A critical part of a company’s overall strategic planning includes the establishment of pricing objectives for the products it sells. A company has several pricing objectives from which to choose, and the objective chosen will depend on the goals and type of product sold by a company. The four most commonly adopted pricing objectives are (1) competitive, (2) prestige, (3) profitability, and (4) volume pricing.
Competitive pricing the concept behind this frequently used pricing objective is to simply match the price established by an industry leader for a particular product. Since price difference is minimized with this strategy, a company focuses its efforts on other ways to attract new customers. Some examples of what a company might do in order to obtain new customers include producing high-quality and reliable products, providing superior customer service, and/or engaging in creative marketing.
Prestige pricing a company may chose to promote, maintain, and enhance the image of its product through the use prestige pricing, which involves pricing a product high so as to limit its availability to the higher-end consumer. This limited availability enhances the product’s image, causing it to be viewed as prestigious. Although a company that uses this strategy expects to have limited sales, this is not a problem because a profit is still possible due to the higher markup on each item. Examples of companies that use prestige pricing are Mercedes-Benz and Rolls Royce.
Profitability pricing the basic idea behind profitability pricing is to maximize profit. The basic formula for this objective is that profits equal revenue minus expenses (P = R – E). Revenue is determined by a product’s selling price and the number of units sold. A company must be careful not to increase the price of the product too much, or the quantity sold will be reduced and total profits may be lower than desired. Therefore, a company is always monitoring the price of its products in order to make sure it is competitive while at the same time providing for an acceptable profit margin.
Volume Pricing When a company uses a volume-pricing objective; it is seeking sales maximization within predetermined. A company using this objective prices a product lower than normal but expects to make up the difference with a higher sales volume. Volume pricing can be beneficial to a company because its products are being purchased on a large scale, and large-scale product distribution helps to reinforce a company’s name as well as to increase its customer loyalty. A subset of volume pricing is the market-share objective, the purpose of which is to obtain a specific percentage of sales for a given product. A company can determine an acceptable profit margin by obtaining a specific percentage of the market with a specific price for a product.
Companies can chose from a variety of pricing strategies, some of the most common being penetration, skimming, and competitive strategies. While each strategy is designed to achieve a different goal, each contributes to a company’s ability to earn a profit.
Types of Pricing Strategies
Penetration Pricing Strategy A company that wants to build market share quickly and obtain profits from repeat sales generally selects the penetration pricing strategy, which can be very effective when used correctly. For example, a company may provide consumers with free samples of a product and then offer the product at a slightly reduced price. Alternatively, a company may initially offer significant discounts and then slowly remove the discounts until the full price of the product is listed. Both options allow a company to introduce a new product and to start building customer loyalty and appreciation for it. The idea is that once consumers are familiar with and satisfied with a new product, they will begin to purchase the product on a regular basis at the normal retail price.
Price Skimming Strategy price-skimming strategy uses different pricing phases over time to generate profits. In the first phase, a company launches the product and targets customers who are more willing to pay the item’s high retail price. The profit margin during this phase is extremely high and obviously generates the highest revenue for the company. Since a company realizes that only a small percentage of the market was penetrated in the first phase, it will price the product lower in the second phase. This second phase pricing will appeal to a broader cross-section of customers, resulting in increased product sales. When sales start to level off during this phase, the company will price the product even lower. This third-phase pricing should appeal to those consumers who were price-sensitive in the first two phases and result in increased sales. The company should now have covered the majority of the market that is willing to purchase its product at the high, medium, and low price ranges. The price-skimming strategy provides an excellent opportunity for the company to maximize profits from the beginning and only slowly lower the price when needed because of reduced sales. Price adjustment with this strategy closely follows the product life cycle, that is, how customers accept a new product. Price skimming is a frequently used strategy when maximum revenue is needed to pay off high research and development costs associated with some products.