Pricing strategies

Pricing, an essential part of any business strategy, creates the revenue to support existing and future opportunities. While it is often assumed that the goal of pricing is to generate the most revenue, there are a number of pricing objectives businesses pursue, each leading to a different pricing strategy. These objectives include PROFIT MAXIMIZATION, market share or sales growth, survival, targeted return, return on-investment, and price matching. Profit maximization considers marginal revenue and marginal cost at various levels of output. Price is determined by market DEMAND at the level of output where the extra (marginal) revenue from the last unit of output produced and sold equals the extra (marginal) cost to produce that unit of output. Market-share or sales-growth objectives lead managers to increase or decrease price to obtain a specified level of sales. Penetration pricing, setting a low initial price to stimulate sales and gain access to the market, is often associated with market-share or sales-growth pricing strategies. Sometimes a firm will desperately need cash in order to stay in business. In these situations, previous pricing strategies are replaced with a survival strategy. Prices are cut and discounts offered to generate enough revenue to stay in business. Targeted-return objectives lead to markup and return on INVESTMENT pricing strategies. In markup pricing, a popular strategy used in wholesaling and retailing, a standard amount or percentage is added to the cost of the product in order to determine price. In many retail stores, keystoning (doubling the cost of the PRODUCT), is used. Percentage markups can be confusing. From a retailer’s perspective, if the cost of an item is $1 and it is sold for $2, this is a 50-percent markup. Logically, if the change in price ($2–$1 = $1) is compared to the cost ($1), it would appear to be a 100-percent markup. But in the retail industry, the change price ($1) is compared to the sales price ($2), which is a 50-percent markup. Return on investment (ROI) pricing compares the expected INCOME to the total ASSETS associated with the product or project. Prices are then determined based on a target return on investment. Price matching (or competitive pricing) is, as the term suggests, an objective to keep prices consistent with competitors’ prices. A price-matching strategy leads to nonprice competition, whereby firms compete for customers based on service, quality, SALES PROMOTION, product differences, and availability—basically anything but price. Price matching is prevalent in markets where there are only a few competing firms (see OLIGOPOLY) and reduces the potential for price wars, severe reductions in prices matched by the other firms in the market. To reduce consumer concerns about getting the lowest price effectively, some retail firms use price-matching guarantees. Pricing strategies also involve psychological pricing and PRODUCT LIFE CYCLE pricing. Psychological pricing considers how consumers’ perceptions and beliefs affect their price evaluations. Premium (or prestige pricing) uses high prices to convey an image of quality to buyers. Odd-even pricing, the use of, for instance, $9.99 rather than $10, leads consumers to think of the product in the lower (less than $10) category rather than in the $10–$20 range. Product life cycle pricing strategies recognize that products and product categories generally go through a cycle, including introduction, growth, maturity and decline. During the introductory stage, often there is only one firm in the market, and higher prices are used to recoup initial expenditures. As with a price-skimming strategy, such high prices appeal only to those consumers most willing and able to buy the product. During the growth stage, prices are lowered as competing products enter the market; and in the maturity stage, prices are lowered again as the market becomes saturated. During the final decline stage, prices are lowered to sell off final inventory. As products go through LIFE CYCLEs, the number of competitors fluctuates, changing the nature of demand in the market. All pricing strategies must consider demand, the willingness and ability of consumers to purchase products. The law of demand states that as producers raise prices, the quantity demanded decreases, and as they lower prices, the quantity demanded increases, assuming nothing other than price is changed in the market. Price ELASTICITY OF DEMAND is the degree of percentage response of consumers to a price change. There are also a number of ethical issues associated with pricing strategy. First, the Federal Trade Commission provides price-comparison guidelines to avoid deceptive price ADVERTISING. Retailers thus must be able to document their claims about comparison prices. A second pricing issue is “bait-and-switch” schemes, in which firms advertise low-priced products but do not have reasonable quantities of the product available for purchase; they do, however, have similar, higher-priced products available. Bait-and-switch practices are illegal. Third, predatory pricing, the use of low prices to weaken and eliminate competitors, is a hard-to-prove but controversial pricing strategy.