Selecting an Appropriate Pricing Strategy: AGRICULTURAL

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AGRICULTURAL
MU Guide
PUBLISHED BY MU EXTENSION, UNIVERSITY OF MISSOURI-COLUMBIA
muextension.missouri.edu
Selecting an Appropriate Pricing Strategy
Nancy Giddens, Joe Parcell, and Melvin Brees
Department of Agricultural Economics
The focus of this publication is the selection of an
charge based on an estimate of customer demand.
appropriate pricing strategy for value-added agricul-
Together, costs and demand estimates provide you with
tural products. Selecting a pricing strategy for your
the amount of price flexibility available in pricing your
product is critical, because price is the most highly visi-
product. Competition and profit objectives will then
ble element of all marketing efforts. Consumers and
factor in to determine the price you can charge for your
competitors easily can access pricing information on
product.
goods sold at the retail level.
To illustrate this process, consider pricing soybean
Suitable pricing is important for price-quality
candles. To establish an appropriate retail price for
signaling. Price-quality signaling occurs when the price
soybean candles, the initial information you need is the
of a good indicates the perceived quality of a good.
break-even asking price, or the minimum price to
Price-quality signaling is an observable incident that
consider charging customers. MU publication G649,
affects consumer purchasing behavior. Whether or not
Break-even Pricing, Revenue and Units, explains this exam-
input materials are, in fact, higher quality does not
ple in detail and determines a break-even asking price
matter necessarily, because the consumer believes the
of $3.69. This number represents the minimum price the
inputs to be of higher quality.
soybean candle producer should consider charging. To
To price products appropriately, you need to know
establish a maximum price, the soybean candle
the following:
producer needs to determine what value customers
• Costs and profit objectives – MU publication G648,
place on a soybean candle that burns longer and cleaner.
Break-even Pricing, Revenue and Units, explains the
Suppose that through surveys or focus groups the
process used to determine break-even prices for
producer determines that the most customers would
products.
pay is $7.14. Given these upper and lower price
• Customers (demand) – What value and benefits do
constraints, the price flexibility in this scenario is $3.45
customers perceive in the product and how willing
($7.14 - $3.69).
are they to pay for it?
To determine the price to be charged given price
• Competition – How many competitors and similar
flexibility, the producer will need to factor in the effects
products are in the market and in what price
of competition and profit objectives. This is difficult due
structure?
to the subjectivity and estimates involved. To ease
subjectivity, most companies subscribe to one of five
A complete understanding of production costs,
main pricing strategies:
profit objectives, customers, competition, and other
• Premium pricing
market information helps you determine the pricing
• Value pricing
strategy that best fits your product and company. With
• Cost/plus pricing
this information, you know the minimum price you can
• Competitive pricing
charge to break even and the maximum price you can
• Penetration pricing
To compare these strategies, consider the following
This publication is one in a series on Managing for Profit
scenario. The soybean candle producer and marketer
in the Value-Added Business. This series was developed
revisits the focus group mentioned earlier. This focus
in collaboration with the staff of the Missouri Value
group consisted of nine potential customers who fit the
Added Development Center.
selected demographic profile and who used the product
$.50
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Printed on recycled paper

for one month. This group reported that the soybean
fits provided the product. A business should select a
candles burned about 60 percent longer and had 100
value pricing strategy when its product has a competi-
percent less smoke than regular petroleum-based
tive advantage that is unsustainable because of the like-
candles, the main market competitor. With these
lihood that competitors will enter the market. Generally,
attributes in mind, the group reported they were willing
value priced products attract many competitors because
to pay 43 percent more on average for a soybean-based
the price for products is high in relation to the barriers
candle than for a petroleum-based candle.
to entering the market.
With consumer information, you begin to assess
Returning to the soy-based candle scenario, the
your competition and find that petroleum-based candles
manufacturer may choose a value pricing strategy if
of the same size sell for an average of $4.99. A 43 percent
competitors can easily enter the market by simply chang-
increase equals $7.14 — the upper constraint of the price
ing a few inputs. The candle would be priced at $5.69 to
flexibility range.
compete more effectively with new market players.
Now, use this scenario to further examine the five
pricing strategies.
