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MBA Help - Marketing

Pricing Strategy

Price is one of the four core elements of the marketing mix, and is often seen as one of the most difficult ones to manage. This is because the price a company charges for its products or services will have a major impact on the bottom line revenue and profits, but pricing is also an important strategic issue, and a vital part of positioning a product in a market segment. As such, companies will need to consider how their price will affect, and be affected by, the marketing strategy; the other elements in the marketing mix; and any environmental factors. At the same time, the company will need to understand how the price will affect demand; how the fixed and variable costs will behave over time; and the ultimate strategic objectives of the company, whether they are profit maximisation, revenue maximisation, growth maximisation or some other. Only then can a pricing method and structure truly be determined.

Pricing must first be considered as part of the marketing strategy and marketing mix. This is because the ultimate price of the product will need to be determined by its quality, and hence the price will have a key impact on the product development. In addition, the impact of price on the quantity demanded will play a key role, depending on whether the company wishes to maximise its revenue or maximise its profits. Finally, companies need to consider the competitive and regulatory environment in which it operates when thinking about price. If the company sets a price much lower than the rest of the market may trigger a price war, harming market share; but setting a price too high risks failing to attract customers from competitors with a cheaper product. In addition, regulatory guidelines may restrict price levels, usually by preventing companies from using predatory low pricing to drive competitors out of business and establish a monopoly. Finally, companies need to be careful if they want to set different prices for different customer groups, as this may be seen as discrimination, and also need to be careful not to communicate with their competitors around prices, as this may be seen as collusion.

Pricing strategies for new products

When introducing a new product, a company will generally aim to either maximise its profit or maximise its market share. This implies that a company should either pursue a price strategy based on skimming or penetration.

Skimming occurs when companies set a high price in an attempt to attract, or ‘skim’ the most valuable customers: the ‘cream’ of the market. Such a strategy targets the most affluent customers in the market who sit at the very top of the demand curve and are not very sensitive to price. Skimming is generally does when a company has developed a unique product and expects demand to be relatively inelastic. As such, customers will not be highly price sensitive, and the company can thus still sell a significant volume of products at high prices. It is also appropriate when a company does not expect significant economic of scale in the short term, and hence would not benefit from increasing the volume sold, or when the company simply does not have the capital and resources to produce a large volume of products.

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Penetration pricing is effectively the opposite of skimming, and involves a company setting a low price and hence attempting to obtain the maximum share of the market possible. This is usually done when a company expects demand to be very elastic, and hence setting a low price will vastly increase revenue. In addition, a firm may use penetration pricing if it expects large economies of scale, or if it is worried about competitors entering the market and wants to maximise its first mover entry. It can also be used when a company expects to make more profits from sales of complementary goods. As such, skim pricing is most often used by companies with a unique and technologically sophisticated product, such as the Apple iPhone, whilst penetration pricing is often used by companies entering a generic market with high economies of scale, significant levels of competition, such as Sony with the PS3. When Sony launched the PS3, it set the price very low, hence obtaining a large market share. This not only reduced levels of demand for competing consoles, but it also gave Sony a large market to sell games to, and also to build support for its Blu-Ray DVD format.

As demonstrated above, in addition to setting the pricing strategy, marketing managers can also develop innovative new pricing models to add value to the company and its customers. This can involve selling the core product cheaply, and then allowing customers to choose additional complementary goods to go with it. In addition, many companies have begun to move from a one off payment model for certain services and towards a subscription based model. This can be seen in the case of antivirus software, where companies now offer their product for a certain fee, with later updates provided on a subscription basis. As such, whilst the consumer can obtain a basic product for a lower fee, they need to continue paying an annual subscription in order to keep the product up to date and effective against new viruses. This helps the company maintain steady revenues, and also allows the customer to spread the cost of the program. In addition, many devices can now be customised with software after purchase. For example, mobile phones traditionally came with a set of programs loaded, but the Apple iPhone allows users to select their own programs. This means that customers do not pay for any programs on the phone they will not use, but instead can select and pay for programs as an when they want to use them.

Another important aspect of pricing is discounting, which is an effective method for companies to price discriminate to different markets. The company sets a recommended price, or a list price, for its product, and then discounts this price depending on the distribution channel used and the end users served. For example, customers who purchase a large volume of goods often receive a quantity discount to reflect the lower transaction cost per unit to the company. In addition, companies often offer seasonal discounts in times of low sales, for example after Xmas when many people have already bought presents and will not have as much money available. Discounts can also be offered for early payment of bills for major goods, trade discounts can be offered to important members of a distribution channel, and short term promotional discounts can be offered to stimulate sales if the company needs to raise cash quickly.

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