Business Pricing Strategies

Abstract

The knowledge of the market and the ability to predict it are crucial aspects of any enterprise. Understanding the nature of changes in market prices and knowing the factors that affect them are two great advantages. Pricing is the process of the formation of the prices of services and goods which affects both public authorities and economic operators. In a more narrow sense, the development of pricing strategy by the companies is linked to the overall objectives and based on a common pricing policy. Given that, considering market conditions is obligatory for successful strategy planning.

The object of this paper is to look critically at the four main market structures and their influence on the pricing strategies of the firms. It observes and analyzes the main pricing peculiarities and their dependence on the market structure.

Business pricing strategies are strongly dependent on the marker model they are connected with. The higher the level of competition is, the less influence the business has on the market prices. For this reason, the company should consider its market power while planning prices.

Business Pricing Strategies

The market structure is a set of specific characteristics and features that reflect the peculiarities of the organization and the operations of the market industry (Tucker, 2013). Theoretically, there can be a large number of market structures. However, many economists believe that it is possible to simplify the analysis by using the typology of market structures, based on a few following basic parameters.

The first one corresponds to the number of firms operating in the market. The number of vendors operating in this industry affects the company’s possibility of having an impact on market equilibrium.

The second aspect is the market price control. The extent of the individual firm’s control over the prices is the most striking indicator of the level of competition between the industry and the market. The more control the individual producer has over prices, the less competitive the market is.

The third parameter is the nature of the product sold on the market, divided into standardized or differentiable goods. The higher the degree of inhomogeneity of industrial production is, the greater the company’s ability to influence the prices of the goods produced by it gets, and the lower the degree of competition in the industry is. Consequently, the more products fill the industry, the more competitive the market is.

The fourth parameter is the conditions of entry into the industry, which depend on the presence or absence of entry barriers. The existence of such barriers prevents the entry of new firms into the industry market, and consequently, affects the development of industry competition.

The fifth parameter is the non-price competition that takes place when an industry product has a differentiable character. The non-price competition includes the competition of a product’s quality, location, service, advertising, and accessibility.

Based on the aforementioned characteristics, it is possible to analyze the various types of market structures: monopoly, perfect monopolistic competition, and oligopoly. All the structures vary in market power, which is inversely related to the degree of competition in market relations.

Perfect Competition

Perfect competition is the market model characterized by the following conditions (Boyes & Melvin, 2012).

1) There is a plurality of buyers and sellers in the market.

2) Under conditions of perfect competition, the prevailing market prices are established by the interaction between market demand and market supply. It also determines the horizontal demand curve and the degree of average income for each firm.

3) Homogenous products and services are offered for sale.

4) No single company can affect the prices and the general situation on the market by itself. Due to the homogeneity of production and the availability of a large number of perfect substitutes, no firm can single-handedly sell their goods at a price a little higher than the equilibrium price of PE. On the other hand, a private company is small when compared to the total market, and it can sell all the products at the prices of PE. For this reason, it does not need to sell the goods at a price below equilibrium (Nicholson & Snyder, 2012). Thus, all firms sell their products at the market price of PE, determined by the market supply and demand.

5) None of the sellers or buyers know more about the market than the competitors.

6) The buyer and sellers are free to enter the market and free to leave it.

An example of a perfectly competitive market is the agricultural market if it does not have any artificial restrictions on pricing. In practice, however, such competition is rare. It is rather a theoretical model for research than a real functioning market structure.

In practice, the market usually demonstrates an imperfect competition. It becomes so when at least one of the conditions of perfect competition does not hold. In fact, it is almost impossible to find sellers with exactly the same goods. If there is no difference in quality and appearance, there are inevitable differences in the location — for example, whether a bakery is near the buyer’s home or on the other side of town, in the conditions, advertising, and sales terms. Such a market represents an imperfect competition, like the monopolistic type of it.

Monopolistic Competition

The market structure where many firms are selling similar, but not perfect substitute products is called monopolistic competition (Boyes & Melvin, 2012). The monopolistic nature of it depends on the fact that each producer has a monopoly over their products and the competitive options because there is a significant number of competitors selling similar products. Product differentiation is a key feature of this market structure. It presupposes the existence of the industry’s group of sellers who produce similar, but not identical products.

