Pricing is a critical component of the marketing mix. Think about what drives shoppers to purchase a product or service. Is it brand value, product quality, level of customer service provided, design, or price?
According to research, 60 percent of online shoppers globally consider pricing as the first criterion affecting their buying decision. In tough economic times, this percentage can rise by as much as 20 percent.
Price is an important part of the marketing mix. When all things are equal, the price of a product or service is often a significant differentiator. Since the 1950s, the focus on the 4 Ps —product, price, place, and promotion —has been at the core of marketing. As the marketing mix has evolved beyond the 4Ps to include packaging, positioning, and people, pricing remains an important differentiator as it is transparent and easily comparable. It has been established that a one percent improvement in pricing raises profits by six percent.
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With e-commerce, price analytics takes on another meaning. Price analytics for e-commerce helps brands track their competitors’ pricing changes and analyze how their own prices perform daily. This is why e-Commerce brands use competitive price analysis software to execute their pricing strategy.
Today, online shoppers have various tools, like Honey, that scour the internet to find the best prices. Many studies show that as much as 90 percent of online shoppers spend substantial time finding the best deals.
What are the most used pricing models?
The cost-plus price model.
When using the cost-plus model, companies determine the unit product costs for each product and then set a target profit margin. The profit margin is added on top of the cost of the products, often as a percentage. These costs are different for retail and e-commerce brands. While e-commerce businesses do not incur brick-and-mortar costs, such as store rent and utilities, they often include other costs, such as domain registration, website hosting, rent (if there is office space), online platform fees if that applies, software, bank processing fees, shipping and fulfillment costs, marketing, returns, and refunds, among others.
Knowing the exact unit costs is critical, and so is arriving at a reasonable profit margin that makes the sale profitable while also considering what the customer is willing to pay. Pricing too low will undervalue the product or service, and pricing it too high will make it less competitive.
For instance, luxury brands like Rolex can afford a massive profit margin because they know their target audience cares more about the brand image than the price. However, the same approach doesn’t work for fast fashion brands because the target audience is looking for affordable clothing and accessories; therefore, the product’s price needs to be competitive.
When using the cost-plus pricing strategy, brands must thoroughly research their competitors’ pricing.
Market-based pricing.
With many tools available to consumers, primarily online, they can easily compare prices of competing goods and services at a click of a button. Therefore, brands need to clearly understand how their competitors price their products and consider the market value and demand for them. However, brands entering a pricing war can risk losing out if they mark their products and services too low.
Using market-oriented and competitive pricing, brands can utilize the data to increase prices while maintaining competitiveness.
By keeping an eye on the market and using competitor pricing software, eCommerce brands often raise prices just below the competitors’ so they stay competitive and increase profit margins.
Dynamic pricing.
Dynamic pricing, also known as surge pricing, is a time-based pricing model. It is a flexible approach to pricing based on market and customer demand. When using dynamic pricing, the prices of goods and services fluctuate based on their demand. For instance, if there is a big concert in town and lots of tourists are expected to attend, the prices of Uber rides, hotels, and airlines for that city will surge upwards.
Hotels and airlines utilize online algorithms to price hotel rooms and airline tickets based on market demand to maximize profits and maintain a competitive edge.
Bundle pricing.
Bundle pricing is a simple pricing strategy where brands sell a range of products together at a lower price than individual products or services.
For instance, a cookware brand may sell its pot and pans in a bundle for less, or an electronics brand may sell a camera, with accessories, at a lower price.
Bundling products of a similar type allows retailers to increase the average order value. Many consumers find their purchase to be more valuable as they are likely to need other products or accessories that go with their purchase. It’s a good deal for all parties involved.
Freemium pricing.
Freemium pricing is offered to acquire new customers. It offers your product or service for free for some time so that potential new customers can try your product for a limited time. Profit margins for freemium pricing are calculated based on converting free trial users or sign-ups.
Freemium pricing is valuable because it gives you access to a new customer’s email, phone, or address so you can use marketing to nurture the customer over time so they purchase from you in the future.
For prospects who sign up for a free trial, they get to experience the product, lowering perceived risk and removing “buyer’s remorse”.
Freemium pricing is often seen with free trials of online software, where prospective users sign-up for a free trial use period.
High-low pricing strategy.
Brands utilizing a high-low pricing strategy initially price their product at a high price but lower it when it loses its novelty value or relevance.
An excellent example is Lululemon studio, a workout mirror launched as Mirror and later rebranded as Lululemon Studio. It recently dropped its price by 50 percent as more similar products entered the market. To learn more about the story behind Lululemon Studio, download our report here:
Skimming pricing model.
Brands use the skimming pricing model when they initially offer a higher price for their product and gradually lower it as it loses market demand and becomes less popular. This pricing model differs from the high-low model because this strategy progressively reduces the price over a period of time.
Penetration pricing.
Brands often use the penetration pricing model when entering a new market or introducing a new product line with lower-than-market prices. These brands set their prices lower than the competing brands to lure customers.
