The Pricing Strategy Matrix

You'll have to consider a number of factors when you're setting your price: your target consumer, your financial and strategic product or brand marketing objectives, and your core business objectives, for example.

You should also take other factors into account when deciding on your price strategy. For example, competitor activity, market position and dynamics, direct costs (that is, costs that go directly into producing your goods or service) and indirect costs (such as general operating expenses, insurance, and depreciation).

The Pricing Strategy Matrix

The Pricing Strategy Matrix shows how different levels of price and quality combine to form four commonly used pricing strategies:

Figure 1: The Pricing Strategy Matrix

The Pricing Strategy Matrix discussed in this article is derived from a paper by Joel Dean titled "Pricing Policies for New Products." [1]

Let's look at the quadrants of this matrix in detail.

1. Economy Pricing

Economy pricing only works sustainably when you have lower overheads and costs than your competitors. Your low cost base allows you to sell at a discount price so that you can gain a high market share.

For example, "value" supermarket chains such as Lidl® have gained a competitive edge over their mid-market and premium rivals by setting low prices. (Here, "quality" might not mean low product quality. Instead, the product range might be limited, or the packaging or environment that the product is sold in could be basic.)

Advantages:

• Economy pricing helps companies to survive during times of economic instability, as it allows them to set lower prices that appeal to customers who are "squeezed" financially.
• Selling a similar item at a lower price can help you to undercut your market rivals and gain a robust competitive edge.

Disadvantages:

• Smaller businesses that use economy pricing may struggle to remain profitable, as they are less likely to achieve the volume of sales needed for this strategy to be successful.
• When cost is a genuine, pressing issue for your customers, their loyalty is not guaranteed. Economy customers are always looking out for the "best deal," and are not afraid to switch suppliers to obtain it. This means that you're vulnerable to competitors, and that your profit margins can become unstable, varying greatly from month to month.

2. Penetration Pricing

Penetration pricing focuses on setting an artificially low initial price, or a "special introductory offer," on a high-quality product. This strategy relies on the expectation that customers will naturally switch to your lower-cost, higher-quality product, helping you to penetrate the market very quickly.

Once you have successfully launched your product or service, you can begin to increase your price or move to a skimming or premium pricing strategy.

Penetration pricing is great if you are launching a product in a market where demand tends to fluctuate significantly as prices change. This "price elasticity" allows you to use your lower launch price as a competitive weapon against your more established rivals. Satellite broadcasters, for example, often use it to grow their subscriber base, before getting existing customers to sign up for more expensive sports and movie packages.

Advantages:

• This strategy is the fastest way to win market share from your competitors and to then secure it against new rivals.
• Rapidly increasing your sales volume makes it possible to achieve economies of scale in a short space of time.

Disadvantages:

• As the price of your product is initially set quite low, your profit margins can suffer until you increase the price.
• If you set the initial price too low, it can lead to your brand being perceived as low quality, or "budget." This can make it difficult to retain customers once you decide to increase your price, and it may lead to sales falling far short of your expectations.
• It can be hard to raise your price as this can meet strong customer resistance.

3. Price Skimming

Price skimming involves setting a high price on a low-quality product, with the aim of generating as much revenue as possible from the small number of people who are prepared to buy it at that price, before lowering the price once this market becomes saturated. Once this happens, you will be able to "skim" profits from wider, more price-sensitive segments of the market.

Price skimming is often used in markets that have a high level of new product launches, and where novelty is important. A good example of this is the book market. A new book is first published in hardback for a high price and, if it sells well, it is later republished as a cheaper paperback.

Advantages:

• Price skimming is designed to maximize profits in a market.
• It is the best strategy for ensuring that you cover your production costs. Your product's lifespan will likely be short, due to the high level of product development and launch activity in these markets. So skimming allows you to take advantage of an initial high price, putting you in a better position to "skim" revenues from different customer segments as both demand and price begin to fall.

Disadvantages:

• Launching with a high price which you then drop can annoy your early buyers, who have paid a premium for the privilege of getting your product first. This can damage their loyalty to your brand, particularly if you drop the price too fast after your launch, and if products aren't sufficiently differentiated.
• Timing is critical. If you keep the price of your product high for too long, customers may begin to lose interest. This can put your potential for future growth at risk.

4. Premium Pricing

When your production costs are high and you have a unique or "prestige" product that you believe will appeal to image-conscious and aspirational buyers, a premium pricing strategy might be the best option. (Think Louis Vuitton®, Cunard®, and Rolex®.)

Advantages:

• Your product comes at a premium, which means that you have the potential to achieve a high profit margin.
• A premium price tag can help to enhance your brand identity, and adds to the aspirational quality of your product.

Disadvantages:

• Premium pricing strategies are difficult to initiate and maintain. Unit and branding costs will likely be high, while sales volumes will be low. At the same time, your product's high price tag means that you will be undercut by discount rivals.
• The risks associated with over- or underproducing a premium offering can be significant – underproduce, and you'll be unable to meet demand; overproduce, and you risk production costs destroying your profit. It's therefore essential that you accurately plan and forecast your sales when using this type of strategy.

Monitoring Your Prices

Nothing stays the same forever. The marketplace is fluid and ever-changing, and production costs are liable to fluctuate.

This means that, once you've settled on a price, it's important to monitor it to ensure that your product or service remains competitive, and that your profit margins stay healthy. Ask your customers for feedback on price, and keep an eye on your rivals' pricing strategies – particularly new entrants to the market that are using penetration pricing strategies.