This is from the “Accounting Makes Cents” podcast episode #26 released on Monday, 14 November 2022.
In this episode, we’re going to discuss 11 pricing strategies that companies use to price their products and services. Additionally, we’re going to explore why we use each strategy and how they actually work.
Jump to show notes.
Our first strategy is something called penetration pricing. Penetration pricing involves offering a new product or service at the lowest initial price to gain customers’ attention. The goal is to aggressively get customers and gain market share. The strategy works with the expectation that customers will switch to the new brand because of the lower price. This of course works if customers are price-sensitive and make their choices based according to who has the lowest price.
This is different from predatory pricing, which is a method wherein the company undercuts the price of a product so that other competitors cannot compete and are forced to exit the market. A company that does this will suffer initial losses, but eventually, it benefits by driving competitors out of the market and raising its prices again. Ethically, this type of pricing is considered illegal because it hurts competition and it’s not undertaken to help consumers.
Our next strategy is market skimming. This strategy works by charging the highest initial price that customers will pay and then it is lowered over time. This strategy is in contrast with penetration pricing. The logic of this strategy is that customers, specifically early adopters, would be willing to pay for a new product that has some special features or technology, and basically own the newest shiny thing first and above others. As the demand of the early adopters is satisfied and competition starts entering the market, the price is lowered to attract the next level, more price-sensitive segment of the market.
Next one is premium pricing. In this strategy, this starts off like market skimming, in which the product is sold at a premium price. But the difference is, of course, in premium pricing, the price stays premium and there is no later time when pricing is reduced. This strategy involves tactically pricing the products higher than competition, so that it gives the impression that the product has a higher quality than the rest of the ones being offered in the market. It’s all about perception.
Our next strategy is bundle pricing. As the name would suggest, bundle pricing uses packages or a set of products or services offered altogether at a lower price than what they actually cost if the customer bought all of them separately. The logic is to leverage the collective attractiveness of all the products. A good example of this is cable TV packages, you get so many channels but perhaps you only really like 5 out of the 100 that you get. But because it’s cheaper to get the 100 or maybe it’s a good deal, you go for it.
Complementary product pricing
Then we have complementary product pricing, which is kinda like bundle pricing, because it also works with products that go together. But in this strategy, the products are sold separately. What happens though is that you have a main product, which is priced at an optimum level, so that it increases the demand for another product which is used with it. So think about a printer and its inks or cartridges. The printer is priced at a very affordable rate, so we can sell the product faster and more products can be sold because the price is attractive. But the inks and cartridges would be priced a bit more costly, because your customers would have no recourse but to buy your inks to use on the printer. Together, the company maximises the profits this way.
Cost plus pricing
So let’s do a simple strategy, the cost plus pricing, or sometimes referred to as mark-up pricing. It’s a pricing method where a fixed percentage is added on top of the cost of the product. The resulting number is the selling price of the product. Simple right? Generally, the percentage is something that would already be in your mind to tack on the cost.
Cost plus pricing
Now let’s get on to price discrimination. This strategy looks at identical or largely similar products or services, and then these are sold at different prices by the same company in different markets. So an example is like Microsoft Office being offered at regular prices to regular consumers, and they have a different pricing for students and education professionals.
Volume discount pricing
A sub-category of price discrimination is volume discount pricing, which offers different price points based on the volume of products being sold. If a customer buys over a tiered amount or level of quantity, then the price of the product changes to become cheaper. This encourages customers to buy in bulk, especially since the products become cheaper with a higher quantity or volume.
Odd-even number pricing or psychology pricing
Next up is odd-even number pricing or sometimes referred to as psychology pricing. In this pricing strategy, the understanding is that certain prices have a psychological impact. So think about prices which are often expressed as just-below numbers, so something like $2.99, this could be seen as under $3. As the names suggest, if the price ends in an odd number, then it is odd number pricing, and when it ends in an even number, then it is even number pricing.
Lastly, let’s talk about target pricing. This is more of a process where we estimate a competitive price in the market and apply our standard or preferred profit margin to that price in order to arrive at the maximum cost that that new product can have. We then try to create the product within the maximum cost we’ve calculated. So a simple example of this, we decide we want to sell the product at $10, but we want to make 40% profit off this product, which then means we can create or produce this product in $6. We have to abide by that target cost, so that we ensure we maintain the 40% profit that we want.
Show notes simplified
Black Friday season is upon us. And it’s no better time for MJ the tutor to tackle the discussion of 11 different types of pricing strategies than now. Reasons as to why specific strategies are used and how they work are explored in this episode.
“Ding Ding Small Bell” (https://freesound.org/s/173932/) by JohnsonBrandEditing (https://www.youtube.com/channel/UC1RImxnsbfngagfXd_GWCDQ) licensed under CC0 Licence.