Pricing strategies
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There are many ways in which the price of a product can be determined. The following are the foremost strategies that businesses are likely to use.
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[edit] Competition-based pricing
Setting the price based upon prices of the similar competitor products.
Competitive pricing is based on three types of competitive product:
- Products have long distinctiveness from competitor's product. Here we can assume
- The product has low price elasticity.
- The product has low cross elasticity.
- The demand of the product will rise.
- Products have perishable distinctiveness from competitor's product, assuming the product features are medium distinctiveness.
- Products have little distinctiveness from competitor's product. assuming that:
- The product has high price elasticity.
- The product has some cross elasticity.
- No expectation that demand of the product will rise.
The pricing is done based on these three factors.
[edit] Cost-plus pricing
Cost-plus pricing is the simplest pricing method. The firm calculates the cost of producing the product and adds on a percentage (profit) to that price to give the selling price. This method although simple has two flaws; it takes no account of demand and there is no way of determining if potential customers will purchase the product at the calculated price.
Price = Cost of Production + Margin of Profit.
[edit] Creaming or skimming
Selling a product at a high price, sacrificing high sales to gain a high profit, therefore ‘skimming’ the market. Usually employed to reimburse the cost of investment of the original research into the product - commonly used in electronic markets when a new range, such as DVD players, are firstly dispatched into the market at a high price. This strategy is often used to target "early adopters" of a product/service. These early adopters are relatively less price sensitive because either their need for the product is more than others or they understand the value of the product better than others. This strategy is employed only for a limited duration to recover most of investment made to build the product. To gain further market share, a seller must use other pricing tactics such as economy or penetration.
[edit] Limit pricing
A Limit Price is the price set by a monopolist to discourage economic entry into a market, and is illegal in many countries. The limit price is the price that the entrant would face upon entering as long as the incumbent firm did not decrease output. The limit price is often lower than the average cost of production or just low enough to make entering not profitable. The quantity produced by the incumbent firm to act as a deterrent to entry is usually larger than would be optimal for a monopolist, but might still produce higher economic profits than would be earned under perfect competition. The problem with limit pricing as strategic behavior is that once the entrant has entered the market, the quantity used as a threat to deter entry is no longer the incumbent firm's best response. This means that for limit pricing to be an effective deterrent to entry, the threat must in some way be made credible. A way to achieve this is for the incumbent firm to constrain itself to produce a certain quantity whether entry occurs or not. An example of this would be if the firm signed a union contract to employ a certain (high) level of labor for a long period of time.
[edit] Loss leader
Loss Leader:
In the majority of cases, this pricing strategy is illegal under EU and US Competition rules. No market leader would wish to sell below cost unless this is part of its overall strategy. The idea of selling at a loss may appear to be in the public interest and therefore not often challenged. Only when the leader pushes up prices, it then becomes suspicious. Loss leadership can be similar to predatory pricing or cross subsidisation; both seen as anticompetitive practices.
[edit] Market-oriented pricing
Setting a price based upon analysis and research compiled from the targeted market.
[edit] Penetration pricing
The price is deliberately set at low level to gain customer's interest and establishing a foot-hold in the market.
[edit] Price discrimination
Setting a different price for the same product in different segments to the market. For example, this can be for different ages or for different opening times, such as cinema tickets.
[edit] Premium pricing
Premium pricing is the practice of keeping the price of a product or service artificially high in order to encourage favorable perceptions among buyers, based solely on the price. The practice is intended to exploit the (not necessarily justifiable) tendency for buyers to assume that expensive items enjoy an exceptional reputation or represent exceptional quality and distinction.
[edit] Predatory pricing
Aggressive pricing intended to drive out competitors from a market. It is illegal in some places.
[edit] Contribution margin-based pricing
Contribution margin-based pricing maximizes the profit derived from an individual product, based on the difference between the product's price and variable costs (the product's contribution margin per unit), and on one’s assumptions regarding the relationship between the product’s price and the number of units that can be sold at that price. The product's contribution to total firm profit (i.e., to operating income) is maximized when a price is chosen that maximizes the following: (contribution margin per unit) X (number of units sold).
[edit] Psychological pricing
Pricing designed to have a positive psychological impact. For example, selling a product at £4.95 rather than £5.
[edit] Dynamic pricing
A flexible pricing mechanism made possible by advances in information technology, and employed mostly by Internet based companies. By responding to market fluctuations or large amounts of data gathered from customers - ranging from where they live to what they buy to how much they have spent on past purchases - dynamic pricing allows online companies to adjust the prices of identical goods to correspond to a customer’s willingness to pay. The airline industry is often cited as a dynamic pricing success story. In fact, it employs the technique so artfully that most of the passengers on any given airplane have paid different ticket prices for the same flight.
