When deciding how to form the price of a product or service, it is necessary to first determine which goals you want to achieve. It can be a survival objective (fundamental, even more than profit), the objective of the maximum current profit (when analyzing demand and costs, you choose a price to obtain the maximum profit), the objective of maximum income from the sale (also in this case it is necessary to know how to evaluate the demand), of the objective of the maximum growth of sales (a price is defined such as to penetrate the market to the maximum possible extent), of the objective of the maximum skimming (when they launch on the market new products or services you can afford high prices, because there is a market segment that will want to buy them regardless of the price) or the goal of leadership in product quality (the price is formed according to the quality in order to give a higher price to higher quality products and services). 

There are of course many factors that influence the pricing of products and services. For example, the benefit that customers have from our product or service and the level of competition in the market are important. Furthermore, sometimes the laws affect the price, on which we cannot intervene.

In the final price decision, the psychological aspect of price formation must also be considered. Typically you decide for one of the following approaches: 

• Price formation based on costs (the amount of costs represents the limit below which the market price must not fall).
• Price formation based on demand (in-depth market research must be done, especially regarding competition, to understand how much consumers are willing to pay).
• Price formation based on costs and demand (best approach that considers both costs and real market conditions). 

Source: Devetak, G. 2000. Temelji trženja in trženjska zasnova podjetja (Basis of commerce and commercial planning), Koper, Visoka šola za management.

Price is the only element of the marketing mix that generates profit. All other elements of the marketing mix only create costs. Price is also the most flexible element of the marketing mix, since it can be quickly changed. Think, for example, of the time required to modify the commercial channels (product distribution) or to modify the entire product. 

Despite everything, or perhaps for this very reason, price and price competitiveness represent a fundamental question for all those who deal with commerce in the company. Unfortunately, many companies do not pay sufficient attention to it and as a result they can incur several errors in price formation. The most common is to focus too much on costs when establishing the price (own price of the product or service). In particular, small businesses do not often take advantage of the possibility of changing the price. To this end, market trends should be followed, especially changes in demand, adjusting the price accordingly. In the formation of the price the other elements of the marketing mix must be considered. It is not indifferent what our ways of distribution are and how aggressive communication is, for example. Before defining a price, you need to choose a commercial positioning strategy, on which our price will then depend. For example, if you choose a market positioning by price, this will affect the final price. In particular, small companies do not adjust their prices to the different market segments and to the purchasing habits of these segments. In addition, prices are generally not adjusted enough for different offers of the same product or service

1. Price formation with mark-up (a standard mark-up is added to the costs) 

Most frequent method. 

Example: Cost per unit = 16 EUR; 20% charge

 Price with markup = (cost per unit) / (1 - desired return) = 16 / (1-0.2) = 20 EUR

 This is a risky method, because the importance of the application is not considered sufficiently.

2. Price formation based on the target return 

In this method, the company defines the price based on the desired level of return on the investment. It is also a method used in public companies, which must generate a fair return on their investments. 

The price that allows you to reach a predefined return is obtained with the following equation: 

Price based on target return = cost per unit + (desired return * invested capital) / units sold

 Even with this method you can take risks, because despite the flexibility of the price and the prices charged by the competitors are important elements, they are not considered in the formation of the price based on the desired return.

3. Price formation based on the value perceived by the consumer 

According to some companies, the perception of the value of their product by the consumer is of crucial importance for the definition of the price. The perceived value is made up of various elements, for example the image that the consumer has of the functioning of the product, the effectiveness of distribution, the quality of assistance services, the reputation of the supplier, reliability and respect.

4. Price formation according to the "higher value at lower price" principle 

It is a very popular method in recent years, because it allows you to offer a low price for a high quality offer, and in this way companies acquire numerous loyal customers. One of the most important variants of price formation based on value is that of daily price formation, which is used in retail outlets. A trader of this type keeps prices always low and rarely has promotional prices or particularly advantageous offers.

5. Price formation based on current market prices 

In this case the price is defined based on the competitors' prices. The company considers its costs and demand to a lesser extent, and defines a lower, equal or higher price than the main competitors. It is a rather widespread method on the market. When it is difficult to define costs or the reaction of the competition is uncertain, companies consider the prices defined according to current market prices to be a good solution.

6. Price formation when an offer is submitted for the purpose of a tender 

It is basically a competition-oriented price formation. It is a method that is applied when different companies compete for certain jobs through written offers. The individual company determines its price based on assessments of how its competitors will define their prices, and not based on costs or demand. This method of price formation is increasingly widespread, especially with the growth in the use of the network.

