13 September 2021
The pricing strategy is one of 4 marketing levers (Product, Price, Place, and Promotion) that is set to achieve competitive advantage. Finding the right pricing strategy is more sophisticated than simply adding a profit margin to a cost price.
How much is it?
Before we answer that question, we need to first understand what it is that you think you are buying and what it is that is being sold.
Price by itself means nothing; it's the value proposition that is the key concept.
Arguably, Price is the most important element of the 4P marketing mix...
...because price speaks directly to the purpose of the marketing exercise which is to generate revenue/profits.
It is also the first hint to the buyer…
- How the product or service being offered is positioned
- The primary ingredient in the value proposition
- Is there any point continuing considering purchasing?
When the purchase process begins, price is normally the first thing the buyer wants to know, but is the last thing the seller should reveal.
In 1871 a fellow called Carl Menger advanced his theory about price setting, he proposed that prices are set at the margin between what a willing seller is prepared to sell at, and what a willing buyer is prepared to buy at. Further, he noted that the price is actually set by the last transaction between the most willing seller and the most willing buyer. It became known as the marginal revolution in economics and it changed economists' thinking.
Prior to Menger economists struggled to agree on how price was actually formed and proposed that it was a function of cost. Others thought the labor component was the key driver.
The implications of this theory is that the value of a product or service is subjective and not always based on any true underlying value.
The price a person is willing to pay for a product or service is based on their own individual perception and circumstance. People draw on a range of considerations to make-up their minds...
- Immediate need. Do I have to buy it now or can I spend more time shopping around?
- Opportunity and difficulty of considering alternatives.
- Scarcity: how readily available is the product or service?
- Reputation and trust (another way of saying "Brand")
- Long term utility and durability.
- Personal preferences, allegiances, and prejudices.
- What have other people being paying?
It is complex but also provides the opportunity for the marketer to influence the buyers' perceptions through setting product, place and promotion strategies.
Price as a positioning signal
Buyers of any product or service generally understand that price is linked to quality. As a simple example, a $100 bottle of wine will be better than a $15 bottle.
One might think there is an opportunity to simply price a cheap wine higher to achieve higher profits (and there is some wriggle room), however the ensuing bad reviews and online complaints would damage the brand. Equally, a good wine priced at a discount may lead some buyers to conclude there is something wrong with it.
Price is very much interpreted by buyers as an indication of where a product is positioned on the quality dimension.
Supply and demand
While price indicates quality, consumers take many other factors into account when making purchase decisions. Economic theory maintains that price is based on the balance between supply and demand. In simple terms, a product that is in short supply (demand exceeds supply) can command a higher price, and when a product becomes plentiful, sellers are forced to lower the price.
Price equilibrium, is the point at which the total number of products available can be consumed by potential buyers. Inherent in this concept is the idea that lower prices will bring more buyers back into the market; buyers have choices. Not only can they choose between competing products, but also choosing not to buy at all.
Each consumer has differing criteria which affects their perception of the value proposition; if their need is urgent they will willingly pay a higher price. The buyer who can wait, may defer their purchase until the price is lower. These various factors that comprise the value proposition can be exploited by the marketer to develop an effective price strategy.
The initial COVID outbreak created a global shortage of face masks. Prices skyrocketed.
People were paying prices like $4.00 for a paper mask that normally cost a few cents. Production rapidly increased and within a few months, supply again equaled demand and prices dropped to previous levels.
In some marketing theory, the concept of "problem solving" is discussed, every purchase decision is characterized as a "problem to be solved." Examples of problems the consumer is seeking to solve can be as simple as "I have run out of milk" to as complex as "I need to build a new office block." Thus, the value proposition (and therefore price a consumer is willing to pay) is a function of...
- How important is the problem (what are the consequences of not solving the problem?)
- How much am I willing to pay to solve that problem?
- How easy is it to find and compare solutions?
- Urgency. How soon do I need to solve the problem?
