Comprehensive Guide to Business Pricing Strategies

Introduction to Pricing Strategies

• Definition of Strategy: A strategy is a comprehensive set of plans designed to meet specific objectives.

• Pricing Strategy Context:

  • Pricing strategy is a component of the broader marketing strategy of a business.

  • Other components of a marketing strategy include product strategy and distribution strategy.

  • Marketing strategy itself is a subset of corporate strategy, which also includes production and financial strategies.

• Objectives: Pricing strategy helps a business achieve its marketing and corporate objectives.

  • Example Case: If a corporate objective is to double in size over the next $5$ years, a marketing objective might be to move products "up-market."

  • Resulting Pricing Strategy: This objective would likely lead to a strategy of increasing the average price of the business's products.

Cost-Plus Pricing

• Definition: Setting prices that ensure all costs are covered by adding a specific mark-up to the unit costs of a product.

• Usage: This method is extremely common among retailers.

• Mechanism: The mark-up is typically calculated as a percentage of the unit cost.

• Formula for Price Calculation:
  $ext{Price} = ext{unit cost} + ( ext{mark-up} imes ext{unit cost})$

• Mathematical Tip for Calculating Percentage Mark-up:

  • Find the difference between unit cost and price, then express it as a percentage of the unit cost.

  • Formula: $ext{Mark-up Percentage} = rac{ ext{Price} - ext{Unit Cost}}{ ext{Unit Cost}} imes 100$

  • Worked Example: If unit cost is $80 GBP$ and price is $140 GBP$, the mark-up is $75 percent$.
    $140 GBP - 80 GBP = 60 GBP$
    $rac{60}{80} imes 100 = 75 percent$

• Manufacturer Example (Fibreglass Canoe):

  • Unit cost: $80 GBP$

  • Mark-up: $25 percent$

  • Calculation: $80 GBP + (25 percent imes 80 GBP) = 80 GBP + 20 GBP = 100 GBP$

• Drawbacks of Cost-Plus Pricing:

  • Market Insensitivity: It ignores market conditions. A business's mark-up might be too high relative to rival products, leading to low sales.

  • Cost Identification Issues: It can be difficult to precisely identify all costs associated with producing a specific item, particularly in multi-product businesses.

Price Skimming (Creaming)

• Definition: Launching a product at a high price for a limited period before lowering it over time.

• Primary Aims:

  • Generate high levels of revenue with a new product before competitors arrive.

  • Exploit the popularity and uniqueness of a new product.

• Common Industries:

  • Technological Products: When laptop computers were first introduced in the UK market, prices exceeded $1,000 GBP$, but can now be purchased for less than $200 GBP$.

  • Pharmaceuticals: New drugs are sold at high prices upon launch to recover high research and development (R&D) costs. When a patent (a license preventing competition for a number of years) expires, competition increases and prices fall.

• Advantages:

  • Maximizes revenue by charging those willing to pay a premium.

  • Lowering prices later draws in other customer groups.

  • Helps elevate the product's brand image.

• Constraints:

  • Can only be used successfully if demand is price inelastic.

  • High margins might attract competitors into the market.

Penetration Pricing

• Definition: Introducing a new product at a low price for a limited period to gain a "foothold" in the market.

• Strategy Goal: To attract customers with a low initial price in the hope they continue buying once the price increases.

• Introductory Offers:

  • Can be half-price, free for a trial period, or the first few items/services offered at a low rate (e.g., initial driving lessons).

• Benefits:

  • Targeting: Highly effective for middle- or low-income groups responsive to low prices.

  • Rapid Growth: Growth in sales volume is typically faster the lower the introductory price is set.

  • Economies of Scale: Fast growth allows businesses to exploit economies of scale and lower production costs.

  • Competitive Pressure: Places financial pressure on rivals to lower their prices or differentiate.

• Requirements and Risks:

  • Requires a relatively low cost base to be sustainable.

  • Businesses must not extend offers too long; if consumers become accustomed to low prices, they may refuse to pay the higher long-term price.

• Sectors Using This: Sports clubs (attracting members), online gaming, satellite broadcasters (attracting subscribers), and driving schools.

Predatory (Destroyer) and Competitive Pricing

• Predatory Pricing Principles:

  • Involves charging very low prices until one or more rivals leave the market.

  • Legality: Selling products below the cost of production to force competitors out is illegal in the UK and EU. This prevents long-term monopolies where the survivor raises prices significantly.

  • Exceptions: Low-price strategies are allowed if a low-cost business simply endures low profit margins, or to clear unsold stock, or to enter a new market.

  • Historical Case (2013): Esso and Shell were accused of localized predatory pricing by the RMI Petroleum Retailers Association (PRA). Franchised dealers reportedly had to buy fuel at wholesale prices higher than the retail prices charged at sites owned and operated by the oil companies.

