Pricing plays a pivotal role in the way your product is marketed to your audiences and how it's perceived by them. Pricing decisions need to be carefully thought out, because pricing can make or break your business. For instance, In 2011, Netflix decided to increase the price of its DVD-by-mail and online streaming combo plan from $10 / month to $16 / month. It didn't realize that almost a million customers just kept subscribing to Netflix without actively consuming it because it didn't look like a bad entertainment service to have for $10. After all, even if they only saw a movie a month, it was still worth it. But increasing the price by 60% crossed that threshold, and cost them 1 million customers!
Netflix's 60% price increase didn't go down too well with Wall Street. Their share price plunged from $300 to $77 in just 4 months.
In the very same year (2011) in India, Maruti Suzuki, a consumer vehicle brand primarily known to serve the Indian middle class families introduced a luxury sedan known as Kizashi. It was priced at a whopping INR 1.7 million. For a brand traditionally renowned for manufacturing cars in the range of INR 300,000 to 600,000, it turned out to be a bad move. Because of their image of being a middle-income car manufacturer, none of the High-Net-Worth Individuals wanted to buy their vehicle; and on the other hand, their loyal audience base of middle-income Indians couldn't afford to buy it anyway.
Pricing should take into consideration a lot of things - the brand image, the brand's customer base, price elasticity, the product or service's perceived value and benefits to the target group etc. Let's understand some of the key product pricing strategies and how they play out in the real world.
Mark-Up Pricing
This is the simplest one to understand, and perhaps a sub-set of every pricing strategy. Mark-up pricing simply entails calculating the final profit you desire from your product and then working back from there. If the total cost involved in the production and sale of your goods is $100 and you want to make a 20% profit, you simply price it at $120. It sounds simple, and it is in fact simple. However, it usually lacks a long term business outlook.
Businesses using Mark-Up Pricing: Most locally owned small-scale businesses such as your neighborhood grocery store, or the local boutique near your apartment complex will follow a mark-up pricing model. They will calculate the cost of goods, operational expenditure, other variable costs, and then work from there.
Value-based Pricing
Value-based pricing is one of the most commonly followed pricing methods by businesses both B2B and B2B, but it's also one of the most easy to misunderstand.
Value-based pricing requires 2 key things -
1) Understanding your target audience's perception about a product,
2) Having a competitor(s) offering a similar product.
Value-based pricing is about gaining a differentiated worth of your product for a particular segment, based on how your product compares with the competitors'.
To explain this further, let's take the example of 2 laptop brands and call them HP and Acer. Both of them manufacture large 16" screens, but HP's hard-disk capacity only goes as high up as 1TB, whereas Acer also has a 1.5TB variant. Now based on the customer's perceived value of HP's 1TB laptop, how much is the same segment willing to pay for a 1.5TB Acer? All other things being equal, if HP's 1TB laptop costs $999 and looks reasonable to the target group, what is the differentiated value someone will pay for an Acer that offers 0.5 TB of extra space? Let's call it $200. In that case, Acer can comfortably price its 1.5 TB laptop at $999 + $200 = $1,199.
Renting a home can be a great example of seeing Value-based pricing at work. You check out many of them and compare their prices vis-a-vis all other parameters and then decide which one's value makes sense.
Value-based pricing has several variants as well. Walmart follows an EDLP (Every-day Low Pricing), where prices for certain products are always much lower than that of competitors. Instead of charging a differential for the value, Walmart lowers the cost. It is still able to get this to work in its favor because of its strong supply chain and economies of scale.
Competitive Pricing / Going-rate Pricing
Competitive Pricing or Going-rate pricing is pricing your product based on how your competitor(s) price a similar product. This pricing works well in industries where products are substitutable in place of each other, and an increase in price of one might cause customers to shift base to the other. You will notice this mostly in case of duopolies or oligopolies. Also, there is a tacit understanding between players in this industry to increase prices together, or keep them stable.
Example of Competitive Pricing: Pepsi and Coca-Cola
Predatory Pricing
Predatory Pricing, also known as Penetrative Pricing, is the practice of entering a market with extremely low prices in a bid to finish off the competition and attract all their customers to your product / offering. This is very tough to execute and often requires deep pockets. Also, in many countries, this type of pricing is banned since it ends up creating a monopoly which is in violation of market competition laws.
Example of Predatory Pricing: Recently in 2017 in India, Reliance Jio entered the telecom industry and offered 30 GB of 4G internet per month and unlimited calling at just INR 3 / month ($0.041/month!). Other leading brands such as Bharti-Airtel and Vodafone filed several law-suits with the Competition Commission of India (CCI) when they experiencing mass erosion of their customer base. However, CCI didn't find violation of their laws by Reliance Jio since according to them, Jio was a new entrant with limited market share as compared to Airtel or Vodafone, which had a bulk of the market share then. Here's an article which talks about the impact of Jio's pricing on the competitors market share and revenue.
Auction Type Pricing
Auction-type pricing involves inviting bids, and then selling your product to the one that meets the criteria. There are 3 different types of auction pricing -
English-auction
This is the most commonly seen auction in movies as well as in real life. There is usually 1 seller and multiple buyers. The bids are successively increased until people stop bidding. The item is then sold to the highest bidder.
