Pricing is a term used in finance and economics to describe the act of setting a price for a product or service. Pricing is when a company decides how much a customer will pay for a product.
Get a complete definition of pricing and how it compares with cost. Also, learn common pricing strategies.
What is the pricing?
Pricing is the process of establishing a price for a product/service. Although there are many options available to businesses when it comes to setting prices, they all fall under the umbrella of pricing. The price that is set during the pricing process determines what the customer will pay to purchase that product or service.
Although the terms may be interchangeable, pricing is different from cost.
What is the pricing?
Although there are many pricing options, most of them boil down to three basic approaches.
There are some markets that offer a mixture of pricing strategies. eBay is one example. It allows wholesalers to set their own prices, often based upon the product’s price. Many sellers who are successful on eBay set competitive prices because there are many buyers and sellers. Sellers may charge more for used products than the original retail price, such as older, out-of-print video games, simply because there is high demand. eBay allows auctions which are another type of variable pricing based upon demand.
Pricing based on cost
This approach does not consider (in theory but not always in practice), how other sellers set their prices for similar products. This pricing strategy instead bases the selling price on how it compares to cost. This pricing strategy bases the selling price on its relationship to cost. 1
Although there may be common markup rates across industries, ultimately it is up to the individual retailers to decide. For example, a music shop might mark up guitars by 50% while keyboards are marked up by 60%. This means that a customer would pay half of the price the music shop paid for the guitar. The mark-ups used by a competitor’s music shop may be similar.
Competitive Pricing
As the name implies, competitive pricing looks at the seller’s competitors before setting a price. You can use this information to help you determine your pricing. You might decide to match or undercut the prices of your competition or, if your product or service is superior, to charge more.
One example of competitive pricing would be penetration pricing. This is where a business sets a very low price in order to remain competitive and establish itself as a leader in its industry. As the business becomes more established, it will increase its price to match the market.
Pricing based on demand
This strategy responds to changes in demand, whether it is growing or waning. A seller might increase the selling price if demand is increasing, particularly if supply becomes less plentiful. This is evident in the housing market. The number of buyers and homes on the market determines the price of a home.
When demand is declining, discount sales are a good example of how demand-based pricing works. A decrease in demand can leave a lingering supply. The business might decide to lower prices in order to clear out any remaining inventory.
Pricing vs. Pricing vs.
| Pricing vs. Pricing vs. | |
|---|---|
| Pricing | Price |
| The price a customer pays for a product/service | A business’s investment in the hopes of selling a product or service. |
| The cost of a product/service may or not be tied. | Directly tied to the investment cost |
| Factors can be a significant contributor to a company’s revenue | Factors that affect a business’s price of goods sold |
While the terms are sometimes used interchangeably in casual conversations, formal business conversations should not confuse cost with a price. The price is the amount the customer pays for the product/service. The seller’s investment in the service or product that is sold later is called cost.
The context of the transaction and the place it takes place within the supply chain will determine the price difference. A wheat farmer may set a price for his product that is paid by a wholesaler. The cost to a food wholesaler is the price that a wheat farmer will pay. The food wholesaler will determine the price at which wheat can be sold to bakeries after it has been purchased. The bakery’s cost is determined by the price set by the food wholesaler.
On a company’s income statements, the difference between these terms can be clearly seen. The price variable is related to sales and appears on an income statement as a revenue item. The income statement shows the cost of manufacturing the product as the cost for goods sold.
