3.9 - Pricing Decisions
Factors that affect pricing decisions
Pricing forms a key part of the marketing mix, where businesses must set prices that cover costs, generate profit, and remain attractive to customers. Prices often vary across a product's life cycle, starting high for new items and potentially dropping as sales decline.
Influences on pricing choices
- Links to other marketing mix elements - Pricing interacts with product, place, and promotion; for example, during intense promotional campaigns, prices might be lowered to boost sales.
- Cost coverage and profit generation - Prices are commonly set to recover production or purchasing costs while adding a profit margin, known as cost-plus pricing. The profit added is called the mark-up.
- Customer acceptability - Prices need to suit the target market's sensitivity; wealthier customers may be less affected by high prices compared to those on tight budgets.
- Price elasticity of demand - This measures how demand changes with price adjustments, influenced by:
- Number of available substitutes
- Nature of the product (essential or luxury)
- Product's age in the market
- Whether it's a high-value purchase
- Strength of brand loyalty
- Product life cycle stage - Early stages might support higher prices, while later stages with falling sales could require reductions to maintain interest.
- Business objectives - Pricing supports goals like expanding market share, maximising profits, or upholding a premium brand image.
- Competitor actions - Prices must consider rivals; setting them too high without differentiation can lead to lost sales and negative perceptions, while setting them much lower might suggest poor quality.
Formula for cost-plus pricing
Where:
- Cost per unit = Total production or buying cost divided by units (£)
- Mark-up percentage = Profit margin added as a percentage of the cost
Worked example - Calculating price using cost-plus pricing
A business produces 350 units of a product with total costs of £2,450. It wants to add a 30% mark-up. Calculate the cost per unit and the final selling price per unit.
Step 1: Identify the values
- Total costs = £2,450
- Number of units = 350
- Mark-up percentage = 30%
Step 2: Calculate cost per unit
Step 3: Apply the mark-up
Step 4: Calculate final price
Promotional pricing strategies for new products
Businesses often use targeted pricing approaches when introducing new products to build market presence or capitalise on innovation. These strategies can also extend the life of existing products.
Price skimming
This involves setting high initial prices for innovative or unique products to maximise early profits from eager buyers.
Features of price skimming:
- Customers accept premium prices due to the product's novelty or limited availability.
- It enhances the product's prestige and desirability.
- Prices usually fall significantly once the market becomes saturated.
- Some brands maintain this as a long-term approach for exclusivity.
- Risks include early buyer reluctance or dissatisfaction when prices later drop.
Penetration pricing
This strategy launches products at low prices to quickly capture market share and attract price-sensitive customers.
Features of penetration pricing:
- It is particularly effective in competitive, budget-focused markets.
- Suited to firms that gain cost advantages from high-volume production through economies of scale.
- Can be applied to refresh demand for older products.
Challenges of penetration pricing:
- Customers expecting ongoing low prices.
- Difficulty in increasing prices without losing loyalty.
- Possible harm to the brand's perceived value.
- Businesses might use this for entry-level products while keeping higher-priced options for premium segments.
Other pricing strategies
Beyond introductory approaches, businesses employ various tactics to influence sales, compete effectively, or shape customer perceptions.
Types of additional pricing strategies
- Predatory pricing - Involves cutting prices below cost to drive competitors out, then raising them once dominance is achieved; this is illegal in the UK, EU, and US.
- Competitive pricing - Involves tracking rivals' prices and setting similar or lower levels, sometimes with guarantees to match any lower offers found elsewhere.
- Psychological pricing - Relies on how prices are perceived; for instance, higher prices can imply superior quality, while ending prices just below round numbers (e.g., £9.99 instead of £10) can make them seem more affordable.
- Loss leaders - Products sold at or below cost to draw in customers, who then buy other profitable items; this is common in stores with wide ranges.
- Price discrimination - Charging different prices for the same product to various groups, often based on factors like age, location, or customer type.
Dynamic pricing
Dynamic pricing allows businesses to adjust prices in real time based on changing conditions, commonly seen in sectors like travel and hospitality.
Features of dynamic pricing
- Prices fluctuate according to competitor rates and demand levels.
- They often rise as availability decreases or dates approach.
- Variations occur by time, day, or season to match peak and off-peak periods.
Advantages of dynamic pricing
- Higher profits during busy times.
- Covering expenses in quieter periods.
- Stimulating extra demand when activity is low.
Pricing influences in industrial marketing
Pricing in business-to-business (B2B) contexts differs from consumer markets, emphasising relationships over short-term gains.
Key differences in B2B pricing
- Focus on fostering long-term partnerships, sometimes at the expense of immediate profits, to encourage repeat business and add-on services.
- Influenced by the level of market competition.
- Buyers are typically more informed and rational in their decisions.
- The marketing mix adapts: promotions provide detailed information rather than persuasion, and distribution often involves channels like trade exhibitions.
- Pricing strategies prioritise ongoing value and reliability over one-off sales.