Pricing Strategies - Part 2
Introduction Price is an amount of money charged on products or services which also mean the cost that customers willing to give up to gain benefits from the usage of the products or services - Pricing Strategies introduction. Pricing is the process every company will encounter in order to get the return from exchanging their products or services.
Therefore, in order for a company to achieve its objectives which is one of it will be maximizing profit, the company has to determine on the pricing strategies of it products and services. We will discuss on the new product pricing strategies for the products in the introductory stage of the product life cycle, product mix pricing strategies for related products in the product mix, price adjustment strategies that account for customer differences and changing situations and strategies for initiating and responding to price changes. Market Skimming Prices
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Price skimming is defines as the pricing strategy use by a company where it sets a relatively high price for the product or services when it enter the market then over the time, it will lowers the price. The objective with skimming is to “skim” off customers who are following the trend in the market which want to have the products sooner than the others are willing to pay more and then the prices are lowered later when, demand from the “early adopters” falls. Some companies use this pricing strategy in order to capture the maximum revenues layer by layer from the target segment which willing to pay the high price sets.
Therefore, the companies are able to make fewer but more profitable sales. In order for the price skimming to work, it has to face certain conditions. First, the product’s quality and image must support its higher price and there are enough buyers who want the product at the particular price set. An example that would fall under this category is Amazon-Kindle unveiled by Amazon. Amazon’s first offering of Kindle in November 2007 sold out in five and a half hours, and the device remained out of stock for five months until late April 2008. The original Kindle device features a 6 inch (diagonal) 4-level grayscale display, retailed for US $399.
Amazon subsequently lowered the price to $359. The $40 drop brings the Kindle down from the initial $400 price it was introduced at. The price drop makes the Kindle even more compelling, that Amazon started to launch more typed of Kindle: Kindle 2, Kindle DX, and even Kindle 2 International Version. Amazon has not only applied the market skimming price strategy, it has also done a great strategy in selling this particular product. Secondly, the costs of producing a smaller volume of product cannot be so high that it will cancel off the advantages of pricing the high price.
Secondly, the costs of producing a smaller volume of the product cannot be so high that they can cancel of the advantage of pricing high price. In this case, we will look at Apple. Apple is a company dealing with computers and consumer electronics. However, when it started to release i-Phone as one of its products that allowed Apple to capitalize and earn more revenues. It does not have been a negative effect of producing a small volume since even though the i-Phone was sold out; dedicated customers were willing to wait until they came available. Lastly, competitors should not be able to enter the market easily and undercut the prices.
The iPhone was also one of a kind when it first came out (which it still pretty much is) and had no competition before Samsung started their own innovations on their mobile phones with android. Market Penetrating Pricing It is defines as the setting of low price for a new product in order to attract a large number of buyers and a large market share. Some companies penetrate into the market by setting low prices of their products and services to capture the market share. The high sales volume results in falling costs allowing the companies to cut their prices.
One of the example is the world largest retailer, Walmart. As we can see, Walmart provide low price products daily to the consumers which enable it to capture the large market share with the slogan “Save money, live better”. This strategy works under several conditions where firstly, the market must be highly sensitive so that a low price produces more market growth. As example for the Walmart case, when it wants to penetrate into the China markets where the peoples there are mostly middle and low income family boost Walmart sales in China because the Chinese are price sensitive.
On the other hand, it helps Walmart market growth to a total of 284 stores in China (Walmart China,2010). Next, production and distribution costs must fall as sales volume increases and finally the low prices must help to keep out competition and the penetration must maintain its low price position-otherwise the price advantage may be only temporary. As for Walmart, it has been able to capture the market share since Sam Walton founded the company in 1962. It has a history of 50 years now. Product Mix Pricing Strategies The 4Ps’ which is the product, price, promotion and place is the four key elements in product mix.
Price is one of the four key elements in what is called “marketing mix”. There are five product mix pricing situations which are product line pricing, optional product pricing, captive-product pricing, by-product pricing and product bundle pricing. Product Line Pricing It is the setting of the price between various of the products in a product line based on the cost differences. For example, Crocs, has various of products in a product line of it which is the men footwear. Other than just a normal footwear, Crocs have various product which is Crocs Rx, Crocs Works and also Ocean Minded.
In Crocs, management has to decide on the price steps between the various products in the line. It should taken account the differences of customer perception of the value of different features. Crocs Rx Crocs Ocean Minded Crocs Works Optional Product Pricing Nowadays, companies like to use optional product pricing strategy to increase their sales. Optional product pricing strategy is the pricing of optional or accessory products along with a main product. An example is in the airline industry. Airasia provide services to the customers by given them the chance of travelling around the world to the destination they wanted to.
