Pricing Strategies

The main objective of any enterprise is to maximize wealth of its shareholders. All decisions that are made for the organization should be based taking this objective into account.

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 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.

Remember the early days of the internet. People paid to have email accounts. Prices then tumbled as competition increased until email is now free.

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

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 pricing 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 customers.

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 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. is powered by Firmsconsulting is a training company that finds and nurtures tomorrow’s leaders in business, government and academia via bespoke online training to develop one’s executive presence, critical thinking abilities, high performance skill-set, and strategy, operations and implementation capabilities. Learn more at

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The Importance of Customer Relations Management

Whereas in the past companies could afford to ignore consumers’ needs and preferences, this is no longer the case. With options available to consumers due to such factors as increased competition and drastic changes and improvements in technology, consumers become increasingly more educated and demanding.

For example, Portia have to work really hard to keep consumers of satisfied and to build long lasting relationships with them. Otherwise they will move to a competitor.

Since Portia’s business is a small business, Portia has an advantage compared to large competitors. This advantage arises because Portia can address each customer personally and superior higher customer service which will lead to greater customer satisfaction and loyalty.

It is crucial for to keep current customers satisfied since acquisition of new customers is very costly. It costs about five times more to acquire a new customer in comparison to keeping an existing one. Current customers also tend to buy more from the enterprise and may refer their family and friends.

On average, businesses keep between 70-90 percent of customers each year. However, if retention of customers could increase by 5-10 percent per year, than businesses could double their profitability.

This statistics highlights how incredibly important it is for Portia to keep current customers satisfied. So think about this for a minute. While Portia wants to spend money on advertising, that is really a small part of the battle. Once people see Portia’s advertising, she needs to convert them into paying customers. Once Portia converts them into paying customers she then needs to ensure they are repeat clients, otherwise she needs to spend even more on advertising. If she does a poor job serving existing customers, they may write poor review of her business which will lead to even less effect from her advertising.

Moreover, customers are often willing to pay a premium for excellent customer service. Therefore, Portia could even increase her profit margin by providing higher customer service than that of her competitors.


Net Profit Margin Ratio

Net profit margin ratio (NPMR) is one of the profitability ratios and measures how much of each sales dollar is remaining after all costs are deducted. In other words it measures how successful the firm is in terms of its earnings on sales.

Net profit margin ratio (NPMR) = Net Profit/Sales

For example, if ABC has a net profit of $300,000 and sales of $3,000,000. The NPMR is calculated as follows.

= 300,000/3,000,000

= 0.1 or 10%

Test yourself

Dillon Corporation has a net profit of $500,000 and sales of $3,500,000.

Required: Find the Net profit margin ratio (NPMR)


The calculation of Net profit margin ratio (NPMR) of Dillon Corporation will be as follows:

= 500,000/3,500,000

= 0.14 or 14%

The higher the Net profit margin ratio (NPMR), the better it is for the company’s health.

Earnings Available for Common Stockholders

In summary, to calculate earnings available for common stockholders, we need to subtract cost of goods sold, operating expenses, and interest, tax and preferred stock dividends from sales revenue.

To calculate these earnings available, we need to understand the format of the income statement.

Income Statement Format

Sales revenue

LESS: Cost of goods sold

= Gross profit

LESS: Operating expenses

= EBIT (earnings before interest and tax/operating profit)

LESS: Interest

= Net profit before tax

LESS: Taxes

= Net profit after tax

LESS: Preferred stock dividends

= Earnings available for common stockholders

Therefore, to calculate earnings available for common stockholders, all we need to do is to subtract cost of goods sold, operating expenses, interest, tax and preferred stock dividends from the sale revenue.

Knowing the the earnings available for common stockholders is very important. Among other uses, it allows us to do the following:

1 – It allows you to calculate EPS:

Calculating EPS allows us to understand how much dollars were earned on each outstanding share of common stock.

2 – It also allows you to calculate the net profit margin ratio:

Net Profit Margin ratio = Earnings Available for Common Stockholders / Sales.

Net profit margin ratio measures how much of each sales dollar remains after all costs are deducted. In other words it measures how successful the firm is in terms of its earnings on sales. is powered by Firmsconsulting is a training company that finds and nurtures tomorrow’s leaders in business, government and academia via bespoke online training to develop one’s executive presence, critical thinking abilities, high performance skill-set, and strategy, operations and implementation capabilities. Learn more at

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