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Pricing is the process whereby a business sets the price at which it will sell its products and services, and may be part of the business's marketing plan. In setting prices, the business will take into account the price at which it could acquire the goods, the manufacturing cost, the market place, competition, market condition, brand, and quality of product.
Pricing is also a key variable in microeconomic price allocation theory. Pricing is a fundamental aspect of financial modeling and is one of the four Ps of the marketing mix. (The other three aspects are product, promotion, and place.) Price is the only revenue generating element amongst the four Ps, the rest being cost centers. However, the other Ps of marketing will contribute to decreasing price elasticity and so enable price increases to drive greater revenue and profits.
Pricing can be a manual or automatic process of applying prices to purchase and sales orders, based on factors such as: a fixed amount, quantity break, promotion or sales campaign, specific vendor quote, price prevailing on entry, shipment or invoice date, combination of multiple orders or lines, and many others. Automated systems require more setup and maintenance but may prevent pricing errors. The needs of the consumer can be converted into demand only if the consumer has the willingness and capacity to buy the product. Thus, pricing is the most important concept in the field of marketing, it is used as a tactical decision in response to comparing market situation.
Objectives of pricing
The objectives of pricing should include:
- to achieve the financial goals of the company (i.e. profitability)
- to fit the realities of the marketplace (will customers buy at that price?)
- to support a product's market positioning and be consistent with the other variables in the marketing mix
- price is influenced by the type of distribution channel used, the type of promotions used, and the quality of the product
- price will usually need to be relatively high if manufacturing is expensive, distribution is exclusive, and the product is supported by extensive advertising and promotional campaigns
- a low cost price can be a viable substitute for product quality, effective promotions, or an energetic selling effort by distributors
From the marketer's point of view, an efficient price is a price that is very close to the maximum that customers are prepared to pay. In economic terms, it is a price that shifts most of the consumer economic surplus to the producer. A good pricing strategy would be the one which could balance between the price floor (the price below which the organization ends up in losses) and the price ceiling (the price by which the organization experiences a no-demand situation).
There are numerous terms and strategies specific to pricing:
Line pricing is the use of a limited number of prices for all product offered by a business. This is a tradition started in the old five and dime stores in which everything cost either 5 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.
A loss leader is a product that has a price set below the operating margin. This results in a loss to the business on that particular item in the hope that it will draw customers into the store and that some of those customers will buy other, higher margin items.
The price/quality relationship refers to the perception by most consumers that a relatively high price is a sign of good quality. The belief in this relationship is most important with complex products that are hard to test, and experiential products that cannot be tested until used (such as most services). The greater the uncertainty surrounding a product, the more consumers depend on the price/quality signal and the greater premium they may be prepared to pay. The classic example is the pricing of Twinkies, a snack cake which was viewed as low quality after the price was lowered. Excessive reliance on the price/quality relationship by consumers may lead to an increase in prices on all products and services, even those of low quality, which causes the price/quality relationship to no longer apply.
Premium pricing (also called prestige pricing) is the strategy of consistently pricing at, or near, the high end of the possible price range to help attract status-conscious consumers. The high pricing of a premium product is used to enhance and reinforce a product's luxury image. Examples of companies which partake in premium pricing in the marketplace include Rolex and Bentley. As well as brand, product attributes such as eco-labelling and provenance (e.g. 'certified organic' and 'product of Australia') may add value for consumers and attract premium pricing. A component of such premiums may reflect the increased cost of production. People will buy a premium priced product because:
- They believe the high price is an indication of good quality
- They believe it to be a sign of self-worth - "They are worth it;" it authenticates the buyer's success and status; it is a signal to others that the owner is a member of an exclusive group
- They require flawless performance in this application - The cost of product malfunction is too high to buy anything but the best - for example, a heart pacemaker.
The old association of luxury only being for the kings and queens of the world is almost non-existent in today’s world. People have generally become wealthier, therefore the mass marketing phenomenon of luxury has simply become a part of everyday life, and no longer reserved for the elite. (Yeoman, 2011). Since consumers have a larger source of disposable income, they now have the power to purchase products that meet their aspirational needs. This phenomenon enables premium pricing opportunities for marketers in luxury markets. (Yeoman & McMahon-Beattie, 2005). Luxurification in society can be seen when middle class members of society, are willing to pay premium prices for a service or product of the highest quality when compared with similar goods. Examples of this can be seen with items such as clothing and electronics. (Yeoman & McMahon-Beattie, 2005). Charging a premium price for a product also makes it more inaccessible and helps it gain an exclusive appeal. Luxury brands such as Louis Vuitton and Gucci are more than just clothing and become more of a status symbol. (Yeoman, 2011).
