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Pricing

Marketing is the act of inventing the product. The effort of designing it. The craft of producing it. The art of pricing it. The technique of selling it."

- Seth Godin

Have you ever considered a product and thought, "That is not worth the price!"? Although you may not be willing to pay £400 for a perfume bottle, several people do. Certain customer segments might consider this a reasonable price for the quality of the product, the type of fragrances used, and the branding. Thus, marketers take advantage of these customer perceptions and accordingly create pricing strategies. Although perceptions may play a role in pricing, there is much more to pricing. Read along to understand what goes on behind the scenes of pricing strategies.

Pricing definition

To understand pricing strategies, we first need to look at the definition of pricing.

Price is the amount of money expected and given in exchange for a good or service.

Pricing can also be defined as the value customers sacrifice to benefit from receiving and using a good or service. Price is, therefore, the element of the marketing mix that leads to revenues, unlike the other elements which incur costs. Pricing is also important as a strategic tool as it creates customer value.

Different types of pricing objectives

Before deciding on a pricing strategy, the company needs to consider its pricing objectives. Pricing objectives should be aligned with the company's overall marketing and corporate objectives. Some of the different types of pricing objectives may include:

  • Attracting new customers to increase revenues,

  • Retaining existing customers,

  • Preventing competitors from entering the market,

  • Preventing competitors from gaining market share,

  • Attracting customer attention to the release of a new product or brand,

  • Increasing sales of a specific product line.

Pricing Pricing objectives StudySmarterFig. 1 - Pricing Objectives

Pricing strategies

Now that we have defined pricing, let's look at the three key pricing strategies: customer value-based pricing, cost-based pricing, and competition-based pricing.

Customer value-based pricing

The idea behind customer value-based pricing is to price a product based on the value it brings to customers rather than the cost of producing it. Thus, the pricing decision starts by examining customer value - how much the product is worth to customers. The steps of value-based pricing are as follows:

  1. Understand customer value perception and needs.

  2. Set target price to match perceived value.

  3. Analyse costs.

  4. Create a product that matches the target value at the target price.

Within value-based pricing, there are two further pricing approaches.

The first is good-value pricing.

Good-value pricing involves offering a quality product and good service at a reasonable price.

The other approach is value-based pricing, which includes adding value through product features and services to justify the higher prices.

Cost-based pricing

The second main pricing strategy is cost-based pricing. Cost-based pricing involves setting prices based on the costs incurred by producing and marketing the product. This pricing method sets a floor price - a minimum price a company should charge to recover costs. Three types of costs considered for this approach are:

  • Fixed costs (overhead),

  • Variable costs,

  • Total costs.

One common cost-based pricing method is cost-plus pricing.

Cost-plus pricing involves adding a pre-set mark-up to the cost of producing a product (e.g. adding a 20% mark-up).

Another approach to cost-based pricing is break-even pricing. This pricing method is based on finding the break-even point whereby the firm recovers all production and marketing costs.

The following formula is used to calculate the break-even volume:

Competition-based pricing

The final primary pricing strategy is competition-based pricing.

Competition-based pricing involves setting prices based on competitors' pricing strategies.

To use this approach, a company has to examine its competitors and their strategies, including:

  • Competitors' market offering,

  • Customers' value perception of competitors' offerings,

  • Competitors' current pricing strategies,

  • How strong/weak competitors are,

  • Whether there is a niche/underserved market.

Types of pricing

Beyond the three main strategies outlined previously, there are other types of pricing. One important thing to note is that pricing strategies often change. The change can be brought about by a product's life cycle, new product mixes, or changing environments and situations. Let's now take a look at some additional pricing strategies.

New product pricing strategies

New product pricing strategies are related to the product life cycle. New product developments can put companies in challenging situations when it comes to pricing. As a result, companies have to choose from the two pain new product strategies:

  1. Price skimming - involves setting a high price initially as the product is introduced to the market to maximise revenues. Due to the high price, the company makes fewer sales at a higher profit margin. Eventually, as new product variations and models are introduced, the company will decrease the original product's price.

