Pricing

Example of an "Everyday Low Price" sign

Pricing is the process whereby a business sets the price at which it will sell its products and services, and may be part of the business's marketing plan. In setting prices, the business will take into account the price at which it could acquire the goods, the manufacturing cost, the market place, competition, market condition, brand, and quality of product.

Pricing is also a key variable in microeconomic price allocation theory. Pricing is a fundamental aspect of financial modeling and is one of the four Ps of the marketing mix. (The other three aspects are product, promotion, and place.) Price is the only revenue generating element amongst the four Ps, the rest being cost centers. However, the other Ps of marketing will contribute to decreasing price elasticity and so enable price increases to drive greater revenue and profits.

Pricing can be a manual or automatic process of applying prices to purchase and sales orders, based on factors such as: a fixed amount, quantity break, promotion or sales campaign, specific vendor quote, price prevailing on entry, shipment or invoice date, combination of multiple orders or lines, and many others. Automated systems require more setup and maintenance but may prevent pricing errors. The needs of the consumer can be converted into demand only if the consumer has the willingness and capacity to buy the product. Thus, pricing is the most important concept in the field of marketing, it is used as a tactical decision in response to comparing market situation.

Objectives of pricing

The objectives of pricing should include:

• to achieve the financial goals of the company (i.e. profitability)
• to fit the realities of the marketplace (will customers buy at that price?)
• to support a product's market positioning and be consistent with the other variables in the marketing mix

• price is influenced by the type of distribution channel used, the type of promotions used, and the quality of the product

• price will usually need to be relatively high if manufacturing is expensive, distribution is exclusive, and the product is supported by extensive advertising and promotional campaigns
• a low cost price can be a viable substitute for product quality, effective promotions, or an energetic selling effort by distributors

From the marketer's point of view, an efficient price is a price that is very close to the maximum that customers are prepared to pay. In economic terms, it is a price that shifts most of the consumer economic surplus to the producer. A good pricing strategy would be the one which could balance between the price floor (the price below which the organization ends up in losses) and the price ceiling (the price be which the organization experiences a no-demand situation).

Terminology

There are numerous terms and strategies specific to pricing:

Line pricing

Line pricing is the use of a limited number of prices for all product offered by a business. This is a tradition started in the old five and dime stores in which everything cost either 5 or 10 cents. Its underlying rationale is that these amounts are seen as suitable price points for a whole range of products by prospective customers. It has the advantage of ease of administering, but the disadvantage of inflexibility, particularly in times of inflation or unstable prices.

Loss leader

A loss leader is a product that has a price set below the operating margin. This results in a loss to the business on that particular item in the hope that it will draw customers into the store and that some of those customers will buy other, higher margin items.

Price/quality relationship

The price/quality relationship refers to the perception by most consumers that a relatively high price is a sign of good quality. The belief in this relationship is most important with complex products that are hard to test, and experiential products that cannot be tested until used (such as most services). The greater the uncertainty surrounding a product, the more consumers depend on the price/quality signal and the greater premium they may be prepared to pay. The classic example is the pricing of Twinkies, a snack cake which was viewed as low quality after the price was lowered. Excessive reliance on the price/quality relationship by consumers may lead to an increase in prices on all products and services, even those of low quality, which causes the price/quality relationship to no longer apply.

Premium pricing

Premium pricing (also called prestige pricing) is the strategy of consistently pricing at, or near, the high end of the possible price range to help attract status-conscious consumers. The high pricing of a premium product is used to enhance and reinforce a product's luxury image. Examples of companies which partake in premium pricing in the marketplace include Rolex and Bentley. As well as brand, product attributes such as eco-labelling and provenance (e.g. 'certified organic' and 'product of Australia') may add value for consumers and attract premium pricing. A component of such premiums may reflect the increased cost of production. People will buy a premium priced product because:

• They believe the high price is an indication of good quality
• They believe it to be a sign of self-worth - "They are worth it;" it authenticates the buyer's success and status; it is a signal to others that the owner is a member of an exclusive group
• They require flawless performance in this application - The cost of product malfunction is too high to buy anything but the best - for example, a heart pacemaker.

Demand-based pricing

Demand-based pricing is a pricing method that uses consumer demand - based on perceived value - as the central element. These include price skimming, price discrimination and yield management, price points, psychological pricing, bundle pricing, penetration pricing, price lining, value-based pricing, geo and premium pricing.

Pricing factors are manufacturing cost, market place, competition, market condition, quality of product.

Price modeling using econometric techniques can help measure price elasticity, and computer based modeling tools will often facilitate simulations of different prices and the outcome on sales and profit. More sophisticated tools help determine price at the SKU level across a portfolio of products. Retailers will optimize the price of their private label SKUs with those of National Brands.

Surge pricing

Uber's online ride service uses an automated algorithm to increase prices to "surge price" levels, responding rapidly to changes of supply and demand in the market, and to attract more drivers during times of increased rider demand, but also to reduce demand. Customers receive notice when making an Uber reservation that prices have increased. The company applied for a U.S. patent on surge pricing in 2013.

