Business pricing strategies

When a business sells a product or service it has a number of options available with regards to pricing strategy. The business must decide on how much it will charge for a product in order to cover costs and make the most money while still being able to sell high volumes.

Supply and demand

Many aspects will affect the price that is charged for a product but one of the main ones is supply and demand. If a product is in short supply then it will be hard to purchase. This leads to a company increasing prices on the product as it is rare now there is a shortage of supply. The reverse is also true – a product that can be easily supplied will usually be quite cheap so that customers do not go elsewhere.

The demand will also have an impact upon the price that a company charges. When demand is very high, businesses can charge a higher price as people will still make purchases due to the fact that they really need the product in question. If demand is low for a product, prices may be dropped in an attempt to entice new clients to buy goods. Some other things that can affect the price of products may include:

• The costs of production and marketing of a product
• The marketing mix used by the company
• The objectives of the business
• Taxes that are imposed on the goods that are being sold
• The pricing used by competition sellers

Pricing strategies

Different types of businesses will often use strategies in order to find the optimum amount of money that a product can be sold for. When setting a pricing strategy, a business will need to make the most money. However, this is not as simple as just putting the price of a product to be high. If the price is too high then the product will not sell in high numbers and so the revenue for sales will actually be less than if the product was cheaper. Some of the main pricing strategies that are used will include:

Cost-based pricing strategy

 To make a profit on each product that is sold, a business may introduce cost-based pricing which involves adding a markup on all products that are sold. The amount of money that it costs to make a product will be worked out and then a markup added on to this (for example, 25%) and the product will be sold for this amount. This is very common with retailers and ensures a business makes money on every sale. The drawback of this method is that it does not consider market conditions and is very rigid. This means that, in times of low or high demand, the business may make less money than is possible if it just adjusted the prices to suit.

 Market-oriented pricing strategy

 One of the drawbacks of cost-based pricing is that it does not consider the strength of a market for the product on sale. This is quite the opposite with market-oriented pricing as this involves setting the price of a product after looking at market conditions. To do this, there are several different approaches that a business can use:

• Skimming or creaming – this price strategy is used to generate high amounts of revenue. When a product is new, it is put on sale at a price that is high so the business can make money when a product is likely to have high amounts of sales. Money is made on a new product before competitors can get their alternatives to the market.
• Penetration pricing – for a limited period of time a business might offer a product at a low price. The aim of this strategy is to establish a base in the market initially by attracting customers who may then carry on making purchases after the price has gone up.
• Psychological pricing – this is a very common pricing strategy and involves using a price that seems to be cheaper than it actually is. Charging £9.99 for a product will make people think that the price is a lot lower than £10. This is a common psychological effect on consumers and works very well for a lot of companies.
• Loss leaders – some products will be sold at a price that is much lower than it should be. This will cause the company to make a loss in selling this product as the cost does not even cover the expenses of making the product and marketing it. However, a loss leader will get people to enter a shop in the hope that they may buy other products while there. This is very commonly used in supermarkets where some items are sold very cheaply just to get people through the door who then might buy other products that they see.
• Sales and discounts – for a short period of time, a business may cut the prices of its products. In doing this, the company will try to spark a frenzy so that customers rush to make a purchase before the sale ends. Products that are seasonal are priced in this manner, in order to clear out old stock before new products are brought to the market.

Influences on pricing strategies

The price that can be charged for a product is determined by a number of different factors. These influences should be understood by a business in order to get the most profit from products that are on sale. With a full understanding of these influences, companies can price their products in such a way that they cover all of their costs and make the most money without discouraging customers from making a purchase due to high prices.

Competition

The amount of competition in a marketplace will determine the price that can be charged. If there are no other businesses that offer the same product then customers will be forced to buy from one company. This will result in the price for a product being higher than usual as the business has control over the market.

Another thing that can affect the prices that a business charges is the amount that a competitor offers goods for. This is known as ‘competition-based pricing’ and relies on a company knowing how much other businesses charge and then pitching its goods at the same or a lower fee. Charging the same will take away sales from a competitor and will likely dilute sales for the competition. By pitching products at a lower price, a company is using something called predatory pricing. Doing this allows a company to take a large number of sales from the competition who could be at risk of losing a lot of customers.

Technology

Another thing that will impact the price of goods is technology. A company that offers the latest products will charge more for these as they will not be available elsewhere. Since people want the latest goods, new technology will be in high demand so prices can be increased accordingly. This desire for the latest technologies is seen in the product life cycle. During initial periods of growth, a product will be new and desirable – this means that a business can charge more money as demand will be very high. Over time, as the product begins to decline, other companies may be offering the same product. This means the technology used has become widely available and is unlikely to be cutting-edge. Prices are likely to be reduced when this happens to encourage more sales.

Another way that technology can affect prices is through the use of modern methods in production and marketing. Technology that is used in a business will help to cut costs through the manufacturing process as well as develop targeted marketing campaigns when attracting customers. This combination will lead to smaller costs so that a business can reduce prices charged to a customer, helping them to attract higher numbers of sales.

Price elasticity of demand

The prices charged by a business will be affected by something known as price elasticity of demand. Price elasticity is a measure of how much the demand for a product changes when prices are altered. Essentially, it is a measure of how much a business can adjust its process while still having the same number of sales. Goods can be split down into two categories:

• Goods with price elastic demand – the majority of products have an elastic demand. This means that a change in price will have a dramatic change in the demand for goods. For example, if a business raises prices by 10%, it could see a drop in custom by 20%. This shows the huge relationship between the price of a product and how much is charged. Goods like this are often luxury items or products where there are lots of alternatives for customers.
• Goods with price inelastic demand – when a business can change prices with little or no change to the demand, it has a product that is said to be price inelastic. For example, an increase of 10% in the price of a product may only result in a drop of 2% in customers. Products that are inelastic to price change are often essential and something that a customer cannot opt out of. Products like gas, electricity or petrol are the most common examples of inelastic goods as these will still need to be purchased despite the price increase.