Understanding the 7 Most Important Pricing Strategies.

Why is Price important to the marketing mix? Is pricing strategy really a marketing function, or is it something that operations should be handling?

The quick and easy answer to these questions is Price is a cornerstone to the 7 P’s of the marketing mix, and pricing strategy can influence a product or service’s brand just as much as the other 6 P’s.

What are the 7 P’s? These include Product, Price, Place, Promotion, People, Process, and Physical Evidence. When developing your marketing plan, you should address these components as they can be differentiators for your product (we will use product as a single term to include both products and services). Some Ps will be more important than others, but they must all be addressed.

So why is pricing strategy one of the 7 P’s? Well, price can influence how you perceive a product, sometimes even more than packaging.

Does Price Really Matter?

Imagine you have your significant other’s parents over for the first time. You see two bottles of California Merlots that both have a 93 rating. Which are you buying?

They are rated the same, so the wise decision is the $9 bottle.

No, you don’t want their parents to think you are cheap or didn’t care enough to buy a “nice” bottle of wine. You buy the $29 bottle to show how important this meeting is.

Shouldn't Operations or Finance Determine Price?

Well, yes and no. Price is a collaborative effort, but marketing plays a far more significant role than many realize.

When developing your pricing strategy, you need to accomplish three things:

Be profitable and achieve the company’s financial goals
Customers must be able and willing to pay the price
Support the product’s positioning in the marketplace

The last two points are obvious about how marketing plays a crucial role in determining a product’s price. But marketing is even critical in the first criterion, even though it may seem like the responsibility of the bean counters.

There are pricing strategies where there may be better options than profitability. You may be asking yourself, why would you ever choose not to be profitable when pricing a product?

Surprisingly there are many reasons profitability doesn’t drive proper pricing strategy, such as a product launch, competition for market share, or to drive additional purchases. It is crucial as a marketer; you are involved in the pricing discussions.

The Power of One

McKinsey conducted a study that shows the impact price has on profitability versus manipulating other levers. Setting the right price is the quickest and most powerful method for managers to boost earnings. Take into account the standard income statement for an S&P 1500 firm: if volumes remain constant, a 1 percent price increase would lead to an 8 percent surge in operating profits. This effect is nearly 50 percent more significant than a 1 percent reduction in variable expenses such as materials and direct labor, and over triple the impact of a 1 percent volume growth.

Regrettably, pricing is a double-edged sword. A 1 percent drop in average prices would inversely affect operating profits, reducing them by the same 8 percent if other elements stay unchanged. Managers might expect that increased volumes would make up for the revenue loss from lower prices, thereby enhancing profits, but this is seldom the case.

To further explore the typical S&P 1500 financial dynamics, volumes would need to increase by 18.7 percent just to counterbalance the profit influence of a 5 percent price reduction. It is incredibly uncommon for demand to be so sensitive to price decreases. Therefore, a plan that relies on lowering prices to boost volumes and consequently raise profits is typically destined for failure across nearly all markets and industries.

Price in the Marketing Mix

Marketers focus on the other P’s, and Price is almost an afterthought. Things like Promotion, Product, or Physical Evidence involve “doing.” These are activities and often exercise creativity. Pricing strategy involves Excel, math, and dealing with overly-brained team members. Working on Price strategy simply isn’t as much fun as the other marketing mix components.

So first, what is Price?

The simple definition of price is the amount of money a buyer (consumer) must spend to receive a product or service.

Price sometimes is not a monetary value but rather an exchange of products and services in exchange for other products and services, which is called barter. We will save the barter discussion for another day.

If you set your price too low, you won’t cover your costs and if you set your price to high, you will lose sales.

Now that you know what price is, the next question is, how does it fit in the Marketing Mix?

Price differs from the marketing mix’s other elements because price is the only component that directly creates revenue. The others are expenses, or as I prefer t call them, investments.

Price also is far more fluid than the other Ps of the Marketing Mix. Adjust price rather rapidly while changing the other Ps are usually long-term efforts.

For example, if you want to change your Product, it will take a while to decide what the change is, then more time to refine and test before you can go to market. In some cases, this can be done in months, while it may take as long as years.

However, if you are in a meeting with your executive team, you can decide to change the price of your product and walk out of the meeting and implement it. Sure, there are some logistics, like having the development team change the price on your website or sending an email to the sales team, but essentially you can change Price instantly.

