Have you ever wondered why companies choose to charge differently for their products or services? Some merchants choose to offer different quantities of their products at different price points, or service providers can bill you based on the amount you use. But what is the rationale behind this marginal price tactic? The marginal price refers to the price charged for an additional unit of a product or service. In this pricing model, the prices of a product or service are not fixed. For instance, in a household, energy use, such as electricity, is priced based on the amount used during billing periods, along with several variables, including time of day (cheaper at night) and season (summer/winter), etc. So, the price fluctuates based on each house’s energy use, in addition to fixed charges.
Marginal Price Formula
You can get an idea of the marginal price by first calculating the average price per unit: take the total price paid for all items and divide it by the quantity of units purchased. Later, you can calculate the marginal price by observing the change in the final price as the quantity of items changes.
To exemplify this, as with multiple unit pricing, imagine you are walking down a grocery aisle and see a box of 3 chocolate bars for 7 dollars. If the chocolate bar is 3 dollars per product, in this bundle, the marginal price of the extra chocolate bar now comes down to 1 dollar. This means the volume of sales can also affect the marginal price, which is very useful for merchants when planning promotions and discounts.
As you determine your prices, you need to ensure you are never selling below your marginal cost. Marginal cost being the expense of producing that extra unit; falling below that level means a loss in profit from selling the extra unit. Or, in other cases, such as undercutting competitors, aggressively using lower marginal prices to sell bundles can help merchants increase their market share.
Benefits of Applying Marginal Price
Customers tend to pay more and become desensitized to the price change with this method. Even though the final price is higher, the value they receive also increases, and since the unit price is lower, customers are now willing to pay a little more for what they are getting. In simple terms, these promotions allow merchants to increase their average cart value. Because customers love to bargain and are more likely to add more to their cart, this presents a great opportunity for upselling.
If you have stock that has been sitting in your inventory for too long, applying promotions with lower marginal prices for extra products can increase your revenue and help you get rid of excess stock. Also, you need to keep in mind that if your customers are price sensitive, the marginal price must be low enough to nudge them to buy the extra unit.
Some Disadvantages of Marginal Price
If you are a service provider that charges based on usage, or if your set of features for a segment has a quota, it may be challenging to nudge your customers to upgrade. A common problem while offering tiered pricing is that companies need to make sure their tiers capture demand and highlight which features or benefits of their products or services are worth upgrading. If the value differentiation is equitable, each tier will have a demand, each customer will have features and benefits at various price points, and, luckily, customers will believe your product or services are worth upgrading to the upper segments.
Wrap Up
When combined with other pricing strategies and considering price elasticity, merchants can create opportunities to increase sales volume, optimize inventory, and boost profits, whether they sell online or in brick-and-mortar stores, by using marginal prices in the form of volume discounts, bundling products, and tiers.
