Pricing Strategies

Pricing strategies are essential approaches that businesses use to set the prices of their products or services. These strategies can significantly influence customer behavior, market competition, and overall profitability. Common pricing strategies include cost-plus pricing, where a fixed percentage is added to the production cost, and value-based pricing, which focuses on the perceived value of the product to the customer. Other approaches include penetration pricing, aimed at gaining market share by setting lower prices initially, and skimming pricing, which involves starting with high prices and gradually lowering them.

Understanding the target market and competitive landscape is crucial for selecting an appropriate pricing strategy. Additionally, factors such as economic conditions, consumer demand, and the elasticity of the product can affect pricing decisions. Businesses must also consider the long-term implications of their pricing strategies, as they can either strengthen or weaken brand perception over time. Ultimately, effective pricing strategies are vital for achieving business goals and driving customer satisfaction while fostering healthy market dynamics.

Published in: 2021

By: Gould, Marie

Subject Terms

Pricing Strategies

Abstract

This article will focus on how marketing professionals develop pricing strategies for their organizations. There will be a review of the guidelines that these individuals process in order to determine the optimal pricing structure for each product or service. The different types of potential pricing strategies (i.e., entrepreneurial, penetration, premium) will be explored. The concept of international countertrade as it relates to pricing will also be introduced.

Overview

Pricing is one of the four aspects (product management, pricing, promotion, and place) in the marketing mix, and it directly affects how a product is positioned in the market. Pricing should take into consideration fixed and variable costs, competition, organizational objectives, proposed positioning strategies, target groups, and consumer willingness to pay the price. When an appropriate price is selected, it should assist the organization in reaching its financial goals, be a realistic price for the target market, and be cohesive with other marketing mix components as well as with product positioning. Many organizations have utilized various factors when determining the pricing strategies for their products and services. However, there are some general guidelines that all share. For example, the marketing representatives may go through a series of steps such as:

Create a marketing strategy: This entails conducting a market analysis, product segmentation, targeting, and positioning. The team will have to determine each aspect of the marketing mix formula. The first step will be to develop a marketing strategy for the product or service. At this point, a decision is made as to who the target market will be and how the product will be positioned. Another factor will be based upon whether pricing is going to be a key point of the positioning.
Determine the proper marketing mix. This involves product definition, distribution, and promotion. There will be trade-offs between the variables in the marketing mix. Pricing will be based on other decisions that have been made in the areas of distribution and promotion. For example, is the expectation to sell a small number of luxury items at high prices so that the product becomes a rare, unique commodity?
Be aware of the demand curve: Determine how price affects the quantity demanded. There tends to be a relationship between price and quantity demanded. Therefore, the marketing team will attempt to estimate the demand curve for the product or service since pricing directly affects sales. The first step will be to conduct market research to find out how a particular price point will affect the demand for the product. If the product already exists, the marketers may want to survey whether the market will accept prices above the current price. The results will give the marketing team an idea of the price elasticity of demand for the product.
Determine cost of product: Calculate a product’s associated fixed and variable costs. Once it has been determined that the product will be launched, the marketing team will need to understand all of the costs involved. Therefore, they will need to calculate the fixed and variable costs associated with the product or service, which is referred to as the total unit cost. The unit cost of the product determines how much is needed in order to break even. Any price set higher than this will help set the profit margin.
Understand environmental factors: Evaluate potential responses from competitors and understand legal constraints. The marketing team should find out if there are any legal restraints on pricing. For example, offering different prices to different consumers can lead to cases of price discrimination. In some markets, there may be legislation that dictates how high prices can go. Also, there are laws that prevent predatory pricing, especially in the international trade market.

