Pricing decisions - Strategic pricing and price discriminati...

Learning Outcomes

After reading this article, you will be able to explain the principles and rationale of strategic pricing for profit maximisation, distinguish between major pricing strategies (skimming, penetration, add-on, product-line, volume discounting, price discrimination), and assess when price discrimination is feasible and effective. You will apply demand-based approaches (including MR=MC), understand price elasticity implications, and evaluate pricing decisions in practical ACCA exam contexts.

ACCA Performance Management (PM) Syllabus

For ACCA Performance Management (PM), you are required to understand the range of pricing strategies available to a business and how these are determined by the competitive environment and economic theory. In particular, ensure you are comfortable with:

• Determining optimum pricing by equating marginal revenue and marginal cost (MR=MC)
• Calculating and interpreting price elasticity of demand and its impact on pricing
• Evaluating strategic pricing options including skimming, penetration, add-on product, product-line, volume discounting, and discrimination
• Understanding the requirements for price discrimination and its effects on revenue and profits
• Applying demand equations to solve for optimal price, output, and contribution

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. When will price discrimination be feasible and beneficial for a business?
2. A company’s demand function is $P = 120 - 0.6Q$. Marginal cost is constant at $30 per unit. What output and price maximise profit?
3. What distinguishes price skimming from penetration pricing and when is each appropriate?
4. True or false? For price discrimination to be effective, markets must have different price elasticities of demand and be separable.

Introduction

Setting the right price is a key decision in performance management. Businesses must balance maximising revenue and profit against customer demand, competitor strategies, and market constraints. Strategic pricing uses demand information and market conditions to find profit-maximising prices, often using economic tools such as demand curves and marginal analysis. In some cases, firms exploit opportunities to charge different prices to different customers—this is known as price discrimination.

This article outlines the calculation and evaluation of strategic prices, compares major pricing strategies, and details the conditions for successful price discrimination, as required for the ACCA exam.

Key Term: strategic pricing
Setting prices based on assessment of demand, competition, and costs to maximise profit or achieve specific business objectives.

Key Term: price discrimination
A pricing strategy where a business charges different prices for the same product or service to different customers, not explained by cost differences.

DEMAND-BASED STRATEGIC PRICING

The basis of demand-based pricing is to find the selling price and output that will maximise profit. Under economic theory, this optimal point occurs where marginal revenue (MR) equals marginal cost (MC).

• Marginal Revenue is the change in revenue from selling one more unit.
• Marginal Cost is the cost of producing one more unit.

In imperfectly competitive markets, businesses use the demand curve to derive MR and compare to MC.

Key Term: marginal revenue (MR)
The additional revenue generated by selling one extra unit of output.

Key Term: marginal cost (MC)
The additional cost incurred by producing one extra unit of output.

Steps to Calculate Optimum Price and Output

1. Find the demand function: Usually in the form $P = a - bQ$, where Q = quantity and P = price.
2. Determine the MR equation: $MR = a - 2bQ$.
3. Set MR = MC: Solve for Q (profit maximising quantity).
4. Find corresponding price: Substitute Q back into the demand equation.
5. Calculate total contribution or profit as required.

Worked Example 1.1

A business faces a demand function $P = 100 - 0.5Q$ and has a constant MC of $30.

What is the profit-maximising price and output, and total contribution?

Answer:
Step 1: MR = 100 - 2 × 0.5Q = 100 - Q
Step 2: Set MR = MC: $100 - Q = 30 \implies Q = 70$
Step 3: Find P: $P = 100 - 0.5 × 70 = 65$
Step 4: Contribution per unit = 65 - 30 = 35
Total contribution = 70 × 35 = $2,450

Price Elasticity of Demand

A key component of strategic pricing is understanding how responsive demand is to price changes.

Key Term: price elasticity of demand (PED)
The percentage change in quantity demanded as a result of a one percent change in price.

