A business can choose from a variety of pricing strategies when selling a product or service. To determine the most effective pricing strategy for a company, senior executives need to first identify the company's pricing position, pricing segment, pricing capability and their competitive pricing reaction strategy. Pricing strategies, tactics and roles vary from company to company, and also differ across countries, cultures, industries and over time, with the maturing of industries and markets and changes in wider economic conditions.Marketing Consumer Products: Key Influences on Buying, Selling & Market Growth, ISR/Google Books, 2021. E-book ISBN 9780906321751. Chapter 2, "Consumer Product Affordability", page 4.
Pricing strategies determine the price companies set for their products. The price can be set to maximize profitability for each unit sold or for the market overall. It can also be used to defend an existing market from new entrants, to increase market share within a market, or to enter a new market. Pricing strategies can bring both competitive advantages and disadvantages to a firm and often dictate the success or failure of a business; thus, it is crucial to choose the right strategy.
Models of pricing Absorption pricing This pricing method aims to recover all the costs of producing a product. The price of a product includes the variable cost of each item plus a proportionate amount of the fixed costs:
Fixed or variable costs, direct or indirect costs, employee salaries, utility costs, and other types of costs can also be calculated by applying the absorption pricing method.
Contribution profit-based pricing
Contribution profit-based pricing maximizes the profit derived from an individual product, based on the difference between the product's price and variable costs (the product's contribution margin per unit), and on one's assumptions regarding the relationship between the product's price and the number of units that can be sold at that price. The product's contribution to total firm profit (i.e. to operating income) is maximized when a price is chosen that maximizes the following:
Contribution profit-based pricing
In cost-plus pricing, a company first determines its break-even price for the product. This is done by calculating all the costs involved in the production such as raw materials used in transportation etc., marketing and distribution of the product. Then a markup is set for each unit, based on the profit the company needs to make, its sales objectives and the price it believes customers will pay. For example, if a product's price is $10, and the contribution margin (also known as the profit margin) is 30 percent, then the price will be set at $10 * 1.30 = $13.
Cost plus pricing
Cost-plus pricing is a cost-based method for setting the prices of goods and services. Under this approach, the direct material cost, direct labor cost, and overhead costs for a product are added together, and a markup percentage is applied (to create a profit margin) in order to derive the price of the product.
Creaming or skimming
Price skimming occurs when goods are priced higher so that fewer sales are needed to break even. Selling a product at a high price, and sacrificing high sales to gain a high profit is therefore "skimming" the market. Skimming is usually employed to reimburse the cost of investment of the original research into the product: commonly used in electronic markets when a new range, such as smartphones, are first sold at a high price. This strategy is often used to target "early adopters" of a product or service. Early adopters generally have a relatively lower price sensitivity—this can be attributed to: their need for the product outweighing their need to economize; a greater understanding of the product's value; or simply having a higher disposable income.
This strategy is employed only for a limited duration to recover most of the investment made to build the product. To gain further market share, a seller must use other pricing tactics such as economy or penetration. This method can have some setbacks as it could leave the product at a high price against the competition.Kent B. Monroe, The Pricing Strategy Audit, 2004, Cambridge Strategy Publications, p. 40
Decoy pricing Method of pricing where the seller offers at least three products, and where two of them have a similar or equal price. The two products with similar prices should be the most expensive ones, and one of the two should be less attractive than the other. This strategy will make people compare the options with similar prices; as a result, sales of the more attractive high-priced item will increase.
Differential pricing Differential pricing occurs when firms set various prices for the same product depending on their consumer's portfolio, geographic areas, demographic segments and the intensity of competition in the region.
Double ticketing A form of deceptive pricing strategy that sells a product at the higher of two prices communicated to the consumer on, accompanying, or promoting the product.
Freemium
Freemium is a revenue model that works by offering a product or service free of charge (typically digital offerings such as software) while charging a premium for advanced features, functionality, or related products and services. The word "freemium" is a portmanteau combining the two aspects of the business model: "free" and "premium". It has become a highly popular model, with notable successes.
Good–better–best
A seller offers three prices for variations of the same good or service: a "good" no frills version, a "best" premium version, and a "better" version in the middle. Invoking the Goldilocks principle, customers may choose the "better" version because they are willing to pay more than the "good" price, but they are not willing to pay for the "best" version. A notable practitioner of the good–better–best pricing strategy is Apple Inc., which originally sold one model of iPhone in 2007, but by 2020, had adopted the practice of introducing good, better, and best models of iPhone and Apple Watch. Apple's competitors, such as Samsung Electronics, followed suit.