Set pricing objectives. There are a variety of ways to set the pricing objectives. Some of the most popular objectives include:

Profit Maximization — By taking into consideration revenue and costs, this objective seeks to maximize current profits.
Revenue Maximization — This objective does not take profit margins into consideration when attempting to maximize current revenue.
Maximize Quantity — The reduction of long-term costs can be achieved by maximizing product or service sales.
Maximize Profit Margin — In a situation where quantity of sales will be low, unit profit margins can be increased to foster greater returns.
Differentiation (Quality Leadership) — This objective looks at the difference in price when determining the target market. While some companies may seek to be the low-cost leader, others will highlight quality as the justification for higher prices. For example, consumers expect to pay a high price for a high-end, name-brand designer handbag.
Survival — This objective is successful when there is a crisis in the marketplace. For example, the market may be experiencing a price war, market decline, or market saturation. Therefore, the company may be forced to temporarily set a lower price that will cover costs and allow the business to continue to operate in order to survive. In this type of situation, survival is more important than profits.
Partial Cost Recovery — An organization may seek only partial cost recovery if it has other sources of income.

Some of the most classical pricing strategies are:

Price Skimming: When the product is introduced, the organization will set a high price in order to attract customers who are not sensitive to price. However, the prices will eventually fall due to an increase in supply, especially from competitors. This strategy is most appropriate when customers are not sensitive to price, there is no expectation of large cost savings at high volumes, and the organization cannot produce high volumes of its product at low profit margins.
Penetration Pricing: When the product is introduced, the price is set low in order to gain market share. Once market share has been obtained, the prices are increased. This strategy tends to be used by companies attempting to enter a new market or desiring to build a small market share. A penetration strategy may also be used when a company wants to promote complementary products. The main product is set at a low price in order to get customers to buy the accessories, which are sold at higher prices.
Economy Pricing: This strategy is considered the "no frills" approach. The cost of marketing and manufacturing are kept low. An example is store brand products or generic drugs.
Premium Pricing: When the product is unique and the company has a competitive advantage, a high price can be set.
Determine pricing: Using the information acquired through the steps above, define a pricing method, pricing structure, and discounts.

Once the prices have been set, the marketing team may employ one or more of the following pricing methods in order to achieve their goals.

Cost-plus pricing — The price arrived at by adding the production costs and a selected profit margin.
Target return pricing — Price set so as to recognize a certain return on investment.
Value-based pricing — A price is set based on the notion that a customer will pay in accordance to the perceived value to the customer versus the cost of an alternative product. Caminal and Vives (1996) research showed that "a higher current market share can be interpreted by future consumers as a signal of higher relative quality and will tend to increase future demand" (p. 222).
Psychological pricing — A price is set based on factors such as product quality and perceived consumer value. The company perceives that the customer will respond based on emotion versus logic. For example, the price may be $1.99 versus $2.00.

The list price is usually the price that is quoted to the target market. However, discounts may be given to distributors and a select group from the target market. Examples of discounts include:

Quantity discounts — Discounts that are awarded to customers based on the quantity purchased.
Cumulative Quantity discounts — Discount offered increases as the cumulative purchase increases. This is a good approach for resellers who make large purchases over time versus purchase large quantities at one time.
Seasonal discounts — Discount offered based on the time of year the purchase is made. The purpose is to offset seasonal variations in sales.
Cash discounts — Discount offered to customers who pay before the due date.
Trade discounts — Discount offered to distributors who successfully perform their responsibilities to the organization.
Promotional discounts — Discount offered in order to generate sales. This type of discount is usually set up for a short, specified period.

Application

Entrepreneurial Pricing. Although pricing represents one of the most visible decision factors for marketing teams, it tends to be one of the least creative parts of the marketing strategy (Pitt & Berthon, 1997). Many marketers look at pricing from a functional point and view it only as a means to cover costs and generate revenue. Others have wrongly assumed that they could not be creative in pricing due to competitor pricing or legal constraints. Basically, many marketing managers have not conducted much research into how they price a product because they "did not really understand how to price, and were insecure about the adequacy of the pricing approach they employed" (Pitt & Berthon, 1977, p. 344).

