the firm wants to clear their stock (e.g. sales on last season's clothes).
- Earns revenue on out of fashion goods that would probably not sell otherwise.
- Can renew customer's interest in products with falling sales.
- Revenue is lower on each product, so profits will be lower (or non-existent).
- When attempting to renew interest, can be risky if sales don't rise
- discount rates creates great loss