By creating its version of the product, each firm acts as if it has the characteristics of a limited monopoly. There is only one producer of Big Mac sandwiches, only one manufacturer of toothpaste Crest, only one publisher of Times magazine, and others. However, they are all facing competition from companies offering substitute products, operating under conditions of monopolistic competition. Product differentiation creates the possibility of a limited effect on market prices (Nicholson & Snyder, 2012), as many consumers remain loyal to a particular brand and the company, even despite some increase in prices.

The theory of monopolistic competition highlights the short and long terms of it. In a short period, a company of monopolistic competition maximizes its profits and seeks to realize the production by combining the prices (P1) and the volume of it (Q1), while its marginal revenue equals marginal cost. As a result, the firm can gain additional profits. The company of monopolistic competition is based on the value of average total cost (AC) when deciding whether to stay in the industry or to leave the market. For this reason, if the firm constantly loses money, which means that the average total cost of production exceeds the established price per unit, it will leave the market in the long term. It should be noted that since the monopoly competitor is a dynamic decision-maker, the company is not capable of efficiently allocating its resources, which leads to its ineffectiveness in the long term.

Oligopoly

Unlike the perfect and monopolistic competition, oligopoly is a market structure with a small number of large enterprises holding most of the production and sales in the industry (Boyes & Melvin, 2012). The dominance of the few relatively — and sometimes absolutely — large enterprises in the industry is a feature of the oligopolistic market. The large size of the vast majority of oligopoly enterprises is a consequence of scarcity in the market. As a rule, only a few companies are able to meet the market demand.

The main consequence of the few companies in the market is their close interdependence and intense competition between the market’s participants. Unlike perfect competition, activities of any of the firms in the pure monopoly or oligopoly market cause the mandatory response from its competitors. Thus, a few firms’ correlations of behavior and actions is the main factor in oligopoly, which relates to all aspects of competition: market share, price, sales promotion strategy, sales volume, investment and innovation activities, after-sales services, and others.

The market power is determined by the relative excess of the market prices of the company in regard to its cost. The degree of its influence on the company’s market price or its monopoly power is high, though not to the same extent as in the pure monopoly.

Monopoly

A monopoly implies that one company is the sole producer of the product (Boyes & Melvin, 2012) which has no analogs. Buyers, in this case, do not have the choice and are forced to buy the products of the enterprise-monopolist. The examples of industries that are considered to be monopolistic are the heat, water, gas, and electricity industries. Practice shows that the pure monopoly is a theoretical category, similar to the concept of perfect competition. However, many markets come closer to the state of pure monopoly in regard to the basic parameters of the structure than to the state of any other market model.

Pricing Strategies Related to each of the Aforementioned Market Structures

All market structures have their characteristics, including pricing features. The company’s pricing in different types of market structures is observed below.

Perfect Competition Price Strategy

Pure competition market presupposes a big number of stakeholders, including sellers and buyers of some commercial products, such as copper. In the context of this market, the individual buyer or seller can have little effect on the prices established for the commodity. The seller can not set a price higher than the market, as consumers are free to buy the goods they need from the numbers of other sellers for that market price. There is also no seller asking for a price below the market because they can sell everything they need for the current market price. It makes no sense to spend time developing a marketing strategy, because as long as the market remains perfectly competitive, the roles of the marketing research, product development activities, pricing policies, advertising, sales promotion, and other activities are minimal for the vendors of this market.

From this perspective, in the market of perfect competition, the influence of supply and demand is the only element that forms the prices. The firms in this market are all price takers, and the landmark in pricing is the market price. The action of setting prices above or below the level that prevails in the market is not justified. In the first case, the company risks losing customers who will turn to the firm’s competitor because of its lower price — since the commodities are interchangeable. On the other hand, setting a price below the market results in the loss of profits. The examples of pure competition market are the international markets of securities, non-ferrous metal ores, and wheat.

