Pricing

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A price tag for a product on sale.

Marketing

Key concepts

Product marketing Pricing Distribution Service Retail Brand management Account-based marketing Ethics Effectiveness Research Segmentation Strategy Activation Management Dominance Marketing operations

Promotional contents

Advertising Branding Underwriting Direct marketing Personal sales Product placement Publicity Sales promotion Sex in advertising Loyalty marketing SMS marketing Premiums Prizes

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Pricing is the process of determining what a company will receive in exchange for its products. Pricing factors are manufacturing cost, market place, competition, market condition, and quality of product. Pricing is also a key variable in microeconomic price allocation theory. Pricing is a fundamental aspect of financial modeling and is one of the four Ps of the marketing mix. The other three aspects are product, promotion, andplace. Price is the only revenue generating element amongst the four Ps, the rest being cost centers. Pricing is the manual or automatic process of applying prices to purchase and sales orders, based on factors such as: a fixed amount, quantity break, promotion or sales campaign, specific vendor quote, price prevailing on entry, shipment or invoice date, combination of multiple orders or lines, and many others. Automated systems require more setup and maintenance but may prevent pricing errors. The needs of the consumer can

be converted into demand only if the consumer has the willingness and capacity to buy the product. Thus pricing is very important in marketing.
Contents
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1 Questions involved in pricing 2 What a price should do 3 Terminology

o o o o o o

3.1 Line Pricing 3.2 Loss leader 3.3 Price/quality relationship 3.4 Premium pricing 3.5 Demand-based pricing 3.6 Multidimensional pricing

4 Nine Laws of Price Sensitivity & Consumer Psychology 5 Approaches 6 Pricing tactics 7 Pricing mistakes 8 Methods 9 References 10 External links and further reading

[edit]Questions

involved in pricing

Pricing involves asking questions like:

How much to charge for a product or service? This question is a typical starting point for discussions about pricing, however, a better question for a vendor to ask is - How much do customers value the products, services, and other intangibles that the vendor provides.

What are the pricing objectives? Do we use profit maximization pricing? How to set the price?: (cost-plus pricing, demand based or value-based pricing, rate of return pricing, or competitor indexing)

Should there be a single price or multiple pricing? Should prices change in various geographical areas, referred to as zone pricing? Should there be quantity discounts?

What prices are competitors charging? Do you use a price skimming strategy or a penetration pricing strategy? What image do you want the price to convey? Do you use psychological pricing? How important are customer price sensitivity (e.g. "sticker shock") and elasticity issues? Can real-time pricing be used? Is price discrimination or yield management appropriate? Are there legal restrictions on retail price maintenance, price collusion, or price discrimination? Do price points already exist for the product category? How flexible can we be in pricing? : The more competitive the industry, the less flexibility we have.

The price floor is determined by production factors like costs (often only variable costs are taken into account), economies of scale, marginal cost, and degree of operating leverage

The price ceiling is determined by demand factors like price elasticity and price points

Are there transfer pricing considerations? What is the chance of getting involved in a price war? How visible should the price be? - Should the price be neutral? (i.e.: not an important differentiating factor), should it be highly visible? (to help promote a low priced economy product, or to reinforce the prestige image of a quality product), or should it be hidden? (so as to allow marketers to generate interest in the product unhindered by price considerations).

Are there joint product pricing considerations? What are the non-price costs of purchasing the product? (e.g.: travel time to the store, wait time in the store, disagreeable elements associated with the product purchase - dentist -> pain, fishmarket -> smells)

What sort of payments should be accepted? (cash, check, credit card, barter) Pricing a price should do

[edit]What

A well chosen price should do three things:

achieve the financial goals of the company (e.g., profitability) fit the realities of the marketplace (Will customers buy at that price?) support a product's positioning and be consistent with the other variables in the marketing mix

price is influenced by the type of distribution channel used, the type of promotions used, and the quality of the product

price will usually need to be relatively high if manufacturing is expensive, distribution is exclusive, and the product is supported by extensive advertising and promotional campaigns

a low price can be a viable substitute for product quality, effective promotions, or an energetic selling effort by distributors

From the marketer's point of view, an efficient price is a price that is very close to the maximum that customers are prepared to pay. In economic terms, it is a price that shifts most of the consumer surplus to the producer. A good pricing strategy would be the one which could balance between the price floor (the price below which the organization ends up in losses) and the price ceiling (the price beyond which the organization experiences a no demand situation).
[edit]Terminology

There are numerous terms and strategies specific to pricing:

