12.3 The Five-Step Procedure for Establishing Pricing Policy
5 min read•june 25, 2024
Pricing policy and strategy are crucial components of a company's marketing mix. They involve determining , estimating demand, analyzing costs, and evaluating external factors to set optimal prices for products or services.
Effective pricing strategies align with overall company goals, maximize profitability, and consider market conditions. From cost-based to value-based pricing, companies can choose from various approaches to set prices that attract customers, maintain competitiveness, and achieve financial objectives.
Pricing Policy and Strategy
Steps in pricing policy procedure
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- Determine pricing objectives that align with overall company goals and strategies such as maximizing profitability, increasing market share, achieving target return on investment (ROI), enhancing brand perception and positioning, or stimulating demand for new or slow-moving products while considering the product life cycle stage and market conditions
- Estimate demand and by conducting market research (surveys, focus groups, observational studies) to gather data on consumer preferences and behavior, analyzing historical sales data and trends, using to measure price sensitivity (), and performing and price experiments to gauge consumer reactions to different
- Calculate and analyze costs for pricing decisions by identifying and categorizing (remain constant regardless of production volume) and (change proportionally with production volume), calculating () and (), determining (), using method (), and considering approach for new product development
- Evaluate external factors influencing pricing strategy such as analyzing competitor pricing and market positioning, assessing customer perception of value and willingness to pay, considering legal and regulatory constraints ( laws, minimum advertised price policies), and evaluating economic conditions and industry trends (inflation, currency fluctuations, supply and demand shifts)
- Choose a pricing strategy and set prices based on objectives and market conditions, selecting from options such as cost-based pricing, value-based pricing, competitive pricing (, ), , and , and psychological pricing tactics (, ) while also considering promotional pricing and discounts to stimulate demand
Pricing objectives and company goals
- Align pricing objectives with overall company goals and strategies
- Maximize profitability by setting prices to generate the highest possible profit margins
- Increase market share by setting competitive prices to attract more customers and gain a larger portion of the market
- Achieve target return on investment (ROI) by setting prices that ensure a desired level of return on the company's invested capital
- Enhance brand perception and positioning by setting prices that reflect the desired image and of the brand (premium pricing for luxury brands)
- Stimulate demand for new or slow-moving products by setting introductory or promotional prices to encourage trial and adoption
Estimating demand and price sensitivity
- Conduct market research to gather data on consumer preferences and behavior
- Surveys and questionnaires to collect information on customer opinions, needs, and willingness to pay
- Focus groups and interviews to gain in-depth insights into customer perceptions and decision-making processes
- Observational studies to analyze customer behavior and purchasing patterns in real-world settings
- Analyze historical sales data and trends to identify patterns and correlations between price changes and sales volume
- Use price elasticity of demand to measure price sensitivity
- Elastic demand indicates that quantity demanded changes significantly with price changes (necessities like gasoline)
- Inelastic demand indicates that quantity demanded is less responsive to price changes (luxury goods, addictive products)
- Perform A/B testing and price experiments to gauge consumer reactions to different price points and pricing strategies
- Consider to tailor pricing strategies for different customer groups based on their unique characteristics and preferences
Cost calculation for pricing decisions
- Identify and categorize costs
- Fixed costs remain constant regardless of production volume (rent, salaries, equipment)
- Variable costs change proportionally with production volume (raw materials, packaging, shipping)
- Calculate unit costs and contribution margin
- Determine break-even point to identify the sales volume needed to cover all costs
- Use cost-plus pricing method to add a desired profit margin to the unit cost
- Consider target costing approach for new product development to ensure that the final price meets market expectations while covering costs and generating a profit
External factors in pricing strategy
- Analyze competitor pricing and market positioning to ensure competitiveness and differentiation
- Assess customer perception of value and willingness to pay based on factors such as product quality, brand reputation, and unique features
- Consider legal and regulatory constraints