Example: Ebay is a great example of a modern business that works on English-auction pricing. Google AdWords follows the bid-model pricing as well, where the best ad slots are sold to the highest bidder (not taking into account other factors like ad score).
Dutch Auction
Dutch auction works the other way round, where the bidder starts with a high price and keeps decreasing it until someone agrees to buy. It is employed by scrap-sellers (sale of junk metal that no one is willing to pick up), and often at times in the share market. Consider the simple example of a company that has 10 shares. Someone agrees to pick 1 share at $10, someone else buys 2 at $9, someone else picks 5 at $8, and so on until all the shares are sold.
Sealed-Bid Auction
In a sealed-bid auction, the bidding process is such that all the bidders simultaneously submit their bids (or before a certain deadline) in as sealed envelope. No one knows that the other has bid. The auctioneer decides the winner based on who has bid the lowest unique value.
Example: Most commonly used wherever a tender is used to decide who will be selected for a project. It is used both in private as well as public sector, and the sealed-bid system tries to eliminate biases or favoritism.
Psychological Pricing
Any pricing methodology so designed as to make a purchase seem attractive to a customer is known as psychological pricing. Often times, this may involve convincing a customer that they're paying lesser than they really are. This can be broken down into -
Odd-Even Pricing
Pricing something to end with .99 or .95 instead of a whole number often ends up creating a fake psychological advantage in the minds of the consumer. Instead of $100, if an item is priced at $99.99, they are most likely to tell others that they got something for $90.
Example: The entire Dollar Store business model is based on psychological pricing. These days, Walmart has started following a model where the prices end with .88 instead of the next rounded whole number.
Anchor Pricing
Anchor pricing involves giving an initial bit of information to the customer for them to base their subsequent decisions on. You will notice this commonly followed in both B2B and B2B scenarios.
Example: Let's consider a shampoo brand with a 100 ml packaging priced at $10. They will also have a 200 ml priced at $18, and a 500 ml priced ridiculously lower at $40 or so. They essentially want you to buy either the 200 ml variant, or the 500 ml variant. The 100 ml variant serves as an anchor.
Another example would be an internet based service provider, which will offer several tiers of packages only for you to buy the one that they want you to buy - most likely the middle one.
Below-Cost Pricing
Traditionally associated with retail stores that sold perishable goods, below-cost pricing has actually become a choice of strategy for various startups. Below-cost pricing is when you sell something even cheaper than what it costs you simply because keeping it on shelf will cause you a greater loss than selling it for below the cost-price.
A lot of startups started following this and still follow this in order to attract customers that they believe they can recoup their initial losses from through customer lifecycle management and repeat business. The investors stay invested in the hopes that the companies will one day become profitable, allowing them to cash out. However, a lot of these businesses have shut shops because of their balance sheets being in the red for long.
Examples of these companies include Uber, SquareCash, Snapchat etc.
Skimming the Market Pricing
This type of pricing involves entering the market with a high-price initially, and then lowering the price as time passes.
Example: When McDonalds first entered India in mid 90s, a usual burger was priced at INR 50-60 ($0.70-0.80). Back then, it was considered a premium food outlet and only affordable to the upper middle class and upper class. However, as time passed, it started introducing meals for INR 20 ($0.3), and in the process lost its identity of being a premium brand.
Another example would be of technological brands. Whenever they launch a new tech gadget, such as an iPhone, its priced at its maximum. However, as 6-12 months pass by and it is time to launch a new model, they lower the price of the previous iteration.
Premium Pricing
As the name suggests, Premium Pricing is all about pricing your product at a premium irrespective of competition. This is a tool of choice for brands that only want to associate with a certain elite audience, and have a product that justifies the same.
Example: Luxury cars, high end jewelry and watch brands, high-end fashion brands.
Differentiation Pricing
This is perhaps the largest super-set of pricing. Differentiation pricing involves pricing a product differently based on things like customer, location, time of the day, season of the year, customer, product packaging etc. Let's take a look at each -
Location based
If you've ever paid more for a cold-drink or a pop-corn inside a cinema hall, you will exactly know what this means. Location based pricing entails charging a different price based on where the product is served. Location based pricing also works inside the movie hall, where you often pay more for being seated at the very back as compared to the front row. Similarly, certain seats are charged more inside the airlines.
Customer based
Customer based pricing differentiates pricing on the basis of who is availing a service. Example: Usually, per-unit electricity or broadband prices differ for retail users versus corporate users.
Time Based
Offering a different price to customers based on what time of the day they're transacting for a product or service.
Example: Flights are significantly cheaper early in the morning as compared to afternoon or evenings. Also, restaurants tend to offer Happy Hour during which alcohol is cheaper during those hours as compared to the rest of the day.
Image Based
This image refers to the actual product packaging rather than the perceived brand image.
Example: Buying Coffee K-Pods versus Ground Coffee Powder. Even though they might be the same blend from the same roastery, their per-unit cost will differ. On an average, K-Cups will cost 4 times more than ground coffee.
As you might have seen, pricing is a huge discipline in itself. No one strategy can apply to all products or brands, and it is likely that even for different product lines of the same brand the pricing methodology might differ significantly. Pricing decisions should be based on thorough research around the product / service's utility, perceived benefit, customer demand, market competition, and of course your brand's long term vision.