Effective Small Business Pricing Strategies: Some Guidelines

What are the main goals of a small business? What are the main goals of effective pricing strategies? What are the core elements of effective pricing strategies? The answers to these questions are markedly different depending on who you ask. For example, many graduate students and business professionals identify profit maximization as the primary goal of a company. Therefore, they mistakenly assume that effective pricing strategies must focus on profit maximization. While profit maximization is a legitimate strategic business goal, for a number of reasons, the primary goal of a business is survival, at least in the short term. In fact, when companies overlook this reality and make profit maximization their primary goal, they tend to adopt behaviors and strategies that threaten their very existence. The relevant literature is replete with modern examples such as Enron, Global Crossing, Ameriquest, etc. The primary objective of this article is to highlight some basic economic theories and practice of effective pricing strategies. This article provides general guidelines for establishing effective pricing strategies. For the formulation and execution of specific pricing strategies, consult a competent professional.

In practice, management attempts, through pricing, to recoup the costs of the core elements of the marketing mix: product, promotion, related advertising, and personal selling expenses; and the various services provided to customers by the members of the distribution channels, as well as generating adequate cash flows to operate the business profitably. Additionally, price sends different signals to various stakeholders: customers, existing competitors, potential competitors, employees, and regulators. For example, if the price is too low, the profit margin may be unsustainably low and potential customers may think that the product is inferior; and if it is too high, the company could price its products out of the relevant market segment. Establishing appropriate pricing strategies and policies is a critical part of overall corporate and marketing strategies and requires a proper understanding of key pricing objectives and price elasticity of demand. The core elements of an effective pricing strategy should include the value of the product to potential customers, the price charged by key competitors, and the costs incurred by the business from generation of the new product idea to commercialization.

Some key pricing guidelines:

Effective pricing strategies depend on a number of factors, such as price targets, price elasticity of demand, competitive position, and the stage of the product life cycle. Key pricing strategies can include penetration, parity, and premium or skim. The penetration pricing strategy is most effective when demand is elastic and involves charging below competitors’ prices to create economies of scale as a key method of building a mass market or to deter potential market entry due to low price. and to the profit margin. The parity price strategy is most effective when the demand is unitary and the product is a commodity; And it involves charging prices identical to those of the competition. The premium pricing strategy is most effective when demand is inelastic and involves charging above competitive prices to quickly recoup R&D costs or position the product as superior in the minds of customers. When survival is the primary goal, for example during a recession or initial entry into a market segment, a company may simply seek to break even: P = AR = ATC. The company sets its average revenue price equal to the average total cost or cost per unit of production. Balance analysis is a common technique for evaluating the potential profitability of a marketing alternative. The breakeven point is the level of sales in revenue or units at which the company covers all its costs. In fact, at the breakeven point, total sales revenue equals the total cost necessary to generate these sales: FC / CM, that is, the fixed cost divided by the contribution margin or SP-VC (sales price-cost variable).

Alternatively, the breakeven point can be calculated in terms of sales revenue simply by multiplying the breakeven units by the selling price or FC / [1- (VC/SP)]. Also, if a company wants to know how many units or sales revenue will produce a certain level of profit, the profit (P) can be added to the fixed cost as follows: (FC + P) / CM or (FC + P) / [1-(VC/SP)]. A more effective pricing strategy must carefully assess the various product attributes that influence pricing, such as competitive position in market segment, uniqueness, perishable, and stage in the product life cycle. And while cost-oriented pricing methods have the advantage of simplicity, marketers point to obvious drawbacks, such as ignoring demand factors, competition, and a high probability of starting a price war. A careful assessment of the price elasticity of demand can minimize these deficiencies. However, as in all business decisions there are costs and benefits, the relevant economic calculation is whether the benefits justify the costs.

Regardless of the market structure-degree of competition, the level of production where MR = MC is always the best, whether the company is making an economic profit, is at breakeven, or is operating at a loss. A small company that seeks to minimize costs must operate at the level of production where P = MR = MC = minimum ATC – price equals marginal revenue and marginal cost; and at the minimum of the average total cost. This is a very useful economic principle because when a small business is making a profit, it maximizes profits where MR = MC and when a small business is incurring losses, it minimizes losses where MR = MC. Finally, a small business should not close automatically because it is incurring financial losses. The closing principle: P