Definition of Premium Pricing
Premium pricing is the practice of setting a price higher than the market price, in the expectation that customers will purchase it due to the perception that it must have unusually high quality. In some cases, the product quality is not better, but the seller has invested heavily in the marketing needed to give the impression of high quality.
Premium pricing works best in the following circumstances:
- There is a perception among consumers that the product is a "luxury" product, or has unusually high quality or product design.
- There are strong barriers to entry. These barriers may include such factors as a large marketing expenditure to gain notice among consumers, a large field service operation to support the product, a reputation for product durability, a reputation for being "fashion forward," and/or a strong replacement warranty policy.
- The seller can restrict the amount of product sold, thereby giving its products an aura of exclusivity.
- There are no substitutes for the product. The company can create this situation by taking aggressive legal action against anyone attempting to copy its products.
- The product is protected by a patent, and the company is aggressively maintaining its rights under that patent.
Example of Premium Pricing
ABC International has developed a patented titanium pen that stores ink at high pressure, thereby allowing it to store four times the normal amount of ink. The company uses metal etching craftsmen to etch custom designs into the metal of the pens. Because of the customized nature of the product and its unique ink storage system, as well as the legal protection provided by its patent, ABC elects to price each pen at $2,000, which is substantially greater than its $200 cost. To enhance the image of the product, ABC invests heroically in advertising the pen in premium magazines, and also supports it with a lifetime warranty.
Advantages of Premium Pricing
The following are advantages of using the premium pricing method:
- Entry barrier. If a company invests heavily in its premium brands, it can be extremely difficult for a competitor to offer a competing product at the same price point without also investing a large amount in marketing.
- High profit margin. There can be an unusually high gross margin associated with premium pricing. However, a company engaging in this strategy must attain sufficient volume to offset the hefty marketing costs associated with it.
Disadvantages of Premium Pricing
The following are disadvantages of using the premium pricing method:
- Branding cost. The costs required to establish and maintain a premium pricing strategy are massive, and must be maintained for as long as this pricing strategy is followed. Otherwise, the premium brand recognition by consumers will falter, and the company will have difficulty maintaining its price points.
- Competition. There will be a continual stream of competitors challenging the top tier pricing category with lower-priced offerings. This can cause a problem, because it increases the perception in the minds of consumers that the entire product category is worth less than it used to be.
- Sales volume. If a company chooses to follow a premium pricing strategy, it will have to confine its selling efforts to the top tier of the market, which limits its overall sales volume. This makes it difficult for a company to pursue aggressive sales growth and premium pricing at the same time. The strategy can be followed as long as the company is expanding into new geographic regions, since it is still pursuing the top tier in these new markets.
- High unit costs. Because the company using this strategy is restricting itself to low sales volume, it can never generate the cost reductions that a high-volume producer would be able to achieve.
Evaluation of Premium Pricing
This approach is a difficult one to create and maintain, requiring an organization experienced in creating, presenting, and supporting products that give the user a premium experience. Companies aspiring to enter the top pricing tier may flounder in this market and lose a great deal of money while they try to establish themselves. For those entities already succeeding with premium pricing, they must be aware that a continual, daily emphasis on the premium strategy is the only way to continually charge the highest prices for what they offer.