What is Pricing Strategies? They are the process through which a business determines the prices of their goods and services. A good pricing strategy works to optimize sales and profits. It’s going to be based on the cost of producing the good/service, the labor associated with it, advertising costs, competitor activities, and a few other market conditions. Pricing strategies will vary industry-wise. To correctly select a feasible pricing strategy, the firm needs to have a clear understanding of the market, customers, and products. Although important, this tactic is often underappreciated in the world of business.
The price will decide how the customer differentiates one product from the rest. All companies wish to set the optimum price that can help them skyrocket their sales, leaving the competition behind. Your pricing strategies lay the foundation for profitability in the future. It’s the tangible variable that lets customers know whether the product or service is worth their cash and interest. Sure, we could go ahead and just state the price for what it is – cash, but it’s so much more than that. A price tag reflects the brand, showing the value proposition in exchange for money.
Pricing Products: Pricing Strategies
A price is a value placed on a product or service. It’s the aftermath of a dense web of research, calculations, and analyzing the ability to take risks. A pricing strategy considers market segments, the customers’ ability to pay, internal and external market conditions, trade margins, competitor actions, and production costs amongst many. It’s a crafter to target the defined customers while differentiating the brand from its competition. In simplest terms, companies need to alter their basic pricing tactics to align with the customers and market.
There are seven pricing strategies, all of which we’ll be diving deeper into in the following segments:
Discount and Allowance Pricing
A discount is a direct reduction in prices upon purchase within a specific time. We can consider allowances as a type of discount, but it’s better termed as another form of reduction of money. Here, the manufacturers pay retailers a sum of promotional money in exchange for the retailers featuring the manufacturer’s product in any way. Most companies offer such discounts and allowances to customers to incite a certain response. That may be paying the bills early, bulk purchases, and off-season purchases. There are a few sections of discount and allowance pricing strategies that will be discussed here.
Type of Discount
- Cash discount: This discount is used to encourage the buyer to pay the bill in advance. For example, SONY TV sells 100 TVs to a brand new five-star hotel and tell them that if they make the payment within 30 days, they’ll be given a 3% discount. This policy helps improve cash flow.
- Quantity discount: This is the discount that’s provided when a buyer purchases goods in bulk. For example, if the five-star hotel bought 100 TVs, they’d have to pay $800 each. However, if the ordered amount crossed 100, they’d get to pay 2% less than the original price as this encourages purchase.
- Functional discount: A functional or trade discount is a price reduction from the seller to members of the trade channel who take part in specific functions such as storing, selling, and recording. For example, a large electronic store is showcasing SONY TVs, so the manufacturers give the retailers a 2% discount for housing their goods.
- Seasonal discount: A seasonal discount is given to a buyer when they purchase the product out of season. For example, a jacket manufacturer will sell their padded jackets to a retailer at a considerably lower price if the retailer buys those in summer. This technique also allows them to keep production steady throughout the year.
Types of Allowance
- Trade-in allowance: The allowance (reduction of price) offered when an old item is traded for a new item. We’ve all seen those offers on television where brands urge you to bring in your old products for an upgrade at a discount—like, trading your iPhone 4 for an iPhone X plus discount.
- Promotional allowance: Price reductions or payments provided to dealers for being a part of the advertisement and sales campaign is a promotional allowance. For example, a snack company gives a promotional allowance to a grocery store chain in exchange for them to place the snacks in a special display in the center aisle.
A company fixes more than one price for the same product without facing notable differences in the cost of manufacturing or distributing the product; that’s segment pricing. The price isn’t exactly based on the cost but more on the opportunity at hand. For example, a business wants to capitalize on the pricing difference between two or more geographical locations that have the same demand for an item. This is where we can observe a segmented pricing structure. The segmented prices do need to be legal, and the segments need to be able to show the difference in degrees of demand.
Types of Segment Pricing
- Customer-segment pricing: Customer-segment pricing happens when different customers pay different prices for the same product/service. An amusement park charges $25 entry for adults and $10 per ticket for the kids. The price depends on the customers, and in this case, it depends on the age of said customers. This is one of the more commonly spotted pricing strategies, especially in places like movie theaters, amusement parks, train/bus/airplane tickets. Another example would be the price-sensitivity level between customers. For some, the price is definitely the biggest factor before they buy a product. On the other hand, the opposite category cares more about the value and less about the price.
