Leading Pricing Strategies and their benefits and risks.

 Commonly used pricing strategies.

There are several factors that affect the pricing of products including consumer demographics, costs of production, marketing and distribution as well as competition and demand. Business managers consider all these factors before they set the price for a product. Pricing is also related to positioning and affects the image of the product and the brand. However, there are various pricing strategies for business managers to choose from and they can consider the most suitable strategy to sustain demand and profits. Below we have discussed the four basic pricing strategies as well as several more pricing methods. Several new strategies have also emerged, many of which are a combination of the strategies discussed here and consider factors like seasonality, customer sentiments, etc for setting prices. However, pricing your product can be challenging but there are several options and you can also employ a mix of two or more strategies for the highest returns.

Economy Pricing:

Economy pricing is the strategy of selling products at lower prices than competitors consistently. It is the most suited for companies that keep their overheads low. Apart from minimizing its overhead, Walmart also keeps its operational costs low which allows it to sell products at highly competitive prices and lower than its rivals. Costco also saves on operational costs and keeps overheads low. It does not have a major marketing budget either. Since these companies save on operational costs and also hold strong bargaining power against their suppliers, they can sell products at lower costs. This strategy also works well when there is an economic recession since consumers become highly price sensitive.

Advantages:

  • It helps attract and retain customers in larger numbers.
  • Price sensitive customers will switch to your brand faster.
  • It can help create a strong competitive edge over rivals. e.g. Walmart.
  • Highly effective during times of recession.

Disadvantages:

  • Profit margins can be thin and unless you can achieve bulk sales, sustaining profitability may become difficult.
  • Small businesses cannot adopt this strategy since they will not be able to achieve the level of sales required to make up for the lost margins.
  • Requires focus on cost and overhead minimization.

Penetration Pricing:

Penetration pricing is a pricing strategy used for market penetration by setting low prices at the introductory phase. This is done mainly to gain market share by encouraging customers to switch brands. As time passes, the company again raises the prices and brings them to normal. This pricing strategy has become more common in the digital era. Websites, streaming services and software services offer a free trial period of one month and customers can continue or cancel as they like once the free trial period is over. 

Many customers would select to buy a subscription of the service for the free trial period first but if they need it still, they will continue with the subscription with the normal pricing. In the other case, a news or streaming video site would offer a three months subscription at a very small price like half or a quarter of the regular price. Post this period, customers would have to pay the normal prices. Netflix has successfully utilized this strategy and several news websites use this pricing strategy. If the product is really useful, the service ends up gaining a large number of customers and profits obtained would far outweigh the losses incurred during the trial period. However, one notable thing about this pricing strategy is that lower prices do not mean lower quality. The number of features or benefits can increase once the customer selects to continue and pay the normal charges. 

Advantages:

  • Penetration pricing is the simplest and easiest strategy used to win market share from competitors and encourage customers to switch. However, existing brands can also use it to prevent switching and secure their competitive edge against new entrants.
  • It can help grow sales faster and achieve economies of scale in a short span of time.
  • It helps grow brand awareness faster since lower prices also give rise to a lot of publicity and word of mouth like in the case of Netflix.

Disadvantages:

  • It can cause customers to perceive the brand as cheap or product quality as low.
  • You can end up gaining wrong customers that will switch later to cheaper substitutes.
  • The pricing strategy can cause a price war to erupt between your brand and your rivals.
  • Raising the prices later can also cause customer dissatisfaction and make them switch.

Price Skimming:

Price skimming is the practice of setting prices higher at the time of introduction and gradually bringing them lower. The initial prices are not permanent and the company knows that soon competitors will enter and price competition will grow resulting in customers switching unless prices are gradually lowered. By setting higher prices during the initial phase companies are successful at offsetting the price declines in the later stages. The higher profit margins earned initially offset the price drop that follows. 

However, this pricing strategy must be applied with caution since it is not always guaranteed that price skimming will be successful. The reason is that while early adopters may be willing to pay higher prices if the product is not unique or innovative, the excitement related to the product may fade sooner than expected resulting in high customer dissatisfaction and negative publicity. However, if the product is new to the market, innovative and unique, the chances of success will be higher and the other players entering the market will be forced to use the pricing as reference prices. 

