Price is the value that is put to a product or service and is the result of a complex set of calculations, research and understanding, and risk-taking ability. A pricing strategy takes into account segments, ability to pay, market conditions, competitor actions, trade margins, and input costs, amongst others. It is targeted at the defined customers and against competitors. There are several pricing strategies:
Premium pricing: high price is used as a defining criterion. Such pricing strategies work in segments and industries where a strong competitive advantage exists for the company. Example: Porsche in cars and Gillette in blades.
Penetration pricing: price is set artificially low to gain market share quickly. This is done when a new product is being launched. It is understood that prices will be raised once the promotion period is over and market share objectives are achieved. Example: Mobile phone rates in India; housing loans, etc.
Economy pricing: no-frills price. Margins are wafer thin; overheads like marketing and advertising costs are very low. Targets the mass market and high market share. Example: Friendly wash detergents; Nirma; local tea producers.
Skimming strategy: high price is charged for a product till such time as competitors allow after which prices can be dropped. The idea is to recover maximum money before the product or segment attracts more competitors who will lower profits for all concerned. Example: the earliest prices for mobile phones, VCRs and other electronic items where a few players ruled attracted lower cost Asian players.
These are the four basic strategies, variations of which are used in the industry.
Pricing as part of the marketing mix
Pricing is one of the most vital and highly demanded components within the theory of marketing mix. It helps consumers to have an image of the standards the firm has to offer through their products, creating firms to have an exceptional reputation in the market. The firm’s decision on the price of the product and the pricing strategy impacts the consumer’s decision on whether or not to purchase the product.
When firms are deciding to consider applying any type of pricing strategy they must be aware of the following reasons in order to make an appropriate choice which will benefit their business. The competition within the market today is extremely high, for this reason, businesses must be attentive to their opponent’s actions in order to have a comparative advantage in the market.
The technology of internet usage has increased and developed dramatically therefore, price comparisons can be done by customers through online access. Consumers are very selective regarding the purchases they make due to their knowledge of the monetary value. Firms must be mindful of these factors and price their products accordingly.
Models of pricing
Method of pricing in which all costs are recovered. The price of the product includes the variable cost of each item plus a proportionate amount of the fixed costs.
- Contribution margin-based pricing
Contribution margin-based pricing maximizes the profit derived from an individual product, based on the difference between the product’s price and variable costs (the product’s contribution margin per unit), and on one’s assumptions regarding the relationship between the product’s price and the number of units that can be sold at that price. The product’s contribution to total firm profit (i.e. to operating income) is maximized when a price is chosen that maximizes the following: (contribution margin per unit) X (number of units sold).
In cost-plus pricing, a company first pricing determines its break-even price for the product. This is done by calculating all the costs involved in the production such as raw materials used in its transportation etc., marketing and distribution of the product. Then a markup is set for each unit, based on the profit the company needs to make, its sales objectives and the price it believes customers will pay. For example, if the company needs a 15 percent profit margin and the break-even price is $2.59, the price will be set at $3.05 ($2.59 / (1-15%)).
- Creaming or skimming
In most skimming, goods are higher priced so that fewer sales are needed to break even. Selling a product at a high price, sacrificing high sales to gain a high profit is, therefore “skimming” the market. Skimming is usually employed to reimburse the cost of investment of the original research into the product: commonly used in electronic markets when a new range, such as DVD players, are firstly sold at a high price. This strategy is often used to target “early adopters” of a product or service. Early adopters generally have a relatively lower price-sensitivity—this can be attributed to: their need for the product outweighing their need to economise; a greater understanding of the product’s value; or simply having a higher disposable income.
This strategy is employed only for a limited duration to recover most of the investment made to build the product. To gain further market share, a seller must use other pricing tactics such as economy or penetration. This method can have some setbacks as it could leave the product at a high price against the competition.
- Decoy pricing
Method of pricing where the seller offers at least three products, and where two of them have a similar or equal price. The two products with similar prices should be the most expensive ones, and one of the two should be less attractive than the other. This strategy will make people compare the options with similar prices, and as a result sales of the more attractive high-priced item will increase.