[edit]Line

Pricing

Line Pricing is the use of a limited number of prices for all product offerings of a vendor. This is a tradition started in the old five and dime stores in which everything cost either 5 or 10 cents. Its underlying rationale is that these amounts are seen as suitable price points for a whole range of products by prospective customers. It has the advantage of ease of administering, but the disadvantage of inflexibility, particularly in times of inflation or unstable prices.
[edit]Loss

leader

A loss leader is a product that has a price set below the operating margin. This results in a loss to the enterprise on that particular item in the hope that it will draw customers into the store and that some of those customers will buy other, higher margin items.
[edit]Price/quality

relationship

The price/quality relationship refers to the perception by most consumers that a relatively high price is a sign of good quality. The belief in this relationship is most important with complex products that are hard to test, and experiential products that cannot be tested until used (such as most services). The greater the uncertainty surrounding a product, the more consumers depend on the price/quality hypothesis and the greater premium they are prepared to pay. The classic example is the pricing of Twinkies, a snack cake which was viewed as low quality after the price was lowered. Excessive reliance on the price/quality relationship by consumers may lead to an increase in prices on all products and services, even those of low quality, which causes the price/quality relationship to no longer apply.[citation needed]
[edit]Premium

pricing

Premium pricing (also called prestige pricing) is the strategy of consistently pricing at, or near, the high end of the possible price range to help attract status-conscious consumers. The high pricing of premium product is used to enhance and reinforce a product's luxury image. Examples of companies which partake in premium

pricing in the marketplace include Rolexand Bentley. As well as brand, product attributes such as eco-labelling and provenance (e.g. 'certified organic' and 'product of Australia') may add value for consumers [1] and attract premium pricing. A component of such premiums may reflect the increased cost of production. People will buy a premium priced product because: 1. They believe the high price is an indication of good quality; 2. They believe it to be a sign of self worth - "They are worth it;" it authenticates the buyer's success and status; it is a signal to others that the owner is a member of an exclusive group; 3. They require flawless performance in this application - The cost of product malfunction is too high to buy anything but the best - example : heart pacemaker.
[edit]Demand-based

pricing

Demand-based pricing is any pricing method that uses consumer demand - based on perceived value - as the central element. These include: price skimming, price discrimination andyield management, price points, psychological pricing, bundle pricing, penetration pricing, price lining, value-based pricing, geo and premium pricing. Pricing factors are manufacturing cost, market place, competition, market condition, quality of product.
[edit]Multidimensional

pricing

Multidimensional pricing is the pricing of a product or service using multiple numbers. In this practice, price no longer consists of a single monetary amount (e.g., sticker price of a car), but rather consists of various dimensions (e.g., monthly payments, number of payments, and a downpayment). Research has shown that this practice can significantly influence consumers' ability to understand and process price information
[edit]Nine
[2]

Laws of Price Sensitivity & Consumer Psychology

In their book, The Strategy and Tactics of Pricing, Thomas Nagle and Reed Holden outline 9 laws or factors that influence how a consumer perceives a given price and how price-sensitive s/he is likely to be with respect to different purchase decisions: [3][4] 1. Reference Price Effect Buyers price sensitivity for a given product increases the higher the products price relative to perceived alternatives. Perceived alternatives can vary by buyer segment, by occasion, and other factors. 2. Difficult Comparison Effect Buyers are less sensitive to the price of a known / more reputable product when they have difficulty comparing it to potential alternatives. 3. Switching Costs Effect The higher the product-specific investment a buyer must make to switch suppliers, the less price sensitive that buyer is when choosing between alternatives.

4. Price-Quality Effect Buyers are less sensitive to price the more that higher prices signal higher quality. Products for which this effect is particularly relevant include: image products, exclusive products, and products with minimal cues for quality. 5. Expenditure Effect Buyers are more price sensitive when the expense accounts for a large percentage of buyers available income or budget. 6. End-Benefit Effect The effect refers to the relationship a given purchase has to a larger overall benefit, and is divided into two parts: Derived demand: The more sensitive buyers are to the price of the end benefit, the more sensitive they will be to the prices of those products that contribute to that benefit. Price proportion cost: The price proportion cost refers to the percent of the total cost of the end benefit accounted for by a given component that helps to produce the end benefit (e.g., think CPU and PCs). The smaller the given components share of the total cost of the end benefit, the less sensitive buyers will be to the component's price. 7. Shared-cost Effect The smaller the portion of the purchase price buyers must pay for themselves, the less price sensitive they will be. 8. Fairness Effect Buyers are more sensitive to the price of a product when the price is outside the range they perceive as fair or reasonable given the purchase context. 9. The Framing Effect Buyers are more price sensitive when they perceive the price as a loss rather than a forgone gain, and they have greater price sensitivity when the price is paid separately rather than as part of a bundle.
[edit]Approaches