When launching new products on the market, special attention must be paid to how the price is formed. The launch of a new product on the market represents a delicate period, since the product is unknown and sales are generally modest, while the costs per unit of products are still high.

If only price and advertising are considered for price formation, you can choose between the following strategies:

• Rapid skimming strategy: it is based on the launch of a new product at a high price and with strong market communication. The high price is introduced to generate the highest profit per unit of product. Many resources are devoted to communication, because we want to convince the market of product quality. It is a valid strategy if consumers, aware that there is a new product on the market, are willing to buy it regardless of price.
• Slow skimming strategy: this too is based on a high price, but less resources are allocated to market communication. The goal is to generate maximum profit with minimum communication costs. This strategy makes sense when the market is small, customers know the product and are willing to pay a high price.
• Rapid penetration strategy: it is based on a low price and on many resources intended for market communication. In this way, the company intends to acquire above all a large market share. It is a valid strategy for large markets, where customers are attentive to prices, where strong competition already exists and for the size of the market it is possible to exploit the advantages of the economy of scale.
• Slow penetration strategy: it is based on the introduction of a new product on the market at a low price and with a low level of market communication. The goal is to attract customers thanks to the low price and not to invest too many financial resources in communication. It is a valid strategy in large markets where customers are particularly price conscious, already know the product and where there is also potential competition.

Source: Kotler, P. 2004. Management trženja (Marketing management, 11. ed.). Ljubljana: GV Založba.

The formation of prices is, within a company, a fundamental strategic decision. When establishing a price, it is necessary to consider several factors that influence it, primarily the objectives of the pricing policy. It is important to define what you want to achieve with a certain price type. We can only be interested in survival, we may want more revenue or perhaps even maximum profit. But these are not the only factors to consider when defining the price. In addition to the objectives of the pricing policy, it is also necessary to know the price of the other products, the demand, the costs, the competition, the distribution chain, the legal and legislative environment, the possibilities for subsequent price adjustments and the possibility of discounts and other sales incentive methods. Here are some other factors that influence the sensitivity of the market to price: the effects of price sensitivity, those of substitute products, difficulties of comparison, final benefits, inventories and the relationship between price and quality. Who is generally responsible for defining the price in a company? In small companies, managers or managers take care of it, while in large companies the definition of the price is in the hands of the managers of the various divisions or the managers of specific product groups. In industry, in the context of intercompany markets, the price is often the subject of negotiations.

From a commercial point of view it is important to follow the price trend when you want to adjust your price to market conditions, things you can do in the following ways:

• Geographical adjustment of prices, in which the company decides to form the price for specific customers. The base price is defined at the place of production and subsequently it is defined on the basis of the central point of sale for all customers with the addition of transport costs.
• Discounts and other advantages: for example, you can decide to lower the price for customers who pay immediately or for those who buy large quantities. You can also choose to apply a functional discount, that is, what the manufacturer offers to the elements of the distribution chain for the sale, storage, conservation and management of data; finally, there are seasonal discounts and other advantages that can be obtained when buying with the "old for new" method.
• Promotional prices: they are those that the manufacturer establishes when he loses market leadership, or those that are formulated for particular occasions, such as discounts for cash payments, any installment payments or other forms of credit with interest rates of low interest; finally, the form of the so-called psychological discount is very popular (first an artificially high price for the product is defined and then it is offered at a heavily discounted price, e.g. before 1500, after 999).
• Formation of differentiated prices: often the price must be defined according to the customer segment (students, pensioners). The shape of the product also influences the definition of the price (for a small accessory of a product you pay much more). The price can also be defined on the basis of similarities between products. The same product in different packaging can have different prices. At the theater, the price can be determined according to the place in the room. In addition, in the case of electricity, the price can be defined per unit of time.
• Price formation by product assortment: particular attention must be paid to price formation when it comes to a product that is part of a specific assortment. In fact, companies often develop different groups of products, and not just single products. In these cases, the prices must be defined both for the optional accessories of the product (e.g. the buyer of a car can order separately and pay for the tinted windows) and for the accessory products (e.g. the film for the car photographic). Some prices are defined in two parts (for example, a telephone subscriber pays the monthly subscription and apart from individual calls). The customer price is formed separately for products that are generated as secondary products. Particular attention should be paid to the prices for product packages.

Source: Kotler, P. 2004. Management trženja (Marketing management, 11. ed.). Ljubljana: GV Založba.

It should be known that the variation of a price triggers different reactions in customers, suppliers, competitors and distributors. For this, before reducing a price, it is necessary to consider the consequences. Customers usually ask questions about the reasons for a price change. A price reduction does not necessarily attract them, because they can interpret it in different ways; for example, they may think that the product is lacking, or that a new one is expected to be introduced on the market shortly. They may also think of the company's financial difficulties and consequently expect a further reduction in price, but above all in quality. 