With the motto “Everyone can fly”, Airasia has provided the lowest fare compare to any other airlines. Other than providing the travelling services (main product), Airasia also provide services in term of serving customer which allow them to purchase foods, souvenirs, accessories in the cabin (optional product). Besides that, it also charge optional extras such as Air Insure (Insurans) and reserving a row of seats next to each other. Captive-Product Pricing Captive product pricing stand for the setting a price of products that must be used along with a main product.
Example such as sim card for the iPhone and iphone itself. The main product iPhone can only used the specific sim card for iphone only, which is much smaller compare to an ordinary sim card. For the case of services, this captiveproduct pricing is called as two-part pricing. The service is broken into two; the fixed fee plus a variable usage rate. By-Product Pricing The term “by product” is generally used to denote one or more products of relatively small total value that are produced simultaneously with a product of greater total value.
It can also be defined as setting a price for by-products in order to make the main product’s price more competitive. The product with the greater value, commonly called the “main product”, is usually produced in greater quantities than the by-products. The manufacturer in this case has limited control over quantity of the by-product that comes into existence. For example, saw dust. It is a by-product of cutting, grinding, drilling or otherwise pulverizing wood with a saw or other tool; it is composed of fine particles of wood. Nowadays, people use sawdust for their gardening or even cleaning in their house.
Product Bundle Pricing Product bundle pricing is defined as combining several products together and offering a reduced price for the bundle. The common example is the fast food restaurant such as Kentucky Fried Chicken (KFC), McDonald’s, Domino’s Pizza and others. They sell their foods in combo where it consists of chicken, drinks and fries coming along with a reduced price rather than buying each item in a single receipt. Price Adjustment Strategies Pricing adjustments are used to make small adjustments in the base price or list price for a product for optimal performance of effectiveness.
These adjustments are short run approaches that do not change the general price level. However, companies are allowed to adjust the prices due to various types of customers and other conditions. These conditions are including the changing competitive environment, changing government regulations, changing demand situations, and meeting promotional and positioning goals. Thus, the seven tactics that are used to tackle these problems are the discount and allowance pricing, segmented pricing, psychological pricing, promotional pricing, geographical pricing, dynamic pricing, and international pricing.
Discount and Allowance Pricing Many companies adjust their base price to reward their customers for certain responses. They are rewarded in the form of discounts and allowances. Discount is a reduction in a price. Reducing the discounts from the list price or base price will give us the market price. In a cash discount, there is a reduction offered to prompt payment for a receipt. For example, “2/10 net 45” means that 2 percent discounts are given if payment is made within 10 days of invoice date, and if full payment is expected within 45 days.
While a quantity discount is a reduction in price for every unit purchased by a customer. It is given to customers who purchase in a large quantity or above a set amount of money. Functional discount is a discount for wholesalers and retailers who perform distribution channel functions for the manufacturer. The functions are something like storing, promoting and etc. Seasonal discount is a price reduction for out-of-season products or for products during low demand season. This type of discount is to keep a steady production throughout the year.
In the form of allowance, promotional money paid by buyers to sellers in return for a good provided. For example, a hand phone dealer offers trade in allowance to buyers if they trade in their old hand phones in order to buy a new one from the seller. Promotional allowance is a payment made to a distributor for promoting the manufacturer’s product. Segmented Pricing Segmented pricing is the selling of a product or service at two or more prices but the price’s difference is not due to the differences in costs.
For this pricing strategy to work, the market must be segmentable, and the segments must show different degrees of demand. Furthermore, cost for segmenting must not exceed the benefit obtained from the price difference. For customer-segmented pricing, the same product or service has different prices due to the difference in customer. Let’s take for an example zoo, where children below twelve are charged lowers compared to the adults. Under product-form pricing, different versions of a product are priced differently, regardless of cost.
For instance, an additional feature with a slight cost might justify a fat price premium. A company can also charge different prices for different locations, regardless of cost. This is called location pricing. In a concert, for example, different locations for seating have different prices. Using time pricing, companies change their prices according to the time factors. These time factors include the season, the month, the day, and even the hour. For example, the cinema, the tickets are usually cheaper during weekdays compared to weekend. Psychological Pricing
In psychological pricing, it is a pricing approach that considers the psychology of prices and not simply the economics; the price is used to say something about the product. Consumers always think that higher-priced products have better and higher quality. Companies use reference pricing when they want to compare the actual selling price to an internal or external price. All customers use internal reference pricing for what a product should cost. For internal pricing, the customers’ experiences have given them the reasonable expectation of how much a product should cost.
