There are generally 3 main pricing strategies that can be used by the manufacturers in setting their prices. The three strategies include customer-based pricing, cost-based pricing and competitor-based pricing. In customer-based pricing, the prices are set according to what a company believes consumers can afford to pay. In cost-based pricing, the prices are determined by the cost of making the product and the intended profit. In competitor-based pricing, the prices are influenced by the competitor prices.
By using cost-based pricing, manufacturers set their prices by adding a certain percentage or fixed amount to the cost of making a product. This is an old-fashioned strategy, but it is still in use. The main advantage of this strategy is that it is very easy to calculate selling prices. It is also very easy for the manufacturers to predict their overall profit margin.
Customer-based pricing uses four approaches to determine prices namely penetration pricing, price skimming, loss leaders, and psychological pricing. Penetration pricing is usually aimed at increasing market share of a product, and the price may be increased once the product has been accepted in the market. Penetration price is usually set lower than the intended price so that it can attract new customers. The strategy used here is aimed at encouraging consumers to switch to the new product on account of the lower price. Penetration pricing results in lower profits, but the strategy has a long-term profitability of creating a higher market share. This strategy is often applied in launching new products and acts as competitive weapon to rival products.
Skimming of the price is a pricing technique where a higher price is set before other competitors’s enter into the market. This strategy is often applied in a new product launching which does not face a lot of competition. This strategy does not last for a long period due to competition which emerges when rival products are launched exerting pressure on the set price. Using skimming of the price, manufacturers can experience a problem of slowing down the growth of demand for the product giving competitors enough time for the development of rival products when market demand is high.
Loss leader is a pricing strategy used for sales promotion. However, this strategy can only be used by manufacturing companies which make more than one product. A loss leader is a product whereby its price is set below the cost price in order to attract customers. The purpose of this strategy is to encourage consumers to make further purchases of profitable goods while purchasing the loss leader product. This strategy can attract new customers and the existing ones may become more loyal.
Psychological pricing is a strategy used to make the consumers believe that the product is much cheaper than it really is. This approach is used when the manufacturer wants the customers respond on the emotional basis instead of rational basis. The strategy is often intended to attract consumers who are looking for value.
Competitor-based pricing is controlled by the level of competition within the market. That is, prices are set according to the prices charged by rivals/competitors. Manufacturers who are forced to use this strategy due to the level of competition within the market have to accept the going market prices as determined by forces of supply and demand. The main advantage of this strategy is that prices cannot offer a competitive advantage as selling prices are always in-line with rivals. The problem of this strategy is that manufacturers need to devise other ways of attracting customers (non-price methods).