Pricing: strategies, techniques, examples [Guide 2022]

The law of supply and demand

Microeconomics teaches us that the price is established at the intersection of the supply and demand curves. When supply exceeds demand, the price falls. When demand exceeds supply, the price rises. This model works in a free market, and we have seen that it is true:

• on the automotive market in 2021 with a drastic decrease in supply (lack of components) and an explosion of profits for car manufacturers
• on the luxury watch market with an increase in demand and an explosion in the prices of certain models on the secondary market

Like any model, it has its exceptions, and we must consider pricing. Price elasticity is a component of the law of supply and demand that must always be kept in mind.

Demand for some products is relatively inelastic. For example, in the post-covid era, the luxury watch market saw a price explosion that did not decrease demand. On the contrary, this growing demand sent a positive signal to the market and encouraged new buyers to take an interest in this market.

Pricing elasticity

Demand is logically affected by price. Demand is expected to decrease as prices increase because fewer customers will want to pay a higher price.

However, many real-life situations show that a price can be inelastic. In other words, in some cases, demand does not decrease in the same proportion as a price increase:

• When energy prices rise, demand remains relatively constant because people need to travel, heat and light. This is a constrained expenditure.
• When the price of a product increases, it can implicitly send a quality signal to the consumer that encourages him to buy. On the other hand, a price that is too low may arouse suspicion, and the prospect may abandon the purchase.

The fuel market is relatively inelastic. When fuel prices rise, demand does not fall by the same amount. It takes extreme prices for demand to start to fall because people still need to travel. This gives fuel suppliers a certain amount of pricing power. For example, during the strike in Paris in October 2022, a petrol station proposed a liter of diesel at €3 without customers rebelling.

The elasticity of demand as a function of price is, therefore, a variable to be considered in pricing. Enzo Ferrari’s rule is exemplary: “Always produce one vehicle less than the demand.” Thanks to this, your pricing is optimal. Many luxury players apply this rule.

Cost-plus pricing

The “Cost Plus Pricing” method is probably the most basic and common. It consists of adding a margin to the costs of the product/service sold. It is an approach to pricing that is purely financial and in the hands of the department of the same name.

This pricing method is far from ideal because it requires understanding the product/service cost structure: fixed and variable costs. It also requires a fair allocation of overheads and ABCosting-type calculations. Finally, production costs can vary over time, and “Cost Plus Pricing” requires a permanent recalculation.

Customer-driven pricing

The “customer-driven pricing” approach is undoubtedly better than the previous one. It takes into account the willingness to pay (WTP) of customers.

This requires understanding the value that a consumer can attach to a product. This is a particularly risky exercise when the product or service is innovative, and the consumer has no reference point. Research has shown that the first consumers did not perceive the value of the first mp3 players and air conditioners, … and that pricing according to “logical” criteria would have led to an unviable situation.

Share-driven pricing

The third type of pricing is called “share-driven.” It involves letting competitive forces dictate the market price. Its objective is to gain market share.

In most cases, there is no good reason to try to gain market share at all costs. It will only harm your margins and profitability in the long term. Share-driven pricing is, therefore, not recommended in all situations.

Low cost

Price can be an element of differentiation. The price then becomes the essential element of the company’s strategy. Examples are numerous, and the current crisis context can only reinforce the popularity of this business model.

Ryanair is a typical example of a “low-cost” company. Thanks to an adapted pricing strategy, Ryanair has become the leading airline in Europe. In retail, Aldi and Lidl have also become European giants.

Companies that opt for low-cost hope to capture additional market share through low prices. They are inspired by an old pricing theory (PIMS or Profit Impact of Market Share) which made low margins a growth factor by capturing market shares.

Freemium

Freemium is a business model where pricing plays a central role. A product or service is proposed for free to the user. The latter can enjoy it without paying until he wants to unlock certain features.

Blinkist is an application that proposes book summaries. You get one “free blink” every day, but if you want more, you have to pay.

