Business Pricing Strategies Article

Written by Drew Coles, member of the chartered institute of Management Accountants.

Business pricing strategies on an idea board
Business pricing is one of the most important decisions for organisations. Several factors need to be considered when setting pricing including competition, profit margins, customers, market conditions, demographics and the cost of producing the item/service. This article will take you through these factors in turn and explain how to effectively set your business pricing.
Brainstorming Penetration pricing

Pricing Strategies

This next section will go through a number of popular pricing strategies and highlight the pros and cons of each and how they may suit your business.

Penetration pricing

Penetration pricing is where the price of a product is initially set with the aim of increasing market share rapidly. The strategy works on the expectation that customers will switch to the new brand because of the lower price. This strategy can also be used to force competitors out of the market. The problem would be an increase of price once the market share has been won, will the customers want to pay an increased price for the same product. This strategy is more suitable to large volume, low cost products with longer expected lifecycles.


Target Costing

Target costing firstly looks at a market for the product. For instance, the company will look at where their product fits in the market place and how much competitors charge for similar products or services. With this information the price of the product is set first, and a required gross profit margin subtracted. This leaves the target cost for the product which the company will aim to match. If the target cost is not possible the product is seen as un-feasible unless changes can be made. This method has the added benefit that the company knows its market before production as well as knowing the price will be competitive. This pricing strategy should reduce risks in the investment and is popular with technology companies such as Apple.

Price skimming brainstorming

Price skimming

Price skimming is a product pricing strategy by which a firm charges the highest initial price that customers will pay. As the demand of the first customers is satisfied, the firm lowers the price to attract another, more price-sensitive segment. This strategy is also popular with technology companies and used by companies such as Apple as demand for new technology is growing customers will pay more for new releases. This strategy is particular useful when demand is inelastic.

Cost plus pricing

This strategy is a simple, traditional price setting method. The cost of the product or service is calculated and then a profit margin will be added to the cost to ensure the company generates its required profit. The issue with this strategy is that it is not market focused and therefore the price set may not be competitive or suitable for the customer. It can also become difficult to judge what costs to add the profit margin to. Companies use cost of sales or full absorption and both will result in a different sales price and effect the attractiveness of the product/service to the customer.
Cost plus percentage
Loss leader pricing on a white board

Loss leader pricing strategies

This strategy involves a group of products or services whereby one is used to make an intentional loss. The product or service sold at below cost requires accompanying products/services in the range. These accompanying products are sold at higher prices as to make a large profit. This pricing strategy works well in the printer market where by printers are sold at small prices and the matching cartridges sold at relatively high prices in order to make up the profit. It’s a good strategy to bring customers on board and increase market share but their is the need to have a range of products which need to work together.

Customer driven pricing

Customer driven pricing is similar to target costing whereby the price is set after taking into account how much customers are willing to pay for the potential product or service. This can be found through customer surveys and studying the market for competitors with similar product sales. This allows the company to ensure the product or service is competitive when it is brought to market, improve forecast reliability and will reduce the risks.
customer driven feedback on a cloud

Porters generic strategies

Porters strategies are aimed at generating competitive advantage using pricing strategies. These strategies are generic because they can be applied across all industries.

Cost leadership

The cost leadership strategy is aimed at being the leader in the industry in creating your products or services for the lowest possible cost. By reducing costs the business can be more competitive in pricing and reduce pricing further to drive out competitors, reduce new entrants into the market and generate competitive advantage. In order to be effective at cost leadership businesses will need to make use of the latest technology, make use of very efficient supply chain logistics and have an effective low-cost base. A good example of this is McDonalds.

cost leadership under construction with cranes

Differentiation – premium pricing

Differentiation strategy is offering a product/service to the market which is a different from and more attractive than your competitors, this could be for example increased quality, functionality and customer support. This allows you to charge a premium price in the market place. To make use of differentiation the company needs to create products which are cutting edge and more attractive to customers, therefore good research is required as well as the ability to turn this research into high quality products or services and effective marketing and sales.

cash showing premium pricing

Focus

Focus is the strategy of targeting a niche market segment. Companies that use Focus strategies concentrate on particular niche markets and, by understanding the dynamics of that market and the unique needs of customers within it, develop uniquely low-cost or well-specified products to suit. Because they serve customers in their market uniquely well, they tend to build strong brand loyalty. This makes their particular market segment less attractive to competitors. In todays world an effective market niche is becoming rare due to the world wide web opening markets all over the globe but there are still possibilities to carve out an effective area. Focus strategies need to be combined with cost leadership and differentiation allowing the business to gain competitive advantage in a niche.

competitors chasing business pricing

Other factors to consider

Competitors – pricing
One of the main factors which has been touched on above is the need to identify your competitors’ pricing and offerings in the market place. The service or product the business is offering must be competitive in the market place and having a understanding of competitors actions will help the organisation set a realistic price.


Demographics - who is our audience?
It is important to identify your target audience. Identifying the segment in the market to target in terms of gender, age, lifestyle makes it much easier to set a price, market and distribute the product or service to where your customers will purchase.

Market conditions
Current economic market conditions will influence the sales price and volume of products and services sold. For example, when interest rates increase sales of products will reduce because of increases to interest payments on loans, credit cards etc.

Profit margin
The company will need to have an idea of the profit margin it wants to generate from each product/service. This will give the organisation an idea of how much the item or service should be sold for and how much it needs to cost to be feasible.

possible or impossible on a board

Feasibility, suitability and acceptability

The organisation should ask itself when first investigating a new product if it is suitable, acceptable and feasible.
· Suitability - is the product suitable for the business in terms of its overall strategy. Will it enable the business to achieve its aims and objectives?
· Acceptable – Is the product acceptable in regard to the company brand. For instance, if the company offers premium home products does the new product fit in with these products.
· Feasibility – Can the product be made, and will it generate the required profit margin, sales and at the correct cost. Is the technology available and the logistics possible?

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