The Variations of Optimal Pricing Strategies - Research Paper Example

OPTIMAL PRICING EXAMININATION The variations of optimal pricing strategies Pricing strategies are crucial to creating the best possible advantage to encourage the deepest profits. Whether a pricing strategy creates a high or low margin must be decided in regard to what creates the largest profit over a long term sales period. There are several strategies that must be considered in order to maximize profits. In creating a optimal pricing strategy, a company must create a situation where the product is considered the best possible choice for the customer based on all the data that is available. The three most valuable considerations when determining the pricing strategy for a product will be cost, competition, and customer. When these things are well considered, an appropriate pricing strategy can be developed in order to optimize profits for a company. According to Kyle (2010), there are seven strategies that will create the best possible profit potential for a company. Competitive pricing, cost plus mark-up, loss leader, close out, membership or trade discount, bundling or quantity discount, and versioning all are very different pricing strategies with the potential to create greater profits. Competitive pricing is determined by looking at the prices that competitors are using and then pricing one’s own product a the same or lower price. One way a company can use this to their advantage is to force their suppliers of materials into bidding on business in order to drive down the costs of creating a product. An example of this can be found through GM who does not contract with its suppliers, but rather allows them to place bids and compete with one another for their business (Hill, 2009, p. 300). For Gm this is done on a yearly basis always forcing the lowest priced supplies. However, the disadvantage of doing this type of business is that the suppliers are well aware that a guarantee of repeat business is not in place. Therefore, quality and product The variations 3 improvements are not the first concern as there is no guarantee that putting themselves in a position to provide a better product will not necessarily provide a pay-off. According to Porter (1998) value is determined by the price that consumers are willing to pay in comparison to the costs to a company to produce a product (p. xvi). The problem with competitive pricing is that while a firm might undercut the prices of another firm, the price of those costs might be absorbed by lowered quality. Therefore, cost plus mark-up might be a more feasible type of pricing. Cost plus mark-up entails the assessment of the costs of creating a product plus a mark-up that provides a suitable profit in order to come to a market price. The use of this strategy will guarantee that the cost of the product will cover the costs of bringing it to the consumer, but the problem comes when this price is then compared to the prices of competitors (Kyle, 2010). In order to attract customers a loss leader might be used to offset the higher prices on the core products for sale. The loss leader is an item that is marked at a low price that is used as a tool in order to bring customers into the door. In providing the lower cost item that acts as a lure, the quality and profit margin can be preserved (Kyle, 2010). A close-out pricing strategy comes when inventory costs more to store and maintain than it does to release at a low cost in order to clear the inventory from the warehouse. A customer will respond positively to the idea that they are getting a good deal. As well, a way to create a loyalty in a customer is to single them out through the use of membership or trade discounting. When a price is exclusive to those who belong to a membership or to a group that is designated to receive a discount, the customer loyalty that is developed can lead to more profits from greater numbers in quantity. As well, items that are bundled together in order to create a discount to the customer can create a deeper overall profit while encouraging sales through better pricing when The variations 4 purchased in bulk (Kyle, 2010). Versioning is used in many technical and services products so that items are altered in order to create a range of prices that are coordinated with the quality of the item. One item that is easily categorized as versioned is that of the iPod products from Apple. IPods currently come in four different categorization: shuffle, nano, classic, and touch. Each of these categories has some variation in color, but also in storage space that creates more variety and pricing options (Apple, 2010). Apple has tuned their products to a specific software program that allows for downloading of products in order to corner a market based on exclusivity of use and high quality performance. While iPod is not the only product that provides a capacity for the use of the technology of music storage in a small portable device, it has created a sense of monopoly a the product has the exclusivity provided by access to downloadable products for the units. Therefore, because of this monopoly scenario, the price of the product is not exclusively related to the costs of the unit, but to the perceived value of the item. Because no other firm can sell a product that will perform in the exact way that an iPod