Marketing Mix – Price – Pricing Decisions Price: A component of the marketing mix that concerns the amount that is paid for a good or service (NOT Cost: Any expenditure incurred in generating sales value) Pricing strategies: The methods used by an organisation to price a product in order to achieve their marketing objective There are three main approaches a business takes to setting price: • Cost-based pricing Price is determined by adding a profit element on top of the cost of making the product. o Cost-plus pricing • Customer-based pricing Where prices are determined by what a firm believes customers will be prepared to pay o Prime skimming - setting a high initial price for a product to maximise sales o Price penetration – “special offer” to increase market share o Predatory pricing – attempt to eliminate competition o Loss leading pricing - priced below cost in order to attract consumers into a shop o Psychological pricing - customer believe the product is cheaper than it really is o Discrimination pricing - charges different price to different groups of consumers • Competitor-based pricing Where competitor prices are the main influence on the price set going-rate pricing –in line with the prices charged by direct competitors Cost based pricing This involves setting a price by adding a fixed amount or percentage to the cost of making or buying the product. In some ways this is quite an old-fashioned and somewhat discredited pricing strategy, although it is still widely used. After all, customers are not too bothered what it cost to make the product – they are interested in what value the product provides them. Cost-plus (or "mark-up") pricing is widely used in retailing, where the retailer wants to know with some certainty what the gross profit margin of each sale will be. An advantage of this approach is that the business will know that its costs are being covered. The main disadvantage is that cost-plus pricing may lead to products that are priced un-competitively. Here is an example of cost-plus pricing, where a business wishes to ensure that it makes an additional £50 of profit on top of the unit cost of production. Unit cost £100 Mark-up 50% Selling price £150 How high should the mark-up percentage be? That largely depends on the normal competitive practice in a market and also whether the resulting price is acceptable to customers. In the UK a standard retail mark-up is 2.4 times the cost the retailer pays to its supplier (normally a wholesaler). So, if the wholesale cost of a product is £10 per unit, the retailer will look to sell it for 2.4x £10 = £24. This is equal to a total mark-up of £14 (i.e. the selling price of £24 less the bought cost of £10). The main advantage of cost-based pricing is that selling prices are relatively easy to calculate. If the mark-up percentage is applied consistently across product ranges, then the business can also predict more reliably what the overall profit margin will be. Cost plus pricing: Setting a target for the profit margin on each unit, and basing the selling price on the cost of production (i.e. basing selling price on cost of production for example 10%) Suitable when a business has a degree of a monopoly power i.e. when the business has a degree of power over consumers because its lack of competition in the market Pros: Can help ensure the producer meets their unit profit targets for each sale Cons: Does not take into consideration the preference of consumers or their competitors Customer-based pricing Penetration pricing You often see the tagline "special introductory offer" – the classic sign of penetration pricing. The aim of penetration pricing is usually to increase market share of a product, providing the opportunity to increase price once this objective has been achieved. Penetration pricing is the pricing technique of setting a relatively low initial entry price, usually lower than the intended established price, to attract new customers. The strategy aims to encourage customers to switch to the new product because of the lower price. Penetration pricing is most commonly associated with a marketing objective of increasing market share or sales volume. In the short term, penetration pricing is likely to result in lower profits than would be the case if price were set higher. However, there are some significant benefits to long-term profitability of having a higher market share, so the pricing strategy can often be justified. Penetration pricing is often used to support the launch of a new product, and works best when a product enters a market with relatively little product differentiation and where demand is price elastic – so a lower price than rival products is a competitive weapon. Price skimming Skimming involves setting a high price before other competitors come into the market. This is often used for the launch of a new product which faces little or no competition – usually due to some technological features. Such products are often bought by "early adopters" who are prepared to pay a higher price to have the latest or best product in the market. Good examples of price skimming include innovative electronic products, such as the Apple iPad and Sony PlayStation 3. There are some other problems and challenges with this approach: Price skimming as a strategy cannot last for long, as competitors soon launch rival products which put pressure on the price (e.g. the launch of rival products to the iPhone or iPod). Distribution (place) can also be a challenge for an innovative new product. It may be necessary to give retailers higher margins to convince them to stock the product, reducing the improved margins that can be delivered by price skimming. A final problem is that by price skimming, a firm may slow down the volume growth of demand for the product. This can give competitors more time to develop alternative products ready for the time when market demand (measured in volume) is strongest. Price skimming (strategy to maximise sales) Pricing strategy whereby businesses are setting a high initial price for a product to maximise short term returns (sales revenue), before dropping the price to attract a wider market. This is often seen with electronic products such as mobile phones or game consoles which are often first released at a very high price because the business knows there are certain consumers who will pay that premium price. Pros: Allows