Product Pricing as a Marketing Strategy

Many small business owners underestimate the strategic

significance of pricing.
Pricing isn't just about a number. There is a lot of strategy
involved. Assume you make widgets for $5 each. As a
business owner, you want to achieve 20 percent profit.
However, simply selling your product for $6 may not work,
as customers may not be willing to pay that much for your
widget. Or the nearest competitor may charge $8, so you
could make an even bigger profit by charging $7. Setting a
reasonable pricing strategy constitutes one of the biggest
marketing decisions a business undertakes.
Measure the Market
Pricing strategy begins with a market analysis of what the
optimal product price for a given product or service
should be. Business owners determine the total cost to
produce one unit of a product or service then conduct
market research--including focus groups and comparative
price analyses--to determine the point where the
company's willingness to supply a unit at a given price is
identical to the market's willingness to purchase a unit at that price. This point is called the
"equilibrium point," although companies are not required to sell at that price.
Cost-Plus Pricing
Cost-plus pricing ensures that the company's total costs plus a predetermined profit margin are
recovered in full. This is classic lemonade-stand pricing, and is common in the manufacturing
business-to-business sector. In this case, pricing equals costs plus a static profit.
Related is target-return pricing, in which the price is set to earn a specific return on an
investment (ROI). For example, a pharmaceutical company that spent $2 billion to develop a
new drug, and which has a 20-year patent on the drug, may set price to recover its research-
and-development costs, the research and development of failed drug development, marketing
and salaries for the projected demand over the life of the patent.
Demand Pricing
Demand pricing fluctuates with consumer needs. For example, gas station owners typically use
demand pricing for fuel, and during peak travel periods, the cost-per-gallon increases. Likewise,
when people typically stay off the road, prices decline.
Demand pricing for items like fuel can also work as a "loss-leader." That is, a company might set
a two-hour period after the big local college football game, with a price-per-gallon equal to the
total score of the game. Consumers, eager for the deeply discounted fuel, will line up for gas,
but the station will partially recover the loss through the sale of additional items in the attached
convenience store, while earning public goodwill that may lead to repeat customers and future
sales.
Competitive Pricing
Tightly competitive industries, or industries where there is already an established market leader
and market price, feature competitive pricing. For example, the town's second pizzeria has less
room to set its own price because the competition already set the price for the community.
Therefore, the new shop may slightly undercut on price in order to earn the patronage of price-
conscious consumers.
Markup Pricing
Most retailers use markup pricing. They resell items they purchased from a wholesaler, and
then set a sale price to the final consumer that consists of a the original wholesale price plus
the retailer's marked-up profit margin. For example, a book store may sell books for 10 percent
over the costs the store incurred to buy its inventory.
This markup must defray the non-inventory costs of running the business (e.g., labor, insurance,
rent) and supply an additional profit margin.
Psychology of Pricing
Business owners must be sensitive to the emotional impact of price. Irrespective of the dollars
and percentages of profit margins, consumers like getting a deal and respect companies that
provide good quality at a fair price.

About Pricing Strategy
Pricing is a major element of marketing and can help determine how successful your product or
service will be. Pricing affects product positioning as well as product features, promotion and
sales strategies. There are a number of different pricing strategies, and the one you chose
should reflect your overall sales strategy and the current state of the market.
Developing a Price
There are many considerations to take into account when developing a pricing strategy. First,
examine the overall marketing strategy to determine the target buyer and product position.
Promotional tactics and distribution should be taken into account, as well as how demand will
alter at different prices. Calculate all the costs involved, in order to determine your bottom line.
You should also consider the prices charged by competitors and the pricing objectives for the
product. For example, do you want to maximize profit or keep the price at a particular level?


Pricing Objectives
To set the best pricing strategy, determine your company pricing objectives. In some cases, the
goal may simply be to recover costs and survive, while in others, the objective may be to
maximize unit profit, the number of units sold or the number of customers served. Some
companies set prices high to signal that the product or service is a quality leader. Or a company
may want price stabilization to maintain a steady profit. For example, in late 2009, the Dallas
Morning News increased its online subscription prices by 43 percent to boost revenue and
signal that it is a high-quality product. At the same time, editors admitted earlier strategies to
keep the paper cheap were based around increasing circulation, not revenue.
Pricing Method
In an article in Bloomberg Businessweek, Rafi Mohammed states that 90 percent of companies
simply mark up costs and do not take into account the value the product may offer compared
to rival products. Mohammed argues that price should be set instead based on overall sales
strategy and objectives. Different pricing methods can be used to achieve different objectives.
For example, in cost-plus pricing, price is set at cost plus a set profit margin. In target-return
pricing, the price is set to achieve a target return. Value-based pricing sets the price at a good
value relative to similar products, whereas psychological pricing sets the price at what the
consumer will pay.
New Product Pricing
For new products, a pricing strategy is usually chosen to either maximize profit or maximize
market share. A common strategy to maximize profit is called skim pricing. In this strategy,
companies set a high price in order to attract customers who do not care as much about price
and to signal the product or service is high quality. To maximize market share, companies set a
low price. This works well if there are cost savings from selling in volume.
Price Discounts
Offering price discounts is another strategy used to meet marketing objectives. This strategy
involves offering discounts to some customers. The discount could be based on quantity
purchased or method of purchase. For example, cash purchasers could be offered a discount.
Discounts may also be seasonal or promotional--for a short time only--to increase short-term
sales. Trade discounts may be used to increase the number of outlets selling the product.

