Pricing Strategies & Profit Margins
Selecting the right pricing strategies for your business is a key component of broader marketing strategies. As part of the marketing mix, your price points go along with your product or service, distribution, and promotions to establish your value proposition to customers. Some pricing strategies emphasize high profit margins, while others focus on maintaining low prices and higher sales volume.
Premium pricing and skimming are two prominent strategies used to emphasize profit maximization. Premium pricing aligns your price point with a brand image of superior quality and service benefits. It helps achieve long-term profit margins if successful. Skimming is more about short-term profit maximization. This approach emphasizes high price points initially to take advantage of eager early adopter buyers willing to pay top dollar for innovative, quality products. Service providers, such as restaurants and beauty salons, may also use skimming when entering a new, underserved market. Once clientele builds up, prices may be lowered to attract customers in the broader market.
The most significant benefit of high margin pricing is the ability to generate more income on each sale. This only works if your product or service quality justify your prices. You don't need to work as hard or sell as many units to earn reasonable profits with high margins. A child care business, for instance, could work with a small number of kids and charge high prices to optimize profit by offering a high-quality educational development program. The downside is the risk that competitors undercut your price and pull customers away. Skimming is particularly risky because if you don't get enough early sales at high prices, your total profits will suffer when you have to lower prices to appeal to lower-to-middle-income buyers.
Low margins aren't really a goal with pricing. Instead, they are the trade-off for aggressive pricing approaches used to attract buyers and create sales. Penetration pricing is a common strategy used at new company or product launches. With this approach, initial prices are intentionally modest to build a customer base quickly. The hope is to impress initial customers, and eventually get more sales and achieve higher price points. A "loss-leader" technique, where certain items are priced at or below cost, is used by many retailers to lure customers. Margins are then recovered on other higher-priced products or services. Captive pricing is a product line strategy where a company accepts a lower margin on a base product so it can sell premium components and add-on items at much higher margins. The strategy gave rise to the old saying in marketing, "Sell razors to sell razor blades."
The intent of low pricing strategies is to build up a customer base quickly. Retailers sometimes use this when entering a new territory, or as a defense against new competitors. Low price is also an effective benefit to offer in competing against higher-priced alternatives. Low profit margins are the anticipated drawback of these low-price strategies. The greater long-term risk is creating a price orientation with your customers that restricts ongoing profitability.