What are the factors that affect price sensitivity and influence the pricing strategy of a firm?

For business, developing the strategies necessary to take advantage of price discrimination should takes innovation, creativity, and experimentation . However, there are ten factors affecting the price segmentation and sensitivity strategies:

1. Perceived substitutes effect

This effect states that buyers are more price sensitive the higher the product's price relative to its perceived substitutes and new customers to a market may be unaware of substitutes, and thus pay higher prices than more experienced buyers.

2. Unique value effect

Buyers are less price sensitive the more they value the unique attributes of the offering from competing products. This is precisely why marketers expend so much energy and creativity trying to differentiate their offering from that of their competitors.

3. Switching cost effect

Buyers will be less price sensitive the higher the costs (monetary and nonmonetary) of switching vendors .e.g. airline industry

4. Difficult comparison effect

Customers are less price sensitive with a known or reputable supplier when they have difficulty in comparing alternatives. E.g. Cellular phone companies

5. Price quality effect

Buyers are less sensitive to a product's price to the extent a higher price signals better quality. E.g.  image products, exclusive products.

6. Expenditure effect

Buyers are more price sensitive when the expenditure is larger, either in dollar terms or as a percentage of household income. E.g. accounting firm

7. End-benefit effect

The larger the end-benefit, the less price sensitive the buyer. This effect is especially important when selling to other businesses. What is the end-benefit they are seeking? Is it cost minimization, maximum output, quality improvement? The fulfillment of the end-benefit is often gauged by its share of the total cost. E.g. steel suppliers

8. Shared-cost effect

when you spend someone else's money on yourself, you are not prone to be price conscious. This is one reason airlines, hotels, and rental car companies can all price discriminate against business travelers, because most of them are not paying their own way.

9. Fairness effect

Notions of fairness can certainly affect customers, even when they are not economically (or mathematically) rational. E.g. a gas station

10. Inventory effect

The ability of buyers to carry an inventory also affects their price sensitivity. E.g. Amateur cooks with large pantries

(Nagle and Holden 1995: 95–99).

1. Cost (Direct and indirect) of the product.2. Operational cost for continued manufacturing of the product.3. Market demand, consumer interest.4. Market penetration.

5. Greed factors of the product owner.It may be less and may get defined as profitability if the owner is good. It may be negative and indicate a loss too. So am placing loss, profitability and greed on a scale for answering this question.6. Cost of managing the risks.7. Cost of introducing and systematically improving efficiency.8. Cost of innovation.

Price sensitivity of a product refers to the level of importance buyers place on price relative to other purchasing criteria. Customers looking for top quality or service, for instance, are usually less price sensitive than economical bargain hunters. The level of sensitivity for a given product is known in economics as elasticity of demand.

Elasticity of demand is a measurement of the willingness of customers to stretch with a product price increase. The law of demand in economics dictates that if all other market factors remain constant, a relative price increase would lead to a drop in quantity demanded. High elasticity for a given product means that customers are more willing to purchase the product even with price increases. Inelastic demand means even modest price increases may significantly lower demand.

From an economics standpoint, businesses should set prices at the exact best point at which supply and demand produce the optimum revenue. This is known as equilibrium price. In reality, it is very difficult to achieve the perfect price, though computer software models and real-time analysis of sales volume at given price points has helped in this area. Even if a slight price increase diminishes sales volume, the relative gains in revenue on each product may overcome a proportionally smaller decline in customer purchases.

Several common factors affect the level of sensitivity customers generally have within a particular industry or toward a certain product. Buyers of luxury goods are often less sensitive than buyers of everyday items. The more options a buyer has, the more sensitive he is to a price change in most cases. Higher-priced products, such as cars, heating and cooling systems and washers and dryers, usually lead to greater price sensitivity since they take up a large percentage of the buyer's budget.

Branding and pricing strategies contribute to the level of price sensitivity in the market. Companies typically use advertising and other promotional techniques to make consumers less price-focused and more concerned with core product benefits. The more a customer values other benefits, the less price sensitive he becomes. Additionally, establishing and maintaining a higher-end upfront price point is a common approach to making customers less price-conscious. Targeting higher-income buyers is another strategy. Some companies use penetration pricing, or low upfront prices to attract customers, often at the risk of establishing price-orientation and sensitivity at the onset of a product launch.

Agree with ghada evada fully described the factors. 

These are some of the strategic factors you need to consider regarding your pricing.