Prestige goods are usually sold by companies that have a monopoly on the market and hold competitive advantage. Due to a firm having great market power they are able to charge at a premium for goods, and are able to spend a larger sum on promotion and advertising. (Kumcu & McClure, 2003). According to Han, Nunes and Dreze (2015) figure on “signal preference and taxonomy based on wealth and need for status” two social groups known as “Parvenus” and “Poseurs” are individuals generally more self-conscious, and base purchases on a need to reach a higher status or gain a social prestige value. (Han, Nunes & Drèze, 2010). Further market research shows the role of possessions in consumer’s lives and how people make assumptions about others solely based on their possessions. People associate high priced items with success. (Han et al., 2010). Marketers understand this concept, and price items at a premium to create the illusion of exclusivity and high quality. Consumers are likely to purchase a product at a higher price than a similar product as they crave the status, and feeling of superiority as being part of a minority that can in fact afford the said product. (Han et al., 2010).
Consumers can have different perceptions on premium pricing, and this factor makes it important for the marketer to understand consumer behaviours. According to Vigneron and Johnson’s figure on “Prestige-Seeking Consumer Behaviours”, Consumers can be categorised into four groups. These groups being; Hedonist & Perfectionist, snob, bandwagon and veblenian. (Vigneron & Johnson, 1999). These categories rank from level of self-consciousness, to importance of price as an indicator of prestige. The Veblen Effect explains how this group of consumers makes purchase decisions based on conspicuous value, as they tend to purchase publicly consumed luxury products. This shows they are likely to make the purchase to show power, status and wealth. (Vigneron & Johnson, 1999). Consumers that fall under the “Snob Effect” can be described as individuals that search for perceived unique value, and will purchase exclusive products in order to be the first or very few who has it. They will also avoid purchasing products consumed by a general mass of people, as it is perceived that items in limited supply hold a higher value than items that do not. (Vigneron & Johnson, 1999). The bandwagon effect explains that consumers that fit into this category make purchasing decisions to fit into a social group, and gain a perceived social value out of purchasing popular products within said social group at premium prices. Research shows that people will often conform to what the majority of the group they are a member of thinks when it comes to the attitude of a product. Paying a premium price for a product can act as a way of gaining acceptance, due to the pressure placed on them by their peers. The Hedonic effect can be described as a certain group of people whose purchasing decisions are not affected by the status and exclusivity gained by purchasing a product at a premium, nor susceptible to the fear of being left out and peer pressure. Consumers who fit into this category base their purchasing decisions on a perceived emotional value, and gain intangible benefits such as sensory pleasure, aesthetic beauty and excitement. Consumers of this type have a higher interest on their own wellbeing. (Vigneron & Johnson, 1999). The last category on Vigneron and Johnson’s figure of “Prestige-Seeking Consumer Behaviours” is the perfectionism effect. Prestige brands are expected to show high quality, and it’s this reassurance of the highest quality that can actually enhance the value of the product. According to this effect, those that fit into this group value the prestige’s brands to have a superior quality and higher performance than other similar brands. Research has indicated that consumer’s perceive quality of a product to be relational to its price. Consumers often believe a high price of a product indicates a higher level of quality.
Even though it is suggested that high prices seem to make certain products more desirable, consumers that fall in this category have their own perception of quality and make decisions based upon their own judgement. (Vigneron & Johnson, 1999). They may also use the premium price as an indicator of the products level of quality.
A price premium can also be charged to consumers when purchasing eco-labelled products. Market based incentives are given in order to encourage people to practice their business in an eco-friendly way in regard to the environment. (Roheim, Asche & Santos, 2011). Associations such as the MSC’s fishery certification programme and seafood ecolabel reward those who practice sustainable fishing. Pressure from environmental groups have caused the implementation of Associations such as these, rather than consumers demanding it. (Roheim et al., 2011). The value consumer’s gain from purchasing environmentally conscious products may create a premium price over non eco-labelled products. This means that producers have some sort of incentive for suppling goods worthy of eco-labelling standard. Usually more costs are incurred when practicing sustainable business, and charging at a premium is a way businesses can recover extra costs. (Roheim et al., 2011).
Demand-based pricing, also known as dynamic pricing, is a pricing method that uses consumer demand - based on perceived value - as the central element. These include price skimming, price discrimination and yield management, price points, psychological pricing, bundle pricing, penetration pricing, price lining, value-based pricing, geo and premium pricing.
Pricing factors are manufacturing cost, market place, competition, market condition, quality of product.