- Double ticketing
A form of deceptive pricing strategy that sells a product at the higher of two prices communicated to the consumer on, accompanying, or promoting the product.
Freemium is a revenue model that works by offering a product or service free of charge (typically digital offerings such as software, content, games, web services or other) while charging a premium for advanced features, functionality, or related products and services. The word “freemium” is a portmanteau combining the two aspects of the business model: “free” and “premium”. It has become a highly popular model, with notable successes.
- High-low pricing
Methods of services offered by the organization are regularly priced higher than competitors, but through promotions, advertisements, and or coupons, lower prices are offered on key items. The lower promotional prices designed to bring customers to the organization where the customer is offered the promotional product as well as the regular higher priced products.
- Keystone pricing
A retail pricing strategy where the retail price is set at double the wholesale price. For example, if the cost of a product for a retailer is £100, then the sale price would be £200. In a competitive industry, it is often not recommended to use Keystone Pricing as a pricing strategy due to its relatively high-profit margin and the fact that other variables need to be taken into account.
- Limit pricing
A limit price is a price set by a monopolist to discourage economic entry into a market and is illegal in many countries. The limit price is the price that the entrant would face upon entering as long as the incumbent firm did not decrease output.
- The limit price is often lower than the average cost of production or just low enough to make entering not profitable. The quantity produced by the incumbent firm to act as a deterrent to entry is usually larger than would be optimal for a monopolist, but might still produce higher economic profits than would be earned under perfect competition.
The problem with limit pricing as a strategy is that once the entrant has entered the market, the quantity used as a threat to deter entry is no longer the incumbent firms best response. This means that for limit pricing to be an effective deterrent to entry, the threat must in some way be made credible. A way to achieve this is for the incumbent firm to constrain itself to produce a certain quantity whether entry occurs or not. An example of this would be if the firm signed a union contract to employ a certain (high) level of labor for a long period of time. In this strategy, the price of the product becomes the limit according to the budget.
- Loss leader
A loss leader or leader is a product sold at a low price (i.e. at cost or below cost) to stimulate other profitable sales. This would help the companies to expand their market share as a whole. Loss leader strategy is commonly used by retailers in order to lead the customers into buying products with higher marked-up prices to produce an increase in profits rather than purchasing the leader product which is sold at a lower cost. When a “featured brand” is priced to be sold at a lower cost, retailers tend not to sell large quantities of the loss leader products and also they tend to purchase fewer quantities from the supplier as well to prevent loss for the firm. Supermarkets and restaurants are an excellent example of retail firms that apply the strategy of the loss leader.
- Marginal-cost pricing
In business, the practice of setting the price of a product to equal the extra cost of producing an extra unit of output. By this policy, a producer charges, for each product unit sold, only the addition to total cost resulting from materials and direct labor. Businesses often set prices close to marginal cost during periods of poor sales. If, for example, an item has a marginal cost of $1.00 and a normal selling price is $2.00, the firm selling the item might wish to lower the price to $1.10 if demand has waned. The business would choose this approach because the incremental profit of 10 cents from the transaction is better than no sale at all.
- Cost-plus pricing
Cost-plus pricing is a cost-based method for setting the prices of goods and services. Under this approach, the direct material cost, direct labor cost, and overhead costs for a product are added up and added to a markup percentage (to create a profit margin) in order to derive the price of the product.
- Odd pricing
In this type of pricing, the seller tends to fix a price whose last digits are just below a round number (also called just-below pricing). This is done so as to give the buyers/consumers no gap for bargaining as the prices seem to be less and yet in an actual sense are too high and takes advantage of human psychology. A good example of this can be noticed in most supermarkets where instead of pricing at £10, it would be written as £9.99.
- Pay what you want
Pay what you want is a pricing system where buyers pay any desired amount for a given commodity, sometimes including zero. In some cases, a minimum (floor) price may be set, and/or a suggested price may be indicated as guidance for the buyer. The buyer can also select an amount higher than the standard price for the commodity.
