Which of the following should a marketing manager consider when determining how price will be used in marketing a product?

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.”

Pricing strategy is a science that requires you to consider many factors if you want to maximize the profits for your small business. From cost and value to what the competition is doing, here's what you need to think about when making pricing decisions for your products or services.

• Pricing decisions for products and services should first be based on how much it costs you to make or how much time it costs you to do the job.
• After that, consider what your competitors are doing with their pricing strategy. If you're able to offer a better rate, you could increase your sales.
• Psychological pricing is also a factor to consider. Pricing items in a certain way could be more appealing to customers.

Obviously, cost needs to be one of your first considerations when making pricing decisions. No business can sustain itself when costs exceed sales.

The simplest pricing models use a "cost plus" approach, in which you add a standard percentage to your costs to determine your price. For example, if it costs you $5 to make one T-shirt, you could sell your T-shirts for $10 each, covering the cost to make plus an additional $5. This will guarantee profitability as long as you maintain sales, but it may not maximize your profitability.

Customers are willing to pay what they think something is worth and don't really care about your costs. If your costs push prices above their perceived value, they simply won't buy. If the perceived value is much higher than your costs, they'll happily pay a price that gives you a huge margin.

One of the best examples of this is in retail clothing. Average markups start at about 100% of the cost, and high-end shoes can be sold for as much as five times what the retailer paid for them. For example, some Nike sneakers cost around $25 to make, yet they retail for over $100, according to an analysis by shoe review website Solereview.

While perceived value is mostly in the customer's mind, you can influence the perception by increasing your levels of service or positioning yourself as a higher-end brand. If you're looking to sell more volume at a lower margin, you might position yourself as a fair-price alternative that is accessible to everyone.

Competition is another key factor in pricing. Open and free markets are very price-sensitive, while monopolies have virtually unlimited power to raise their prices. Ask two questions about your competitors:

1. Do they offer the same level of quality and service?
2. How much does it cost the consumer to switch to a competitor in terms of time, gas, or shipping costs?

The more you can differentiate yourself, the more power you'll have to set monopoly-like prices. Even with commodities, such as gas and groceries, you can still find differentiators such as being on the right side of the road during the evening commute. If you fail to differentiate yourself and are seen as equivalent to your competitors, you'll always have to compete on price.

You also need to consider real and effective spoilage risks. A real risk is when perishable or dated items, such as milk or calendars, go bad or are no longer useful. An effective risk is when unsold seasonal items, such as holiday decorations, could be sold next year but the costs of storage lead you to scrap unsold items.

When there is spoilage risk, you either need to be more conservative when setting initial prices or faster to give discounts to prevent waste from unsold merchandise.

You don't need to earn a profit on every item. Some items can be listed at a loss to drive customers to your store in the hope that you more than make up the loss when they purchase additional, higher-margin items.

Costco is one of the industry front-runners when it comes to loss leaders. The company sells hot dogs at $1.50 each, and the price has not changed for years. It's an example of a loss leader, according to food economist David Ortega. Costco's rotisserie chickens are another example. Executives believe that customers who come to the store knowing they can pick up a quick meal will purchase additional items, grow more loyal to the store, and spur the sale of more memberships.

Early-stage companies have the problem of needing to cover their fixed costs with fewer sales and not having the purchasing power to reduce their variable costs by negotiating for volume discounts from their suppliers.

You have two options in this situation.

The first is to keep prices above costs knowing that your higher prices may make it harder to pick up market share and then reduce prices as you scale production.

The second is to set your price based on your projected break-even point and take a loss on early sales in a more aggressive push to gain market share.

Bundling has long been a favored strategy of cable, internet, and phone companies. But Walmart's $3.3 billion acquisition of Jet.com in 2016 is another good example of how bundling is a pricing strategy that can benefit a company.

While Jet.com now redirects to Walmart.com, it used to work like this: Each time a customer added an item to their cart, the price of all the items in their cart dropped by a few cents to represent the company's cost savings and increased profits from larger orders.

Bundled pricing can help increase your average sale and overall profits when customers might otherwise be inclined to only purchase one item at a time.

Sometimes, the price isn't about the actual cost but how consumers view it. This is why car dealerships like to negotiate based on monthly payments rather than the full sale price.

Customers might feel better about paying only $100 per month than $1,000 per year, and $99 sounds a lot less expensive than paying the three-figure sum of $100. At the same time, customers looking for a higher-end product or service may feel better paying a higher price than a lower one.

Pricing is just as much in the presentation as it is in the actual numbers.

The biggest question to answer is what end goal do you want to achieve? Are you trying to build market share, put competitors out of business, maximize profits, raise quick cash to survive another month, or position yourself as the low-cost alternative?

Your end goal will guide what pricing strategy you pursue and how aggressively you follow it.

A pricing strategy is a way you decide how to price your products or services so that you can make a profit. There are several different types of pricing strategies that could help you maximize profits. Not every pricing strategy will work for every business, so consider cost, value, goals, and more before choosing the pricing strategy that is right for you.

Dynamic pricing is when prices are automatically adjusted up or down at a regular cadence. A few examples of where you may experience dynamic pricing include airline tickets, hotel rooms, and Amazon. This pricing strategy is often seen online with e-commerce retailers.

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