- Price discrimination laws that prohibit charging different prices to different customers without justification
- Minimum advertised price (MAP) policies that set a floor price for resellers to maintain brand value
- Evaluate economic conditions and industry trends
- Inflation and currency fluctuations that affect costs and consumer purchasing power
- Supply and demand shifts that influence market dynamics and pricing strategies
- Identify competitive advantages that can justify premium pricing or differentiate the product in the market
Pricing strategies for market scenarios
- Cost-based pricing sets prices based on production and overhead costs, ensuring a desired profit margin (commonly used in manufacturing)
- Value-based pricing sets prices based on the perceived customer value, considering factors such as benefits, quality, and brand image (often used for luxury or innovative products)
- Competitive pricing sets prices in relation to competitor prices
- Penetration pricing sets low initial prices to gain market share and attract price-sensitive customers (common for new market entrants)
- Price skimming sets high initial prices for new, innovative products to capture value from early adopters before gradually lowering prices (often used in technology markets)
- Dynamic pricing adjusts prices in real-time based on demand and market conditions (used by airlines, hotels, and ride-sharing services)
- Bundling offers multiple products or services as a package at a discounted price (software suites, cable packages) while unbundling sells them separately at individual prices (à la carte options)
- Psychological pricing tactics
- Odd-even pricing uses prices ending in odd numbers (e.g., 10) to create the perception of a lower price
- Prestige pricing sets high prices for luxury or premium products to convey exclusivity and superior quality
- Promotional pricing and discounts stimulate demand by offering temporary price reductions (sales, coupons, buy-one-get-one offers)
Advanced pricing techniques
- Price discrimination involves charging different prices to different customer segments based on their willingness to pay, perceived value, or other characteristics (e.g., student discounts, senior citizen rates)
- optimizes pricing and inventory allocation to maximize revenue, particularly in industries with perishable inventory or fixed capacity (e.g., airlines, hotels)
- Value proposition pricing aligns prices with the unique benefits and value delivered to customers, emphasizing the product's competitive advantages and justifying premium pricing when applicable
Key Terms to Review (24)
A/B Testing: A/B testing, also known as split testing, is an experimental methodology used to compare two or more versions of a marketing or product element to determine which one performs better. It involves randomly showing different variations to users and measuring the impact on a desired outcome, such as conversion rates, click-through rates, or user engagement.
Break-Even Point: The break-even point is the level of sales or production at which a company's total revenue exactly matches its total costs, resulting in neither a profit nor a loss. It is a crucial metric used in evaluating new products, pricing decisions, and establishing pricing policies.
Bundling: Bundling is the practice of offering two or more products or services together as a single combined offering, often at a discounted price compared to purchasing the items separately. It is a strategic pricing and product packaging technique used by businesses to increase sales, customer value, and profitability.
Competitive Advantage: Competitive advantage refers to the unique attributes or capabilities that allow a business to outperform its competitors and provide superior value to customers. It is the edge a company has over its rivals in attracting and retaining customers, as well as achieving greater profitability and market share.
Contribution Margin: Contribution margin is the amount by which revenue from a sale exceeds the variable costs associated with producing and selling that product or service. It represents the portion of revenue that contributes to covering fixed costs and generating profit.
Cost-Plus Pricing: Cost-plus pricing is a pricing strategy where a business sets the selling price of a product or service by adding a markup to the total cost of production. This markup is typically expressed as a percentage and represents the desired profit margin. Cost-plus pricing is a widely used approach that focuses on the internal factors of the business rather than external market conditions.
Dynamic Pricing: Dynamic pricing is a pricing strategy where prices for products or services are adjusted in real-time based on current market conditions, demand, and other factors. This allows businesses to maximize revenue by charging the highest price the market will bear at any given time.
Fixed Costs: Fixed costs are expenses that remain constant regardless of the level of production or sales. They are incurred by a business even when there is no activity or output, and do not vary with changes in a company's level of activity or volume of goods/services produced.