Spotify is another example of a freemium service. You can listen to music for free, but it will be interspersed with ads. You’ll have to opt for a paid subscription if you want to skip the ads and zap at will.

The “all-you-can-eat” and subscription models

This pricing model comes in many forms. Some restaurants apply an “all you can eat” formula, which has become their trademark. But the most common form is, of course, the subscription model.

Subscription is a business model that has spread in many sectors; this article gives 11 examples in sectors as diverse as e-commerce, VOD, retail, or software.

Darty proposes a subscription model that covers all the breakdowns of small and large household appliances that you may have.

PWYW (Pay What You Want)

PWYW is a very special pricing model. The customer decides what he wants to pay (Pay What You Want).

One airline company had tried it, but it was more of an auction model when you look at it closely.

SN Brussels Airlines proposed a system in which anyone could propose a voluntary amount to buy tickets. However, in the true sense, this was more of an auction system (the highest bidder won) than a Pay-What-You-Want pricing model.

Real examples of PWYW are still rare, but they do exist. A few years ago, we talked about a shoe brand, Garçonne et Chérubin, and even interviewed its founder to get his feedback on this pricing method.

In 2012 the Belgian daily Le Soir proposed a formula based on “Pay What You Want” (PWYW) pricing.

Dynamic pricing

Dynamic pricing consists in varying the prices for the same product/service according to:

• of the demand
• the offer
• the consumer’s profile

To vary prices according to supply and demand is the basis of microeconomics. Airlines do this well, and it even has a name: yield management.

What is more questionable is to vary prices according to your profile. Of course, pricing is according to the risk profile (the insurance model), but we are talking about even more dynamic pricing. The price can vary according to your actions, assumed profile, and purchasing power. This raises real ethical questions. Are we all equal in front of prices?

Technology, and in particular algorithms, have made it possible to create these consumer profiles almost in real time and calculate a probability of sale. Some applications are really “borderline.” For example, they presented facial recognition technology at the NRF retail show in New York. It opened the way to pricing “according to the customer’s head” (literally).

Luxury is a special case

A high price is part of the DNA of luxury. According to Jean-Noël Kapferer, a company active in the luxury sector has no choice but to raise its prices to send a signal to the market. This “pricing power” also reflects the attraction it has on its customers.

To maintain its pricing power, a brand like Ferrari always makes sure to “produce one less car than the demand.” This probably explains why it is doing so well, and its sales are only growing (see graph below).

LVMH is another case in point. In October 2022, during the crisis, the parent company of Louis Vuitton raised its prices in Europe. The weakness of the Euro against the dollar is encouraging American tourists to make massive European purchases. LVMH’s pricing power allows brands to easily increase their margins without fearing a decrease in demand.

Transaction History

A consumer’s transaction history or group of consumers can be used to understand how price changes affect their buying propensity. Structural equation models are the most common. These are statistical research studies that model behavior and predict the effects of a price change.

This allows you to define your pricing according to your strategic objectives:

• increase your market share
• maximize your revenue
• maximize your margin

Data from the consumer panels

Consumer panels (which we use for our B2C research) are very useful for tracking household consumption. In particular, you can observe consumption trends for each product type and deduce whether price sensitivity increases or decreases.

Data from the checkout

We can also analyze checkout data held by the retailer to detect trends in price changes.

Interviews

Short interviews at the checkout can be realized. They have the advantage of taking place in situ, i.e., in the purchase context. This is the ideal moment to make the customer’s memory work.

Sondage

We can ask questions about purchase intentions via online surveys. Our market research firm uses this approach for many surveys. The difficulty remains in differentiating between aspirations and actual behavior. A famous example is that of organic consumption. For years, surveys delivered very enthusiastic results about consumers’ intentions, but purchases did not take off. To learn more, go here for figures on the European organic market and an analysis of the 2021-2022 trends.

Note, however, that there is some skepticism about whether those surveyed can put a monetary value on an object or service. We recommend reading this article to learn more about the limitations of this type of approach.

Semi-structured interview

The semi-structured interview is more in-depth than the checkout interview. It allows us to link price sensitivity to the respondent’s situation and understand the hidden factors influencing their choices.