Competitors will also react in a similar way. They will try in every way to understand the objectives of the company that suddenly lowered prices. If they find that the reduction is aimed at increasing market share, they will likely adjust and reduce their prices. But in this way no one will achieve the desired effect. The issue is complex, because competitors can think that the company has problems or that it wants to lower the prices of the whole sector in order to stimulate demand.

Source: Kotler, P. 2004. Management trženja (Marketing management, 11. ed.). Ljubljana: GV Založba.

A company can decide to reduce prices for several reasons, for example for a production surplus. In this case it is necessary to start a new business to avoid having undistributed resources. So you can choose aggressive pricing, which can lead to a price war. Another reason may be the drop in market share. Sometimes, however, a company can decide a price reduction when it wants to control the market with lower costs. But the price reduction strategy often also hides several risks, such as: 

• Low quality trap (customers suspect that they are low quality products).  

• Low market share trap (with a low price, the company can acquire market share, but not customer loyalty on the market. Customers will pass to the competitor as soon as they have lowered prices). 

• Empty pocket trap (competitors can be stronger, lower prices and hold on longer with this pricing policy if they have more financial resources).

Source: Kotler, P. 2004. Management trženja (Marketing management, 11. ed.). Ljubljana: GV Založba.

Sometimes, although rarely, a company may decide to increase prices. If it does it right, it can significantly increase profits. If, for example, the net return on sales is 3%, then a 1% price increase will increase revenues by 33%, without any increase in sales. There are also several reasons for increasing the price. The most frequent is cost inflation. If costs increase, and at the same time there is no greater productivity, the yield decreases, and this can lead to the decision to increase prices. Too often, companies however raise prices more than the cost increase, because they expect further increases in inflation. A company often decides to increase prices even when demand is excessive. In addition, a company can decide to increase prices even when it cannot supply its customers in time.

But a company can react to rising costs or demand even without increasing prices. You can choose one of the following options: 

• Reduce the size of the store rather than raise prices
• Replace the materials or raw materials with cheaper ones
• Give up some characteristics of the product
• Give up some accessory product service
• Use cheaper packs e
• Reduce the choice between different product models

Source: Kotler, P. 2004. Management trženja (Marketing management, 11. ed.). Ljubljana: GV Založba.

The purchase can be incentivized with the so-called promotional prices. To this end, various techniques can be used: 

• Establish very low prices for leading products (some large stores and supermarkets often lower the prices of some products of the best known brands, encouraging customers to come to their shop)
• Establish prices for particular occasions (in certain periods, merchants determine particular prices to attract customers)
• Offer discounts for cash payment (in this way you incentivize purchases effectively; these discounts allow you to reduce stocks without reducing the list price)
• Offer credits with low interest rates
• Offer longer payment terms
• Offer guarantees and contracts for after-sales and assistance services
• Offer psychological discounts

Often, pricing strategies have no financial effects. If they are effective, competitors imitate them. If they are not, resources are spent that could have been invested in other marketing tools.

Source: Kotler, P. 2004. Management trženja (Marketing management, 11. ed.). Ljubljana: GV Založba.

Companies differentiate prices mainly by offering each market segment the same product or slightly different products at different prices. This can be linked to the quality of the product, quantity, age or other characteristics of this type. In this way, the company optimizes its sales and profits. It is simply a matter of adjusting the price to the differences between customers, products, places and the like. We can talk about price differentiation every time a company sells its products at at least two different prices.

 To make price differentiation effective, certain conditions must be met. It must be possible to segment the market and in these segments there must be a different demand. Members of the lower price segment must not have the option to resell the product to the higher price segment. In addition, in the differentiation of prices, the company must be careful not to act illegally. 

Source: Kotler, P. 2004. Management trženja (Marketing management, 11. ed.). Ljubljana: GV Založba.

There are several ways to differentiate prices: 

• The same product is sold at different prices in different market sectors
• Quantity discounts are granted for large buyers
• Time differentiation (lower prices when demand drops)
• Differentiation of prices by type of market segment, for example lower transport prices for students and pensioners
• Differentiation of prices by intended use (e.g. electricity for domestic or commercial use)
• Price differentiation for payment terms (discount for immediate payment)
• Differentiation of prices by terms of supply
• Other 

Source: Devetak, G. 2000. Temelji trženja in trženjska zasnova podjetja (Fundamentals of the company's marketing and commercial organization). Koper, Visoka šola za management