Reference no: EM132739918

Beyond the Many Faces of Price: An Integration of Pricing Strategies

A Classification of Pricing Strategies

In a shared economy, one consumer segment or product bears more of the average costs than another, but the average price still reflects cost plus acceptable profit.

Three groups of pricing strategies:
• Differential pricing: the same brand is sold at different prices to consumers
• Competitive pricing: prices are set to exploit competitive position
• Product line pricing: related brands are sold at prices that exploit mutual dependencies
Characteristics of consumers:
• Search costs: consumers do not know exactly which firm sells the product they want and they have to search for it
• Low reservation price for the product
• All consumers have certain transaction costs other than search costs (e.g. traveling costs, the risk of investment, the cost of money, or switching costs

Differential Pricing Strategies
Consumer heterogeneity along three dimensions:
• Transaction costs that motivate second market discounting
• Demand that motivates periodic discounting
• Search costs that motivate random discounting
Discounting in general has a sales enhancing effect, probably because consumers overweight the saving on a deal. However, if the product were regularly at the discounted price, many of these consumers may not buy it at all!

Second Market Discounting
(Generics, secondary demographic segments, and some foreign markets provide opportunities for profitable use of this strategy)
The relevant strategy would be to enter the generic market segment with an unbranded product and arrest loss of sales to that segment without either foregoing margin or position in the branded segment.
If its variable costs are sufficiently below the selling price, in the foreign market, the firm can export profitably at a price somewhere between the selling price in the foreign market and its variable costs.
Dumping: if the firm's selling price in the foreign market is below its average costs.
Requirements: unused capacity and consumers have transaction costs so there is no perfect arbitrage between the two markets.

Periodic Discounting
(Off-season fashion goods, off-season travel fares, matinee tickets, and happy hour drinks)
The manner of discounting is predictable over time and not necessarily unknown to consumers and the discount can be used by all consumers.
Pricing high and systematically discounting with time.

Random Discounting
Discounting should be undiscernible or "random" to the uninformed consumers and infrequent, so that these consumers do not get lucky too often.
In this way the firm tries to maximize the number of informed at its low price instead of at a competitor's low price, while maximizing the number of uninformed at its high rather than its low price.
The real saving from the discounts is the overweighed in relation to the opportunity cost of time.
Consumers relate the benefits of search to the cost of the good rather than to the cost of the time it takes to search.
The individual firm should adopt a strategy of random discounts if the increased profit from new informed consumers at the discounted price exceeds the cost arising from the uninformed buying at the discounted price plus the cost of administering the discount.

Competitive Pricing
• Penetration pricing attempt to exploit scale of economies by currently pricing below competitors in the same market and thus driving them out
• Experience curve pricing attempt to exploit experience economies by currently pricing below competitors in the same market and thus driving them out
• Predatory pricing is a strategy of pricing low to hold out competition with the sole objective of establishing monopolistic conditions and subsequently raising prices.
• Price signaling: a firm exploits consumer trust in the price mechanism developed by other firms
• Geographic pricing: involves competitive pricing for adjacent market segments
Penetration Pricing
Periodic discounting is obviously preferable for a firm, even if its costs are lower than demand prices, as long as there is no immediate threat of competitive entry.
A variation: limit pricing: a firm prices above costs but just low enough to keep out new entrants.
Experience Curve Pricing
Essential requirements: that experience effects are strong, the firm has more experience than competitors, and that consumers are price sensitive.
The mechanisms for tracking costs and pricing products are very different.

Price Signaling
Three pricing strategies (example):
• A firm could produce the low quality product and sell it at $30
• A firm could produce the high quality product and sell it at $50
• Price signaling: A firm could produce the low quality product and sell it at $50
o With the intention that some consumers who cannot tell high quality but want it will be fooled
Extensive research in marketing has indicated that consumers may use price to infer quality.
Three conditions are necessary for price signaling: (1) consumers must be able to get information about price more easily than information about quality, (2) they must want the high quality enough to risk buying the high priced product even without a certainty of high quality, and (3) there must be a sufficiently large number of informed consumers who can understand quality and will pay the high price only for the high quality product.
Variations:
• Image pricing (discussed later)
• Reference pricing: a firm places a high priced model next to a much higher priced version of the same product, so that the former may seem more attractive to risk aversive uninformed consumers
• Firms may state that a product is on sale, with the "regular" sticker price adjacent, when actually the regular price is on for less than half the time

Geographic Pricing
• FOB (e.g.): if the competitive price in market Y is above $40, the firm can sell the product at $30 in market X and $40 in market Y to reflect the transportation costs of $10 per unit to the latter market.
• Uniform delivered price (e.g.): if the competitive price in market Y is a little over $35, the firm could sell at $35 in both markets and still achieve the same competitive effect.
• Zone pricing: the firm would charge different prices for different zones depending on the transportation costs to each.
• Basing point: the firm chooses a base point for transportation costs to points other than the point of production.
• Freight absorption cost: when market Y bears none of the transportation cost it incurs for the product.

Product Line Pricing Strategies
The firm seeks to maximize profit by pricing its products to match consumer demand.
• Price bundling when it faces heterogeneity of demand for non-substitute, perishable products
• Premium pricing when it faces heterogeneity of demand for substitute products with joint economies of scale
• Image pricing is used when consumers infer quality from prices of substitute models
• Complementary pricing (including captive pricing, two-part pricing, and loss leadership) is used when a firm faces consumers with higher transaction costs for one or more of its products

Price Bundling
The mixed bundling strategy has the added advantage of creating the reference price effect: the package is offered at a much lower price than the sum of the parts.

Requirements: non-substitute (i.e. complementary or independent), perishable products with an asymmetric demand structure.
It must not be confused with that of "trading up", in which consumers are persuaded to buy more or higher priced models than they originally intended.

Premium Pricing
Premium pricing applies to substitutes and price bundling applies to complementary products.
Image Pricing
Image pricing: a firm brings out an identical version of its current product with a different name and a higher price.

Complementary Pricing
Complementary pricing: captive pricing, two-part pricing, and loss leadership.

Sunk cost effect: consumers may not view the basic product they purchased as a sunk cost, and may try to "recover" their investment by buying the accessories and using it.

Well-known examples of captive pricing are razors and blades, cameras and films, autos and spare parts.
In the case of services, this strategy is referred to as two-part pricing, because the service price is broken into a fixed fee plus variable usage fees.

In retailing, the corresponding strategy is called loss leadership: dropping the price on a well-known brand to generate store traffic.
Complementary pricing is similar to premium pricing in that the loss in the sale of a product is covered by the profit from the sale of a related product.