Setting Prices Higher Than The Competition Can Help Create An Image Of Quality.

New Product Pricing

With a new product, competition does not exist or is minimal, hence the general pricing strategies depend on different factors.

Learning Objectives

Compare and contrast penetration pricing and skimming pricing

Key Takeaways

Key Points

Penetration pricing is the pricing technique of setting a relatively low initial entry price, often lower than the eventual market price, to attract new customers. The strategy works on the expectation that customers will switch to the new brand because of the lower price.
Skimming involves goods being sold at higher prices so that fewer sales are needed to break even. By selling a product at a high price, sacrificing high sales to gain a high profit is therefore "skimming" the market.
The decision of best strategy to use depends on a number of factors. A penetration strategy would generally be supported by the opportunity to keep costs low, and the anticipation of quick market entry by competitors. A skimming strategy is most appropriate when the opposite conditions exist.

Key Terms

market penetration: having gained part of a market in which similar products already exist
Market Share: The percentage of some market held by a company.

With a totally new product, competition does not exist or is minimal. Two general strategies are most common for setting prices:

(1) Penetration pricing

In the introductory stage of a new product's life cycle means accepting a lower profit margin and to price relatively low. Such a strategy should generate greater sales and establish the new product in the market more quickly. Penetration pricing is the pricing technique of setting a relatively low initial entry price, often lower than the eventual market price, to attract new customers. The strategy works on the expectation that customers will switch to the new brand because of the lower price. Penetration pricing is most commonly associated with a marketing objective of increasing market share or sales volume, rather than to make profit in the short term. The advantages of penetration pricing to the firm are as follows:

It can result in fast diffusion and adoption. This can achieve high market penetration rates quickly. This can take the competitors by surprise, not giving them time to react.
It can create goodwill among the early adopters segment. This can create more trade through word of mouth.
It creates cost control and cost reduction pressures from the start, leading to greater efficiency.
It discourages the entry of competitors. Low prices act as a barrier to entry.
It can create high stock turnover throughout the distribution channel. This can create critically important enthusiasm and support in the channel.
It can be based on marginal cost pricing, which is economically efficient.

A penetration strategy would generally be supported by the following conditions: price-sensitive consumers, opportunity to keep costs low, the anticipation of quick market entry by competitors, a high likelihood for rapid acceptance by potential buyers, and an adequate resource base for the firm to meet the new demand and sales.

A gas station sign in Taiwan that shows prices.

Pricing: Companies and businesses set prices at certain levels in order to attract customers.

(2) Skimming

Skimming involves goods being sold at higher prices so that fewer sales are needed to break even. Selling a product at a high price and sacrificing high sales to gain a high profit is therefore "skimming" the market. Skimming is usually employed to reimburse the cost of investment of the original research into the product. It is commonly used in electronic markets when a new range, such as DVD players, are firstly dispatched into the market at a high price. This strategy is often used to target "early adopters" of a product or service. Early adopters generally have a relatively lower price-sensitivity and this can be attributed to their need for the product outweighing their need to economize, a greater understanding of the product's value, or simply having a higher disposable income.

This strategy is employed only for a limited duration to recover most of the investment made to build the product. To gain further market share, a seller must use other pricing tactics such as economy or penetration. This method can have some setbacks as it could leave the product at a high price against the competition. A skimming strategy would generally be supported by the following conditions:

Having a premium product. In this case, "Premium" does not just denote high cost of production and materials- it also suggests that the product may be rare or that the demand is unusually high. An example would be a USD 500 ticket for the World Series or an USD 80,000 price tag for a limited-production sports car such as this.
Having legal protection via a patent or copyright may also allow for an excessively high price. Intel and their Pentium chip possessed this advantage for a long period of time. In most cases, the initial high price is gradually reduced to match new competition and allow new customers access to the product.

Product Line Pricing

Line pricing is the use of a limited number of price points for all the product offerings of a vendor.

Learning Objectives

Describe the characteristics of line pricing

Key Takeaways

Key Points

Line pricing is beneficial to customers because they want and expect a wide assortment of goods, particularly shopping goods. Many small price differences for a given item can be confusing.
From the seller's point of view, line pricing is simpler and more efficient to use. The product and service mix can then be tailored to select price points.
Line pricing suffers during inflationary periods, where such a strategy can be inflexible.

