Supply and demand and the price policy

Prices that are too low will wreck a business. Those that are too high handicap sales. Prices that are correct will produce maximum profits consistent with maximum sales. All prices must conform ultimately to the economic law of supply and demand, but the law of supply and demand does not work quickly. It can seldom be called upon, in any absolute sense, to help a manufacturer fix his price for a new product going to a new market.

Elements of final selling price

A manufacturer's selling price must include three elements ; the cost of manufacture, the cost of distribution, and the desired net profit. Overhead costs, of course, are spread over manufacturing costs and distributing costs. After all direct and indirect manufacturing and distributing costs have been met, there must be, in addition, a net profit sufficient to recompense the manufacturer for the risk he has taken in engaging in the business, and to return an adequate interest, greater than normal interest, on the invested capital.

These elements of costs and profits will depend upon the policy adopted fixing the type, quality, and style of the product to be manufactured, and upon the correlated price-level policy.

Price-level policies

A manufacturer who enters a competitive market has three price-level possibilities, any one of which, or any combination of which he may adopt as a general price policy. These three price-level policies may be listed as :

• Selling and pricing at the market minus
• Selling and pricing at the market level
• Selling and pricing at the market plus

In predetermining the price-level policy, careful consideration must be given to all elements of cost and of risk which must be provided for in expected net profits.

Market-minus price policy

A market-minus price policy is based on the theory that large sections of the market for a certain product desire above everything else a low price for a liberal quantity of definite quality of the product. Because of the low price, the quality may have to be lower than the grade that the manufacturer wishes to establish as a standard. But consumers in the minus market are often willing to sacrifice something in quality to obtain a greater quantity.

Such a policy may relieve its user, to some extent, of the necessity of differentiating his product sharply from those of his competitors. His appeal to the ultimate -consumer may be almost entirely that of price. He may depend upon an increased volume of sales to secure lower unit production costs, lower unit sales costs and a reduced proportion of overhead expense, thus increasing his profit.

The application of this policy successfully over a long-term period, in a competitive market, necessitates a continuing ability to sell the given commodity for less than the price at which the competitive makers or sellers of almost identical products are willing or able to sell them.

The policy itself depends upon an accurate knowledge of costs at all times. There is the danger that this price-level policy may precipitate a frenzy of competitive price-cutting, extra discounts, and similar attacks. Such price-cutting may start a price-war that knows no end until some of the competitors fail in business. In this connection, it should be pointed out that price-cutting does not necessarily indicate an attempt to use a market-minus price policy. Price-cutting may aim only to relieve a temporary situation.

Market-level price policy

The at-the-market price policy is common in modern business. Consumers who are reached under such a policy are interested in quality at the price they are called upon to pay. The policy assumes the general market price of a commodity to be relatively fixed, and involves lowering or raising prices in accord with the market in the several localities in which the product is being sold. It is a policy common in industries in which considerable stress is laid upon production costs and in cases where a small group of companies, each of which produces only limited quantities, tends to dominate a given industry.

This price policy presents to the manufacturer two methods of increasing his "area of profit." He may reduce his plant costs in order to increase his profits, or he may attempt to differentiate his product and build up consumer preference or insistence for his brand, which of itself will result in a larger sales volume.

He may use the same technique of building up a demand for his commodity in preference to the products of other manufacturers, at the prevailing price level, as he would use in establishing his product as a distinct and individualistic commodity on a higher price level. This technique, which involves product adaptation, branding and packaging, may bring new ultimate consumers to the particular manufacturer by giving to the differentiated commodity a subjective valuation on the part of these new consumers greater than that which they experience "for the stock commodity of like nature."

Added attention to higher quality, a superior process of manufacturing a patent monopoly, excellence of finish, improved packaging, and identification are factors which may aid in giving a product an advantage over the majority of competitors. Unlimited guarantees, free installations, service-at-cost, more frequent deliveries and longer credit terms are also methods of "trading-up" the product line.

Market-plus price level

The market-plus price policy is based upon the theory that it is possible to break away from the acceptance of the market price as a fixed condition, by differentiating and individualizing the product. The improvements introduced, although minor in nature, may justify an increased subjective valuation by the consumer and result in considerable demand on a higher price level than the price level that prevails for stock commodities of like kind. Under this marketing policy, price is of practically no concern to the consumer. He demands exclusive goods and is willing to pay a high rate for them.

