Have you heard of the term pricing? It is an area of pricing strategy that is gaining in popularity, especially in the world of e-commerce. Read more Pricing of Amazon in 2024, how to sell better on Amazon?
In this article:
- What is pricing?
- What are the factors that determine the price of a product?
- You will learn about examples of pricing methods
- You will learn the difference between margin and mark-up
Definition of Pricing📄
Pricing directly affects the value of a product and its image. It means establishing monetary value, i.e. setting the price at which Customers are prepared to pay for a product or service. It is a key element of marketing and business strategy. Adopting the right pricing model influences the audience’s perception of the brand and the company’s profit level. In short, pricing can be said to be price management.
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Product price determinants
Pricing should start by considering the following factors:
- Production cost 💰 – This determines how much of the company’s financial outlay needs to be spent on each product or service.
- Target audience 👥 – Customers do not just buy the product, but also the value it provides. Therefore, consumer value is a key element of marketing and business strategy. When setting the pricing model, companies must pay attention to the specific needs and expectations of Customers.
- Government regulation 📜 – Can affect the specific product and the financial outlay required for it.
- Competition 🏅 – The originality of the product allows for a higher price. At the same time, if the competition offers similar products at lower prices, this is an important signal to decide on a potential change in the pricing model and thus adjust the selling prices in line with the competition.
Examples of pricing methods
There are many types of common pricing strategies:
📌 The cost-plus pricing (cost-based pricing,/mark-up pricing) involves setting a price based on the production cost (or purchase) and overhead costs (taxes, rent etc.) and then adding a set margin or mark-up to it.
It is used in industries where production or redistribution costs account for a significant proportion of the total product price.
For example, if a company produces a product that costs 10$ to make and wants to achieve a 20 per cent profit margin, it would add 2.5$ to the cost of production, resulting in a selling price of 12.5$. Cost-plus pricing strategy is often used in industries where there is a high level of competition or where costs can change dynamically over time.
Pp = Ps / (1 – mark-up%)
📌 Penetration pricing – is based on setting the selling price in relation to the price of competitors. The key element in this strategy is to define your competitors and price index vs competitors. E.g. We want to be more expensive on a weighted sales basket by 5% than Competitor 1. Assuming we have 1 product on sale and a competitor sells it at £1,000, we would sell the same product for £1,049.99.
📌 Dynamic pricing (economy pricing) is very similar to the above method. It involves setting a selling price analogous to that of the competition. This method is often used by companies that offer standard products or services and prices are set based on the competitiveness of the market. A key aspect in this area is the continuous monitoring of competitors’ prices and the implementation of market changes.
For example, if one telecommunications company offers a phone plan for US$50 per month, other companies in the industry may set their prices within the same range to remain competitive. This allows companies to attract Customers by offering a similar price point while remaining profitable. Competitive pricing strategy is beneficial because it helps companies stay competitive in the market and appeals to price-sensitive consumers.
📌 The ROI-based method involves managing sales prices based on a target return on investment (ROI). This strategy is commonly used in industries where the cost of production is known and predictable.
For example, a smartphone company may calculate the total costs: production (including materials and wages), logistics and other costs. It will then determine the desired return on investment, for example 20%.
ROI = (revenue – cost of sales) / cost of sales
The company would price the smartphones in a way that provides a 20% return on investment. This strategy helps the company maintain profitability while taking into account market demand and competition.
📌 Value-based pricing (psychological pricing or premium pricing) involves managing selling prices based on the Customer’s perception of the value of the product or service. It is setting the selling price at a level that reflects the higher perceived value and captures the maximum price for the Customer.
For example, luxury brands such as Rolex and Louis Vuitton use perceived value-based pricing to position their products as high-end and exclusive. These brands deliberately set their prices at a premium level to create an impression of superior quality and status among consumers. In this way, they are able to maintain a sense of exclusivity and achieve higher profit margins.
Price skimming is another example of value-based pricing. It involves charging Customers the highest initial price (premium price) they are willing to pay and then gradually reducing it over time to get to more price-sensitive Customers.
❓What is the difference between a mark-up and a margin ❓
The difference lies in the reference point.
How do you calculate the margin and the mark-up?
Pp – purchase price
Ps – selling price
Mark-up: (Ps – Pp) / Ps
Margin (Ps – Pp) / Pp
Example 1️⃣
Product A is bought for £50 and sold for £100.
The mark-up in this case is 50% and is calculated on the selling price.
(100 – 50) / 100 = 50 / 100 = 50%
The margin is 100% and is calculated on the purchase price.
(100 – 50) / 50 = 50 / 50 = 100%
Example 2️⃣
Product B is bought for £100 and sold for £80.
In this case, the mark-up is -25% as the loss of £20 represents 25% of the selling price.
(80 – 100) / 80 = -20 / 80 = -25%
The margin is -20% as the loss of PLN 20 represents 20% of the purchase price.
(80 – 100) / 100 = -20 / 100 = -20%
Pricing objectives
The objective of pricing is not only to generate profits, but also to maintain price competitiveness and meet business objectives. Which objectives are set will depend on the specific needs and strategy of the business in question. It is important that the effective pricing strategy is aligned with marketing and corporate objectives. In this way, consistency of action can be achieved and effectively contribute to business development.
➡️ Competitive pricing – it is worth doing marketing research and adjusting prices to be competitive, as well as the quality and value of the product. Pricing should be based on current market information.
➡️ Attracting new Customers – it is possible to adjust prices so that it is competitive and attracts new potential Customers, but at the same time ensures a profit for the company.
➡️ Pricing for regular Customers – setting a special price for regular Customers – additional discounts for regular Customers or promotions that are targeted only at them. This is part of popular price strategies.
➡️ Achieving profitability and building the brand – the highest possible price for the product allows the company to make a profit and maintain the high quality of its services and products, thus promoting the brand as exclusive.
Depending on a company’s preferences and market conditions, different methods may be used when setting a price. However, in order to be successful, it is crucial to choose a method that is appropriate to the product or service in question, and to take into account Customer requirements and market competitiveness.
Summary
Pricing, or sales price management, is an integral part of business. It enables you to increase sales, achieve higher profits and attract new Customers. It is worth paying attention to the specifics of the product, the target Customers, the competition and broader marketing research to know how to manage prices in the right way. You should also carry out a thorough market analysis and set business objectives. All of this is done in order to realise the full potential of pricing and achieve success in a given business. Properly carried out and implemented, product pricing promotes increased sales of the product.
Find out more – contact us! We can help you choose the right pricing method for your business.