Price discrimination.
Many eCommerce brands employ the price discrimination model, selling the same item at different prices to different buyers. This is a tailored approach based on the customers, not the product.
Price discrimination can be used in the following ways:
- Consumers are in the driving seat; for instance, they might be offered free shipping or a lower price if they purchase a certain number of items or shop for a minimum amount.
- Consumers bid for products, so they pay more than they may be willing to pay otherwise due to auctions on platforms like eBay.
- Products are priced based on customer segments. This is done by utilizing customer order history and data to generate prices for specific customer segments.
Psychological pricing.
Psychological pricing utilizes human psychology to boost sales. When brands price items at 3.99 instead of 3.00 or 99.99 instead of 100.00, they use consumer psychology to increase sales.
This has intrigued researchers for years: How can rational consumers perceive a price ending in nine to be significantly lower than a price less than one percent higher?
Research has shown consumers do not respond to minor price changes; however, recent research suggests that the last digit of a price can have a massive impact on a firm’s revenue. This is because we process data from left to right and perceive an item priced at 2.99, closer to 2.00 than 3.00, according to numerical cognition.
Geographical Pricing.
In this pricing model, brands set prices based on the geographical location or market.
How to price a product or service for international markets
Pricing can become even more complex when brands enter new international markets and various market forces and price structures come into play.
So what determines a successful export pricing strategy? It includes assessing your company’s foreign market objectives, costs, demand and competition, transportation, taxes and duties, sales commissions, insurance, and financing.
How do you adjust prices in markets where the currency exchange rates are much lower? In 1986, The Economist, a British weekly newspaper, invented the Big Mac Index, which measures the purchasing power parity between nations using the price of McDonald’s Big Mac as a benchmark to determine whether currencies are at their “proper” level.
The Big Mac Index is based on the purchasing-power-parity theory, which suggests that exchange rates over time should move in the direction of equality across national borders in the price charged for an identical basket of goods, in this case, the Big Mac.
The Big Mac Index was created as a lighthearted tool to measure the differences in consumer purchasing power between nations.
The idea was to make the exchange-rate theory easier to understand. But it has now become a global standard for brands entering new markets and academic studies.
According to PPP theory, a change in the exchange rate between countries should be reflected in the price of a basket of goods.
The Big Mac Index is based on the premise that a basket of goods in one country can rarely be exactly duplicated in another country. For example, an Indonesian basket of groceries and a basket in England likely contain very different products. On the other hand, the Big Mac provides a fair comparison as apart from a few local ingredients, it’s the same product.
The Big Mac Index isn’t the only method brands use to price their products and services in international markets. The GDP-adjusted index has challenged the Big Mac Index, suggesting the average burger prices should be cheaper in a country like India versus the U.S., based on lower labor costs.
While the PPP theory addresses where exchange rates are headed in the future, it doesn’t factor in the current exchange rates.
Many economists believe the relationship between prices and GDP per person is a better guide to assess the current fair value of a currency.
Despite not being a perfect tool, the Big Mac Index is widely used by brands entering new markets. There are also similar PPP models such as the Starbucks Index and the Apple iPhone index.
Pricing products during times of high inflation.
Inflation is back; for many brands, this means sustainably adjusting their pricing. This is a frequently discussed topic in boardrooms globally as organizations work toward strategies to cope with an inflationary market.
Strong demand in a post-pandemic world, supply chain disruptions due to extended lockdowns in China, Russian supplier sanctions, labor shortages, and rising fuel prices have resulted in cost volatility worldwide. Brands need to adjust their pricing to offset fluctuations and inflation without risking future revenue growth.
Inflation is the rate of price increases that impacts the cost of living in a country over a given period.
When the money supply grows too big compared to the size of an economy, the unit value of the currency reduces; in other words, its purchasing power falls, and prices go up.
With inflation and a recession on the horizon, consumers are tightening their purse strings. High prices of fuel to food are impacting consumer spending. For brands, it often signals a need to get more creative, and eCommerce sellers are in a more favorable position to weather the economic downturn using competitive pricing software and data-rich touchpoints to inform better decision-making.
How to create a sustainable pricing strategy and stay competitive.
Fix your current pricing strategy.
Focus on the easy wins and communicate your positioning to the consumers, like reducing less profitable SKUs and adjusting service pricing based on market trends, like shipping costs that have gone up over the past two years.
Build a strategic pricing plan.
Build a structured pricing strategy based on a deep understanding of products and customers for improved retention and volume growth.
Communicate effectively.
Communicate effectively internally to sales teams and externally to the consumers and public. Deliver customer-centric thinking, clearly communicate attributes and price points, and emphasize product uses and value.
Provide transparency on price increases.
If it is necessary to increase the cost of your product based on an increase in logistics costs such as fuel and shipping, breaking out that cost separate from the product cost can help consumers separate any necessary price increases and why they are necessary.
Understand new consumer behaviors and revisit brand positioning.
