Pricing Strategies: Understanding Value, Costs, and Competition

Introduction

Price is the sum of all the values that customers give up to gain the benefits of acquiring or using a product. It is one of the most flexible elements of the marketing mix, as prices can be changed quickly.

Importance and Impact of Price

Price has a major impact on a firm's market share and profitability. Due to fixed costs, a small change in price can have a larger impact on profit.

In recent years, the Great Recession and the internet have made it easier for consumers to compare offers, leading to more frugal and conscious spending habits.

Cutting Prices: Not Always the Best Answer

Cutting prices is often not the best answer, as it can lead to lost profits, damaging price wars, and cheapening the brand.

Instead, companies should focus on selling value, not price. They should explain to customers why it is worth paying a higher price for their product.

Price and Marketing Strategy

Price must fit with an organization's strategy, positioning, and other marketing mix elements.

Customer Value-Based Pricing

Customer value-based pricing starts by understanding how much value consumers perceive that they can obtain from the product.

The procedure to set a price using this method is as follows:

1. Assess customer needs and value perceptions.
2. Set a target price.
3. Determine which costs can be incurred to produce that product.

While this method allows for larger profits, consumers' value is hard to measure, as it is subjective and varies for different consumers and situations.

Cost-Based Pricing

Cost-based pricing starts by understanding the costs necessary to produce, deliver, and sell the product and then adds a rate of return.

While this method leads to smaller profits, it is typically easier to measure. It is important to know how costs vary with different levels of production.

Economies of Scale: Increasing the number of units produced decreases the average cost of each unit.

Economies of Experience (or Learning Curve): Increasing the experience in producing one good decreases the average cost of each unit.

The formula for cost-based pricing is as follows:

Markup Price = Unit Cost / (1 - Desired Return on Sales)

Break-Even Point: The price at which the organization starts having profit.

Competition-Based Pricing

Competition-based pricing sets the price based on competitors' strategies, costs, prices, and market offerings.

Consumers often judge a product's value based on the competitors' prices for similar products.

Looking at competitors is the starting point for competition-based pricing:

1. Compare the organization's offering with competitors.
2. Evaluate competitors' strength.
3. Set your own price.

Competition-based pricing often has a strategic purpose, such as differentiating from competitors with a different positioning or driving weaker competitors out of the market.

The goal of pricing should not be to beat the competitors, but to price relatively to the value created by the organization and the competition.