11.9 Pricing Strategies and Future Trends
- What strategies are used for pricing products, and what are the future trends?
An important part of the marketing planning process is setting the right price. Price is the perceived value that is exchanged for something else. Value in our society is most commonly expressed in dollars and cents. Thus, price is typically the amount of money exchanged for a product. Note that perceived value refers to the perception of the product’s value at the time of the transaction. After a consumer has used a product, the consumer may decide that its actual value was less than its perceived value at the time it was purchased. The price paid for a product is based on the expected satisfaction that the customer will receive and not necessarily the actual satisfaction of the customer.
Although price is usually a dollar amount, it can be anything with perceived value. When products are exchanged for each other, the trade is called barter. For example, if your car needs a repair, you might offer to do the house chores for your mechanic roommate in exchange for their service repairing your car. You have engaged in a barter exchange.
Pricing Objectives
Price is important in determining how much a firm earns. The price charged customers times the number of units sold equals the gross revenue for the firm. Revenue is what pays for every activity of the company (production, finance, sales, distribution, and so forth). The money that is left over (if any) is profit. Managers strive to charge a price that will allow the firm to earn a fair return on its investment and will maximize return on investment to the highest extent while still maintaining a fair return.
The chosen price must be neither too high nor too low, and the price must equal the perceived value to target consumers. If consumers think the price is too high, sales opportunities will be lost. Lost sales mean lost revenue. If the price is too low, consumers may view the product as a great value, but the company may not meet its profit goals. Sometimes, as in the case of services, a price that is too low will cause the product to be viewed as less than credible and lose sales for the company.
Product Pricing
Managers use various pricing strategies when determining the price of a product, as this section explains. Price skimming and penetration pricing are strategies used in pricing new products; other strategies such as leader pricing and bundling may be used for established products as well.
Price Skimming
The practice of introducing a new product on the market with a high price and then lowering the price over time is called price skimming. As the product moves through its life cycle, the price usually is lowered because competitors are entering the market. As the price falls, more and more consumers can buy the product. Examples include gaming systems and flat-screen TVs. When a new gaming system comes out, they are often priced around $500, and flat-screen TVs were originally released at over $1000. Over time, the price of the gaming system decreases to a lower price point to encourage more sales, and the same is true for TVs. You can purchase a flat-screen TV for around $100, although prices vary by size and features.
Price skimming has four important advantages. First, a high initial price can be a way to find out what buyers are willing to pay. Second, if consumers find the introductory price too high, it can be lowered. Third, a high introductory price can create an image of quality and prestige. Fourth, when the price is lowered later, consumers may think they are getting a bargain. The disadvantage is that high prices attract competition.
Price skimming can be used to price virtually any new products, such as high tech electronics, pharmaceutical drugs, and cars. For example, The Republic of Tea offers Emperor's White Tea, which it says is among the rarest of teas. Because it is minimally processed, white tea is said to retain the highest level of antioxidants and has a lower caffeine content than black and green teas. The company says the tea is picked only a few days each year, right before the leaf opens, yielding a small harvest. The product retails for approximately $18.50 per tin. Products don’t have to cost hundreds of dollars to use a skimming strategy.
Penetration Pricing
A company that doesn’t use price skimming will probably use penetration pricing. With this strategy, the company offers new products at low prices in the hope of achieving a large sales volume. Procter & Gamble did this with its Oral-B electric toothbrushes. Penetration pricing requires more extensive planning than skimming does because the company must gear up for mass production and marketing. When Ford invested nearly $4 billion in its facility in Michigan to produce lower cost EV car batteries, it produced enough batteries to supply 400,000 cars per year. If the company had been wrong about demand, its losses would have been huge.
Penetration pricing has two advantages. First, the low initial price may induce consumers to switch brands or companies. Using penetration pricing on its wines, Yellow Tail has lured customers away from more well-known brands. Second, penetration pricing may discourage competitors from entering the market. Their costs would tend to be higher, so they would need to sell more at the same price to break even.
Leader Pricing
Pricing products below the normal markup or even below cost to attract customers to a store where they wouldn’t otherwise shop is leader pricing. A product priced below cost is referred to as a loss leader. Retailers hope that this type of pricing will increase their overall sales volume and thus their profit.
Items that are leader priced are usually well known and priced low enough to appeal to many customers. They also are items that consumers will buy at a lower price, even if they have to switch brands. Supermarkets may use leader pricing on products like rotisserie chickens, milk, or eggs to attract customers, pricing them at or near cost while earning profits on other purchases. Department stores and specialty stores also rely heavily on leader pricing.
Pricing of Services
Pricing of services tends to be more complex than pricing of products that are goods. Services may be priced as standard services, such as the price for a cheeseburger value meal at a fast food restaurant, or pricing may be based on tailored services designed for a specific buyer, such as the prices charged for hair stylist services, which vary by the types of services desired.