Differential Pricing Strategy
A strong and effective pricing strategy takes advantage of a company's position and product
offerings to maximize profit. A differential pricing strategy allows the company to adjust pricing
based on various situations or circumstances. The price variations come in different forms, from
discounts for a particular group of people to coupons or rebates for a purchase. Knowledge of
differential pricing allows you to determine if this strategy is a possibility for your company.

Basics
The differential pricing strategy means certain customers pay less for the same product than
others pay. This technique works for services, admission fees, restaurants and products. The
nature of differential pricing generally avoids conflict or feelings of unfair treatment by those
who don't qualify for the discount. The discounted prices may come in the form of a temporary
discount or a permanent lower price for a particular group of people. In other situations, the
price may start high for everyone and gradually lower the longer the product is on the market.
This is often seen in electronics as newer models become available.
Types
One discount option is to provide people from a certain group with a lower price. An example is
a senior or student discount on admission to a museum or entertainment facility. This option is
typically well-received by others who don't qualify because the targeted groups are generally
thought of as lower income and deserving of the discount. A similar example is to base cost on
income level, such as a reduced doctor's fee for those who meet low income guidelines.
Reduced pricing may come in the form of bulk discounting or bundling of multiple services or
goods from your company. For example, your base price may apply for the purchase of one to
five units, while a 10 percent discount applies for six or more units. Another example of
differential pricing is allowing anyone to receive the discount if they are willing to seek out a
coupon, fill out a rebate form or wait for a sale.
Benefits
Offering discounts allows your company to expand to customers who might not otherwise buy
your product. The lower price makes your business more attractive to the groups you target.
The company's overall sales increase due to this expanded customer base. In cases when
strategies like coupons, sales or rebates are used, the initial discount gives the new customers a
chance to try the product. If they like what they experience, they may continue buying the
product at full price when the discount is no longer available.
Disadvantages
Your profits on the discounted sales drop since you won't receive the full amount you normally
charge. For a permanent lower price such as a senior discount or lower student rate, this means
continued lower profits over time. If the prices eventually go back up after a sale or the end of a
coupon offer, you may lose those new clients who cannot afford to pay full price. In the case of
a physical product being purchased, someone who qualifies for a significantly discounted price
could turn around and sell it to someone else for a higher price. This allows the consumer to
profit from your product without your company receiving any of the money.




How Does a Pricing Strategy Affect Brand Equity?


Most grocery chains use everyday low pricing as
part of their brand's positioning.
Pricing is just as important to brand equity as other
differentiators, because it is a source of meaning
and identity. A solid pricing strategy can have a
positive effect on brand equity, while a poor
strategy can do the opposite. The various types of
pricing strategies include premium pricing,
discounted or competitive pricing, cost-based
pricing, introductory or penetration pricing,
everyday low pricing and bundle or bulk pricing.
Finding the right pricing strategy is vitally important
for the brand equity of your business.






Discounted Pricing
Businesses usually adopt a strategy of differentiation or price leadership. Differentiation works
for companies operating in luxury or niche markets, while price leadership works for discount
stores. The effect of a discount or competition pricing strategy can create an image of second-
rate products, which could have a negative effect on the brands equity. For example, Europes
leading low-cost airline, Ryanair, created new routes to smaller airports to save on landing fees,
which serve areas not covered by traditional airlines. This alienated some customers, but
gained brand equity for the company in other target markets.
Everyday Low Pricing
This pricing strategy is the official positioning of most grocery store chains. Walmart
successfully follows this strategy, which is imitated by stores in other countries. The chains
approach of profitable and sustainable price differentiation has become a winning strategy and
created significant brand equity, positioning the company as a low price, high value retailer. In
addition, brands that successfully move into developing markets with a large number of less
affluent customers, such as China and India, have their brand equity directly affected by the
affordability of their products to the target market.


