Pricing Strategies and Methods
Whichever pricing policy is in place, it should be the result of a strategy that is in tune with your marketing objectives. Pricing generally falls into one of 4 categories:
Ever wonder why some things are just expensive and most things on those “only on TV” ads are $19.95?
The perception of quality is tied directly to price. The average consumer is well aware that “you get what you pay for”. Further, most people perceive $19.95 as $19.00 instead of $20.00. A good psychological pricing strategy takes advantage of these facts.
If we are selling discounted bags of candy at Halloween or Easter, or if we discount the VCR’s when the new DVD players are coming out, then we have implemented a promotional strategy.
Introductory pricing falls into 2 subcategories, either of which apply to the same situation; the product is new to the market.
This is the practice of setting the highest price that consumers are willing to pay. By setting a higher price, the costs of bringing the product to market can be recovered faster, and enhance the perception of quality (see psychological pricing). New technologies often are released with this strategy in place.
This is the practice of introducing your product at the lowest acceptable profit margin. Often the product in question is entering an established market.
The down side to penetration pricing is that it is far easier for consumers to accept a price decrease than an increase.
Flexible pricing allows some room for negotiation. Sales people are often given a price range in which to sell the item, with their commission tied to the final sale price. The automotive industry has a long tradition of flexible pricing.
So, there comes a time when we have to actually decide what to charge. Along with the variety of policies and strategies, we have a number of methods to make those decisions. Generally, there are 5.
Supply & Demand
As discussed, lower prices can generate sales. The Sales Volume of existing products usually drives the production of new products. In determining your final price, it is necessary to take into consideration the Elasticity of Demand for your products. Elasticity is determined by dividing the %change in Quantity Demanded by the %change in price (%quantity / %price)
For example, if Sony raises the price of DVD players 5%, which causes demand to decrease 10%, then the elasticity is 2% (10 / 5 = 2).
Breakeven Analysis determines how many units you must sell at a given price in order for profits to equal the costs incurred in brining the product to market. In other words, calculate the total fixed cost divided by the unit contribution to cost (Fixed Cost / Unit Contribution).
For example, assume the following is true; Sony’s fixed cost for producing DVD players was $500,000.00; the cost for producing 1 unit is $100.00, and the selling price is $150.00.
The unit contribution to cost is then $50.00.
At $50.00 per unit, Sony must sell 10,000 units to break even
(500,000 / 50 = 10,000).
Cost plus pricing takes a base cost per unit and adds a specific percentage to establish the retail price.
For example, if Circuit City adds a 20% markup to Sony DVD players purchased from a wholesaler at $150.00 per unit, then the retail price is $180.00 ($179.99)
It is often necessary to adjust a pricing strategy in relation to the competition’s actions. Retailers are often advertising on the basis of meeting or beating someone else’s price. Price match guarantees abound in the current marketplace.
For example, if Best Buy can sell Sony DVD players for $169.99, and still show an acceptable profit per unit, they may want to advertise that fact and attract customers away from Circuit City. Circuit City, in turn may reduce their price to $159.99, or they may temporarily sell the DVD players at cost and offer a selection of DVD’s.
This is the realm of contractors, ranging from residential construction to the military industrial complex. Basically, a buyer establishes a set of requirements and invites contractors to Bid. The bid is essentially the amount of money that the contractor has determined to be necessary to complete the job and show an acceptable profit.
Keep in mind when evaluating bids that the lowest cash outlay is not always the most economical in the long run.
Keep in mind when bidding that you have to cover all of the costs associated with the project, and be competitive in that market.