What is Pricing?
Pricing is a way for a brand to communicate a product’s value to consumers. Pricing can also help sellers determine their net profit margins, demonstrating how much a business earns from their goods and services.
Increased prices can infer a higher quality product, whereas lower prices can target consumers looking for cheap products. To determine the price of a product, you must first establish your target demographic and their preferences.
Setting A Price
When selling your product or service, it is important to develop pricing objectives, to help determine what price to set for your product. During this process, you must decide what you want to communicate to consumers about the price of your product. When shopping for phones, do you look for the cheapest phone or for one that is high quality? Because different prices appeal to different consumer tastes, buyers are attracted to strategically priced products.
There are multiple ways to price a product. A price-competitive product is a lower-cost alternative to competitors, particularly in comparison to more developed brands. While being aware of market prices for similar products is important, you must remain conscientious about continuing to make a profit after costs are incurred. For example, Walmart is known for their price competitive products in comparison to other department stores like Target.
Alternatively, pricing higher than competitors can be a pricing strategy. A higher price can communicate a higher quality and more developed brand than competitors. However, you must be careful not to overprice your product. The higher price a product gets, the lower consumer demand it receives. An example would be generic prescription drugs vs brand name drugs. Many people choose generic drugs because of their affordability in comparison to their competitors. It is important to maintain your price at an amount your target demographic is willing to pay.
Regardless of your pricing strategy, it is necessary to remain aware of your competitors’ prices.
Why is Pricing Important?
By using the Profitability Framework, you can break down your profit into two basic components: revenue vs costs. Profit is only able to occur if a business has more revenue than its costs. The difference between a business’ revenue and cost is called the contribution margin. Understanding your contribution margin as a business is crucial to understanding the profitability of your business.
Revenues can be further broken down into price, volume, and product mix. Costs can then be broken down into fixed and variable. Here you can demonstrate how price will affect your revenue and then your profitability. There are many effective methods to changing your pricing strategies to increase profitability.
Common Pricing Strategies
Many pricing strategies are cost-based, meaning they take your cost per unit into account when determining what price you should charge for the unit. Cost-plus pricing and markup pricing are two examples of cost-based pricing strategies.
Cost-Plus Pricing - Cost-based pricing are strategies to set a price amount based on the cost to produce each unit. This ensures that you are making a profit on your product.
Example: If baking a loaf of bread costs $2.00, a baker will sell their loaves of bread for more than $2.00 to make a profit.
To use cost-plus pricing you first need to determine your cost per unit. Next, you add a specified dollar amount to this number to determine your price.
(Cost per unit) + (Expected % of return) = price
In order to calculate the expected rate of return, multiply the potential outcome of profit loss by the probability rate. After taking into account all potential outcomes, you add them all together to get the total expected rate of return.
Markup Pricing - Using markup pricing you add a predetermined percentage to the established unit cost. This consistent amount is your markup rate.
(Cost per unit) + (Markup rate) = price
Demand-based vs Competition-based pricing
Demand-based pricing - based on the amount consumers demand
Example: Hotels are cheaper in Arizona in the summer because people want to avoid the extreme heat. With fewer people visiting, Hotels decrease their prices to remain competitive.
Example: Airfare is more expensive around holidays due to individuals traveling to visit their family. In order to supply the need for travel, airfare prices increase.
Competition-based pricing - based on competitors’ prices
Example: Burger King setting hamburger prices based on nearby fast food prices such as McDonald’s.
Example: Pepsi lowering their prices to match Coca-Cola’s
Using the Right Pricing Strategies
Captive pricing - pricing the base product in a product line at a low cost, but increasing the price of necessarily related products. This strategy encourages consumers to buy your initial product and increase profits as they continue to purchase the higher-cost item.
For example, printers are relatively inexpensive, but ink cartridges are priced higher. Keurig machines are another example. The Keurig itself is priced lower, but the K-cups needed to make drinks are pricier.
Premium pricing - Pricing the higher quality or most desirable product higher than other products in your product line. This communicates to the consumer that the higher price version is the best or most advanced option. It also capitalizes on the customer’s demand for that product.
An example of this pricing strategy is TV cable services. The most requested package, which often
includes the most channels, is priced higher than the other options. Usually, this is also by a larger margin than other packages.
Price lining - Selling goods at certain predetermined prices, reflecting definite price breaks. When using this pricing strategy, customers must often buy your product in quantities and not in individual units.
A pack of ties, for example, could utilize this strategy. For one set of four ties, you might be charged $11.99 but for a pack of ten ties, you are charged $21.99. Package discounts are important because the increase in the volume of a product increases revenue which leads to higher profits.
Odd-number pricing - using odd numbers and prices just below whole dollar amounts, makes consumers more likely to pay more.Ending prices in .99 called “charm pricing” because it makes the consumer believe they are paying less for goods and services whereas they are paying the same amount.
Multiple unit pricing - packaging together multiple units of your product and selling them at a single price. Deals like buy one get one free or buy one get one 50% off are ways to use this strategy. This strategy is effective because it creates a sense of urgency by pushing customers to take advantage of the sale and purchase a product or service.
Reference pricing - pricing a product at a moderate amount and displaying it next to a more expensive brand. This communicates your product as a lower-priced alternative to leading brands. Grocery stores utilize this when they place their own branded products next to more expensive name brands. Walmart and Kirkland are examples of this.
Bundle pricing - packaging two or more complementary products and selling them together. These don’t have to be the same product, but rather two products that might be used in tandem with one another. Cox tv services often offer phone lines and wifi as part of their bundles. Spotify also uses bundle pricing, offering Hulu subscriptions as part of one of their premium plans.
Adjusting prices due to changes in consumer demands
Special-event pricing - during holidays, or seasons associated with buying special items it might be beneficial to adjust your prices. When selling office supplies, one might drop their prices during the back-to-school season to encourage customers to buy their brand. During Black Friday and Christmas, many companies offer lowered prices for their products.
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