Price and Pricing Strategies

Class 12 Entrepreneurship — Cost-Plus, Penetration, Skimming and Variable Pricing

What is Price?

Price

Price refers to the value that is put on a product. It depends on cost of production, segment targeted, ability of the market to pay, supply–demand and a host of other direct and indirect factors.

There can be several types of pricing strategies, each tied in with an overall business plan.

Pricing can also be used as a demarcation — to differentiate and enhance the image of a product.

⭐ Exam-critical fact

Price is the only revenue generating element among the four Ps — the rest (Product, Place, Promotion) are cost centres.

Cost-Plus Pricing

The most common technique: the manufacturer charges a price that covers the cost of producing a product plus a reasonable profit. The cost-plus method is simple, but it does not encourage the efficient use of resources.

Cost-plus pricing is typically based on a manufacturing estimate. Estimates of manufacturing costs are made to: justify planned capital expenditure; determine likely production costs for new or modified products; focus attention on areas of high cost. In principle, estimates cover the resources required (materials, labour, equipment), the cost of those resources, and the time they will be used. Accounting methods are used for depreciation and cash-flow analysis when capital-expenditure justifications are made.

Worked example

If a company has incurred expenses of ₹ 1000 and wants a profit margin of 10%, it will sell the product at ₹ 1100.

Advantages

The company knows exactly the expenditure incurred on making a product, so it can add profit margin accordingly — helping achieve the desired revenue (₹ 1000 cost + 10% margin = ₹ 1100).
It is the simplest method: add up all the cost, add the profit you want to earn — that gives the product price.
The company uses its own data for deciding cost, making it easier to evaluate reasons for escalations in expenses and take corrective action immediately.

Disadvantages

It does not take into account the future demand for a product — which should be the base before deciding price. A serious limitation.
It does not take into account competitors’ actions and their effect on pricing — in today’s competitive world, sole reliance on cost-plus can lead to failure of the company’s product.
It can result in overestimating the price: this method includes sunk cost, ignores opportunity cost, and there is an element of personal bias while deciding the profit margin.

Penetration Pricing

A pricing strategy where the price of a product is initially set lower than the eventual market price to attract new customers. It works on the expectation that customers will switch to the new brand because of the lower price. Penetration pricing is most commonly associated with the marketing objective of increasing market share or sales volume, rather than making profit in the short term — the price is raised later once market share is gained.

Real-world example

Toothpaste sold in a remote rural area — priced low to win customers, raised after market share is captured.

Advantages

It can result in fast diffusion and adoption — achieving high market rates quickly, taking competitors by surprise without time to react.
It can create goodwill among early adopters — creating more trade by word of mouth.
It creates cost control and cost reduction pressures from the start, leading to greater efficiency.
It discourages the entry of competitors — low prices act as a barrier to entry.
It can create high stock turnover throughout the distribution channel.
It can create critically important enthusiasm and support in the channel.

Disadvantages

It establishes long-term price expectations for the product and image preconceptions for the brand and company — making it difficult to eventually raise prices. Some commentators claim penetration pricing attracts only switchers (bargain hunters) who will switch away as soon as the price rises. (There is controversy over whether to raise prices gradually over years so consumers don’t notice, or use one large increase. A common solution: set the initial price at the long-term market price but include an initial discount coupon — perceived price points stay high while the actual selling price is low.)
The low profit margins may not be sustainable long enough for the strategy to be effective.

Creaming or Skimming

Creaming / Skimming

Selling a product at a high price, sacrificing high sales to gain a high profit — 'skimming' the market. Goods are sold at higher prices so that fewer sales are needed to break even. Skimming is usually employed to reimburse the cost of investment in original research — commonly used in electronic markets when a new range (e.g., smartphones) is first dispatched at a high price.

Early adopters:This strategy targets “early adopters” — who generally have relatively lower price-sensitivity. This can be attributed to their need for the product outweighing their need for savings, a greater understanding of the product's value, or simply having a higher disposable income.

Duration: The strategy is employed only for a limited duration to recover most of the investment. To gain further market share, a seller must use other pricing tactics such as economy or penetration. Setback: it can leave the product at a high price against the competition.

Advantages

Helps the company recover the research and development costs associated with developing a new product.
Works great if the company caters to consumers who are quality conscious rather than price conscious.

Disadvantages

Can backfire if close competitors introduce the same products at lower prices — consumers may think the company always sells at higher prices and abandon its other products too.
Not a viable option under strict legal and government regulations regarding consumer rights.
If the company has a history of price skimming, consumers will never buy at launch — they wait a few months and buy at the lower price.

Variable Price Method

Variable Pricing

A marketing approach that permits different rates to be extended to different customers for the same goods or services. Often employed where dickering over price is the norm, or where buyers participate in bidding (auctions). Even where fixed pricing is standard, variable pricing comes into play when a customer commits to large volumes — the customer must usually comply with specific criteria to enjoy pricing that varies from the standard cost.

Classic settings: Street vendors — a standard price is posted, but if the vendor really wants to sell, he/she negotiates (dickering): offers back and forth until both believe the price is fair (buyer pushes down, seller pushes up). Real estate — prospective homeowners bid below the asking price, leading to offers and counteroffers; sometimes no sale takes place.

Examples of variable pricing

Difference in order size

The 200 ml soft drink bottle is placed at ₹ 8, while the 2000 ml / 2-litre bottle is placed at ₹ 55.

Difference in anticipated business

School fees for the second child and other siblings are charged at a lower rate by schools.

Difference in bargaining power

Unbranded/assembled computers are charged differently depending on the awareness and bargaining power of the customer.

Difference in ability to pay

Public distribution shops run by the government charge different prices for wheat, rice and other food items depending on income groups.

Benefit

Sellers can move goods or services that failed to perform as originally anticipated — earning a modest profit or at least recouping their investment.

Drawback

It can lead to losing other customers who paid full price, if they find out a more recent customer received a lower price.

Pricing Strategies at a Glance

The four pricing strategies
Strategy	Approach	Best used when	Main risk
Cost-Plus	Cost of production + reasonable profit	Company wants guaranteed revenue per unit; simple costing	Ignores demand and competitors; may overestimate price
Penetration	Low initial price, raised later	Increasing market share/sales volume; entering a new market (e.g., rural toothpaste)	Hard to raise prices later; attracts bargain hunters
Skimming (Creaming)	High initial price, lowered later	Recovering R&D costs; tech launches (smartphones); quality-conscious buyers	Competitors undercut; consumers wait for price drop
Variable	Different rates for different customers	Negotiation/dickering cultures, auctions, bulk buyers	Full-price customers may resent lower prices

Exam tip

Questions often give a scenario and ask which pricing strategy is being used. Identify by the price direction: low-then-rise = penetration; high-then-fall = skimming; cost+margin = cost-plus; different prices for different customers = variable.

Think about it: When you buy the 200 ml soft drink bottle for ₹ 8 instead of the 2-litre bottle for ₹ 55, you are experiencing variable pricing by order size. When a new phone launches at a premium and drops after a few months, that is skimming. Price strategies are all around you — spot them in your next shopping trip.

Price and Pricing Strategies

Notes

Price and Pricing Strategies

What is Price?

Cost-Plus Pricing

Advantages

Disadvantages

Penetration Pricing

Advantages

Disadvantages

Creaming or Skimming

Advantages

Disadvantages

Variable Price Method

Benefit

Drawback

Pricing Strategies at a Glance