Power of Pricing
Pricing at both ends of the strategy spectrum can affect brand equity in different ways.
Premium pricing is the principle of setting a high price point to reflect the products exclusivity
and quality. With niche brands, such as Chanel, Mercedes Benz or Rolex, the price is an aspect
that the customers of the brand enjoy. It adds meaning and value to their purchase and sets the
product apart from its competition. This makes the pricing strategy an important and integral
aspect of the products brand equity. If the product doesnt have any other strong
differentiators, however, lower prices are likely to sell better than more expensive ones.
Value
In a 2011 Value-D study by brand research company Millward Brown, thousands of brands
globally were compared and classified into groups based on their perceived value to customers.
Different brands were considered the best value for the price, depending on the respondents
countries. For example, in India, eight of the top 10 brands were considered good value, which
is defined as both desirable and cheaper. In China, however, Starbucks charges the same price
for its coffee as it does in the United States. This has resulted in the brand being considered an
aspirational or luxury brand, so its premium pricing strategy has contributed to boosting its
brand equity in this case.

Long-Term Pricing Strategy


Long-term pricing strategies help you avoid poorly
planned, spontaneous price adjustments.
Pricing is a key component of an effective
marketing strategy. Your product and service prices
impact revenue, cash flow, profits and the
reputation your brand has in the marketplace. Prior
to launching a new product or business, you should
have a well-planned long-term pricing strategy to
optimize customer growth, revenue or profits,
depending on your company goals.








Penetration and Skimming
Penetration pricing is the use of a low upfront price to break in to a new market or to launch a
new product and entice a large number of customers. Skimming means you start with a high
price on a new product to optimize short-term profits from the most interested customers.
While these strategies emphasize your approach during early stages of a product launch, the
follow-up is critical as well. With penetration pricing, you typically want to subtly move prices to
a higher, longer-term level once your customer base is established. With skimming, you want to
maintain premium prices until the market dries up and then reduce them over time to appeal
to more moderate buyers.
Premium Pricing
Premium pricing is a long-term strategy employed by companies that emphasize superior
product benefits or quality services. The intent is to establish and maintain a relatively high
price position that goes along with the message of top quality. With this strategy, you can
normally maintain a regular price point during introduction, growth and early maturity stages of
a product life cycle. Often, when products enter decline and the company prepares to launch a
new version or product, they are marked down to sell out remaining inventory.
Value-Based Pricing
Value-based pricing is a strategy where you set prices based on the target market's perception
of value compared to competing brands. For instance, if customers believe your coat is fairly
priced at $30, you would price it at or near $30. Market research prior to product launch is
critical with effective initial pricing. Over time, you have to monitor changes in demand based
on the availability of new product options and waning interest in your product. Later in the
product life cycle, customer perceptions of value may fall if more advanced products enter the
market.
Profitability
Strategies such as cost-plus pricing and target return pricing emphasize long-term profit
maximization. In essence, you set prices based on the desired level of profits you hope to
obtain over time. If your goal is 20 percent profit over the life of a product, you have to
estimate how long initial demand will last when you can have higher prices at 30 to 40 percent
margin. You also have to take into account that near the end of the life cycle, you may have to
discount remaining inventory for little to no profit.







Steps in Selecting a Pricing Strategy


Prices should not be set arbitrarily, but
with use of a well thought-out pricing
strategy.

Pricing is an important strategic issue
because it is related to product positioning
reports Net MBA. Pricing affects all other
aspects of your marketing strategy
including product features and
promotions. Once you set a price, it is
difficult to change it without additional
effort and cost. Finally, your price sends a
message about the product to the buyer


Understand Marketing
All elements of the marketing mix are interdependent: consumers, price, distribution,
promotion, positioning and features. Product positioning refers to where consumers rate your
product in comparison with competitors. Price sends a message about quality: usually lower
prices indicate lower quality materials or fewer features, so it is important to choose a level
that tells customers what you want them to hear. Price also determines your profit level, so it
defines what you can spend on advertising and developing new products.
Verify Demand
It is crucial to get a detailed view of your customers and what they are willing to spend, both in
general, and on your product specifically. You do this by conducting market research. Each
product has a demand curve, that is, the relationship between what a product’s
price and what consumers are both willing and able to pay for it. You need to estimate the
demand curve of the product before setting the price. Questions to ask are: will demand rise
sharply as soon as the product is available? Alternatively, does your product have such
longevity that customers will buy only one? You can charge more for a product with initially
high demand, but keep in mind that, once purchasers drop off, you may need to lower the price
using clearance or sale strategies.
The total unit cost of a product includes “the variable cost of producing each
additional unit and fixed costs that are incurred regardless of the quantity
produced,” says Net MBA. The unit cost is the absolute lowest you can price your
product and still break even, or make exactly enough money to cover your expenses. If the unit
cost is higher than you would like to charge for the product, you will need to consider changing
features, marketing or production costs to lower your outgo. Otherwise, you will need to sell
the item for at least this much, preferably more, since the goal of business is to make a profit.
Competition
You might not want to base prices on your competitors, but you must at least consider them. If
your product is the same as a competitor’s, you probably will not sell many if you
charge a higher price. Decide how you want to relate to similar products. Is your product
cheaper with the same qualities? Is it more expensive, but with additional features or unique
services? Small businesses might want to focus on selling unique products at a premium price
and leave large quantities of basic products to large corporations.