High-low pricing
A practice whereby many items are regularly priced higher than by competitors, but through promotions, advertisements, and or coupons, lower prices are offered on key items, or where products are sold initially at a higher price and then discounted. The lower promotional prices are designed to bring customers to the seller where the customer is offered the promotional product as well as the regular higher-priced products.Philip Kotler & Gary Armstrong, Principles of Marketing 13E, 2010, Pearson Prentice Hall, p.293
Keystone pricing A retail pricing strategy where retail price is set at double the wholesale price. For example, if a cost of a product for a retailer is £100, then the sale price would be £200. In a competitive industry, it is often not recommended to use keystone pricing as a pricing strategy due to its relatively high profit margin and the fact that other variables need to be taken into account.
Limit pricing
A limit price is the price set by a monopolist to discourage economic entry into a market. It is the price that an entrant would face upon entering, as long as the incumbent firm does not decrease output. The limit price is often lower than the average cost of production or just low enough to make entry unprofitable. The quantity produced by the incumbent firm to act as a deterrent to entry is usually larger than would be optimal for a monopolist, but might still produce higher economic profits than would be earned under perfect competition.
The problem with limit pricing as a strategy is that once the entrant has entered the market, the quantity used as a threat to deter entry is no longer the incumbent firm's best response. This means that for limit pricing to be an effective deterrent to entry, the threat must in some way be made credible. A way to achieve this is for the incumbent firm to constrain itself to produce a certain quantity whether entry occurs or not. An example of this would be if the firm signed a union contract to employ a certain (high) level of labor for a long period of time. In this strategy price of the product becomes the limit according to budget.
Loss leader
A loss leader or leader is a product sold at a low price (i.e. at cost or below cost) to stimulate other profitable sales. This would help the companies to expand its market share as a whole. Loss leader strategy is commonly used by retailers in order to lead the customers into buying products with higher marked-up prices to produce an increase in profits rather than purchasing the leader product which is sold at a lower cost. When a "featured brand" is priced to be sold at a lower cost, retailers tend not to sell large quantities of the loss leader products and also they tend to purchase less quantities from the supplier as well to prevent loss for the firm.Hess J.D., Gerstner E. . (2001). Loss Leader Pricing and Rain Check Policy . Marketing Science (Volume 6), 1-18. Supermarkets and restaurants are an excellent example of retail firms that apply the strategy of loss leader.
Marginal-cost pricing In business, the practice of setting the price of a product to equal the extra cost of producing an extra unit of output. By this policy, a producer charges, for each product unit sold, only the addition to total cost resulting from materials and direct labor. Businesses often set prices close to marginal cost during periods of poor sales. If, for example, an item has a marginal cost of $1.00 and a normal selling price is $2.00, the firm selling the item might wish to lower the price to $1.10 if demand has waned. The business would choose this approach because the incremental profit of 10 cents from the transaction is better than no sale at all.
Odd-Even pricing Odd-Even pricing is often used by sellers to portray their products to be either cheaper or more expensive than their actual value. Sellers competing for price-sensitive consumers, will fix their product price to be odd. A good example of this can be noticed in most supermarkets where instead of pricing milk at £5, it would be written as £4.99. Contrarily, sellers competing for consumers with low price sensitivity, will fix their product price to be even. For example, often in upscale retail stores, handbags will be priced at £1250 instead of £1249.99.
Pay what you want
Pay what you want is a pricing system where buyers pay any desired amount for a given commodity, sometimes including zero. In some cases, a minimum (floor) price may be set, and/or a suggested price may be indicated as guidance for the buyer. The buyer can also select an amount higher than the standard price for the commodity.
Giving buyers the freedom to pay what they want may seem to not make much sense for a seller, but in some situations it can be very successful. While most uses of "pay for what you want" have been at the margins of the economy, or for special promotions, there are emerging efforts to expand its utility to broader and more regular use.
Penetration pricing
Penetration pricing includes setting the price low with the goals of attracting customers and gaining market share. The price will be raised later once this market share is gained.Kent B. Monroe, The Pricing Strategy Audit, 2003, Cambridge Strategy Publications, p.41
A firm that uses a penetration pricing strategy prices a product or a service at a smaller amount than its usual, long range market price in order to increase more rapid market recognition or to increase their existing market share. This strategy can sometimes discourage new competitors from entering a market position if they incorrectly observe the penetration price as a long range price.