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When we talk about pricing strategies, we often mean the determination of fundamental decisions in pricing policy – such as a high-price or low-price strategy. The core question of the pricing strategy is how prices are set for products or services.
The pricing strategy, on the other hand, refers to the “Pricing” or “Price Management” function within the company. The core question of a pricing strategy is how the ability to set prices is built and organized within the company.
In retail and e-commerce, both perspectives must be worked out with a specific industry reference.
The pricing strategy determines the fundamental decisions regarding the formation of prices.
It begins with the fundamental decisions of the pricing strategy and specifies them in pricing tactics (also called pricing concepts), which are then broken down into concrete pricing logics for price calculation.
We consider this hierarchy in pricing in the following sections.
Pricing strategies involve fundamental decisions about how prices are set.
Pricing strategies involve fundamental decisions about how prices are set. Among other things, these decisions are based on the strategic competitive advantage defined by senior management, which affects the entire marketing mix—including aspects beyond the company itself. The appropriate pricing strategy is then selected to match the company’s context and objectives. Accordingly, it should be reviewed at regular intervals over time whether the “best pricing strategy” for the current context is still being pursued. This review of the right pricing strategy typically takes place once a year in what is known as a “Pricing Strategy Review.”
These decision dimensions and possible characteristics in the various pricing strategies are described below. It is important to keep in mind that not all types of pricing strategies are equally relevant for a company in retail, wholesale, or e-commerce.
Price level strategies refer to the positioning of the relative price level compared to relevant competitors. This price positioning corresponds to a brand positioning that is as congruent as possible. As classic examples in the food retail sector, (hard & soft) discounters rely on a low-price strategy, while supermarkets focus on a mid-price range and organic food stores pursue a high-price strategy.
Dynamic pricing strategies refer to the conscious change in the price level over time.
Skimming strategies begin with a relatively high price level that decreases over time. The economic logic is that a higher willingness to pay—for example, from “early adopters”—is skimmed accordingly, to then reach customers with a lower willingness to pay through subsequent price reductions.
Penetration strategies deliberately employ a low introductory price for new products to attract as many customers as possible and achieve a relatively high market share early on. The sales volumes are intended to lead to cost advantages (“economies of scale”), which in turn should build barriers to market entry for competitors. This price is dynamically increased at a later point.
The cost-oriented pricing strategy refers to the calculation basis of pricing. This strategy is based on the costs for the production (for producers) or the purchase (for merchandise) of products or the provision of services. A profit margin is added to these production costs or purchase prices, which should lead to a profitability that is appropriate from the company’s point of view. In practice, different levels of contribution margin accounting are taken into account as a cost basis – from pure variable unit costs to an almost proportional full cost accounting. Cost-oriented pricing strategies are simple to implement and apply, but do not necessarily ensure that the price determined in this way is competitive and that the perceived value or the willingness to pay of the target customers is taken into account. This leads us to a competition-oriented strategy in the determination of prices.
The competition-oriented pricing strategy relates prices for products and services to the prices of competitors. The price difference can be “zero,” but it does not have to be. Companies can consider a price difference for each competitor deemed relevant. This price difference can be positive if, for example, brand perception is higher compared to the respective competitor. However, the price difference can also be negative, meaning that a price below that of a competitor is maintained according to the brand position.
The competition-oriented pricing strategy raises the question of which of the market participants takes the initiative in the event of price changes and which competitors then follow. You make the decision as to whether you want to cancel the current relative price level between the market participants and consciously increase or decrease prices. This decision is often preceded by scenario analyses that anticipate how the competition will react, what relative price levels will result from this, and how the market shares will shift in sales.
A cost- or competition-oriented pricing strategy only leads to optimal prices by chance. We remember: Price and value are the two sides of the same coin. Customers are (maximally) willing to pay the price for a product or service that corresponds to the perceived value. Why should customers pay more for an offer than it is worth from their point of view? The perception of value and the resulting willingness to pay vary depending on the target group of customers.
A related concept to value perception is the importance of price from the customer’s point of view for the purchase decision. Simply put, there is greater scope for design in pricing if the price is less relevant for customers.
Why is a <em>cost-oriented pricing strategy<em> not optimal?
Suppose you develop a new feature for a product. From the customer’s point of view, this feature justifies a price surcharge of 100 euros. However, this price surcharge can be below or above your target margin. If the additional willingness to pay of your customer target group is above a profit surcharge that is appropriate from your point of view, you will offer the product too cheaply. If the willingness to pay is below an appropriate profit surcharge, the price will be set too high. In the latter case, you could have already incorporated the value perception, the willingness to pay, and the expected pricing into the product development.
Why are <em>competition-oriented pricing strategies<em> not optimal?
A consistently competition-oriented pricing approach reduces the customer’s decision to the “price” dimension. These pricing strategies overlook the “value” of products and services from the customer’s perspective, which varies depending on the offering from retailers. Similarly, competition-oriented pricing (just like cost-oriented pricing strategies) neglects the possibility of price differentiation within one’s own product range.
In short: If the customer’s perception of value is considered, one’s own pricing can be significantly more “surgically precise” than with a pure focus on one’s own costs and competitors’ prices.
“The use of Artificial Intelligence in decision-making will become a strategic competitive advantage. Companies currently lack the competence to use and understand AI, the associated trust in AI outputs, and the necessary data infrastructure to make AI work for decisions.” Dr. Markus Husemann-Kopetzky, Managing Director, Price Management Institute
The pricing strategy is developed. But how should prices be set? Which “Guiding Principles” direct the determination of prices?
