Marketing - Pricing approaches and strategies
There are three main approaches a business takes to setting price:
Cost-based pricing: price is determined by adding a profit element on top of the cost of making the product.
Customer-based pricing: where prices are determined by what a firm believes customers will be prepared to pay
Competitor-based pricing: where competitor prices are the main influence on the price set
Let’s take a brief look at each of these approaches;
Cost based pricing
This involves setting a price by adding a fixed amount or percentage to the cost
of making or buying the product. In some ways this is quite an
old-fashioned and somewhat discredited pricing strategy, although it is
still widely used.
After all, customers are not too bothered what it cost to make the product – they are interested in what value the product provides them.
Cost-plus (or “mark-up”) pricing is widely
used in retailing, where the retailer wants to know with some certainty
what the gross profit margin of each sale will be. An advantage of
this approach is that the business will know that its costs are being
covered. The main disadvantage is that cost-plus pricing may lead to
products that are priced un-competitively.
Here is an example of cost-plus pricing, where a business
wishes to ensure that it makes an additional £50 of profit on top of the
unit cost of production.
| Unit cost |
£100
|
| Mark-up |
50%
|
| Selling price |
£150
|
How high should the mark-up percentage be? That largely
depends on the normal competitive practice in a market and also whether
the resulting price is acceptable to customers.
In the UK a standard retail mark-up is 2.4 times the cost
the retailer pays to its supplier (normally a wholesaler). So, if the
wholesale cost of a product is £10 per unit, the retailer will look to
sell it for 2.4x £10 = £24. This is equal to a total mark-up of £14
(i.e. the selling price of £24 less the bought cost of £10).
The main advantage of cost-based pricing is that selling
prices are relatively easy to calculate. If the mark-up percentage is
applied consistently across product ranges, then the business can also
predict more reliably what the overall profit margin will be.
Customer-based pricing
Penetration pricing
You often see the tagline “special introductory offer” – the classic sign of penetration pricing. The aim of penetration pricing is usually to increase market share of a product, providing the opportunity to increase price once this objective has been achieved.
Penetration pricing is the pricing technique of setting a relatively low initial entry price, usually lower than the intended established price, to attract new customers. The strategy aims to encourage customers to switch to the new product because of the lower price.
Penetration pricing is most commonly associated with a marketing objective
of increasing market share or sales volume. In the short term,
penetration pricing is likely to result in lower profits than would be
the case if price were set higher. However, there are some significant
benefits to long-term profitability of having a higher market share,
so the pricing strategy can often be justified.
Penetration pricing is often used to support the launch of a
new product, and works best when a product enters a market with
relatively little product differentiation and where demand is price
elastic – so a lower price than rival products is a competitive
weapon.
Price skimming
Skimming involves setting a high price before other competitors come into the market.
This is often used for the launch of a new product which faces little
or no competition – usually due to some technological features. Such
products are often bought by “early adopters” who are prepared to pay a higher price to have the latest or best product in the market.
Good examples of price skimming include innovative electronic products, such as the Apple iPad and Sony PlayStation 3.
There are some other problems and challenges with this approach:
Price skimming as a strategy cannot last for long, as
competitors soon launch rival products which put pressure on the price
(e.g. the launch of rival products to the iPhone or iPod).
Distribution (place) can also be a challenge for an
innovative new product. It may be necessary to give retailers higher
margins to convince them to stock the product, reducing the improved
margins that can be delivered by price skimming.
A final problem is that by price skimming, a firm may slow
down the volume growth of demand for the product. This can give
competitors more time to develop alternative products ready for the
time when market demand (measured in volume) is strongest.
Loss leaders
The use of loss leaders is a method of sales promotion. A
loss leader is a product priced below cost-price in order to attract
consumers into a shop or online store. The purpose of making a product a
loss leader is to encourage customers to make further purchases of
profitable goods while they are in the shop. But does this strategy
work?
Pricing is a key competitive weapon and a very flexible part of the marketing mix.
If a business undercuts its competitors on price, new
customers may be attracted and existing customers may become more loyal.
So, using a loss leader can help drive customer loyalty.
One risk of using a loss leader is that customers may take
the opportunity to “bulk-buy”. If the price discount is sufficiently
deep, then it makes sense for customers to buy as much as they can
(assuming the product is not perishable).
Using a loss leader is essentially a short-term pricing
tactic for any one product. Customers will soon get used to the
tactic, so it makes sense to change the loss leader or its
merchandising every so often.
Predatory pricing (note: this is illegal)
With predatory pricing, prices are deliberately set very low by a dominant competitor in the market in order to restrict or prevent competition.
The price set might even be free, or lead to losses by the predator.
Whatever the approach, predatory pricing is illegal under competition
law.
Psychological pricing
Sometimes prices are set at what seem to be unusual price
points. For example, why are DVD’s priced at £12.99 or £14.99? The
answer is the perceived price barriers that customers
may have. They will buy something for £9.99, but think that £10 is a
little too much. So a price that is one pence lower can make the
difference between closing the sale, or not!
The aim of psychological pricing is to make
the customer believe the product is cheaper than it really is.
Pricing in this way is intended to attract customers who are looking
for “value”.
Competitor-based pricing
If there is strong competition in a market, customers are
faced with a wide choice of who to buy from. They may buy from the
cheapest provider or perhaps from the one which offers the best
customer service. But customers will certainly be mindful of what is a
reasonable or normal price in the market.
Most firms in a competitive market do not have sufficient
power to be able to set prices above their competitors. They tend to use
“going-rate” pricing – i.e. setting a price that is in line with the prices charged by direct competitors. In effect such businesses are “price-takers” – they must accept the going market price as determined by the forces of demand and supply.
An advantage of using competitive pricing is that selling
prices should be line with rivals, so price should not be a competitive
disadvantage.
The main problem is that the business needs some other way to attract
customers. It has to use non-price methods to compete – e.g. providing
distinct customer service or better availability.
Refer: http://www.tutor2u.net/business/gcse/marketing_pricing_strategies.htm