The logic of establishing the value of a particular price covers the principles of “cost-plus” setting, based on the level of current prices. The company in a short period produces the amount of production in which the price or the income limits equal the marginal cost: MR (P) = MC. In the long term, the competitive price will tend to equalize with the minimum average cost of production. In light of the existence of economic profits in the industry, other companies can join a competitive industry as long as these profits do not disappear under the influence of competition.

Monopolistic Competition Price Strategy

The pricing in the market of monopolistic competition functions under the conditions of competition of business, producing a diverse group of products or services that can not be considered as complete substitutes. However, the goods or services of a particular enterprise differ from each other by specific characteristics. In this regard, the company has a certain monopoly in determining the price of its branded products, limited by the availability of its competitive substitutes produced by other companies on the market.

Oligopoly Price Strategy

In an oligopolistic market, where the number of the sellers range from three to ten, the influence of the laws of the market and the possibility of collusion between the oligopolists determine the price (Arnold, 2015). Besides the collusion, an oligopolistic market sets the prices in regard to the following principles:

a) the principle of “cost-plus” which determines the price as the cost per unit of the product and a normal profit added to the costs. For example, “General Motors’ first determines the average cost of car manufactured, and then adds 15% of the profit after taxes;

b) the principle of “price leadership” plays a leading role in the formation of an effective price of the company branch that is responsible for price changes, and other firms follow it without the formal consent. For example, the US cigarette manufacturing companies “American Tobacco” and “Reynaldo” alternately changed prices for an extended period of time, which resulted in the average profit of 18% after taxes.

Monopoly Price Strategy

Pricing on a purely monopolistic market, where only one company operates, is subjected to the process of maximizing the benefits of the monopoly (Whitehead, 2014). For the same cost, pure monopoly deems it advantageous to limit the amount of production and to set a higher price than that of the competition (Dixit, 2014). Such a limitation of production volume results in the inefficient use of limited resources. However, the monopolist can minimize the costs, thus benefiting.

A firm with monopoly power can use it for special pricing policy, resulting in the appearance of the concept of price discrimination. Price discrimination is the establishing of the different prices for different units of the same product, for the same or different customers. The monopoly firm needs different price elasticity for the commodity for different buyers in order to implement price discrimination. It needs the buyers to be easily identifiable. In addition, the firm needs to make it impossible to resale goods from its buyers to other buyers. As practice shows, the most favorable conditions for price discrimination exist in the services market or in the material goods market, since high tariffs and distance separate them.

Case Study

The analysis of the real-life pricing strategy dependence on a market structure can be regarded as an example of the international oil market. The system of its pricing occurs under an obviously oligopolistic scenario. There is a very limited number of major oil exporters in the world, and the small ones are unable to influence world prices. OPEC countries are the largest in terms of oil exports and production, and they have a significant influence on the supply of oil. In addition, the cost of oil production in these countries is one of the lowest in the world. Representatives of the OPEC meet regularly to develop a unified position in order to change the quota of oil production, aiming to increase the prices. The OPEC’s share of world oil production has been gradually increasing over the past two decades. Therefore, in this case, it is obvious that a pricing policy of oligopolistic collusion does exist.

Conclusion

Pricing is a complex process during which both the objective factors, such as costs, demand, and competition and many subjective manifestations must be taken into account. It consists of the processes of the formation of the prices for certain goods and of the price system as a whole. On the free market, the price formation process occurs spontaneously, and the prices form under the influence of supply and demand in a competitive environment, where the process of decision-making is related to the establishment of the prices of goods or services.

The pricing policy of the company is directly dependent on the type of market where it sells its products. The differences between the types of market entry conditions relate to the market, its ability to influence the prices, and other indicators. The small competitive firm does not need to develop a pricing strategy due to its role as a price taker. However, the oligopoly should consider every step of its competitors while planning its pricing strategy.

The pricing solutions for the majority of products can not be regarded without taking into account all aspects of the marketing structure, such as prices of the related products, competitors’ prices, costs of production and marketing of the product, demand, and pricing purposes.