Page 623 - Encyclopedia of Business and Finance

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Pricing

PRICING STRATEGIES an adequate number of customers exist at that price. Pro-
Companies can chose from a variety of pricing strategies, ducers of high-definition televisions have used price skim-
some of the most common being penetration, skimming, ming as a strategy to maximize revenue.
and competitive strategies. While each strategy is designed
to achieve a different goal, each contributes to a com- Competitive-Pricing Strategy. Competitive pricing is yet
pany’s ability to earn a profit. another major strategy. A company’s competitors may
either increase or decrease their prices, depending upon
Penetration-Pricing Strategy. A company that wants to their own objectives. Before a company responds to a
build market share quickly and obtain profits from repeat competitor’s price change with one of its own, a thorough
sales-generally selects the penetration-pricing strategy, analysis as to why the change occurred needs to be con-
which can be very effective when used correctly. For exam- ducted. An investigation of price increases or decreases
ple, a company may provide consumers with free samples will usually result in one or more of the following reasons
of a product and then offer the product at a slightly for the change: a rise in the price of raw materials, higher
reduced price. Alternatively, a company may initially offer labor costs, increasing tax rates, or rising inflation. To
significant discounts and then slowly remove the dis- maintain an acceptable profit margin for a particular
counts until the full price of the product is listed. Both product, a company will usually increase the price. In
options allow a company to introduce a new product and addition, strong consumer demand for a particular prod-
to start building customer loyalty and appreciation for it. uct may cause a shortage and, therefore, allow a company
The idea is that once consumers are familiar with and sat- to increase its price without hurting either demand or
isfied with a new product, they will begin to purchase the profit.
product on a regular basis at the normal retail price.
When a competitor increases its price, a company has
Retailers with high sales volumes frequently use the
several options from which to chose. The first is to
penetration-pricing strategy. High sales volume allows increase its price to approximately the same as that of the
retailers, in some cases, to reduce prices even more.
competing firm. The second is to wait before raising its
price, a strategy known as price shadowing. Price shadow-
Price-Skimming Strategy. A price-skimming strategy uses
ing allows the company to attract those new customers
different pricing phases over time to generate profits. In
who are price-sensitive away from the competing firm. If
the first phase, a company launches the product and tar- consumers do switch over in large numbers, a company
gets customers who are more willing to pay the item’s high
will make up lost profits through higher sales volume. If
retail price. The profit margin during this phase is
consumers do not switch over after a period, the company
extremely high and obviously generates the highest rev-
can increase its price. Typically, a company will increase its
enue for the company. Since a company realizes that only
a small percentage of the market was penetrated in the price to a level slightly below that of its competitors in
first phase, it will price the product lower in the second order to maintain a lower-price tactical advantage. The
airline industry uses the competitive pricing strategy fre-
phase. This second-phase pricing will appeal to a broader
quently.
cross-section of customers, resulting in increased product
sales. When sales start to level off during this phase, the When competitors decrease their prices, a company
company will price the product even lower. This third- has numerous options. The first option is to maintain its
phase pricing should appeal to those consumers who were price, since the company is confident that consumers are
price-sensitive in the first two phases and result in loyal and value its unique product qualities. Depending
increased sales. The company should now have covered on the price sensitivity of customers in a given market,
the majority of the market that is willing to purchase its this might not be an appropriate strategy for a company
product at the high, medium, and low price ranges. to use. The second option is to analyze why a competitor
The price-skimming strategy provides an excellent might have decreased its prices. If price decreases are due
opportunity for the company to maximize profits from to a technological innovation, then a price decrease will
the beginning and only slowly lower the price when probably be necessary because the competitor’s price
needed because of reduced sales. Price adjustment with reduction is likely to be permanent. Regardless of its com-
this strategy closely follows the product life cycle, that is, petitor’s actions, a company may decrease its price. This
how customers accept a new product. Price skimming is a price reduction option is called price covering. This
frequently used strategy when maximum revenue is option is most useful when a company has done a good
needed to pay off high research and development costs job of differentiating the qualities of its product from
associated with some products. This strategy is effective if those of a competitor’s product. On the flip side, the
product image and quality support the higher price and if advantage of price covering is reduced when no noticeable

600 ENCYCLOPEDIA OF BUSINESS AND FINANCE, SECOND EDITION