Brands need to deeply understand the dramatic shifts in consumer behavior over the last few years to manage high inflation. The pricing strategy should consider changes in post-pandemic behaviors and preferences.
Best pricing strategies for high inflation rates
There are several pricing strategies to increase the price of your products ad services during an inflationary economy. Companies often use a combination of pricing strategies to combat high inflation.
Cost-plus pricing model
During a period of high inflation, it helps when companies allow the product price to increase in line with the cost of the product. However, this pricing model can make a brand less competitive when used alone.
Competitive pricing model
During inflation, your competitors also make price adjustments, so it is essential to utilize the competitive pricing model to stay ahead.
The key-value item pricing model
During times of high inflation, brands can lure customers into their physical or online stores with discounted prices for best-selling products. Once in the door, they profit from their other purchases, so dividing products into key-value items and profit-margin items is best.
Dynamic Pricing model
Dynamic pricing is an excellent strategy for companies selling multiple products during high inflation. This type of pricing uses competitive pricing software, AI, and algorithms to automate the price adjustment process.
How can brands maintain quality without impacting price, even though their costs have increased?
Shrinkflation
A brand’s response to rising costs of goods and inflation depends on the product or service. There are many products for which consumers are more sensitive to changes in price rather than quantity. This is where downsizing or shrinkflation comes into play.
Shrinkflation is the practice of reducing the product size in an attempt to maintain its sticker price. This is an excellent strategy, especially in the food and beverage industry, to boost profit margins or maintain profits during inflation. This is not a new practice and is not limited to inflationary times. However, when costs are rising, brands utilize it to their advantage as it allows them to maintain quality while also reducing prices.
For instance, Simply Lemonade (and other juice brands) in the U.S. have gone from 64oz to 59oz to 52oz over the years while the price has remained the same or increased.
Earlier this year, the size of a Cadbury Dairy Milk chocolate bar was reduced by 10 percent and is available at the same price. The parent company, Mondolez, uses this tactic to combat the rising costs of producing chocolate bars to provide consumers with the same taste and quality without increasing prices.
Skimpflation
Yet another practice brands use to combat inflationary environments is skimpflation. As the name suggests, skimpflation refers to skimping on service or quality to cut costs. For instance, airlines may stop serving meals, or hotels may reduce the number of times they offer housekeeping services. Airport lounges or hotels may skimp on the hot meals or free breakfasts and offer pre-packaged cereal and bars instead. Brands may also choose to swap out more expensive ingredients with cheaper substitutes. However, there is always the risk of losing consumers if they find the difference noticeable.
Brands globally are facing enormous challenges due to socio-political issues and supply-chain problems. They must become creative to offset rising materials, gas, and labor costs to maintain profitability. The use of sound pricing strategies, retaining positioning, and communicating the brand’s position with internal and external stakeholders are critical measures in product pricing.
How market research helps brands determine the optimal pricing.
Market research has developed several approaches to price optimization that are widely used to evaluate optimal pricing for different products and innovations. They include direct methods, such as estimation of willingness to pay, indirect methods, such as Gabor-Granger and Van Westendorp techniques, and product/ price mix methodologies, such as several discrete choice methods.
Gabor-Granger Vs. Van Westendorp pricing techniques
The Gabor-Granger method is used to measure the elasticity of demand. It determines how much a potential customer is willing to pay for a product or service. For instance, a brand may show a camera to its customers and ask them how much they are willing to pay for it. But this may be too simplistic for certain cases because when consumers think of pricing, there is a range. Also, not every customer who is offered the camera at the price point determined via this method will be willing to purchase it at that price.
The Van Westendorp
The Van Westendorp is one of the most commonly used pricing techniques that help customers understand such price ranges. It may ask multiple questions, like at what price is it s low that they would doubt product quality, at what price they would consider the camera to be a bargain, at what price is it too expensive, and so forth. This p[rovides more insights into the price range and a better understanding of the consumer’s mindset.
Both methods have their place depending on the situation. When a brand has little or no idea about the price range from the customer’s standpoint, it is better to use the Van Westendorp pricing method. Once the range is known, the Gabor-Granger pricing technique can be used to measure demand elasticity to discover price points at which a brand can maximize revenue.
Purchase intent testing
Consumers may want a product or service, but this doesn’t necessarily mean they are willing to open their wallets and purchase the product.
Purchase intent testing is a type of concept testing approach related to pricing, which helps determine if people will purchase your product or service at your desired price.
Many brands test the product without the price first to estimate consumer interest and later add the price to determine purchase intent.
For instance, the pioneering Electric Vehicle brand Tesla conducted purchase intent testing for a car model before it even designed it.
It is paramount to get the product pricing right. Pricing products is an art and skill that makes brands calculate how much human behavior impacts how people perceive price and value. A pricing strategy is used to determine and establish the best price for a product or service to maximize profitability and shareholder value while assessing consumer demand and perception.
Kadence International helps brands worldwide understand the importance and impact of price on demand. If you would like to increase demand or profit by developing a deeper understanding of how price impacts growth, please contact our team for more information.
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