Price
Pricing strategies, price elasticity of demand, and how price fits the marketing mix.
- Explain the role of price and its links to the rest of the marketing mix
- Describe and evaluate pricing strategies including cost-plus, penetration, loss leader, predatory, and premium
- Explain dynamic pricing, competitive pricing, and contribution pricing HL
- Define price elasticity of demand (PED) and calculate it HL
- Apply PED to pricing decisions HL
The Role of Price
Price is the amount paid by a customer to purchase a good or service. It is the only element of the marketing mix that generates revenue — all others generate costs.
Price is closely linked to:
- Product — price signals quality; a premium product needs a premium price
- Promotion — price promotions (sales, discounts) are a promotional tool
- Place — prices may vary by channel or geography
- Revenue — Revenue = Price × Quantity; changing price affects total revenue depending on elasticity
- Market conditions — competition, consumer income, substitute availability all affect what price is viable
- Positioning — price communicates where the product sits in the market relative to rivals
Pricing Strategies
| Strategy | Description | When appropriate | Risks |
|---|---|---|---|
| Cost-plus (mark-up) | Calculate total cost per unit, then add a fixed percentage profit margin | When costs are stable and predictable; construction, manufacturing, retail | Ignores what customers are willing to pay; may be over or under-priced relative to market |
| Penetration pricing | Set a low initial price to gain market share quickly, then raise it later | Entering a competitive market; building a customer base fast | Initial losses; difficult to raise prices later without losing customers |
| Loss leader | Price one product below cost to attract customers who then buy other, profitable items | Supermarkets, retailers with wide product ranges | Only works if other products are bought alongside; can attract one-time bargain hunters |
| Predatory pricing | Deliberately price below cost to drive competitors out of the market, then raise prices | When a large business wants to eliminate smaller rivals | Often illegal (anti-competitive); reputational risk; unsustainable long-term |
| Premium pricing | Set a high price to signal luxury, exclusivity, or superior quality | Strong brand; genuinely differentiated product; target market is price-insensitive | Limits market size; vulnerable if a competitor offers similar quality cheaper |
| Dynamic pricing HL | Prices change in real time based on demand, time, or customer segment | Airlines, hotels, ride-sharing, event ticketing | Can alienate customers who feel exploited; requires sophisticated technology |
| Competitive pricing HL | Set prices in line with or slightly below competitors | Highly competitive markets with similar products; when price leadership exists | Margins can be squeezed; does not differentiate the product |
| Contribution pricing HL | Price is set above variable cost so each unit contributes to fixed costs and profit — even if it doesn't cover full costs | When a business has spare capacity and wants to fill it; airline seats, hotel rooms | Long-term reliance on this can fail to cover fixed costs if volume is insufficient |
Note: price skimming (starting high and reducing over time) is sometimes seen here — it is similar to premium pricing but used specifically at product launch to maximise revenue from early adopters before widening the market.
Price Elasticity of Demand (PED) HL
Price elasticity of demand (PED) measures the degree of responsiveness of demand to a change in price.
PED = (% change in quantity demanded) ÷ (% change in price)
The result is almost always negative (price up → demand down), so we typically work with the absolute value.
| PED value (absolute) | Description | Effect of a price increase on revenue |
|---|---|---|
| > 1 | Elastic — demand changes a lot relative to price | Revenue falls |
| = 1 | Unit elastic — demand changes proportionally to price | Revenue unchanged |
| < 1 | Inelastic — demand changes little relative to price | Revenue rises |
What makes demand more elastic or inelastic?
- More elastic: many substitutes available; luxury goods; high proportion of income; easy to switch
- More inelastic: few or no substitutes; necessities; habit-forming; strong brand loyalty
Applying PED to pricing decisions
- If demand is inelastic: raising price increases total revenue — often used for necessities or premium brands
- If demand is elastic: lowering price increases total revenue by attracting significantly more buyers
- Governments use PED when setting taxes: taxing inelastic goods (fuel, tobacco, alcohol) raises revenue without dramatically reducing consumption
Key Terms
- Price is the only revenue-generating element of the marketing mix
- Pricing strategies: cost-plus, penetration, loss leader, predatory, premium, dynamic (HL), competitive (HL), contribution (HL)
- PED = % change in quantity ÷ % change in price; elastic = |PED| > 1; inelastic = |PED| < 1
- Raising prices when demand is inelastic increases revenue; when demand is elastic, it reduces revenue
- Always connect pricing to the product's positioning, brand, and target market
Question: The price of sneakers rises from $100 to $120. Quantity demanded falls from 500 to 400. Calculate PED and interpret the result.