- Product-form pricing: For product-form pricing, the same product has different prices, but this isn’t based on the manufacturing cost either. The price varies due to different variations. E.g., You walk into a wholesale garments market. You’re bound to find one basic t-shirt in every single store that just differs in colors. Although the price margin between all the shops is the same, all the sellers have priced the black tees much higher than the rest. Why’s that? If you asked them, they’d say that black t-shirts are the most popular sales, so the price for that one is more.
- Location-based pricing: The same product goes for different prices based on the locations where they’re offered – that’s location-based pricing. A rather common, yet frustrating experience would be buying snacks at the movies. A packet of instant popcorn could cost a few cents, and even if you bought popcorn anywhere outside, the price wouldn’t cross a dollar. However, try to buy a mini bucket of popcorn at the cinema, and suddenly it’s $2.30. So, the price of the same product changed due to the location. Another good example would be paying varying amounts for different seats inside the hall.
- Time-based pricing: The factor that decides the price in this one is – time. Since we were on the topic of movies, let’s compare the ticket prices in off-season versus season time. Going to the movies on holidays can be a hassle, not just because of the crowd, but also the annoying soaring prices. In addition to that, tickets for movies played after 7 pm cost much more than tickets for a matinee show. With this pricing strategy, the pricing system is quite fickle. It could change in a month, a week, a day, or even an hour!
Psychological pricing is related to the perceived value of any product or service in the mind of the customers. In this case, the price reflects the product – everything it has to offer. Let’s think about a customer who’s walking into the local grocery store to buy a skillet. They look into multiple brands and the difference in prices. Naturally, they’ll use their perceived value of the skillet as a bar when comparing prices. They’ll think that the higher the price, the better the quality. Apart from that, consumers care little about prices if they can judge the product by testing it or having past experiences of using it.
A clever addition to the list, promotional pricing is the strategy of temporarily reducing the prices of products and services to create an artificial buying excitement. Sometimes, this price cut can be quite extreme and drag the price even lower than the production mark. However, this “tricks” the consumers into thinking that they should buy more of the product during the discount period to “get it at a steal.” Supermarkets will sometimes intentionally price products less, maybe incur losses in hopes of getting consumer attention and them buying the other goods at regular markup prices.
Types of Promotional Pricing
- Special event pricing: Christmas sale! Thanksgiving Day sale! Easter sale! Sounds familiar, right? Special event pricing is the strategy of reducing the price tag during holidays, seasons, or a day advertised for sales. The value of this pricing strategy is truly two-fold. If advertised correctly, it’s an effortless way to attract a flock of customers who wish to avail of the limited time offers. Given the brand sells quality products, the customers may even become permanent ones, or they might end up buying a regularly priced item while hunting for the ones on sale. This can even work in clearing off old stock to bring in the new.
- Limited time pricing: “Buy our new product at a stunning discount for a limited period!” Limited time pricing is reducing the price of a product for a short time while advertising it as something that’s very desired and running out of stock extremely quickly. The underlying motive is to call for attention on the products up for the same price. This, in many ways, is similar to the first type, special event pricing, as both are implemented for a short period. E.g., Online grocery stores market a product like, “Get them before stock runs out! Only 113 pieces at a discounted price of $8!”
- Cash rebate: If we think about it, a cash rebate is much similar to a discount coupon. It’s an offer which gives the customers a cash discount if they buy a product. This strategy is implemented to incentivize the customers into purchasing the product. For example, Amazon sends you a gift card out of the blue saying that you can get 12% on a fireplace screen if you buy the product in three days. Maybe you didn’t even need the product they advertised, but the offer will be enough to grab your attention.
- Low-interest financing: Another strategy crafted to encourage purchase, the-low interest finance scheme drags people in by promising goods at a much lower price than they had expected. In particular, cell companies are offering lucrative EMI schemes with eye-catching interest rates to make people buy their products. Ever seen those advertisements on TV where they’re trying to get you to buy a car by saying there’s no need for a down payment, and neither will you be charged interest if you purchase with your credit/debit card? Exactly that. Customers love shaving off their finances, and this pricing strategy uses that philosophy at its core.
