Pricing Strategies Essay

Definition Pricing is a powerful element of a small business’s marketing strategy. The pricing structure of your products and services, and how it relates to your competitors’ pricing strategies and the expectations of consumers, play an important role in creating an image for your company and establishing a specific customer base. An analysis of pricing strategy reveals that companies have a range of options in their pricing toolkit they can use to augment their marketing initiatives. Pricing strategy refers to method companies use to price their products or services. Almost all companies, large or small, base the price of their products and services on production, labor and advertising expenses and then add on a certain percentage so they can make a profit. There are several different pricing strategies, such as penetration pricing, price skimming, discount pricing, product life cycle pricing and even competitive pricing. Different Types of Pricing Strategies Penetration Pricing A small company that uses penetration pricing typically sets a low price for its product or service in hopes of building market share, which is the percentage of sales a company has in the market versus total sales. The primary objective of penetration pricing is to garner lots of customers with low prices and then use various marketing strategies to retain them. For example, a small Internet software distributor may set a low price for its products and subsequently email customers with additional software product offers every month. A small company will work hard to serve these customers to build brand loyalty among them. Price Skimming Another type of pricing strategy is price skimming, in which a company sets its prices high to quickly recover expenditures for product production and advertising. The key objective of a price skimming strategy is to achieve a profit quickly. Companies often use price skimming when they lack financial resources to produce products in volume, according to the article â€Å"Pricing Strategy† at NetMBA.com. Instead, the company will use the quick spurts of cash to finance additional product production and advertising. Product Life Cycle Pricing All products have a life span, called product life cycle. A product gradually progresses through different stages in the cycle: introduction, growth, maturity and decline stages. During the growth stage, when sales are booming, a small company usually will keep prices higher. For example, if the company’s product is unique or of higher quality than competitive products, customers will likely pay the higher price. A company that prices its products high in the growth stage also may have a new technology that is in high demand. Competitive-Based Pricing There are times when a small company may have to lower its price to meet the prices of competitors. A competitive-based pricing strategy may be employed when there is little difference between products in an industry. For example, when people purchase paper plates or foam cups or a picnic, they often shop for the lowest price when there is minimal product differentiation. Consequently, a small paper company may need to price its products lower or lose potential sales. Temporary Discount Pricing Small companies also may use temporary discounts to increase sales. Temporary discount pricing strategies include coupons, cents-off sales, seasonal price reductions and even volume purchases. For example, a small clothing manufacturer may offer seasonal price reductions after the holidays to reduce product inventory. A volume discount may include a buy-two-get-one-free promotion. Cost-Plus pricing Cost-plus pricing is the simplest pricing method. The firm calculates the cost of producing the product and adds on a percentage (profit) to that price to give the selling price. This method although simple has two flaws; it takes no account of demand and there is no way of determining if potential customers will purchase the product at the calculated price. This appears in two forms, full cost pricing which takes into consideration both variable and fixed costs and adds a percentage as markup. The other is direct cost pricing which is variable costs plus a percentage as markup. The latter is only used in periods of high competition as this method usually leads to a loss in the long run. Limit pricing A limit price is the 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 firm’s 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 price of the product becomes the limit according to 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 its market share as a whole. Market-oriented pricing Setting a price based upon analysis and research compiled from the target market. This means that marketers will set prices depending on the results from the research. For instance if the competitors are pricing their products at a lower price, then it’s up to them to either price their goods at an above price or below, depending on what the company wants to achieve. 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. 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. Predatory pricing Predatory pricing, also known as aggressive pricing (also known as â€Å"undercutting†), intended to drive out competitors from a market. It is illegal in some countries. 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). 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 as $99, then it is called psychological pricing. In most of the consumers mind $99 is psychologically ‘less’ than $100. A minor distinction in pricing can make a big difference is sales. The company that succeeds in finding psychological price points can improve sales and maximize revenue Dynamic 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. 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 is shared by a small number of producers or sellers. Target pricing 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 used 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, and if the entire volume is not sold, a company might sustain an overall budgetary loss on the product. Absorption 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 and is a form of cost-plus pricing High-low pricing Method of pricing for an organization where the goods or 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 are designed to bring customers to the organization where the customer is offered the promotional product as well as the regular higher priced products. 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. 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. 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 is frequently used where the value to the customer is many times the cost of producing the item or service. For instance, the cost of producing a software CD is about the same independent of the software on it, but the prices vary with the perceived value the customers are expected 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 work around, or not doing an activity. In order to employ value-based pricing you have to know your customer’s business, his business costs, and his perceived alternatives. 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. Freemium Freemium is a business 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 â€Å"freemium† is a portmanteau combining the two aspects of the business model: â€Å"free† and â€Å"premium†. It has become a highly popular model, with notable success. Odd pricing In this type of pricing, the seller tends to fix a price whose last digits are odd numbers. 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. This pricing policy is common in economies using the free market policy. 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 the similar prices should be the most expensive ones, and one of the two should be less attractive then the other. This strategy will make people compare the options with similar prices, and as a result sales of the most attractive choice will increase. Conclusion Pricing strategies for products or services encompass three main ways to improve profits. These are that the business owner can cut costs or sell more, or find more profit with a better pricing strategy. When costs are already at their lowest and sales are hard to find, adopting a better pricing strategy is a key option to stay viable. Merely raising prices is not always the answer, especially in a poor economy. Many businesses have been lost because they priced themselves out of the marketplace. On the other hand, many business and sales staff leave â€Å"money on the table†. One strategy does not fit all, so adopting a pricing strategy is a learning curve when studying the needs and behaviors of customers and clients. Bibliography 1. The Strategy and Tactics of Pricing: A Guide to Growing More Profitably by Thomas Nagle 2. Power Pricing: How Managing Price Transforms the Bottom Line by Robert J. Dolan 3. http://sixrevisions.com/project-management/pricing-strategies-research/ 4. http://entrepreneurs.about.com/od/salesmarketing/a/pricingstrategy_2.htm