Giving buyers the freedom to pay what they want may seem to not make much sense for a seller, but in some situations, it can be very successful. While most uses of pay what you want have been at the margins of the economy, or for special promotions, there are emerging efforts to expand its utility to broader and more regular use.
- Penetration pricing
Penetration pricing includes setting the price low with the goals of attracting customers and gaining market share. The price will be raised later once this market share is gained.
A firm that uses a penetration pricing strategy prices a product or a service at a smaller amount than its usual, long-range market price in order to increase more rapid market recognition or to increase their existing market share. This strategy can sometimes discourage new competitors from entering a market position if they incorrectly observe the penetration price as a long-range price.
Companies do their pricing in diverse ways. Small companies, prices are often set by the boss. In large companies, pricing is handled by division and the product line managers. In industries where pricing is a key influence, pricing departments are set to support others in determining suitable prices.
Penetration pricing strategy is usually used by firms or businesses who are just entering the market. In marketing, it is a theoretical method that is used to lower the prices of the goods and services causing a high demand for them in the future. This strategy of penetration pricing is vital and highly recommended to be applied over multiple situations that the firm may face. Such as, when the production rate of the firm is lower when compared to other firms in the market and also sometimes when firms face hardship into releasing their product in the market due to the extremely large rate of competition. In these situations, it is appropriate for a firm to use the penetration strategy to gain consumer attention.
- Predatory pricing
Predatory pricing, also known as aggressive pricing (also known as “undercutting”), intended to drive out competitors from a market. It is illegal in some countries.
Companies or firms that tend to get involved with the strategy of predatory pricing often have the goal to place restrictions or a barrier for other new businesses from entering the applicable market. It is an unethical act which contradicts antitrust law, attempting to establish within the market a monopoly by the imposing Company. Predatory pricing mainly occurs during price competitions in the market as it is an easy way to obfuscate the unethical and illegal activities. Using this strategy, in the short term consumers will benefit and be satisfied with lower cost products. In the long run, firms often will not benefit as this strategy will continue to be used by other businesses to undercut competitors margins, causing an increase in competition within the field and facilitating major losses. This strategy is dangerous as it could be destructive to a firm in terms of losses and even lead to complete business failure.
- Premium decoy pricing
Method of pricing where an organization artificially sets one product price high, in order to boost sales of a lower priced product.
- Premium pricing
Premium pricing is the practice of keeping the price of a product or service artificially high in order to encourage favorable perceptions among buyers, based solely on the price. The practice is intended to exploit the (not necessarily justifiable) tendency for buyers to assume that expensive items enjoy an exceptional reputation, are more reliable or desirable, or represent exceptional quality and distinction. Moreover, a premium price may portray the meaning of better quality in the eyes of the consumer.
Consumers are willing to pay more for trends, which is a key motive for premium pricing, and are not afraid of how much a product or service costs. The novelty of consumers wanting to have the latest trends is a challenge for marketers as they are having to entertain their consumers.
The aspiration of consumers and the feeling of treating themselves is the key factor in purchasing a good or service. Consumers are looking for a constant change as they are constantly evolving and moving.
Examples of premium pricing:
These are important drivers and examples of premium pricing, which help guide and distinguish how a product or service is marketed and priced within today’s market.
- Price discrimination
Price discrimination is the practice of setting a different price for the same product in different segments to the market. For example, this can be for different classes, such as ages, or for different opening times.
Price discrimination may improve consumer surplus. When a firm price discriminates, it will sell up to the point where marginal cost meets the demand curve. There are 3 conditions need for a business to undertake price discrimination, these include:
Accurately segment the market
Have market power
There are three different types of price discrimination which revolve around the same strategy and same goal – maximize profit by segmenting the market, and extracting additional consumer surplus.
- First-degree price discrimination
The business charges every consumer exactly how much they are willing to pay for the product.
