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5.2 Pricing Strategies
A company's pricing strategy reflects the sum of its activities aimed at finding a product's o
ptimum price. Pricing strategy takes into account overall marketing objectives, consumer d
emand, product attributes, competitors' pricing, and market and economic trends. The pric
es consumers encounter in advertising and at the point of sale are just the tip of the iceberg
. The company cannot set a price higher or lower than customers expect. Competitors' prici
ng also constrains the price range a company can charge and yet remain competitive.
Two overarching questions must be addressed to choose an appropriate pricing strategy: w
hether to emphasize volume or profit, and whether to adopt a fixed or variable approach.
Volume or Profit Maximization?
The question of volume or profit maximization represents two different objectives. In the v
olume maximization approach, the company's primary objective is to generate as much sale
s volume (and revenue) as possible. On the other hand, the profit maximization approach
makes the objective to generate the highest net income over time. The main difference bet
ween volume maximization and profit maximization is the financial effect. Volume maximiz
ation generates cash flow but can reduce profits, because companies can find themselves se
lling at a loss to generate revenue. Profit maximization requires that all sales maintain acce
ptable profit margins.
A clear difference between the volume and profit maximization approaches is the timeline i
n question. Volume maximization is a shortterm strategy intended to generate sales volume quickly. This can be effective to build up c
ash on hand, expand a customer base, attract customers from competitors, or dispose of un
wanted inventory. The underlying goal is often to increase market share and reduce costs, r
esulting in long-term profits.
On the other hand, profit maximization addresses the profit objective directly with a focus
on positioning a brand for longterm success. In many cases, profit maximization is the overarching goal but volume maxim
ization takes temporary priority, for example during the launch of a business or near the en
d of a quarter or fiscal year. Before marketers can establish the pricing strategy that will for
m the basis for day-today decisions, they need deep understanding of overall company strategy.
One Price or Many?
The varying price sensitivity among market segments introduces the possibility of charging
different prices to different segments. When different market segments have different perc
eptions of value, a different price can be charged to different customers or at different time
s. With this variable pricing strategy a company can generate more revenue from market ni
ches willing to pay higher prices and still maintain sales to those placing a lower value on t
hat offering. There are advantages and disadvantages to a variable price strategy.
A fixed pricing strategy, in which the same price is charged to all customers, is easier to ad
minister. Training the customer service staff and accounting for sales is easier, but the rigid
ity of this policy can seem unfriendly to customers, and revenue opportunities could be lost
.
If a company chooses a fixed price strategy, it must decide whether to occupy the high, aver
age, or low price position. If instead a company chooses a variable price strategy, certain co
mplications ensue—
but the promise of greater revenue makes overcoming those complications attractive.
The goal of variable pricing is to ensure that companies are selling the right product to the r
ight consumer at the right price, while steering clear of illegal practices. U.S. law prohibits p
rice discrimination, defined as the practice of charging different prices to different buyers f
or goods of like grade or quality.
The norms of specific industries tend to define which companies opt for a variable pricing s
trategy. The tiered pricing plans common among cell phone carriers are an example of a va
riable pricing strategy designed to avoid problems with overburdening existing networks
while allowing carriers to make money from mobile data and applications, rather than just
voice minutes (Wortham, 2011). Tiered pricing is legal because each tier represents a bund
le of different service options for calls, text messaging, and data usage.
Variable pricing is accepted in many parts of the world. Haggling is an ancient form of varia
ble pricing. North Americans tend to expect marketers to practice a oneprice policy, representing the fundamental fairness of a democracy. A company's strategic d
ecision to pursue a fixed or variable pricing strategy must take this into account.
Pricing Strategies for Every Situation
Dell Computers was one of the first to adopt the cocreation model, offering a base price for specific features and then encouraging customers to customi
ze features to create a unique product.
Associated Press
Having chosen an objective of either volume or profit maximization, and a oneprice or variable pricing approach, it falls to marketers to finetune their choice of pricing strategy to fit the specifics of their situation.
Marketers in service industries can adopt peakload pricing to counter the perishability of their offerings. Similarly, marketers can adopt yi
eld management to exploit timing to generate sales while managing a fixed, perishable capa
city. Most people have had experience with airlines' use of price changes to profitably mana
ge the fit of a fixed supply to a varying demand. Airlines change prices frequently—
even minute-by-minute—depending on their supply of seats and demand for them.
Marketers can adopt a cocreation model, in which customers bundle options to design their own offerings that suit t
heir individual ideas of value. A company can participate in a dynamic pricing model, in whi
ch the buyer collaborates with the seller, allowing retailers to offset the threat created by p
rice comparison, which drives prices down and narrows profit margins (Swabey, 2007).
Ecommerce facilitates dynamic pricing, which gave rise to the "Name Your Own Price" (NYO
P) variation popularized by Priceline.com. Unlike the traditional sellerdriven pricing model, in which the seller prices the goods, leaving the buyer to "take it or le
ave it," the NYOP approach is buyerdriven. In response, sellers opt for opaque exchanges, strategically withholding information
from customers who may not know the exact features of their purchase at the point of pay
ment. Processing is fast, and competition among customers is minimized since no one kno
ws what anyone else is paying. NYOP gives firms more leverage in inventory control and pr
icing to different segments. But in the end, it may be a doubleedged sword, making it difficult to predict profit margins and increasing buyerdriven sales by cannibalizing seller-driven channels (Huang & Sosic, 2011).