1. Positioning

You know the old saying, "You get what you pay for." Your price affects the perception of your product in the market.

2. Cost

You're in business to make a profit, and you probably have a good idea just how much profit you'd like to make on your investment. Calculate the variable cost per sale and the fixed overhead costs. What price do you need to be at in order to achieve your desired profitability based on your sales projections? Be sure to combine this with your demand curve data, i.e., keep in mind that changing your price will change your sales forecast.

3. Demand Curve

Generally speaking, all other things being equal, a lower price will increase demand and a higher price will reduce demand. Any time you change pricing, track the demand changes closely. You can supplement this with market research, asking research participants if they would buy the product or service at various price points

5. Market Control

A good demand curve model can help you optimize your pricing for maximum profitability, but that may not always be your best strategy. For example, lower prices when you first launch may be critical to help you gain market share against established competitors. And higher revenues at a slim profit, or even a loss, signal that the company will likely reach profitability later by achieving economies of scale, volume discounts from suppliers, or upsells to existing customers of higher-profit products.

6. Psychological Factors

Even if you don't have any direct competition, customers will have a concept of what constitutes a fair price based on other things they are familiar with. For example, I wonder if peanut butter and jelly would have been so successful if one cost five times what the other did. Remember that you're not only competing against your direct competitors, but potentially against everything else they can spend their money on. Also, there are often key price points that will make a significant different in people's willingness to buy.

7. Value

What is your product worth to your customers? Does it make or save them money? If so, its value should significantly exceed its price. If it does, you can base your pricing more on its value to them than what it costs you to produce it. If it doesn't, you probably need to rethink your offering!

Pricing is an essential element of your marketing strategy. Don't pull a number out of thin air. Give it the time and consideration it's due.

Pricing is often one of the most difficult things to get right in business. There are several factors a business needs to consider in setting a price

Competitors – a huge impact on pricing decisions. The relative market shares (or market strength) of competitors influences whether a business can set prices independently, or whether it has to follow the lead shown by competitors

Costs– a business cannot ignore the cost of production or buying a product when it comes to setting a selling price. In the long-term, a business will fail if it sells for less than cost, or if its gross profit margin is too low to cover the fixed costs of the business.

The state of the market for the product – if there is a high demand for the product, but a shortage of supply, then the business can put prices up

The state of the economy – some products are more sensitive to changes in unemployment and workers wages than others. Makers of luxury products will need to drop prices especially when the economy is in a downturn

The bargaining power of customers in the target market– who are the buyers of the product? Do they have any bargaining power over the price set? An individual consumer has little bargaining power over a supermarket (though they can take their custom elsewhere). However, an industrial customer that buys substantial quantities of a product from a business may be able to negotiate lower or special prices

Other elements of the marketing mix– it is important to understand that prices cannot be set without reference to other parts of the marketing mix. The distribution channels used will affect price – different prices might be charged for the same product sold direct to consumers or via intermediaries. The price of a product in the decline stage of its product life-cycle will need to be lower than when it was first launched

I agree with the list of things presented by Ms.Ghada!

To assist those who are in charge of pricing in ascertaining and judging price sensitivity, the following ten factors should be examined to see which apply to your particular customer circumstances. There are many factors that influence a customer's price sensitivity, and pricers need to understand these factors long before setting a price for any individual customer. Nagle and Holden identify ten factors affecting price sensitivity (Nagle and Holden 1995: 95–99).

1. Perceived substitutes effect

This effect states that buyers are more price sensitive the higher the product's price relative to its perceived substitutes. New customers to a market may be unaware of substitutes, and thus pay higher prices than more experienced buyers. Restaurants in resort areas face less pressure to compete based upon price (which locals may describe as “tourist traps”). Branding can also overcome, to a certain extent, the substitute effect. Woolite, for example, has maintained a relatively expensive price because it positions itself as an alternative to dry cleaning, not a substitute to regular laundry detergent. Customers have a reference price when there are many substitutes, and as long as the offering is within that range — sometimes referred to as a zone of indifference — it will be considered acceptable, the point being that your marketing can influence which products customers will compare yours with, possibly pushing up the price they are willing to pay.

2. Unique value effect

Buyers are less price sensitive the more they value the unique attributes of the offering from competing products. This is precisely why marketers expend so much energy and creativity trying to differentiate their offering from that of their competitors. Heinz ketchup, for example, developed a secret formula for making its product thicker and was able to increase its market share from 27 to 48 percent while maintaining a 15 percent wholesale price premium.