- Extended warranties: This isn’t exactly a discount or allowance like most of the ones till now on the list, but this has shown to bring great results. Brands and companies offer extended warranties on their products to establish a trustworthy image in the customer’s minds, and it works! Customers are brought in by the promise that if anything goes wrong with their product, the company will take full responsibility for fixing it. Customers are lured in by decreasing their perceived risk. Imagine getting a five-year warranty on a phone that you originally thought would last you about two.
- Free maintenance: Quite similar to the one mentioned before, free maintenance is one of the promises a brand makes to its consumers. They promise to offer free maintenance for the purchased goods. This comes in super handy for the products that are expected to live a long life, which is why they might fall victim to malfunction more frequently. It’s not surprising how some people just learn to live with their problematic products without fixing them because sometimes that can be incredibly expensive. So by providing free maintenance, the company reduces consumers’ assumed risk.
The next one of the pricing strategies is geographical pricing. In this strategy, the company has to make decisions regarding varying prices due to geographical locations. It’s common seeing some products being cheaper in some parts of the world while costing some extra pennies in other regions. The brands fix prices based on location, but there are some critical factors they need to consider. Increasing prices to make up for the higher shipping charges could end up costing them many potential and existing customers. If they didn’t change the prices, wouldn’t they face losses? So what should the company do? Change prices, or keep it the same despite the distance?
Type of Geographical Pricing
- FOB-origin pricing: For FOB-origin pricing, the goods are kept free on a carrier and shipped to the prospective locations. At that point, all responsibility is transferred to the customer who needs to pay the freight charges from the storehouse to their shipping address. For example, I ordered some electronics from some seller I found on the internet and paid them $1,000 to get it shipped to my location. Unfortunately, the shipping vehicle causes damage to my package, but I can’t take any legal actions against the seller as I received all ownership the moment the shipment leaves the place of origin.
- Uniform delivery pricing: The company charges the same amount for all customers, regardless of location. In other words, the price plus the same freight charges will apply to the customers. There’s no geographical price difference. E.g., I ordered a speaker from the USA and set my destination as Australia, and at the same time, my Chinese friend ordered the same speaker. Now, technically, we would expect the shipping charges would vary due to distance between the US and the two countries, but that won’t happen. If I have to pay $20 for shipping, my friend has to do the same.
- Zone pricing: Zone pricing is the exact opposite of uniform delivery pricing, i.e., prices will increase/decrease based on shipping distance. The company sets up multiple zones, considering the warehouse/factory as the center of the shipping options across the world. Aside from that, zone pricing can also mean setting prices that reflect the local market the brand is competing in. Using the old example, now my friend and I will have to pay two different freight charges. Since China is closer to the US than Australia, my friend will pay less. Zone pricing is very prominent in the resource industry, like gasoline, gold, and some others.
- Basing point pricing: This geographic pricing strategy dictates that companies will determine a charge for the product sold, plus the shipping (freight) charges that’s going to be calculated based on the buyer’s distance from the “base point” or starting. Customers located closer to that pay less than the ones staying further away. This can balance the price difference due to geographical differences. Basing point pricing is used by companies that have to transport products in bulk from one location to the other, and it’s more relevant if the company has more than one manufacturing points.
- Freight absorption pricing: To conduct business smoothly, the seller absorbs the entirety of the freight charges. Thus, there’s no scope for price differences. The seller may justify this by stating that the more sales, the less average cost per unit. That will perfectly compensate for the extra expenditure that’s shipping. This pricing strategy has been popularized for market penetration as well as to establish a presence in competitive and saturated markets. E.g. I can buy chocolate from the local stores made by local brands. However, when a French company offers to sell me chocolates at a similar price tag for no extra shipping, I will consider trying it out.