The practice has often caused passengers to become upset and invited criticism when it has happened as a result of holidays, inclement weather, or natural disasters. During New Year's Eve 2011, prices were as high as seven times normal rates, causing outrage. During the 2014 Sydney hostage crisis, Uber implemented surge pricing, resulting in fares of up to four times normal charges; while it defended the surge pricing at first, it later apologized and refunded the surcharges. Uber CEO Travis Kalanick has responded to criticism by saying: "...because this is so new, it's going to take some time for folks to accept it. There's 70 years of conditioning around the fixed price of taxis."

See also: Price gouging

Multidimensional pricing

Multidimensional pricing is the pricing of a product or service using multiple numbers. In this practice, price no longer consists of a single monetary amount (e.g., sticker price of a car), but rather consists of various dimensions (e.g., monthly payments, number of payments, and a downpayment). Research has shown that this practice can significantly influence consumers' ability to understand and process price information.

Nine laws of price sensitivity and consumer psychology

In their book, The Strategy and Tactics of Pricing, Thomas Nagle and Reed Holden outline nine laws or factors that influence how a consumer perceives a given price and how price-sensitive s/he is likely to be with respect to different purchase decisions:

• Reference price effect: Buyer’s price sensitivity for a given product increases the higher the product’s price relative to perceived alternatives. Perceived alternatives can vary by buyer segment, by occasion, and other factors.
• Difficult comparison effect Buyers are less sensitive to the price of a known / more reputable product when they have difficulty comparing it to potential alternatives.
• Switching costs effect: The higher the product-specific investment a buyer must make to switch suppliers, the less price sensitive that buyer is when choosing between alternatives.
• Price-quality effect: Buyers are less sensitive to price the more that higher prices signal higher quality. Products for which this effect is particularly relevant include: image products, exclusive products, and products with minimal cues for quality.
• Expenditure effect: Buyers are more price sensitive when the expense accounts for a large percentage of buyers’ available income or budget.
• End-benefit effect: The effect refers to the relationship a given purchase has to a larger overall benefit, and is divided into two parts:

  Derived demand: The more sensitive buyers are to the price of the end benefit, the more sensitive they will be to the prices of those products that contribute to that benefit.

  Price proportion cost: The price proportion cost refers to the percent of the total cost of the end benefit accounted for by a given component that helps to produce the end benefit (e.g., think CPU and PCs). The smaller the given components share of the total cost of the end benefit, the less sensitive buyers will be to the component's price.

• Shared-cost effect: The smaller the portion of the purchase price buyers must pay for themselves, the less price sensitive they will be.
• Fairness effect: Buyers are more sensitive to the price of a product when the price is outside the range they perceive as “fair” or “reasonable” given the purchase context.
• Framing effect: Buyers are more price sensitive when they perceive the price as a loss rather than a forgone gain, and they have greater price sensitivity when the price is paid separately rather than as part of a bundle.

Approaches

Pricing is the most effective profit lever. Pricing can be approached at three levels. The industry, market, and transaction level.

• Pricing at the industry level focuses on the overall economics of the industry, including supplier price changes and customer demand changes.
• Pricing at the market level focuses on the competitive position of the price in comparison to the value differential of the product to that of comparative competing products.
• Pricing at the transaction level focuses on managing the implementation of discounts away from the reference, or list price, which occur both on and off the invoice or receipt.

Pricing tactics

Micromarketing is the practice of tailoring products, brands (microbrands), and promotions to meet the needs and wants of microsegments within a market. It is a type of market customization that deals with pricing of customer/product combinations at the store or individual level.

Dynamic pricing is a pricing strategy in which businesses set highly flexible prices for products or services based on changes in the level of market demand.

Pricing mistakes

Many companies make common pricing mistakes. Bernstein's article "Use Suppliers Pricing Mistakes" outlines several which include:

• Weak controls on discounting (price override)
• Inadequate systems for tracking competitor selling prices and market share
• Cost-plus pricing
• Price increases poorly executed
• Worldwide price inconsistencies
• Paying sales representatives on dollar volume vs. addition of profitability measures

Methods

• Base point pricing
• Cost the limit of price
• Drip pricing
• Group buy
• Options pricing
• Pay what you want
• Price elasticity of demand
• Price system
• Price umbrella
• Product life cycle management
• Product sabotage
• Psychological pricing
• Purchasing power
• Suggested retail price
• Target pricing
• Time-based pricing
• Value pricing

See also

• Pricing strategies

External links and further reading

• William Poundstone, Priceless: The Myth of Fair Value (and How to Take Advantage of It), Hill and Wang, 2010
• Engineering New Product Success: the New Product Pricing Process at Emerson Electric. A case study by Jerry Bernstein and David Macias. Published in Industrial Marketing Management.
• How To Price and Sell Your Software Product, Redpoint Ventures