Psychological Pricing Strategy

Psychological pricing or odd price strategy was introduced as a means of marketing, way back in the early 1900s. It is a pricing strategy that helps create a positive psychological impact on buyers and tempts them to purchase a product. One of the oldest proponents of psychological pricing happens to be Tomas Bata, the world-renowned shoe manufacturer. The strategy was widely used by Wal-Mart and Chicago Daily to deal with cut throat competition in the market at the time of their respective introductions. Let us now understand the basic principles of psychological pricing.

Pricing Strategies

Customer Psychology: The demand theory of economics rightly assumes that an average customer makes his buying decision by thinking rationally. However, this pricing strategy is designed to make an average customer buy a certain product by playing with his emotions. In majority of psychological pricing cases, the customer fails to think rationally before finalizing his purchases. And not to forget, these very customers take pride for finding a cheaper deal!

Five Dollar Benefit: To help you understand this situation better, I will give you an example. Let us assume that two competing brands of cars named A and B are priced at $13,995 and $14,000 respectively. The price of car A is lower than that of car B by a mere $5. However, if the price is rounded off, both the cars are actually equally priced. Here we see that the manufacturer of car A is using the psychological pricing strategy. An average buyer fails to think rationally under such circumstances. Instead of rounding off the price to $14000, he tends to round it off to $13000. Here, the seller plays with buyer’s mind by displaying 13000 prominently in the price.

Using Superscripts: Another pricing variation is to display prices with the use of superscript. Here is an illustration to make this concept better. A pizza at a restaurant costs $5. However, the restaurant displays the price as $499! Interesting, isn’t it? Most of the customers look at $4 but fail to notice the remaining 0.99 cents. This variation is also used for quoting gasoline prices in the US.

Hidden Conditions: A number of business units around the world lure customers into their outlets by displaying product prices exclusive of taxes. There is of course, a tiny asterisk in the corner stating this fact. But the asterisk and its corresponding declaration is in a fine print. The customer realizes the ultimate price of the product much later.

The Number Play: A typical pricing strategy involves usage of specific numerals for product prices. A research conducted by Marketing Bulletin found out that numerals 9 and 5 were most commonly used in psychological pricing. E.g. A product worth $100 might be sold with a price tag of $99 or $95 or $99.99. As far as psychological pricing is concerned, the usage and popularity of numerals 9 and 5 stand at 60% and 30% respectively. The numeral 0 follows close on the heels of numerals 9 and 5. It is used in approximately 8% of psychological pricing strategies. The rest of the numerals are used only in 2% instances of psychological pricing.

Why is Psychological Pricing Used?

– One of the main motives behind use of this marketing strategy is to play with the buyer’s emotions and make him believe that he is paying lesser than the regular price. And it is a fact that some of the most rational and price-conscious customers fall for this strategy.
– By fixing an odd price for the product, the manufacturers can make the buyers feel that the products are sold at the most honest and lowest possible prices. On the other hand, customers have a tendency to assume that goods with rounded up prices have a huge profit margin.
– This strategy is assumed to help manufacturers or storekeepers keep a control over cash thefts. The assumption is made on the principle that cashiers are likely to steal some cash if customers pay the rounded off amount for their purchases. However, cashiers are forced to record a sale in their cash register if the amount is odd. This is because customers mostly pay a round sum for an odd priced product and expect to get the change back from the cashiers.

Marketing experts around the world have voted this pricing strategy to be one of the most successful ones. The advantage of using it, is that it does not require any kind of monetary expenditure from the manufacturer’s side. There are plenty of industries or organizations around the world that have adopted this strategy for years together albeit with a slight variation to suit their individual requirements.

Penetration Pricing Strategy

The mention of penetration pricing strategy always manages to raise eyebrows. Admirable in some cases; cheeky and underhand, otherwise. The intent of penetration pricing is honorable, of course. It simply aims at boosting the market share of an established product or capturing customers in case of a new launch by underpricing it. Implementing this strategy is akin to playing with fire, as a few dubious qualities associated with it can create unnecessary problems for any company.

