Product pricing refers to establishing a selling price for a product. The basic rules of pricing are:
- All prices must cover costs and profits.
- The most effective way to lower prices is to lower costs.
- Review prices frequently to assure that they reflect the dynamics of cost, market demand, response to the competition, and profit objectives.
- Prices must be established to assure sales.
Prices are generally established in one of four ways:
Cost-Plus Pricing
Many manufacturers use cost-plus pricing. The key to being successful with this method is making sure that the “plus” figure not only covers all overhead but generates the percentage of profit you require as well. If your overhead figure is not accurate, you risk
profits that are too low. The following sample calculation should help you grasp the concept of cost-plus pricing:
Demand Price
Demand pricing is determined by the optimum combination of volume and profit. Products usually sold through different sources at different prices–retailers, discount chains, wholesalers, or direct mail marketers–are examples of goods whose price is determined by demand. A wholesaler might buy greater quantities than a retailer, which results in purchasing at a lower unit price. The wholesaler profits from a greater volume of sales of a product priced lower than that of the retailer. The retailer typically pays more per unit because he or she are unable to purchase, stock, and sell as great a quantity of product as a wholesaler does. This is why retailers charge higher prices to customers.
Demand pricing is difficult to master because you must correctly calculate beforehand what price will generate the optimum relation of profit to volume.
Competitive Pricing
Competitive pricing is generally used when there’s an established market price for a particular product or service. If all your competitors are charging $100 for a replacement windshield, for example, that’s what you should charge. Competitive pricing is used most often within markets with commodity products, those that are difficult to differentiate from another. If there’s a major market player, commonly referred to as the market leader, the company will often set the price that other, smaller companies within that same
market will be compelled to follow.
To use competitive pricing effectively, know the prices each competitor has established. Then figure out your optimum price and decide, based on direct comparison, whether you can defend the prices you’ve set. Should you wish to charge more than your competitors, be able to make a case for a higher price, such as providing a superior customer service or warranty policy. Before making a final commitment to your prices, make sure you know the level of price awareness within the market.
If you use competitive pricing to set the fees for a service business, be aware that unlike a situation in which several companies are selling essentially the same products, services vary widely from one firm to another. As a result, you can charge a higher fee for a superior service and still be considered competitive within your market.
Mark-up Pricing
Used by manufacturers, wholesalers, and retailers, a mark-up is calculated by adding a set amount to the cost of a product, which results in the price charged to the customer. For example, if the cost of the product is $100 and your selling price is $140, the mark-up
would be $40. To find the percentage of mark-up on cost, divide the dollar amount of mark up by the dollar amount of product cost:
$40/$100 = 40%
This pricing method often generates confusion–not to mention lost profits–among many first-time small-business owners because mark-up (expressed as a percentage of cost) is often confused with gross margin (expressed as a percentage of selling price). The next
section discusses the difference in mark-up and margin in greater depth.
Pricing strategies
Premium Pricing
Use a high price where there is uniqueness about the product or service. This approach is used where a substantial competitive advantage exists. Such high prices are charge for luxuries such as Conrad Cruises, Savoy Hotel rooms etc
Penetration Pricing
The price charged for products and services is set artificially low in order to gain market share. Once this is achieved, the price is increased. This approach was used by France Telecom and Sky TV.
Economy Pricing
This is a no frills low price. The cost of marketing and manufacture are kept at a minimum. Supermarkets often have economy brands for soups, spaghetti, etc.
Price Skimming
Charge a high price because you have a substantial competitive advantage. However, the advantage is not sustainable. The high price tends to attract new competitors into the market, and the price inevitably falls due to increased supply. Manufacturers of digital
watches used a skimming approach in the 1970s. Once other manufacturers were tempted into the market and the watches were produced at a lower unit cost, other marketing strategies and pricing approaches are implemented.
Premium pricing, penetration pricing, economy pricing, and price skimming are the four main pricing policies/strategies. They form the bases for the exercise. However there are other important approaches to pricing.
Psychological Pricing
This approach is used when the marketer wants the consumer to respond on an emotional, rather than rational basis. For example ‘price point perspective’ 99 cents not one dollar
Product Line Pricing
Where there is a range of product or services the pricing reflect the benefits of parts of the range. For example car washes. Basic wash could be $2, wash and wax $4, and the whole package $6.
Optional Product Pricing
Companies will attempt to increase the amount customer spend once they start to buy. Optional ‘extras’ increase the overall price of the product or service. For example airlines will charge for optional extras such as guaranteeing a window seat or reserving a row of
seats next to each other.
Captive Product Pricing
Where products have complements, companies will charge a premium price where the consumer is captured. For example a razor manufacturer will charge a low price and recoup its margin (and more) from the sale of the only design of blades which fit the
razor.
Product Bundle Pricing
Here sellers combine several products in the same package. This also serves to move old stock. Videos and CDs are often sold using the bundle approach.
Promotional Pricing
Pricing to promote a product is a very common application. There are many examples of promotional pricing including approaches such as BOGOF (Buy One Get One Free).
Geographical Pricing
Geographical pricing is evident where there are variations in price in different parts of the world. For example rarity value, or where shipping costs increase price.
Value Pricing
This approach is used where external factors such as recession or increased competition force companies to provide ‘value’ products and services to retain sales e.g. value meals at McDonalds.