There are several examples of products that were costly when they were introduced but gradually became a lot more affordable as new players entered the market. For example, the prices of smartphones and gaming consoles have declined a lot over the years. Companies many times also release cheaper versions of the same product if the initial launch of a high priced product is successful. In this way, they gain more customers who will also buy related products and services.

Advantages:

  • Companies can maximize their profits from any market using this strategy.
  • If your product has a short lifespan and your production costs are high, this is the most suitable strategy which will not just help you cover your production costs but also grow revenues by hacking into new customer segments that are attracted by lower costs. Down the line, as the demand falls, you can lower prices and attract new customers.
  • Higher profit margins and initial profits offset the lower margins after demand reduces.

Disadvantages:

  • Lowering prices later can leave your customers who bought at a higher price disappointed. It will affect customer loyalty.
  • It needs to be used with caution since you will need to match consumer expectations with quality and customer service.
  • You will lose potential customers if prices remain high for an extended period. If a competitor brings a competing product with competing benefits to the market at a lower price in the meantime, your most loyal customers too could switch.
  • Risky in terms of future growth. You may need to review your positioning strategy.

Premium pricing:

Premium pricing is a pricing strategy that suits the products or brands which are clearly differentiated from their competition on the basis of product quality, level of luxury and value. In terms of marketing, a premium price is a sign of the highest product quality and luxury. Premium price generally implies the product is a luxury product targeted at the higher end of the market. Luxury brands including hotels, automobiles, and fashion use this pricing strategy. However, it will work only when you are offering a product or service of the highest quality as in the case of 5-star hotels, luxury cars or watches. The buyers of premium products are from the higher end. Premium pricing is related to the image of the product and the customer both. A customer selects an expensive item over the less expensive one depending upon several things including the brand’s image, product quality, market buzz, etc.

Advantages:

  • Image of a high-quality product or brand.
  • Stronger profit margins.
  • Higher buzz (publicity) in the market.

Disadvantages:

  • Requires heavy focus upon quality and customer experience.
  • Competition from rivals offering products at discount.
  • Higher production and marketing costs.
  • Limited customers.

Other Pricing Strategies:

Apart from these, there are several other pricing strategies too like value-based pricing, usage-based pricing, freemium pricing, dynamic pricing, high low, cost plus and competitive pricing. As the digital and the cloud industries have evolved so have pricing strategies and apart from users’ preferences, several new factors need to be considered to set appropriate prices.

Value-Based Pricing:

Value-based pricing considers the perceived value of the product or what the customer thinks this product is worth. The focus of this pricing strategy is the customer segment and how much would it be willing to pay for the product or service. Differentiation is an important factor that affects product prices when you are using value-based pricing. It is most suited for companies offering differentiated products or highly unique items. According to Utpal M Dholakia, Professor of Marketing and author of How to Price Effectively: A Guide for Managers and Entrepreneurs, Value-based pricing is an effective pricing method and to set a value-based price, the marketer does not need to assess every feature but only the differentiated features of the product.

Usage-Based Pricing:

Usage-based pricing focuses on the level of product use and instead of the product/service or even the consumer is based on the level of consumption only. The primary benefit is that the level of flexibility offered by this pricing strategy can attract consumers from new segments and generate extra revenue.  Accommodating other variables in the pricing method can make the product unaffordable or cost restrictive for a vast segment of customers. However, it can also help grow customer satisfaction since irrespective of the level of usage, the customer will be happy that he is paying only for what he consumed. Moreover, in the age of the internet, data and AI when tracking consumption has become much easier, companies can easily set usage-based prices for both digital and physical products. This also helps the company tailor the product or service to suit customer needs as well as estimate future demand based upon consumption.

