Any business has two goals which are to maximize profits and growth. When starting a business, there are a number of factors to consider like available market, competition, location strategy, budget and pricing. The agenda behind pricing strategies is to ensure that a business recovers the initial cost invested as well as generate profit. According to (Saunders, 2010) price optimization is determined by linking the demand curve to the cost function and finding the point where marginal and revenue costs meet. However Saunders concept does not consider the long term effect on customers or competition reaction in the market.
The three main pricing approaches in the market include cost based pricing, customer based pricing and competitor based pricing. In cost based pricing, also known as mark- up pricing, a fixed percentage or amount is added to the original purchase cost. Customer based pricing entails setting a low entry price in order to attract customers. This strategy, which is also known as penetration pricing works on a marketing principle me and to draw away customers from competing with a price lower than the intended or market price. Competitor based pricing is a strategy based on reviewing competitive prices in the market and setting a relatively similar price. As the prices are almost same the business person is left with the task of creating other ways to attract customers in order to sell his product.
The effectiveness of a pricing strategy can be measured over a long term or short term growth period. Being a key determinant, pricing strategies are meant to maximize on the available customer margin pool. According to (Shiller, 1989) market volatility also plays a key role in determining the pricing of goods and services. Short term market volatility implies the price varies according to the available market at a given point while long term volatility puts into consideration the standard market price regardless of shifting market volatility. When starting a new business some people will opt to go for the short term pricing strategy while others opt for a long term kind of perspective.
Some of the short term strategies include pricing goods much lower than normal market rate, introducing free products or supplementing products with accessories. This form of pricing is also known as marginal cost pricing. Long term pricing involves doing a research on the market and competition, then pricing goods or services within the same range. Depending on the product each of these strategies has their advantages as further discussed below.
Advantages of marginal cost pricing
A business man is able to capture profit instantly by reducing costs. This method appeals to customers who are price eccentric on purchase of goods or services. Lower prices attract more people, therefore, increasing popularity of a business. Putting into consideration market volatility and competition sprouting every other day, then this is an advisable method to make quick sales in bulk.
This method is also advisable for people attempting to gain level market entry. Companies take risk of foregoing initial profit in order to capture a specific target with their product. This method works to the advantage of a business only if the market are well drawn to the product that, upon price alterations or introduction of a competitive product of the same nature, the original market stays.
Marginal cost pricing gives room for the introduction of accessory products linked to the main one. A customers psychology is influenced by the idea of thinking an item is very cheap therefore creating room to buy another one. The latter pricing is kept at a standard or slightly higher rate thus ensuring a business stands a chance of gaining profit.
An added advantage of short term pricing as a strategy is that businesses are able to clear their stock within a short period of time. Business people take advantage of the temporary demand they create in order to move as much of their stock as they can.
Advantages of value-based pricing strategy
According to (Ronald W. Hilton, 2003) long term strategies experience lower market volatility. Although profits may or may not be generated immediately there is a sense of stability in long term pricing investment. In this instance the customers are not responsible for dictating the market price. This eliminates pricing as a factor for business growth because the rate remains standard across the market.
Business competition in long term strategic pricing is diverted from the costs. This means that businesses have to rethink of other ways to increase sales by providing value added services. This method gives all businesses a fair chance to compete on the mode of delivery basis. The value of service and products is increased, hence giving customers the feel of paying for something that is worth the cost.
Long term investments in the form of pricing provides an avenue to cut on costs. Most economies usually tax long term businesses as below the income bracket while short term businesses are taxed as regular income. Long term business investments also save on active trading transaction costs. Funds for those holding shares over a long period can be deferred by some mutual funds.
Companies that use long term pricing as a strategy to increase the chance of capturing a wider margin. For people who are quality sensitive in the acquisition of products cheap is associated with poor quality. Setting a standard price of products is able to capture this market well.
Using long term pricing as a business strategy gives the business room to adjust prices. Depending on the nature of the economy and increased production cost, a business owner can adjust his pricing to meet his demands. The allure of short term pricing is that the object is readily available and cheap. Increasing the price of such products leads to the loss of clients who no longer find the product attractive. Clients who purchase value for money are likely to be accepting of price adjustments as opposed to clients whose purchasing power is influenced solely by the price. This makes long term pricing strategy a more stable approach.
Stability provided by long term pricing investment strategy ensures a business stays in line with the financial projections. Growth over a long period of time gives room for a clear analysis of the financial market and solid long term solutions or decisions can be based on the analysis without inconsistencies.
Choosing the pricing strategy, whether short or long term, therefore, depends on the business objectives, targets and intended life line. As (Drury, 2001) implies, when these factors are well defined in a business, then individuals setting foot in the commercial market are able to choose which of these means works best for the intended business.
Drury, C. (2001). Management Accounting for Business Decisions. Australia: Thomson Learning.
Ronald W Hilton, M. M. (2003). Cost management : Strategies for Business Decisions. Boston: McGraw-Hill.
Saunders, J. (2010). Pricing for Long Term Profit and Growth. Journal of Professional Pricing from the Professional Pricing Society.
Shiller, R. J. (1989). Market Volatility. Cambridge: MIT Press.
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