There are seven crucial elements of the ‘marketing mix’, or the strategies that companies use to promote and sell their goods or services. These are product, price, place, promotion, people, processes and physical evidence (and you can read more about these in our page on the Seven P’s of Marketing).
This page discusses the second of these, price. Pricing as a marketing activity is of course particularly important when you are introducing a new product, or moving an existing product into a new market. The page therefore sets out some common pricing strategies and explains why companies might choose each of these strategies.
What is a Pricing Strategy?
Your pricing strategy is the approach you use to decide on the right price for your goods or services.
First and foremost, you need to consider your costs—because you have to charge more than the cost of producing the products, or you will make a loss. However, it is also helpful to consider aspects like consumer demand, and what your competitors are charging for similar products or services.
Why Not Just Cost-Plus?
Before talking about possible pricing strategies, it is worth discussing why companies do not simply work out the cost of their product or service and then add on a mark-up (known as a ‘cost-plus’ strategy).
Cost-plus is a perfectly reasonable strategy.
You can use this approach if you want—and it may well be fine. It will certainly mean that you do not make an immediate loss on your product or service.
However, there are reasons why this approach might not work:
Your customers may not be prepared to pay the price you need to charge. Unfortunately, your manufacturing costs may be too great for your customers, who are looking for something cheaper. This is why so many clothing companies produce goods abroad, where production costs are cheaper.
Your customers may be prepared to pay considerably more than you were planning to charge, meaning that you could charge more, and make more profit.
You may need to undercut your competitors to gain a foothold in the market. If you are just starting out, your overheads may be smaller, so you could take a hit for a short time just to become established
It is therefore worth doing some market research first to understand what your competitors are charging for similar products, and what your customers are prepared to pay.
The Concept of Price Elasticity
It is also worth discussing the concept of price elasticity. This means how much demand changes when the price of a product changes.
When consumers continue to buy the product despite a price increase, the product is said to be inelastic. An example of this is petrol or diesel, where repeated tax increases have failed to change demand.
When consumers stop buying a product as the price increases, demand is said to be elastic in relation to price.
If you are selling a product or service with price inelasticity, you have more scope to increase the price without affecting demand—provided that your competitors also increase their prices.
Common Pricing Strategies
There are several common pricing strategies that many businesses choose. These include:
1. Competitive Pricing
Competitive pricing is comparing your competitors’ prices, and charging about the same.
You need to consider whether this will cover your costs. However, if it will, then this is quite a good way of assessing what the market will bear. Be aware, though, that you may be under-selling your products, especially if they are better quality than your competitors’ goods.
Price-skimming is the practice of setting a very high price while demand is low, and then gradually reducing it as demand increases.
This is often used in new and emerging markets, because ‘pioneers’ and ‘early adopters’ of products are often prepared to pay a premium to be one of the first to have a product. Its advantage is that it means that you can undercut competitors as they enter the market over time, especially if there are major costs to entering the market.
3. Market Penetration Pricing
Market penetration pricing is the practice of charging a low price when you first enter a market.
This allows you to undercut those already in the market and distinguishes your products from the competition. However, depending on the price you need to charge to undercut others, you may find that you are making a loss at first. Amazon used this approach to break into book-selling; it was famously not expected to make a profit for about ten years. Being able to hold to this strategy therefore needs patient investors, with very deep pockets, but it can pay real dividends in the long run.
4. Value-Based Pricing
Value-based pricing is pricing your goods at the price that your customers are prepared to pay: that is, the value that they place on them.
Value-based pricing requires you to go and find out what your customers are prepared to pay, and what they value in your product.
There are two particular sub-forms of value-based pricing:
Economy pricing is aimed at customers who want to spend as little as possible. Supermarkets like Walmart in the USA and Asda, Lidl and Aldi in the UK all focus on economy pricing and value for money.
Luxury or premium pricing focuses on quality, and charges extra because the product is considered a luxury. The idea is to create exclusivity around owning the product. Designer clothes, jewellery and perfume all use premium pricing policies.
Advantages of Value-Based Pricing
Value-based pricing is more complicated than simple competitive pricing or cost-plus. You need more information, including some reliable market research.
However, it has some very real advantages, particularly:
- You can charge what your customers will pay, which usually makes your product more profitable.
- The price is a better fit with your customers’ expectations.
- If there is a mismatch between price and expectation, you don’t always have to adjust the price. Instead, you can adjust the product, so that you offer more value.
Bundling is the practice of selling several products within a single ‘wrapper’more cheaply than buying each of them separately.
It is often used by telecoms companies when you buy broadband, landline and television services together. The idea here is to sell people goods that they might not otherwise have bought, because the combined product is cheaper, and looks like a bargain. ‘Buy one, get one free’ is also an example of bundle pricing, when it is used to shift products quickly.
The Price is Right: Making Your Decision
The crucial part of pricing is to ensure that your price matches your customers’ willingness to pay. If it is too high, nobody will buy.
Fortunately, pricing is not a one-off activity. You can change the prices of your products at any time. You can therefore afford to try different strategies to see which one is right. However, be aware that you may put off potential customers by getting the price wrong. It may therefore be better to test strategies through market research, rather than after product or market launch.