Ethics in Practice
Pricing Before, During, and After Hurricanes
The late summer of 2017 brought several devastating hurricanes that impacted large areas of Texas, Florida, Puerto Rico, and the Virgin Islands. As often happens during events like these, there were several reports of stores, hotels, and service stations engaging in price gouging. Many states have laws against price gouging during natural disasters, but a photo on social media of an electronics retailer charging over $40 for a case of water was widely circulated. A case of water typically costs under $10, so the price was thought to be an instance of price gouging. The retailer quickly addressed the exorbitant price and issued an apology, stating they normally do not sell cases of water, and that an employee wanting to provide a service in advance of the storms simply multiplied the price of a single bottle they normally sell by 24 to arrive at the per-case total. The retailer's response was aimed at deflecting a negative public perception with regard to the pricing "error."
Another example of how companies might be accused of price gouging occurs with companies that use “dynamic pricing,” which uses computer algorithms to analyze demand and automatically raises prices as demand increases. Amazon uses dynamic pricing, and consumers saw an increase in the price of things like generators and water in the days prior to hurricanes Harvey, Irma, and Juan in 2017.
Some economists believe that price increases during natural disasters are a good thing. They state that letting the market forces work to regulate prices discourages hoarding during disasters such as hurricanes, with buyers purchasing more than they need when the prices are kept low. With the increased demand and lower prices in place, firms do not see the incentive to maintain supply because they are making less money. This leads to shortages for critical items needed during natural disasters, such as water. For example, let's say a retailer decides to raise the price of an essential good such as toilet tissue during a disaster such as the COVID-19 pandemic. A customer might not purchase more than they think they need, thus leaving product for other customers. The higher price, thus higher return to the business, encourages the retailer to restock the product when needed rather than letting the shelves go empty.
- What risks do companies face when selling a product that they normally don’t sell and then are accused of price gouging, or when they using dynamic pricing?
- Why is the use of dynamic pricing deemed acceptable for selling tickets to sporting events but not during a natural disaster?
- Do you agree with the arguments in support of higher prices put forth by free-market economists?
Sources: Andrew Ross Sorkin, “Hurricane Price Gouging Is Despicable Right? Not to Some Economists,” The New York Times, https://www.nytimes.com, September 11, 2017; Tom Popomaronis, “Amid Preparations for Hurricane Irma, Amazon Draws Scrutiny for Price Increases,” Forbes, https://www.forbes.com, September 6, 2017; Dennis Green, “Best Buy Explains Why It Charges $42 for a Case of Water in Texas During the Hurricane in ‘a Big Mistake,’” Business Insider, https://www.businessinsider.com, August 29, 2017; Matt Zwolinski, “The Ethics of Price Gouging,” Business Ethics Quarterly, 18(3): 347–378, 2008, https://facpub.stjohns.edu; Lili Carneglia, "Price Gouging During Disasters Is Actually a Good Thing," Foundation for Economic Education, https://fee.org, October 15, 2018; "Price-Gouging Laws and Consumer Welfare: An Economic Analysis," Northeastern University, https://econ.sites.northeastern.edu, January 18, 2024.
Bundling
Bundling means grouping two or more related products together and pricing them as a single product. For example, a local restaurant might bundle menu items with a bottle of wine and flowers for a Valentine's Day weekend special. Appliance stores may offer a washer and dryer together for a price lower than if the units were bought separately.
The idea behind bundling is to reach a segment of the market that the products sold separately would not reach as effectively. Some buyers are more than willing to buy one product but have much less use for the second. Bundling the second product to the first at a slightly reduced price thus creates some sales that otherwise would not be made. For example, Aussie Miracle Moist Shampoo is typically bundled with its conditioner because many people use shampoo more than conditioner, so they don’t need a new bottle of conditioner.
Odd-Even Pricing
Psychology often plays a big role in how consumers view prices and what prices they will pay. Odd-even pricing (or psychological pricing) is the strategy of setting a price at an odd number to connote a bargain and at an even number to imply quality. For years, many retailers have priced their products in odd numbers—for example, $99.95 or $49.95—to make consumers feel that they are paying a lower price for the product.
Prestige Pricing
The strategy of raising the price of a product so consumers will perceive it as being of higher quality, status, or value is called prestige pricing. This type of pricing is common where high prices indicate high status. In high-end shops located in places such as Chicago or New York City, products that would sell elsewhere for less are often marked up because of the prestige of the shop and the perception of higher quality. If the price were lower, customers would perceive them as being of low quality. Prestige pricing is also very prevalent in services because services providers with reputations for excellent service are more in demand, often with a waiting list. This is due to the fact that services are tied directly to the people who provide them and those people have only so much time in a week in which to provide services. Once the calendar fills up, the demand goes up, and the prices become prestige prices.
Concept Check
- What is the difference between penetration pricing and price skimming?
- Explain the concept of price bundling.
- Describe odd-even pricing and prestige pricing.
- Why is prestige pricing prevalent in services?