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Marketing Strategy and Price
One of the most important and challenging elements of the marketing mix is pricing. Price is the value that must be exchanged for a customer to receive a product or service. It is usually monetary and has a direct impact on sales. Many entrepreneurs are intimidated by financials and the prospect of using statements and other information to make projections. Correctly pricing your product enables your company to be competitive while maximizing your product’s profit potential.
Here are several methods that entrepreneurs can use to effectively price products:
Cost-Based Pricing
Cost-based pricing is the easiest way to price a product. It involves taking the cost of making the product and creating a profit margin, which is how much profit your business stands to make after costs have been deducted. For example, if you add the direct costs for materials and labor to the indirect costs of salaries, marketing, rent, and utilities, you determine that your product costs $5 to make. Adding, say, a 30 percent profit margin would give you a sales price of $6.50. The percentage added depends on the business’s goals. This type of pricing is helpful when start-ups do not have much information about their target market and need more time to define their value proposition and business identity.
Competition-Based Pricing
Another option to set prices is for the entrepreneur to consider what the competition is doing—what they are charging customers. And remember, it is the competition that establishes the price range for given product/service categories. If you perform your competitive analysis properly, you will know the prices charged by your competitors. In other words, you will be able to establish the current “going rates.”
What you must decide as an entrepreneur is how you will price your products/services given this range. For example, do you wish to be at the high end of the range? Do you wish to be at the low end of the range? Or, do you wish to be at the middle of the range? Now, of course, the key question is how do you know whether to price at the high end, low end, or middle of the range? Well, here is some guidance. For example, if you have a high-quality and highly differentiated product/service, you should probably charge a price at the high end of the price range. If, on the other hand, you are marketing a product/service designed to appeal to the price-sensitive customer, then you will price it at the low end of the price range. If your product/service is similar to your key direct competitors, you will charge basically the same price.
Customer-Based Pricing
Unlike cost-based pricing that emphasizes the cost side of the business, customer-based pricing focuses on the demand side of the business. The price ceiling is the maximum amount that customers are willing to pay for a product. This ceiling is contingent on the elasticity of demand. And elasticity of demand is generally driven by availability of substitutes and the urgency of need for the product (or strong desire for it). So, one thing you need to determine is whether there will be elastic demand (demand that increases as price decreases or demand that decreases as price increases) or inelastic demand (demand does not change if prices increase or decrease) for your product.
One customer-based pricing method, skimming pricing, leverages the newness of a product to justify the highest price possible in order to “skim” the most profits off the top, meaning in the first phase of sales. As time passes, the price is lowered to accommodate for more price-sensitive customers. Apple often introduces its products with this particular method, charging the highest price for them until it has exhausted the market willing to buy at that price and when newer and more technologically advanced products are introduced. Then, Apple slowly lowers its pricing.
On the other hand, penetration pricing (charging a low initial price) is appropriate if you have a market with price-sensitive customers; you want to use the low initial price to discourage competitors from entering the market and when production and marketing costs fall dramatically as demand (volume) increases. However, it may also lead to “price wars” in which competitors keep dropping prices in an attempt to beat each other. Obviously, the disadvantage is diminished profits for all.
If you start with a skimming price strategy, you can, over time, lower your price to attract more price-sensitive customers. However, if you enter the market with a penetration price strategy, it is often very difficult to raise your prices. In other words, while you can move down the going price range with a skimming price strategy, you may not be able to move up the going price range if you initially used a penetration price strategy.
Prestige pricing involves setting high prices on products to convey a message of uniqueness or premium quality. However, you need a clear reason why customers would want to spend more on your product. When Duracell launched its high-performance Ultra brand AA alkaline battery with a 25 percent price premium over standard Duracell batteries, Energizer quickly countered with its own high-performance battery—Energizer Advanced Formula. Believing that consumers would not pay the premium price, Energizer priced its Advanced Formula brand at the same price as its standard AA alkaline battery, expecting to gain market share from Duracell. It did not happen. Why? Consumers associated Energizer’s low price with inferior quality in the high-performance segment. Energizer lost market share.
Some customers are demanding better value (increased benefits at the same price). Therefore, many new ventures appeal to this type of customer using value-based pricing. For example, they might offer customers “better value” by offering a greater quantity of product at the same price as competitors. A startup yogurt company, for example, offers 20 percent more product per package at the same price as a competitor that offers the standard amount. Another value-based pricing strategy is bundling two or more products in a single package deal, thus lowering the total cost compared to if the customer purchased each item separately. An example of this strategy is used by DirectTV, which bundles its phone, Internet, and satellite services for a monthly fee. If a customer were to purchase these services separately, they would be more expensive. The benefits of bundling include gaining more revenue per customer, as they would not have paid for some services separately, and making the order-taking task simpler. Take fast-food chains, for example. Instead of asking the customer to list everything separately from the menu, they give you the name or number of the bundle. They make more profit by including the drink and sides to the main entrée, and the customer saves money and time ordering.
One of the good things about using a customer-based pricing approach is that you should be able to determine the “target price” based on the customer's perspective. Knowing this target price, you can then “back into that price.” In other words, you can “design to price.” For example, an upstart commercial furniture manufacturer used customer input to establish the optimal price point that customers were willing to pay for particular furniture pieces. The company then went back and pulled costs out of its production system, stripped away costly features the customers do not value, and designed and produced the product to meet the customers’ target price.
Another advantage of using a customer-based pricing approach is the possibility of uncovering the opportunity to “price by segment” and to offer “good, better, best” product options. In other words, you might be able to develop a line of products with specific price points designed to appeal to very specific segments. For example, consider a casual clothing store for women that sells three different lines of casual dresses priced at $39, $59, and $79. This practice is known as price lining.
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Ultimately, you need to consider cost, competitors, and customers when setting prices. You must know your price floor (your cost), know what your competitors are charging (the price range), and know your customers’ willingness and ability to pay (the price ceiling). While pricing must be established when starting a new business, pricing strategies should be reviewed on an ongoing basis. These occasions in particular merit consideration:
When adding a new product or service to your offerings
When demand shifts (due to market, consumer, or other factors)
When entering a new market
When competitors are making changes
When your costs are changing
When adjusting products/services or strategies
