In order to give a comprehensive answer to this question, it’s relevant, first of all, to discuss pricing in theory. According to standard price theory, the firm’s price depends on market structure and firm’s objective. As there’s a wide range of different objectives, firms may follow such objectives as profit maximisation, sales-revenue maximisation, which would usually lead to a lower price contrary to profit maximisation, more complicated as non-maximising objectives etc, while the price of firms will definitely vary according to firms’ objectives.
Also, the price will tend to differ from firm to firm depending on the type of market within which those firms operate. As there’s a wide variety of possible combinations of these, such as monopoly, perfect competition (PC), oligopoly etc. and wide variety of firms’ objectives, any product or service may experience a different range of possible prices. To illustrate this point, let’s assume that the firm’s objective is to maximise profit (? ) and it operates within a specific type of market structure (here I’ll show the comparison between the PC and pure monopoly).
Since all firms’ objective is ? aximisation, MC=MR for all firms (, ). So, under the PC firms are price-takers and, hence, price plays a role of constraint:. As MC=MR, MC=P, in other words, under the PC firms always operate where P=MC. However, under monopoly, firms are price-makers, what implies that price doesn’t play a role of constraint and relationship between P and Q is given by Market Demand Curve. So, . Hence, . This formula stresses the idea that under monopoly firms always operate where demand is elastic (>1), but they don’t produce where =, as in the case with PC, hence, 1;; and ;1, P;MC.
This implies that, in comparison to PC, a monopoly produces a lower output at a higher price. The graph printed below proves this statement. P PM;PC=MC S(MC) QM;QC PM MC’ PC MR D(AR) PM PC Q However, monopolists may have different MC (e. g. MC’) if it exploits significant economies of scale and/or makes improvements in technology, what will result in lower prices. Nonetheless, all of the above information is basically about pricing in theory, but in practice, there are other main factors that determine product prices in the UK. One of those factors is cost-plus pricing.
The main emphasis lies upon the idea that it’s not so much ‘the demand side of the market that affects price, but the rather the supply side, via costs of production’ (Griffiths and Wall, 2001, p. 200). In other words, it’s the costs that influence price and then the producer tries to sell what he can at that price, while demand has little influence on price-setting under this theory, except, perhaps, affecting the size of the mark-up added to costs. So, under the cost-plus pricing strategy, in order to achieve the final price, a certain percentage (mark-up) has to be added for profit on top of the firm’s costs.
However, other thing to be mentioned here is that the precise outcome for price will vary among firms due to three main reasons, such as the problem of selecting which costs should be included in the pricing decision (variable costs, ‘marginal costing’, or both variable and fixed costs, full-cost pricing); the problem of estimating the normal level of output, whatever the costs should be included, at which the firm will operate; and, finally, the problem of determination of the size of the mark-up that has to be added to costs, whatever the costs and the estimate of capacity utilisation included.
To illustrate this point, the study by Coutts, Godley and Nordhaus (1978) of 7 UK industries gave support to cost-plus pricing, whereas the most recent research made by Shipley and Bourdon (1990) found that out of 193 industrial distributors they took into account, almost 52% used a cost-plus pricing strategy. Finally, Hall et al. (1996) survey discovered that cost-based pricing was recognised as important by over 47% out of a sample of 654 UK companies (Griffiths and Wall, 2001, p. 01).
According to these examples, it can be assumed that the cost-based pricing method is popular among the businesses. This takes place due to several reasons, such as that many firms don’t change their prices quite often partly because of the costs that will inevitably appear due to search of information important to identify the profit-maximising price; and due to ‘the cost of implementing the adjustments to current pricing and policy strategies’.
An example of this is the conclusion made by the Small Business Research Trust, which stated that 42% of a sample of 350 small UK firms changed their prices at most only once a year, but often even less frequently. So, all of the above simply shows that prices tend to be ‘sticky’ or, in other words, more closely associated with cost rather than with demand. In addition, even if the prices are related to costs, market factors can still play some part on determination of the size of mark-up: especially when demand is relatively price inelastic, what will create a higher mark-up on costs.
This is true due to studies of Eichner (1987), who found that a higher mark-up is more likely to take place in markets with fewer substitutes available, and to Shipley and Bourdon survey, stating that 27% of the industrial distribution firms raised the mark-up when demand increased and 41% decreased when demand fell. Moving on, other factor determining product prices in the UK is the Market-Share Strategy. According to Griffiths and Wall (2001, p. 03), short-term pricing policy can be dictated by market-share strategies. This can be interpreted in such way that even if the prices appear to be ‘sticky’, their change is often for reasons of strategy rather than in response to changes in cost. So, firms may use this strategy to raise or defend market share. According to the survey of Jobber and Hooley (1987), the market-share pricing strategy was practised more by large firms and they used to follow parallel pricing to defend their market share.