the business to gain a ‘premium price’ from those customers who are prepared to pay it Cons: Setting the initial price too high may put off too many consumers Price penetration (often used for penetrate mass market products) Setting a low initial price in order to attract attention and gain market share, before raising price periodically in the future (‘Special Introductory offer’). This is often seen with gyms when they first open to attract new users. It is used because customers are already brand loyal, so we need to give them a reason why to swap a product. They might buy product in addition to other product to try or they might just buy the product instead. Pros: A strategy for gaining interest and market share Cons: Consumers may be unwilling to pay a higher price at a later stage (psychological anchor) Loss leaders The use of loss leaders is a method of sales promotion. A loss leader is a product priced below cost-price in order to attract consumers into a shop or online store. The purpose of making a product a loss leader is to encourage customers to make further purchases of profitable goods while they are in the shop. But does this strategy work? Pricing is a key competitive weapon and a very flexible part of the marketing mix. If a business undercuts its competitors on price, new customers may be attracted and existing customers may become more loyal. So, using a loss leader can help drive customer loyalty. One risk of using a loss leader is that customers may take the opportunity to "bulk-buy". If the price discount is sufficiently deep, then it makes sense for customers to buy as much as they can (assuming the product is not perishable). Using a loss leader is essentially a short-term pricing tactic for any one product. Customers will soon get used to the tactic, so it makes sense to change the loss leader or its merchandising every so often. Predatory pricing (note: this is illegal) With predatory pricing, prices are deliberately set very low by a dominant competitor in the market in order to restrict or prevent competition. The price set might even be free, or lead to losses by the predator. Whatever the approach, predatory pricing is illegal under competition law. Process of setting an artificially low price for a product in order to drive away competition. It is deemed illegal by the UK and European competition authorities. Predatory pricing is the act of setting prices low in an attempt to eliminate the competition. Predatory pricing is illegal under anti-trust laws, as it makes markets more vulnerable to a monopoly Firms who are confident that they can drive other firms out of the market place. Businesses might sell their products at a very low levels assuming rivals might be able to match in the short-term but not able to sustain as long as we are. A sign of predatory pricing can occur when the price of a product gradually becomes lower, which can happen during a price war. This is difficult to prove because it can be seen as a price competition and not a deliberate act. Psychological pricing Sometimes prices are set at what seem to be unusual price points. For example, why are DVD's priced at £12.99 or £14.99? The answer is the perceived price barriers that customers may have. They will buy something for £9.99, but think that £10 is a little too much. So a price that is one pence lower can make the difference between closing the sale, or not! The aim of psychological pricing is to make the customer believe the product is cheaper than it really is. Pricing in this way is intended to attract customers who are looking for "value". Competitor-based pricing If there is strong competition in a market, customers are faced with a wide choice of who to buy from. They may buy from the cheapest provider or perhaps from the one which offers the best customer service. But customers will certainly be mindful of what is a reasonable or normal price in the market. Most firms in a competitive market do not have sufficient power to be able to set prices above their competitors. They tend to use "going-rate" pricing – i.e. setting a price that is in line with the prices charged by direct competitors. In effect such businesses are "price-takers" – they must accept the going market price as determined by the forces of demand and supply. An advantage of using competitive pricing is that selling prices should be line with rivals, so price should not be a competitive disadvantage. The main problem is that the business needs some other way to attract customers. It has to use non-price methods to compete – e.g. providing distinct customer service or better availability. Within the competitive pricing exists the: Price takers • Price takers accept the ruling market price and sell each unit at the same price. AR=MR. We find price takers in perfectly competitive markets. Price makers • Price makers are found in imperfectly competitive markets such as Monopoly & Oligopoly • Price makers have some pricing power and will face a downward sloping AR curve An oligopoly market has a small number of relatively large firms that produce similar but slightly different products. Again, there are significant barriers to entry for other enterprises. In a monopoly, the seller charges high prices for the goods because there is no competition Competitive pricing is setting the price of a product or service based on what the competition is charging (in line with competitors) This pricing method is used more often by businesses selling similar products, since services can vary from business to business, while the attributes of a product remain similar. By taking price out of the equation when consumers are making their purchasing decision, it causes consumers to base their purchasing decision on other aspects of marketing such as the quality of the product, the place strategy, the promotion etc. Pros: Ensures that your price is in line with that of competitors Cons: Price is not a source of differentiation, nor does it take your costs of production into consideration Very slim profit margin or perhaps even a loss if you haven’t taken the cost of production into consideration What is price discrimination? Price discrimination happens when a firm charges a different price to different groups of consumers for an identical good or service, for reasons not associated with costs of supply.
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