Price Is a critical strategic lever in the Marketing Mix. You can use Price to:

Create a brand’s position in the market
Introduce a new product
Recoup R&D
Steal market share
Reduce excess inventory
Maximize revenue
Maximize margins
Sales growth
Keeping the lights on

Pricing Strategies

Now that we have established that Price is an important element in the Marketing Mix, let’s discuss the various pricing strategies.

You can utilize several strategies when determining the price of your product or service.

Cost-Plus Pricing

Cost-plus pricing is the most common and straightforward pricing strategy out there. Cost-plus is based on the fundamental business premise of selling something for more than it costs to make it. This works for every type of business, from the lemonade stand you had in 2nd grade to major infrastructure construction.

To determine your Price utilizing the cost-plus strategy, you simply take the cost of your product (material costs, labor costs, overhead) and add a percentage markup. The markup can be based on management decisions or sometimes the client dictates, especially in government contract bidding.

There is no correct markup. This can be as low as 2% for a high-volume commodity product to 1000% for a hammer for the Military.

The formula for determining your Price utilizing a cost-plus strategy is easy to calculate. First, add your material, labor, and overhead (fixed costs) costs together. Then multiply this amount by (1 + the markup amount).

To help illustrate this pricing strategy, let’s imagine we are Lazy Dog Beds and are asked to price a new dog bed. We start by figuring out the costs of making a single dog bed.

Material Costs: $10
Labor Costs: $20
Fixed Costs: $5

The total cost of the new dog bed is $35. Your management team has determined the appropriate markup should be 75%. Therefore to calculate your selling price:

Selling Price = $35 X (1+.75)

Selling Price = $35 X (1.75)

Selling Price = $61.25

Some advantages to cost-plus pricing include its simplicity and predictability. The main difficulty is figuring out your product or service’s cost. While it may seem intimidating, it isn’t that bad. Promise.

Cost-Plus is also an excellent strategy if you don’t have the resources or knowledge required for other strategies. It will ensure you are, at the very least, covering your costs.

While simple and predictable, there are several disadvantages to cost-plus pricing. First, It does not consider the customer, what they are willing to pay, or what the competition charges. Secondly, it could be a better strategy for services, as those costs are far more ambiguous than manufacturing.

It can also lead to inefficiency in your operations. With the product being profitable, an organization often fails t continually look for ways to increase efficiencies that can lower production costs.

Competition-Based Pricing

While cost-plus does not consider any outside factors, such as the price of similar products or services, competitive-based pricing, as the name implies, looks primarily at what the market price is.

To develop a competitive-based pricing strategy, you must understand how your competitors are pricing their product and service. You also need to understand the differentiators between you and your competitors.

It is important to know that consumers generally look for the best value outside of a commodity, not necessarily the lowest price. Therefore, the more you understand your benefits and how they compare with your competitors, the more likely you will pinpoint the right price.

To pinpoint the right price effectively, you must do a fair amount of research.

First, determine who your competitors are. This may seem easy, but a market often has several subsets. Figure out who the overall competition is and who your specific competition is.

Then you map each of the competitors based on their price and features.

After this, average the price of the overall competition as well as any key subsets you have determined to be important.

Finally, plot the highest, lowest, and average prices; these three data points will be used to determine your pricing.

Pricing on the higher end will result in fewer sales but at a higher margin. It will also signal to consumers you are a premium product in your competitive set,

Pricing on the lower side can lead to stealing market share and higher volume. But obviously, this comes at a lower margin. It can also position you as a more inferior quality product, though through packaging and messaging, you can counter this.

Lastly, you can be around the average, which will have you relying on the other P’s of your marketing mix to acquire market share. For example, you could be like Zappos and have excellent customer service and a generous exchange policy.

All three can be effective pricing strategies based on your situation.

One of the most significant advantages of competitive-based pricing is knowing your pricing will always remain relevant to your customers and won’t be a reason they are going to a competitor.

Another advantage is by understanding what the customer is willing to pay, you can prevent yourself from underpricing your product or service. Often we undervalue ourselves out of fear. Competitive-based pricing removes that emotional fear with good ol’ data-driven decision-making.

Competition-based pricing strategy focuses on external factors and doesn’t consider internal ones. This is the primary disadvantage of this strategy.

As a result, you may have to offer your product at a price below an acceptable margin or even lower than your cost of production to compete with the others in your market space on price.

