Although prices for individual products are made on a case-by-case basis, most firms have developed a general and consistent approach or base pricing strategy to be used in establishing prices. The relationship between price and other elements of the marketing program dictates that pricing decisions cannot be made in isolation. In fact, price changes may result in minor modifications to the product, distribution, or promotion strategies. As we have discussed, it is not so much the actual price being charged that influences buying decisions as the way that members of the target market perceive the price. This reality reminds us that many of the strategic issues involved in pricing have close ties with customer psychology and information processing: What customers think about prices is what those prices are to them.
A firm’s base pricing strategy establishes the initial price and sets the range of possible price movements throughout the product’s life cycle. The initial price is critical, not only for initial success, but also for maintaining the potential for profit over the long term. There are several different approaches to base pricing. Some of the most common approaches include:
A firm’s base pricing strategy establishes the initial price and sets the range of possible price movements throughout the product’s life cycle. The initial price is critical, not only for initial success, but also for maintaining the potential for profit over the long term. There are several different approaches to base pricing. Some of the most common approaches include:
- Price Skimming. This strategy intentionally sets a high price relative to the competition, thereby “skimming” off the profits early after the product’s launch. Price skimming is designed to recover the high R&D and marketing expenses associated with developing a new product. For example, new prescription drugs are priced high initially and only drop in price once their patent protection expires.
- Price Penetration. This strategy is designed to maximize sales, gain widespread market acceptance, and capture a large market share quickly by setting a relatively low initial price. This approach works best when customers are price sensitive for the product or product category, research and development and marketing expenses are relatively low, or when new competitors will quickly enter the market. To use penetration pricing successfully, the firm must have a cost structure and scale economies that can withstand narrow profit margins.
- Prestige Pricing. This strategy sets prices at the top end of all competing products in a category. This is done to promote an image of exclusivity and superior quality. Prestige pricing is a viable approach in situations where it is hard to objectively judge the true value of a product. Ritz-Carlton Hotels, for example, never compete with other hotels on price. Instead, the company competes only on service and the value of the unique, high quality experience that they deliver to hotel guests.
- Value-Based Pricing (EDLP). Firms that use a value-based pricing approach set reasonably low prices, but still offer high quality products and adequate customer services. Many different types of firms use value-based pricing; however, retailing has widely embraced this approach, where it is known as everyday low pricing or EDLP. Prices are not the highest in the market, nor are they the lowest. Instead, value-based pricing sets prices so they are consistent with the benefits and costs associated with acquiring the product. Many well-known firms use value-based pricing, including Walmart, Lowe’s, Home Depot, IKEA, and Southwest Airlines.
- Competitive Matching. In many industries, pricing strategy focuses on matching competitors’ prices and price changes. Although some firms may charge slightly more or slightly less, these firms set prices at what most consider to be the “going rate” for the industry. This is especially true in commoditized markets such as airlines, oil, and steel
- Non-Price Strategies. This strategy builds the marketing program around factors other than price. By downplaying price in the marketing program, the firm must be able to emphasize the product’s quality, benefits, and unique features; as well as customer service, promotion, or packaging in order to make the product stand out against competitors, many of whom will offer similar products at lower prices. For example, theme parks like Disney World, Sea World, and Universal Studios generally compete on excellent service, unique benefits, and one-of-a-kind experiences rather than price. Customers willingly pay for these experiences because they cannot be found in any other setting.
Adjusting the Base Price
In addition to a base pricing strategy, firms also use other techniques to adjust or finetune prices. These techniques can involve permanent adjustments to a product’s price, or temporary adjustments used to stimulate sales during a particular time or situation. Although the list of potentially viable pricing techniques is quite long, five of the mostncommon techniques in consumer markets are:
- Discounting. This strategy involves temporary price reductions to stimulate sales or store traffic. Customers love a sale and that is precisely the main benefit of discounting. Virtually all firms, even those using value-based pricing, will occasionally run special promotions or sales to attract customers and create excitement. Dillard’s, for example, will hold a quick sale early in a selling season, and then return prices to their normal levels. Near the end of the season, Dillard’s will begin to make these sale prices (or markdowns) permanent as time draws closer to the end-of-season clearance sale.