Key Terms

price point: Price points are prices at which demand for a given product is supposed to stay relatively high.
shopping goods: Goods that require more thought and comparison than convenience goods. Consumers compare multiple attributes such as price, style, quality, and features.
product line pricing: the practice of charging different amount for goods or services that are variations on a base good or service
basing-point pricing: goods shipped from a designated city are charged the same amount

Line pricing is the use of a limited number of prices for all the product offerings of a vendor. This is a tradition started in the old five and dime stores in which everything cost either 5 cents or 10 cents. Its underlying rationale is that these amounts are seen as suitable price points for a whole range of products by prospective customers. It has the advantage of ease of administering, but the disadvantage of inflexibility, particularly in times of inflation or unstable prices.

Five and Dime Stores: Traditional five and dime stores followed a line pricing strategy. All of the goods were either $0.05 or $0.10. The dollar store is a modern equivalent.

Line pricing serves several purposes that benefit both buyers and sellers. Customers want and expect a wide assortment of goods, particularly shopping goods. Many small price differences for a given item can be confusing. If ties were priced at $15, $15.35, $15.75, and so on, selection would be more difficult. The customer would not be able to judge quality differences as reflected by such small increments in price. So having relatively few prices reduces this kind of confusion.

From the seller's point of view, line pricing holds several benefits:

It is simpler and more efficient to use relatively fewer prices. The product and service mix can then be tailored to select price points.
It can result in a smaller inventory than would otherwise be the case. It might increase stock turnover and make inventory control simpler.
As costs change, the prices can remain the same, but the quality in the line can be changed. For example, you may have bought a $20 tie 15 years ago. You can buy a $20 tie today, but it is unlikely that today's $20 tie is of the same fine quality as it was in the past.

Psychological Pricing

Psychological pricing is a marketing practice based on the theory that certain prices have meaning to many buyers.

Learning Objectives

Explain the types of psychological pricing

Key Takeaways

Key Points

Products and services frequently have customary prices in the minds of consumers. A customary price is one that customers identify with particular items.
Odd prices appear to represent bargains or savings and therefore encourage buying. Thus, marketers often use odd prices that end in figures such as 5, 7, 8, or 9.
A somewhat related pricing strategy is combination pricing, such as two-for-one or buy-one-get-one-free. Consumers tend to react very positively to these pricing techniques.

Key Terms

customary price: A price that customers identify with particular items.
Price Points: Price points are prices at which demand for a given product is supposed to stay relatively high.

Price, as is the case with certain other elements in the marketing mix, has multiple meanings beyond a simple utilitarian statement. One such meaning is often referred to as the psychological aspect of pricing. Inferring quality from price is a common example of the psychological aspect of price. For instance, a buyer may assume that a suit priced at $500 is of higher quality than one priced at $300.

Products and services frequently have customary prices in the minds of consumers. A customary price is one that customers identify with particular items. For example, for many decades a five-stick package of chewing gum cost five cents and a six-ounce bottle of Coca-Cola also cost five cents. Candy bars now cost 60 cents or more, which is the customary price for a standard-sized bar. Manufacturers tend to adjust their wholesale prices to permit retailers to use customary pricing.

Another manifestation of the psychological aspects of pricing is the use of odd prices. We call prices that end in such digits as 5, 7, 8, and 9 "odd prices." Examples of odd prices include: $2.95, $15.98, or $299.99. Odd prices are intended to drive demand greater than would be expected if consumers were perfectly rational.

Odd Pricing: Odd prices end with digits like 5, 7, 8, and 9. They are intended to drive demand higher.

Psychological pricing is one cause of price points. For a long time, marketing people have attempted to explain why odd prices are used. It seemed to make little difference whether one paid $29.95 or $30.00 for an item. Perhaps one of the most often heard explanations concerns the psychological impact of odd prices on customers. The explanation is that customers perceive even prices such as $5.00 or $10.00 as regular prices. Odd prices, on the other hand, appear to represent bargains or savings and therefore encourage buying. There seems to be some movement toward even pricing; however, odd pricing is still very common. A somewhat related pricing strategy is combination pricing, such as two-for-one or buy-one-get-one-free. Consumers tend to react very positively to these pricing techniques.

The psychological pricing theory is based on one or more of the following hypotheses:

Consumers ignore the least significant digits rather than do the proper rounding. Even though the cents are seen and not totally ignored, they may subconsciously be partially ignored.
Fractional prices suggest to consumers that goods are marked at the lowest possible price.
When items are listed in a way that is segregated into price bands (such as an online real estate search), the price ending is used to keep an item in a lower band, to be seen by more potential purchasers.

Pricing During Difficult Economic Times

During a recession, companies must consider their unique situation and what value they provide customers when devising a pricing strategy.

