PRICING STRATEGIES

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

ENCYCLOPEDIA OF BUSINESS AND FINANCE, SECOND EDITION 601
Pricing
difference can be seen between a company’s product and
that of a competitor.
OPTIONS FOR INCREASING SALES
Companies have several options available when attempting
to increase the sales of a product, including coupons,
prepayment, price shading, seasonal pricing, term pricing,
segment pricing, and volume discounts.
Coupons. Almost all companies offer product coupons,
reflecting their numerous advantages. First, a company
might want to introduce a new product, enhance its market
share, increase sales on a mature product, or revive an
old product. Second, coupons can be used to generate
new customers by getting customers to buy and try a company’s
product in the hope that these trial purchases will
result in repeat purchases. A variety of coupon distribution
methods are available, such as the Internet, point-ofpurchase
dispensers, and Sunday newspapers. Internet
coupons may be found at the following Web sites:
http://www.couponcraze.com, http://www.couponpages.
com, http://www.couponsurfer.com, and http://www.
dealcatcher.com.
Prepayment. A prepayment plan is typically used with
customers who have no credit history or a poor one. This
prepayment method does not generally provide customers
with a price break, although sometimes it does. For example,
the magazine industry widely uses the prepayment
strategy. A customer who agrees to purchase a magazine
subscription for an extended period normally receives a
discount as compared to the newsstand price. Purchase of
gift certificates is another example of how prepayment can
be used to promote sales. For example, a company may
offer discounts on a gift certificate whereby the purchaser
may pay only 90 to 95 percent of the gift certificate’s face
value. This strategy has several advantages. First, consumers
are encouraged to buy from the company offering
the gift certificates rather than from other stores. Second,
the revenue is available to a company for reinvestment
prior to the product’s sale. Finally, receivers will not
redeem all gift certificates, and as a result, a company
retains all the revenue.
Price Shading. One way to increase company sales is to
allow salespeople to offer discounts on the product’s price.
This tactic, known as price shading, is normally used with
aggressive buyers in industrial markets who purchase a
product on a regular basis and in large volumes. Price
shading allows salespeople to offer more favorable terms
to preferred business buyers in order to encourage repeat
sales.
Seasonal Pricing. The price for a product can also be
adjusted based on seasonal demands. Seasonal pricing will
help move products when they are least salable, such as air
conditioners in the winter and snow blowers in the spring.
An advantage of seasonal pricing is that the price for a
product is set high during periods of high demand and
lowered as seasonal demand drops off to clear inventory to
make room for the current season’s products. Pricing for
seasonal holiday products, such as those connected with
Thanksgiving and Christmas, are frequently reduced the
day after the holiday to clear inventory.
Term Pricing. A company has another positive reinforcement
strategy for use when establishing product price,
term pricing. For example, a company may offer a discount
if the customer pays for the product promptly. The
definition of promptly varies depending on company policy,
but normally it means the account balance is to be
paid in full within a specified period; in return, a company
may provide a discount to encourage continuation
of this early payment behavior by the customer. This term
pricing strategy is normally used with large retail or industrial
buyers, not with the general public. Occasionally, a
company will offer a small discount to customers who pay
for a product with cash. For example, Gill Brothers, a furniture
store located in Muncie, Indiana, occasionally
offers additional discounts to customers who pay cash.
During one promotional event, selected items were
marked down as much as 40 percent; in addition, customers
who paid by cash or check were given an extra 10
percent discount.
Segment Pricing. Segment pricing is another tactic a
company can use to modify product price in order to
increase sales. Everyday examples of segment-pricing discounts
are those extended to children, senior citizen, and
students. These discounts have several positive benefits.
First, the company is appearing to help those individuals
who are or are perceived to be economically disadvantaged,
a perception that helps create a positive public relations
image for a company. Second, members of those
groups who ordinarily may not purchase the product are
encouraged to do so. Therefore, a company’s sales will
increase, which will likely result in increased market share
and revenue. Best Western and Marriott are examples of
hotel chains offering discounts to senior citizens.
Volume Discounts. A common method used by a company
to price a product is volume discounting. The idea
behind this pricing strategy is simple: If a customer purchases
a large volume of a product, the product is offered
at a lower price. This tactic allows a company to sell large
quantities of its product at an acceptable profit margin.

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Privacy and Security
Volume pricing is also useful for building customer loyalty.
For example, Stacks and Stacks HomeWares often
provides volume discounts to customers ordering $1,000
worth of any one item.
DYNAMIC PRICING
The strategy where price is negotiated between buyers and
sellers, dynamic pricing, has been used throughout history,
but its use waned when fixed pricing became popular
during the later part of the nineteenth century.
Dynamic pricing is a strategy where price is set based on
the individual customer and situations.
Advances in technology such as the Internet have
made modern dynamic pricing possible. Companies selling
via the Internet can mine databases to determine customer
characteristics and adapt products to match buying
behavior and set prices accordingly. Companies selling via
the Internet can also adjust pricing based on customer
demand and product supply. The speed with which
changes can be made on the Internet allows sellers to
make pricing changes on a daily or even hourly basis. Buyers
can even negotiate prices with sellers via the Internet.
For example, buyers can negotiate prices on products such
as hotel rooms and rental cars at the Web site
Priceline.com (http://tickets.priceline.com).