What is Pricing? Types of Pricing Strategies, PDF
Pricing is a process of setting the value that a manufacturer will receive in the exchange of services and goods. If manufacturers set prices too high, they miss out on valuable sales. Set them too low, and they miss out on valuable revenue.
The pricing depends on the company’s production cost, and the buyer’s perceived value of an item, as compared to the perceived value of the competitor’s product. So different pricing methods and strategies are exercised to adjust the cost of the producer’s offerings suitable to both the manufacturer and the customer. The best pricing strategy maximizes profit and revenue without hampering customers’ expectations.
Some of the important factors affecting price fixation are:
- Fair trade laws: Manufacturers make agreements with dealers who retail their products, at the price they can be sold to the consumer.
- Nationally advertised prices and government restriction prices of different products.
- Sometimes pricing policy depends upon buying habits of the customers.
- Company monopoly: whether the company has a monopoly or it is in a competitive position.
- Manufacturers suggested prices, depending upon the cost of manufacturing and selling the product.
- Type of merchandise, whether they are novelties or special interest items, etc.
Types of Pricing Strategies
Let’s discuss different types of pricing strategies.
1. Competitive Pricing
A competitive pricing strategy uses the competitors’ prices as a benchmark. It doesn’t take into account the cost of their product or consumer demand. With competitive pricing, you can price your products slightly below your competition, the same as your competition, or slightly above your competition.
In a competitive pricing strategy one of the following three approaches can be taken:
In co-operative pricing, you try to match your competitor’s pricing. If a competitor increases the price by 5%, you will hike your product price by 5%. If they reduce the price, that’s lead to your price cut.
Gas station prices their product according to cooperative pricing.
In an aggressive pricing strategy, if competitors increase their prices, your price will remain the same. If they lower their prices, you further reduce your prices.
The most possible trend for this strategy is a progressive cutting down prices. But if sales volume drops, the company risks running into financial trouble.
In the Dismissive pricing approach, you price your product as you wish, and do not react to what your competitors are doing. As a matter of fact, ignoring competitors can increase the size of the protective moat around your market control.
If you lead your market and understand your customer well, or you are selling a premium product or service, a dismissive pricing approach can be a good option.
2. Cost-plus Pricing
A cost-plus pricing or make-up pricing strategy focuses purely on the cost of production of your product or service. You just take the product production cost and add a certain percentage to it. Retailers who sell physical products typically use cost-plus pricing.
Retailers, manufacturers, restaurants, distributors and other intermediaries often find cost-plus pricing to be a simple, time-saving way to price.
Cost-plus pricing can be a disadvantage sometimes. For example, if you are selling a seasonal product, one season can trigger huge demands and retail stock-outs. If you stick to cost-plus pricing, you will miss out on potential profit.
3. Value-based pricing
With value-based pricing, you set your prices according to what consumers think your product is worth. We’re big fans of this pricing strategy for SaaS businesses. Value-based pricing strategy successes because customers feel as though they are receiving excellent value in the good or service.
Advantages and disadvantages of value-based pricing
In value-based pricing, the profit potential is higher and increased perceived value in your brand and services. Also, creates a loyal customer base.
Additional market research is required to determine what consumers think your product is worth. This kind of high-end product is cost-effective to product.
4. Dynamic Pricing
Dynamic pricing, also known as demand pricing, surge pricing, time-based pricing. It’s a flexible pricing strategy where prices vary based on market and customer demand, who is buying your product or service, and when they are buying it.
E-commerce, hotels, airlines, event venues, and utility companies use dynamic pricing by applying algorithms that consider competitor pricing, demand, and other factors.
Advantages and disadvantages of dynamic pricing
Dynamic pricing helps you to maximize your profits by matching your price to the market demand.
Major disadvantages of dynamic pricing are, prices that are always fluctuating may scare customers off. It can increase competition within the market, thus higher risk of starting price wars.
