STRATEGIC PRICING

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Roel P. Dolaypan Jr., CPA, MDM

Chapter 1
AN OVERVIEW OF THE PRICING STRATEGY
Learning Objectives At the end of this unit, you are expected to:
1. Define Price and Pricing Defined
2. Familiarized with the Approaches to setting price
3. Solved what is pricing strategy.
Overview
The focus of this module is to present concepts, principles, and techniques that guide to
help a seller set the best price. Our study of how to set the best prices will take the
marketing approach. In this chapter, we will describe the business context for pricing and
provide an overview of how the basic principles of marketing can guide effective price
setting.

WHAT IS A PRICE?
Price is the value that is put on a product or service and is the result of a complex set of
calculations, research and understanding, and risk-taking ability. A pricing strategy
considers segments, ability to pay, market conditions, competitor actions, trade margins,
and input costs, amongst others. It is targeted at the defined customers and against
competitors. From this understanding of the commercial exchange, we are now able to
give a formal definition of a price: that which is given in return for a product in a commercial
exchange. This essential role of price in commerce is sometimes disguised using
traditional terms. If the product in the commercial exchange is good, then the product’s
price will most likely be called ―price. However, if the product is a service, then the
product’s price may well go by one of a variety of other possible names (see Figure 1.2).

Figure 1.2 Some Terms Used to Mean “Price”

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“PRICE” VERSUS “COST”
Although a price may go by many names, one name it should not go by is cost. This is
because, in this book, we will usually be taking the viewpoint of the seller. If we were
taking the viewpoint of the buyer, this would not be an issue. Buyers, particularly
consumers, will typically use the terms price and cost synonymously. For example, a
woman could tell her friend, ―The price of this sweater was only $30.‖ Or she could just
as easily say, ―This sweater cost me only $30.

However, from the viewpoint of the seller, the difference between prices and costs is quite
important. A price is what a business charges and a cost is what a business pays. Thus,
a grocery manager may set a price of$3.79 for a 17-ounce box of Honey Nut Cheerios,
may price large navel oranges at 3 for $1.99, or may sell ground chuck at the price of
$3.49 per pound. But the manager must also attend to his costs. These costs include, for
example, what he pays the wholesaler per case of Cheerios, what he pays employees to
stock it on the shelves, what he pays for the building, for heat and lights, for advertising,
and so on.

PRICING STRATEGIES:

Premium pricing: the high price is used as a defining criterion. Such pricing strategies
work in segments and industries where a strong competitive advantage exists for the
company. Example: Porche in cars and Gillette in blades.

Penetration pricing: the price is set artificially low to gain market share quickly. This is
done when a new product is being launched. It is understood that prices will be raised
once the promotion period is over and market share objectives are achieved. Example:
Mobile phone rates in India; housing loans etc.

Economy pricing: no-frills price. Margins are wafer thin; overheads like marketing and
advertising costs are very low. Targets the mass market and high market share. Example:
Friendly wash detergents; Nirma; local tea producers.

Skimming strategy: the high price is charged for a product until competitors allow after
which prices can be dropped. The idea is to recover maximum money before the product
or segment attracts more competitors which will lower profits for all concerned. Example:
the earliest prices for mobile phones, VCRs, and other electronic items where a few
players ruled attracted lower-cost Asian players.

PRICING AS A MARKETING ACTIVITY

Marketing activities are those actions an organization can take to facilitate commercial
exchanges. Four categories of marketing activities are particularly important, which are
traditionally known as the four elements of the marketing mix: Product—designing,
naming, and packaging goods and/or services that satisfy customer needs Distribution—
efforts to make the product available at the times and places that customers want

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Promotion—communicating about the product and/or the organization that produces it
Pricing—determining what must be provided by a customer in return for the product

If you use the term place for the activities of distribution, the four elements of the
marketing mix can be referred to as ―the four Ps a mnemonic that has proved useful to
generations of marketing students.

