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In today’s competitive business landscape, every element of the marketing mix plays a crucial role in a company’s success. Price, one of the four Ps of marketing (Product, Price, Place, Promotion), holds immense power. Strategic pricing decisions can significantly impact the company’s bottom line, influencing brand perception, customer behavior, and, ultimately, profitability. This comprehensive guide delves into pricing strategies, empowering businesses to unlock profit potential.
Understanding price
Price represents the monetary value of a product. For companies, it’s what they get paid to sell products. Meanwhile, for consumers, it is the cost they have to pay to get the product.
The decision about price is strategic. If the price is lower than the perceived value, the consumer will be dissatisfied and likely will not buy again. Conversely, if it is higher than the perceived value, they will buy and are likely to buy again.
Setting prices considers several factors, including production costs, profit targets, competition, and consumer’s ability to pay.
Factors shaping pricing strategy
Several factors influence the price the company sets for its offerings. Understanding these factors will equip businesses to make informed pricing decisions:
- Production costs: The cost of raw materials, manufacturing, and labor directly affects the price a company needs to charge to ensure profitability.
- Profit targets: Companies strive to achieve specific profit goals. Pricing strategies should factor in desired profit margins to ensure financial sustainability.
- Competition: Market competitiveness plays a significant role. Businesses need to analyze competitor pricing to ensure their product remains attractive to consumers.
- Consumer’s ability to pay: Businesses consider their target audience’s purchasing power. Pricing too high might alienate potential customers, while pricing too low could undermine perceived value.
- Product quality: High-quality products often command premium prices. Consumers are willing to pay more for products they perceive to be well-made and reliable.
- Brand image: A strong brand image allows companies to charge higher prices due to the perceived value associated with the brand.
- Government regulations: Certain industries may be subject to government regulations that establish price ceilings or minimum prices.
Pricing strategies: a guide to profitability
Now that we understand the factors influencing price, let’s explore various pricing strategies commonly employed by businesses:
Pricing strategies can be categorized in several ways:
- Short-term vs. Long-term pricing: Short-term pricing strategies focus on immediate sales goals, while long-term strategies aim for sustainable profitability.
- Cost-based vs. Market-based vs. Competition-based pricing: Cost-based pricing uses production costs as the primary factor, market-based pricing considers market demand, and competition-based pricing focuses on competitor pricing.
Short-term pricing vs. Long-term pricing
A short-term pricing strategy is set to support sales in the short term. Companies adopt it, for example, to optimize sales during peak seasons. So, they don’t use it long-term because of the risk of loss.
Alternatively, the company relies on a short-term pricing strategy to speed up inventory turnover. Companies want to deplete inventory faster before costs increase due to stockpiling and obsolescence in warehouses.
Short-term pricing strategies include:
- Penetration pricing
- Promotional pricing
- Demand-driven pricing
- Predatory pricing
- Market skimming pricing
Meanwhile, long-term pricing will be valid for a long time. As a result, the company ensures prices cover costs and can, therefore, operate profitably.
Long-term pricing includes:
- Premium pricing
- Competitive-based pricing
- Value-based pricing
- Cost-plus pricing
Cost-based, market-based, and competition-based pricing strategies
Cost-based pricing uses production costs as the primary consideration when determining selling prices. The company assesses the cost and then adds the profit (markup) to it to determine the selling price. Examples are:
- Cost-plus pricing
- Marginal-cost pricing
This method is relatively easy. However, if operations are inefficient (high costs), prices may be too high, making the product less competitive.
Market-based pricing uses market demand factors and their characteristics – such as consumer psychology, seasonal trends, and consumers’ willingness to pay – to set prices. Examples are:
- Penetration pricing
- Market skimming pricing
- Discriminatory pricing
- Loss leader pricing
- Razor-and-blades pricing
- Psychological pricing
- Promotional pricing
Competition-based pricing uses competitors’ prices or the competitive level in the market as the primary consideration in setting selling prices. For example, a company researches the competitors’ prices and then sets prices based on these.
The selling price may be slightly lower, similar, or higher than the price charged by competitors. That, for instance, may depend on the competitive strategy adopted. For example, a company might charge a higher price under a differentiation strategy because it offers uniqueness. High prices are also important to build the impression the product is priceless.
Examples of competition-based pricing are:
- Price leadership
- Predatory pricing
- Going-rate pricing
A look at key pricing strategies
We’ve unpacked the factors influencing price and highlighted the importance of strategic pricing. Now, let’s get granular and explore the various pricing strategies businesses can employ.
Cost-plus pricing
Under cost-plus pricing, companies add a certain percentage (markup) to their cost per unit to ensure a product’s contribution to profits.
For example, it costs $5 to make one unit. However, the company wants to make a 20% profit so that it will sell the product at $5 ($5 + $5 * 20%).
Marginal-cost pricing
Marginal cost pricing sets a selling price equal to the additional cost of producing one more unit. In other words, the selling price equals the marginal cost.
Companies usually apply this strategy when sales are poor, such as during a recession. Prices are meager and can’t cover fixed costs. However, it may be a better option than no sales at all.
Price leadership
Under price leadership, companies set prices after waiting for signals from market leaders. In other words, the market leader sets the price first, and then other companies follow.