performs, competitive pricing is not a very relevant issue. Other products with similar programs exist, but none with the quality and selection that is provided through the iPod. Therefore, the number of units sold per day becomes relevant to the choice to increase or decrease the price. The choice to adjust the price is associated with the law of demand in which the number of units sold is related to the value associated to the product. If seven units are sold per day at $140 per day, then decreasing the price, according to the law of demand, should increase the number of units sold per day (Boyes & Melton, 2008, p. 232). The key to creating the best possible situation is in creating a price that will optimize the number of sales per day in The variations 5 balance with the costs of the unit to produce. When these factors come into balance, the product has a successful run. The quantity of the item to be produced is then related to the number of units per day that are expected to be sold. According to Boyes and Melvin (2010), “ all profit-maximizing firms produce at the point where marginal revenue equals marginal costs “. The profit is determined by examining the ATC (average total cost) against the demand curve and multiplied by the quantity sold (p. 235). This represents the total profit. The lowered price provides an increase in profit proportional, though, to a loss represented by the lowered price. Eventually, however, the lowered price dips below the costs of manufacturing and no longer provides a profit for the item. Most products are subject to competitive pricing through the creation of like technologies when products are successful. While the original may retain a quality that cannot be interpreted by the copycats, the copied products might find a success that takes away from the original product. In the case of iPod, there are competers such as Zune, that have produced enough of a business to provide competition for the iPod. The iPod must then price its product in a way that suits the mind set of the consumer while providing enough of a competitive price to beat the competition. In this case, the price may not be lower than a competitive product, but will still be within reason so that the existing consumers of the product continue to remain loyal. When considering the options for creating optimal pricing, the three C’s, cost, competition and customer have the deepest relevance to the end price. The cost of the item is relevant to what must be assessed in order to cover the overhead and materials that are used in creating the product. The competition must be assessed so that sales do not get diverted to a product that is similar with a better price. Lastly, the needs of the consumer must be taken into The variations 6 consideration in order to take the best advantage of available revenue that can be allocated to the purchase of the product. As in the case of iPod, the costs of the creation of the product are balanced against the value that the consumer puts on the product. The competition is handled not through pricing concerns, but through the power of the brand and the desire to own the product when the costs are within what the consumer finds reasonable to the benefit of owning the product. While there are many other products with similar functions, none have the ease of usability nor the advantages of downloadable products. This perception of a better product with an associated branding that is appealing creates a consumer that has no interest in the competition. By creating a variety of options, the consumer can have the product without considering any other brand. Competition is not handled by lowered prices, but by creating a perception of a higher quality product that is more desirable through trends. Optimal pricing is concerned with strategies that provide the best possible profit scenarios for a given product. In creating the price for a product, cost, competition, and customer must be considered as aspects of the decision. As in the example of iPod, several strategies are used in order to create the best possible price for a maximized profit. Versioning provides the consumer with a choice of products which are associated with differing options and price categories. Cost plus mark-up is the foundation for the price which is then adjusted according to the evaluation of value to the consumer. Eventually, the price comes down as newer versions are released and as increases in sales are needed to sustain the initial level of profit created at the time of the first release. Price is created through the need to create profit and in this need a complex web of strategies has the best possibility of being successful. The variations 6 References Apple. (2010). iPod. From http://store.apple.com/us/browse/home/shop_ipod/family/ipo d_shuffle?mco=OTY2ODA0Nw Boyes, W. J., & Melvin, M. (2008). Microeconomics. Boston: Houghton Mifflin. Hill, C. (2009) Strategic management: An integrated approach. [S.l.]: South-Western. Kyle, B. (2010). 7 pricing strategies that improve profit. Website Marketing Plan. from http://www.websitemarketingplan.com/techniques/pricing2.htm Porter, M. E. (1998). Competitive advantage: Creating and sustaining superior performance. New York: Simon and Schuster. Samuelson, L. (1986). Microeconomic theory. Recent economic thought series. Boston: Kluwer- Nijhoff Pub. Read More