Note that there is an important way in which pricing differs from the other three elements
of the marketing mix. This is illustrated in Figure 1.3. Product, distribution, and promotion
are all part of the process of providing something satisfying to the customer. Product
activities concern the design and packaging of the good or service itself, distribution
involves getting the product to the customer, and promotion involves communicating the
product’s existence and benefits to customers and potential customers. All three of these
types of marketing activities contribute to the product being of value to customers. In this
book, the term value will refer to the benefits, or the satisfaction of needs and wants, that
a product provides to customers.

Figure 1.3 Pricing Harvests the Value Created by the Other Three Marketing Mix

Elements

Pricing, on the other hand, is not primarily concerned with creating value. Rather, it could
be said to be the marketing activity involved with capturing, or ―harvesting,‖ the value
created by the other types of marketing activities.1 In the words of Philip Kotler, ―Price
is the marketing mix element that produces revenue; the others produce costs.‖2
Because it is a marketing activity fundamentally different than the others, the implications
of pricing’s uniqueness must be fully understood. This is one of the reasons that a course
in pricing is an important part of business education.

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THE MARKETING CONCEPT
The marketing approach to business involves not only engaging in a variety of marketing
activities but also having these marketing activities be guided by the marketing concept.
The marketing concept can be expressed as follows: The key to business success is to
focus on satisfying customer needs.

What this means is that an organization that works toward satisfying customer needs in
every feasible way when carrying out marketing activities is likely to see more long-run
success than a company that does not have such a customer focus. Sellers who rely only
on their own opinions and ignore those of their customers or sellers who view their
customers as ―marks‖ to be tricked or manipulated may do well at a particular time but
are unlikely to be able to sustain whatever short-term success they may have. A marketing
concept is a modern form of the philosophical viewpoint known as ―enlightened self-
interest‖: One’s self-interest is best served by focusing one’s attention on the needs of
others.

PRICING AND THE MARKETING CONCEPT

It is clear how product, distribution, and promotional activities can be guided by the
marketing concept. Through marketing research (which, by the way, is a fifth important
category of marketing activities), a personal computer manufacturer can learn, for
example, the features and styling consumers want and then build machines to satisfy
consumer preferences. A bank could determine the hours consumers would prefer walk-
in service and could arrange to have those services available during those hours. A cell
phone service provider may find out that many consumers are unaware of all of the
convenient features of their service and may design a promotional program to
communicate this information.

However, it is less clear how pricing activities can be guided by the marketing concept.
Certainly, customers would prefer to pay less. Paying nothing at all might well be their
first choice! But it is simply not feasible to ―give away the store. An organization that
gives away the value it creates will soon cease to exist, and thus the value it creates will
disappear. This does not serve customers well. Rather, it is in the customer’s interest for
an organization that creates customer value to set prices that maximize the organization’s
profitability, since that would give the organization the greatest possible chance of
continuing to create that value.

EARLY PRICING PRACTICES

In the earliest commercial exchanges, goods or services were exchanged for other goods
or services. For example, the price that a farmer might pay for a bolt of cloth could be a
bushel of corn. This practice, termed barter, still goes on today, especially in less
developed countries. Barter occurred in recent years when Shell Oil purchased sugar
from a Caribbean country by giving in return one million pest control devices.4 Although
barter is still used, it can make exchange difficult. For example, what if the seller of the
bolt of cloth did not need the farmer’s bushel of corn? Because of such inefficiencies of

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barter, almost all modern commercial transactions use a medium of exchange—
something that is widely accepted in exchange for goods and services in a market.

A medium of exchange could be anything that the buyers and sellers in a society agree
upon. In the past, items such as cattle, seashells, dried cod, and tobacco have been used
as a medium of exchange. However, many of these presented certain difficulties. In his
book The Wealth of Nations, Adam Smith gives an example of this: The man who wanted
to buy salt, for example, and had nothing but cattle to give in exchange for it, must have
been obliged to buy salt to the value of a whole ox, or a whole sheep, at a time. He could
seldom buy less than this because what he was to give for it could seldom be divided
without loss.