- Reference Pricing. Firms use reference pricing when they compare the actual selling price to an internal or external reference price. All customers use internal reference prices, or the internal expectation for what a product should cost. As consumers, our experiences have given us a reasonable expectation of how much to pay for a combo meal at McDonald’s or a gallon of gas. In other cases, the firm will state a reference price, such as “Originally $99, Now $49.” These comparisons make it easier for customers to judge prices prior to purchase.
- Price Lining. This strategy, where the price of a competing product is the reference price, takes advantage of the simple truth that some customers will always choose the lowest-priced or highest-priced product. Firms use this to their advantage by creating lines of products that are similar in appearance and functionality, but are offered with different features and at different price points. For example, Sony can cut a few features off its top-of-the-line Model A1 digital camcorder and Model B2 can be on the shelf at $799 rather than the original $999. Cut a few more features and the price can drop to $599 for Model C3. Here, each model in the Sony line establishes reference prices for the other models in the line. The same is true for all competing camcorders from other manufacturers.
- Odd Pricing. Everyone knows that prices are rarely set at whole, round numbers. The concert tickets are $49.95, the breakfast special is $3.95, and the gallon of gas is $3.799. The prevalence of odd pricing is based mostly on psychology: Customers perceive that the seller did everything possible to get the price as fine (and thus as low) as he or she possibly could. To say you will cut my grass for $47 sounds like you put a lot more thought into it than if you just said, “I will do it for $40,” even though the first figure is $7 higher.
- Price Bundling. Sometimes called solution-based pricing or all-inclusive pricing, price bundling brings together two or more complementary products for a single price. At its best, the bundled price is less than if a company sold the products separately. Slow moving items can be bundled with hot sellers to expand the scope of the product offering, build value, and manage inventory. All-inclusive resorts, including Sandals and Club Med, use price bundling because many customers want to simplify their vacations and add budget predictability.
Many of these techniques are also used in business markets to adjust or fine-tune base
prices. However, there are a number of pricing techniques unique to business markets,
including:
- Trade Discounts. Manufacturers will reduce prices for certain intermediaries in the supply chain based on the functions that the intermediary performs. In general, discounts are greater for wholesalers than for retailers because the manufacturer wants to compensate wholesalers for the extra functions they perform, such as selling, storage, transportation, and risk taking. Trade discounts vary widely and have become more complicated due to the growth of large retailers who now perform their own wholesaling functions.
- Discounts and Allowances. Business buyers can take advantage of sales just like consumers. However, business buyers also receive other price breaks, including discounts for cash, quantity or bulk discounts, seasonal discounts, or trade allowances for participation in advertising or sales support programs.
- Geographic Pricing. Selling firms often quote prices in terms of reductions or increases based on transportation costs or the actual physical distance between the seller and the buyer. The most common examples of geographic pricing are uniform delivered pricing (same price for all buyers regardless of transportation expenses) and zone pricing (different prices based on transportation to predefined geographic zones). • Transfer Pricing. Transfer pricing occurs when one unit in an organization sells products to another unit
- Barter and Countertrade. In business exchanges across national boundaries, companies sometimes use products, rather than cash, for payments. Barter involves the direct exchange of goods or services between two firms or nations. Countertrade refers to agreements based on partial payments in both cash and products, or to agreements between firms or nations to buy goods and services from each other.
Another important pricing technique used in business markets is price discrimination, which occurs when firms charge different prices to different customers. When this situation occurs, firms set different prices based on actual cost differences in selling products to one customer relative to the costs involved in selling to other customers. Price discrimination is a viable technique because the costs of selling to one firm are often much higher than selling to others.
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