Market Segmentation: Market segmentation is the process of dividing a broad consumer or business market into subsets of consumers or businesses that have, or are perceived to have, common needs, interests, and priorities. Marketers can then design and implement strategies to target these specific segments with offerings that match their unique needs and characteristics.
Odd-Even Pricing: Odd-even pricing is a pricing strategy where products are priced at odd or even numbers, typically ending in 9 or 5, rather than round numbers. This strategy is often used to create the perception of lower prices and encourage impulse purchases.
Penetration Pricing: Penetration pricing is a pricing strategy where a company sets a low initial price for a product or service in order to attract a large customer base and gain market share. The goal is to establish the product or service in the market and create brand awareness, with the expectation that prices can be raised later once a dominant market position has been achieved.
Prestige Pricing: Prestige pricing is a pricing strategy where products are priced high to convey a sense of exclusivity, quality, and status. It is often used for luxury or premium goods to appeal to consumers who are willing to pay more for the perceived value and prestige associated with the product.
Price Discrimination: Price discrimination is the practice of charging different prices for the same product or service to different customers or market segments based on their willingness or ability to pay. It allows a seller to capture more consumer surplus by segmenting the market and setting prices accordingly.
Price Elasticity of Demand: Price elasticity of demand is a measure of how sensitive the quantity demanded of a good or service is to changes in its price. It quantifies the responsiveness of consumers to price changes and is a crucial factor in pricing decisions and strategies.
Price Points: Price points refer to the specific monetary values at which products or services are offered for sale. They represent the strategic pricing levels that a company selects to position its offerings in the market and appeal to target consumers. Price points are a critical consideration in the overall pricing strategy and policy for a business.
Price Sensitivity: Price sensitivity refers to the degree to which a consumer's demand for a product or service is affected by changes in its price. It measures how responsive consumers are to price fluctuations and how their purchasing decisions are influenced by the cost of the offering. This concept is crucial in understanding pricing strategies and its role within the marketing mix.
Price Skimming: Price skimming is a pricing strategy where a company sets a high initial price for a product or service, and then gradually lowers the price over time. This approach is often used for new, innovative, or high-end products to maximize profits from customers willing to pay a premium price.
Pricing Objectives: Pricing objectives are the specific goals or targets that a business aims to achieve through its pricing strategies. These objectives guide the company's approach to setting and adjusting prices for its products or services, and they are critical considerations in the overall pricing policy and decision-making process.
Revenue Management: Revenue management is a strategic approach to pricing and inventory control that aims to maximize revenue by understanding, anticipating, and influencing consumer behavior. It involves the application of analytics and data-driven decision-making to optimize the availability and pricing of products or services to match demand.
Target Costing: Target costing is a strategic cost management technique used to determine the maximum allowable cost for a product or service based on its expected market price and desired profit margin. It involves working backward from the target selling price to establish cost targets that must be met in order to achieve profitability goals.
Unbundling: Unbundling refers to the process of separating a product or service into its individual components, allowing customers to select and pay for only the specific features or elements they desire, rather than being required to purchase the entire bundled offering.
Unit Costs: Unit costs refer to the total cost associated with producing one unit of a product or service. It encompasses all the expenses incurred, including raw materials, labor, overhead, and other direct and indirect costs, to create a single item. Understanding unit costs is crucial for establishing effective pricing policies and maintaining profitability.
Value Proposition: A value proposition is a clear, concise statement that describes the unique benefits a company's product or service offers to its target customers. It outlines how a company's offering solves a customer's problem or improves their situation, and why they should choose that company over competitors. The value proposition is a critical element in the marketing and strategic planning processes, as it helps a business differentiate itself and communicate its core value to potential customers.
Variable Costs: Variable costs are expenses that fluctuate directly with the level of production or sales activity. They increase or decrease in proportion to changes in business volume, unlike fixed costs which remain constant regardless of output. Understanding variable costs is crucial for pricing decisions and managing profitability.