Pricing Strategies | Sample Business Plan

Pricing Strategies


 

Every company knows that revenues are earned through pricing (while profits are made in purchasing). This article will focus on the various pricing strategies. Research has shown that many companies don’t conduct the necessary pricing research to establish a solid pricing strategy, which can have a significant effect on revenues… this lack of research results in lower revenues in many cases. Having a well-defined pricing strategy lays the foundation for future pricing decisions. There are 3 primary strategies for pricing, as follows:

 

1) Skimming
2) Penetration
3) Status Quo

 

Skimming

 

Price skimming is a strategy of establishing high prices relative to competitor prices. Skimming is usually an approach used when a product is new, with little competition, and viewed by the consumer as having unique and valuable attributes. Many companies will use this approach, especially when introducing a new product to the market, because they would rather start high to test the market and if necessary adjust the price down. Additionally, companies will use this strategy when they want their brand/product to be perceived by consumers as an elite product. While this may be intuitive, an advantage of starting out with high prices is it allows companies to recoup research and development, and other initial production expenses quicker. This strategy is most successful when demand is greater than supply and when others cannot compete in the market for various reasons, such as; patents, shortages on resources, technological requirements or special skills that are not widely available. Finally, if a skimming strategy is successful it encourages competition due to the higher profit margins.

 

Penetration

 

A penetration pricing strategy is the opposite of skimming; products are priced relatively low compared to competitors. When a company wants to capture a large share of a particular product market, they will establish a low price. One of the benefits to low pricing is selling volume, which facilitates production and logistical economies of scale. Additionally, this increase in demand means an increase in production levels, having a positive effect on the experience curve; in theory, as a firm gains more experience they are able to improve the process and reduce per unit production costs. However, with lower pricing comes lower profit margins which will lengthen the time it takes for a firm to recoup research and development and initial start-up costs.

 

If the product is in a price sensitive market (the product has elastic demand), then a penetration pricing strategy works really well. The lower price will draw more consumers and result in greater demand, and if the market potential is large enough, this growth will justify expansion of production facilities. While a skimming strategy tends to draw competitors as a result of the high prices, penetration has a tendency to deter competitors from entering the market because the margins aren’t attractive enough to justify entry. A major consideration for establishing a penetration pricing strategy is mass producing a product that doesn’t garner the anticipated sales- a company will end up with a large inventory of items that don’t sell.

 

Status Quo

 

The status quo strategy is a safe approach to pricing as pricing is comparable to competitor pricing. This can be an effective strategy for a small or new start-up; however, this approach often overlooks demand and cost.

 

In addition to the primary strategies, there are several pricing practices and tactics (it should be noted that 1-3 are considered unethical and not advised):

 

1) Price Fixing
2) Price Discrimination
3) Predatory Pricing
4) Promotional Methods
5) Value Pricing
6) Geographic Pricing
7) Single Price
8) Flexible Pricing
9) Price Lining
10) Leader Pricing
11) Bait Pricing
12) Odd/Even Pricing
13) Price Bundling

 

Next (Unethical Pricing Practices)