All About Pricing Strategy

Pricing and customer value are closely linked. Basically stated, the value a customer places in a product and brand is indicated by how much they are willing to give up, usually in the form of money. The price is the monetary value set by an organisation at a level they believe is worthy of their offering. However, if a customer wants a product, but the price is too high, their value analysis of the trade is lower than the price set and they won’t make a trade.

This ‘trade’ for a customer, which is the price set from the perspective of the organisation, comes in many forms, such as rent, tuition, fees, fares, tolls, premiums, commissions, incentives and even bribes. Price is the only element of the marketing mix that produces an income for an organisation in the form of revenue. It is the one part of the marketing mix that is the easiest to adjust quickly, which is as to why organisations often opt to that element to spur a customer response to their offering, over changing the product itself, its promotion, people or distribution methods.

Bribes may be illegal in certain countries and acceptable in others, however in the illegal countries, it may be classed as other things, such as perks and added bonuses.

Who Sets the Price?

It is a typical accounting argument, where an accounting department of an organisation may believe it is their responsibility given that pricing involves monetary terms. This would be all well-and-good if the price was a simple recuperation of costs for the organisation. However, it is not that simple: pricing of a product speaks volumes to consumers.

This is why the task of setting price is with the marketing department: as the consumer receives a whole lot of messaging from the setting of the price alone. It signals to a customer what positioning and image the brand and product has. If it is expensive, often consumers will use it as a surrogate indicator for a judge of quality. This is most common in the wine industry, where higher priced wines are often thought of immediately as better in consumption.

Therefore, marketing manage the price setting tasks as it indicates much more than simply cost plus profit. It isn’t a simple equation- it takes the department familiar with communicating with the target audience, as price is just another communication stream.

Price and Demand

As can be expected, the price of a particular product directly impacts on the amount of demand it receives from customers. The actual relationship is known as the economic term of price elasticity. Whilst in reality, nothing works as simply as economic models suggest, in general, a product with a high price elasticity of demand means that a change in price results in a large, corresponding change in quantity purchased. Luxury and nonessential products tend to be within this category, as a large price increase will greatly drop demand, and visa-versa.

A low price elasticity of demand means that a change in price will not greatly affect demand shifts- this is known as inelastic demand. Less substitutable products and essentials full into these categories as, within reason, when price shifts, consumers still require them.

A more realistic approach to price and demand prediction is more toward the idea of pricing points. For example, if the price is high and quantity is purchased for a luxury brand, and the price is suddenly dropped, initially, the demand would increase as consumers believe there is more value. However dropping the price further may then decrease demand, as consumers start to feel that the luxury brand is losing its exclusivity. This makes demand fall.

All of these types of factors must be taken into account by the marketing department when setting price of their products.

The Pricing Phenomena

As much as economic theory attempts to assume that consumers are rational, they just aren’t when it comes to purchasing. The perceptions of value and price given by an individual consumer is so unpredictable that it takes the function of marketing research to really delve into why consumers think and act as they do.

Take, for example, bridal products. Large organisations over charge for pretty much everything to do with ‘the big day’, however the consumer is more than willing to pay as it’s more of an emotional purchase rather than a rational, ‘utility maximisation’ purchase. A bride doesn’t want a cheaper product, even if it is the same as an expensive version, as they value feeling expensive and exclusive and therefore justify the high prices.

Pricing as an Information Cue

As discussed before, price can be used as a surrogate indicator of quality, even if it’s not true. In the customers mind, higher price raises expectations as the amount they have to trade for it is high. There are two associated pricing techniques relevant to pricing as a communicative device:

(1) Price Skimming- this refers to setting the price very high, thus skimming the very top of the market’s customers. This creates an aura of prestige and/or technologically advanced status and is a good way to recuperate research and development costs, control initial demand and supply and generate high profit. However the product must justify this image if this technique is used.

(2) Price Penetration- this is when a product’s price is set very low to attract high quantities of sales and obtain large uptake in the market before a competitor.

(3) Yield Pricing- setting the pricing to manage exact quantities of purchasing. For example, if stock is perishable, the price may be discounted to increase numbers and then when supply is short, the price rises to manage this.

(4) Volume Pricing- setting a price to ensure high sale/bulk volume purchasing over profit per unit.

(5) Loss Leader- Pricing at a loss per unit to encourage impulse, related purchasing of other products in the same offering.

Pricing strategy all depends on the organisation’s justification and rationalisation of all aspects of their marketing strategy.
 
Pricing and the Psychology Of Consumption

There is a directly psychological relation between pricing/cost and the consumption rationale of a consumer. Most organisations do not draw attention to the price as it represents a cost to the consumer, and they would much rather the consumer benefit from the product’s value rather than them dwelling on how much they paid for it. This makes sense. This is why some organisations offer upfront bulk payments, season passes, bundling and so on.

However, as mentioned previously, consumers aren’t always rationale and sometimes, the constant reminder of cost is motivating for them. Basically, a consumer who doesn’t utilise their purchase will actively make a decision to not rebuy it. This means that charging upfront could make the consumer forget about the product (e.g.: a gym membership), and once they forget, they will not justify a repurchase, however smaller costs more regularly are more manageable in a consumer’s mind and the constant reminder stimulates motivation for consumption, and therefore repeat purchase.

It all depends on the organisation’s product offering and pricing strategy as to what approach they take.