The process of adjusting prices continuously over some time to meet the requirements and desires of individual consumers is termed as dynamic pricing. If we take a look back at thousands of years of history, we’ll remember how prices used to be fixed through negotiation. In this way, prices were altered to a particular situation or customer. That’s how this concept came into being. Rather than fixing the price, it’s fixed on an everyday basis, or sometimes even hourly basis. Many factors are considered while doing so – demand for products, available inventory, costs, etc.
On that note, customers have gotten accustomed to negotiation on online auction sites like eBay or ShopGoodwill. Many retailers leave the strenuous task of scouring the internet for needed products to price intelligence software. So, if the prices aren’t competitive, they’ll lose the chance of being shown to the buyers. This tactic offers inside knowledge of market trends. Retailers can test with various options before fixating on the optimal price. Amazon’s dynamic pricing strategy helped it to increase sales by 27.2% from 2012 to 2013. They change their prices almost every ten minutes. Being open to testing out multiple price ranges is a prerequisite to surviving in the industry.
Amongst the mentioned pricing strategies, international pricing is undisputedly one of the harder concepts to grasp. Brands thrive on competition, and to be competitive in a new market that you don’t know much about; they’ll need to be flexible. The brand/company has to adjust the price to fit the ones of the local market. Since every market has some unique factors about it, a different pricing strategy will be best for each new market they penetrate. Some major factors that play a role in international pricing are currency, taxes, government regulations, cultural differences, customer preference.
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Price Strategies for New Products
As the product steadily moves through its life cycle, the pricing strategy for its changes. One step, in particular, is quite challenging, and perhaps the most crucial: The introductory stage. Pricing a new product can be tricky because the company isn’t completely sure how the customers will react to it. Companies presenting a new product or service face the question of setting a price point for the first time. If it’s a densely saturated market, the decision gets even tougher, as they need to draw a visible line between their products and their competition’s products.
Market Skimming Pricing
A market skimming pricing strategy is the company/brand charging the highest possible price for a brand new product, and then decreasing it over time. The decrease in price happens due to the fall in popularity, which is a normal thing for a product as it ages. Smartphones, video game consoles, and technological products, in general, are released into the market after implementing this strategy. As these become less relevant over time, it is feasible. This allows steady recovery of sunk costs alongside selling products at rates that surpass the innovation behind it.
Market Penetration Pricing
In contrast to skimming pricing, in penetration pricing strategy, the brand/company enters the market with strikingly low prices. Since there’s a huge reduction in prices going on, in the long run, penetration pricing isn’t sustainable. However, the core concept is to have it along for long enough to draw all eyes on the brand. This pricing strategy is apt for newer businesses wanting to break into established, competitive markets, and also the ones looking for customers. The company should hope they made an impression strong enough to bring the customers back to the store when original markup prices return.
Market Skimming and Market Penetration for Entering New Markets/Launching New Products
Out of the two, market penetration pricing is the more effective choice when it comes to entering new territories. When launching a new product, increasing the price helps to gather a sizable amount of revenue in a short time. Thus, this is supposedly effective for product launches. On the other hand, when entering a market that’s saturated to the tee, reducing prices does a great job in attracting attention. When combined, a company can enter into a pre-existing market first with market penetration, and then build a market presence with other strategies. They can effectively pull out the market skimming tactic during a product launch.
Market Skimming VS Market Penetration
The motive behind implementing penetration pricing is to attract a huge section of customers away from the competition. The concept is to incorporate a satisfactory mix of products with impactful low price ranges to get the customer’s attention. This is quite different from skimming’s idea. That pricing strategy is more appropriate for a niche market with very selective consumers. In skimming, the priority is selecting some initial customers, and the need to appeal to a broader market comes in relatively later. Penetration pricing can establish a safety barrier between the brand and the competitors from interrupting the market with even lower prices. In market skimming, any suitable competitor can undervalue your prices by stealing the early customers.
Product Mix Pricing Strategies
Many products are usually part of a wider product mix. With products like these, putting a price tag gets tricky, as their price needs to be complementary to the other product(s) as they have similar demand and costs but varying competition. Product mix pricing strategies handle these issues. Since the products are interrelated, the company seeks to set a range of prices to maximize profits on the entire mix instead of a single product. We’ll look into all five core product mix pricing strategies below.
