0264 · 3.3.2Price

Pricing foundations

0:00A new electronic gadget can launch at a high price, while a café might charge almost the same as nearby competitors. Both decisions can make business sense. The right choice depends on costs, customers, competition and the business’s aims. By the end of this video, you will understand five pricing methods and how to justify a suitable choice. Price is the amount customers pay for a product. For the business, the price it sets affects how much it receives from each sale and how many customers are willing to buy.

0:28A high price can provide more money per sale, but some customers may choose another supplier. Charging less can attract buyers, although the business then receives less from each purchase. Revenue is the income a business receives from selling goods or services, and profit is total revenue minus total costs. These definitions help us judge pricing decisions because extra sales bring additional costs as well as income. A successful method must fit what customers will pay and what the business needs to achieve.

0:58Demand is the quantity customers are willing and able to buy at a given price over a particular period. The five methods are cost-plus, competitive, penetration, skimming and dynamic pricing. Each starts from a different consideration, such as production costs, rival prices or changing demand. Understanding that starting point explains both the benefits and the risks of each method.

Cost-plus and competitive pricing

1:20A mark-up is the amount added to cost when setting a selling price. Cost-plus pricing sets the price at the cost of making the product plus a percentage mark-up for profit. To find the cost of each item, the business divides total cost by output, and the result is called average cost. It then adds its chosen percentage to this average cost. Willow Craft makes wooden desk organisers. Its average cost is eight dollars per item, including an allocation of all its production costs.

1:48The owner chooses a twenty-five per cent mark-up on that cost. We calculate the addition first because the percentage applies to the eight-dollar cost. Eight dollars divided by one hundred gives eight cents, which is one per cent of the cost. Eight cents multiplied by twenty-five gives a mark-up of two dollars. Eight dollars plus two dollars gives a selling price of ten dollars per organiser. The business receives two dollars above its estimated average cost on each sale.

2:13For Willow Craft, the advantage is simplicity because the owner can apply the same approach across several products. The method also allows for costs in the price, provided the estimates remain accurate and expected sales are achieved. Its weakness is that the calculation ignores competitors and customer demand. Buyers may reject the resulting price, so the business can struggle to achieve its planned sales. Cost-plus pricing suits a business that can estimate unit costs reliably and expects customers to accept the resulting price.

2:41The percentage mark-up is measured against cost. In our example, twenty-five per cent applies to eight dollars, and the addition is two dollars. Actual profit still depends on sales and whether total costs match the estimates. Competitive pricing sets a price similar to or just below competitors’ prices. This starts with what other suppliers charge for comparable products. Clear Stream offers car washing services. If nearby rivals charge fifteen dollars for a similar service, its owner might match that price.

3:11Charging fourteen dollars would put Clear Stream just below them. In a crowded market, Clear Stream gains an advantage because customers comparing prices have less reason to reject its service. Matching rivals can also give the owner a useful guide when buyers already know typical charges. However, competitors may have lower costs than this business. Copying their prices could leave too little revenue to cover its own costs. Customers can benefit from competitive pricing because businesses face pressure to keep charges close to available alternatives.

3:42For the business, further price reductions by rivals create another risk. Following every reduction can shrink the amount earned from each sale. This method suits markets with many similar products, but the business must check its own costs before choosing a price.

Penetration and skimming pricing

3:56Market share is a business’s sales revenue as a percentage of the total sales revenue of the whole market. Penetration pricing sets a low launch price to gain market share quickly, with the intention of raising it later. Meadow Dairy produces fruit yoghurt and wants customers to try its new range. A low introductory price gives buyers an immediate reason to choose it over familiar alternatives. The business benefits if this encourages trial purchases and quickly builds a customer base.

4:23Customers gain from the lower introductory price because they spend less when trying the product. However, the business receives less revenue per sale at first. Its total revenue depends on how many items customers buy, so increased sales are important to the method’s success. Penetration pricing also carries an image risk because customers may associate the low price with basic quality. Raising the price later can cause some buyers to leave for cheaper alternatives.

4:50Meadow Dairy therefore needs customers to value the yoghurt enough to return after the introductory period. This method suits a launch where attracting many buyers quickly matters and the business can afford limited early earnings. Price skimming sets a high launch price for a new or unique product, then lowers it later. Birch Works makes a new flower pot that waters its plant automatically for a whole month. No rival product offers this feature yet.

