Different prices reflect what different customers are prepared, and able, to pay. But is price simply what the customer will pay, or is it a more flexible marketing tool? Setting the right price can mean the difference between profit and loss, survival and failure.
The basic rule in pricing is to price your product or service at the level which your customers expect to pay for the quality you are delivering.
This does not mean that high price means high quality. Nor does it mean that high quality will justify a high price.
Customers generally buy at a certain level of price and quality which is compelled by the social and psychological forces around them.
Different segments are attracted by different price/quality levels. This is called the Price-Quality Relationship.
Ford and Rolls-Royce sell into different markets, but for most of their markets they are neither cheap nor expensive – they simply deliver the quality their customers expect at the price they expect to pay for it.
Pricing directly affects sales revenue. A company has to relate sales revenue to costs – cost of sales, cost of production, cost of raw materials, and other costs, such as transport and promotion.
So most companies try to run a long-term strategy for their pricing. World prices of raw materials can go up and down, but consumers may expect the price to remain stable.
Combining the product and the price is often referred to as the Product-Price Mix.
For example, consumers may be willing to pay more because there is good after-sales service. A brand which is well-supported by advertising will normally be able to command a higher price. Even when consumers have less money to spend, as in a recession, a strong well-supported brand is often able to command a premium price.
Price is also unique within the marketing mix in that it is the only ingredient in the mix which makes money. All the other ingredients incur cost. Yet many companies conduct little or no research into pricing.
Most customers in any particular target market have similar perceptions of the price-quality relationship, and this should be a main factor in developing prices. Too high a price and sales might be too low. Too low a price and sales might be high but without profit.
Effective marketing should include research into customers’ attitudes towards not just the product, but also how they will value it. Value is a combination of price and perceived quality.
Understanding the price-quality relationship is vital in marketing.
But market situations can vary, and Kotler suggests that a company can pursue the following six major pricing objectives.
SURVIVAL – is a typical objective of a company faced with intensive competition and not enough customers. Prices are set to cover variable costs and some fixed costs to ensure the company stays in business.
MAXIMUM CURRENT PROFIT – is where companies with weak competition set a high price that produces the most cash flow or return on investment.
MAXIMUM CURRENT REVENUE – is where companies set prices to maximise sales revenues – unit sales multiplied by unit price. Demand is calculated at different price points.
MAXIMUM SALES GROWTH – is where companies set low prices to achieve high unit sales in order to get lower unit cost and higher long-term profit. This is also called market penetration pricing.
MARKET SKIMMING – is where a company sets a high price to capture those customers who are willing to pay more for a product. It is skimming the cream off the top of the market, and it works well with an innovative or new technology product.
PRODUCT QUALITY LEADERSHIP – is where a company aims to provide the best quality product in the market, and therefore charges more than its competitors. These companies are usually market leaders.
Pricing objectives for particular products or services can also vary according to the stage in the product life cycle.
For example, in the decline stage a company may choose a harvesting strategy that gradually reduces expenditures on advertising and maybe even product quality, whilst maximising profits by maintaining prices. Alternatively, in the decline stage the company might adopt a divesting strategy which looks for another organisation to buy that part of the business.
Pricing objectives are never simple. They result from the company trying to balance a number of different business aims both short and long-term, such as market share, sales, profit, and technical or quality leadership. These have to be considered so that the company is both able to survive and to achieve sound long-term profits.
Pricing objectives must fit in with the overall marketing objectives. They must fully integrate with and support all the other elements of the marketing mix.
The section on pricing strategies explains how objectives can be developed into meaningful strategies for the market place.
Pricing strategies also depend on what is happening in the market and how the company wants to react to it. They can be defensive or aggressive, and appropriate options will vary throughout the life cycle of the product.
When a product is introduced into a market, companies tend to use either Skimming or Penetration Pricing Strategies.
In Skimming Pricing Strategies, products are introduced at a high price to skim off the cream of the customers who are price-insensitive. This is useful if the market is small and costs need to be recovered quickly.
A Rapid Skimming Strategy uses high price and extensive promotion to face competition and establish market share quickly. When no serious competition is expected, a Slow Skimming Strategy may be used – high price with low promotion.
Penetration Pricing Strategies are used for entering large markets at a low price. This enables a company to build up a major market share quickly. Marginal Pricing and Experience Curve effects provide long term profit and a defence against competition.
A Rapid Penetration Strategy uses low price and high promotion.
When the market is not expected to react to promotion, a Slow Penetration Strategy, with low price and low promotion, is used.
In the growth and maturity stages of the product life cycle, pricing strategies will vary according to market situations: customer reactions and price competition.
Psychological Pricing Strategies are immersed in the mind of the customer and what they think about prices. What are the thresholds beyond which they are less likely to buy? How do prices affect their perceptions, attitudes, intentions and actual purchasing behaviour?
Prestige pricing, or high prices, can confirm a product’s top quality status in the mind of some buyers. A price increase can sometimes be presented as a signal of quality and cause sales to go up.
Differential Pricing Strategies set different prices for different market segments. This might be in the form of a Geographical Pricing Strategy or Regional pricing, with different prices charged in different areas.
Product Line Pricing is another strategy used for lines of products or services, with prices stepping up from a basic standard product as options and extras are added to the product. This ‘price lining’ is typical of many consumer brands.
Finally, research reveals that most companies do not consider, in detail, all of these alternative pricing strategies throughout the life of a product or brand, despite the fact that the final price strategy directly affects long term profitability and market share.