Learning Objectives

Discuss pricing strategies during difficult economic times

Key Takeaways

Key Points

Many companies are tempted to slash prices during a recession, but this strategy should be carefully considered.
Cutting prices can degrade the value of the brand, lead to a price war, and also lead customers to put off buying when times are good in expectation of price cuts when times are bad.
Unlike traditional brands that are designed with target consumers in mind, fighter brands are created specifically to combat a competitor that is threatening to take market share away from a company's main brand.
When the strategy works, a fighter brand not only defeats a low-priced competitor, but also opens up a new market.

Key Terms

recession: A period of reduced economic activity
fighter brand: A pricing strategy where a company prices items lower than the competition in order to protect or gain market share.

Pricing During Difficult Economic Times

Every company has a unique pricing strategy during a boom period, based on their own product, market, and managerial decision making. However, during a recession, many companies may be tempted to abandon these strategies. After all, if customers are less willing to spend money, simplistic logic suggests that, by cutting prices, you can attract more customers. However, this strategy should be approached with caution.

Cutting prices can quieten customer complaints and help boost sales for a time, but can have longer-term effects on profitability, and weaken the brand's image. Reductions can also lead customers to expect discounts whenever the economy dips, causing them to wait to make purchases in the future.

A model of pricing based on 'rational' economic theory suggests that prices are set by the forces of supply and demand, and individual companies in a perfectly competitive market must follow the equilibrium price. However, real life is not so simple; people do not always act in the prescribed logic. Sometimes prices go up and people buy more, and vice versa.

A smart pricing strategy during a recession can become a competitive advantage. By knowing what value a company delivers to its customers, it can price more confidently and not panic into slashing prices when it does not necessarily need to. Price-cutting may even lead to price wars where nobody wins. If cuts must be made, companies should focus on cutting the prices of low-value items and retaining high-value products.

Customers shop in a store that has lots of different sale signs.

Price Cuts: Slashing prices on low value goods (while maintaining prices on high value goods) is a potential pricing strategy during difficult economic times.

Similarly, price increases during a recession can also be a bad idea. Many firms try to recover higher costs through price increases, which can turn away customers. Customers locked into contracts may have no regress if a company raises prices on them, but it tarnishes the seller's reputation and will make the customer think twice when the time comes to renew.

Ultimately, the pricing strategy becomes even more important during a recession, and companies must consider all these factors when attempting to adjust. It is important to protect the brand, not alienate customers, and remember what value the company offers in order to get through the difficult economic period unscathed.

Fighter Brands

In marketing, a fighter brand (sometimes called a fighting brand) is a lower priced offering launched by a company to take on, and ideally take out, specific competitors that are attempting to under-price them. Unlike traditional brands that are designed with target consumers in mind, fighter brands are created specifically to combat a competitor that is threatening to take market share away from a company's main brand.

The strategy is most often used in difficult economic times. As customers trade down to lower priced offers because of economic constraints, many managers at mid-tier and premium brands are faced with a classic strategic conundrum: Should they tackle the threat head-on and reduce existing prices, knowing it will reduce profits and potentially commoditize the brand? Or should they maintain prices, hope for better times to return, and in the meantime lose customers who might never come back? With both alternatives often equally unpalatable, many companies choose the third option of launching a fighter brand.

Fighter Brands: The Celeron microprocessor is a case study of a successful fighter brand.

When the strategy works, a fighter brand not only defeats a low-priced competitor, but also opens up a new market. The Celeron microprocessor, shown here, is a case study of successful fighter brand. Despite the success of its Pentium processors, Intel faced a major threat from less costly processors that were better placed to serve the emerging market for low-cost personal computers, such as the AMD K6. Intel wanted to protect the brand equity and price premium of its Pentium chips, but it also wanted to avoid AMD gaining a foothold on the lower end of the market. So it created Celeron as a cheaper, less powerful version of its Pentium chips to serve this market.

Everyday Low Pricing

Everyday low price is a pricing strategy offering consumers a low price without having to wait for sale price events or comparison shopping.

Learning Objectives

Translate the meaning of the EDLP (everyday low price) pricing strategy

Key Takeaways

Key Points

Every day low pricing saves retail stores the effort and expense needed to mark down prices in the store during sale events, as well as to market these events.
One 1994 study of an 86-store supermarket grocery chain in the United States concluded that a 10% EDLP price decrease in a category increased sales volume by 3%, while a 10% Hi-Low price increase led to a 3% sales decrease.
Trader Joe's is an example of successful EDLP. It is unique because it does not market itself like other grocery stores do, nor are customers required to obtain membership to enjoy its low prices – at Trader Joe's, its everyday low prices are available to everyone.

