What is an Economy Pricing Strategy – How Does it Work?

What is an economy pricing strategy?

An economy pricing strategy uses lower prices to generate higher sales volumes. Companies create “private label” products, like generic medications, or “no-frills” service offerings, like budget airlines.

It’s a short-term strategy designed to undercut competitors and take market share. Like when entering a new market. Unlike penetration pricing, economy pricing is a long-term strategy that attracts higher sales volumes with permanently low prices. Big box retailers like Walmart are pros at economy pricing.

Alongside known-name brands, these retailers also sell private-label, budget-friendly products. For example, Walmart currently sells 24oz Heinz ketchup for $4.28, but they also offer their own label Great Value Tomato Ketchup for $1.78.

How does economy pricing work?

In practice, economy pricing is similar to cost-plus pricing. The sales price is created by considering production cost of an item and adding the associated costs, plus the desired profit. Economy pricing is so-called because companies market their products and services as budget-friendly. So they become widely known as a cheaper alternative to competitors.

Economy pricing strategies work because companies rely on existing customers and established demand for the product or service. They can sustain these low prices because they don’t incur the same research, development, marketing and advertising costs as known-name brands. As such, private labels have much lower costs and can pass this saving on to customers through cheaper prices for comparable products.

Economy pricing examples

There are several industries where economy pricing strategies are commonly used because of the conducive market conditions. Here are a few examples.

Generic drugs

When picking up a prescription at your local pharmacy, you have probably been asked if you want the generic option. New medications are only patented for a specific period of time (usually around 20 years). After this, other players can capitalize on all the research, development, and marketing already conducted to create generic drugs, without the associated costs. For example, Sertraline is the generic name for Zoloft, the common anti-depressant. This economy pricing strategy works because there is existing awareness and demand for the product.

Retailer private label

Wayfair is a well-known e-commerce business that sells a wide selection of home goods from various household brands alongside its private-label products. Rather than branding them as “Wayfair”, they have developed a series of 80+ house brands, like Joss & Main, Birch Grove, and Allmodern. All of which have their own unique identity. The strategy has been successful for the retailer. 70% of its sales come from house brands, which provide a cheaper alternative to the likes of Pottery Barn and West Elm.

Airlines

The airline industry is one of the most explicit examples of economic pricing — the cheapest fare is even called “economy”. The level of service in first class or business class is far superior to economy. This includes larger seats, more legroom, gourmet food, complimentary drinks, and personalized service. The budget airline industry has also capitalized on the effectiveness of economy pricing. Price-sensitive passengers who just want to get from A to B may be happy to forgo the extra “frills”, and accept lower fares without the premium service.

What types of businesses should use an economy pricing strategy?

Economy pricing strategies only work with very specific market conditions. Here are some examples.

High-demand products and services

Economy pricing only usually works if the company can generate high sales volumes, like with popular pharmaceuticals and FMCG. Products or services that only cater to a small section of the market are not suited to economy pricing. This is because companies can not generate the demand and economies of scale to make it profitable.

Price-sensitive customers

If a customer can obtain a comparable product or service for a lower price, they may be willing to switch brands, especially during an economic downturn. Economy pricing is most conducive to markets where customers are price-sensitive and non-brand loyal. On the other hand, if customers are loyal to a particular brand and are prepared to pay more for it, then they are less likely to switch. In this case, economy pricing may be less effective.

Low production costs

If the above two criteria are met but the cost of production is too high, companies may struggle to implement an economic pricing strategy. Economy pricing is only effective if companies can use economies of scale to ensure a healthy profit margin.

Economy pricing advantages and disadvantages

No pricing strategy is a silver bullet for all businesses. Economy pricing has some pros and cons that must be considered before diving in.

Advantages of economy pricing

The main reason companies adopt an economy pricing strategy is because of the positive effects on sales volumes.

Easy and versatile to implement – Pricing can be complex, but economy pricing is one of the simplest strategies companies can use. The formula to calculate economy pricing is simply costs plus a desired margin. In the case of economy pricing, the margin is likely to be lower than the market average, but sales volumes will be higher. This doesn’t have to be guesswork either — Flintfox’s Margin Reporting tool allows businesses to track and manage margins in real-time, maximizing profits with scientific precision, even on budget items.

Economy pricing is also versatile. Existing companies can introduce a new “budget” range without damaging their existing brand. While new companies can adopt this pricing strategy using very competitive prices and the right messaging.

Increased sales volume – Low prices mean greater market penetration. Companies using economy pricing can expect their products and services to be accessible to a greater number of customers. That’s why the economy cabin of the plane is so much bigger than business and first class.

Keeps costs low – Every business wants to avoid unnecessary costs, and economy pricing is one way to do this. An economic pricing strategy forces companies to look at where they can make savings, including production, marketing costs, and branding. This strict approach to cost control means greater profits for the company and lower customer prices.

Disadvantages of economy pricing

Companies that adopt an economy pricing model must accept small profits as a reality of doing business.

Low brand equity – When you think of brands like Telsa, Chanel, and Rolex, you know that the brand names carry a certain amount of prestige and positive sentiment. Premium brands work very hard to build brand equity so customers are more likely to be loyal and more willing to pay a higher price. On the other hand, budget brands do away with big marketing budgets, celebrity endorsements, and fancy packaging, to keep costs low. The result is lower customer loyalty and more fickle consumers who will switch to another brand for a better price.

Requires specific market conditions – As we discussed earlier, an economy pricing strategy isn’t suitable for every type of business — it requires the right commercial environment. For example, if a company develops a new technology that will revolutionize how people live, it would be wise to adopt a price-skimming strategy. Charging the maximum price the market will tolerate until more competitors enter the market. Or value-based pricing, charging based on the perceived value rather than the cost of production, to maximize profits. Economy pricing will only work in markets with high demand, price-sensitive customers, and low production costs.

Slim profit margins – The nature of economy pricing means that businesses will sacrifice high-profit margins in return for greater sales volumes. This can be effective with streamlined production, close margin monitoring, and economies of scale.

Implement economy pricing the smart way

Economy pricing can be a highly effective way to open up new markets and take market share from competitors, however, it doesn’t come without its risks. Underpricing your products in a “race to the bottom”, could leave you financially exposed and engaged in an unprofitable price war.

Smart businesses are doing away with spreadsheets, manual work (and headaches), with the Flintfox Margin Reporting tool. Empower your team to understand the lowest profitable price in real-time, give them the agility to set and forget price changes, and keep your eye on the prize.

Contact our team today to discuss how we can supercharge your business.