3. Switching cost effect

Buyers will be less price sensitive the higher the costs (monetary and nonmonetary) of switching vendors. Airlines that have a fleet of Boeing airplanes may be reluctant to switch to Airbus because of the enormous investment they have in operating a certain plane. Personal relationships are most susceptible to this type of perceived cost, due to the emotional investment the customer has made in the relationship.

4. Difficult comparison effect

Customers are less price sensitive with a known or reputable supplier when they have difficulty in comparing alternatives. Cellular phone companies employ this strategy by offering different features among their myriad calling plans, making it deliberately very difficult to compare one company's offering to another.

5. Price quality effect

Buyers are less sensitive to a product's price to the extent a higher price signals better quality. These products can include image products, exclusive products, and products without any other cues as to their relative quality. It is said that only 15 percent of Rolls Royce customers ask about price before purchasing (Docters et. al 2004: 220).

6. Expenditure effect

Buyers are more price sensitive when the expenditure is larger, either in dollar terms or as a percentage of household income. A one-office accounting firm may not pay much attention to the price of paper clips, but an international firm that buys in large quantities will. Business purchasers look at the total amount of the purchase, while households will compare the expenditure to total income.

7. End-benefit effect

The larger the end-benefit, the less price sensitive the buyer. This effect is especially important when selling to other businesses. What is the end-benefit they are seeking? Is it cost minimization, maximum output, quality improvement? The fulfillment of the end-benefit is often gauged by its share of the total cost. For instance, steel suppliers selling to auto manufacturers know the price of the steel comprises a large component of the cost of the car; on the other hand, when steel is sold to a luggage manufacturer, the steel cost is relatively minimal compared to the other material used.

The end-benefit effect is also psychological. Think of going out for a romantic anniversary dinner and paying with a two-for-one coupon. Most people view price shopping as tacky when the purchase involves something emotional. Wedding florists, caterers, and bands certainly understand this principle.

8. Shared-cost effect

Chapter 7 looked at the fact that when you spend someone else's money on yourself, you are not prone to be price conscious. This is one reason airlines, hotels, and rental car companies can all price discriminate against business travelers, because most of them are not paying their own way. This also explains some of the success of the frequent flyer and other reward programs. Many business travelers value these rewards and will not accept alternative offerings, especially since they are reimbursed anyway.

9. Fairness effect

Notions of fairness can certainly affect customers, even when they are not economically (or mathematically) rational. If a gas station sells gas for $2.90 per gallon and gives a $0.10 discount if the buyer pays with cash, and another gas station offers the same gallon at $2.80 but charges a $0.10 surcharge if the customer pays with a credit card, which station will sell more gas to credit card users? The economic cost is exactly the same, but most people will psychologically prefer to deal with the first station and not the second because there appears to be something inherently unfair about being assessed a surcharge.

10. Inventory effect

The ability of buyers to carry an inventory also affects their price sensitivity. Amateur cooks with large pantries will stock up on a good deal, but a single person living in a small apartment will not. The perishability of the item in question is another factor to consider.

Analyzing price sensitivity is certainly an important task for any firm that wants to capture the value it receives from its offerings. Taking into account these ten factors of price sensitivity is a good start to formulating your firm's pricing strategy.

All of the price segmentation and sensitivity strategies discussed in this chapter explicitly recognize that not all customers are created equal. Charging different prices to different customers based upon the subjective value they place on your offerings is one of the most effective ways to increase a firm's profits, without adding proportionately to overhead. Developing the strategies necessary to take advantage of price discrimination takes innovation, creativity, and experimentation — the same characteristics needed to avoid the so-called “commodity trap,

Thanks

Mrs. Ghada eweda covered the question by her great words and information

Great answers by the colleagues. 

To assist those who are in charge of pricing in ascertaining and judging price sensitivity, the following ten factors should be examined to see which apply to your particular customer circumstances. There are many factors that influence a customer's price sensitivity, and pricers need to understand these factors long before setting a price for any individual customer. Nagle and Holden identify ten factors affecting price sensitivity (Nagle and Holden 1995: 95–99).