Pricing is the most effective profit lever.[5] Pricing can be approached at three levels.The industry, market, and transaction level. Pricing at the industry level focuses on the overall economics of the industry, including supplier price changes and customer demand changes. Pricing at the market level focuses on the competitive position of the price in comparison to the value differential of the product to that of comparative competing products. Pricing at the transaction level focuses on managing the implementation of discounts away from the reference, or list price, which occur both on and off the invoice or receipt.
[edit]Pricing

tactics

Micromarketing is the practice of tailoring products, brands (microbrands), and promotions to meet the needs and wants of microsegments within a market. It is a type of market customization that deals with pricing of customer/product combinations at the store or individual level.
[edit]Pricing

mistakes

Many companies make common pricing mistakes. Bernstein's article "Supplier Pricing Mistakes"[6][7] outlines several which include:

Weak controls on discounting Inadequate systems for tracking competitor selling prices and market share Cost-Up pricing Price increases poorly executed Worldwide price inconsistencies Paying sales representatives on dollar volume vs. addition of profitability measures

Premium Pricing.
Use a high price where there is a uniqueness about the product or service. This approach is used where a a substantial competitive advantage exists. Such high prices are charge for luxuries such as Cunard Cruises, Savoy Hotel rooms, and Concorde flights.

Penetration Pricing.
The price charged for products and services is set artificially low in order to gain market share. Once this is achieved, the price is increased. This approach was used by France Telecom and Sky TV.

Economy Pricing.
This is a no frills low price. The cost of marketing and manufacture are kept at a minimum. Supermarkets often have economy brands for soups, spaghetti, etc.

Price Skimming.
Charge a high price because you have a substantial competitive advantage. However, the advantage is not sustainable. The high price tends to attract new competitors into the market, and the price inevitably falls due to increased supply. Manufacturers of digital watches used a skimming approach in the 1970s. Once other manufacturers were tempted into the market and the watches were produced at a lower unit cost, other marketing strategies and pricing approaches are implemented.

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Premium pricing, penetration pricing, economy pricing, and price skimming are the four main pricing policies/strategies. They form the bases for the exercise. However there are other important approaches to pricing.

Psychological Pricing.
This approach is used when the marketer wants the consumer to respond on an emotional, rather than rational basis. For example 'price point perspective' 99 cents not one dollar.

Product Line Pricing.

Where there is a range of product or services the pricing reflect the benefits of parts of the range. For example car washes. Basic wash could be $2, wash and wax $4, and the whole package $6.

Optional Product Pricing.

Companies will attempt to increase the amount customer spend once they start to buy. Optional 'extras' increase the overall price of the product or service. For example airlines will charge for optional extras such as guaranteeing a window seat or reserving a row of seats next to each other.

Captive Product Pricing

Where products have complements, companies will charge a premium price where the consumer is captured. For example a razor manufacturer will charge a low price and recoup its margin (and more) from the sale of the only design of blades which fit the razor.

Product Bundle Pricing.

Here sellers combine several products in the same package. This also serves to move old stock. Videos and CDs are often sold using the bundle approach.

Promotional Pricing.

Pricing to promote a product is a very common application. There are many examples of promotional pricing including approaches such as BOGOF (Buy One Get One Free).

Geographical Pricing.
Geographical pricing is evident where there are variations in price in different parts of the world. For example rarity value, or where shipping costs increase price.

Value Pricing.
This approach is used where external factors such as recession or increased competition force companies to provide 'value' products and services to retain sales e.g. value meals at McDonalds.

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 Lets 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 Mark-up Selling price

100 50% 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 productbecause 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 costprice 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 DVDs 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 nonprice methods to compete e.g. providing distinct customer service or better availability.

Pricing Approaches
By Michael Beck | April 4th, 2011

I once heard a story about a man that created a machine that could clean spilled fuel from asphalt. He determined he could build the machine and market it for approximately $15,000 so he charged $25,000 for each machine. Now that may not sound very impressive, until you learn that a fuel spill at an international airport may cost over $150,000 per incident. After these airports began purchasing his machines as soon as he could build them, he found himself in an awkward position. He realized what he was creating was extremely valuable and worth well over his original $25,000 price. He would like to raise the price but worries about damaging the relationships hes created. How could this have been prevented? Consider the different pricing approaches.