Over time, it became clear that the best medium of exchange is finely divisible one, such
as the metals of various weights used in coins. This use of coins and notes to represent
them led to national systems of money, such as dollars, yen, or euros. It is prices
expressed in such monetary terms that will be considered in this book.

THREE CATEGORIES OF PRICING ISSUES

As the use of prices in monetary terms proliferated among human societies, various
questions that required pricing decisions began to arise. Most of these issues fall into one
of the following three categories: (1) buyer–seller interactivity, (2) price structure, and (3)
price format.

Price Structure
Although there are benefits to moving from negotiated prices to fixed prices, there are
also disadvantages. One strength of interactive pricing is that it makes it easy for the
seller to charge different prices to different buyers. For example, when prices are
negotiated individually, a customer willing to pay a particularly high price could be
charged, say, $200 for an item without interfering with the seller’s ability to charge more
typical customers a lower price, say, $125 for the same item. The practice of charging
different customers different prices for the same item is known as price segmentation.

To accomplish price segmentation with fixed prices, it is necessary to have more than one
price for a single product. For example, a product may have one price when purchased
alone and another price when purchased in large quantities or when purchased along
with other items. The product may have one price when purchased during the week and
another when purchased on a weekend. It may have one price when purchased in the
city and another when purchased in a rural area. These numerous prices for an item are
part of the pattern of the seller’s prices. In general, the pattern of an organization’s prices
is known as its price structure.

The price structure of a seller involves more than the array of prices that can be charged
for the same item. Most organizations sell more than one product, and the pattern of
prices across these different products is another component of the organization’s price

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structure. Often the various products are interrelated such that the price charged for one
item should take into account the prices charged for other items sold by the organization.

Price Format
The third category of pricing issues involves how a price is expressed when it is
communicated to potential customers. For example, early fixed prices tended to be round
numbers, such as $1.00, $5.00, or $2.50. However, by 1880 retail advertisements began
to appear showing items priced at a penny or two below the round number (see Figure
1.4). The practice of pricing an item just below a round number does not substantially
affect the level of a price, but it does affect how that price level is expressed. The form of
expression of a price is known as the price format.

Expressing a price in a ―just-below‖ format often has the effect of lowering the price’s
leftmost digit. This may make the price level appear lower than it is and have a positive

effect on sales. It is sometimes suggested that early retailers used this technique as a
means of reducing dishonesty among clerks. For example, a price such as $1.99 would
oblige employees to use the cash register to make a change and thus reduce their
opportunity to pocket the payment. However, research on early price advertising has
indicated that just-below prices were more likely to be used when the advertised item was
claimed to be a discount or an otherwise low price. This suggests that the use of the just-
below-price format was, from the start, motivated by managerial intuitions about its effects
on the perceptions of the consumer.

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Price format also involves the question of how many numbers are required to express an
item’s price. For example, a price advertisement could directly show the price of a
mushroom and pepperoni pizza, or it could express that price as a base price plus an
additional amount for the two toppings (see Figure 1.5). The price of a lamp in a home
furnishings catalog might be expressed as a price for the lamp that includes shipping or
as a price for the lamp alone along with a separate price for the shipping of the lamp to
the purchaser. The question of whether a price should be expressed as a single number
or as the sum of more than one number is the issue of price partitioning.

THE FUTURE OF PRICING

For too long, pricing decisions have been dominated by economists, discounters, and
financial analysts. While making a reasonable profit remains a necessity, pricing must
become a more strategic element of marketing. Smarter pricing, as portrayed by the
value-based strategy, appears to represent the future. A case in point is the Ford Motor
Company, which managed to earn USD 7.2 billion in 2000, more than any automaker in
history. Despite a loss of market share, the key to their success was a 420,000-unit
decrease in sales of low-margin vehicles such as Escorts and Aspires, and a 600,000-
unit increase in sales of high-margin vehicles such as Crown Victorias and Explorers.
Ford cut prices on its most profitable vehicles enough to spur demand, but not so much
that they ceased to have attractive margins.