However, this approach may change as many organizations use modern approaches in developing their pricing formulas. The change is being driven by environmental factors such as international legislation forcing firms to open up markets and consumer preference for quality over brand image. For instance, companies such as Coca-Cola and Pepsi experienced a backlash from consumers as they decided to purchase store brand cola over their respective products (Hulbert & Pitt, 1986).

Some researchers have looked to the field of entrepreneurship as a way to add life and creativity to the pricing process. Miller and Friesen (1983) assert that entrepreneurship is based on three dimensions—innovativeness, assumption of risk, and proactiveness. Innovativeness implies that an organization's vision is designed around a unique product, service, or process. Risk-taking infers that the organization is willing to pursue opportunities even if it loses money and takes calculated risks. Miller (1987) defined proactiveness as an organization's willingness to be assertive and take bold risks (i.e., acting versus reacting to market conditions).

As mentioned in the Overview section, developing a pricing structure for a product or service requires decision making on a number of topics. The marketing department must come to a consensus on issues such as price objectives, price strategy, pricing method, promotions, and discounts. In each category, there are a number of options in which the appropriate selection can be made. However, there is evidence that organizations still need to review their pricing strategy based on four key dimensions. The four dimensions are:

Cost-based versus market-based. Cost-based strategy occurs when the marketing team focuses on covering its own costs more than any of the other determinants (i.e., demand conditions, competitive market structures, company marketing strategies). It tends to rely on formulas such as cost-plus, keystone, or target return (Pitt & Berthon, 1997). Market-based strategy values the opinion of the consumer. The pricing structure is based on the perceived value that the customer receives from the product or service.
Risk-averse versus risk-assumptive. Risk-averse strategy is the conservative approach. Prices are kept in line with competitors, only changed when necessary, and the process is kept simple. Risk-assumptive strategy is more uncertain because the managers go into uncharted territories with less concern over potential loss in revenue.
Reactive versus proactive. Reactive strategy refers to when a company copies the pricing patterns of their competitors. In most cases, there will not be an adjustment in price if the market does not warrant a change. On the other hand, the proactive approach assumes that the organization is the leader and initiates changes in the market. It will introduce the new pricing schemes and tends to be more aggressive in pricing as well as quick in making adjustments.
Standardization versus flexibility. Standardization is self-explanatory. There is a universal price set regardless of the situation. However, flexibility implies that the organization may fluctuate prices based on "segment or user elasticities, time and place of purchase, as well as in response to opportunities for product or service unbundling or bundling, and anticipated or actual moves by competitors" (Pitt & Berthon, 1997, p. 346).

These are the major dimensions in which organizations must make decisions when analyzing and evaluating factors that are important to the pricing strategy. When participating in the entrepreneurial pricing strategy, the dominant factors in the pricing formula are market based, risk assumptive, proactive, and flexible. In order to combat threats and capitalize on opportunities, organizations are encouraged to design pricing structures based on the entrepreneurial pricing strategy. Organizations have to be ready to respond and adapt to a global economy that constantly changes. Pitt and Berthon (1997) created a checklist for marketing departments to assess whether or not they are positioned to transition to an entrepreneurial pricing system.

Viewpoint

International Countertrade. During the Clinton administration, the United States experienced high trade deficits. In order to combat the trend, the administration identified ten emerging markets and committed to assisting American corporations with winning contracts in these areas. The American government created a national exporting strategy that had components such as lowering obstacles to United States exports, developing a responsive trade finance strategy, improving access to trade information, and focusing on key markets and sectors (Paun, Compeau & Grewal, 1997). Unfortunately, these efforts had "no clear and consistent policy stance on international countertrade" (Park, 1990, p. 38). Countertrade occurs when "a seller provides a buyer with products and agrees to take some or all of the payment in a form other than money" (Paun, Compeau & Grewal, 1997, p. 69). As the buyer pool decreases and competition among sellers in the global market increases, sellers will participate in countertrade in order to gain a competitive advantage over noncountertrade bids (Cavusgil & Ghauri, 1990).