While customers with less experience, external reference pricing becomes more important. Most of the time reference pricing is used when comparing the sale prices and the regular prices. Naturally, the customers will choose the lowest possible priced products. Due to this advantage, companies usually create lines of products that are quite similar in appearance and functionality but a small different in features and at different price. For example, Sony can cut a few features off its home stereo receiver and Model B can be on the shelf at RM450 rather than RM650 for Model A.
Then, cut a few more features and the price drop to RM300 for Model C. Here, each model in Sony line establishes reference prices for the other models in the line. Besides that, odd-even pricing is also part of psychological pricing. It is a strategy of setting prices a few ringgit or cents below a round number. For instance, a retailer may price a bottle of cooking oil as RM12. 99 or a personal computer is priced at RM2,495. The two prices will seem to be much cheaper in the mind of customers than RM13. 00 and RM2,500 respectively.
Sellers normally use odd-prices to imply bargains, and even-numbered prices to imply quality. Promotional Pricing The definition of promotional pricing is that the products are temporarily priced below the list price, and sometimes even below cost, to increase short-run sales. The hallmark of promotional pricing is a sale. Under promotional pricing, the companies also use special-event pricing to attract more customers during certain season. For instance, during Chinese New Year, there is always promotion or discounts for clothes and shoes. Cash rebates are also part of promotional pricing.
It is an amount paid by way of reduction, return, or refund on what has already been paid or contributed. Advantages of promotional pricing are that they can help to reduce the excess inventory that is perishable or has a specific shelf life. They can also help expanding the customers’ base due to the fact that new customers are attracted to promotional pricing of the products. Furthermore, customers’ behaviors can be influenced to purchase low-cost products in bulk and finally, increase the market shares of the products. However, the frequent use of promotional pricing can have a harmful effect as well.
Customers may intentionally wait until the companies go on sale before buying them. Sometimes, customers may view that the brands’ value are eroded due to frequent discount being offered. Geographical Pricing Customers may be based at different countries all over the world or may be located at different regions within a country. The geographical pricing strategies are FOB-origin pricing, uniform-delivered pricing, zone pricing, based-point pricing, and freight-absorption pricing. The Free on Board (FOB) strategy requires customers to absorb the freight costs.
The companies’ prices are for the product at the point of shipment. The customers will have to determine the mode of transportation, choose the carrier, claim for damages, and pay the freight charges (Monroe, 1990). Normally, the letter FOB will not stand by itself. It will have destination together like FOB Port Klang or FOB factory. Those destinations will be the points of shipment from where the buyers will pay for the freight charges. This can be considered as the fairest way to access freight charges. However, for distant customers, they will incur higher cost.
While uniform-delivered pricing is a geographical pricing strategy in which the company charges the same price plus freight to all customers, regardless of their location. Titles to the products are transferred once the products reach a destination. Between FOB-origin pricing and uniform-delivered pricing, there is the zone pricing. Customer’s flat freight rate is charged differently at different geographic zones due to differences in distance, demand, and competition (Monroe, 1990). A company may differentiate all buyers in the East Malaysia from the buyers in West Malaysia, and charging two different flat rates for each zones.
This strategy allows no price advantage given to the customers. A geographical pricing strategy in which the seller designates some city as a basing point and charges all customers the freight cost from that city to the consumer is called the basing-point pricing. A customer in Sarawak purchases products from a manufacturer’s head office in Kuala Lumpur and the product is actually produced and transported from Seremban. However due to Kuala Lumpur has been specified as the base point, the customer is charged a price as if the goods come from Kuala Lumpur.
The company is actually absorbing the freight charges from Seremban to Kuala Lumpur. Finally, a geographical pricing strategy in which the seller absorbs all or part of the freight charges in order to get the desired business is called the freight-absorption pricing. The choice of transportation mode and distance will not matter to the customers in this case, as costs of transportation are absorbed by the companies. Normally, this pricing strategy is used for market penetration and to hold on to increasingly competitive markets. Dynamic Pricing
Now, most of the companies like to use dynamic pricing strategy, which is, adjusting prices continually to meet the characteristics and needs of individual customers and situations. Customers are divided into two or more groups with separate demand curves, and different prices are charged to each group. Price discrimination can increase the profit of the firm by capturing the consumer surplus. However, ethical issues exist with some price discrimination policies, especially thanks to the advent of technology, which gives firms the possibility of charging prices based on consumer history and profiling.