Advantages of Penetration Pricing

Does penetration pricing work? It definitely does, and it succeeds in taking your rivals completely by surprise, giving them no time to recover from your onslaught. If your sales pick up, thanks to word-of-mouth publicity, nothing else could be better.

1. Penetration price strategy is implemented with the sole intention of spreading your presence in the market. It is an appropriate marketing tool which creates a loyalty base for your product.
2. Deliberate underpricing is suitable for average quality products and new products under automobiles, computer accessories or cosmetics. It also works well for commodities with a shorter shelf life, such as consumable items. The distributors and retailers have reasons to cheer as penetration pricing effectively accelerates the turnover.
3. The low cost manages to generate an interest, especially among those looking to snag a bargain. After this, it is up to the product to impress the consumer. If it gets an approval from the consumer, the company can think of gradually increasing the cost and rake in actual profits.
4. It results in startling your competitors, more so if the product segment is overflowing with options for the consumer. If a rival product is looking to enter the market, your penetration pricing strategy will arrest it by grabbing a lion’s share in consumer preference. It puts your product in a vantage position to establish a firm hold in its arena.
5. There are also instances where companies have managed to pocket some profit despite using this strategy. The trick used here works on products that need add-ons to function. Cheap razors that need expensive cartridges or low cost printers, which function on outrageous refills illustrate this point.
6. When a product is placed in the market at an attractive “introductory price”, consumers expect a price rise in the near future, and sometimes decide to stock up on it, thus fulfilling the purpose of penetrative pricing. Mind you, this is only possible in cases of products launched by recognized brands.

Examples: Automobiles, computer accessories, food supplies, cosmetics, etc.

Disadvantages of Penetration Pricing

The catch here is that penetrative pricing works best with products that are in demand. Just think – would consumers care any less if a new, low-priced doorknob was launched in the market? Certainly not, thus rendering it incompatible with several products.

1. A company has to forgo all hopes about making any profit in the short term. The low entry price puts to rest all chances of earning revenues. Further, if the consumer parameters are not fulfilled, the company may have to kiss the product goodbye.
2. Having thrust your product into the market with an obscenely low price, expect several hurdles when you eventually decide to hike the cost. While a price increase is inevitable, doing so may result in the consumers turning their backs to your product.
3. Consumers looking for a cheap deal often fall prey to penetration pricing. You could be missing out on your target consumers, which is not a good sign for any product looking to establish itself in the market.
4. The price is not the only factor that a consumer has in mind while buying a new product. In fact, a whole breed of consumers equate premium quality with high prices. It would be inappropriate to implement this strategy on products in the niche segment.
5. This strategy can horribly backfire if your rivals decide to join the bandwagon and lower their product prices further, triggering a price war. This can have a disastrous end, with all offenders involved having to do some serious damage control.
6. Predatory pricing is a cruel variant of penetration pricing. This is when a company prices its product abysmally low, demolishes all traces of competition, and finally creates a monopoly. Reason enough for some countries to deem this practice illegal.

Examples: Luxury products, high-end automobiles and gadgets, limited-edition products, etc.

It is impossible to remove the crookedness out of penetration pricing. This strategy stands on the premise of elbowing out competition, straying on to unethical territories at times. However, there is no doubt about its success rate and its practicality, more so in the consumer packaged goods market.

Skimming Pricing Strategy

We all know what price means in terms of commercial goods and services – it is the value we pay in exchange for receiving such goods and services. On the consumer’s side, the process of such a receipt of goods/services in exchange of a price paid is what we know as purchase or buying. On the manufacturer’s/service provider’s/seller’s side, the process of parting with such goods/services in exchange for the price received is known as sale or selling. Have you ever wondered on what basis the prices of commercial goods and services are fixed? Well, the price is the sum total of all the costs incurred in producing/procuring the goods/services plus a profit percentage which can be calculated either on the cost price or the selling price.

