Evan On... The price point

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Leading the charge

With so many competing factors, how do companies set prices?

The Bottom Line presenter Evan Davis gets behind the mystery of how companies fix their prices.

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Most of us probably don’t think about how companies set prices very often. We observe the prices, we grumble about them or we’re very pleased with them - but we don’t think about how they go about doing it.

If we did think about it, we’d probably have in our mind a rather simple process where they take the cost of what they produce and add a little bit on. Maybe they take into account supply and demand, or something like that.

In practice, though, it turns out it’s vastly more complicated than perhaps it sounds, and we had some illustrations of the kinds of complexities that companies have to deal with.

First off, when you’re thinking about the cost of your product, well, it depends on the volume that you’re going to produce. But you don’t know what volume you’re going to produce until the customers have bought it. Terribly complicated, therefore, just to take a cost and add a bit, you’re sort of finessing your notion of your costs as you go as the volumes come in. And there’s obviously something of a gamble there for companies as they work out what volume they expect and update that with the volumes that actually ensue.

And then we have the second, and perhaps even more elaborate complication, which is that markets aren’t simple. You take a company like a bus company, it’s not just one set of consumers paying the same price at all times of day because, firstly, the buses at some times of day are too full and at other times of day are too empty and you have some consumers who, frankly, can afford to pay a lot and are willing to pay a lot and you have other backpacker-type consumers who basically can’t pay very much and are very sensitive to the price. And, if you’re trying to maximise the revenue of your service, you somehow have to find a way of getting one lot to pay a lot in order that you get enough money in while nevertheless getting the others onto the bus so that your buses aren’t running empty.

It all, in practice, turns out to be, well, far more complicated than the simple notions I think that most of us would have. So if we sometimes find ourselves complaining about the complexity of the prices that we end up paying, well there is truly a logic to it.