Price modeling using econometric techniques can help measure price elasticity, and computer based modeling tools will often facilitate simulations of different prices and the outcome on sales and profit. More sophisticated tools help determine price at the SKU level across a portfolio of products. Retailers will optimize the price of their private label SKUs with those of National Brands.
An example of demand-based pricing is the Uber car-ride service company's use of an automated algorithm to increase prices to "surge price" levels, responding rapidly to changes of supply and demand in the market. By responding in realtime, an equilibrium between demand and supply of drivers can be approached. Customers receive notice when making an Uber reservation that prices have increased. The company applied for a U.S. patent on surge pricing in 2013, though airlines are known to have been using similar techniques in seat pricing for years.
The practice has often caused passengers to become upset and invited criticism when it happens as a result of holidays, inclement weather, natural disasters or other factors. During New Year's Eve 2011, Uber prices were as high as seven times normal rates, causing outrage. During the 2014 Sydney hostage crisis, Uber implemented surge pricing, resulting in fares of up to four times normal charges; while it defended the surge pricing at first, it later apologized and refunded the surcharges. Uber CEO Travis Kalanick has responded to criticism by saying: "...because this is so new, it's going to take some time for folks to accept it. There's 70 years of conditioning around the fixed price of taxis."
Multidimensional pricing is the pricing of a product or service using multiple numbers. In this practice, price no longer consists of a single monetary amount (e.g., sticker price of a car), but rather consists of various dimensions (e.g., monthly payments, number of payments, and a downpayment). Research has shown that this practice can significantly influence consumers' ability to understand and process price information.
Micromarketing is the practice of tailoring products, brands (microbrands), and promotions to meet the needs and wants of microsegments within a market. It is a type of market customization that deals with pricing of customer/product combinations at the store or individual level.
Nine laws of price sensitivity and consumer psychology
In their book, The Strategy and Tactics of Pricing, Thomas Nagle and Reed Holden outline nine laws or factors that influence how a consumer perceives a given price and how price-sensitive s/he is likely to be with respect to different purchase decisions:
- Reference price effect: Buyer’s price sensitivity for a given product increases the higher the product’s price relative to perceived alternatives. Perceived alternatives can vary by buyer segment, by occasion, and other factors.
- Difficult comparison effect Buyers are less sensitive to the price of a known / more reputable product when they have difficulty comparing it to potential alternatives.
- Switching costs effect: The higher the product-specific investment a buyer must make to switch suppliers, the less price sensitive that buyer is when choosing between alternatives.
- Price-quality effect: Buyers are less sensitive to price the more that higher prices signal higher quality. Products for which this effect is particularly relevant include: image products, exclusive products, and products with minimal cues for quality.
- Expenditure effect: Buyers are more price sensitive when the expense accounts for a large percentage of buyers’ available income or budget.
- End-benefit effect: The effect refers to the relationship a given purchase has to a larger overall benefit, and is divided into two parts:
- Derived demand: The more sensitive buyers are to the price of the end benefit, the more sensitive they will be to the prices of those products that contribute to that benefit.
- Price proportion cost: The price proportion cost refers to the percent of the total cost of the end benefit accounted for by a given component that helps to produce the end benefit (e.g., think CPU and PCs). The smaller the given components share of the total cost of the end benefit, the less sensitive buyers will be to the component's price.
- Shared-cost effect: The smaller the portion of the purchase price buyers must pay for themselves, the less price sensitive they will be.
- Fairness effect: Buyers are more sensitive to the price of a product when the price is outside the range they perceive as “fair” or “reasonable” given the purchase context.
- Framing effect: Buyers are more price sensitive when they perceive the price as a loss rather than a forgone gain, and they have greater price sensitivity when the price is paid separately rather than as part of a bundle.
Pricing is the most effective profit lever. Pricing can be approached at three levels: the industry, market, and transaction level.
- Pricing at the industry level focuses on the overall economics of the industry, including supplier price changes and customer demand changes.
- Pricing at the market level focuses on the competitive position of the price in comparison to the value differential of the product to that of comparative competing products.
- Pricing at the transaction level focuses on managing the implementation of discounts away from the reference, or list price, which occur both on and off the invoice or receipt.
A "price waterfall" analysis helps businesses and sales personnel to understand the differences which arise between the reference or list price, the invoiced sale price and the actual price paid by a customer taking account of contract, sales and payment discounts.
