pricing strategy

What is Pricing Strategy?

Every company knows that revenues are earned through pricing; while profits are made in purchasing. This is an important distinction- revenue is income from sales (price of the good/service), but profits are directly affected by the cost of those goods at the time they are purchased (the delta between price and cost = profit). This article will focus on the various pricing strategies. Research has shown that many companies don’t conduct the necessary pricing research to establish a solid pricing strategy, which can have a significant effect on revenues… this lack of research results in lower revenues in many cases. Companies typically have a strong buying team because they know that when they drive the cost of their goods down, they enjoy the benefit of better margins/returns on the sale of the goods. However, buying is only half of the puzzle. If a business can't have a team of pricing analysts, then it's important to be aware of pricing tactics and how they can impact, or improve, revenues. Having a well-defined pricing strategy lays the foundation for future pricing decisions and in the competitive market, we need to use all tools available.

Types of Pricing Strategies


There are 3 primary strategies for pricing, as follows: 1) Skimming
2) Penetration
3) Status Quo

 

Price Skimming


Price skimming is a strategy of establishing high prices relative to competitor prices. Skimming is usually an approach used when a product is new, with little competition, and viewed by the consumer as having unique and valuable attributes. Many companies will use this approach, especially when introducing a new product to the market, because they would rather start high to test the market and if necessary adjust the price down. Additionally, companies will use this strategy when they want their brand/product to be perceived by consumers as an elite product. While this may be intuitive, an advantage of starting out with high prices is it allows companies to recoup research and development, and other initial production expenses quicker. This strategy is most successful when demand is greater than supply and when others cannot compete in the market for various reasons, such as; patents, shortages on resources, technological requirements or special skills that are not widely available. Finally, if a skimming strategy is successful it encourages competition due to the higher profit margins.

 

Price Penetration


A penetration pricing strategy is the opposite of skimming; products are priced relatively low compared to competitors. When a company wants to capture a large share of a particular product market, they will establish a low price. One of the benefits to low pricing is selling volume, which facilitates production and logistical economies of scale. Additionally, this increase in demand means an increase in production levels, having a positive effect on the experience curve; in theory, as a firm gains more experience they are able to improve the process and reduce per unit production costs. However, with lower pricing comes lower profit margins which will lengthen the time it takes for a firm to recoup research and development and initial start-up costs.

 

If the product is in a price sensitive market (the product has elastic demand), then a penetration pricing strategy works really well. The lower price will draw more consumers and result in greater demand, and if the market potential is large enough, this growth will justify expansion of production facilities and as a result of increased sales a business may be able to capture greater economies of scale. While a skimming strategy tends to draw competitors as a result of the high prices, penetration has a tendency to deter competitors from entering the market because the margins aren’t attractive enough to justify entry. A major consideration for establishing a penetration pricing strategy is mass producing a product that doesn’t garner the anticipated sales- a company will end up with a large inventory of items that don’t sell.

 

Price Status Quo

 

The status quo strategy is a safe approach to pricing as pricing is comparable to competitor pricing. This can be an effective strategy for a small or new start-up; however, this approach often overlooks demand and cost.

 

In addition to the primary strategies, there are several pricing practices and tactics (it should be noted that 1-3 are considered unethical and not advised):

 

1) Price Fixing
2) Price Discrimination
3) Predatory Pricing
4) Promotional Methods
5) Value Pricing
6) Geographic Pricing
7) Single Price
8) Flexible Pricing
9) Price Lining
10) Leader Pricing
11) Bait Pricing
12) Odd/Even Pricing
13) Price Bundling

 

See also: Unethical Pricing Practices