Competing on Price

Relationship between PED and total revenue

Types of pricing strategies

A pricing strategy is the approach which a business decides on for setting the price of its product or service. A business can adopt a pricing strategy for several reasons: to try to break a new product into a new market, to try to increase its market share, to try to increase its profits or To ensure its costs are covered and a particular profit is earned etc.

The business objective being sought will heavily influence the pricing strategy that a business decides to use. There are 6 main strategies that we need to know:

Penetration pricingStart off with a low price to attract customers. E.g. first issue of a magazine. This ensures that sales are made and the good enters the market – though obviously profits will be low.
Price skimmingStart with a high price for a unique product. E.g. the new Xbox or Playstation 3 or latest tech product. This will establish an image of quality – but also put some customers off.
Competitive pricingCharge a price similar to competitors (thus quality and image becomes the competitive factor). It’s the most common strategy.
Predatory pricing (aka ‘destroyer pricing’)A tactic used by dominant businesses to eliminate the competition (e.g. Today newspaper) or prevent a rival from taking market share (e.g. Current ‘Big 4’ supermarket price war). It involves setting low prices, perhaps even selling at a loss, to ‘destroy’ the competition. Once achieved, prices can return to normal again. It relies on the dominant business being able to sustain the pain of this! Predatory pricing is illegal under competition law….however proving that behaviour is predatory is difficult
Cost-plus pricingAdd a percentage profit to the actual cost (i.e. calculate mark-up on unit cost). It’s a very easy method to apply – though if your competitors have low costs compared to you then you maybe in trouble!
Psychological pricingMaking people think they are paying less than they actually are. E.g. $4.99 instead of $5. Also supermarkets make regularly purchased items cheap so that you think it’s a really good value shop! A variation is ‘eye-catching low headline prices’ with extra hidden charges – e.g. phone contracts and budget airlines!!

Competing on Price, figure 1

The rise of the internet/technology imposed far reaching changes on pricing strategies and prices in general. Ask yourself how? In what ways has the internet affected business price?

  • Online sales – The rise of the internet/technology imposed far reaching changes on pricing strategies and prices in general.__ Consumers have access to a wider range of goods__ and can compare a full range of prices and availability. Online sales have __broadened choice and competition, often making market more price competitive. __Consumers can see what the going rate is and businesses have to justify charging more than this.

  • The other side of this gain for consumers and being more price aware, is that via technology and __loyalty cards, the amount of information businesses can learn about consumers can become a source of power. Hyper-targeted marketing __in action! Have you ever been tempted by a Amazon e-mail or Nectar voucher? That’s hyper-targeted marketing in action.

  • Prices can be based on the consumer as well as the product – software is available to give online businesses ways to vary prices between customers based on what they are willing to pay.

  • Price comparison sites – Give power to consumers by enabling them to see a range of prices at a glance. Businesses try to fight against this by having complex pricing structures that make accurate comparisons difficult. In 2014 Ofgem (energy company regulator) forced energy companies to simplify their bills. They also discovered that these websites themselves prioritise the companies that give them the highest commission, so consumers in fact are not getting the best deal!

  • Nevertheless these sites have driven prices down.

Factors that determine the most appropriate pricing strategy for a particular situation

As stated previously, the strategy chosen will depend on a range of factors – nature of product/service (does it have a USP or strong brand, is it a market leader or a new product?), the target market, amount of competition/substitutes available and finally external factors (state of the economy or government policies).

1) USP/differentiation – has it been clearly product differentiated? If so a higher price might be justified.

2) PED – elastic (drastic! Very sensitive to changes in price) so what about price? Maybe competitive might suit. Inelastic (not so drastic/sensitive), so what about price? Maybe more so skimming.

3) __Level of competitio__n – An obvious factor. Highly competitive = competitive pricing.

4) Strength of brand – This is why a USP/strong brand is important as it reduces PED to inelastic and price becomes less of a decision making factor. Apple have done this well!

5) Costs and need to make profit – Costs are mounting as is the need to make quick sales. Cost-plus pricing! This can help get immediate debts settled, however long term success and survival depend on marketing mix, which will hopefully lead to profitability.

6) Stage of Product Life Cycle – as previously covered, depending on the stage in the product life cycle it will affect which pricing strategy is chosen.