What is a pricing strategy and what are the factors that influence it?
A pricing strategy is a way to set the price of a product or service based on a number of factors, including:
- The level of competition
- Variable costs
- Consumer demand and ability to pay
- Brand image
- Product quality
- Market conditions
- Cost of manufacturing.
A starting point for determining what you need to charge is the cost to produce and deliver your product or service. If you can’t cover your costs, then you won’t survive in business. Check out our article on Breakeven Analysis for SMEs to learn about the variables that determine your breakeven point.
Once you know what you need to cover your costs, you can consider other factors such as market conditions and how customers feel about your brand. While making profit is the basic objective, other factors include where you want to be positioned in the market, how competitors are positioned and your ability to meet demand.
When using this strategy for product pricing, you add a small margin to the costs of producing and distributing your products or services. Use the cost of goods sold formula to determine the costs of your products and add the fixed costs that are connected to them to determine total costs. Applying the cost-based pricing strategy should enable you to offer a competitive price while staying profitable.
Using this method for services, you calculate the relevant business costs at an hourly rate and add in a profit margin. You will want to include all costs, including wages, superannuation, and annual leave.
The goal of this type of pricing is to attract new customers by offering lower prices than competitors. For a new and unknown business, this is a way to get products and services into the market. This is meant to be a short-term marketing strategy to attract customers and gain market share. After building brand awareness and loyalty, the goal of the penetration pricing strategy is to raise prices closer to competitors and become profitable. One risk of this strategy is that price-sensitive customers won’t buy the product or service at a higher price.
With this strategy, you strip back the frills and minimise marketing and production costs to provide a basic product or service at a lower price. Common examples are the generic products in your supermarket. A few businesses using this model in Australia include Aldi, Kmart and Ibis Budget Hotels. By minimising expenses, these businesses can offer lower prices while still being able to turn a profit.
Economy pricing can be used by large businesses because they have the economies of scale to minimise costs. For example, they can buy inputs in bulk to reduce the cost or create highly efficient business models that reduce their cost. Usually, smaller businesses aren’t able to achieve these economies of scale, so they can’t apply this strategy effectively.
As the opposite of economy pricing, businesses using this model can charge high prices because they have an exceptional brand or unique product. Examples of brands that use premium pricing include Mercedes, Nespresso and Ray Ban. Some businesses offer both standard and premium products as options. For instance, Toyota created the Lexus brand in the 1980s to offer a premium product. In order to charge premium prices, you need to deliver the quality and experience (and create the perception) that justifies premium pricing.
With a skimming pricing strategy, also known as price skimming, you start out with a high price and lower it later. This can be used for products that are unique or in high demand. An example of the skimming strategy is iPhones. New models have a high initial price for iPhone fans who want the new model immediately. Over time, the price is lowered. This model can be used when early adopters are willing to pay more for a new product. As other businesses enter the market with similar products, prices can be lowered to remain competitive.
With this pricing strategy, also called value-based pricing, you price the product on its perceived value, rather than the cost of producing it. Examples of value pricing include Starbucks and DeBeers. By creating a perception of value, these businesses are able to charge premium prices for coffee and diamond jewellery.
In the case of DeBeers, a long-running advertising campaign has associated diamonds with luxury, durability and commitment. Although the tradition of engagement rings can be traced back to Ancient Rome, it wasn’t until the late 1940s when De Beers launched its “A diamond is forever” campaign that the popularity of diamond engagement rings skyrocketed (along with the price).
This pricing strategy can be used when you have a core product that’s connected to other products needed to make the other product work. One captive pricing strategy example is printer cartridges. Manufacturers sell printers at low profit margins with the aim of selling high-priced replacement printer cartridges. While you can find cheaper third-party versions, some printers include technology that renders third-party cartridges inoperable. Printer manufacturers also state that using third-party cartridges will void the warranty.
Another example of captive pricing is food and beverages at amusement parks. Since you can’t leave the venue, or it’s too inconvenient, the operator can charge exorbitant prices for mediocre food.
Dynamic pricing is when prices for products or services are charged based on times and conditions. One example is the airline industry which charges different prices based on the time of year. Ticket prices are raised when demand is high – such as during Christmas and school holidays – and lowered when demand is lower. The same applies to holiday accommodation, with peak, shoulder and low season rates.
First steps for determining pricing strategies
While there are many ways you can set pricing for products or services, you will need to consider which are most practical and beneficial for your business. A good place to begin is by including pricing strategies in marketing planning. Keep in mind that your pricing strategy is not set in stone and should be adapted as business and market conditions change.