Freemium Pricing:

Freemium pricing strategy is a type of pricing method where some aspects of a product/service are offered for free whereas others come for a premium price. This has become a commonly used pricing strategy among smartphone app developers and internet startups. These companies offer a basic version of their subscription for free and richer functionalities are available at extra cost. Take Cloudflare for example. You can have a basic CDN subscription for free and a pro subscription with additional features for just $20. However, premium features like Railgun are available at a higher price of $200 available with business or higher subscriptions only.

Freemium services also offer indefinite free access which is generally a more potent strategy to attract customers. As in the example of Cloudflare, you can continue using the basic version till you like without paying anything. This also proves to be more attractive than free trials where you enter credit card details and are charged after the first month. However, for the freemium model to succeed the basic version of your product/service needs to be compelling enough to attract users and the premium version should also include compelling benefits to grow conversions which means a continuous focus on innovation.

Dynamic Pricing:

Dynamic Pricing is the practice of continuously adjusting prices based on demand and supply trends. Amazon’s pricing strategy is the best example of this pricing method. The e-commerce giant makes use of Algorithms to adjust prices in real-time based on the level of demand and supply. Dynamic pricing is the opposite of fixed pricing.  It is a flexible pricing strategy and considers the market situation and customer demand to price products. Moreover, the flexibility offered by this pricing strategy will not affect your brand value or image. Managing dynamic pricing does not remain complex given the right software, tools, and algorithm.

High Low Pricing:

High low pricing is the practice of pricing products higher and then bringing prices lower with time as demand for the product falls. However, it is different from Price Skimming but incorporates some aspects of the strategy. Companies using this strategy alternate between high and low prices. They mainly use sales, discounts, and promotions to grow sales. The use of discounts and sales promotions helps create a sense of urgency. Limited durations sales are a common strategy adopted by the companies following this pricing method. Promotions last for a few days or weeks during which people can buy products at discounted prices following which prices are back to normal. Companies using this strategy also utilize clearance sales and year-end sales with the purpose of driving traffic to stores and generate extra sales. Clearance sales are used to clear slow-moving inventory and apart from the items under sale, stores can also find customers for non-discounted items.

Cost Plus Pricing:

Cost Plus Pricing is one of the simplest pricing methods. All that companies need to do is calculate what goes into the making, marketing and distribution of the product and add a percentage markup which is its profit. You first calculate the costs of raw material, labor and the overhead to find out what it costs the company to make that product. Total costs of making the product include fixed and variable costs. Once you have found out the total costs, you easily add a percentage markup. The markup can vary depending upon certain factors like product demand and market conditions. However, cost-plus pricing is not always an effective method of pricing because while you stand to gain some profit, this pricing method ignores factors like the level of competition which can affect sales and revenue.

Competitive Pricing:

Competitive pricing strategy, as the name implies considers the size and effect of competition on business. It has become one of the most opted pricing strategies because of the growing competition in the market. In the case of competitive pricing, a business can set the price the same as its competitor or very close or higher than a competitor or lower if it can afford a loss or smaller profit margin. However, to set a price significantly higher than the competition, your product should have quality or features that warrant premium prices. Otherwise, you can price the product the same as the competitors and differentiate it through marketing.  In another case, the company can price its products much lower compared to the competition at very low or no profit margins to drive higher sales which can either compensate for the lost margins or drive the sales of other products sold by the business too. Loss leaders often employ this strategy where they sell a product at no profit margin or even a loss in order to gain market share faster.

CITE THIS.
APAPratap, A. (2020, February 21). Leading Pricing Strategies and their benefits and risks. Retrieved February 21, 2020, from https://notesmatic.com/2020/02/leading-pricing-strategies-and-their-benefits-and-risks/
MLAPratap, Abhijeet. Leading Pricing Strategies and Their Benefits and Risks. 21 Feb. 2020, notesmatic.com/2020/02/leading-pricing-strategies-and-their-benefits-and-risks/. Accessed 21 Feb. 2020.
Abhijeet Pratap

Abhijeet has been blogging on educational topics and business research since 2016. He graduated with a Hons. in English literature from BRABU and an MBA from the Asia-Pacific Institute of Management, New Delhi. He likes to blog and share his knowledge and research in business management, marketing, literature and other areas with his readers.