Pricing objectives are the goals that guide your business in setting the cost of a product
or service to your existing or potential consumers.

A pricing objective underpins the pricing process for a product and it should reflect your
company's marketing, financial, strategic, and product goals, as well as consumer price
expectations and the levels of your available stock and production resources. Some
examples of pricing objectives include maximizing profits, increasing sales volume,
matching competitors' prices, deterring competitors – or just pure survival. Each pricing
objective requires a different price-setting strategy to successfully achieve your business
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goals. It requires you to have a firm understanding of both your product attributes and the
market.

Your choice of a pricing objective does not have to last forever. As business and market
conditions change, adjusting your pricing objective may become necessary or
appropriate.

HOW TO CHOOSE A PRICING OBJECTIVE

Pricing objectives are selected with your business and financial goals in mind. Elements
of your business plan can guide your choice of a pricing objective and the strategies that
go with it.

Give due consideration to your business’s mission statement and plans for the future. If
one of your overall business goals is to become a market leader then you’ll want to
consider the quantity maximization pricing objective as opposed to the survival pricing
objective.

If your business mission is to be a leader in your industry, you may want to consider a
quality leadership pricing objective. On the other hand, profit margin maximization may
be most appropriate if your business plan calls for production growth soon, since you will
need funding for facilities and labor.

Some objectives, such as survival and price stability will be used when market conditions
are poor or shaky, when first entering a market, or when a business is experiencing hard
times and needs to restructure.

PRICING FOR PROFIT

This objective is aimed, simply, at making as much money as possible for your business
– and maximizing price for long-term profitability.

Price has both a direct and indirect effect on your profits - the direct effect relates to
whether the price covers the cost of producing the product. Price affects profit indirectly
by influencing how many units are sold. The number of products sold also influences profit
through economies of scale, i.e., the relative benefit of selling more units.

Profit margin maximization: seeks to maximize the per-unit profit margin of a product. This
objective is typically applied when the total number of units sold is expected to be low.
Profit maximization: seeks to earn the greatest pound amount in profits. This objective is
not necessarily tied to the objective of profit margin maximization.

SALES-RELATED OBJECTIVES
Sales-oriented pricing objectives seek to boost volume or market share. A volume
increase is measured against a company's sales across specific periods.

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A company's market share measures its sales against the sales of other companies in
the industry. Volume and market share are independent of each other, as a change in one
doesn't necessarily activate a change in the other.

THE MAIN SALES-RELATED PRICING OBJECTIVES INCLUDE:

Sales growth: It is assumed that sales growth has a direct positive impact on profits so
pricing decisions are taken in a way that sales volume can be raised. Setting a price, and
altering or modifying policies are targeted to improve sales.

Targeting market share: Pricing decisions are taken in such a way that enables your
company to achieve targeted market share. Market share is a specific volume of sales
determined in the light of total sales in an industry. For example, your company may try
to achieve a 25% market share in the relevant industry.

Increase in market share: Sometimes, price and pricing are taken as tools to increase
market share. When you realize that your market share is lower than expected it can be
raised by appropriate pricing; pricing is aimed at improving market share.

WHAT ARE PRICING STRATEGIES?

Pricing strategies refer to the processes and methodologies businesses use to set prices
for their products and services. If pricing is how much you charge for your products, then
pricing strategy is how you determine what that amount should be. Some of the more
common pricing strategies include:
• Value-based pricing
• Competitive Pricing
• Price skimming
• Cost-plus pricing
• Penetration pricing
• Economy pricing
• Dynamic pricing

A WINNING PRICING STRATEGY

Portrays value
The word cheap has two meanings. It can mean a lower price, but it can also mean poorly
made. There's a reason people associate cheaply priced products with cheaply made
ones. Built into the higher price of a product is the assumption that it's of higher value.

