Pricing 345
Not only does price have a strong influence on
demand, but such influence is manifested much
fasterthan for other marketing mix
instruments (e.g. advertising), for which
considerable time lags may be involved (e.g.
Ehrenberg and England, 1990).
Compared to the rest of the marketing mix
elements, price can be modified relatively
quickly; the downside is, of course, that this
applies equally to the competition as well!
Making/responding to price changes can take
place within a short time period, whereas
initiation of or reactions to changes in product
formulation, advertising, etc. can take much
longer due to the nature of the preparations
involved (e.g. Simon, 1992).
Competitive reactions to price variations
both in terms of speedand in terms of
intensitytend to be much more severe than
competitive reactions to changes in other
marketing mix variables; for example, it has
been estimated that reaction elasticities to
price variations are almost twice as high as
reaction elasticities to advertising changes
(e.g. Lambin, 1976).
Irrespective of situation, the manipulation of
price is notassociated with an initially negative
cash flow (Simon, 1989); in contrast, the
manipulation of other marketing mix elements
(e.g. promotion, personal selling) typically
results in expenses that are only recovered at
a later time (as in the case of a new product,
where initial investments have to be set against
future income streams).
The ‘leverage’ effect of price on profit
(discussed in detail in the next section) is much
greater than that of other profit drivers; for
example, it has been argued that
‘improvements in price typically have three to
four times the effect on profitability as
proportionate increases in volume’ (Marn and
Rosiello, 1992, p. 84).
Price often fulfils two functions simultaneously:
it reflects the ‘sacrifice’ that the buyer must
make in order to acquire the product/service
involved and it also acts as a signal of the
quality of the product (Monroe, 1990); no
other element of the marketing mix serves
such a dual function.
Pricing has also been identified as a key factor
governing new product success or failure (e.g.
Cooper, 1979), a crucial criterion affecting
supplier choice in business-to-business markets
(e.g. Shipley, 1985), and the most likely aspect
of a firm’s activity to draw government
attention and/or be subjected to regulation
(e.g. Reekie, 1981).In the light of the above, it is perhaps not
surprising that price has been described as a
‘dangerously explosive variable’ (Oxenfeldt,
1973, p. 48) which, if not properly managed,
‘can cripple a business, no matter how other-
wise efficient it may be’ (Marshall, 1979, p. 1).
Indeed, ‘few (companies) have figured out how
much money they are giving up by using lunk-
headed pricing strategies’ (Coy, 2000, p. 160).
The first step towards effective price manage-
ment is understanding: understanding how
price interacts with volume and costs to pro-
duce a profit (or loss), and understanding how
the ‘demand side’ works. It is to these issues
that we now turn.The drivers of profit: price, volume and cost
Figure 13.1 shows the familiar decomposition
of profit into revenue and cost elements. The
revenue side is a function of the price level and
the sales volume (in units) sold at that price,
while the cost side is made up the fixed costs
(which are incurred regardless of the volume of
sales attained) and the variable costs (which are
dependent upon the volume produced and
sold). Thus, there are four distinct forces that
‘drive’ profit: price, volume, variable unit cost
and fixed cost (note that sales volume is the
only profit driver which operates both on the
revenue andthe cost side; this has important
implications, as will become clear shortly).