1.3.3 Pricing Strategies

Question 1

Definition: Pricing

Answer 1

• The process of pricing is the choice of pricing strategy that a business makes when setting prices for their products or services

Question 2

Types of pricing strategy

Answer 2

1. cost plus
2. price skimming
3. penetration
4. predatory
5. competitive
6. psychological

Question 3

Cost plus pricing

Answer 3

• A cost-plus pricing strategy seeks to set a price for a product or service which covers the costs AND provides a good profit margin for the business
• Cost-plus is the most logical approach to pricing because it achieves the business objective of maximising profits

Question 4

Advantages and disadvantages of Cost plus?

Answer 4

Advantages:
- Protects the profit margins of the business -Easiest method of pricing to apply
- Easy to estimate profit levels

Disadvantages:
- This method of pricing does not take into account the prices of the competition

Question 5

Skimming pricing

Answer 5

• A skimming price strategy is used when launching a new product
• The price is set high to start, this will create high profits and may be used to pay back high Research and Development (R&D) costs
• Usually used in technological or very innovative products which have few competitors
• As competitors eventually enter the market the price is then reduced

Question 6

Skimming benefits and drawbacks

Answer 6

Advantages:
- A high starting price can establish an upmarket image
- For innovative products it can be a great way to harvest high profits from early buyers who want the latest gadget / item / product and are prepared to pay a premium

Disadvantages:
- Cheaper imitations of the product may appear on the market too soon and take sales away from the product

• Risky strategy as customers may be put off from buying due to the high price

Question 7

Competitive pricing

Answer 7

• Some products or services are priced in line with competitors
• This means that customers will have to judge a product or service on “non-price” methods such as; quality of service or speed
• Strategy usually used where products in a market are all very similar

Question 8

Competitive benefits and drawbacks

Answer 8

Advantages:
- Useful in a market where one brand is dominant, the other brands would need to discount and offer lower prices encourage customers to buy

Disadvantages:
- Pricing at the competitive rate may not cover all the costs of some smaller businesses which can’t get the same economies of scale as the larger ones

Question 9

Penetration pricing

Answer 9

• This means setting prices really low on a new product to encourage sales and to persuade customers to try the product. Then when they like the product and have to keep buying it the business raises the price
• Low prices should gain the business more market share (market penetration)
• Mass market – repeat purchases e.g. tea bags, biscuits which are called Fast Moving Consumer Goods (FMCG).

Question 10

Penetration benefits and drawbacks

Answer 10

Advantages:
- Works best with new products being launched to encourage consumers to try the product

Disadvantages:
- Consumers may have bought anyway, even without the low start price
- Expensive as it eats into profits by reducing sales revenue

Question 11

Predatory Pricing

Answer 11

• In oligopolies (markets with just a few large businesses e.g. budget airlines) existing businesses may hold off the threat of a new entrant to the market by lowering their prices so that any competitor cannot make a profit.
• This is when aggressive price cutting is used to deter competitors or push them out of the market

Question 12

Predatory pricing benefits and drawbacks

Answer 12

Advantages:
- The intention with predatory pricing is to drive competitors out of the market place or set a barrier to entry to discourage new entrants to the market

Disadvantages:
- Depends on the price elasticity of the product, if it is low then a lower price won’t make much difference to customer demand

Question 13

Psychological pricing

Answer 13

• This means pricing a product at £1.99 rather than £2.00 to appear cheaper
• Some businesses consider pricing carefully as it is often an indicator of quality
• High value or status items like luxury cars avoid pricing just below but instead may price higher to match their customers’ expectations

Question 14

Psychological pricing benefits and drawbacks

Answer 14

Advantages :
- Ideal for products which want to project a premium image – the price might be part of the appeal

Disadvantages:
- Psychological pricing strategy can be high risk, if comparable products are available for a lower price consumers could be tempted away

Question 15

Factors that determine a pricing strategy

Answer 15

1. number of USPs/amount of differentiation
2. price elasticity of demand
3. level of competition in the business environment
4. strength of brand
5. stage in the product life cycle
6. costs and the need to make a profit

Question 16

Level of competition in the business environment

Answer 16

• No business works in isolation so a change in the price of one business may result in the change of all the others
• The availability of substitute products will affect business pricing decisions
• If a business wants to establish and maintain loyal customers it will need to match or have similar prices to its competitors

Question 17

Strength of brand

Answer 17

• A brand helps to define a business in the eyes of a consumer
• A strong brand can charge higher prices because consumers will pay the higher price for the strong brands

Question 18

Online sale

Answer 18

• Websites can offer low prices than the bricks and mortar shops because they don’t have the overheads, rent and costs of running a store.
• Many customers look at the goods in a store and then buy online at a cheaper price
• This means many online retailers need to have dynamic pricing which is constantly checking and updating based on competitors prices

Question 19

What can customers use to shop around and get a good price?

Answer 19

Price comparison sites
• Customers are now able to shop around and using these sites compare prices of insurance, where previously they would have had to phone a few companies to get quotes, this was time consuming and an expensive phone bill

Question 20

Homogenous

Answer 20

Products which are all the same or alike

Question 21

Mark-up

Answer 21

The amount above cost added to a product before it is placed for sale

Question 22

Competitive pricing

Answer 22

To charge a similar amount for goods as are charged elsewhere

Question 23

What is product life cycle?

Answer 23

Shows the different stages in the life of a product and the cells that can be expected at each stage