9.3: Developing pricing strategy
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While pricing a product or service may seem to be a simple process, it is not. As an illustration of the typical pricing process, consider the following quote: "Pricing is guesswork. It is usually assumed that marketers use scientific methods to determine the price of their products. Nothing could be further from the truth. In almost every case, the process of decision is one of guesswork."2
Good pricing strategy is usually based on sound assumptions made by marketers. It is also based on an understanding of the two other perspectives discussed earlier. Clearly, sale pricing may prove unsuccessful unless the marketer adopts the consumer's perspective toward price. Similarly, a company should not charge high prices if it hurts society's health. Hertz illustrates how this can be done in “Integrated marketing” below.
A pricing decision that must be made by all organizations concerns their competitive position within their industry. This concern manifests itself in either a competitive pricing strategy or a nonprice competitive strategy. Let us look at the latter first.
Nonprice competition means that organizations use strategies other than price to attract customers. Advertising, credit, delivery, displays, private brands, and convenience are all example of tools used in nonprice competition. Businesspeople prefer to use nonprice competition rather than price competition, because it is more difficult to match nonprice characteristics.
How to select the best price
The Hertz Corporation knows when its rental cars will be gone and it knows when the lots will be full. How? By tracking demand throughout past six years. "We know, based on past performance and seasonal changes, what times of year there is a weak demand, and when there is too much demand for our supply of cars," says Wayne Meserue, director of pricing and yield management at Hertz. To help strike a balance, the company uses a pricing strategy called "yield management" that keeps supply and demand in check. The strategy looks at two aspects of Hertz's pricing: the rate that is charged and the length of the rental.
"Price is a legitimate rationing device,"says Meserue. "What we're really talking about is efficient distribution, pricing, and response in the marketplace." For example, there are times when cars are in great demand. "It's always a gamble, but it's definitely a calculated gamble. With yield management, we monitor demand day by day, and adjust (prices as necessary)," Meserue says.
Hertz also uses length of rental as a yield management device. For instance, in the US they established a three-night minimum for car rentals during President's Day weekend in February. "We didn't want to be turning away business for someone who wanted the car for five nights just because we had given our cars to people who came in first for one night," says Meserue, who adds that it is often better for Hertz to mandate a minimum number of days for a rental, because it ensures that cars will be rented for more days.
A smart pricing strategy is essential for increasing profit margins and reducing supply. Yet at last count, only 15 per cent of large corporations were conducting any sort of pricing research, reports Robert Dolan, professor at Harvard Business School. "People don't realize that if you can raise your prices by just 1 percent, that's a big increase in your profit margin," he says. For example, if a supermarket is operating with a 2 per cent net margin, raising the prices by 1 per cent will increase profitability by 33 per cent. "The key is not taking one percent across the board, but raising it 10 per cent for 10 per cent of your customers," says Dolan, "Find those segments of the market that are willing to take the increase." That doesn't mean that companies can automatically pass their cost increases on the customer, notes Dolan. If the costs are affecting an entire industry, then those costs can be passed through easily to the consumer, because competitors will likely follow the lead.
A fundamental point in smart pricing, according to Dolan: base prices on the value to the customer. As much as people talk about customer focus, they often price according to their own costs, Companies can profit from customizing prices to different customers. The value of a product can vary widely depending on factors such as age and location.
AD 1: An example of nonprice competition.
Competing on the basis of price may also have a deleterious impact on company profitability. Unfortunately, when most businesses think about price competition, they view it as matching the lower price of a competitor, rather than pricing smarter. In fact, it may be wiser not to engage in price competition for other reasons. Price may simply not offer the business a competitive advantage (employing the value equation).
Once a business decides to use price as a primary competitive strategy, there are many well established tools and techniques that can be employed. The pricing process normally begins with a decision about the company's pricing approach to the market.
Approaches to the market
Price is a very important decision criteria that customers use to compare alternatives. It also contributes to the company's position. In general, a business can price itself to match its competition, price higher, or price lower. Each has its pros and cons.
Pricing to meet competition
Many organizations attempt to establish prices that, on average, are the same as those set by their more important competitors. Automobiles of the same size and having equivalent equipment tend to have similar prices. This strategy means that the organization uses price as an indicator or baseline. Quality in production, better service, creativity in advertising, or some other element of the marketing mix are used to attract customers who are interested in products in a particular price category.
The keys to implementing a strategy of meeting competitive prices are an accurate definition of competition and a knowledge of competitor's prices. A maker of hand-crafted leather shoes is not in competition with mass producers. If he/she attempts to compete with mass producers on price, higher production costs will make the business unprofitable. A more realistic definition of competition for this purpose would be other makers of handcrafted leather shoes. Such a definition along with a knowledge of their prices would allow a manager to put the strategy into effect. Banks shop competitive banks every day to check their prices.
Pricing above competitors
Pricing above competitors can be rewarding to organizations, provided that the objectives of the policy are clearly understood and that the marketing mix is used to develop a strategy to enable management to implement the policy successfully.
Pricing above competition generally requires a clear advantage on some nonprice element of the marketing mix. In some cases, it is possible due to a high price-quality association on the part of potential buyers. Such an assumption is increasingly dangerous in today's information-rich environment. Consumer Reports and other similar publications make objective product comparisons much simpler for the consumer. There are also hundreds of dot.com companies that provide objective price comparisons. The key is to prove to customers that your product justifies a premium price.
Pricing below competitors
While some firms are positioned to price above competition, others wish to carve out a market niche by pricing below competitors. The goal of such a policy is to realize a large sales volume through a lower price and profit margins. By controlling costs and reducing services, these firms are able to earn an acceptable profit, even though profit per unit is usually less.
Such a strategy can be effective if a significant segment of the market is price-sensitive and/or the organization's cost structure is lower than competitors. Costs can be reduced by increased efficiency, economics of scale, or by reducing or eliminating such things as credit, delivery, and advertising. For example, if a firm could replace its field sales force with telemarketing or online access, this function might be performed at lower cost. Such reductions often involve some loss in effectiveness, so the tradeoff must be considered carefully.
Historically, one of the worst outcomes that can result from pricing lower than a competitor is a "price war". Price wars usually occur when a business believes that price-cutting produces increased market share, but does not have a true cost advantage. Price wars are often caused by companies misreading or misunderstanding competitors. Typically, price wars are over reactions to threats that either are not there at all or are not as big as they seem.
Another possible drawback when pricing below competition is the company's inability to raise price or image. A retailer such as K-mart, known as a discount chain, found it impossible to reposition itself as a provider of designer women's clothiers. Can you imagine Swatch selling a USD 3,000 watch?
How can companies cope with the pressure created by reduced prices? Some are redesigning products for ease and speed of manufacturing or reducing costly features that their customers do not value. Other companies are reducing rebates and discounts in favor of stable, everyday low prices (ELP). In all cases, these companies are seeking shelter from pricing pressures that come from the discount mania that has been common in the US for the last two decades.
1. Sources: Ginger Conlon, "Making Sure the Price is Right;' Sales and Marketing Management, May 1996, pp. 92--93 Thomas T. Nagle and Reed K. Holden, The Strategy and Tactics of Pricing, 2nd ed., Upper Saddle River, N.J.: Prentice Hall, Inc. 1995; William C. Symonds, "'Build a Better Mousetrap' is No Claptrap;' Business Week, February 1, 1999, p. 47; Marcia Savage, "Intel to Slash Pentium II Prices," Company Reseller News, February 8, 1999, pp. 1, 10.