• If PED > 1: Demand is elastic (responsive)—a decrease in price increases total revenue.
• If PED < 1: Demand is inelastic (unresponsive)—an increase in price increases total revenue.

Worked Example 1.2

If a business sells 500 units at $20 each, but a price rise to $22 reduces sales to 400 units, what is the price elasticity of demand?

Answer:
% Change in price = $(22 - 20)/20 \times 100 = 10\%$ % Change in demand = $(400 - 500)/500 \times 100 = -20\%$ PED = |-20% / 10%| = 2 Demand is elastic.

STRATEGIC PRICING APPROACHES

A profit-maximising approach is not always possible or desirable, so businesses may use alternative strategic pricing methods, especially when launching new products, facing competitors, or in response to market conditions.

Price Skimming

Charging a high initial price and lowering it over time once early adopters have purchased, useful for new or innovative products with few immediate substitutes.

Key Term: price skimming
A strategy where a firm charges a high initial price for a new or innovative product, reducing it later to attract price-sensitive customers.

Penetration Pricing

Setting a low entry price to gain market share quickly, appropriate when demand is elastic and there are potential economies of scale.

Key Term: penetration pricing
A strategy involving a low launch price to rapidly build sales volume and market share, then raising price once established.

Add-on Product Pricing

Setting a low price for a primary product to increase sales of higher-margin accessories or necessary consumables (e.g., cheap printers, expensive ink).

Product Line and Volume Discount Pricing

• Product line pricing: Setting different prices for product variants or bundles, reflecting feature differences or perceived value.
• Volume discounting: Lower prices per unit for buying in bulk to encourage larger orders or lock-in.

Worked Example 1.3

A gym launches a basic membership for $30 and a premium one for $50, each with exclusive features. What pricing strategy is this, and why might it be effective?

Answer:
This is product line pricing. By offering differentiated packages, the gym can appeal to both price-sensitive and service-focused customers and increase overall sales.

PRICE DISCRIMINATION

Price discrimination requires three main conditions:

1. Market segment separation: Customers can be grouped and charged different prices, with minimal resale between groups.
2. Different price elasticities: Customer groups differ in willingness to pay or sensitivity to price changes.
3. Some market power: The firm can influence price, not merely accept it (so not perfectly competitive markets).

Common examples include:

• Student or senior discounts
• Higher rail/air tickets for business travelers
• Off-peak pricing for utilities or services

The business aims to improve profit by extracting greater consumer surplus from markets with inelastic demand, while maintaining volume in elastic segments.

Worked Example 1.4

A cinema charges $12 for adults, $9 for students, and $7 for children for the same film. Under what conditions is this price discrimination strategy most likely to improve profits?

Answer:
If groups cannot resell tickets, have different price elasticities, and the cinema can identify group status, charging higher prices to adults with inelastic demand and lower to more elastic child/student markets will increase overall revenue compared to a single price.

Exam Warning

Beware: For price discrimination to be effective and legal, goods/services must not be resold easily between groups, and differentials must not breach competition or anti-discrimination laws.

Summary

Strategic pricing uses demand and marginal analysis to determine profit-maximising output and price. Firms may use skimming, penetration, or add-on pricing strategies depending on market structure and objectives. Price discrimination increases profit by charging different customer groups different prices when conditions allow. Understanding these approaches and being able to apply demand equations is essential for the ACCA PM exam.

Key Point Checklist

This article has covered the following key knowledge points:

• Calculate profit-maximising price and output using MR=MC and demand equations
• Apply the concept and formula of price elasticity of demand
• Distinguish between skimming, penetration, add-on, product-line, and volume discount pricing strategies
• Identify the conditions necessary for effective price discrimination
• Recognise relevant worked examples applying these pricing strategies
• Understand common pitfalls in pricing exam questions

Key Terms and Concepts

• strategic pricing
• price discrimination
• marginal revenue (MR)
• marginal cost (MC)
• price elasticity of demand (PED)
• price skimming
• penetration pricing