Competition-based pricing

Setting the price based upon prices of the similar competitor products.

Competitive pricing is based on three types of competitive product:

• Products have lasting distinctiveness from competitor's product. Here we can assume
o The product has low price elasticity.
o The product has low cross elasticity.
o The demand of the product will rise.
• Products have perishable distinctiveness from competitor's product, assuming the product
features are medium distinctiveness.
• Products have little distinctiveness from competitor's product. assuming that:
o The product has high price elasticity.
o The product has some cross elasticity.
o No expectation that demand of the product will rise.

Cost-plus pricing
Cost-plus pricing is the simplest pricing method. The firm calculates the cost of producing the
product and adds on a percentage (profit) to that price to give the selling price. This method
although simple has two flaws; it takes no account of demand and there is no way of determining
if potential customers will purchase the product at the calculated price.

This appears in 2 forms; Full cost pricing which takes into consideration both variable and fixed
costs and adds a % mark-up. The other is Direct cost pricing which is variable costs plus a %
mark-up, the latter is only used in periods of high competition as this method usually leads to a
loss in the long run.

Creaming or skimming
Selling a product at a high price, sacrificing high sales to gain a high profit, therefore ‘skimming’
the market. Usually employed to reimburse the cost of investment of the original research into the
product: commonly used in electronic markets when a new range, such as DVD players, are
firstly dispatched into the market at a high price. This strategy is often used to target "early
adopters" of a product or service. These early adopters are relatively less price-sensitive because
either their need for the product is more than others or they understand the value of the product
better than others. In market skimming goods are sold at higher prices so that fewer sales are
needed to break even.

This strategy is employed only for a limited duration to recover most of investment made to build
the product. To gain further market share, a seller must use other pricing tactics such as economy
or penetration. This method can come with some setbacks as it could leave the product at a high
price to competitors.
Limit pricing
A limit price is the price set by a monopolist to discourage economic entry into a market, and is
illegal in many countries. The limit price is the price that the entrant would face upon entering as
long as the incumbent firm did not decrease output. The limit price is often lower than the
average cost of production or just low enough to make entering not profitable. The quantity
produced by the incumbent firm to act as a deterrent to entry is usually larger than would be
optimal for a monopolist, but might still produce higher economic profits than would be earned
under perfect competition.

The problem with limit pricing as strategic behaviour is that once the entrant has entered the
market, the quantity used as a threat to deter entry is no longer the incumbent firm's best
response. This means that for limit pricing to be an effective deterrent to entry, the threat must in
some way be made credible. A way to achieve this is for the incumbent firm to constrain itself to
produce a certain quantity whether entry occurs or not. An example of this would be if the firm
signed a union contract to employ a certain (high) level of labour for a long period of time.

Loss leader
A loss leader or leader is a product sold at a low price (at cost or below cost) to stimulate other
profitable sales.

Market-oriented pricing
Setting a price based upon analysis and research compiled from the targeted market.

Penetration pricing
The price is deliberately set at low level to gain customer's interest and establishing a foot-hold in
the market.

Price discrimination
Setting a different price for the same product in different segments to the market. For example,
this can be for different ages or for different opening times, such as cinema tickets.

Premium pricing
Premium pricing is the practice of keeping the price of a product or service artificially high in
order to encourage favorable perceptions among buyers, based solely on the price. The practice is
intended to exploit the (not necessarily justifiable) tendency for buyers to assume that expensive
items enjoy an exceptional reputation or represent exceptional quality and distinction.
Predatory pricing
Aggressive pricing intended to drive out competitors from a market. It is illegal in some places.

Contribution margin-based pricing

Contribution margin-based pricing maximizes the profit derived from an individual product,
based on the difference between the product's price and variable costs (the product's contribution
margin per unit), and on one’s assumptions regarding the relationship between the product’s price
and the number of units that can be sold at that price. The product's contribution to total firm
profit (i.e., to operating income) is maximized when a price is chosen that maximizes the
following: (contribution margin per unit) X (number of units sold)..

Psychological pricing
Pricing designed to have a positive psychological impact. For example, selling a product at $3.95
or $3.99, rather than $4.00.

Dynamic pricing
A flexible pricing mechanism made possible by advances in information technology, and
employed mostly by Internet based companies. By responding to market fluctuations or large
amounts of data gathered from customers - ranging from where they live to what they buy to how
much they have spent on past purchases - dynamic pricing allows online companies to adjust the
prices of identical goods to correspond to a customer’s willingness to pay. The airline industry is
often cited as a dynamic pricing success story. In fact, it employs the technique so artfully that
most of the passengers on any given airplane have paid different ticket prices for the same flight.

Price leadership
An observation made of oligopic business behaviour in which one company, usually the dominant
competitor among several, leads the way in determining prices, the others soon following.

Target pricing
Pricing method whereby the selling price of a product is calculated to produce a particular rate of
return on investment for a specific volume of production. The target pricing method is used most
often by public utilities, like electric and gas companies, and companies whose capital investment
is high, like automobile manufacturers.

Target pricing is not useful for companies whose capital investment is low because, according to
this formula, the selling price will be understated. Also the target pricing method is not keyed to
the demand for the product, and if the entire volume is not sold, a company might sustain an
overall budgetary loss on the product.

Absorption pricing
Method of pricing in which all costs are recovered. The price of the product includes the variable
cost of each item plus a proportionate amount of the fixed costs. A form of cost plus pricing

High-low pricing
Method of pricing for an organization where the goods or services offered by the organization are
regularly priced higher than competitors, but through promotions, advertisements, and or
coupons, lower prices are offered on key items. The lower promotional prices are targeted to
bring customers to the organization where the customer is offered the promotional product as well
as the regular higher priced products.

Premium Decoy pricing

Method of pricing where an organisation artificially sets one product price high, in order to boost
sales of a lower priced product.

Marginal-cost pricing
In business, the practice of setting the price of a product to equal the extra cost of producing an
extra unit of output. By this policy, a producer charges, for each product unit sold, only the
addition to total cost resulting from materials and direct labour. Businesses often set prices close
to marginal cost during periods of poor sales. If, for example, an item has a marginal cost of
$1.00 and a normal selling price is $2.00, the firm selling the item might wish to lower the price
to $1.10 if demand has waned. The business would choose this approach because the incremental
profit of 10 cents from the transaction is better than no sale at all.

Value Based pricing

Pricing a product based on the perceived value and not on any other factor. Pricing based on the
demand for a specific product would have a likely change in the market place.