Strategic Pricing Methods and Considerations

Posted on Feb 11, 2025 in Economy

Topic 6: Pricing Strategies

Price is the sum of all values that customers give up to gain the benefits of having or using a product or service. Price is directly related to value; customers are willing to pay higher prices for products that provide higher value.

Methods for Setting Prices

In the economic world, we have several methods to set prices:

  • Based on Costs
    • Markup Pricing

      Price = Total Unit Cost + Markup

      This involves calculating the price by first determining the cost of producing one unit of product and then adding a commercial markup or margin.

      First, calculate the Total Unit Cost, then add a markup.

      A company’s costs take two forms:

      • Fixed Costs (FC): Do not vary with production level or sales revenue.
      • Variable Costs (VuC): Vary with the level of production.

      This markup could vary according to:

      • The Total Unit Cost

        P = TuC + m * TuC => P = TuC * (1 + m)

      • The Final Selling Price (Margin depends on the Final Selling Price)

        P = TuC + m * P => P = TuC / (1 – m)

    • Target-Return Pricing

      This method calculates the price at which a company should sell its products, considering a profit goal and an estimated demand. It uses the profit formula to calculate the price: (B = Revenue (Price * Quantity) – Costs (FC + VuC * Quantity)).

      The company determines the price that would yield its target rate of return on investment (ROI) or desired profits, assuming that demand can be estimated.

      This can be used to calculate the “Break-Even Point,” where the company’s profits are zero.

  • Based on Perceived Value and Demand
    • Perceived Added Value

      This involves calculating the value that the customer assigns to a specific product. Calculating this perceived value allows for better pricing decisions. The goal is to identify the main benefits a consumer receives when purchasing a product and reduce the sacrifices of obtaining it.

    • Good-Value Pricing

      This involves calculating the value that the consumer assigns to the product and offering discounted prices. Reducing the price increases the real value for the consumer. It’s a relationship between quality of service and the price of the product.

  • Based on Competitors

    Methods based on competitors involve calculating average market prices and positioning the company’s prices below or above the market level.

    This requires comparing different companies that offer the same product and analyzing the relationship between service quality and price.

Relevant Elements to Consider When Setting Prices

  • Price Sensitivity
    • Consumers are less sensitive to price variations when:
      • There is no competition.
      • The products are low-cost.
      • The products are low-frequency purchases (e.g., emergencies).
      • They believe the high price is justified (e.g., exclusivity, quality).
      • The cost is shared with other customers.
      • They have already invested money in complementary products (more expensive), such as Nespresso and its capsules.