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29 March 2017

The 4 Ps of Marketing. Part 2: Pricing Strategy

In the previous article on the 4 Ps of marketing, we discussed the main concepts the Product and Brand. Today I want to focus on the second component, the Pricing Strategy, and offer you an overview of all the main factors that you have to consider when setting the price of your products.

1. The price has an impact on the profit

Research shows that cutting the price by 1 % increases the profit by an average of 10 %. Changing the flow of costs and the sales volume by the same 1% increases the profit only by 2 to 8%. Of course, a lot depends on the specifics of your business; but you should always keep in mind that the price can significantly affect the profit, so don’t ignore it.

Formula

Profit growth with the 1% change

2. The price should always be lower than the customer value

Considering the relation between the customer value and price allows you to view the price from a different angle. The customer value of the product or service must always be higher than the price that the customer is ready to pay for the product.

3. Three methods to price your products
  • Focus on the customer. This method is considered the most advanced. It requires you to understand the customer value that you deliver. By raising the customer value, you can also raise the price.
  • Focus on the market. This method is based on the analysis of your competitors’ prices. By doing so, you can form your own position on the market; for example, by setting an average price or a price higher than average.
  • Focus on the product cost. This method implies that the price is set according to the cost of producing the product and the production plan. Therefore, the price is formed according to the revenue rate and the product cost.
4. Elasticity of demand according to the price behavior

The relation between the demand for the product and the price behavior depends a lot on the industry sector.
The coefficient of elasticity is the percentage change in the quantity demanded divided by the percentage change in price.

Calculation of demand elasticity

There are five possible variants:

Formula

Demand elasticity types

You should always take the price elasticity into account. This way you can consider your options and set the most appropriate price. Here is a simple example that does not consider the industry specifics:

Formula

Example of best price calculation

5. Price discrimination and its forms

Different customers are prepared to pay a different price for the same product. The logic here is simple. For one market segment, the product has a higher value than for another market segment. And the higher the value, the higher is the price that the customer is ready to pay.
Therefore, the manufacturer can structure the customer value, segment the market and use various forms of price discrimination:

  • First-degree price discrimination. The seller sets the maximum price that the customer can pay for a certain product. This type of price discrimination is ideal.
  • Second-degree price discrimination. The price varies depending on the demanded quantity of the product. This type of price discrimination is used when the seller does not have information on each customer but can differentiate the customers by groups. For example, the seller can offer different mobile plans or package deals to different groups of customers. Each customer then chooses the option that he or she finds the most convenient.
  • Third-degree price discrimination. The price is different for different consumer groups according to their income, for example, consider the discounts offered to students and senior citizens.
6. Pricing Psychology. Prospect Theory.

According to the Prospect Theory, people evaluate equal losses and gains differently. Losses are always considered more significant than the gains even when they are comparable. Keep this in mind when setting your prices, forming special offers and customer loyalty programs.

Formula

Prospect Theory

For example, you send out a newsletter offering a 40% on a certain product during the following two days. The customer decides to make the purchase, but when they start placing the order, it turns out that the product has already sold out. As a result, the customer does not have the product just as they did not have it before, but now they feel the pain of losing the opportunity.

Here is what you can do: offer alternatives. For example, offer a personal discount and promise to notifiy the customer as soon as the product is back in stock. A good offer, personal touch and your focus on the customer can help neutralize the pain and raise the customer’s loyalty to your brand.

In this article, I have briefly described the main concepts of the pricing strategy. For more information on the product and brand, read my first article of the 4Ps series. If you have any questions, feel free to leave a comment below.

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Aleksey Trefilov
Aleksey
Trefilov
CEO