Key Terms

supermarket: a large self-service store that sells groceries and, usually, medications, household goods and/or clothing
Hi-low price: High-low pricing (or hi-low pricing) is a type of pricing strategy adopted by companies, usually small- and medium-sized retail firms, where a firm charges a high price for an item and later sells it to customers by giving discounts or through clearance sales.

Everyday low price (EDLP) is a pricing strategy promising consumers a low price without the need to wait for sale price events or comparison shopping.

EDLP saves retail stores the effort and expense needed to mark down prices in the store during sale events, as well as to market these events. EDLP is believed to generate shopper loyalty. It was noted in 1994 that the Wal-Mart retail chain in America, which follows an EDLP strategy, would buy "feature advertisements" in newspapers on a monthly basis, while its competitors would advertise 52 weeks per year.

Procter & Gamble, Wal-Mart, Food Lion, Gordmans, and Winn-Dixie are firms that have implemented or championed EDLP. One 1992 study stated that 26% of American supermarket retailers pursued some form of EDLP, meaning the other 74% were Hi-Lo promotion-oriented operators.

One 1994 study of an 86-store supermarket grocery chain in the United States concluded that a 10% EDLP price decrease in a category increased sales volume by 3%, while a 10% Hi-Low price increase led to a 3% sales decrease; but that because consumer demand at the supermarket did not respond much to changes in everyday price, an EDLP policy reduced profits by 18%, while Hi-Lo pricing increased profits by 15%.

An example of a successful brand (other than the infamous Wal-Mart) that uses the EDLP strategy is Trader Joe's. Trader Joe's is a private-brand label that conducts a Niche marketing strategy describing itself as the "neighborhood store. " The firm has been growing at a steady pace, offering a wide variety of organic and natural food items that are hard to find, enabling the business to enjoy a distinctive competitive advantage.

Trader Joe's: Trader Joe's is unique because it doesn't require membership for its customers to enjoy its low prices.

Apart from the many strengths of Trader Joe's, the most prominent is their commitment to quality and lower prices. The company has worked hard to manage this economic image of value for its products that competitors, even giant retail stores, are unable to meet. Trader Joe's is not an ordinary store. It is unique because it does not market itself like other grocery stores do nor does it require its customers to take out a membership to enjoy its low prices.

At Trader Joe's, its everyday low prices are available to everyone. The firm states that "every penny we save is every penny our customer saves" (Trader Joe's 2010).

High/Low Pricing

High-low pricing is a strategy where most goods offered are priced higher than competitors, but lower prices are offered on other key items.

Learning Objectives

Recognize the mechanism of High/Low pricing strategies

Key Takeaways

Key Points

The lower promotional prices are designed to bring customers to the organization where the customer is offered the promotional product as well as the regular higher priced products.
The basic type of customers for the firms adopting high-low price do not have a clear idea about what a product's price would typically be or have a strong belief that "discount sales = low price".
The way competition prevails in the shoe and fashion industry is through high-low price strategies.

Key Terms

everyday low price: Everyday low price ("EDLP") is a pricing strategy promising consumers a low price without the need to wait for sale price events or comparison shop.
belief: mental acceptance of a claim as truth regardless of supporting or contrary empirical evidence

High-low pricing is a method of pricing for an organization where the goods or services offered by the organization are regularly priced higher than competitors. However, through promotions, advertisements, and or coupons, lower prices are offered on other key items consumers would want to purchase. The lower promotional prices are designed to bring customers to the organization where the customer is offered the promotional product as well as the regular higher priced products.

High-low pricing is a type of pricing strategy adopted by companies, usually small and medium sized retail firms. The basic type of customers for the firms adopting high-low price will not have a clear idea about what a product's price would typically be or have a strong belief that "discount sales = low price. " Customers for firms adopting this type of strategy also have strong preference in purchasing the products sold in this type or by this certain firm. They are loyal to a specific brand.

A Nike swoosh on a shoe.

High-Low Pricing Strategies: Many big firms are using high-low pricing strategies, especially in the shoe industry (ex: Reebok, Nike, and Adidas).

There are many big firms using this type of pricing strategy (ex: Reebok, Nike, Adidas). The way competition prevails in the shoe industry is through high-low price. Also high-low pricing is extensively used in the fashion industry by companies (ex: Macy's and Nordstrom) This pricing strategy is not only in the shoe and fashion industry but also in many other industries. However, in these industries one or two firms will not provide discounts and works on fixed rate of earnings. Those firms will follow everyday low price strategy in order to compete in the market.