5. Pricing skimming
A skimming pricing strategy is when companies set the highest possible price for a newly launched product that has no or less competition, and then lower the price over time as the product becomes less and less popular.
Technology products, such as laptops, gaming consoles, and smartphones, are typically priced using skimming, as they become less relevant over time.
At the beginning of the sale, high pricing helps the business to recover some of its development costs. After that, when the market becomes saturated and sales decline, producer lower the price to reach a more price-sensitive segment of customers.
Advantages and disadvantages of price skimming
Price skimming helps businesses to maximize profits through early adopters and allows small businesses to recoup development costs. It also creates an illusion of exclusivity and quality in consumers’ minds.
If the price-skimming strategy does not work, excess inventory may occur. It will fail if your competitors release a copycat product at a lower price.
6. Penetration Pricing
Unlike the skimming strategy, In a penetration pricing strategy companies enter the market with a cheap price, effectively drawing attention away from higher-priced competitors. This pricing method better works for brand-new businesses looking for customers or for businesses that are entering an existing, competitive market. Penetration pricing isn’t sustainable in the long run.
Advantages and disadvantages of penetration pricing
Penetration pricing can be risky because it can cause an initial loss of income for the manufacturer. Over time, however, allows a product to be quickly adopted and accepted by customers and increase brand awareness. That can drive profits and help small businesses stand out from the competition.
In the long run, after penetrating a market, business owners can increase prices to better reflect the status of the product’s position within the market.
Penetration pricing Can create pricing expectations for customers, which means they might always expect a cheap price and be disappointed if the price rises. That may hurt the brand image.
7. Differential Pricing
This method is applied when the pricing has to be unique to particular groups of customers. Here, the pricing might vary with time, according to the region, area, product, time, etc. It is also called Discriminatory Pricing, Flexible Pricing, Multiple Pricing, and Variable Pricing.
An example of differential or discriminatory pricing is – the Power plants enforce lower prices for more elastic industrial electricity and higher prices for less elastic household electricity. In this case, the power plants focus on volume sales, which can generate large revenue.
A price discrimination strategy is not workable for all companies as there are many issues that the firms may face because of the action. For example: if a manufacturer sells a product to their customer for a cheaper price and that customer resells the product and calls for a higher price from another buyer then the chances of the firm failing to make a higher profit are predicted because they could have sold their product at a higher rate than the re-seller and made a further profit.
8. High-Low Pricing Strategy
In a high-low pricing strategy, a company initially sells a product at a high price but lowers that price when the product drops in novelty or relevance. Discounts, clearance sections, and year-end sales are examples of high-low pricing strategies.
In high-low pricing products or services offered by the organization are regularly priced higher than competitors, but through promotions, advertisements, or coupons, lower prices are offered on key items. The lower promotional prices are designed to bring customers to the organization.
Download Pricing PDF
How to Create a Pricing Strategy
1. Determine pricing potential
First of all, you need to evaluate your pricing potential. This is the most probable pricing of your product or service in regard to cost, demand, location, etc.
2. Determine your buyer’s personality
You have to price your product according to the type of buyer persona that’s looking for it.
When you look at your potential customer, you’ll have to look at their:
- Customer Lifetime Value
- Willingness to Pay
- Customer Pain Points
3. Analyze historical data
You analyze previous historical pricing-related data. Then you can calculate the difference in closed deals, churn data, or sold products on different pricing strategies that your business has worked with before and determine which were the most successful.
4. Balance value and business goals
The pricing should maintain a proper balance between value and business goals to ensure the price is good for your bottom line and your buyer personas.
5. Look at competitor pricing
You can’t make a pricing strategy without researching your competitors’ offerings. You’ll have to decide between two crucial choices when you see the price difference for the same product or service:
If a competitor is charging more for the same offering as your brand, then make the price more affordable.
The second one is- you can potentially price your offering higher than your competitors if the value you provided to the customer is greater.