• Competitive Pricing Principles:

  • Used in fiercely competitive markets where firms set prices based on rivals.

  • Going Rate/Safe Strategy: Charging the same price as competitors to avoid price wars.

  • Price Leadership: The market leader (often the dominant or lowest-cost firm) sets the price, and others follow. Dominance is often built through a strong brand or cost efficiency.

Psychological Pricing

• Definition: Setting a price slightly below a round figure (e.g., $99.99 GBP$ instead of $100 GBP$).

• Mechanism: Consumers are psychologically "tricked" into perceiving the price as significantly cheaper than the rounded figure.

• Target Audience: Consumers specifically looking for bargains.

• Usage Limitation: Typically not used for "up-market" or luxury products where the perception of value is not tied to low-digit price endings.

Factors Determining the Appropriate Pricing Strategy

• Differentiation and USP (Unique Selling Point): Higher prices can be charged if a product is unique.

  • Example: Restaurants with innovative dishes, unique environments, and friendly service can charge more.

• Price Elasticity of Demand (PED):

  • Inelastic Demand: If $PED = -0.8$, a $10 percent$ price increase only causes an $8 percent$ drop in demand, increasing total revenue. Standard for utilities (gas, electricity, water).

  • Elastic Demand: If $PED = -2.7$, a $10 percent$ price cut leads to a $27 percent$ increase in demand, increasing total revenue. Strategy used by low-cost supermarkets.

• Amount of Competition:

  • Little competition (e.g., isolated shop in the Scottish Highlands) allows for high prices.

  • High competition leads to "price taking," where firms must accept the market price (common for farmers in commodity markets).

• Strength of Brand:

  • Strong brands (e.g., Coca-Cola, Unilever) can justify higher prices via heavy advertising and can utilize skimming or predatory strategies more effectively.

• Stage in the Product Life Cycle:

  • Launch: Penetration pricing for establishment or skimming for unique products.

  • Growth: Prices might be increased.

  • Maturity: Prices may be reduced slightly to stay competitive against imitators.

• Costs and Profit Needs: Long-term prices must cover all production costs and yield profit. However, businesses must also consider "value for money" as customers care more about value than the company's internal costs.

Changes Reflecting Social Trends and Online Sales

• Consumer Shift: Modern consumers are better informed, more likely to haggle, search for bargains, and rely on social media reviews rather than brand loyalty.

• Dynamic Pricing: Flexible prices based on demand and capacity.

  • Travel/Hotels: Fares vary by day of week, time of day, and lead time before travel. Factors include seat capacity, departure time, and average cancellation rates.

• Auction Sites: (e.g., eBay, Gumtree, Avabid) Goods go to the highest bidder. This creates a sense of urgency, though sellers pay platform fees.

• Personalised Pricing: Using Shopper data (browsing history, purchase history, demographic data, and even hardware used) to set unique prices. Amazon has reportedly experimented with this to charge higher prices to those willing to pay.

• Subscription Pricing: Regular monthly fees for service access.

  • Examples: Netflix, Spotify, Adobe Systems, PlayStation Plus, ASOS Premier, online newspapers.

  • Advantages: Improves cash flow, creates sales certainty, and leverages the fact that many customers do not cancel even if they have the right to.

• Price Comparison Sites:

  • General or specialists (trivago for hotels, KAYAK for flights, Carrentals, uSwitch for energy, Mobile Checker).

  • Allows consumers to find the cheapest deals or research online before buying in-store.

  • Caveat: Different sites may yield different results for the same query based on which providers they can access.

Case Studies and Questions & Discussion

• Hambleton Farm (Dairy, Warwickshire):

  • Owners: Ruth and Carl Fletcher.

  • 2014 Market: Price takers selling to wholesalers at approximately $32 p$ per litre.

  • Financials: Total costs were $1,560,500 GBP$ and total revenue was $1,561,000 GBP$. This resulted in a very small profit.

  • Discussion Point: What would happen if they tried to increase the price to $35 p$? As price takers, they would likely lose all sales to competitors willing to sell at the market rate.

• Virgin Media (2014 Bundle):

  • Product: 'Essential Family Sports Collection' including TV, home phone, and broadband (including $154$ Barclays Premier League games).

  • Price Structure: $46.75 GBP$ per month (plus line rental) for the first $6$ months, rising to $66.25 GBP$ thereafter.

  • Discussion Point: This is a form of penetration pricing/introductory offer designed to attract subscribers with a lower (by $19.50 GBP$) initial price.

• Exam Tip regarding Pricing Confusion:

  • Do not confuse penetration with predatory pricing.

  • Penetration: Legal, short-term low price to break into a market.

  • Predatory: Potentially illegal, long-term low price below cost with the express intent to