Dangers in use of market-plus policy

The business enterprise that uses the market-plus level must usually be satisfied with a limited volume of business with a large margin of gross profit on each sale. Care must be exercised not to push the selling prices too far above the prevailing market prices, or the cost of selling may be increased and a large part of the quality market may be cut off automatically. The volume of sales and the cost of special service must be watched continually to guard against increases in total costs that will wipe out net profits.

Factors that influence price-level selection

The special factors that will influence any decision on the price-level are:

• The type of product
• The type of market
• The average size of unit sale
• The character of competition
• Trade advantages

Convenience goods, comprised of a large variety of staples, of course, are sold usually at a low margin of profit. Turnover of stock and volume of sales are relied upon to secure adequate net profits. Consequently, convenience goods tend to be sold at or slightly below the prevailing market prices.

Shopping goods, on the other hand, may at times be sold above the market because of some individual feature. In general, however, they tend to be sold at somewhat below the market. Specialty goods, because of their very nature, should usually be sold above the prevailing market price for staple commodities.

Setting of definite selling prices

The federal Robinson-Patman Act was designed to prevent unwarranted price discriminations among buyers in the same trade groups or quantity-buying classes. The discriminations prohibited cover unfair concessions in prices, discounts, rebates, advertising allowances, or special services. Such favours in the past had fostered cut-throat competition and had tended to permit certain companies to build up monopolies by wiping out competitors who were unable to grant similar concessions and thus remain in business.

Under the regulations now imposed, definite selling prices must be set by vendors for each group or class of buyers. Within these classes no differentials may be made directly in prices, or indirectly through special cash or quantity discounts, trade allowances, advertising appropriations, rebates, or special concessions or services, unless such advantages are granted equally to all buyers within the respective classes.

Vendors whose costs of manufacture, sale, or delivery are reduced because of the differing methods or quantities under which they sell to different customers, are allowed to lower their prices correspondingly to such customers on an equal basis. The Federal Trade Commission may set quantity limits where only a few purchasers buy in very large quantities and the vendor's prices to them are unjustly discriminatory or promotive of monopoly.

Prices on distress merchandise—perishable, obsolete, sold under court order, or sold by a closing business—may be reduced as conditions warrant, however. A vendor may meet a competitor's price, or furnish services and facilities supplied by such competitor, if these concessions are made in good faith. The recipient of unjustly discriminatory prices, concessions, or services is as guilty under the Act as is the grantor.

Price policies in a rising market

During a period of rising prices, the selling house must decide how rapidly it will advance its prices in relation to its general market-level policy. Obviously, the wholesalers and retailers will profit by rapid price advances, for they will be able to make extra profits on the stock that they have on hand. But the house must weigh its own increasing costs and general market-level policy against the probable effect on ultimate-consumer sales.

Often, because of sharp increases in manufacturing costs, it may be necessary to advance , prices on very short notice, or without any notice, to avoid accepting large orders at existing prices.

Price policies in a falling market

In a period of declining prices some manufacturers adopt the policy of guaranteeing their distributors against losses caused by such declines. They assume that the distributor has practically no control over a drop in basic prices and that if he is overstocked during the period of a declining market he may be placed at the mercy of his competitors. Accordingly, the manufacturer may decide to assume the risk of price declines for a certain length of time.

The exact terms of the guarantee, of course, will differ. Some guarantees apply to orders taken for future delivery and cover any decline in prices up to the date of shipment. Others may cover any decline up to the date on which the distributor receives the goods. Still others extend the period of coverage beyond the date of shipment and receipt, to the time of sale of the goods by the distributors.

Advantages of the guarantee against price decline

The principal arguments in favour of a guarantee against price decline are listed by Edmund Brown, marketing consultant, as follows:

• It enables the distributor to order in advance of requirements and thus to carry adequate stocks.
• Distributors operate on such small margins that they cannot be expected to run the risk of losses due to conditions beyond their control.
• It induces the distributors to pass along price reductions, whereas they would otherwise attempt to hold up prices.
• It enables the factory to operate on an economical production schedule and to maintain an even rate of shipments.

Unquestionably, the guarantee against price decline is an inducement to distributors to stock up for longer periods. In this sense, the guarantee insures an adequate flow of goods to the retailer, who is dependent upon the jobber for quick deliveries. An inquiry of the Federal Trade Commission among the members of the National Wholesale Druggists' Association brought out the opinion that 70 per cent of the goods handled by wholesale druggists carried a profit margin too small to permit the assumption of possible losses by market declines.