Internal Pricing Factors: Objective Based

There are different types of objectives of consideration when setting a price, aiming to achieve a particular goal.

(1)   Financial
These are strictly about monetary goals, such as setting price to achieve a gross profit margin of 23%, or Return On Investment (ROI) by 12% this year.

(2)   Marketing
These revolve around market and consumer focused goals, such as increasing market share, gaining more consumer awareness or increasing brand loyalty.

(3)   Societal
Pricing is set by the organisation based on managing a societal rationale. For example, adding into the cost a donation to charity, or carbon offsetting.

Internal Pricing Factors: The Marketing Mix

Does the marketing plan and current marketing mix support the proposed price? In other words, is the price set consistent with the expectations a consumer would have given the rest of the product’s attributes. The price must be reasonably consistent and in context with the product’s design, process, distribution, people, reputation, brand and positioning.

Internal Pricing Factors: The Market Classification

Pricing is also very subject to the type of market the product exists in. In a monopoly, there is only one offering organisation, so excusing government regulation, pricing can be set at whatever they wish. In an oligopoly, where there are a two to five large main players in the market, the strategy tends to be a lead and follow pricing strategy, basing price off the movements of the main competitors.

In a perfect competition market, where the product is an identical commodity, the price solely depends on the supply and demand of the time.

In a monopolistic competitive market, which is the typically normal market where many organisations are within a market offering substitutable yet differentiated products, pricing is set based more on each organisation’s marketing plan.

Internal Pricing Factors: Organisational Considerations

Naturally, the management within an organisation decides who best to set the prices of all the elements within the product offering- this is known as the pricing process. Typically, in smaller organisations, price is usually set by management but in larger organisations, it is set by product managers within the marketing team. The most important part is that the person or people that set the price must have well informed insights into the customer and their perception of value.

Revisiting the Concept of Customer Value

Remember that customer value is total benefits over the total costs. Costs include a lot of pricing, such as the initial purchase price, maintenance and repair costs, ongoing fees, installation, training, financing and so on.

The benefits of the product, such as performance, features and quality must outweigh all of the prices and costs to be worth the value to the customer.  

Approaches to Pricing

There are three main approaches to setting a price.

(1)   Cost-Based

Basing the pricing barriers (such as the price floor- the lowest possible price), on how much the product costs to produce. Generally, if fixed costs are quite high, a part of the price is set lower to maximise volume sold. If variable costs are high, price can be set to maximise the per unit margin.

The issue, again, is that this pricing is based on internal measures, rather than on the target market, and could communicate the incorrect message to them. Still, the cost-based approach can be a background consideration.

(2)   Competition-Based

As the name suggests, this is basing it on however the competition prices and differentiating a product based on their pricing strategy. However this assumes that the competitor has a good grasp on the target market.

(3)   Value-Based

This approach bases costs on what level of value the target market places on the product itself. Then, the organisation can employ a price skimming strategy (pricing at the top value), price penetration (pricing at the lowest value) or somewhere in between. This requires a bit of research to discover what attributes and expectations the customer values the most and pricing it on this.

In reality, there should be a blend of the approaches. The price ceiling (or the price point at which demand becomes zero) should be set at the top, and the price floor (or the price point at which profit becomes zero) should be established first. The Price ceiling represents customer perception of value and the price floor represents the consideration for product cost.

The price is then set in the middle, in between these points, with all factors such as marketing strategy, objectives, competitors and market place factors taken into consideration here to find the ideal price.

The Value Based Approach

Basing pricing strategy on the target market is an obvious choice, given the impact price has in communicating with the target market. Through starting with the customer’s value and working backward, a price can be settled on that will allow an organisation to best maximise the price per segment and manage customer value perceptions.

The Gift Economy

With technology increasing so rapidly, a ‘gift-economy’ also referred to often as a ‘free-love’ economy has emerged. This is where an organisation offers their main product as free and finds another solid revenue stream to gain profit from. Search engines are a good example of this, where the search function is free, but the google adword service and other advertisements and services are paid for.

The issue with this is the consumers lose the perception of value when products, such as music and news) are available for free, online. This shift in mind-set is a rapid game changer for a lot of organisations as consumers start to question why they are paying for specific products. For example, years ago, customers would purchase a newspaper, because they saw the value as worth the money, however today, when news is so rapidly available online, they can no longer justify paying for it.

Today, organisations are creating business models where the consumer doesn’t pay and then charges associated organisations for their access to these customers, such as YouTube or social media advertising. 

This has the risk of becoming so extreme that it may get to a point where organisations will pay or reward the customer to use their product, rather the other way around, just to give them access to the customer to sell this onto other organisations for profit.

However, there is a predicted limit with this as over-exposure to secondary ads and the other revenue-gaining ‘add-ons’ will render them ineffective and these secondary organisations will avoid these business models.

The Freemium

This relates to the new pricing technique known as ‘freemium’. A freemium is when an organisation gives the basic level product to the consumer for free and then charges for the premium use of it. This is very evident in free phone apps on smart phones, where the basic app is free to download and use, however the customer must pay to get the ad-free version or open up all of the service for them to use.

The Bait-and-Hook

A pricing technique where the main product is free or extremely discounted, however then the customer must purchase an expensive associated product to utilise the main product. An example of this is office printers, where the printer is given for free, and the customer has to purchase the paper and print ink off the printer’s organisation.  

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