Pricing is one of the 4 Ps of marketing and the most basic tactic, having been around for hundreds if not thousands of years. It is the most direct way of communicating value to customers and has the most direct impact on bottom-line performance.

At the same time, price as a marketing instrument is difficult to leverage effectively because it involves integrating decision-making vertically and horizontally within the organization. Apart from the bottom line, it can also impact brand perception: Too low a price may cause the brand to be perceived as a commodity, whereas too high a price runs risk of being priced out of the market.

Pricing has multiple levels of implementation. At the highest level is strategic pricing, which takes into account long-term profit objectives of the organization at brand or franchise level. The next layer is tactical pricing, which optimizes price to take into account short-term market dynamics, including demand shifts and competitive effects. The lowest layer is execution level, where SKU-level dynamics and inventory and supply management come into play.

If too much focus is placed on strategic pricing, short-term opportunities occurring due to competitive actions may be missed or aggressive campaigns may go unchallenged, leading to expensive market share loss, which may not easily be regained. On the other hand, a myopic focus on tactical pricing will miss the big picture, causing long-term loss of profitability.

Pricing optimization is the process by which revenue is optimized by maximizing buyers for minimum reduction in price, or maximizing price for a minimal loss of buyers. This is a tricky tradeoff, as under-pricing directly impacts the bottom line and over-pricing indirectly impacts market share.

Pricing relies on tried and tested concepts from economics, like demand-supply equilibrium and utility functions.

Pricing has greater leverage for products or brands with higher price elasticity, since small changes in pricing can result in substantial changes in revenue (Price elasticity is the percentage change in demand/revenues for a percentage change in price).

The effectiveness of pricing as marketing lever is also affected by competitive pricing activities, especially for brands and products with high cross-elasticities. Cross-elasticity is the percentage change in the demand for a product for a percentage change in the price of a competing product.

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Joy V. Joseph is a director in the Business and Consumer Insights group at Information Resources, Inc. (IRI), global provider of enterprise market solutions for the consumer packaged goods, retail, and healthcare industries.