Product line pricing
The segregation of services and goods into cost categories designed to form multiple perceived quality levels in the customers’ minds is termed as product line pricing. This is also called price lining. The purpose of this strategy is to maximize profits by placing newer products with top-notch individual features or the most number of features at the highest possible price point. At the same time, the base product (the one with the older features) will be put on sale, acting like a cheaper alternative. E.g., walking into a shoe store, there’s a huge selection available that’s been purposely price differentiated; price indicates more/fewer features.
Optional product pricing is the term related to a business selling their products for quite a low price than they normally would. They rely on the optional sales to make up for the “losses” incurred. In some cases, the products will be sold at rates lower than the manufacturing prices. The optional products that are hoped to level the differences are called “loss leaders.” This works best if the company is offering something that’s way out of the typical customer’s affordability range. The somewhat passive effect it has on people is that by selling the products cheaply, it may create a new-formed need between the consumers.
This pricing strategy brings two products to the table, with two separate pricings. One is the “core product,” and the other(s) are termed as “accessory products.” This strategy takes advantage of consumers needing to purchase both products as they’re complementary to/dependent on each other. Let’s talk about a printer and the ink. If you bought a printer, you would have to buy ink. Even if the ink is super expensive, you’d have to buy it to keep the printing function operational. Then again, if you simply had ink, you wouldn’t have anything to process the ink onto the papers.
The secondary product gained after any manufacturing process is called a “by-product.” In by-product pricing, you guessed it – the by-products are sold separately at a specific price to earn extra revenue without the additional setup. Usually, these by-products don’t have much value, so they’re disposed of, but in cases where there’s a value, companies capitalize on it. The best part of this strategy is that the manufacturer can hope to gain a competitive advantage by acquiring more sales. For example, after the meat is sold off for daily human consumption, the remains of the animal (intestines and fat) can be used to make animal food.
Product Bundle Pricing
A marketing strategy where multiple products are offered in a combined unit at a reduced price. All the products are on sale, and the total price of the bundle is less than the sum of the separate items included. Also termed as “package deal pricing,” this strategy is commonly used in fast-food chains, computer software services, cable TV connections, etc. For example, cable TV connections are constantly urging you to take their new plans that contain a selection of channels of various genres at a discount price. This is intended to make the bundle appear economical and lucrative as a whole.
A price change refers to the change in trading prices between different periods. In other words, the difference between a good’s closing price – on the present day of trading and the day before, a price change. It can also be the opening and closing prices for a day. For example, let’s say that a small-time bakery opens up the price of a dozen cupcakes at $10 one morning, and by the end of the day, the price falls to $8. So, the price change here is a negative $2, or 20%. Price changes can be calculated for different time periods.
A product’s price is the most accurate barometer of a company’s financial standing. The company definitely wishes for its product to do well, so it’s going to have to closely monitor the variations to be successful. Here are some reasons every brand/company should be sensitive about price changing.
- For starters, the product’s price and its demand is the earliest indicator of how the market participants feel about the product.
- The prices reflect the manufacturer’s perception of the company’s ability to grow and rake in profits. For example, if SONY TV suddenly increased the price of its products, we’d assume that as a growth opportunity for themselves in the future. If the prices suddenly fell, experts would deduce that SONY TV foresees a decline in their popularity, so they’re reducing prices to retain customers.
- Given that a company does well, it’s sure to receive positive media attention.
- Price changes play a key role in predicting prices. For any business to be successful, they need to keep observing the market for any potential rises or dips in demand.
Initiating Price Changes
All companies come across market situations where they need to initiate price changes. This means either one of the two things – they’re going to cut the prices, or they’re going to increase them. Initiating price changes can be crucial for the business’ survival in the industry and future growth chances. With price cuts, the company can start gradually lowering the prices than its rivals, or it can directly slash off prices in hopes of gaining market attention. Price increasing is a bit trickier as sloppy strategies can affect sales volume. The reasons for price increase could be – inflation, excessive demand, etc.