This is a so-called kind of tacit collusion: collusive-price leadership. For example, this is what took place in 1988 when, even though the sector accounted for 69 petrol wholesalers, it was dominated by ESSO, Shell, BP, Texaco and Mobil, which claimed to hold over 65% of the volume of petrol sold in the UK and four firms for 59% by 1996, when those 5 dominant oil companies used to follow parallel pricing since the early 1970s, charging, on average, the same wholesale price within a geographic region.
Finally, Hall et al. (1996) research showed that over 65% out of a sample of 654 UK companies claimed their most important pricing strategies to be ‘market-led pricing’ (Sloman, 2000, p. 217). Other factor that may influence firm’s pricing strategy is Market Segmentation Strategy. This theory states that the price of goods and services may be related to demand characteristics of the market segment rather than to the actual costs of production.
For instance, Griffiths and Wall (2001, p. 205) state that the forms of life-style segmentation are now used by many firms in preference to the social class distinctions of the previous four decades. A real example of the market segmentation pricing strategy in the UK can be the Monopolies and Mergers Commission Report (MMC, 1986) on the “Supply of Beer”, where it was stated that lager was more highly priced compare to beer, while it wasn’t justified by the cost of production.
This can be explained as larger is more attractive to younger drinkers, who are actually less sensitive to price. Hence, the demand for it shows lower price elasticity and, as a result, this allows adding a higher percentage mark-up on the top of costs. Also, life-cycle strategies should be taken into account as the position of the product in its life cycle influences price as well.
It has been broadly recognised that products have a finite market life, which is divided into the growth phase, when the product’s market share is increasing and market leaders can either adopt a ‘skimming’ strategy, charging a higher price, or a ‘penetration’ strategy, charging a lower price and increasing market expenditure with a purpose to establish a larger market presence; maturity phase, when the strategic pricing decisions depends on the market share that has been established in the growth phase and on the quality of the products in comparison to those of its rivals (e. . the study of Vishwanath and Mark (1997) about Procter and Gamble, the producer of Pampers Baby Dry and Pampers Premium, who tried to extend maturity phase for as long as possible); finally, the decline phase, when the company usually tries to maintain its high price by relying on the brand loyalty of those customers who remain (e. g. video games like “Doom” or “Quake” with an attempt to re-package the products as classics).
Moreover, price discrimination strategy may also influence firm’s pricing strategy. This strategy simply means charging different prices for exactly the same product in different markets and if it tends to be possible, there must be barriers such as distance, time and others, to prevent consumers changing one market to a cheaper one. If this strategy tends to be profitable, there must be ‘differences in price elasticity of demand between the markets … nd higher prices would be in markets for which demand was less elastic, irrespective of cost conditions’ (Griffiths and Wall, 2001, p. 206).
An example of this can be the European Commission Report on the market for motor vehicles in 2000. Another example is based upon a standard economy fare on British Airways from Heathrow to Rome that was i??557 in April 2002. As Lipsey and Chrystal stated (Oxford University Press, 2004, p. 185), that this fare allowed return the same day or within the week.
However, if people stayed over Saturday night, the fare was only i??209. In other words, this difference for the same class of fare on the same plane discriminates between the business traveller and the tourist. Moreover, such discrimination is profitable as the elasticities of demand for these two types of travel are different: lower for business travellers than for tourists or leisure travellers. In addition, product differentiation strategy plays a part in determining product pricing in the UK.
This strategy refers to endeavours made by firms to make their products look different from other products by changing products’ characteristics through additional marketing expenditure. This, in its turn, gives a chance to a firm to lessen the degree of facing direct competition and move towards a more monopolistic position, what gives greater control over price. According to Sellars survey (1994), an example of this strategy can be the introduction of PepsiMax by PepsiCo Inc.
Finally, briefly to mention, influence of retailers on price is significant as well. This happens when the power to control prices, in some markets, moves out of the hands of producers and into the hands of distributors, so that they become more powerful and can control prices from the producer. Good examples of this are such retailers as Tesco, Sainsbury, Safeway and Marks and Spencer. To conclude, all of the above information is broadly focused on the main factors that determine product prices in the UK.