1. Perceived substitutes effect

This effect states that buyers are more price sensitive the higher the product's price relative to its perceived substitutes. New customers to a market may be unaware of substitutes, and thus pay higher prices than more experienced buyers. Restaurants in resort areas face less pressure to compete based upon price (which locals may describe as “tourist traps”). Branding can also overcome, to a certain extent, the substitute effect. Woolite, for example, has maintained a relatively expensive price because it positions itself as an alternative to dry cleaning, not a substitute to regular laundry detergent. Customers have a reference price when there are many substitutes, and as long as the offering is within that range — sometimes referred to as a zone of indifference — it will be considered acceptable, the point being that your marketing can influence which products customers will compare yours with, possibly pushing up the price they are willing to pay.

2. Unique value effect

Buyers are less price sensitive the more they value the unique attributes of the offering from competing products. This is precisely why marketers expend so much energy and creativity trying to differentiate their offering from that of their competitors. Heinz ketchup, for example, developed a secret formula for making its product thicker and was able to increase its market share from 27 to 48 percent while maintaining a 15 percent wholesale price premium.

3. Switching cost effect

Buyers will be less price sensitive the higher the costs (monetary and nonmonetary) of switching vendors. Airlines that have a fleet of Boeing airplanes may be reluctant to switch to Airbus because of the enormous investment they have in operating a certain plane. Personal relationships are most susceptible to this type of perceived cost, due to the emotional investment the customer has made in the relationship.

4. Difficult comparison effect

Customers are less price sensitive with a known or reputable supplier when they have difficulty in comparing alternatives. Cellular phone companies employ this strategy by offering different features among their myriad calling plans, making it deliberately very difficult to compare one company's offering to another.

5. Price quality effect

Buyers are less sensitive to a product's price to the extent a higher price signals better quality. These products can include image products, exclusive products, and products without any other cues as to their relative quality. It is said that only 15 percent of Rolls Royce customers ask about price before purchasing (Docters et. al 2004: 220).

6. Expenditure effect

Buyers are more price sensitive when the expenditure is larger, either in dollar terms or as a percentage of household income. A one-office accounting firm may not pay much attention to the price of paper clips, but an international firm that buys in large quantities will. Business purchasers look at the total amount of the purchase, while households will compare the expenditure to total income.

7. End-benefit effect

The larger the end-benefit, the less price sensitive the buyer. This effect is especially important when selling to other businesses. What is the end-benefit they are seeking? Is it cost minimization, maximum output, quality improvement? The fulfillment of the end-benefit is often gauged by its share of the total cost. For instance, steel suppliers selling to auto manufacturers know the price of the steel comprises a large component of the cost of the car; on the other hand, when steel is sold to a luggage manufacturer, the steel cost is relatively minimal compared to the other material used.

The end-benefit effect is also psychological. Think of going out for a romantic anniversary dinner and paying with a two-for-one coupon. Most people view price shopping as tacky when the purchase involves something emotional. Wedding florists, caterers, and bands certainly understand this principle.

8. Shared-cost effect

Chapter 7 looked at the fact that when you spend someone else's money on yourself, you are not prone to be price conscious. This is one reason airlines, hotels, and rental car companies can all price discriminate against business travelers, because most of them are not paying their own way. This also explains some of the success of the frequent flyer and other reward programs. Many business travelers value these rewards and will not accept alternative offerings, especially since they are reimbursed anyway.

9. Fairness effect

Notions of fairness can certainly affect customers, even when they are not economically (or mathematically) rational. If a gas station sells gas for $2.90 per gallon and gives a $0.10 discount if the buyer pays with cash, and another gas station offers the same gallon at $2.80 but charges a $0.10 surcharge if the customer pays with a credit card, which station will sell more gas to credit card users? The economic cost is exactly the same, but most people will psychologically prefer to deal with the first station and not the second because there appears to be something inherently unfair about being assessed a surcharge.

10. Inventory effect

The ability of buyers to carry an inventory also affects their price sensitivity. Amateur cooks with large pantries will stock up on a good deal, but a single person living in a small apartment will not. The perishability of the item in question is another factor to consider.

Analyzing price sensitivity is certainly an important task for any firm that wants to capture the value it receives from its offerings. Taking into account these ten factors of price sensitivity is a good start to formulating your firm's pricing strategy.

All of the price segmentation and sensitivity strategies discussed in this chapter explicitly recognize that not all customers are created equal. Charging different prices to different customers based upon the subjective value they place on your offerings is one of the most effective ways to increase a firm's profits, without adding proportionately to overhead. Developing the strategies necessary to take advantage of price discrimination takes innovation, creativity, and experimentation — the same characteristics needed to avoid the so-called “commodity trap,