There is little question that the guarantee against price decline made by the manufacturer provides an incentive to the distributor to keep goods moving. When declines occur, the jobbers' salesmen, as a means of making sales, immediately notify their retail clientele of the decline. Finally, the effect of such a guarantee, particularly in seasonal industries, is to let the manufacturer know, well in advance, the quantities and qualities which he must produce. This knowledge enables him to operate his plant more regularly and more economically than he could by manufacturing only for stock, or by attempting a highly seasonal production.

Dangers of guarantee against price decline

There are, of course, many economic arguments against the use of this policy of a guarantee against price decline. Edmund Brown lists them as follows :

• It tends to induce artificial prices and encourages the making of large profits
• It is essentially a form of rebate
• It gives the large operator an unwarranted advantage over the small concern
• It favours the less progressive distributor
• It causes the jobber to speculate and does not reduce prices to the consumer

In the first place, a manufacturer's guarantee against price decline which extends beyond the date of shipment encourages the distributors to buy abnormally and tends to create artificial prices rather than sound prices based upon normal consumption. The guarantee constitutes a form of rebate, especially when it is applied to goods that are in the distributor's hands. Also, it is often pointed out that only the manufacturer with plenty of capital can afford to offer such a guarantee.

Moreover, only the large jobber can insist on the guarantee. Under a guarantee that goes beyond the date of receipt of goods, the unprogressive distributor receives an adjustment on goods that he may not have sold because of his lack of enterprise. Finally, a guarantee against decline encourages the distributor to buy in large quantities in pure speculation against an advance in prices.

The problem of price maintenance

Until recent years every manufacturer who reached the consumer through middlemen had to decide whether he would or would not adopt a policy of price maintenance. The adoption of the policy implied an attempt to control the price at which middlemen might sell the manufacturer's goods. The manufacturer tried either to fix definite resale prices or to establish maximum and minimum price limits for his distributors.

Until 1908 price maintenance was an established policy of many manufacturers. Then the courts began to take cognisance of price maintenance practices and during the years immediately following 1908, a long series of court decisions set up a general trend of judicial opposition to the attempts of manufacturers to dictate the resale prices of their distributors. After 1908, and until the advent of the Fair-Trade Acts, most manufacturers abandoned attempts to control distributor's prices because of legal difficulties.

Supporters of price maintenance

For a long time there was considerable discussion and agitation in favour of a federal law that would definitely legalize certain methods of maintaining resale prices.

The manufacturer who made his product uniform in character and appearance, identified it by brand name and trademark, and advertised its uniform and standard qualities to a widespread market, wished to be able to assure the market that his product could be obtained at a uniform price. However, other manufacturers were indifferent to the whole problem, particularly in cases where the prices of their products were of little importance in the act of purchase, where the prices varied considerably and could be fixed for any length of time, where the costs of transportation necessitated different prices in different sections of the market, and where it was desirable to stress quality as opposed to price.

Purpose of price maintenance

The main purpose of a policy of resale price maintenance is to prevent retail price-cutting on standard brands of nationally distributed merchandise. The manufacturer of this type of commodity objects to the price-cutting indulged in by dealers who take advantage of the consumer demand for well-known, advertised goods and offer them at cut prices leaving no profit, in order to attract trade to their stores. The public is likely to believe that other dealers who insist upon their legitimate profits are charging too high a price.

Price-cutting by one dealer may lead to retaliatory cutting by others. A price war may result that leaves no profit in the line to any dealer. When the price-cutting pushes the price down below a profit-yielding point, the dealers who handle the product may throw it out of their stocks entirely or they may push competing goods, selling the unprofitable line only when consumers insist upon having it.

Price maintenance and restraint of trade

The judicial objection to price maintenance arose from a belief that the practice of controlling resale prices was contrary to the laws that forbid restraint of trade. The phrase "restraint of trade" is used to include everything that tends to prevent full and free competition among manufacturers and among dealers. Two of the things that are considered most subversive of full and free competition are conspiracy prices and the development of monopolies.

A conspiracy price is a price fixed for a class of commodities by manufacturers or dealers conspiring together so that consumers will no longer get the benefit of price competition. The opponents of price maintenance contended that resale prices fixed by a manufacturer were no different from conspiracy prices, and were equally against public policy.