Cost-based pricing approaches

There are two models of Cost-Based pricing. They are break-even and markup options. The break-even price is determined by dividing total cost by number of units produced plus variable costs. The break-even price is largely avoided because you typically want to make more than you spend. Markup pricing is often used by retailers and is determined by dividing the cost of goods sold by [(100 - %markup)/100]. Markup is the percentage of selling price and not as a percentage of the cost, which is why the formula looks a little complicated. Ex. If a couch costs $1000 with a 50% markup then $500 goes to cost and $500 is profit.

Profit-based pricing approach

The most popular model of profit-based pricing is target profit pricing. Begin by calculating the amount of profit you would like to generate. The profit figure will be calculated into the pricing equation just like an additional cost. The equation is as follows: (Total Fixed Costs + Total Variable

Costs + Profit) / Number of Units. The problem with cost-based and profit-based pricing is the competition and demand is ignored.

Demand-based pricing approach

There are many models of demand-based pricing. Lets review the skimming/penetration, prestige, and bundle pricing options. Skimming is when the initial price is extremely high and reduced slowly over time. This allows for businesses to recoup from production quicker but only in markets where consumers are willing to pay higher prices (think about flat screen TVs). The opposite is penetration price when a business is trying to build market share. Discounts and rebates are often used in penetration pricing and gradually removed. Prestige pricing is used to try to communicate the value of the brand (think about Tiffany). Bundling pricing has become wildly popular due to the home cable and phone companies. Bundling combines complimentary products to add to volume.

Value-based pricing approach

The last pricing approach may have been the most relevant for the subject of the opening story. In value-based pricing it is important to understand the use of the product and analyze the benefits. Sports teams use the value-based pricing option by charging more for tickets versus major competitors. What kind of pricing strategies have you taken in the past?

Penetration pricing
From Wikipedia, the free encyclopedia

This article does not cite any references or sources. Please help improve this article by adding citations to reliable sources. Unsourced material may be challenged and removed. (May 2009)
For other pricing strategies and policies please see here: Pricing strategies Penetration pricing is the pricing technique of setting a relatively low initial entry price, often lower than the eventual market price, to attract new customers. The strategy works on the expectation that customers will switch to the new brand because of the lower price. Penetration pricing is most commonly associated with a marketing objective of increasing market share or sales volume, rather than to make profit in the short term. The advantages of penetration pricing to the firm are:

It can result in fast diffusion and adoption. This can achieve high market penetration rates quickly. This can take the competition by surprise, not giving them time to react.

It can create goodwill among the early adopters segment. This can create more trade through word of mouth.

It creates cost control and cost reduction pressures from the start, leading to greater efficiency.

It discourages the entry of competitors. Low prices act as a barrier to entry (see: porter 5 forces analysis).

It can create high stock turnover throughout the distribution channel. This can create critically important enthusiasm and support in the channel.

It can be based on marginal cost pricing, which is economically efficient.

The main disadvantage with penetration pricing is that it establishes long term price expectations for the product, and image preconceptions for the brand and company. This makes it difficult to eventually raise prices. Some commentators claim that penetration pricing attracts only the switchers (bargain hunters), and that they will switch away as soon as the price rises. There is much controversy over whether it is better to raise prices gradually over a period of years (so that consumers dont notice), or employ a single large price increase. A common solution to this problem is to set the initial price at the long term market price, but include an initial discount coupon (see sales promotion). In this way, the perceived price points remain high even though the actual selling price is low. Another potential disadvantage is that the low profit margins may not be sustainable long enough for the strategy to be effective. Price Penetration is most appropriate where:

Product demand is highly price elastic. Substantial economies of scale are available. The product is suitable for a mass market (i.e. enough demand). The product will face stiff competition soon after introduction. There is not enough demand amongst consumers to make price skimming work. In industries where standardization is important. The product that achieves high market penetration often becomes the industry standard (e.g. Microsoft Windows) and other products, whatever their merits, become marginalized. Standards carry heavy momentum.

A variant of the price penetration strategy is the bait and hook model (also called the razor and blades business model), where a starter product is sold at a very low price but requires more expensive replacements (such as refills) which are sold at a higher price. This is an almost universal tactic in the desktop printer business, with printers selling in the US for as little as $100 including two ink cartridges (often half-full), which themselves cost around $30 each to replace. Thus the company makes more money from the cartridges than it does for the printer itself. Taken to the extreme, penetration pricing becomes predatory pricing, when a firm initially sells a product or service at unsustainably low prices to eliminate competition and establish amonopoly. In most countries,

predatory pricing is illegal, although it can be difficult to differentiate illegal predatory pricing from legal penetration pricing.