Price is the amount a customer pays for a product or service. It’s a critical part of marketing strategy, as poor pricing can lead to product failure.
Businesses face the challenge of setting a price that’s both competitive and profitable. Setting a price too high can deter customers, while setting it too low can lead to stock shortages and dissatisfied customers.
Price also affects a company’s corporate image. Luxury brands like Omega or Gucci benefit from high prices, as lower prices can damage their reputation.
Understanding the relationship between price and demand is essential for businesses.
Cost-Plus Pricing
Cost-Plus Pricing:
- Method: Adds a fixed percentage (mark-up) to the unit cost to determine the selling price.
- Example: A coffee shop with a $2 average cost and a 100% mark-up sets the price at $4.
- Pros: Simple and easy to calculate.
- Cons: Relies on intuition, not market research
Penetration Pricing
Method: Setting a low price to enter an industry and gain market share.
Strategy: Often used with heavily advertised discounts to attract customers quickly.
Benefits: Allows for brand awareness and recognition, can be raised later.
Example: Brilliance Auto launched cars in Europe at a lower price than competitors.
Loss Leader Pricing
Loss leader pricing involves selling a product below its cost price to attract customers.
- Commonly used: Supermarkets use this strategy to attract customers who often end up buying other, higher-margin products.
- Brand Switching: Loss leaders can encourage customers to switch to a new brand, leading to long-term gains.
- Games Console Industry: Manufacturers sell hardware at a loss to attract buyers, hoping to recoup losses through sales of games, accessories, and subscription services.
By offering a loss leader, businesses aim to attract customers and potentially increase overall sales.
Predatory Pricing
Predatory pricing is a pricing strategy where a company temporarily lowers its prices to drive competitors out of business.
- Strategy: Setting prices so low that competitors can’t profitably compete.
- Goal: Gain a dominant market position and eventually raise prices.
- Common Industries: Supermarkets, airlines, and mobile phones often engage in price wars.
- Legality: Predatory pricing is illegal in many countries due to its anti-competitive nature.
While price wars can benefit customers in the short term, predatory pricing can harm competition and harm consumers in the long run.
Premium Pricing
Premium pricing involves setting a significantly higher price than competitors for a product perceived as:
- Higher quality: Examples include Nike and Adidas in sportswear.
- Unique: Customers perceive owning them as a status symbol (e.g., Honda NSX supercar vs. Honda Jazz).
Benefits:
- Higher profit margins
- Strong brand image and value
- Barriers to entry for competitors (loyal customer base)
Drawbacks:
- Limited customer base due to high price
- Potential loss of status if appealing to the mass market
- Requires strong and expensive-to-maintain brand loyalty
Dynamic Pricing
Dynamic pricing is a pricing strategy where prices are adjusted based on real-time market conditions.
- Flexibility: Businesses can change prices throughout the day to capitalize on demand fluctuations.
- Factors: Time of day, day of week, consumer demand, location, competitor prices are considered when setting dynamic prices.
- Examples: Airlines, cinemas, hotels, ride-sharing services.
Advantages:
- Greater pricing control
- Optimized profits
Disadvantages:
- Customer dissatisfaction due to unpredictable prices
- Potential for price wars and unsustainable pricing practices
Competitive Pricing (HL Only)
Competitive pricing sets prices at the same or similar level as competitors. It’s also called “going-rate pricing” and is common in markets with many substitutes.
Three options:
- Pricing above competition: Justified by extra features or services.
- Pricing at the same level: Focus on brand differentiation.
- Pricing below competition: Can be risky for brand image and profits.
Advantages:
- Simple and requires minimal effort.
- Maintains competitiveness.
Disadvantages:
- Requires non-price differentiation (e.g., advertising, customer service) to attract customers.
Contribution Pricing
Contribution pricing sets prices based on the direct costs of producing a good or service.
- Aim: Ensure the selling price covers direct costs and contributes towards covering fixed costs.
- Calculation: Contribution per unit = Selling price – Direct cost per unit.
Example:
- Selling price: $8
- Direct costs: $3
- Contribution per unit: $5
This means every product sold contributes $5 towards covering the company’s fixed costs.
Advantages:
- Ensures covering direct costs and contributing to fixed costs.
- Helps avoid making a loss on individual sales.
Limitations:
- Allocating indirect costs can be subjective.
- Needs to be checked for competitiveness.
Price Elasticity of Demand
PED measures how responsive demand is to price changes.
- Inelastic: Small change in quantity demanded with a price change (customers not very responsive).
- Elastic: Large change in quantity demanded with a price change (customers very responsive).
Calculation: PED = (% change in quantity demanded) / (% change in price)
Interpreting PED:
- PED < 1: Price inelastic (increase price, increase revenue)
- PED = 1: Unitary price elasticity (price change doesn’t affect revenue)
- PED > 1: Price elastic (decrease price, increase revenue)
Example:
- Cinema tickets: Price increase from $7 to $8, demand falls from 4,000 to 3,000.
- PED = 25% / 14.28% = 1.75
- Demand is price elastic (increase in price leads to a larger decrease in demand).
Importance of PED for Businesses:
- Pricing policy: Helps determine if price increases or decreases will increase revenue.
- Economic downturns: Identifies products most affected by recessions.
- Exchange rate fluctuations: Predicts the impact of exchange rate changes on exports.
Government Taxation: Helps governments determine optimal tax levels on products.