Convinces customers to buy

A price that's too high may convey value, but if that price is more than a potential customer
is willing to pay, it won't matter. A price too low will seem cheap and get your product
passed over. The ideal price convinces people to purchase your offering over that of your
competitors.

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Gives your customers confidence in your product
If higher-priced products portray value, then the opposite follows as well. Prices that are
too low will make it seem as though your product isn't well made.

A WEAK PRICING STRATEGY

Doesn't accurately portray the value
If you believe you have a winning product, and you should if you are selling it, then you
need to convince customers of that. Pricing too low sends the opposite message.

Makes customers feel uncertain about buying

Just as the ideal price is one that a customer will pull the trigger on quickly, a price that's
too high or too low will cause hesitation.

Targets the wrong customers

Some customers prefer value, and some prefer luxury. You have to price your product to
match the type of customer it is targeted towards.

Top 7 pricing strategies

Let's now take a closer look at the seven pricing strategies that were outlined above.
1. Value-based pricing With value-based pricing, you set your prices according to what
consumers think your product is worth. We're big fans of this pricing strategy for SaaS
businesses.
2. Competitive pricing When you use a competitive pricing strategy, you're setting your
prices based on what the competition is charging. This can be a good strategy in the
right circumstances, such as a business just starting, but it doesn't leave a lot of room
for growth.
3. Price skimming If you set your prices as high as the market will possibly tolerate and
then lower them over time, you'll be using the price skimming strategy. The goal is to
skim the top off the market and lower prices to reach everyone else. With the right
product, it can work, but you should be very cautious using it.
4. Cost-plus pricing This is one of the simplest pricing strategies. You just take the cost
of creating your product and add a certain percentage to it. While simple, it is less than
ideal for anything but physical products.
5. Penetration pricing In highly competitive markets, it can be hard for new companies
to get a foothold. One way some companies attempt to do so is by offering prices that
are much lower than the competition. This is penetration pricing. While it may get you,
customers, you'll need a lot of them and you'll need them to be very loyal to stick
around when you need to raise prices in the future.
6. Economy pricing This strategy is popular in the commodity goods sector. The goal is
to price a product cheaper than the competition and make the money back with
increased volume. While it's a good method to get people to buy your generic soda,
it's not a great fit for SaaS and subscription businesses.
7. Dynamic pricing In some industries, you can get away with constantly changing your
prices to match the current demand for the item. This doesn't work well for subscription

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and SaaS businesses, because customers expect consistent monthly or yearly
expenses.

3 Pricing strategy examples

Real-world pricing strategy examples are the best way for a business to better
understand the above-listed pricing strategies. Evaluating other businesses'
approaches can be a good starting point but keep in mind that your strategy should
be based on math, market research, and consumer insights. For now, let’s look at the
pricing strategy examples of some of the biggest brands of today:
1. Streaming services Have you noticed that you pay roughly the same amount for
Netflix, Amazon Prime Video, Disney+, Hulu, and other streaming services? That's
because these companies have adopted competitive pricing, or at least a form of
it, called market-based pricing.
2. Salesforce When Salesforce first came out, they were the only CRM in the cloud.
(It wasn't even called 'the cloud' back then!) Armed with ground-breaking
deployment and a target customer of a large enterprise, Salesforce could charge
what it wanted. Later, after they'd grown, they were able to lower prices so smaller
businesses could sign up. This is a classic example of price skimming.
3. Dollar Shave Club At one time, you couldn't turn on your TV without an ad for Dollar
Shave Club telling you how much cheaper they were than razors at the store.
Although that level of marketing and advertising is unusual for the pricing model,
they were nevertheless employing economy pricing. It worked out well for them.
They were acquired by Unilever in 2016 for a reported $1 billion.

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