Other Pricing Strategies

One pricing strategy does not fit all, thus adapting various pricing strategies to new scenarios is necessary for a firm to stay viable.

Learning Objectives

Describe various pricing strategies

Key Takeaways

Key Points

Cost-plus pricing is the simplest pricing method. The firm calculates the cost of producing the product and adds on a percentage ( profit ) to that price to give the selling price.
Dynamic pricing allows online companies to adjust the prices of identical goods to correspond to a customer's willingness to pay. The airline industry is often cited as a success story. Most of the passengers on any given airplane have paid different ticket prices for the same flight.
Non-price competition means that organizations use strategies other than price to attract customers. Advertising,credit, delivery, displays, private brands, and convenience are all examples of tools used in non-price competition.

Key Terms

marketing mix: A business tool used in marketing products; often crucial when determining a product or brand's unique selling point. Often synonymous with the four Ps: price, product, promotion, and place.
economies of scale: The cost advantages that an enterprise obtains due to expansion. As the scale of output is increased, factors such as facility size and usage levels of inputs cause the producer's average cost per unit to fall.

Pricing strategies for products or services encompass three main ways to improve profits. The business owner can cut costs, sell more, or find more profit with a better pricing strategy. When costs are already at their lowest and sales are hard to find, adopting a better pricing strategy is a key option to stay viable. There are many different pricing strategies that can be utilized for different selling scenarios:

Cost-Plus Pricing

Cost-plus pricing is the simplest pricing method. The firm calculates the cost of producing the product and adds on a percentage (profit) to that price to give the selling price. This method although simple has two flaws: it takes no account of demand and there is no way of determining if potential customers will purchase the product at the calculated price.

Limit Pricing

A limit price is the price set by a monopolist to discourage economic entry into a market, and is illegal in many countries. The limit price is the price that the entrant would face upon entering as long as the incumbent firm did not decrease output. The limit price is often lower than the average cost of production or just low enough to make entering not profitable. The quantity produced by the incumbent firm to act as a deterrent to entry is usually larger than would be optimal for a monopolist, but might still produce higher economic profits than would be earned under perfect competition.

Dynamic Pricing

A flexible pricing mechanism made possible by advances in information technology, and employed mostly by Internet based companies. By responding to market fluctuations or large amounts of data gathered from customers – ranging from where they live to what they buy to how much they have spent on past purchases – dynamic pricing allows online companies to adjust the prices of identical goods to correspond to a customer's willingness to pay. The airline industry is often cited as a success story. In fact, it employs the technique so artfully that most of the passengers on any given airplane have paid different ticket prices for the same flight.

An Air Canada airplane.

Dynamic Pricing: Dynamic pricing allows online companies to adjust the prices of identical goods to correspond to a customer's willingness to pay.

Non-Price Competition

Non-price competition means that organizations use strategies other than price to attract customers. Advertising, credit, delivery, displays, private brands, and convenience are all examples of tools used in non-price competition. Business people prefer to use non-price competition rather than price competition, because it is more difficult to match non-price characteristics.

Pricing Above Competitors

Pricing above competitors can be rewarding to organizations, provided that the objectives of the policy are clearly understood and that the marketing mix is used to develop a strategy to enable management to implement the policy successfully. Pricing above competition generally requires a clear advantage on some non-price element of the marketing mix. In some cases, it is possible due to a high price-quality association on the part of potential buyers. Such an assumption is increasingly dangerous in today's information-rich environment. Consumer Reports and other similar publications make objective product comparisons much simpler for the consumer. There are also hundreds of dot.com companies that provide objective price comparisons. The key is to prove to customers that your product justifies a premium price.

Pricing Below Competitors

While some firms are positioned to price above competition, others wish to carve out a market niche by pricing below competitors. The goal of such a policy is to realize a large sales volume through a lower price and profit margins. By controlling costs and reducing services, these firms are able to earn an acceptable profit, even though profit per unit is usually less. Such a strategy can be effective if a significant segment of the market is price-sensitive and/or the organization's cost structure is lower than competitors. Costs can be reduced by increased efficiency, economies of scale, or by reducing or eliminating such things as credit, delivery, and advertising. For example, if a firm could replace its field sales force with telemarketing or online access, this function might be performed at lower cost. Such reductions often involve some loss in effectiveness, so the trade off must be considered carefully.