  2. Penetration pricing - involves setting a low initial price to attract many buyers and increase market share. As prices are low, profit margins may also be lower, but due to the high number of sales, the company's costs will fall, allowing it to decrease its prices even further.

Product mix pricing strategies

On the other hand, product mix strategies are used as sometimes companies have to change their pricing when a product is part of a product mix. The five product mix pricing types are as follows (see Figure 2 below):

  1. Product line pricing - involves determining the price steps to be set between different products in a product line. These price steps should be determined based on cost and value differences.

  2. Optional product pricing - involves setting prices for optional or additional products that come with the original product, also known as add-ons and accessories. Examples include specific types of rims when purchasing a car.

  3. Captive product pricing - is similar to optional-product pricing, except the products are accompanied by another product—for example, ink cartridges for a printer or filters for a water filtering jug.

  4. Byproduct pricing - involves determining a price for the byproducts derived from the production of the main product. This can help the company recover costs and even make extra profits. For example, farmers can turn their vegetable resin into biodegradable plastic.¹

  5. Product bundle pricing - involves combining various products into a product bundle and setting the bundle price lower than what the price would be for buying each product individually.

Pricing Product Mix Pricing Strategies StudySmarterFig. 2 - Product Mix Strategies

Price adjustment strategies

Companies often have to adjust their pricing strategies with situational and environmental changes. However, this is not a simple task as there are seven different types of price adjustment strategies:

  1. Discount/allowance pricing - including cash discounts (e.g. 5% discount if the bill is paid within the first ten days) or trade allowances (e.g. a discount if you return your old machine when buying a new one).

  2. Promotional pricing - adding a discount to a product to increase sales volume (e.g. a 20% discount limited time offer).

  3. Segmented pricing - charging different prices for different geographical, product, or customer segments (e.g. students get 20% off).

  4. Geographical pricing - setting different prices for customers in different countries or cities. For example, a standard Netflix subscription in the UK is £10.99; in Egypt, it is EGP 165 (around £7.20).²

  5. Psychological pricing - involves considering the psychology behind pricing. Customers may be willing to pay a higher price for a product perceived as good quality.

  6. Dynamic pricing - constantly monitoring and adjusting prices to match customer demand and needs.

  7. International pricing - setting prices in different countries based on market factors such as economic conditions, political conditions, legislation, etc.

Examples pricing strategies

Let's now take a closer look at some examples of pricing strategies. For instance, let's consider how Apple adjusts its pricing. When the iPhone 12 first came out, its price was around £800-£1,000. After several months, Apple released newer models - the iPhone 13 and iPhone 13 Pro - and the price of the iPhone 12 dropped to around £600. This is an example of price skimming. Apple sets a high price when a new product is first introduced. Later on, as more recent models of the iPhone are developed and launched, the company gradually decreases the price of its older models.

Another example of pricing strategies can be observed through museum ticket prices. For example, to enter the Van Gogh Museum in Amsterdam, you must pay €19; however, if you have a valid student card, you only pay €10 to enter. On the other hand, if you are under 18 or have a museum card, other museum passes, or memberships, you can join for free. This is an example of segmented pricing as different customer groups (segments) are charged different entry prices. Therefore, depending on the company's industry, it can use various pricing strategies to encourage customers to purchase its product.

Pricing - Key takeaways

  • Price is the amount of money expected and given in exchange for a good or service. Pricing objectives should be aligned with the company's overall marketing and corporate goals.
  • There are three main pricing strategies: value-based pricing (based on customer value), cost-based pricing (based on production costs), and competition pricing (based on prices set by the competitors).
  • New product pricing strategies include price skimming and penetration pricing.
  • There are five product mix pricing strategies: product line, optional product, captive product, byproduct, and product-bundle pricing.
  • Companies often have to adjust their pricing strategies with situational and environmental changes. The seven price adjustment strategies include discount, promotional, segmented, geographical, psychological, dynamic, and international pricing.