- Second-degree price discrimination
The business uses volume discounts which allow buyers to purchase a higher inventory at a reduced price. While this benefits the high-inventory buyer, it obviously hurts the low-inventory buyer who is forced to pay a higher price. This buyer may then be less competitive in the downstream market.
- Third-degree price discrimination
This occurs when firms segment the market into high demand and low demand groups.
Firms need to ensure they are aware of several factors of their business before proceeding with the strategy of price discrimination. Firms must have control over the changes they make regarding the price of their product. By which they can gain profitability depending on the number of sales made. The price can be increased or decreased at any point depending on the fluctuation of the rate of buyers and consumers. Price discrimination strategy is not feasible for all firms. As there are many consequences that the firms may face due to the action. For example: if a firm sells a product to its customer for a cheaper price. And that customer resells the product demanding a higher price from another buyer. Then the chances of the firm failing to make a higher profit are predicted. Because they could have sold their product at a higher rate than the re-seller and made a further profit.
- Price leadership
An observation made of oligopolistic business behavior in which one company, usually the dominant competitor among several, leads the way in determining prices, the others soon following. The context is a state of limited competition, in which a market shares by a small number of producers or sellers.
- Psychological pricing
Pricing designed to have a positive psychological impact. For example, selling a product at $3.95 or $3.99, rather than $4.00. There are certain price points where people are willing to buy a product. If the price of a product is $100 and the company prices it at $99, then it is called psychological pricing. In most consumers minds, $99 is psychologically ‘less’ than $100. A minor distinction in pricing can make a big difference in sales. The company that succeeds in finding psychological price points can improve sales and maximize revenue.
- Sliding scale
The economic concept of sliding scale at its most basic: people pay as they are able to for services, events, and items. Those with access to more resources pay more and thus provide the cushion. For those with less access to pay less, creating a sustainable economic underpinning for said services, events and items.
- Target pricing business
Pricing method whereby the selling price of a product is calculated to produce a particular rate of return on investment for a specific volume of production. The target pricing method is to use most often by public utilities. Like electric and gas companies, and companies whose capital investment is high, like automobile manufacturers. Target pricing is not useful for companies whose capital investment is low because, according to this formula, the selling price will be understated. Also, the target pricing method is not keyed to the demand for the product. If the entire volume is not sold, a company might sustain an overall budgetary loss on the product.
- Time-based pricing
A flexible pricing mechanism made possible by advances in information technology and employed mostly by Internet-based companies. By responding to market fluctuations or large amounts of data gathered from customers. Ranging from where they live to what they buy to how much they have spent on past purchases. Dynamic pricing allows online companies to adjust the prices of identical goods to correspond to a customer’s willingness to pay. The airline industry is often cited as a dynamic pricing success story. In fact, it employs the technique so artfully that most of the passengers on any given airplane. Have paid different ticket prices for the same flight. As of 2018, several third-party tools have allowed merchants. To take advantage of time-based dynamic pricing including Price more, Sweet Pricing, BeyondPricing, etc.
- Time-sensitive pricing
Time-sensitive pricing is a cost-based method for setting prices for goods that have a short shelf life. Careful consideration has to be taken to the “Use By” and “Best Before” dates of the products. In relation to the “Mark Up” or “Return” of the products. That is to say, the shorter period of time should have a lower Markup/Return margin. Thus increasing the Turnover/sales of the product, and decreasing the Wastage/loss of products.
- Value-based pricing
Pricing a product based on the value the product has for the customer and not on its costs of production or any other factor. This pricing strategy frequently uses where the value to the customer is many times. To the cost of producing the item or service. For instance, the cost of producing a software CD. CD is about the same independent of the software on it. But the prices vary with the perceived value the customers expect to have. The perceived value will depend on the alternatives open to the customer. In business, these alternatives are using competitors software, using a manual workaround, or not doing an activity. In order to employ value-based pricing, one must know its customers’ business, one’s business costs, and one’s perceived alternatives. It is also known as perceived-value pricing.