One unique advantage the Internet offers is the ability to customize prices to individual consumers or business customers based on their purchase histories. This price segmentation approach is made possible through the power of databases. Based on customer data, companies are able to offer better deals to their best customers, or to strategically price items that are similar to those purchased in the past. In mid-2001, InfoWorld announced that IBM, Compaq, Hewlett-Packard, and Dell were all looking into dynamic pricing approaches for their e-commerce operations.
Different factors were involved in each company’s strategy. For Dell, the price of computer memory chips and processors was an influencing factor, while IBM’s approach involved product life cycle and demand. Hewlett-Packard referred to its approach as “contextual pricing,” as the number of total items being purchased as part of special promotions would affect what customers paid overall. As a consultant pointed out in the article, dynamic pricing must be handled carefully. Such approaches have been known to cause problems for companies if consumers feel as though they have not received a fair deal.
International Pricing In an era of globalization, one of the challenges that companies face when selling their products abroad is how to set appropriate prices. Most companies adjust their prices to reflect local market conditions and cost considerations. One of the main factors to determine an international pricing strategy is the size of the national market, which affects prices in different ways. A company will often attempt to use the potential volume of sales to estimate the price at which they will need to market their product to break even.
For larger countries with the potential for more sales, this price may be set lower; for smaller countries, the price may be higher. Besides that, exchange rates also play a significant role in setting prices. Due to discrepancies in the value of different currency, similar products in different countries may be priced differently. This has to do not just with demand for that particular product, but with macroeconomic demand for national currencies, which affects inflation and, by extension, pricing.
Companies often have to adjust prices due to fluctuations in exchange rates. One of the more complicated factors in international pricing is cultural variations between companies. Cultural variations that affect pricing can take many forms, most of which have to do with how members of certain cultures perceive the value of certain products, which in turn affects how much they are willing to pay for them. For example, in the United States women’s handbags often are seen as a status symbol. Female consumers, therefore, often are willing to pay high prices.
In other cultures, however, handbags are considered more functional, meaning they can only command a significantly lower price. Price Changes What does it means of price changes? Price change could be define as the dollar change in the price of a security from one day’s close to the next day’s close. The cost of an assets or security is normally difference from one period to another period. “Daily price change” is the most commonly cited price change in the financial media while it is computed for any length of time. Initiating Price Changes
In some cases, the company may find it desirable to initiate either a price cut or a price increase and it must anticipate possible buyer and competitor reaction. Initiating Price Cuts Several situations may lead a firm to consider cutting its price. One of the circumstances is excess capacity. In this case, the firm needs more business and cannot get it through increased sales effort, product improvement, or other measures. When in excess plant capacity, a firm would not be able to generate additional revenue without price reduction.
Another situation is a falling demand in the face of strong price competition. In such cases, the firm may aggressively cut prices to boost sales and share. It may drop its “follow-the-leader pricing” which means it charging about the same price as its leading competitor. Another situation leading to price changes is falling market share in the face of strong price competition. Therefore, if they want to restore their market in a certain industry, they have to decrease their price of the products. A company may cut the prices in a drive to dominate the market through lower cost.
Initiating Price Increases A successful price increase can greatly increase profits. A major factor in price increases is cost inflation. The cost inflation means that the rising cost unmatched by productive gains squeeze profit margins and lead companies to regular round to increase prices. Another factor leading to price increases is over demand. When a company cannot supply all its customers’ needs, it can raise its price, ration products to customers, or both. in the over demand situation, price can be increased in many ways.
When a company does not fix the price of its product until it is finished or delivered, we can use an adoption of delayed quotation pricing. Other than that, reduction of discount may allow the company to instruct its sales force not to offer its normal cash and quantity discounts. While passing on price increases to the customers, the company needs to avoid the image of a price gouge, because customer will turn against the price gougers when the market softens. Therefore, the company has to decide whether to raise the price sharply on a one-time basis or to raise it by small amounts several times.
Buyer Reaction to Price Changes Whether the price is raised or lowered, the action will affect buyers, competitors, distributors, and suppliers and may interest government as well. Customer does not always interpret price changes in a straightforward way. When a price increase, it would normally lower the sales, may have some positive meaning for buyers. As a consumer, we will think that the item is very “hot” and may be unobtainable unless you buy it soon. Or we also will think that the item is an unusually in a good value. On the other hand, consumer may view a price cut in several ways.
