Traditionally the economist has looked at price and pricing decisions from the perspective of price being determined by the interplay of demand and supply. At a broader level, the economist views pricing decisions as an ‘allocatory’ mechanism, with prices being used as the signal to solve the basic problems of an economic society; namely, the allocation of scarce resources between competing users and individuals in that society so that resources are used in the most effective way. From the perspective of the price setter, traditional economic theory suggests that the ‘optimum’ price is one that equates marginal costs to marginal revenue so as to ‘maximize’ profits. This summary of the economist’s view of price and pricing decisions is most striking by its lack relevance to the practising marketing manager. In short, although the economist has some useful concepts to offer the marketing manager when it comes to setting prices (for example the relationship between demand and price) much of what traditional economics has to offer in this area of decision making is not helpful.
The main problems associated with bringing together the theoretical and practical side of pricing can be explained by the apparent reluctance of the economist to take full cognizance of the implications associated with the setting of either a particular price, or an overall pricing strategy, when considered in the context of an organization and its overall corporate and marketing objectives. Essentially, the economist’s viewpoint is based on a set of assumptions which, in many cases, are unrealistic and hence would be difficult to apply in the business environment.
An example of such an assumption is when the individual customer is considering the price of a given product. Economic theory suggests that the customer will act in a totally rational economic manner, such that his or her total utility (or satisfaction) is maximized. In deciding whether or not to ‘try’ the product our ‘totally rational’ consumer will carefully equate whether or not buying the product at the asking price set will maximize his or her utility. In making this judgement, the economist ‘assumes’ that the consumer has ‘perfect information’ about both the prices and utility of all other competitive products in the market, and that price is the only consideration in choice.
Clearly these are unrealistic assumptions.
Another example of unrealistic, and unhelpful, assumptions is that which we mentioned earlier in our introductory summary of the economist’s concepts of pricing; namely the assumption of ‘profit maximization’. Although profits are an essential element of long-run survival in many organizations, and as such are likely to be enshrined in overall corporate and marketing objectives, these are much more likely to be couched in terms of a required level of profits rather than ‘profit maximization’. Most importantly, it is well known that there are many other objectives a company might pursue through its pricing strategies. For example, if a company wanted to maximize market share or simply survive, a different set of prices would be delivered than if the objectives were to maximize profits. Again, we can see that the assumptions of the traditional economist, as to the objectives of the price setting exercise, are somewhat restrictive and unhelpful to the practical price setter.
Set against this seemingly dismissive view of the economist’s approach to pricing decisions is the fact that in some areas the economist has provided a number of useful concepts and tools for the marketing practitioner when it comes to making pricing decisions. In particular, the economist has made an important, if only partial, contribution to price setting in the area of the relationship between price and demand.
Not with standing this, it is unsurprising that a gulf has opened between the theoretical/economist viewpoint and the practical/marketing side of pricing. It is important that we develop a structure for strategic pricing decisions that is helpful to marketing and which can be implemented in the ‘real world’ of business and it is to this that we now turn our attention.
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