How are prices set and why do they change?

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— Aimee Holland formed Grow My Profit in 2011 to support local businesses in their development. The team has now grown to include fresh young talent and a qualified programmer so that they can offer both offline and online business solutions.

The rising costs of living are a favourite topic of conversation of late. Prices do fluctuate – in July prices rose to 3.2% for a range of products known as the retail price index.

But how is price determined and why do prices change?

A business will use a range of methods to decide on a ‘price of best fit’. It is important they get it right because overpricing means products and services will not sell and under-pricing means the business will fail.

Businesses start with counting the costs of production to define the minimum price to be charged, this includes both fixed costs and variable costs. Fixed costs are what a business needs to spend before they can begin trading and typically include things like premises and insurance. Variable costs are the costs associated with that particular product or service, the unit cost of buying in stock for example. Once this is determined the business can then set the minimum sale price that is profitable.

Commonly a business will then look to its competitors to see what they are charging. The supermarkets have recently taken to using this type of pricing strategy in their advertising campaigns and money off at the till style promotions. If the business has a directed substitute for their product or service a customer will often buy on price, the rise and success of the comparison website is a testimony to this behaviour. So a business can gain valuable information from the range of prices on offer from their competitors.

Now imagine a sizzling sausage. It could be made from low quality meat in a factory or it could be from an organic farm with free range pigs made by a highly skilled sausage maker. The price a customer expects to pay will depend on whether or not the product is a high quality. Conversely the price can indicate the quality to the customer and can encourage or discourage sales. Pricing based on quality can help to establish a business in the right area of the market for long term growth.

Finally there are the basic economic principles of demand and supply. These show the most likely sales price for a product based on the quantity demanded by the customer and supplied by the business. The life cycle of a product is also very important, technology and games are prime examples of prices that drop rapidly after release. The price will vary depending on how new the product is, the exception of course being antiques.

Brining all of these methods together businesses can attract buyers for their product or service at a price that will help the business grow. Given the difficult trading conditions, a well thought out pricing strategy could make the difference in market share a business needs to survive and thrive. As a consumer, knowing that prices will vary gives the option to shop around for the best deal.