NARRATOR: Pricing is the one variable a company can change overnight and see an immediate effect on revenues and profits. However, pricing decisions inconsistent with a firm's competitive strategy can be dangerous, which is why companies should address the topic with much caution and attention. There are three important components we need to distinguish in this process-- the amount a product costs to be produced, the price customers pay to buy the product, and the value they acquire from the product. So, to sum up, cost, price, and value-- the three main variables to consider when making pricing decisions.

If a company aims at cost leadership, then the focus will be costs, trying to keep them as low as possible. The company must offer a price slightly lower than the one offered by competitors. Conversely, if a firm's strategy is differentiation, then the critical factor will be the value delivered to customers. Costs are not that important, as companies offering a differentiated product can charge more.

When UK's price discount retailer Poundland thinks about prices, it focuses on its own costs and competitors' prices. Its strategy is to offer undifferentiated products at a lower price than the competition. You can buy a four pack Bounty in Tesco, too, but its price will be 1.50. Poundland offers a better deal for the same product. So as long as the company can offer lower prices than competitors, its competitive strategy works well.

Apple is a company that produces and sells highly differentiated products. Customers believe its devices and software are best in class and will pay a premium price, regarding Lenovo laptops and mobile phones with the same technical characteristics. Apple's strategy is to produce a product that delivers a lot of value to customers and to charge extra for it. Its business model remains valid for as long as the customers continue to perceive the value they get from Apple's products is worth the extra dollars they pay.

So pricing must be coherent with competitive strategy, although sometimes it is tempting to adjust prices to stimulate short-term gains of market share and increases of sales. Top-level managers have to stay focused on the big picture and make coherent decisions in line with the firm's long-term strategy.