When employees try to sell a higher priced alternative to a potential customer it is called?

Your customer needs to find that your price falls within their range of what’s acceptable, and your ability to price is constrained by your costs.

In the chart below, the floor of your pricing is your total costs for what you’re selling. The ceiling, or highest price, is the number at which your customer values your offer. Above this price, you lose the sale because the customer feels that your price exceeds the value he or she gets from your offer.

Between the floor and ceiling sits a price your customer will find acceptable.

Price floor and price ceiling

Source: Eric Dolansky

To choose the right price within your customer’s acceptable range, consider the main factors that affect price:

• operating costs
• scarcity or abundance of inventory
• shipping costs
• fluctuations in demand
• your competitive advantage
• perception of your price

Choosing the right pricing strategy

1. Cost-plus pricing

Many businesspeople and consumers think that cost-plus pricing, or mark-up pricing, is the only way to price. This strategy brings together all the contributing costs for the unit to be sold, with a fixed percentage added onto the subtotal.

Dolansky points to the simplicity of cost-plus pricing: “You make one decision: How big do I want this margin to be?”

The advantages and disadvantages of cost-plus pricing

Retailers, manufacturers, restaurants, distributors and other intermediaries often find cost-plus pricing to be a simple, time-saving way to price.

Let’s say you own a hardware store offering a large number of items. It would not be an effective use of your time to analyze the value to the consumer of each nut, bolt and washer.

Ignore that 80% of your inventory and instead look to the value of the 20% that really contributes to the bottom line, which may be items like power tools or air compressors. Analyzing their value and prices becomes a more worthwhile exercise.

The major drawback of cost-plus pricing is that the customer is not taken into consideration. For example, if you’re selling insect-repellent products, one bug-filled summer can trigger huge demands and retail stockouts. As a producer of such products, you can stick to your usual cost-plus pricing and lose out on potential profits or you can price your goods based on how customers value your product.

2. Competitive pricing

“If I’m selling a product that’s similar to others, like peanut butter or shampoo,” says Dolansky, “part of my job is making sure I know what the competitors are doing, price-wise, and making any necessary adjustments.”

That’s competitive pricing strategy in a nutshell.

You can take one of three approaches with competitive pricing strategy:

Co-operative pricing

In co-operative pricing, you match what your competitor is doing. A competitor’s one-dollar increase leads you to hike your price by a dollar. Their two-dollar price cut leads to the same on your part. By doing this, you’re maintaining the status quo.

Co-operative pricing is similar to the way gas stations price their products for example.

The weakness with this approach, Dolansky says, “is that it leaves you vulnerable to not making optimal decisions for yourself because you’re too focused on what others are doing.”

Aggressive pricing

“In an aggressive stance, you’re saying ‘If you raise your price, I’ll keep mine the same,’” says Dolansky. “And if you lower your price, I’m going to lower mine by more. You’re trying to increase the distance between you and your competitor. You’re saying that whatever the other one does, they better not mess with your prices or it will get a whole lot worse for them.”

Clearly, this approach is not for everybody. A business that’s pricing aggressively needs to be flying above the competition, with healthy margins it can cut into.

The most likely trend for this strategy is a progressive lowering of prices. But if sales volume dips, the company risks running into financial trouble.

Dismissive pricing

If you lead your market and are selling a premium product or service, a dismissive pricing approach may be an option.

In such an approach, you price as you wish and do not react to what your competitors are doing. In fact, ignoring them can increase the size of the protective moat around your market leadership.

Is this approach sustainable? It is, if you’re confident that you understand your customer well, that your pricing reflects the value and that the information on which you base these beliefs is sound.

On the flip side, this confidence may be misplaced, which is dismissive pricing’s Achilles’ heel. By ignoring competitors, you may be vulnerable to surprises in the market.

3. Price skimming

Companies use price skimming when they are introducing innovative new products that have no competition. They charge a high price at first, then lower it over time.

Think of televisions. A manufacturer that launches a new type of television can set a high price to tap into a market of tech enthusiasts (early adopters). The high price helps the business recoup some of its development costs.

Then, as the early-adopter market becomes saturated and sales dip, the manufacturer lowers the price to reach a more price-sensitive segment of the market.

Dolansky says the manufacturer is “betting that the product will be desired in the marketplace long enough for the business to execute its skimming strategy.” This bet may or may not pay off.

Risks of price skimming

Over time, the manufacturer risks the entry of copycat products introduced at a lower price. These competitors can rob all sales potential of the tail-end of the skimming strategy.

There is another earlier risk, at the product launch. It’s there that the manufacturer needs to demonstrate the value of the high-priced “hot new thing” to early adopters. That kind of success is not a given.

If your business markets a follow-up product to the television, you may not be able to capitalize on a skimming strategy. That’s because the innovative manufacturer has already tapped the sales potential of the early adopters.

4. Penetration pricing

“Penetration pricing makes sense when you’re setting a low price early on to quickly build a large customer base,” says Dolansky.

For example, in a market with numerous similar products and customers sensitive to price, a significantly lower price can make your product stand out. You can motivate customers to switch brands and build demand for your product. As a result, that increase in sales volume may bring economies of scale and reduce your unit cost.

A company may instead decide to use penetration pricing to establish a technology standard. Some video console makers (e.g., Nintendo, PlayStation, and Xbox) took this approach, offering low prices for their machines, Dolansky says, “because most of the money they made was not from the console, but from the games.”

Research can help you find the optimum price for your products. Generally, the optimum price is one that your customers are willing to pay, without it affecting your profits. This isn't a one-off activity, you must monitor your key pricing influences regularly as part of your overall market research to ensure your prices stay competitive and you still meet your customers' expectations.

Market testing

To help you determine how much your customers are willing to pay for your product or service you should perform some form of market testing. As a start, research your customer's purchasing behaviour such as:

• their current and anticipated demand for this type of product or service
• what they pay for similar products or services
• the quantity likely to be purchased
• additional features they value.

With this customer information in mind, you can then develop a price comparison offering a number of different product or service options for testing to help you determine a price range that is acceptable.

Competitors

You should have already determined who your direct competitors are and how your business compares to them when you developed your marketing plan. This information can be useful to help you determine your price point.

If you decide to use your competitors' prices as a guide, be careful that it doesn't dictate your prices too much, as it can seriously undervalue your product or service and drive down your profits.

When you compare your business to competitors, it's also important to ensure you look at the business as a whole and compare on other value-based traits (such as special features, quality and customer service) as well as price.

Influences

Pricing influences are external factors that can impact the price of products. Four influences that you may encounter include:

• price sensitivity
• level of demand
• level of competition
• government regulation.

Price sensitivity

Price sensitivity refers to price fluctuations as customer demand increases and decreases. For example, commodity goods such as petrol have high price sensitivity. The difference of a few cents in price can impact a customer’s behaviour.

Some markets are more sensitive to price increases than others. Price sensitivity can change over time based on a number of factors including changes in the economic environment, competition or demand. Factors other than price, such as quality, service, and uniqueness, can also influence price sensitivity.

Level of demand

Product and service demand can influence your prices. If there is high demand, it is likely you can increase your price. Price can also influence demand. For example, if the price lowers, then demand can temporarily increase.

Level of competition

Competition can also influence your product’s or service’s price. In general, the less competition you have, the more demand there is for your product. If a new competitor enters the market, the competitor can affect your price.

Government regulations

Government regulation can influence your pricing decision, as additional fees or levies may increase the sale price of your product or service.