Another risk in basing your truth on the pricing of your competitors is you run the risk that your competitors didn’t price their product or service correctly. They may have undervalued themselves, so you are now charging a lower price than the consumer is willing to pay.

I don’t ever suggest you price gouge, but leaving money on the table is a Cardinal Sin in business.

Price Skimming

Price skimming is a strategic pricing approach businesses adopt, particularly when introducing new or innovative products. This pricing strategy involves setting a high initial price for a product, targeting early adopters, and gradually lowering the price over time to capture more price-sensitive consumers. The primary goal of price skimming is to maximize profits by capitalizing on the product’s novelty and the willingness of early adopters to pay a premium.

The price skimming strategy is primarily effective in markets with high price elasticity, where demand is sensitive to price fluctuations. It is particularly suitable for products with high innovation, limited competition, and a strong brand presence. These conditions enable the company to command a higher price for its product without losing substantial market share.

However, price skimming also comes with potential drawbacks. One notable disadvantage is the risk of alienating potential customers unwilling or unable to pay the high initial price, leading to negative perceptions of the brand as elitist or overpriced. Setting a high initial price can also invite competition, as rival companies may enter the market with similar or more affordable products.

This increased competition can erode the company’s market share using price skimming, forcing them to lower prices earlier than planned, negatively impacting profitability. Moreover, the gradual price reduction may cause some customers to delay their purchases, waiting for the price to drop further, which can slow down sales momentum.

Price Skimming in Action

A classic example of price skimming in action is the launch of Apple’s iPhone. When the first iPhone was introduced in 2007, it came with a premium price tag of $599 for the 8GB model. The innovative features, such as the touch-screen interface and sleek design, combined with Apple’s strong brand presence, allowed the company to justify the high initial price.

Early adopters were willing to pay this premium, allowing Apple to profit from their enthusiasm. As time passed and introduced new iPhone models, Apple reduced the price of older models, making them more accessible to price-sensitive consumers while maintaining its premium brand image.

Price skimming can be an effective pricing strategy for businesses with innovative products, strong brand presence, and limited competition, as it maximizes profits, creates a perception of exclusivity, and caters to diverse consumer segments.

However, it is crucial to weigh the potential risks, such as alienating customers, attracting competition, and slowing sales momentum, before implementing this approach. Companies must carefully assess their target market, product offering, and competitive landscape to determine if price skimming is the optimal pricing strategy for their business.

Price Penetration

Another pricing strategy is Price Penetration. Price penetration is a popular pricing approach businesses employ, particularly when introducing new products or entering new markets. This pricing strategy involves setting an initial price lower than the market average, aiming to capture a substantial market share by attracting a large volume of price-sensitive consumers.

The primary objective of price penetration is to achieve rapid market penetration, foster customer loyalty, and leverage economies of scale to maintain or enhance profitability.

The price penetration strategy is especially effective in markets characterized by intense competition, price-sensitive consumers, and low product differentiation. By offering products at a lower price, businesses can attract a more extensive customer base, drive brand awareness, and create a strong foundation for long-term growth. Furthermore, the increased sales volume can lead to economies of scale, enabling businesses to lower production costs and maintain competitive prices.

However, price penetration also has its drawbacks.

One significant disadvantage is the risk of compromising brand perception, as consumers may associate the low price with inferior quality. This negative association can be challenging to overcome, even if the company decides to raise prices later.

The lower initial price may also limit the profit margins, requiring the company to generate substantial sales volumes to ensure profitability. This reliance on high sales volume can pressure the production and distribution systems, potentially leading to logistical challenges.

The launch of Netflix’s streaming service is an excellent example of price penetration. When Netflix introduced its streaming service in 2007, it offered a low subscription price compared to traditional cable television providers. This competitive pricing, combined with a user-friendly platform and a wide selection of content, allowed Netflix to capture a significant market share rapidly. The company’s aggressive pricing strategy enabled it to establish a strong foothold in the market and ultimately disrupt the traditional television industry.

As Netflix grew its subscriber base, it leveraged economies of scale to expand its content library and invest in original programming, further enhancing its value proposition. Despite increasing competition from other streaming services, Netflix’s early market penetration and customer loyalty enabled it to maintain its leadership position in the industry.

