The main objective of any enterprise is to maximize wealth of its shareholders. All decisions that you make have to make should be based on this objective.
Pricing strategy should also be aligned with the main objective of the enterprise. Further, in determining the pricing strategy, the goal should be to select prices which will allow achieving the highest profitability, which is determined by sales level and profit margin. Therefore, organizations should target attainment of the highest feasible profit margin at the highest sales level. A trade-off needs to be made between highest margins, at lower sales against lower margin against highest sales.
There are various pricing strategies that can be considered in determining the most appropriate price for the product or service. Some strategies are presented below.
Skimming (skim, creaming) pricing strategy
A skimming (skim, creaming) pricing strategy refers to setting a very high price (with a high profit margin) for a limited period. It refers to “skimming the cream” from the market. Skimming (skim, creaming) pricing strategy may be possible when businesses have no or very few competitors. When competition will become more intense, business can lower its prices to more competitive levels. The skimming pricing strategy is often selected if investment costs must be quickly recovered and if there is no or very limited competition than he or she may consider it prestige at the creaming price.
Remember the early days of the internet. People paid to have email accounts. Prices then tumbled as competition increased until email is now free. No one will pay for email today.
Prestige (premium) pricing strategy
Prestige pricing strategy, which is also referred to as premium pricing consists of charging a very high price on a permanent basis throughout the entire product life cycle. Such a strategy is only possible for unique and high quality products or services in situations whereby an entrepreneur has a very strong competitive advantage. It is relevant when targeting an elite target market. This is because customers with high income levels have more inelastic demand (lower sensitivity to price and greater sensitivity to value provided by product or service). Moreover, taking psychological effects into account, very high price of a product may be part of the reason elite customers buy the product as high prices may evoke perceptions of additional “status”, “prestige” and “quality” value added to the product.
Variable pricing strategy
Majority of businesses charge a fixed price, which refers to situation whereby standardized price is charged for the product or service. However, sometimes business can use variable pricing strategy, a form of price discrimination. Under variable pricing strategy, business offers different prices to different customers based on factors such as customers’ bargaining power and quantities purchased.
In the case of a variable pricing strategy, a consistent price generally should not be promoted to allow for the price to vary. In other cases, standardized prices may be promoted and concessions may be granted to specific customers based on the factors such as customer knowledge, quantity purchased and bargaining power. However, it should be noted that some experts strongly advise against variable pricing strategy as they believe it diminishes the value of the brand.
Certainly, in some situations, variable pricing is more adequate than in others. For example, variable pricing may work for consulting work when different clients are charged different price for similar service based on number of factors. However, variable pricing may be damaging for the soft drinks’ brand.
Sometimes a dynamic pricing strategy is followed, which is a variation of the variable pricing strategy. Under a dynamic pricing strategy, price is determined for each customer separately based on such factors as customer’s financial position, past purchases history, where the customer lives and extent of eagerness to buy a product or service. Dynamic pricing strategy is possible due to advances in information technology and mainly used by internet based companies. Dynamic pricing strategy is also widely used by the airline industry.
Psychological pricing strategy
Psychological pricing strategy refers to situations where businesses take psychological effects into account when setting the price. For example, price set at $7.99 or $9.95 will have a psychological effect of being perceived as smaller than $8 and $10.
Penetration pricing strategy refers to setting prices below long-term market prices. This is especially relevant if the business has lower costs than competitors and therefore can afford to offer lower prices while maintaining adequate profit margins. This price strategy is also more appropriate for types of products and services which are demand elastic.
When price is set below the long-term market price to discourage new competitors from entering the market, this is called a pre-emptive pricing strategy. Further, when the lowest possible price is set, often one that does not cover the costs of production, to drive away competitors and to discourage new competitors, such pricing strategy is referred to as an extinction pricing strategy. Under pre-emptive and extinction pricing strategies, business often try to create an impression that penetration pricing is actually a long-term market pricing. In reality, when competitors leave the market, the business will increase prices back to profitable levels.
Product Line (price lining) pricing strategy
Product Line (price lining) pricing strategy refers to businesses which offer lines of similar product at different prices. An example can be a line of shampoos by the same producer at $10, $15 and $25. Each subsequent product claimed to be more advanced. Such assortments make it easier for customers to select an appropriate product which most adequately meets needs of the customer.
Leader pricing strategy
Leader pricing strategy, which is also called follow-the-leader pricing strategy, refers to situation whereby business follows the price level of the dominant competitor. Leader pricing strategy is relevant for markets where intense competition is predominant. The leading competitor is usually a large firm with lower costs due to economies of scale. Therefore, following this strategy may significantly decrease profit margin of a small business. In such case, it is more advantageous for small business to differentiate its product from the dominant competitor and offer it at a price which is sustainable for a small business.
Mark-up pricing strategy
Mark-up pricing strategy which consists of adding a certain percentage, possibly based on industry average, to the cost of the product. Percentage of cost is determined as follows:
Mark-up as a percentage of cost = Mark-up/Cost * 100
It is important to ensure that the mark-up incorporates profit margin and all anticipated relevant costs such as operating costs, future price reductions and discounts. Different mark-ups can be used for different products and services.
Pricing-at-what-the-market-will-bear pricing strategy
Pricing at what the market will bear refers to the setting of the maximum prices at which customers still will buy the product or service. This is only feasible if the business has no or limited competition and if the product is really unique.
For example, if the business has no competitors and products have no substitutes than customers may continue to purchase the product or service at a very high price since no other alternatives to obtain this product or service exist, or a substitute for this product or service is unavailable.
Manufacturer suggested retail price (MSRP)
According to this pricing strategy, retailer charges a price suggested by manufacturer. This can be advantageous in avoiding price wars with other retailers.