Determining the price at which a good or service is offered for sale is one of the most important decisions for a firm.There are many different inputs into the pricing decision: price relative to costs; the frequency of price changes; pricing relationships between different products; etc. With good decision-making, pricing can be an important competitive weapon. On the other hand, bad pricing decisions can erode a firm’s competitive advantage and its profitability.
Good pricing decisions flow out of a sound and comprehensive understanding of a firm’s economics. Below are some pricing axioms that can be used to guide pricing decisions:
- A key ingredient in a pricing strategy is a forecast of competitive responses from current and future competitors.
- Price cutting is a more effective strategy for goods and service which have elastic demands.
- Information symmetries about prices in a marketplace erode the effectiveness of a firm’s pricing strategy.
- Excess capacity and large inventories favour price cutting.
- Smaller competitors benefit more from price cutting than the dominant firm in an industry.
- Price cutting is a more effective strategy for firms which possess a cost advantage.
- Penetration pricing, based on moving down the experience or learning curve, work best when the firm has a first mover advantage.
- Threats to cut pricing will work best when industry exit costs are high.
- Holding down prices through limit pricing can deter entry by signalling that a firm has lower costs than it actually does.