What is Market Skimming Policy?
As the name suggests, the market skimming strategy seeks to skim away or churn out all those customers from the market who are willing to pay a higher price just to get access to the marketer’s products or services before anyone else does. This customer segment is considered as the creme-de-la-creme, the premium segment that has a very high consumer’s surplus in terms of their demand for the product or service and are willing to pay a higher price for outstripping their contemporaries in owning such a product. Market skimming is a variant of discriminatory pricing strategy. The strategy of market skimming is to charge a higher price for a product during its initial launch in the market. Once the premium paying customer segment has been optimally exploited, the price of the product is, then, gradually lowered in order to exploit the other, lower paying consumer segments.

Adopting a skimming pricing strategy is a good way for firms, that have incurred sunk costs, to recover these before competitors enter the market and target the common customer segment. This way, while the competitors are busy planning and manufacturing similar and alternative products and services, the original marketer churns the profits out of the premium paying market segment. Sometimes, the reverse of this happens. Sometimes, when a company launches a new, novelty product/service range at a high price, the entrance of competitors soon after compels it to lower its prices to survive competition and remain in the market.

Besides recovering sunk costs, another reason for following a skimming pricing strategy is to cover up for the product life cycle by earning excess in the initial stages of the product life cycle to cover up for the stagnating market demands during its maturity stage.

Examples of Market Skimming Strategy
Most prominent instances of market skimming can be seen in the electronics and computer technology markets because upgrades come up every 6-8 months, pushing previous technology versions towards the maturity stage of the product life cycle. One such prominent example is the Sony PlayStation 3. When launched, it was priced approximately USD 600 but these days, it is available at around USD 300. Laptops and mobile phone handsets are other prominent examples of market skimming.

Skimming strategy may be profitable in the following instances:-

– The R&D costs involved in an innovative product or technology tends to be very high. Skimming serves to recover such cost before competitors get a chance to barge in on the scene.
– Once the cream customer segment is optimally exploited, the product gets established in the market. Also, being the first to introduce such a product to the market, the market skimmer becomes the market leader in that product/service.
– Skimming often helps the marketer to identify different segments for future discriminatory pricing.
– High prices mean high dealer markups and following a skimming strategy may be beneficial where third-party distributors and dealers are involved. This creates a win-win situation for both the supplier as well as the dealer.

Following are the limitations of this pricing strategy:-

– Products for whom a shift in price results in a shift in demand should not be priced under market skimming strategy as higher prices would mean lesser buyers.
– Discriminatory pricing is subject to many legal implications and as such, a marketer considering using this pricing strategy must make sure he is doing so within the scope of law.
– Stock clearance may become a problem as the premium paying segment is usually always smaller than the mainstream/lower paying segments. Manufacturers must keep this in mind while planning production volume.
– A high-priced market entrant is more likely than others to attract competitors sooner. This is due to the fact that competitors would be tempted to earn high margins as well.
– Subsequent lowering of price may tarnish the premium image of the product and marketer and people may view such a price switch as evidence of lowering of quality standards.

Types of Pricing Strategy
As mentioned previously, the price is the sum total of all the costs incurred in producing/procuring the goods/services plus a profit percentage which can be calculated either on the cost price or the selling price. Besides these, a lot of other economic and financial considerations also go into pricing such as consumer’s surplus, indifference curve analysis, margins claimed by the channels of distribution, etc. There are, in totality, eighteen types of prices and pricing strategies:-

1. Competitive Pricing
2. Cost-plus Pricing
3. Market Skimming
4. Loss Leader Pricing
5. Limit Pricing
6. Penetrative Pricing
7. Market-oriented Pricing
8. Contribution-margin-based Pricing
9. Predatory Pricing
10. Flexible Pricing
11. Psychological Pricing
12. Target Pricing
13. Leadership Pricing
14. Marginal Cost Pricing
15. High-low pricing
16. Absorption Pricing
17. Premium Pricing
18. Discriminatory Pricing

Like any other micro-economic policy, the various policies and strategies of pricing have various justifications and different benefits and limitations. What pricing strategy one marketer chooses may differ from others based upon the product/service he offers, the life cycle of such product and service and the frequency of upgrades that occur in that product segment.