Pricing Strategies

Pricing strategy is not just about setting prices once, but the principles for setting and managing prices in the mid to long term. It can include price positioning - for instance against a leading competitor, discounting and margin structures or even complex dynamic pricing models such as those used in the transportation industry.

Behind successful pricing strategies is an understanding of the demand curve - how demand shifts as prices alter Pricing research is central to understand demand and to track competitor behaviours.

Why a strategy?

"What price should we charge?" is a common dilemma for many businesses. Too much and the business won't make sales. Too little and the business gives away margin and profitability. Finding the optimum point for the business and maintaining and adjusting prices over time needs a combined financial, sales and marketing view.

The price itself represents different things to different people. To a customer price is obviously the price they pay, but can also represent the value they perceive they are getting - it's possible to set a price too low as too high. Many marketeers and market researchers first reactions to price are to talk about price positioning - where is our price compared to other people in the marketplace? But to a financial accountant, price represents revenue, margin and profit and is balanced against the need to cover fixed costs. And to the sales team in negotiation, price is not necessarily a fixed number, but something to be varied with appropriate discounting, packaging (eg of service) and value at risk analysis. And if you are selling through a distribution channel, price needs to be separated from margin and mark up and represents profitability and income.

With such a range of views of price, price cannot be seen as just a single number to be set once. The business can use prices and price structures in many different ways to stimulate different effects in the marketplace. Do we take a value or a premium position - are we looking for sales volume or sales value? How do we position the prices of our products relative to each other? What do we include in a price and what is left out?

Types of price strategy

Pricing is then one mechanism for achieving a range of different strategic goals for the company. Obviously the fundamental goal is to make a profit and to keep the business running. This means making forecasts of sales against price and clearly monitoring changes in demand and using price to smooth out fluctations within certain boundaries. This can be informal, but many businesses use econometrics and other pricing research and forecasting tools to manage the process of setting prices.

The main strategic view of price are the ideas of a 'skimming' strategy - set a high price to maximise margin, but don't worry so much about volume; Or 'penetration' pricing, that is set a lower price with the aim of generating a volume of sales and building market share. The approach you take will depend on the resources available. Penetration pricing is good where there is a large production volume possible. Skimming works better where production capacity is more limited and demand is naturally lower.

Within these generic ideas, pricing can also be flexed using discounts and promotions. A high-price skimming strategy might set a position of quality in the minds of consumers, which then combined with a judicious discounting or promotional structure can still be used to achieve volume. Alternatively, a dynamic pricing model which sets low prices for the early bird customers can also have elements of premium pricing for those booking or buying late.

The ability to choose and adjust prices then relies on being able to forecast the impact of different prices on demand. As an accountant will tell you, cutting 10% off a product selling for $10 may not seem much, but if the margin is 30%, that is cutting $1 out of $3 of net profit. Would you have sufficient increase in sales by making this price cut? Pricing research from a sample is one method, but the business needs to keep it's eye on how sales and prices are related based on financial and database data and so be able to respond. Pricing is therefore a full-time job.

And if it wasn't complicated enough, in complex channel arrangements, the manufacturers may only set a recommended retail price (RRP), or suggested resale price (SRP), the true end user price will be set by the dealers, distributors and retailers. The sell-in price to a distributor needs to be considered against the margin, and so profitability, that distributor will make on the product. This combined with different routes to market and the potential of channel conflict and pricing is much more tricky than it first seems. Extend this over territories and international boundaries and throw in the fact that consumers can see prices in multiple locations via the internet and pricing becomes a major corporate decision. For instance Southern European has more complex distribution networks for products such as kitchen appliances and a lower transparency of prices through the Internet and so often has prices more than double those available in the UK for exactly the same product

Choosing which prices to set, how to set prices, what promotions and discounts to set, when to update and flex prices, estimating all the time the impact on sales, and then monitoring and measuring against the market place is essential to maximum profitability. To do this relies on good quality data and good quality predictions of what will happen if and when prices change.

Pricing research

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