Product Pricing

Businesses use various pricing strategies when determining the price of a product, as this section explains.

price skimming

Price skimming is a new-product strategy in which marketers choose to initially set a high price for a product or service and lower it over time.

The goal of price skimming is to attract the segment of the market that is willing to pay the highest possible price for the product. Once achieved, the price is lowered to attract another segment of the market and so on. The term skimming comes from the skimming the cream, layer by layer, from raw milk—or in this case, each segment of customers.

Innovative technology often uses price skimming. For example, when Sony launched the PlayStation 3, it was set at a fairly high price of $599. With little competition and a well-established brand, it was successful. Each year thereafter, it lowered the price—and gained new customers—until it eventually reached a price of $299.^[1]

Benefits and Challenges of Price Skimming

Price skimming has four important advantages.

1. A high initial price can be a way to find out what buyers are willing to pay.
2. If consumers find the introductory price too high, it can be lowered.
3. A high introductory price can create an image of quality and prestige.
4. When the price is lowered later, consumers may think they are getting a bargain.

The disadvantage to price skimming is that high prices attract competition.

penetration pricing

The penetration pricing strategy is one in which the new product or service is set at the lowest price possible.

Penetration pricing is the opposite of price skimming. This strategy’s objective is to penetrate the market, or gain as many customers in all segments as possible from the beginning of the product life cycle.

In the late 1990s, Netflix introduced its movie rental service. For a monthly subscription fee, users could rent four movies at a time with no return date. The low initial price targeted the most segments of the market and allowed customers to try the new service with little effort or financial impact.

break-even pricing

Break-even pricing is a pricing strategy in which marketers choose a price that will cover all of the costs of manufacturing.

Another new product pricing strategy is break-even pricing. The break-even point is when the number of units produced equals the revenue for the product. The break-even point will produce zero profit but will cover all associated costs.

The break-even formula is calculated by dividing the total fixed costs by the production unit price minus variable unit costs. The break-even point in units will tell a marketer exactly how many units must be sold in order to start making a profit.

[latex]\text{Break Even} = \frac{\textstyle \text{Fixed Costs}}{(\textstyle \text{Unit Price} - \textstyle \text{Variable Unit Costs})}
[/latex]

Let’s look at an example. Assume you are opening a new gourmet cookie shop and you have estimated your projected costs. You’d like to know how many units you must sell in order to break even and then start making a profit. Let’s assume your fixed costs are $20,000. This includes rent, deliveries, ingredients, and new signage. You have estimated your variable costs to be $1.50 per unit, or cookie. You plan to charge $2.00 per cookie. How many units must you sell to break even? Using the formula above, you find that you must sell 40,000 cookies in order to break even.

[latex]\begin{align*}
\text{Break Even} &= \frac{\$ 20,000}{(\$2.00 - \$1.50)} \\
\text{Break Even} &= \frac{\$ 20,000}{(\$0.50)} \\
\text{Break Even} &= 40,000\ \text{Units}
\end{align*}[/latex]

Break-even pricing is particularly useful when:

• The market is highly competitive with established players
• The company needs to test market acceptance
• Long-term customer relationships are more important than immediate profits
• The company has investors or stakeholders requiring demonstrated viability of the new product

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 often feature coffee and bacon in their leader pricing. Department stores and specialty stores also rely heavily on leader pricing.

odd-even pricing

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.

Psychology often plays a big role in how consumers view prices and what prices they will pay. For years, many retailers have priced their products in odd numbers—for example, $99.99 instead of $100.00—to make consumers feel that they are paying a lower price for the product.

prestige pricing

The strategy of setting a high price 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 the specialty shops on Rodeo Drive in Beverly Hills, which cater to the super-rich of Hollywood, shirts that would sell for $30 elsewhere sell for at least $150. 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.

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 a hair stylist might charge for a haircut, or pricing may be based on tailored services designed for a specific buyer, such as the prices charged for the design of a new building by an architect.

 

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