Within a defined pricing strategy, pricing tactics are used to further increase the effectiveness of the underlying strategy. We highlight two classes of pricing tactics in this article.
Tactics of price differentiation set prices and relative price levels for articles and sub-ranges (e.g. subcategories and sub-product groups) at different levels.
This price differentiation is based on the willingness to pay and price expectations of customers. In retail, wholesale, and e-commerce, prices are differentiated along various dimensions—these include, among others:
These price differentiations offer sales, revenue, and profitability potentials compared to an undifferentiated, “average” pricing decision (“one price fits all”).
Dynamic pricing means that prices are adjusted over time to the respective price-determining context. If the influencing factors on pricing change, the price reacts accordingly to these developments.
Dynamic pricing is commonly equated with frequent price changes. This is not a mandatory characteristic of dynamic pricing. In this context, we more accurately refer to it as “adaptive pricing.” Even if the input variables for pricing are frequently collected and evaluated, it can be decided that prices should maintain a certain stability if this price stability itself provides value from the customer’s perspective.
Dynamic pricing is primarily a technically supported pricing tactic that ensures one’s own pricing is close to the intended target prices. This approach—also referred to as “dynamic pricing strategies”—can be based on either rule-based or algorithmic price optimization. We will examine both classes of pricing logic in the following section.
The calculation and determination of the prices for individual products are carried out according to the pricing logic. Here we distinguish two basic approaches.
In rule-based pricing, decision trees are created. These decision trees usually consist of two parts.
The first part determines the scenario for which a pricing rule is to apply. This is the so-called differentiation layer.
The second part defines the actual rule. Price rules consist of (1) equalization rules, (2) maximum rules, and (3) minimum rules.
A simple example could be: For “corner items” in the “dairy products” category (e.g., 1 liter, 1.5% fat content, private label) [= identification layer]
Price rules help to establish uniform procedures in pricing, to document expert knowledge, and to scale price calculations.
Algorithmic price optimization goes beyond rule-based pricing. Instead of static price rules that have been configured by experts, algorithmic price optimization starts with a range of possible prices. In extreme cases, this range can range from the purchase price (PP) as the lower limit and the recommended retail price as the upper price limit.
In this price range, an algorithm finds an optimal price. The business owner not only provides the algorithm with the price range (“guardrails”) but also defines the optimization direction. This optimization direction—mathematically referred to as the objective function—is usually based on financial key performance indicators (KPIs) that can be in conflict with each other: revenue, sales volume, and profit (contribution margin).
Therefore, the objective function defines a target variable that is to be maximized, while a minimum level is defined for the other target variables. For example, the optimization algorithm can set the prices in such a way that a sales growth of 2% is maintained, while the contribution margin is maximized.
Pricing strategies focus on price setting. The pricing strategy focuses on “Pricing” or “Price Management” as a corporate function. We will adopt this perspective in the following section.
How important is pricing as a function and as an entrepreneurial skill for your business success?
What role does pricing play in your corporate strategy?
What do we understand by strategy at all?
According to a classic definition, strategy means creating a unique and valuable position that requires a different set of activities.
[Original: “Strategy is the creation of a unique and valuable position, involving a different set of activities.” – Porter, M. E. (1996). What is a strategy? Harvard Business Review, November, 74(6), 61-78]
In order to achieve a competitive advantage, a company must perceive other activities and do things differently. This may sound like a truism – but fundamental truths do not necessarily have to be complicated. The opposite is often the case.
In their book “Playing to Win,” Alan G. Lafley and Roger L. Martin, both renowned experts in corporate management and strategy, describe: “At its core, strategy is about making specific choices to win in the marketplace. (…) Strategy, therefore, means making conscious decisions—to do some things and not others—and building the company around those decisions. In short: strategy is choice. More specifically, strategy is an integrated set of choices that uniquely positions the firm in its industry to create sustainable competitive advantage and superior value compared to the competition.”
[Original: “Really, strategy is about making specific choices to win in the marketplace. (…) Strategy, therefore, requires making explicit choices—to do some things and not others—and building a business around those choices. In short, strategy is choice. More specifically, strategy is an integrated set of choices that uniquely positions the firm in its industry so as to create sustainable advantage and superior value relative to the competition.” – Lafley, A. G.; Martin, R. L. (2013): Playing to Win: How Strategy Really Works, HBR Press (p. 11)]
The authors describe five choices and questions (“Choices”) that companies should answer in the strategy development process (ibid., p. 24).
Roger L. Martin succinctly captures this compelling need to become concrete in strategic implementation:
“And ‘capabilities and management systems’ act as a reality check on the ‘where to play’ and ‘how to win’ choices. If you can’t identify a set of ‘capabilities and management systems’ that you currently have, or can reasonably build, to make the ‘where to play’ and ‘how to win’ choices come to fruition, you have a fantasy, not a strategy.”
[Original: “And ‘capabilities and management systems’ act as a reality check on the ‘where to play’ and ‘how to win’ choices. If you can’t identify a set of ‘capabilities and management systems’ that you currently have, or can reasonably build, to make the ‘where to play’ and ‘how to win’ choices come to fruition, you have a fantasy, not a strategy.“ – Martin, R. L. (2020): Five Questions to Build a Strategy in HBR Guide to Setting Your Strategy, HBR Press (p. 95)]
Pricing and price management are a core capability that supports the aforementioned questions 4 and 5 and must be considered in the corporate strategy.
If you would like to discuss the added value of a smart pricing strategy without obligation, please feel free to arrange a meeting with us. Introduction.
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