Value-based pricing has many effects on the business and consumer of the product. Value-based pricing is a fundamental business activity and is the process of developing product strategies. To pricing them properly to establish the product within the market. This is a key concept for a relatively new product within the market. Because, without the correct price, there would be no sale. Having an overly high price for an average product would have negative effects on the business. As the consumer would not buy the product. Having a low price on a luxury product would also have a negative impact on the business. As in the long run, the business would not be profitable. This can be seen as a positive for the consumer. They are not needing to pay extreme prices for the luxury product.
There has been an evident change in the marketing area within a business from cost-plus pricing to the value.
- Variable pricing strategies
Variable pricing strategy sums up the total cost of the variable characteristics associated with the production of the product. Examples of variable characteristics are interest rates, location, date, and region of production. The sum total of the following characteristics is to add within the original price of the product during marketing. Variable pricing enables product prices to have a balance “between sales volume and income per unit sold”. The variable pricing strategy has the advantage of ensuring the sum total of the cost businesses. That would face in order to develop a new product. However, variable pricing strategy excludes the cost of fixed pricing. Fixed pricing includes the price of dedication received from manufactures. In the production of developing the product and other involvement of factors.
- Yield management strategies
Yield management is a strategy which aims to monitor consumer behavior to gain and achieve maximum profit through selling goods and services that are perishable. The theory behind this strategy is to focus on the following aspects. Those are buying behavior patterns of consumers, external environmental factors and market price to successfully gain the most profit. This strategy of yield management normally applies to the firms associated with the airlines’ industry. For example: A customer may purchase an airline ticket in the day time for $600. Another customer may purchase the same airline ticket on the same day in the evening for $800. Reason being that during the day time the airline contained many seats that were spare. Their intention is to sell seats. Thus, the price decrease in order to attract. To manipulate the customers into buying an airline ticket with great deals or offers. However, only in the evening time, most seats will fill. And the firm decided to increase the price of the airline ticket for desperate customers. Who needed to purchase the spare seats that were available. This type of strategy is a vigilant way of connecting with the target consumers as well as flourishing the business.
- Other pricing approaches
Other pricing strategies include congestion pricing.
Nine laws of price sensitivity and consumer psychology
In their book, The Strategy and Tactics of Pricing, Thomas Nagle and Reed Holden outline nine “laws” or factors that influence how a consumer perceives a given price and how price-sensitive they are likely to be with respect to different purchase decisions. They are:
- Reference Price Effect – buyer’s price sensitivity for a given product increases the higher the product’s price relative to perceived alternatives. Perceived alternatives can vary by buyer segment, by occasion, and other factors.
- Difficult Comparison Effect – buyers are less sensitive to the price of a known or more reputable product when they have difficulty comparing it to potential alternatives.
- Switching Costs Effect – the higher the product-specific investment a buyer must make to switch suppliers, the less price sensitive that buyer is when choosing between alternatives.
- Price-Quality Effect – buyers are less sensitive to price the more that higher prices signal higher quality. Products for which this effect is particularly relevant. Products to include image products, exclusive products, and products with minimal cues for quality.
- Expenditure Effect – buyers are more price-sensitive when the expense accounts for a large percentage of buyers’ available income or budget.
- End-Benefit Effect – the effect refers to the relationship a given purchase has to a larger overall benefit and is divided into two parts: Derived demand: The more sensitive buyers are to the price of the end benefit, the more sensitive they will be to the prices of those products that contribute to that benefit. Price proportion cost: The price proportion cost refers to the percent of the total cost of the end benefit. That accounted for by a given component that helps to produce the end benefit (e.g., think CPU and PCs). The smaller the given components share of the total cost of the end benefit. The less sensitive buyers will be to the components’ price.
- Shared-cost Effect – the smaller the portion of the purchase price buyers must pay for themselves, the less price sensitive they will be.
- Fairness Effect – buyers are more sensitive to the price of a product when the price is outside the range they perceive as “fair” or “reasonable” given the purchase context.
- The Framing Effect – buyers are more price sensitive when they perceive the price as a loss rather than a foregone gain, and they have greater price sensitivity when the price is paid separately rather than as part of a bundle.