Marketers can signal positioning of their brands through pricing, choosing a high, average,
or low price point in relation to competitors, as mentioned earlier. Skim pricing is defined
by setting prices high to attract higherincome groups for luxury or status goods. Neutralpricing is defined by matching prices of t
he general market, a decision that shifts comparison to other features of an offering. Penetr
ation pricing is defined by keeping prices low in comparison to competitors' and widely pr
omoting an offering, to quickly achieve more sales to more buyers. Opting for a penetration
price works best when the seller intends to maintain consistency of pricing, forgoing use of
sales events or other discounts that would lower revenue even further. Walmart long held
this position with its strategy of promising "everyday low pricing" with few discount sales
promotions (Perner, 2008).
Field Trip 5.2: Walmart’s Everyday Low Pricing
Follow this link to an article on Walmart Watch, evaluating the company’s relaunch of an ev
eryday low pricing strategy in 2011.
http://makingchangeatwalmart.org/2011/10/11/high-price-of-low-cost-press-release/
Penetration pricing de-emphasizes market segments. It works where buyers are pricesensitive and markets are large enough that thin profit margins are sustainable, but it is hig
hly vulnerable to competitors who match low prices (Nagel & Holden, 1995). This and othe
r pricing strategies are shown in the graph in Figure 5.2.
Figure 5.2: Pricing strategies that signal economic value
Price is a signal of economic value.
Adapted from Nagel and Holden, 1995
Table 5.3 summarizes pricing strategies discussed in this chapter.
Table 5.3: Pricing strategies and objectives
Definition
Peak load
Charging higher prices during periods of rising demand
Yield management
Strategic control of inventory to maximize yield or profits from a fixed, perishable re
e
Co-creation
Allowing customers to select from options to design customized offerings
Dynamic pricing
Buyer collaborates with seller to establish the price, accepting tradeoffs in exchange
vorable pricing.
Opaque exchanges
Seller withholds information from customers about exact features of their purchase
ransaction is completed.
Brand leadership (
skim)
Setting prices high in comparison to competitors
Neutral
Matching prices of the general market
Penetration
Keeping prices low in comparison to competitors'
In a marketing era that values longterm customer relationships, both organizational buyers and consumers have come to expe
ct a degree of flexibility in pricing. While all the pricing strategies discussed are viable choic
es, those that allow for customer negotiations are gaining in importance.
Segmented Pricing
An appropriate response for companies wanting to pursue a variable pricing strategy while
staying on the right side of the law is segmented pricing, a tactic for separating markets an
d matching differentiated offerings to them.
A segmented pricing strategy is a natural extension of a company's market segmentation st
rategy. Segmentation can be an effective response to variations in segment price sensitivity
and a useful tool for differentiation from competitors. In industries with high fixed costs, s
uch as cell phone carriers and power utilities, segmented pricing is often essential (Nagle &
Holden, 1995). Without it, the companies could never cover their costs and still serve all th
e customers who need their services.
Why don't all companies implement a segmented pricing strategy? Certain factors work aga
inst it:
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Customers don't selfidentify themselves into segments; this puts the burden on the seller to identify segmen
ts with differing demand.
The costs of managing the segmentation program can't be higher than the extra revenu
e earned by the differences in prices.
Intermediaries can undermine the strategy by figuring out how to buy low and sell high.
A poorly designed segmented price strategy can violate federal antitrust laws.
Consumer resentment can result when the price charged to different segments doesn't reflect an actu
al difference in value. Adidas learned this when it charged more for team shirts in one country than an
other.
Associated Press
An extremely important factor is that whatever price a customer is charged for the value he
or she receives, that price should reflect a real difference in value from similar offerings pu
rchased at other price points by other customers. Otherwise, the company risks charges of i
llegal price discrimination.
There is also the possibility of an outcry of consumer resentment if prices charged to differ
ent segments do not reflect a real difference in value. This happened when Adidas charged
more for rugby team shirts in the team's home country of New Zealand than it charged for t
he same shirts in other countries.
In summer 2011, when New Zealand's hugely popular rugby team the All Blacks made it to
the Rugby World Cup, national pride soared—
and so did demand for the official team jersey. New Zealand fans went into a frenzy when t
hey discovered shirts were being sold online in the United States and Britain for about half
the local price in New Zealand. Local news outlets ran with the story. Anger escalated when
it was reported that Adidas told online retailers selling internationally to remove New Zeal
and from the available delivery options. The Adidas brand image suffered as a result, to the
extent that corporate sponsorship events were canceled and branding removed from comp
any vehicles after staff members were publicly harassed (Hutchison, 2011). In a Marketing
3.0 world of connected consumers, discriminatory pricing policies will be met with consum
er protest, if not a legal challenge.
A segmented pricing strategy benefits consumers. It spurs competitive innovation when co
mpanies develop improvements that different market niches will value, thus allowing them
to charge more profitable prices. Without segmented pricing, some small market niches' de
mands would more frequently go unmet.
Some segmented pricing tactics that have proven effective (and legal) include varying the p
rice by customer segment, demand elasticity, price sensitivity, product version, seasonality,
geography, and volume purchase. Other tactics include product bundling, in which the item
s combined increase the value for a specific buyer segment, such as an orchestra bundling c
oncert tickets into a season package or an airline offering hotel and rental car bundled with
the purchase of a flight.
In conclusion, a pricing strategy must reflect overall corporate objectives regarding volume
and profitability over both short and long time frames. Marketers may support the objectiv
e by offering a fixed price to all comers or a price that varies by market segment. A number
of pricing strategies serve different purposes and situations; those that allow customers to
participate in establishing the price are becoming more important. A segmented pricing str
ategy holds potential to yield the most revenue, as each customer pays what he or she perc
eives as a fair price for the value received. However, this is the most difficult strategy to im
plement.
In the end, successfully responding to the economics of pricing relies on marketers who mu
st find product advantages that create sustainable competitive differentiation. This is the o
nly way to avoid competing solely on price.
Questions to Consider
Choose one product category and describe how a segmented pricing tactic could be used to
increase revenue while steering clear of laws against price discrimination.