Businesses searching for optimal pricing models must walk a fine line between sustainable and meaningful market share. When rolling out a new product or service, companies also need to keep a close eye on the competition, ensuring their own company neither slices margins too thinly, nor sets prices so high that the phone never rings or inventory collects dust on a shelf.
Through penetration pricing, one of several types of competitive pricing, Costco set out in 2014 to gain a foothold in the grocery space where little difference exists between products offered by its main competitors that include Kroger and Target. Largely by keeping a tight lid on operating costs, the giant retailer leveled the cost of organic foods with non-organic choices. To make up for thin margins, Costco limited store hours and offset less profit with fees from memberships, which renewed at a 90 percent clip in 2017. Competitive pricing involves three approaches, and the one you choose hinges on prevailing market conditions, your sales vision, and customer perception.
Why use competitive pricing?
Unless you have patent protection, the likelihood of bumping up against a competitive product is pretty close to 100 percent. You may have the distinct advantage of being first to market but competitors will soon follow with goods or services that duplicate the benefits of your own offerings. In this case, you’ll have to convince potential customers there’s a compelling reason to purchase from your company for the same price—perhaps a service guarantee after the sale.
You can focus solely on the next quarter or adopt a longer-term approach to customer acquisition. Pricing below competitor levels may help make a splash with buyers in the short-term and transform those customers into loyal customers as time passes. Using this strategy might lead to a loss, so be certain your business has the resources to absorb the hit. Cutting operating costs prior to launch can help lessen the impact on bottom-line dollars.
Consumers have been known to say they wouldn’t mind paying a bit more for something if only they had received additional value in return. A recent survey found 68% of consumers would be willing to pay for price increases of 15% or more for the same product or service if they received a better customer experience.
So you can charge more than your rivals, but you should be aware of the risks of potentially losing customers. Factors like improved service, online reviews, and perception, as well as an uncomplicated return policy and process, might convince people to patronize your business.
Types of competitive pricing
There are a number of specific competitive pricing models—some simple and some complex. The strategy your business chooses to run with depends on the characteristics of your product or service and the goals you hope to achieve.
Penetration pricing helps companies infiltrate new markets. Promotional efforts stimulate interest among customers new and established. Captive pricing heaps revenue from supplementary products on top of core offerings. What follows is a more detailed look at all three approaches:
1. Penetration pricing
Penetration pricing usually means unveiling a new product or service at an eye-popping price point, usually well below prevailing market rates. At such deep discounts, price-driven consumers find it difficult to resist, at a minimum, a quick comparison to the features, benefits, taste or quality of currently used goods or services. Penetration pricing is initiated largely to establish market presence, and at the outset, little regard is cast toward profit margins.
This model allows companies to gain a foothold in a new market or boost sales in an existing one. Increased sales numbers could benefit the organization through lower acquisition costs of both new customers and/or materials used in manufacturing or design. However, if demand tapers off and prices must remain low to maintain volume, profits suffer.
Companies use penetration pricing to swiftly gain the attention of a competitor’s customers. These methods are deployed to secure a targeted number of users, and once lassoed, those customers continue to buy even as prices elevate to meet revenue goals and profit margins. The object of the exercise is to push the hot button of cost-conscious buyers and convert transactional behavior into loyalty.
You may have witnessed this strategy in action through mobile phone purveyors such as Apple that, owing to its innovative devices and corresponding premium prices, is viewed as the upper crust of the smartphone industry. Yet in 2013, the tech giant offered the plastic-encased 5C iPhone for $99, rolling Yugos off the assembly line while still building and selling the Cadillac 5S model for a much higher cost. By choosing not to discriminate against consumers on a slim budget, Apple attacked and grew market share from opposite ends of the price continuum.
2. Promotional pricing
Promotional pricing assaults the consumer psyche in two ways: It suggests that items reduced in price are in short supply and that those quantities will only last for a limited amount of time. Sellers must project buying activity and calculate just how much volume will be needed to hit a prescribed revenue target.
Sales strategies can both negatively and positively impact revenue and profits. Promotions can rein in the buyer at the decision stage of the process, moved to action by a perceived sweet price. On the other hand, some consumers may view sales items as inventory that a seller wants to shed quickly, conveying lower quality and triggering avoidance even at less cost.
Like penetration pricing, sales are used to nab new customers while enticing existing customers to spend more. Buy-one, get-one-free offers, and one-day-only sales are a way to impart a sense of urgency on new and established customers alike.
Holiday promotions in grocery stores are a fine example of the practice. Food purveyors often sell Thanksgiving turkeys or Easter hams near or at cost to attract customers in hopes that more dollars are spent on fruits, vegetables or desserts whose prices might be hiked to compensate for less revenue on heavily discounted sales items.
3. Captive pricing
With captive pricing, sellers create the impression that buyers must purchase ancillary items tied to a core product. Through this method, companies remain competitive with pricing on a base item while affixing higher costs to accessories that a consumer seemingly can’t do without.
This approach works well when companies can accurately gauge the lifespan of a core product and accurately forecast what price will maximize profits for the accompanying components. Captive pricing backfires when costs for accessories are deemed so outrageous that the sales volume of the core product is adversely impacted.
Captive pricing is used in the automotive industry to appeal to brand-loyal customers who will only repair or customize their automobiles with original equipment manufacturer parts and accouterments. Many owners may have safety or quality concerns with mechanical devices or body panels that are produced by any entity other than the automaker itself.
Retailers roll the dice with captive strategies. Some companies risk revenue growth by testing the limits of customer tolerance. Faced with high prices for ink cartridges, for example, small business owners often shuck brand loyalty in search of cheaper replacement options. In 2011, Brother unveiled an affordable small business laser printer that pushed cost per page to two cents, about four to six cents less than competitors such as Hewlett Packard. Without forsaking noticeable quality, the company was able to boost global printer market share—from 7.9 percent in 2015 to 11.1 percent through Q1 2018—by implementing a calculated captive pricing approach on both core and ancillary products.
Entrepreneurs should perform their own due diligence to determine which individual or combination of pricing methodologies work best in their particular industry. Full-scale efforts to boost revenue and increase profit margins can’t be taken lightly because an error in judgment could spell disaster. Advanced pricing models allow businesses to update and automate prices in a few easy steps. Enlist the help of advanced pricing tools to assure that your pricing strategies pave a path to success.