Price penetration can be an effective pricing strategy for businesses operating in highly competitive markets with price-sensitive consumers and low product differentiation. By offering lower-priced products, companies can achieve rapid market penetration, foster customer loyalty, and leverage economies of scale. However, before implementing this approach, businesses must carefully consider the potential risks, such as compromising brand perception and limiting profit margins. A thorough assessment of the target market, product offering, and the competitive landscape are crucial to determine if price penetration is the optimal pricing strategy for a given business.

Value-Priced-Pricing

Value-based pricing is when a business sets prices based on the perceived value of a product or service to the customer rather than solely on production costs or market competition. This pricing strategy focuses on understanding customer needs, preferences, and the unique benefits offered by the product to determine an optimal price that reflects the value delivered to the consumer.

The primary objective of value-based pricing is to maximize profits by capturing the value customers place on the product or service while fostering customer satisfaction and loyalty.

Value-based pricing is most effective in markets characterized by differentiated products or services, where customers have varying needs and preferences. This strategy requires businesses to conduct thorough research on their target customer segments, including their willingness to pay, pain points, and the unique value proposition of the product or service. By aligning the price with customer-perceived value, businesses can effectively communicate the benefits of their offering, justify the price, and create a strong foundation for long-term customer relationships.

However, value-based pricing also has its drawbacks. One significant disadvantage is the difficulty in accurately determining customer-perceived value, as it can be highly subjective and may change over time due to evolving customer preferences or competitive landscape. Additionally, researching, analyzing, and setting value-based prices can be time-consuming and resource-intensive, potentially diverting resources from other critical business functions.

A notable example of value-based pricing is the software company Adobe’s transition to a subscription-based model for its Creative Cloud suite of products. Adobe recognized that customers valued the convenience and flexibility of accessing the latest software updates and features through a subscription service, rather than purchasing individual software licenses.

By offering various subscription plans tailored to different user needs, Adobe captured the value customers placed on this new model, leading to increased revenue and customer satisfaction.

As a result of this value-based pricing strategy, Adobe was able to align its prices with customer-perceived value, while also encouraging customer loyalty through regular software updates and feature enhancements. This approach enabled Adobe to maintain its competitive edge in the market and build strong relationships with its customers

Value-based pricing doesn’t always work, though. One of the biggest blunders of erroneously attempting to employ this strategy was by JC Penney.

In 2012, J.C. Penney attempted to implement a value-based pricing strategy under the leadership of its then-CEO, Ron Johnson. The company moved away from its traditional promotional pricing model, which relied heavily on discounts, sales events, and coupons, to a more straightforward, “fair and square” pricing approach.

The new strategy aimed to simplify pricing by offering everyday low prices, month-long values, and occasional clearance sales. J.C. Penney believed that this approach would better communicate the value of its products to customers and reduce the confusion caused by

constant price fluctuations. However, the company failed to accurately assess customer-perceived value and neglected that many of its customers were deeply attached to the thrill of bargain hunting through discounts and coupons.

As a result of this misjudgment, J.C. Penney’s customers perceived the new pricing strategy as a loss of value, leading to a significant decline in sales, store foot traffic, and overall customer satisfaction. The company’s stock price also plummeted, and Ron Johnson was eventually replaced as CEO in 2013, just over a year after he took the helm. J.C. Penney was forced to revert to its previous promotional pricing strategy to regain its customer base.

J.C. Penney’s blunder with value-based pricing serves as a cautionary example for businesses considering this strategy. The company’s failure to accurately assess customer-perceived value and the importance of their traditional pricing model led to severe consequences.

This case highlights the need for businesses to conduct thorough research on their target market, customer preferences, and competitive landscape before implementing a value-based pricing strategy.

Value-based pricing can be an effective pricing strategy for businesses offering differentiated products or services, as it seeks to maximize profits by capturing the value customers place on the product or service. However, companies must carefully consider the challenges of determining customer-perceived value and the resource-intensive nature of implementing this approach.

A thorough assessment of the target market, customer preferences, and product or service offering are crucial to determine if value-based pricing is the optimal pricing strategy for a given business.

Dynamic Pricing

Dynamic pricing is a pricing strategy that involves adjusting prices in real time based on changes in supply and demand. This approach is increasingly popular in industries such as transportation, hospitality, and e-commerce, where pricing can fluctuate rapidly based on various factors.

One advantage of dynamic pricing is that it allows companies to optimize revenue by charging the highest possible price that customers are willing to pay. By using real-time data and algorithms to set prices, companies can quickly adjust prices to match fluctuations in demand, resulting in higher profits.