Price maintenance and conspiracy prices

Conspiracy among dealers must be prohibited, because if it is permitted in one case it must be permitted for all. If dealers are permitted to conspire to fix prices, competing manufacturers must be allowed the same privilege. This privilege would provide a legalized opportunity for the restriction of all price competition and for the development of complete monopoly through voluntary combinations in all fields.

The law prohibits conspiracy prices, because of the possible results of such prices. But no such results can come from price maintenance. It has nothing in it that encourages monopoly. The price fixing is done not by the cooperation of competing units but by a single manufacturer, who, operating in a competitive field, must fix a price that will sell his goods in competition with many other similar articles.

Price maintenance does, of course, restrain price competition among distributors so far as the goods of the price-fixing manufacturer are concerned. It is wrong to assume, however, that unrestricted price competition is always of benefit to the public. Some of the earlier so-called "trusts" were built up largely by driving small competitors from business by means of a policy of selling below cost in one town and making up this loss by higher prices in other communities. The absolute independence of each dealer is a fiction. Unrestricted price competition has proved a failure in encouraging competition.

Price maintenance and monopoly

It should be remembered always that price maintenance does not eliminate all price competition. It does away with only a very small part of such competition, because comparatively few manufacturers ever have had, or are very likely to have, any interest in controlling their resale prices. So long as the law keeps those manufacturers from conspiring to maintain a uniform price on competing goods, there can be no danger to the consumer.

If all manufacturers of flour were to form a combination for the purpose of fixing a uniform price upon flour, such a combination would be a real monopoly, dangerous in principle and practice. People would have to pay the uniform price or go without flour. The difference between this situation and the situation under price maintenance is fundamental. Under price maintenance, there is no combination among manufacturers. They are still kept apart by law.

One flour manufacturer fixes the resale price on his product alone. The remaining millers may similarly fix their resale prices if they wish, but there is nothing arbitrary or monopolistic about the prices. They must be governed absolutely by the laws of competition. The consumer need not pay one manufacturer's price or go without flour. He has a choice among the products of many manufacturers, all seeking his trade and all in real competition with one another.

Consignment selling

There is a limited number of manufacturers who consign goods to dealers, and under such an arrangement, still retain title to the goods. Consequently they can designate the prices at which they shall be sold, because they retain ownership of the goods.

The manufacturer is really selling directly to the consumer because the distributors or dealers are merely the commissioned agents of the manufacturer and cannot determine the terms of sale to the ultimate consumer. However, this method of selling is costly. The manufacturer is obliged to assume the risk of physical deterioration, style changes, and price declines on the merchandise until he disposes of it through his agents to the ultimate consumer.

The right to refuse to sell

In the absence of monopoly, such as exists in the case of a public utility or a transportation company, the manufacturer has the right to select his own customers. He can refuse to sell to anyone for any reason, or for no reason. After he sells merchandise to a dealer, however, he cannot control the price at which the dealer will resell it, unless he adopts a price-maintenance plan.

If the dealer is causing an injury to his business through price-cutting, of course, he can refuse to sell to the dealer. But the seller is limited to some extent in finding out which distributors are cutting prices. He must not use any "cooperative" method of discovery. He can secure information through his own salesmen, or he can receive information voluntarily given to him by customers. But beyond this, he must not go in finding out which dealers are cutting prices, except in cases where he has announced a price-maintenance plan.

Indefiniteness of present law

The interpretation of the law shifts with successive court decisions. Of late, it appears that judicial opinion is somewhat more liberal in its attitude toward manufacturers and sellers who have a legitimate interest in resale prices. But we are still a long way from knowing in advance of a decision what factors will be held by the court as indicating "a purpose to create and maintain a monopoly," and what technique of discovering which dealers are cutting prices constitutes a "cooperative" method of discovery.

Legislative attempts have been made in recent years to eliminate unfair trade practices, and the industrial codes of 1933 to 1935 regulating business are indicative of the social trends in marketing policies. When the codes came to a Supreme Court test of constitutionality, however, they were found to be invalid. Nevertheless, many trades and trade associations have continued voluntarily in their efforts to conduct their businesses by fair trade practices.

Other legislation of a similar nature are the various state laws protecting trade-marks. These laws prohibit intrastate price-cutting by prohibiting a retailer from selling a trade-marked product below the retail price stipulated by the manufacturer.

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