How to consider marginal costs when determining the price of commodities
- Introduction
In a typical business environment, determining the price of a commodity is very critical as it influences the way the product or service will be perceived and the overall expected sales volume. In reference to past research, price has been shown to influence consumers’ perception of brand quality (high price is higher value and vice versa), and it also influences reduced sales, especially in cases where there are other cheaper alternatives (Binkley and Bejnarowicz, 2003; Dolan, 1995; Mesak and Clelland, 1979; Monroe, 1973, 1992; Shapiro, 1968; Simon, 1989; Turley and Cabaniss, 1995; Vanhuele and Dre`ze, 2002). In recognition of the above fact, this research paper seeks to analyse pricing and evaluate how prices of products influence sales and the overall profit generated from such products.
- Product pricing and profit maximisation
The basic aim of any given business is to enhance sales and maximise profit in the process. As economists have proven, it is impossible to generate profit in business without making sales because production is not deemed competitive until the finished goods have reached their final consumers. This is because it is through the exchange of product value with consumers’ money that the company will be able to cover for production costs and generate profit in the process. Thus, the question is: how should or do businesses determine or set the price of their commodities? This question is very difficult for businesses. However, one myth that has been dispelled is that selling products at the highest price doesn’t guarantee profit maximisation (Sheth et al., 1991; Ambler, 1997; Bhat and Reddy, 1998; Long and Schiffman, 2000). In reality, charging a high price for a product in a competitive market can reduce sales, especially when there are other highly affordable alternatives (Brown, 1971; Hirn, 1986; Kujala and Johnson, 1993; McGoldrick and Marks, 1987).
While it may appear difficult to achieve, some innovative brands have demonstrated that setting prices at the highest level can result in increased sales and profit maximisation in both the short and long run.For example, Apple has maximised its profit over the years by selling its Apple brands at a higher price than competing brands.Their success however has been geared by their product innovation and pioneering – offering products that competitors find hard to imitate.
Thus, setting prices at their highest for products can have both a positive and negative effect. The outcome generally depends on the market position that the brand occur (Brown, 1971; Hirn, 1986; Kujala and Johnson, 1993; McGoldrick and Marks, 1987). For pioneers and innovators, this is the best strategy, as it will bring in high profit before eventual imitation. For imitators and newcomers, the best pricing strategy is competitive or penetration pricing, as skim pricing (high pricing) will only yield reduced sales and low profit.
- How to consider marginal costs when determining the price of commodities
Raph (200) defined marginal cost as the expected change in economic cost as output changes.In layman’s terms, marginal cost can be described as the cost of not using an asset due to a decrease in demand or the cost of overrunning an asset due to an increase in demand. Thus, when it comes to considering marginal cost when setting the price of commodities, such considerations should reflect forecasted changes in consumers’ demand.
As an example, assuming that a company produces 1,000 units of a particular product and the forecast is an increase in demand to 1,500 units of the same product, the company can decide to effect a slight increase in the price of the product in order to increase profit in the process, as an increase implies high value and a positive perception of the brand. On the other hand, if demand is forecast to decrease for the same product, the decision should be to maintain or reduce the price in order to increase sales turnover and profit maximisation in the process. As such, marginal cost should be considered in determining the price of a given product with respect to changes in the demand curve, which basically implies that prices of commodities should only increase with subsequent increases in demand (to cover for overrunning of machines or possibly purchase new ones to meet demands) and remain the same or decrease with decreases in demand (as less expenses are incurred due to non-full utilisation of assets).
- Conclusion
From the above discussion, it has been demonstrated that the price of a given commodity can influence sales of that commodity and the overall profit generated from selling that commodity. The decision to charge a high price is influenced by a number of environmental factors, in which innovators and pioneers can skim prices in order to maximise profit before imitators, while newcomers and imitators need to penetrate prices or competitively charge their products in order to penetrate the market and increase profit.
References
Ambler, T. (1997), "How much of brand equity is explained by trust?", Management Decision, Vol. 35 No. 4, pp. 283-92.
Bhat, S. and Reddy, S.K. (1998), "Symbolic and functional positioning of brands", Journal of Consumer Marketing, Vol. 15 No. 1, pp. 32-43.
Binkley, J.K. and Bejnarowicz, J. (2003), "Consumer price awareness in food shopping: the case of quantity surcharges", Journal of Retailing, Vol. 79 No. 1, pp. 27-35.
Brown, F.E. (1971), "Who perceives supermarket prices most validly?", Journal of Marketing Research, Vol. 8, pp. 110-13.
Dolan, R.J. (1995), "How do you know when the price is right?", Harvard Business Review, pp. 174-83.
Hirn, F. (1986), "La me´ morisation des prix des produits courants. Analyse des re´ sultats d'un test limite´ (mai 1985)", Revue Franc¸aise du Marketing, Vol. 106 No. 1, pp. 55-61.
Kujala, J.T. and Johnson, M.D. (1993), "Price knowledge and search behavior for habitual, low involvement food purchases", Journal of Economic Psychology, Vol. 14, pp. 249-65.
Long, M.M. and Schiffman, L.G. (2000), "Consumption values and relationships: segmenting the market for frequency programs", Journal of Consumer Marketing Vol. 17 No. 3, pp. 214-32.
McGoldrick, P.J. and Marks, H.J. (1987), "Shoppers' awareness of retail grocery prices", European Journal of Marketing, Vol. 21 No. 3, pp. 63-76.
Mesak, H.I. and Clelland, R.C. (1979), "A competitive pricing model", Management Science, Vol. 25 No. 11, pp. 1057-68.
Monroe, K.B. (1973), "Buyers' subjective perceptions of price", Journal of Marketing Research, Vol. 10, pp. 70-80.
Monroe, K.B. (1992), Polı´tica de Precios, McGraw-Hill, Madrid.
Ralph Turvey (2000). What are Marginal Costs and how to Estimate Them? Technical paper 13. University of Berth School of Management. Available at: http://www.bath.ac.uk/management/cri/pubpdf/Technical_Papers/13_Turvey.pdf [Accessed on: 24th – 8 – 2014].
Shapiro, B.P. (1968), "The psychology of pricing", Harvard Business Review, Vol. 46, pp. 14-25 and 160.
Sheth, J.N., Newman, B.I. and Gross, B.L. (1991), "Why we buy what we buy: a theory of consumption values", Journal of Business Research, Vol. 22, March pp. 159-70.
Simon, H. (1989), Price Management, Elsevier, Amsterdam, North-Holland.
Turley, L.W. and Cabaniss, R.F. (1995), "Price knowledge for services: an empirical investigation", Journal of Professional Services Marketing, Vol. 12 No. 1, pp. 39-47.
Vanhuele, M. and Dre` ze, X. (2002), "Measuring the price knowledge shoppers bring to the store", Journal of Marketing, Vol. 66, pp. 72-85.
Posts
