Market based pricing

An introduction to market-based pricing

Choosing a price for a new product or service is a decision to be made with careful consideration. With accurate market data, a market-based pricing strategy can help a company maximize its profits for that product or service. Using this data, a company may set the price at market price, below market price or above market price.

What is Market Based Pricing?

Market-Based pricing (MBP) refers to the idea of setting a price for an item based on the current market price for the same or similar item.

As opposed to cost-based pricing, market-based pricing will focus on demand, the product and brand's perceived value, market competition, and the product life cycle.

Market-based pricing = cost of product + market factor price + premium*

'Market factor' relates to the market data to be considered, such as competitor brands, competing products and their features, product availability, historical prices.

'Premium' refers to the perception of quality or actual quality differential between the retailer's product and the market equivalents. If a company's brand is positioned as a premium retailer, it could also add a premium.

What is the process of Market Based Pricing?

When using a market-based pricing strategy, before deciding the price of your product, you must study these market factors;

  1. Indirect and direct competitor brands
  2. Competitor sales and data
  3. Product demand and availability
  4. Historical sales and competitive data
  5. Your target audience
  6. The lifecycle of your product

The strategies and tools of market-based pricing

Strategies for MBP involve a process whereby the prices for a product are fixed following a study of the costs of producing similar products available on the market. It does depend on what the other products have to offer, whether this is more or less than the competitive product. The business then uses this information to set the price for their product.

To achieve this, a business needs to look carefully at the costs they incur for producing the product themselves and look at their competitor's products to see where they might sit in terms of costs compared to the prices they are charging. They need to consider the finer details, such as whether the competitor's products have more or fewer features, helping them determine where their pricing will sit.

Another strategy is how the product is introduced to the market. If significant demand has been created, then there is a likelihood that buyers will be prepared to pay a higher price to be one of the first people to own that product. At this point in the product life cycle, demand for the product may well outstrip the initial supply available. As the product ages and enters the second half of its lifecycle, which is particularly true of any products in technology, then a lower price may need to be introduced.

With this in mind, many businesses prefer to set their prices higher at the beginning of a product's life with the idea of dropping them or offering discounts once initial interest in a product has subsided.

The advantages

MBP is an ideal choice for supporting revenue and competitiveness. Using competitors as a benchmark allows a company to select the most competitive price upon launching a product. When they price lower than competitors, they should, in theory, attract more sales. If they choose to price higher, they need to offer features that are not present in the competitor's product.

A company should consider the demand when determining the correct price that will allow them to maximize sales. If, for example, they launch a new product at a low price, they should gain market position. For example, a cost-based pricing approach may not achieve these gains. Using this strategy, the company may set a high selling cost because it will have to bear the higher initial costs involved with the marketing and developing of the product. This can result in product failure, as consumers may not be willing to buy a more expensive product.

The disadvantages

It can be challenging to measure consumer taste, satisfaction or preference. The satisfaction level is highly subjective and therefore not easy to assess, making it difficult to quantify into prices.

Preferences and taste are also dynamic. Whilst the price may have been suitable for a product and resulted in success in the past, this does not guarantee success either in the current moment or for the future.

It is not only the product's price and features that influence the consumer's satisfaction and demand. The image of the company can also play its part. For example, in a developed country, consumers will prefer purchasing from companies with an environmentally friendly outlook, even if this means a slightly higher price.

Companies need to adjust their prices to the desires and needs of their consumers and competitive conditions. These adjustments can be quicker and more expensive and do not always match the company's resources and capabilities.

As prices may only be appropriate for some consumers, companies may find it necessary to split the market into several groups. Those consumers in one group many are alike in terms of preference, willingness to pay and taste. Companies can charge differentiated prices to different groups of consumers if this is the case.

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