What’s it: Premium pricing is a pricing strategy in which a company offers high prices for its product quality. The keywords are of high price and quality.
The company charges a high price to differentiate its products from the competitors’ products. Most of them operate in the mass market. Hence, the company uses price as a signal about its product quality. For example, Apple uses a premium price to indicate that its product is of better quality than other smartphone products.
Why do companies use premium pricing
The pricing strategy correlates with the strategic position that the company craves to build. A strategic position tells you in what dimensions the company must compete and gain a competitive advantage.
To answer that, let us briefly review the concept of competitive advantage.
Porter divides competitive advantage into two sources:
- Cost leadership
Under differentiation, companies emphasize product uniqueness, which makes consumers willing to pay a premium price.
Meanwhile, cost leadership focuses on operating with a lower cost structure. Companies charge price around the industry average but while lowering costs. That way, the operation is more profitable.
Back to the concept of pricing.
When setting a premium price, the company adopts a differentiation strategy to achieve a competitive advantage. The company will make products as unique as possible through the quality or other product attributes.
Premium pricing has a high-profit margin. That is, of course, attractive to several companies.
Since companies charge high prices, they have to think about how to attract consumers. This is where the concept of added value comes into play.
Long story short, the company will add higher added value to the product, making some consumers desire it.
In the market, not all consumers are budget conscious. Some may be more concerned with quality and luxury than price.
For such reasons, companies like Apple are introducing their premium brands. They try to reap the market’s profits, which no other mass product can satisfy.
How premium pricing works
Companies must decide how to position their products in the market. Positioning affects the pricing strategy chosen.
And, in general, the factors considered in pricing are:
- Number of consumers in the target market
- Consumer demographic & psychological characteristics
- Unique selling point
- Product image the company wants to build
- Promotion budget
Premium pricing is one of the alternatives. The company competes with several companies in the mass market. Still, it targets a more specific group of consumers (quality-conscious consumers).
Premium pricing acts as differentiation in the mass market. It usually gives the perception that the product or service has an exclusive image and superior quality.
Whether or not premium pricing is successful depends on:
First is the way companies shape customer perceptions.
Consumers may have imperfect information about products on the market. At this point, companies try to influence their perceptions through various promotions about the product.
When there is no alternative information, consumers may just agree with what the company has to say.
Say, you are busy at work and have little time to compare smartphone products. When you get a brochure about a product, maybe you will agree with what the manufacturer claims.
Relying on brochure information is impossible to take an objective assessment. Unless you are looking for alternative information by Googling. But, you don’t have time to do it.
For such reasons, not surprisingly, some companies are successful at charging high prices even if their product are not necessarily superior to others.
Apart from promotions, companies can use limited sales to impress exclusivity. You can see some people queuing up just to get a new edition of the iPhone.
Second, the success of premium pricing depends on the value added by the company.
What uniqueness the company stands out for. How does the company differentiate it from competitors? Is it through product features, packaging, support services, or other product attributes?
The third key to success is the company’s marketing budget.
Premium pricing usually requires a larger marketing budget. It was mainly to attract attention and influence consumer perceptions.
Low priced products may not require enormous promotional costs because the price reflects quality itself. You don’t expect to get high quality from a cheap price product.
Conversely, when setting prices high, consumers may hesitate. Is the price really worth the quality? They don’t necessarily associate high prices with high quality.
Consumers have never tried it out before. They also may not be able to buy two products at once (low priced and high priced) and compare their quality. The budget limits them to compare both.
At this point, the company needs a large promotional budget. It must build the perception that their product is superior. It requires intensive, targeted, and long enough promotion.
The fourth success factor is the protection of intellectual property rights.
Patents, for example, ensure that competitors cannot copy the uniqueness of a product.
Take Apple and Samsung, for example. The two have been involved in a series of lawsuits over smartphone patents over the past decade. And, finally, Samsung had to pay US$539 million for violating Apple’s patents.
Advantages and disadvantages of premium pricing
As with other pricing, this strategy has some advantages and disadvantages.
Among the advantages of premium pricing are:
First is the profit margin is thicker. Companies charge high prices because they add more value to the product. Due to high margins, companies may not rely on large sales volumes to cover operating costs and turn a profit.
Second, the premium price becomes an entry barrier. Usually, consumers tend to be loyal. They find the product satisfies their needs and wants. Strong loyalty ultimately results in high switching costs.
Competitors need massive investments to be competitive. They may find it difficult to offer similar products at the same price point because they have to effectively build consumer perceptions.
Next, some of the downsides to the premium pricing strategy are:
First, this strategy requires a more considerable investment. It is not only for building perceptions but also maintaining it over time. That way, customers remain loyal to the company’s products.
Second, the company must maintain the relevance and consistency of its unique selling points. Companies must ensure that their offerings remain relevant to market needs.
It is a difficult task. Consumer tastes and competitive maps are dynamic.
Their quality may no longer be attractive to customers because competitors offer better ones.
Third, strategies are vulnerable to a boomerang effect. Failure or damage of a few products can damage the company’s overall product image.
In some cases, the product’s quality is not better. It’s just that the company invests a lot in marketing, which builds a high-quality image of the product.
Once consumers find out, they won’t rebuy it.
Fourth, sales growth may be more moderate. The company sells limited products to give the impression of exclusivity. Like some luxury items, the rarer they are, the more valuable they are.
As a result, the company had a hard time catching up with aggressive sales growth.
Fifth, the economies of scale may be lower. If the company limits sales volume, it is difficult to achieve better economies of scale. As a result, the cost per unit is likely to be higher.