During this festival of discounting, I thought it might be useful to provide a guide to pricing strategies:
(1) Absorption pricing. We shall start with the least devious method that does actually relate to micro-economics. The aim in absorption pricing is to ensure that all costs are absorbed, or recovered (seems sensible, eh – unless you’re in a price war?). Thus, the price of the product includes the variable cost of production and distribution (wages, power, materials, etc.) of each item plus a proportionate amount of the fixed costs (real estate, plant, normal profit etc.).
(2) Contribution margin-based pricing. This is sometimes called cost-plus pricing. A company determines its break-even price for the product by working out all the costs involved in the production, marketing and distribution. Then a ‘mark-up’ or ‘margin’ is set for each unit of production, this being based on the profit the company desires, its sales objectives and the price it thinks the market will take. If the margin is massive then this is also called rip-off pricing. It is very common. The ‘rip-off’ can be maximised by investing in a premium brand image and having all the gear made in Bangladesh or Indonesia by people who live under corrugated iron. No, I’m not going to mention BRAND DELETED DUE TO LEGAL ADVICE: they have never done anything remotely like this and I’ve heard that their lawyers are really good…
(3) Creaming or skimming. Creaming sounds slightly seedy and skimming sounds like fun. However, this pricing strategy is neither of these things from the consumers’ point of view. In many skimming scenarios goods are sold at higher prices so that fewer sales are needed to break even. Skimming is usually employed to reimburse the cost of investment of the original research into the product and so is commonly used for tech goods. The ‘early adopter’ consumers pay a high price so the rest of us can get it cheaper later. The company is getting you to pay for the R&D, to reduce its risks. You buy the floating car or holographic TV or whatever and you are the first person in your street to own it. Pat yourself on the back because you and your ilk have ensured that everyone else in your street will be able to buy it for a quarter of the price within 18 months.
(4) Decoy pricing. Let’s imagine a company wants to trick you (unthinkable I know). It offers you three products. ‘A’ is very cheap and very basic but reasonable value, ‘B’ is better and ‘C’ is discernibly better still and only slightly more than ‘B’. You compare them on your trip to the shop or your browse of the website and you buy the best one because its features are great value for that little bit more than ‘B’ (‘C is not aimed at you). You have been nudged into this situation. The ‘B’ is a decoy, produced only to get you to buy the superior one. The rival is simply a piece of nudgery to make you think the other one is good value, even though ‘C’ has also been priced according to a ‘cost-plus’ or rip-off strategy (its extra features cost a few pence per unit to install). This has cost implications to initiate but it must make sense in money terms or companies wouldn’t bother. It seems silly and sad that they make things just to get you to buy other things but wait, ‘B’ will eventually be sold off at a lower cost when stocks of ‘A’ are depleted. When you see the sales promotion you will look smug and think, ‘I knew it was inferior and not worth it. I’m glad I bought the best one.’ Then you buy ‘B’ as a present for your nephew because it’s good value now and he’ll like you for it. Fact is, they are still making a profit on it. Now, that is clever, isn’t it?
(5) Freemium. The word ‘freemium’ is an obvious a slightly crass example of a portmanteau; it reflects the fact that the service is free to some and others cough up cash. A company offers a basic product or service free of charge (typically digital things like software, apps, games and all the other stuff you need to live) while charging a premium for advanced features, functionality or freedom from annoying marketing communications (ads). The thing is, it is never free. You usually subject yourself to ads and let them have your data; this means that you are still paying them and they are still making money out of you – without you knowing it.
(6) High–low pricing. The company offers a product at a higher price than the competition but bundles it up with offers and promotions and extras that make you think that it is better value. ‘Hey, it’s a $100 more but that warranty, the free bag made in Indonesia and the free software downloads will save me more in the long run. I’ll take it.’
(7) Limit pricing. A company can pull this one off only if it has a monopoly (or at least a large market share) or is first to market. It pitches the price below cost so that no one can compete with it in any way that is economically rational. If the competitor is big and has huge resources then a price war is likely.
(8) Loss leader. A brand offers a cheap thing to you in order to stimulate the overall demand for the brand. You know – the really good value entry-level version that means that one day you will buy the premium super deluxe version. This is another manifestation of nudgery (see ‘Decoy pricing’) and using products to sell other products.
(9) Odd pricing or so-called psychological pricing. £9.99 or £9.95 sounds less than £10. They are less than £10 but not by much and we fall for it all the time, even though we know it’s a well-worn tactic. Why? Yep, because we are idiots.
(10) Pay what you want. This allows you to boast that you paid €90 for the download of your favourite band’s new album, thus announcing your devotion to said band and marking you out as someone with no economic sense whatsoever. Clever people pay one cent. It works on the premise that there are enough idiots who will pay quite a bit out of some misplaced sense of loyalty or habit and the fact that many people who don’t even like your band will give it a go for one cent (these soon add up to a euro). You can then release limited-edition signed vinyl copies for €100,000 each – for the utterly deranged.
(11) Penetration pricing. This is a trick whereby the thing is offered to you at a low price at first to lure you into a lifetime of purchase. Then you fall in love with the amazing new shampoo because your hair feels like silk and, after all, you’re worth it. You might not even notice the gradual price increases.
(12) Predatory pricing. This is undercutting to drive out the opposition.
(13) Premium pricing. We assume that better things are more expensive. Sometimes this assumption is justified (e.g. an aircraft carrier versus a dinghy), sometimes it is not (e.g. two identical shirts that came out of the same factory in Guangdong with different labels). Premium pricing is an attempt to suggest something is better when it is not, or when it doesn’t cost much more to make than the ‘inferior’ version.
(14) Price discrimination. Travel to London from York at 7:00 am and you will pay twice the price paid by the person who goes at 10:00am. There have been examples of online real-time price discrimination based on the fact that the retailer has data that suggests you will pay more or have more cash to spend (now that is naughty).
(15) Time-based pricing. Budget airlines like this. You sit next to some huge guy with wandering arms and he’s paid 10% of the price you paid because he booked early. Makes you feel good, doesn’t it?
This list is not exhaustive. Pricing is a pseudo-science with all manner of jargon attached to it. Frankly it often comes down to what they think you will pay for their amazing new product. Then they’ll make it as cheaply as they can. That’s marketing folks!
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