5:13Some early customers place a high value on it. The business can therefore charge them more before offering lower prices to a wider market. For Birch Works, high revenue per sale can help recover the money spent developing its product. A high price may also support a quality image because buyers often associate expensive products with premium performance. Customers who value early access gain the opportunity to own the new pot immediately.

5:37Their willingness to pay makes the high launch price possible. The disadvantage for the business is a smaller initial market because many customers cannot afford or justify the price. High potential earnings can also attract competitors that introduce similar products. Once buyers have close alternatives, maintaining the launch price becomes harder. Skimming therefore suits a distinctive new product with customers willing to pay more and limited immediate competition. The direction of the planned price change helps distinguish the two launch methods.

6:09Penetration begins low to encourage rapid adoption, and the intended later movement is upwards. With skimming, the price begins high and falls as the business seeks additional customers. Their starting prices reflect different aims and different customer situations.

Dynamic pricing

6:23Dynamic pricing changes prices frequently according to demand, time or the customer. Harbour Rest provides overnight accommodation and adjusts room charges through its online booking system. During a busy period, many customers compete for the remaining rooms. The business can raise its price because demand is strong relative to the rooms available. During quieter periods, lower charges can attract bookings that would otherwise be lost. The advantage for Harbour Rest is the opportunity to maximise revenue from available rooms as conditions change.

6:53Customers with flexible travel dates can benefit by selecting cheaper periods. Airlines use the same principle for seats on busy dates, and taxi services charge more for rides at busy times. However, customers may consider dynamic pricing unfair when similar purchases carry different charges. A sudden increase can damage trust and encourage buyers to choose another supplier. The business also needs reliable information and a system capable of adjusting prices accurately.

7:20This method suits markets where demand changes frequently and customers commonly make purchases online.

Justifying pricing choices

7:26A useful accuracy check is to separate money received per sale from total revenue. A higher price brings more revenue from each buyer, while the number of purchases determines the overall result. Cost-plus calculations rely on accurate cost estimates and sufficient sales. For dynamic pricing, connect each adjustment to demand, time or the customer. In Paper One Short Answer and Data Response, stimulus material can support a calculation or an explanation of a pricing method.

7:54Paper Two Case Study can require a justified choice for a particular business. Explain means set out purposes or reasons, say why and how, supported with relevant evidence. To justify, you support a case with evidence or argument. An explanation should connect a method to a business consequence. For example, a low introductory price encourages customers to try a new product. If those customers return, the business gains repeat sales.

8:19A justified recommendation also uses case details and explains why a suitable alternative is weaker in that situation. Heron Labs makes a wearable translator with a unique offline feature. This small business has eight employees and has spent twenty thousand dollars developing the product. It has thirty thousand dollars available for launch. Travellers are willing to pay for the distinctive feature, and its aim is to recover development spending. Consider this information and justify an appropriate pricing method.

8:48I recommend price skimming for Heron Labs. Its unique offline feature gives interested travellers a reason to accept a high launch price. High revenue per sale would help recover the twenty thousand dollars spent on development. Penetration pricing is weaker because a low introductory charge would give up revenue from customers already willing to pay more. Skimming therefore best supports recovery of development spending while the feature remains distinctive. Maple Corner sells drinks and snacks from a new café.

9:14It has four employees and six thousand dollars available to support the launch. Several established competitors on the same street charge five dollars for a comparable drink. The owner has checked that this price can cover costs at expected sales. Its aim is to attract regular customers while covering costs. I recommend competitive pricing for Maple Corner. Charging five dollars matches nearby alternatives, so customers comparing similar drinks have less reason to reject the new outlet.

9:41This checked price supports cost coverage, which matters because the business has only six thousand dollars available. Penetration pricing is weaker because lower early revenue per sale would put greater pressure on those limited funds. Competitive pricing therefore offers a suitable starting point for attracting regular customers while covering costs. Keep the five definitions connected to their starting points. Cost-plus pricing sets the price at the cost of making the product plus a percentage mark-up for profit.

10:08With competitive pricing, the price is similar to or just below competitors’ prices. These approaches begin with costs and rivals respectively, so each needs a check against the other. Penetration pricing sets a low launch price to gain market share quickly, with the intention of raising it later. Its appeal comes from encouraging customers to try the product. Price skimming sets a high launch price for a new or unique product, then lowers it later.

10:32That approach uses early customers’ willingness to pay more. Dynamic pricing changes prices frequently according to demand, time or the customer. The best recommendation links the method to the business’s product, finances, customers and aims. Use two relevant case details, then explain why the strongest alternative is weaker. A convincing choice shows how the proposed price helps that particular business achieve its objective.