- Weak controls on discounting (price override)
- Inadequate systems for tracking competitors' selling prices and market share
- Cost-plus pricing
- Price increases poorly executed
- Worldwide price inconsistencies
- Paying sales representatives on dollar volume vs. addition of profitability measures
- Algorithmic pricing
- Base point pricing
- Cost the limit of price
- Drip pricing
- Group buy
- Options pricing
- Pay what you want
- Price elasticity of demand
- Price system
- Price umbrella
- Product life cycle management
- Product sabotage
- Psychological pricing
- Purchasing power
- Suggested retail price
- Target pricing
- Time-based pricing
- Value pricing
- Unit price
- "Prestige Pricing: Pros & Cons and Examples". Inevitable Steps. March 15, 2016. Retrieved March 17, 2016.
- Paull, John, 2009, The Value of Eco-Labelling, VDM Verlag, ISBN 3-639-15495-9
- Yeoman, I (2011). "The changing behaviours of luxury consumption". Journal of Revenue and Pricing Management. 10 (1): 47–50. doi:10.1057/rpm.2010.43.
- Yeoman, I; McMahon-Beattie, Una (2005). "Luxury markets and premium pricing". Journal of Revenue and Pricing Management. 15: 319–328. doi:10.1057/palgrave.rpm.5170155.
- Kumcu, E.; McClure (2003). "Explaining Prestige Pricing: An Alternative to Back-Bending Demand". Marketing Education Review. 9 (1): 49–57. doi:10.1080/10528008.2003.11488811.
- Han, Y.; Nunes, J.; Drèze, X. (2010). "Signaling Status with Luxury Goods: The Role of Brand Prominence". Journal of Marketing. 74 (4): 15–30. doi:10.1509/jmkg.74.4.15.
- Vigneron, F., & Johnson, W., L. (1999). Interpersonal effects. A Review and a Conceptual Framework Of Prestige-Seeking Consumer Behavior, pp. 1-17
- Vigneron, F., & Johnson, W., L. (1999). Interpersonal effects. A Review and a Conceptual Framework Of Prestige-Seeking Consumer Behavior, pp. 1-17.
- Roheim, C.; Asche, F.; Santos, J. (2011). "The Elusive Price Premium for Ecolabelled Products: Evidence from Seafood in the UK Market". Journal of Agricultural Economics. 62 (3): 655–668. doi:10.1111/j.1477-9552.2011.00299.x.
- Kumcu, Erdogan; McClure, James E. (2003-03-01). "Explaining Prestige Pricing: An Alternative to Back-Bending Demand". Marketing Education Review. 13 (1): 49–57. doi:10.1080/10528008.2003.11488811. ISSN 1052-8008.
- Clay, Kelly (October 27, 2011). "Is Uber Really a Good Alternative to Taxis?". LockerGnome. Lockergnome.
- Harris, David (April 24, 2014). "That time Uber almost charged me $1,099 for a Boston-to-Cambridge trip". Boston Business Journal.
- "Uber Seeks to Patent Pricing Surges That Critics Call Gouging". Bloomberg L.P. December 19, 2014.
- "Uber Is Trying to Patent Its Surge Pricing Technology". Time. December 19, 2014.
- Dan Kedmey (December 15, 2014). "This Is How Uber's 'Surge Pricing' Works". Time Magazine.
- Bilton, Nreick (January 8, 2012). "Disruptions: Taxi Supply and Demand, Priced by the Mile". The New York Times.
- Issie Lapowsky (December 15, 2014). "What Uber's Sydney Surge Pricing Debacle Says About Its Public Image". Wired Magazine.
- In Praise of Efficient Price Gouging (August 19, 2014), MIT Technology Review
- Estelami, H: "Consumer Perceptions of Multi-Dimensional Prices", Advances in Consumer Research, 1997.
- Nagle, Thomas and Holden, Reed. The Strategy and Tactics of Pricing. Prentice Hall, 2002. Pages 84-104.
- Mind of Marketing, "How your pricing and marketing strategy should be influenced by your customer's reference point"
- Dolan, Robert J. & Simon, Hermann (1996). Power Pricing. The Free Press. ISBN 0-684-83443-X.
- Erasso, A. and Linnenkamp, M., "Beyond the Price Waterfall", Sales Management Association, 2012, accessed 28 October 2016
- Bernstein, J., "Use Suppliers' Pricing Mistakes", Control, 2009
External links and further reading
|Look up pricing in Wiktionary, the free dictionary.|
- William Poundstone, Priceless: The Myth of Fair Value (and How to Take Advantage of It), Hill and Wang, 2010
- Engineering New Product Success: the New Product Pricing Process at Emerson Electric. A case study by Jerry Bernstein and David Macias. Published in Industrial Marketing Management.
- How To Price and Sell Your Software Product, Redpoint Ventures