There is a long and storied history regarding pricing of goods and services. Wikipedia has a nice overview article with linked sub-articles.
Simplicity - The Rule of Three
Complexity is managed easiest with simplicity. In this case all the various Pricing "strategies" can be summed under three specific uses of pricing:
- Pricing as a competitive weapon
- Pricing as a product attribute
- Pricing as a market segmentation tool
Pricing is Psychology
One key thing to remember is that pricing is all about psychology. It is true that some so-called rational strategies (such as cost + plus) are based on non-psychological elements, but that is simply another approach to justify or legitimate a particular price. We have learned from Goldratt that that is a fundamentally flawed approach. All pricing communicates value, it is to whom and what is of value that are the two components of a strategy.
Pricing as Competitive Weapon
This approach usually means aggressive pricing (usually undercutting the competitors in a given market) to reduce the profitability in a market and make it less attractive. Combined with an already-established brand name, and a highly profitable segment, this can be an effective weapon to attack rivals and gain market share.
Usually only a single competitor can be successful with this approach and two equally matched competitors will simply bleed each other (remember the cola wars). The best approach to counter this is a differentiated offering which cannot be overcome by lower pricing alone. (This is nothing more than elementary Porter.)
And so here we communicate to rivals about the value of the market segment, as well as the defensibility of the segment.
- A low-priced offering tells rivals that the market is unattractive
- A high-priced offering tells rivals that a market niche is defensible
Pricing as a Product Attribute
This strategy communicates to customers the value of the product.
- Low cost means it is cheap, both in price and quality
- High cost means that it is expensive, desirable, valuable, and rare
A high-quality product or service without a commensurate high price is only confusing to the customer and makes them doubt the quality of the offering. The terms affordable, reasonably-priced, competitively-priced all really mean low quality and not "justifiable price" which is what some companies want to communicate.
The best thing is to abandon trying to justify price based on anything other than the perceived value to the customer. This means that a high degree of utility of the product or service and a high or medium-high price should be the focus. There are other ways of reducing the cost of the offering so that a given segment remains profitable. Kim and Mauborgne are most instructive in terms of cost and pricing strategies.
Pricing as a Market Segmentation Tool
A fundamental understanding of a market is that there are various levels of price sensitivity and desirable product attributes. The idea is that a diversity of offerings are used in order to capture the maximum profits of each market segment.
- A high price means that only those with a low price sensitivity will buy
- A low price means that higher potential profits are foregone
Offer two products or services at different prices, and everyone's needs are met at prices they are willing to pay.
Airlines are a visible model of segmentation. More legroom and better service enable a higher price for the same transportation service. Price differentiation based on when to buy tickets perform the same function, enabling greater profits.
Here are some questions based on these three simple strategies:
- Is your pricing being used as an effective competitive weapon, communicating offensive and defensive positions to the competition?
- Is your pricing effectively communicating the value and utility of the offerings to customers?
- Is your pricing effectively segmenting the market in order to capture greater profits?