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

Cost-Plus Pricing

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

Markup Pricing

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.