Harnessing The Power Of Pricing – Part Two

So, a couple of weeks ago, we brought you a round-up of the three main pricing strategies. For those of you who have been slacking off on your homework (and can’t remember), these three strategies are: Mark Up Pricing (where the seller adds a standard mark-up to the cost of the product), Target-Return Pricing (where sellers set a price that will yield its target rate of return on investment) and Perceived Value Pricing (where price is based on the consumer’s perceived value of the product or service). Hopefully that very brief summary is ringing some bells otherwise check out Part 1 of Harnessing The Power Of Pricing.

Now that you understand the basic principles of pricing strategy, we thought we’d run you through the five main pricing objectives. These objectives should play a huge part in deciding which pricing strategy to go with. The clearer your objectives, the easier it will be to set a price. The five major objectives are:

Survival

Generally speaking, companies stick with survival as their major business objective if they are grappling with overcapacity, intense competition or highly erratic consumers. The mentality is that as long as prices cover variable costs and some of the fixed costs, the company will be able to stay afloat. Clearly, survival is a short-term objective. In the long-run, you’ve got to learn how to add real value to your brand or product (thereby increasing the consumer’s perceived value of your product or brand) or face reality – you’re going to be out of business pretty quickly. Survival is an old friend of the Mark-Up Pricing Strategy.

Maximum Current Profit

This pricing objective is quite popular. Many companies try to set a price that maximises their current profits. In doing so, they estimate the demand for their product as well as the costs associated with alternative prices. Based on these calculations, they identify the price that generates the maximum current profit or cash flow or rate of return on investment. There is a major flaw in this way of thinking though; it assumes that the company can pinpoint (with absolute certainty) the exact rate of demand for its product as well as all conceivable costs. In reality, these are next to impossible to estimate. Even worse, by focusing on the company’s existing performance rate, companies often end up sacrificing long-term success; they tend to ignore the effects of other market variables and competitors. This objective is often seen walking hand-in-hand with Target-Return Pricing Strategies.

Maximum Market Share

It is the objective of some companies to maximise their market share. Their ultimate goal is to corner the market. Generally, if a company or product has a combined market share exceeding 60%, then they most likely have market power and dominance. Think Apple iPod (within the portable media player industry) or Google (when it comes to internet searches) or Intel (in relation to personal computer processors).

Companies that fly the flag for maximum market share usually believe that higher sales volumes lead to lower unit costs and increased long-term profits. In a market penetration scenario, these companies will set the lowest possible price (based on the assumption that consumers are extremely price sensitive) to stimulate growth and discourage any actual or potential competitors. Market cornered!

Maximum Market Skimming

Probably unbeknownst to you, we have all been a target of this pricing objective. It is usually companies that are unveiling a new technology who use it. When the new technology is first launched, they set high prices to maximise market skimming. Prices then slowly drop over time. For example, when Sony introduced the world’s first high-definition television in 1990, it cost $43K. This ridiculous price point enabled Sony to ‘skim’ the maximum amount of revenue from particular market segments. As we have all come to expect, the price dropped steadily over the years. The same television was down to $6K only three years later in 1993, and a mere $600 by 2010.

This strategy can be fatal. Customers who buy early at high prices will be completely dissatisfied if you drop the price too quickly. When Apple dropped the price of the iPhone from $600 to $400 in only two months, the public outcry was deafening. Apple had to offer all consumers that purchased early a $100 credit. This can be even worse if a worthy competitor decides go with a market penetration objective and prices low.

Market skimming does makes sense if there a sufficient number of buyers with a high demand; the unit costs of producing a small volume are high enough to cancel the advantage of charging what the traffic will bear; the high initial price does not attract competitors; and the high price conveys the image of a superior product.

Product-Quality Leadership

Last but not least, we have product-quality leadership. If a company decides to go with this objective for their brand, it means they will be striving to be ‘affordable luxuries’. These are products or services characterised by high levels of perceived quality, taste and status with prices just high enough not to be out of the average consumers reach. We’re talking BMW, Aesop and Louis Vuitton. These brands have positioned themselves as leaders in their categories. They combine quality, luxury and premium prices to attract a customer base that is intensely loyal. This objective goes hand-in-hand with Perceived Value Pricing.

Marketing.com.au would like to thank Sally for sharing with us this great article on how marketers can harness the power of pricing objectives. If you didn’t get a chance yet, check out Part 1 of Harnessing The Power Of Pricing.