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Demand-based pricing is a pricing strategy based on how much the customer is willing to buy for a product or service. In short, companies charge prices based on perceived value as the central element.
Types of demand-based pricing
In demand-based pricing, the company assumes customers have different responses to the price of the product or service. They consider the value they feel before deciding to buy.
In addition to the perceived value of the customer, other factors that influence pricing are manufacturing costs, product quality, competition, market conditions, and market place.
Various forms of demand-based pricing are:
- Price skimming
- Price discrimination
- Penetration pricing
Price skimming
The company has an initial asset so high that only customers with more purchasing power can afford the product. After that, the company gradually reduced prices so that price-sensitive customers – who previously could not buy the product – can now buy.
Penetration pricing
In this strategy, the company sets a low initial price. The aim is to attract as many customers as possible and increase market share. The company might offer discounted prices to attract customers.
As the company’s market share and market power increase, the company can slowly raise prices. In other words, companies sacrifice short-term profits by selling at low prices (or even a loss) and trying to maximize long-term profits, especially when the competition is loose and the company’s market position is getting stronger.
Price discrimination
The company sets the price based on the amount the customer is willing to pay for a product or service. There are various forms of price discrimination: perfect price discrimination (first-degree discrimination), second-degree discrimination, and third-degree discrimination.
In perfect price discrimination, companies charge prices based on the maximum value each customer is willing to pay. That way, the company maximizes profits and converts every consumer surplus into a producer surplus. Although it offers maximum benefits, it is difficult to apply in the real world. It isn’t effortless to measure the maximum price that each individual is willing to pay. Also, the second difficulty is preventing product sales from customers who pay low prices to customers who pay high tariffs.