Another advantage of dynamic pricing is that it can help to manage inventory levels and reduce waste. By adjusting prices based on inventory levels and expiration dates, companies can incentivize customers to purchase products that may be going out of stock or reaching their expiration date soon. This can help to reduce waste and increase overall efficiency.

A third advantage of dynamic pricing is that it can be used to target specific customer segments with personalized pricing. By analyzing customer data and behavior, companies can set prices tailored to individual preferences and purchasing patterns. This can help to increase customer loyalty and drive repeat business.

However, one disadvantage of dynamic pricing is that it can be perceived as unfair or discriminatory by some customers. Suppose customers feel that they are being charged different prices for the same product or service based on factors such as their location, demographics, or purchasing history, it can erode trust and damage the company’s reputation.

No one likes a price gouger.

As such, it is essential for companies to be transparent and ethical in their use of dynamic pricing and to communicate clearly with customers about how prices are set.

Prestige Pricing

Prestige pricing is a pricing strategy in which a company sets a high price for its products or services to convey a sense of luxury or exclusivity to consumers. This approach is commonly used by high-end brands that want to create a perception of quality and status among their customers.

One example of when prestige pricing worked well is with luxury car brands like Mercedes-Benz and BMW. These companies have maintained high prices for their vehicles, even during economic downturns, because they have cultivated an image of sophistication and exclusivity. Customers are willing to pay a premium for these brands because they associate them with quality, performance, and prestige.

However, prestige pricing is not always successful. For instance, in the early 2000s, Starbucks attempted to expand its brand by introducing its own line of instant coffee called Via. The company set a high price point for the product, hoping to tap into the market for gourmet coffee. However, consumers were unwilling to pay a premium for instant coffee, even if it was associated with the Starbucks brand. As a result, sales of Via were disappointing, and the product was eventually repositioned as a more affordable option.

Prestige pricing often overlaps with the price skimming strategy. The primary difference is that price skimming often is not sustainable as competition that the consumer perceives as comparable enters the market at a lower price, while prestige pricing can ward off those challenges and sustain premium pricing.

Prestige pricing can be an effective strategy for companies that want to establish themselves as luxury or high-end brands. However, it is vital to ensure that the pricing is aligned with the perceived value of the product or service and that it resonates with the target audience. In the case of Starbucks, the company misjudged the demand for instant coffee, which ultimately led to the failure of the prestige pricing strategy.

Conclusion

As you can see, You can use many different pricing strategies for your product or service. Carefully evaluate your market and costs to determine the right one to employ. And by all means, gather information from the finance and operations departments, but keep them from dictating the final pricing strategy.

In conclusion, two tales show the difference between choosing the right pricing strategy and the wrong one.

Apple Gets It Right with the iPod

When Apple introduced the iPod in 2001, the MP3 player market was dominated by low-cost, low-quality devices. However, Apple chose to price the iPod at a premium (price skimming/prestige pricing) compared to its competitors, positioning it as a high-end device with superior features and design. This strategy paid off, as consumers were willing to pay more for a product they perceived as superior in quality and aesthetics. As a result, the iPod became capturing 70% of the MP3 market.

However, as competition in the quality MP3 player market increased, Apple introduced lower-priced models such as the iPod Shuffle and the iPod Mini (competition-based pricing). These lower-priced models helped Apple capture a larger market share and appeal to price-sensitive consumers. By using a penetration pricing strategy, Apple increased its sales volume and maintained its market dominance.

Uber Misses with Surge Pricing

But companies don’t always get it right, as demonstrated by the case of Uber’s surge pricing during a crisis. In 2014, during a snowstorm in New York City, Uber implemented surge pricing, which raised fares to more than seven times the regular rate. This caused outrage among customers who felt Uber was taking advantage of the crisis to charge exorbitant prices.

While surge pricing is a common and accepted practice for Uber during times of high demand, the company misjudged the situation. Customers felt the company was exploiting the crisis and prioritizing profits over customer satisfaction. The backlash against the surge pricing was severe, with many customers boycotting the service and turning to other ride-hailing companies instead.

The lesson from this example is that while dynamic pricing can be an effective pricing strategy in certain situations, companies must be mindful of its impact on their brand reputation and customer loyalty. In times of crisis, customers may be more sensitive to perceived price gouging, and companies need to balance their desire for profits with the need to maintain customer trust and goodwill.

Go forth my marketing friends and maximize your profits by choosing the right pricing strategy.