Set pricing Strategy objectives

While there is no single recipe to determine pricing, the following is a general sequence of steps that might be followed for developing the pricing of a new product:

1. Develop marketing strategy - perform marketing analysis, segmentation, targeting, and positioning.
2. Make marketing mix decisions - define the product, distribution, and promotional tactics.
3. Estimate the demand curve - understand how quantity demanded varies with price.
4. Calculate cost - include fixed and variable costs associated with the product.
5. Understand environmental factors - evaluate likely competitor actions, understand legal constraints, etc.
6. Set pricing objectives - for example, profit maximization, revenue maximization, or price stabilization (status quo).
7. Determine pricing - using information collected in the above steps, select a pricing method, develop the pricing structure, and define discounts.

These steps are interrelated and are not necessarily performed in the above order. Nonetheless, the above list serves to present a starting framework.

Pricing Objectives

The firm's pricing objectives must be identified in order to determine the optimal pricing. Common objectives include the following:

• Current profit maximization - seeks to maximize current profit, taking into account revenue and costs. Current profit maximization may not be the best objective if it results in lower long-term profits.
• Current revenue maximization - seeks to maximize current revenue with no regard to profit margins. The underlying objective often is to maximize long-term profits by increasing market share and lowering costs.
• Maximize quantity - seeks to maximize the number of units sold or the number of customers served in order to decrease long-term costs as predicted by the experience curve.
• Maximize profit margin - attempts to maximize the unit profit margin, recognizing that quantities will be low.
• Quality leadership - use price to signal high quality in an attempt to position the product as the quality leader.
• Partial cost recovery - an organization that has other revenue sources may seek only partial cost recovery.
• Survival - in situations such as market decline and overcapacity, the goal may be to select a price that will cover costs and permit the firm to remain in the market. In this case, survival may take a priority over profits, so this objective is considered temporary.
• Status quo - the firm may seek price stabilization in order to avoid price wars and maintain a moderate but stable level of profit.

For new products, the pricing objective often is either to maximize profit margin or to maximize quantity (market share). To meet these objectives, skim pricing and penetration pricing strategies often are employed. Joel Dean discussed these pricing policies in his classic HBR article entitled, Pricing Policies for New Products.
Skim pricing attempts to "skim the cream" off the top of the market by setting a high price and selling to those customers who are less price sensitive. Skimming is a strategy used to pursue the objective of profit margin maximization.
Skimming is most appropriate when:

• Demand is expected to be relatively inelastic; that is, the customers are not highly price sensitive.
• Large cost savings are not expected at high volumes, or it is difficult to predict the cost savings that would be achieved at high volume.
• The company does not have the resources to finance the large capital expenditures necessary for high volume production with initially low profit margins.

Penetration pricing pursues the objective of quantity maximization by means of a low price. It is most appropriate when:

• Demand is expected to be highly elastic; that is, customers are price sensitive and the quantity demanded will increase significantly as price declines.
• Large decreases in cost are expected as cumulative volume increases.
• The product is of the nature of something that can gain mass appeal fairly quickly.
• There is a threat of impending competition.

As the product lifecycle progresses, there likely will be changes in the demand curve and costs. As such, the pricing policy should be reevaluated over time.
The pricing objective depends on many factors including production cost, existence of economies of scale, barriers to entry, product differentiation, rate of product diffusion, the firm's resources, and the product's anticipated price elasticity of demand.