Cost/plus pricing
Cost/plus pricing is used when a company has a
Premium pricing
two-tiered focus: costs and return on sales. Companies
Premium pricing is used when the product has one
implement cost/plus pricing when market share and
or more unique characteristics. This uniqueness differ-
profit are the objectives. To establish a price using a
entiates the product greatly from competition and
cost/plus strategy, the company needs to determine its
creates a significant competitive advantage. This strat-
break-even price by calculating all costs involved in the
egy demands a high-quality item to merit the high price.
production and distribution of the product. MU publi-
Because of the extremely high price, premium pricing
cation G648 explains the calculation of break-even price.
generally is a short-term strategy as competitors are
Once the break-even price is known, the firm estab-
attracted to markets with high-margin items. The length
lishes a markup for each unit to be sold. The markup
of time you can charge customers a premium price
must be large enough to provide a sufficient profit, but
depends on the sustainability of the competitive advan-
should not exceed what customers are willing to pay.
tage — the greater the sustainability, the longer time
Suppose that the firm decides on a 12 percent margin for
premium pricing is a viable option.
its soybean candles. Since it already knows the break-
A premium pricing strategy yields the highest prod-
even price is $3.69, it sets the price at $4.13 ($3.69 x 1.12).
uct prices of the strategies available. It is best to use
The $4.13 price tag better enables the candle manufac-
premium pricing when there are no substitutes for your
turer to focus on costs, to reach its gross sales objectives.
product, substantial barriers to enter the market exist,
and your potential customers are price insensitive
Competitive pricing
because they value the benefits provided by the product.
Competitive pricing is a basic pricing strategy
Also, economies of scale are not necessary for this strat-
focused on cost reduction. Costs of production, market-
egy to work. The most important detail to remember is
ing, and distribution are kept to a minimum. To deter-
that you cannot use premium pricing when facing
mine a price using a competitive pricing strategy, a firm
competition. Competition would undercut your price,
can simply identify and record competitors’ prices and
leaving you with an ineffective pricing strategy and
price its product accordingly – a little more or a little less
poor product sales.
depending on differentiation. Competitive pricing
In the soy-based candle scenario, the candle manu-
maintains price status quo in product categories that use
facturer could implement a premium pricing strategy
this strategy. Consider the cereal industry for example.
effectively because of little or no competition. Research
There are many competitors with many brands to offer
from the focus group combined with the candles’
cereal consumers. However, cereal manufacturers have
unique market position results in a premium price of
reached a delicate balance over time by pricing their
$7.14 per candle. Your candles merit the premium price
products competitively. No manufacturer would benefit
because of longer burning time, reduced smoke, and no
greatly by undercutting the prices of its competitors.
competition.
Undercutting competitors’ prices would result in price
wars that would lower profits for each company
Value pricing
involved.
Value pricing is an abbreviated version of the
Obviously, competitive pricing is not appropriate
premium pricing strategy. Put simply, value-priced
for soybean candles given the added benefits valued by
products are priced a bit lower than premium products
customers.
because they face moderate market competition. A
value pricing strategy is used best when only a few
Penetration pricing
competitors exist, barriers to entering the market are
Penetration pricing is used when a company
relatively high, and potential customers value the bene-
launches a product in a market with several competitors.
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Initially, the price for the product is set low to grow
value these qualities and are willing to pay for them.
product sales and increase market share. Doing this
This willingness to pay reduces price sensitivity and,
attracts new customers more quickly and easily than
consequently, the effectiveness of penetration pricing.
other strategies. Once market share is gained, price is
increased. This strategy is effective when potential
Guide to strategy selection
customers are price sensitive and economies of scale can
Knowing and understanding production costs,
be exploited. Although this strategy might seem to work
profit objectives, customers and competition will help
for small, value-added enterprises, few will have the
you select an appropriate pricing strategy. Pricing is
infrastructure and size to operate at economies of scale.
difficult but should reflect the value and benefits your
Like competitive pricing, penetration pricing is not
product provides customers.The following table can be
appropriate for soy-based candles. Soy-based candles
used to select appropriate pricing strategies in specific
offer a competitive advantage in longer burning times
market situations.
and less smoke than other candles. Targeted customers
Selecting an appropriate pricing strategy depends on market conditions.
Entry
Price
Economies
Strategy
Substitutes
barriers
sensitivity
of scale
Goal
Premium
None
Very high
None
None
High/unit margin
Value
Few
High
Low
Low
Pro?t
Cost/plus
Some
Medium
Medium
Medium
Market share and pro?t
Competitive
Many
Low
High
High
Protect market share
Penetration
Many
Low
High
High
Market growth and leadership
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