Step 1 — Calculate changes:
ΔQ = 400 – 500 = –100 | Original Q = 500
ΔP = 120 – 100 = 20 | Original P = 100
Step 2 — Apply formula:
PED = (ΔQ/Q) ÷ (ΔP/P) = (–100/500) ÷ (20/100) = –0.2 ÷ 0.2 = –1
Step 3 — Interpret:
|PED| = 1 → unit elastic. A 20% price increase leads to a 20% fall in quantity demanded. Total revenue is unchanged. This business should consider whether raising price is worth the effort if revenue stays the same — unless it reduces costs per unit by producing less.
Format for "Discuss whether Company X should use Pricing Strategy A or B":
- Introduction (2–3 sentences): Context + define both strategies + state the choice to be made
- Paragraph 1 — Strategy A: Advantage → explain → evidence from stimulus → stakeholder impact (ST/LT) → disadvantage → same structure → link back to question
- Paragraph 2 — Strategy B: Same structure
- Conclusion: Summarise. State which strategy you recommend and why. Identify limitations from the case — what else would you need to know to be more certain?
In pricing questions, always consider the interaction between price and the rest of the marketing mix. A premium product at a low price creates cognitive dissonance for customers — it doesn't feel right. Conversely, a low-quality product at premium pricing will quickly fail. The best answers connect pricing back to positioning, brand, and the target market.
For each situation below, identify the most appropriate pricing strategy and justify your choice:
- A new budget airline entering a market dominated by two established carriers
- A luxury Swiss watch brand launching a limited-edition timepiece
- A supermarket selling basic white bread
- A large online retailer temporarily pricing below cost to drive a smaller competitor out of a product category
- A hotel adjusting room rates based on how close the booking is to the date
- A small bakery calculating costs and adding 40% to set its cake prices
- A cloud software company offering a per-seat licence price that covers variable costs but not full overheads during a promotional period
One-step (calculate PED):
- If the price of chocolate bars rises by 20%, the quantity people buy drops by 10%. Calculate PED and interpret the result.
- A 15% rise in the price of petrol only reduces the amount demanded by 5%. Calculate PED. Is demand elastic or inelastic?
- When the price of movie tickets increases by 25%, ticket sales fall by 40%. Calculate PED. What happens to total revenue?
Two-step (calculate change in revenue):
- The price of headphones rises from $100 to $120, and sales fall from 1,000 to 800 units. Calculate PED. Has total revenue increased or decreased?
- A coffee shop raises latte prices from $4 to $5, and daily sales drop from 200 cups to 140. Is this a good decision? Justify using PED.
- A gym membership falls from $80 to $60 per month, and membership rises from 300 to 420. Calculate PED. Should the gym have cut the price?
Show answers
- PED = –10% ÷ 20% = –0.5. Inelastic — a 20% price rise reduces demand by only 10%, so revenue rises.
- PED = –5% ÷ 15% = –0.33. Inelastic — demand is relatively unresponsive to price changes.
- PED = –40% ÷ 25% = –1.6. Elastic — a price rise causes a proportionally larger fall in demand, so total revenue falls.
- PED = (–200/1000) ÷ (20/100) = –0.2 ÷ 0.2 = –1. Original revenue: $100 × 1000 = $100,000. New revenue: $120 × 800 = $96,000. Revenue has decreased.
- PED = (–60/200) ÷ (1/4) = –0.3 ÷ 0.25 = –1.2. Elastic — revenue falls from $800 to $700. This is not a good decision based on PED alone.
- PED = (120/300) ÷ (–20/80) = 0.4 ÷ –0.25 = –1.6. Elastic — cutting price increases revenue: $80 × 300 = $24,000 vs $60 × 420 = $25,200. The price cut increased revenue.
Nexa Audio is a high-end boutique manufacturer launching the Nexa-Buds — eco-friendly wireless headphones with revolutionary noise-cancelling technology and a 100-hour battery life. Production cost per unit is $120. The current market leader sells comparable headphones for $350. Nexa's brand is associated with innovation and sustainability.
- Should Nexa use premium pricing, cost-plus pricing, or penetration pricing? Discuss at least two options.
- The Finance Director wants a 60% mark-up. What price does this produce? Is it appropriate?
- How does Nexa's brand positioning affect the pricing decision?
Show answer for Q2
60% mark-up on $120: $120 × 1.60 = $192. This is well below the market leader's price of $350. Given Nexa's premium positioning, this may undercut the brand's perceived value — a low price could signal lower quality to customers who use price as a quality cue.