If an item price is decreases, then consumer may think of the item quality, it is quality reduced? A brand price and image are often linked. A price change, especially a drop in price, can adversely affect how consumers view the brand. Like when Rolex cuts its price, consumer may think that the models have some fault are not selling well, and its quality has been reduced and finally will destroy its image and brand. Competitor Reaction to Price Changes Competitor are most likely to react when the number of firms involved is small, when the product is uniform, and when the buyers are well informed.
The standard differentiated-product model with Nash-equilibrium price setting suggests that the density of sellers in a market can affect both a seller’s price elasticity of demand and a competitor’s reaction to a price change. Consistent with the theory, we find that competitors’ price reactions are in the same direction, with the magnitude of the competitors’ reactions being inversely related to the market’s density of sellers. The competitor will also interpret that the company in many ways as customer.
Competitor may think that the company is trying to grab a larger market share, or the company is doing poorly and trying to boost it sales or the company would want the whole industry to cut prices to increase demand. If the firm faces one large competitor, and if the competitor tends to react in a set way to price changes, that reaction can be easily anticipated, but if the competitor treats each price change as a fresh challenge and reacts according to itself interest, the company will have to figure out just what makes up the competitor’s self-interest at the time.
The company have to guess the reaction of all competitors. If all competitors are behave alike, this amount to analyse only a typical competitor. In contrast, if the competitor do not behave alike, then separate analyses are necessary. Moreover, if some competitors will match the price change, there is a good reason to expect that the rest will also match it. Responding to Price Change The firm needs to consider several issues when the firm is going to respond to a price change by a competitor. The firm should search for ways to enhance its augmented product.
If it cannot find any way it has to meet the price reduction. In responding to the price changes of competitors, the firm shall evaluate the competitors reason of price change, evaluate market place respond to the price change, and considers own product strategy. There are several ways a company might assess and respond to a competitor’s price cut. Once the company has determined that the competitor has cut its price and it is going to harm company sales and profits, it might simply decide to hold its current price and profit margin.
The firm should search for ways to enhance its augmented product. If the company decides that effective action can and should be taken, it might make any of four responses. First, reduce price to match the competition. It may decide that the market is price sensitive and that it would lose too much market share or worry that recapturing lost market share later would be too hard. Cutting the price will reduce the company’s profits in the short run. Other than that, the company should try to maintain its quality as it cuts prices.
This action of reducing price may answer the question of why did the competitor change their price. Second, maintain its price and raise the perceived quality. It could improve its communications, stressing the relative quality of its product over that of the lower-price competitor. The firm may find it cheaper to maintain price and spend money to improve its perceived value than to cut price and operate at a lower margin. The company might improve quality and increase price, moving its brand into a higher-price position.
The higher quality justifies the higher price, which in turn preserves the company’s higher margins. Finally, the company might launch a low-price “fighting brand” or we know as low price fighter line. One of the best responses is to add lower-price items to the line or create a separate lower-price brand. It is necessary if the particular market segment is price sensitive and will not respond to arguments of higher quality. The best respond varies with situation. Thus, companies have to be aware with the strategy it choose. Public Policy and Pricing
Price competitor is a core element of our free market economy. In setting prices, companies usually are not free to charge whatever prices they wish. Many laws govern the rules of fair play in pricing. Besides that, companies must consider broader societal pricing concern. The most important of legislation curb is the formation of monopolies and regulate business practices that might unfairly restrain trade. The major public policy in pricing includes the potentially damaging pricing practices within a given level of the channel and across level of the channel.
Pricing Within Channel Level Price Fixing Price fixing is an agreement between participants on the same side in a market to buy or sell a product, service, or commodity only at a fixed price, or maintain the market conditions such that the price is maintained at a given level by controlling supply and demand. Legislation on price fixing state that the sellers must set prices without talking to competitors. Otherwise, price collusion is suspected. Price fixing is generally illegal. Companies found guilty of such practices can receive heavy fines.
Government have been aggressively enforcing price fixing regulation in industries ranging from gasoline, insurance, and concrete to credit cards, CDs, and computer chips. Antitrust legislation makes it illegal for businesses to decide to fix their prices under specific circumstances. However, there is no legal protection against government price fixing. Some economists believe antitrust laws are unnecessary because the free market already contains several built-in guards against price fixing. Consumers who believe that an item is priced unfairly high can do any of the following which is