Research has shown that countertrade transactions can be very complex, especially when selecting a pricing strategy (Kublin, 1990). Therefore, it is critical for marketing departments to understand pricing strategy as it relates to countertrade (Yoffie, 1984). Pricing is considered to be the primary factor in determining whether or not a countertrade transaction is processed (Cho, 1987). Although exporters wanted to use price as a competitive tool in countertrade, they did not know how to perform this task effectively (Kublin, 1990).

Nagle and Holden (1995) believed that once an organization determined its marketing objectives, there were three potential pricing strategies it could utilize. The three strategies were to sell at premium price, sell at a going-rate or neutral price, or sell at a discount price. Countertrade results are based on the contributions of the buyer and seller on the pricing process. The success of a countertrade transaction occurs when there is an intersection between the seller's and buyer's pricing strategies or expectations. Based on the model that Paun, Compeau, and Grewal (1997) introduced, "a countertrade transaction is more likely to occur when a buyer is willing to pay a price that matches or exceeds the seller's asking price for the countertrade products and less likely to occur when a seller's asking price exceeds what the buyer is willing to pay" (p. 70). In order to close a deal, the difference between the price the seller is seeking and the price the buyer is offering must be minimized. This can occur if the seller lowers the asking price, the buyer raises the offering price, or a combination of both options.

Conclusion

Pricing is one of the four aspects (product management, pricing, promotion, and place) in the marketing mix and directly affects how a product is positioned in the market. It should take into consideration fixed and variable costs, competition, organizational objectives, proposed positioning strategies, target groups, and consumer willingness to pay the price. Many organizations have utilized various factors when determining the pricing strategies for their products and services. However, there are some general guidelines that all share.

Although pricing represents one of the most visible decision factors for marketing teams, it tends to be one of the least creative parts of the marketing strategy (Pitt & Berthon, 1997). Many marketers look at pricing from a functional point, and view it only as a means to cover costs and generate revenue. Others have wrongly assumed that they could not be creative in pricing due to competitor pricing or legal constraints. Miller and Friesen (1983) assert that entrepreneurship is based on three dimensions—innovativeness, assumption of risk, and proactiveness.

The marketing department must come to consensus on issues such as price objectives, price strategy, pricing method, promotions, and discounts. In each category, there are a number of options in which the appropriate selection can be made. However, there is evidence that organizations still need to review their pricing strategy based on four key dimensions. When participating in the entrepreneurial pricing strategy, the dominant factors in the pricing formula are market based, risk assumptive, proactive, and flexible. Pitt and Berthon (1997) have created a checklist for marketing departments to assess whether or not they are positioned to transition to an entrepreneurial pricing system.

Terms and Concepts

Entrepreneurial Pricing: Viewed as the "Cinderella" approach because the strategy deviates from the traditional pricing approaches and takes innovativeness, assumption of risk and proactiveness into consideration when setting prices.

International Counter Trade: Agreement in which one country imports goods from a country to which it exports goods.

International Markets: When the target population is in more than one country.

Penetration Pricing: The lowering of prices so as to increase sales and market share.

Predatory Pricing: Selling products at low prices so as to negatively affect competitors: Could be in order to get rid of them, weaken them for mergers, discipline them or prevent new competitors from entering the market.

Premium Pricing: Pricing that is set high so as to present an air of product exclusiveness.

Price Skimming: Pricing strategy that involves setting prices high initially and then incrementally lowering the price to entice a wider market; objective is to “skim” the market for profits, layer by layer.

Pricing: One of the four elements of the marketing mix; refers to the cost of a product exchange.

Pricing Strategies: Creating a plan for pricing structure so as to reflect consumer wants, product characteristics and competition in a way that generates the most profit.

Bibliography

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Pricing Strategies

On this Page

Subject Terms

Pricing Strategies

Abstract

Overview

Application

Viewpoint

Conclusion

Terms and Concepts

Bibliography

Suggested Reading