It is a qualitative technique whose usefulness can be understood within a more global market research approach here.

In-situ experience

Research sometimes takes place in situ. For example, environmental factors (light, noise, odors) modify consumer behavior. It is, therefore, interesting, as in this research, to vary these factors to observe customers’ reactions. We are, therefore, in a controlled environment.

Regarding price sensitivity, there are also many possibilities for conducting in-situ research. You can use a website and decide to show one price to one group of users and another price to the second group. This is called A/B testing.

If you have access to a physical location, you can imagine doing the same thing by changing the labels (or changing the prices on electronic labels). These give a lot of flexibility and minimize the costs of in-situ pricing research.

Laboratory experience

Laboratory experiments can also better control the ambient parameters and measure the customer’s reactions. Often eye-tracking technologies are very useful.

Building a real fake store just for research purposes is, of course, expensive. It exists, but technology offers new possibilities. Virtual reality allows, for example, to recreate virtual environments where customers can move around.

Purchase simulation

Experiments are also possible to simulate purchases. In this case, we will work with a panel of testers who will have to choose from several options. This is similar to A/B testing except that the environment in which the simulation is done is a test environment.

Conjoint analysis

In pricing, you will often hear about conjoint analysis. A conjoint analysis works by making the participant choose between 2 options. This technical approach does not measure absolute amounts (see the limitations raised by Diamond and Hausman in this article).

The context

When you go shopping, the environment (physical or online) “sends” signals that are unconsciously interpreted by your brain. Light, sounds, smells, but also visible or suggested images are all factors that will influence your decisions.

The brand positioning will also influence your choices without you realizing it. The simple fact of hammering in your communication that you are the cheapest will change the customers’ perceptions. In every country, retailers have positioned themselves in this niche. In Belgium, for example, the lowest price statement is part of the Colruyt logo.

The Belgian retailer Colruyt has written its commitment to low prices directly into its logo. It thus imposes a message to the consumer that will likely affect his free choice when he has to make a purchase.

Frequency and depth of promotions

The frequency and number of promotions can influence customer behavior. Alba et al. (1999) have shown that a pricing strategy based on small, frequent discounts helps to anchor the brand’s positioning in the consumer’s mind. Based on frequency, this strategy is more effective than the one that offers one-off but higher discounts.

The price differences

This pricing technique is very common. It consists of proposing an alternative as an option rather than displaying a total price. You will find 2 real examples below:

• A car rental company that applies this technique to propose extra charges (extended insurance, additional driver, …)
• A magazine (Harvard Business Review) that proposes different subscription packages but does not apply this pricing technique

On most car rental companies’ websites, options are proposed. The pricing is expressed as an additional charge per day of rental.

The Harvard Business Review subscription variants are not expressed as a price difference (although this is more effective for sales).

Avoid round prices (“just below pricing”)

This pricing technique is very common. It forms prices that are not “round”: 15,99€, 299$, 9990€, …

The brain interprets 9990€ as being significantly cheaper than 10000€. The underlying psychological mechanism has been explained in research like this. As we read from left to right, it is the first numbers read that form the impression of the price.

Psychological anchoring

An advertised price influences consumer perception. Northcraft and Neale (1987) have shown that the advertised price of property influences the perception of quality and the price paid. For example, this pricing technique is applied when “crossed-out prices” are promoted after a promotion. The former price and the applied discount will likely modify your behavior and purchase decision.

Prices of the past

The final mechanism that influences purchasing decisions is past prices. In another context (school), Caverni and Pris (1990) showed that teachers were influenced by a student’s previous grades when they had to correct a new copy.

In pricing, it’s the same thing. If you are used to always paying more or less the same price, you don’t think twice when buying the item. However, if the price increases in proportions that you find unacceptable, your brain will start working again. In times of inflation, like now, buying decisions can be questioned, which is not good for retailers. This is why producers opt for shrinkflation to keep prices constant.

Some Tropicana products have been reduced in size, so prices do not explode.