What price point should you set for your products and services? This important and common question can better be answered by determining company objectives. Several common company objectives are:
- Maximize current profits
- Increase market share
- “Skim” the market
- Seek “product-quality leadership”
Survival: Companies facing new and intense competition, over capacity, or changing consumer behavior may pursue a survival strategy. Survival is clearly a short run objective to make it through tough times. As long as price exceeds variable costs and covers some fixed costs, the company can carry on. In the long run, the company must adapt and find ways to add value.
Maximize current profits: Maximizing current profit is a common company objective. To do so, costs and consumer demand have to be estimated for different prices. The price point that generates the highest profit is then chosen. In practice, it’s not always easy to estimate demand accurately (we discuss ways to do this in our article about determining demand and calculating costs). Additionally, focusing on current profits may mean reducing long run company performance.
Increase market share: A company may pursue an objective of increasing or maximizing market share. This makes sense especially if a company feels it can achieve lower unit costs with higher volumes, thereby increasing long-term profit. Many companies set a low initial price to achieve market penetration. This strategy can be advantageous in industries with consumers that are price sensitive, sales and production costs fall with production experience, and where a low price discourages the entry of possible competitors.
Skim the market: “Skimming” means setting high prices initially to target those that are willing to pay the high price, and then gradually lowering the price to attract the more price sensitive customers. Video game and other software producers often use this strategy. Die-hard fans are willing to pay the higher initial price, and as sales decline, the company reduces the price for more casual users. Intel is another prime example a company that successfully uses price skimming. It’s latest computer chips are sold to those who can’t wait for well over $1000 initially. A year later, the price drops and there is a new and more powerful $1000+ chip released.
Product-quality leadership: Companies that produce high quality products relative to the competition often try to position themselves as the product-quality leader. They charge more, but convince the customer that it’s worth it because of the superior product experience, reliability, or other quality related benefits. Price sensitive customers need to be convinced that the higher price is worth it in the long run.
The main point is that using price as a strategic tool is better than simply letting costs determine price. If your product is superior to the competition, you’ll be more profitable if you convey that to the market and charge a higher price.
For information on some common pricing techniques and when you’d use them, see our article about setting prices.