Responding to Price Changes
Any degree of price change is going to evoke reactions from a company’s distributors, suppliers, customers, competitors, as well as the government. The customers are more concerned about the reason behind the price change. They’ll make assumptions like: the item isn’t selling well; the item’s a hot commodity; the quality has gone down, and what else. The competitors will be most bothered if the sold products are homogenous, and there are well-informed buyers. They can interpret it as the company trying to steal the market, a trick to increase sales, or they’re doing so to force the whole industry to change prices.
Public Policy and Pricing Strategies
Sometimes, companies use specific pricing strategies to unfairly price a product or harm the competition. This tendency stems from an insatiable need for excess profits. These comprise two different types: pricing within channel levels and pricing across channel levels. To stop these pricing issues from repeating regularly, the government establishes public policies. These legal threats for businesses dictate strict laws against unfair pricing. This way, the companies have to abide by the federal rules and regulations and conduct business without overdoing it.
These laws prevent any company from putting whatever price tag they wish for on their products. Apart from the channel flows mentioned, companies almost implement dynamic pricing. These fix higher prices on products to compensate marketing costs, distribution costs, advertisement costs, and sometimes to simply generate more revenue. They enforced laws to ensure the rights of the customers, making sure they’re the most benefited. Although businesses don’t have the liberty to tamper with the prices, public policies do have a good side. Proper understanding and dedicated implementation of these can help create long, fulfilling relationships with customers.
Pricing Within Channel Levels
- Price-Fixing: When otherwise competitors work together and agree on setting a specific price, that’s price-fixing. They do so with the intention of establishing control over the demand and supply of the market, i.e., increasing prices without reducing customer demand. This is a direct infraction of the law, which is why rival brands or companies are restricted from communicating with each other before fixing prices. This practice is illegal in most international markets. Companies can receive punishments and fines if they’re caught participating in price-fixing. In 2010, Apple and a few other companies were fined $400 million for a similar case.
- Predatory Pricing: Predatory pricing is termed as a company decreasing the price way below manufacturing costs to purposely decrease rivals’ sales while increasing its own. Prolonged practicing can effectively increase profits over time. Large businesses gain enough profits to compensate for their initial losses, but it’s extremely difficult for a small company to redeem themselves from this position if they’re completely dependent on regular sales. Taken from history, predatory pricing has been hard to prove. The reasons being – other underlying factors like real price competition and genuine issues with pricing.
Pricing Across Channel Levels
- Price Discrimination: Pricing the same product differently across customers at any level of sales is named price discrimination. Unless a brand/firm provides reliable receipts for the difference in costs due to having numerous retailers, this practice is federally illegal. This can be marked off as legitimate if the firm is selling the same products but of different qualities to those retailers. A rather harmless example is the difference in ticket pricing for an adult and a child at the movie theater. Although the prices vary, there’s no cost difference. Both the child and the adult take the same services.
- Retail Price Maintenance: Laws mandate that firms can make dealers price their products according to their wishes. That’s retail price maintenance. The firm can surely request a price they deem fit, but they can’t legally require it. Let’s assume that SONY TVs has come out with a new model equipped with state-of-the-art features, and they’re disbursing products to different retailers across the world. They can’t rightfully order any store to put up their products at a specific price, especially if it’s over the fair price. Resellers reserve the right to sell products at a lesser price than requested.
- Deceptive Pricing: The unethical practice of misleading consumers with a price or discount that they can’t avail is termed as deceptive pricing. Some common examples would be brands advertising their illogically expensive rates as original to make the sale seem more lucrative. Or something simple like luring in customers with an offer and then charging them something else. E.g., we’ve all had those instances when we pick up some goods at the supermarket because they are on “sale.” However, when we proceed to checkout, we’re charged the original pre-sale prices.
In conclusion, Pricing is one of those factors that directly influence a customer’s buying decision. To sum it up, prices are the written documents of the value the company perceives its products will deliver. With the correct pricing strategy, it gets much easier to enter and establish a footing in the market. For smaller businesses, even more so. When the company is just starting, the optimal pricing helps attract customer attention and even make long-term buyers. Bigger businesses perfect their pricing strategies game, and that’s how they sustain themselves. Small businesses need to hit the sweet spot between overpricing and underpricing for maximum profits.
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