For the marketer to develop an effective pricing strategy, understanding the problem from the consumer's perspective is essential because...
Cost Plus Pricing is the most common and yet least effective pricing strategy
More about this later.
The consumer seeks price discovery early because (as explained above) it can tell them a lot about the product or service. However, part of the value-proposition is the question "is this a good use of my funds?" or even "can I afford it?"
Buyers can choose to buy your product, your competitors' product, or to buy nothing at all.
People seek to determine first if they should even be investing time in finding out more about the product or service. In traditional sales training, the sales person is taught to delay discussing price as long as possible to allow time to fully discover the potential customer's "hot buttons" and to create desire.
However, context is everything in marketing. In retail, it is common practice to label every product on the shelf with a price (and is required by law). But, in B2B selling, often the price is impossible to quote until the customer's requirements are fully scoped.
Developing the price strategy - the role of the marketer
When developing marketing strategy, the marketer must consider all elements of the 4P marketing mix, the other elements being Product, Place, and Promotion. Together, each of these are the levers the marketer sets to achieve competitive advantage.
Here is a collection of various pricing strategies with examples.
Cost plus pricing
Cost Plus pricing is the simplest and least sophisticated pricing method. The price offered is the cost price plus a profit margin. Read more Cost Plus Pricing
Start with a low price and then progressively increase it. Penetration pricing is a method for gaining market share particularly used when a new product/service or brand is launched into a mature market. Read more Penetration Pricing
The opposite to penetration pricing is price skimming. Start with a high price and then over time, lower the price in steps. Typically used by technology manufacturers when introducing the new higher specification versions of their products. Read more Price Skimming
Premium Pricing Strategy
As the name suggests, premium pricing sets the asking price at the top end of the market.
Premium pricing is as much a positioning strategy as it is a pricing strategy as it seeks to signal to the potential customer that the product/service is of high quality or high desirability as evidenced by its high price. Read more Premium Pricing
Price bundling is the practice of packaging-up various price elements that comprise an offer and presenting it as one price. Read more Price Bundling
Cascading demand pricing is a product-mix and pricing strategy where the sale of an initial product locks in an on-going stream of future sales of accessories, spare parts, or consumables. Read more Cascading Demand Pricing
Pure price discrimination is a pricing strategy where identical products or services are sold to different market segments at different prices. Read more discriminatory pricing
Yield pricing (or yield management) is a variable pricing strategy applied to managing goods or services that have a fixed maximum capacity and relatively fixed cost. Common examples are Airlines, Accommodation, Advertising Inventory, Rental Car Hire, Equipment Hire, and Live Performances. Read more Yield Pricing
Low Balling is more a tactic than a strategy unless a company decides that it will always use low-balling. Low balling is the practice of quoting a price below the level needed to achieve satisfactory profits in order to open-up a new customer relationship or win a project that has opportunity for recovering profits through changes to project scope. Read more about low balling.
Relationship pricing is price setting based on considering the overall profitability of a customer across a portfolio of products/services over an extended period of time, rather than each individual transaction. Read more Relationship Pricing.
Price elasticity refers to the extent to which price variation impacts demand.
Common sense suggests that (in general) as you increase the price of a product or service the less likely the product will be purchased. Conversely, lowering the price increases demand. This is the key motivation for discounting.
However, some products and services are not impacted by price changes - the price of fuel is the classic example. People will pay what they have to pay to fill-up at the service station; they might grumble about high fuel prices, but regardless they purchase anyway.
Purchase volumes that vary little with price are referred to as having inelastic demand.
However, some products or services are less price elastic than others. Where the volume decreases at a slower rate than the price (i.e. if you increase the price by 20% and sales volume falls by only 10% then you have the opportunity to maximise profits through implementing a price increase. However, for manufactured products, profitability can be eroded by sales volume declines because overhead recovery can be decreased if there are less products to amortize fixed overhead costs over.