Traditionally pricing decisions are made after careful costing of the product and determination of the level of profit or consumer surplus the firm may be able to realize. This approach is appropriate under the classical economic conditions of a free market characterized by many more or less equally competent suppliers, none of which is able to dominate the market. In such a setting the price will be set equal to the average cost of producing each unit, which is the sum of fixed costs, variable costs, overhead, and profit. (See: Two Ways of Setting Prices : Full Costing versus Incremental Costing)
In international business, pricing is not simply an exercise in costing out a product. Rather, pricing is an exceedingly important element of the marketing mix, to the extent that the firm uses prices as a competitive weapon. Usually one large producer has a competitive advantage, which allows it to become the so-called price setter. "Price takers" are the companies that exist under the "price umbrella" of the dominant competitor.
Because of the Significant competitive advantage it holds, the price-setting .firm has the opportunity to manipulate the umbrella, lowering it when it wishes to wipe out existing competitors and/ or discourage newcomers and raising it when it wants to let the marginal competitors survive. In the absence of competition, the price setter may adopt a price skimming strategy, setting the initial price for its product high enough that the firm can quickly recover most, if not all, product development and marketing sunk costs. IBM, as the largest mainframe computer manufacturer, has been accused of using a price skimming strategy.
As technology becomes familiar and competitors gain experience, the dominant firm begins to slide down the experience curve, gradually cutting manufacturing costs. If the product has become well known, it may be possible to considerably reduce marketing costs as well. With costs at a minimum, the firm is in a position to adopt a penetration or predatory pricing strategy.
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