References

  1. Stephen West. 10 Seemingly Useless By-Products That Made Millions. Listverse. 2013.
  2. Netflix. Plans and Pricing. 2022.

Frequently Asked Questions about Pricing

Pricing can be defined as the value customers sacrifice to benefit from receiving and using a good or service. Price is, therefore, the element of the marketing mix that leads to revenues, unlike the other elements which incur costs

The four main types of pricing include customer value-based pricing, cost-based pricing, competition-based pricing, and new product pricing strategies.

For example, when Apple released the iPhone 12, its price was around £800-£1,000. After several months, Apple released newer models - the iPhone 13 and iPhone 13 Pro - and the price of the iPhone 12 dropped to around £600. This is an example of price skimming.

Numerous factors may affect pricing. Examples include the stage at which a product is in its life cycle, the customer segment that is being targeted, the geographical location of the product, how competitors price the product, etc.

Pricing is important for business as 'price' is the only element of the marketing mix that leads to revenues, as opposed to the other elements which incur costs. Pricing is also important as it is a strategic tool businesses can use to create customer value.

Final Pricing Quiz

Question

Define 'price'.

Show answer

Answer

Price is the amount of money expected and given in exchange for a good or service.

Show question

Question

Price is the only element of the marketing mix that leads to costs, unlike all the other elements which lead to revenues.

Show answer

Answer

False

Show question

Question

Name two pricing objectives.

Show answer

Answer

Any of: 


  • Attracting new customers to increase revenues,

  • Retaining existing customers,

  • Preventing competitors from entering the market, 

  • Preventing competitors from gaining market share,

  • Attracting customer attention to the release of a new product or brand, 

  • Increasing sales of a specific product line. 

Show question

Question

The three main pricing strategies are:

Show answer

Answer

Value-based pricing

Show question

Question

Good-value pricing involves adding value through product features and services to justify the higher prices.


Show answer

Answer

False

Show question

Question

Cost-plus pricing involves adding a pre-set mark-up to the cost of producing a product.


Show answer

Answer

True

Show question

Question

What is break-even pricing?

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Answer

Break-even pricing is based on finding the break-even point whereby the firm recovers all production and marketing costs.

Show question

Question


Fill in the blank.


Show answer

Answer

Break-even volume

Show question

Question

_________ involves setting prices based on competitors' pricing strategies.

Show answer

Answer

Competition-based pricing

Show question

Question

Name two aspects companies have to consider when using competition-based pricing.

Show answer

Answer

Any of: 


  • Competitors' market offering,

  • Customers' value perception of competitors' offerings,

  • Competitors' current pricing strategies,

  • How strong/weak competitors are,

  • Whether there is a niche/underserved market. 

Show question

Question

Product mix pricing strategies are related to the product life cycle. 


Show answer

Answer

Flase

Show question

Question

__________ involves setting a high price initially as the product is introduced to the market.

Show answer

Answer

Price skimming

Show question

Question

___________ involves setting a low initial price to attract many buyers and increase market share.

Show answer

Answer

Penetration pricing 

Show question

Question

Product line pricing involves determining the ________ that should be set between different products in a product line. 


Show answer

Answer

Price steps

Show question

Question

Which of the following statements is correct?


I. Optional product pricing involves setting prices for optional or additional products used with the original product. 


II. Byproduct pricing can help the company recover costs and sometimes even turn it into a profitable product. 

Show answer

Answer

Only statement I. is correct

Show question

Question

There are ____ key price adjustment strategies.

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Answer

7

Show question

Question

Charging different prices for different geographical, product, or customer segments is known as ________ .


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Answer

segmented pricing 

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Question

The idea that 'customers may be willing to pay a higher price for a product that is perceived to be of good quality' is the foundation of which pricing method?


Show answer

Answer

Psychological pricing

Show question

Question

Setting prices in different countries based on market factors such as economic conditions, political conditions, legislation, etc. is known as _______ .


Show answer

Answer

international pricing

Show question

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