This strategy usually aims to avoid direct competition with market leaders. So, on the one hand, the company is reluctant to start a price war when it lowers prices. But, on the other hand, they are concerned about decreasing revenue if prices are increased. Thus, the solution is to check the pricing by market leaders and adjust the pricing accordingly.
Predatory pricing
Predatory pricing involves charging meager prices and selling at a loss for some time to reduce competition. Low prices force competitors out of the market and create a barrier to entry for potential entrants. Once the competition is reduced, predators increase selling prices to cover losses when adopting this strategy, which is also known as destroyer pricing.
Big players usually adopt this strategy. They can use this strategy because they can sustain losses longer than small players.
Going-rate pricing
Going-rate pricing sets prices at market prices. In other words, prices will be relatively similar between companies.
This approach is usually applied to homogeneous products, such as commodities, which have minimal variations in features and functions. Thus, consumers find it difficult to differentiate products between different companies.
For example, if market prices are unavailable, a company might set the price based on market leader pricing. Depending on the steps taken by the market leader, the company will increase or decrease the selling price.
Penetration pricing
Penetration pricing charges a low price to entice people to buy. Companies usually adopt this strategy when they enter a new market. Because they have yet to get a customer base, they must immediately be able to attract consumers to buy. And setting a low price is the way to go.
Established companies may only use this strategy as it involves high costs and risks. However, new companies may also adopt this by being willing to lose money in the short term.
Penetration pricing allows a company to quickly achieve a high sales volume and gain some market share. Low prices can also increase brand awareness.
However, there are risks. For example, profit margins are low, and consumers may perceive the product as low quality. In addition, consumer resistance arises when prices are increased in the future.
Market skimming pricing
Market skimming pricing involves setting a high price initially and then lowering it. It is usually adopted for new, innovative products where none existed before. The high price helps cover the costly development and consumer education costs.
This strategy works if quality or innovativeness justifies the high price. And consumers want products at such high prices.
High prices provide enough profit to cover costs. Moreover, it builds a valuable and unique product image.
However, the high price is likely to discourage consumers from buying. If they know prices will decrease in the future, consumers will be more likely to wait. In addition, high prices attract new entrants, increasing competition.
Discriminatory pricing
Discriminatory pricing involves setting different prices for the same product to different consumers. For example, airlines charge high prices during the holiday season and low prices during the regular season.
Prices may be based on each customer’s reservation price, which is the highest price they are willing to pay.
In other cases, price is based on how much consumers like the product, as indicated by how much they buy. As a result, the company may charge a slightly lower price for large purchases and a higher price for small purchases.
This strategy is used when:
- Companies control supply, making it almost impossible for customers to switch.
- There is no opportunity for resale, preventing those who bought it cheap from selling it to other buyers.
- The company knows each consumer’s ability to pay
Loss leader pricing
Loss leader pricing involves setting a low price for a product to encourage consumers to buy other, higher-margin products. The company expects profits on the high-margin product to compensate for the loss-leading product.
Retail stores usually use this strategy, where prices are low, to attract consumers to the store and hope they will buy other, more expensive products.
Razor-and-blades pricing
Razor-and-blades pricing is a bit like a loss leader; however, it applies to two complementary products: razors and blades. It is also known as captive product pricing or bait and hook pricing.
Companies take lower margins on main products and higher margins on complementary products. Apart from razors and razor blades, another example is printers with ink cartridges.
Psychological pricing
Psychological pricing sets prices to make a product psychologically attractive. For example, the company charges $2.99, which seems cheaper than $3.
A difference of $0.01 can affect consumer psychology, even if it is immaterial from a value standpoint. Finally, it can affect their decision to buy the product.
Promotional pricing
Promotional pricing offers discounts to attract more purchases. In addition to discounting, this strategy may also involve special offers, buy one get one free, or vouchers.
Companies usually adopt this strategy during peak seasons. Or, they provide a discount to help clear out old or obsolete stock.
Despite lower margins, the company has the potential to earn more revenue by increasing sales volume. In addition, increased inventory turnover also helps reduce costs related to warehousing.
Premium pricing
Premium pricing involves setting a deliberately high price, possibly higher than competitors. As a result, the company may not rely on large sales because the product has a high margin.
Companies charge a premium price for several reasons.
- Products are unique and not available in competitors’ offerings.
- A high price is to signal high quality.
- Companies try to build a perception of luxury or quality.
Geographical pricing
Geographical pricing involves different prices for different locations. Therefore, the company adjusts prices based on the buyer’s geographical location. Such adjustments reflect differences in shipping costs, local taxes, or willingness to pay.
This strategy has several variations, such as:
- Zone pricing: the location is divided into several zones, each with different additional costs.
- Free on Board origin pricing: the buying consumer pays variable shipping costs from the production facility or warehouse.
- Basing point pricing: The company defines certain cities as the starting point (base point) for calculating additional shipping costs.
- Uniform delivered pricing: All customers pay a uniform delivery fee regardless of distance from the delivery point. This is also known as single-zone pricing.
- Freight absorption pricing: the company absorbs all or part of the shipping cost to a particular area.
Everyday low-pricing strategy
Under the everyday low pricing strategy, the company maintains lower prices than competitors. Moreover, they offer it consistently throughout the season.
Walmart is a famous example. Companies promise their consumers the lowest prices on their stock. So consumers don’t have to wait for peak seasons, coupons, and sales events to buy and get a reasonable price.
