Captive pricing

Captive pricing
See also
Competitive Pricing Product line pricing Resale price maintenance Price strategy to eliminate competitors Sales and profit growth strategy Trade allowance Prestige pricing Trade discount Skimming pricing strategy

Captive pricing is selling one product at a low margin to enter the market and block customers from buying a more remunerative "tied" product (e.g. razors are inexpensive and the revenue is made on blades that must be used with that specific razor) (M. Goic 2011, p. 44). Marketers use captive pricing because it is certain that, finally, customers will have to buy the refills, recharges, or expensive replacement parts or services over time in order to continue using this product. Companies set a very low starting price for the product because the seller knows that the consumer will eventually have to buy spare parts at a higher price (J. L. Ferguson 2009, p. 97).

Examples of captive pricing

Many modern companies use this strategy. Captive pricing is used in Starbucks, where baristas urge customers to spend more by proposing additional products (e.g. reusable mugs) (M. Hilčišin, B. Gahir, D. Gannon, A. Boguszakova, P. Silondi, S. Gray, G. Allen, J. Boehringer 2015, p.14).

Companies conduct initial sales of the product at a reduced or even zero-price because they are the only ones selling this specific product and in this way, they make sure that the future purchases will be made at a highly profitable price. Captive Pricing, sometimes called Captive-Product Pricing basically involves making additional products that have to be used with the main product (e.g. video game consoles and printers). There are several varieties on this practice:

• Selling the leading product at a low price with the following products sold by only one seller at a premium price. The customer is not legally required to purchase printer ink but must do so to run the main product.
• Selling the main product at a great discount and then the customer is legally obliged to buy the captive product. This technique is used by a significant number of mobile phone providers. In this case, the phone is much cheaper if the customer signs a contract for 2 years.
• Giving away the main product for free to stimulate the sale of a captive product. By giving away a candy dispenser, a company can get its customers to buy candy in the future.

Today, in the market we can observe any number of transpositions of free or discounted main products and voluntary or mandatory captive products. It is important to maintain, at least for a moment, monopolistic control of the internal sales market. An example is the launch of a phone with chargers and cables not available from other sellers to have a monopoly on these additional items at least for some time (R. A. Greenwood, C. D. Wrege, P. Gordon 2014, p. 1-2).

Advantages of Captive pricing

Captive pricing can be a successful pricing strategy for businesses, as it offers a range of advantages, such as:

• Creating a competitive edge: Captive pricing creates a competitive edge, as it enables businesses to reduce prices of a product or service in order to capture more customers, while still generating revenue from the sale of the associated product or service.
• Blocking the competition: Captive pricing can also be used to block competitors from entering the market, as the low-margin pricing of the primary product makes it difficult for competitors to undercut without suffering significant losses.
• Creating Loyalty: By making customers dependent on a certain product, captive pricing can create a loyal customer base, as customers will have to keep purchasing the related product or service to get the full value of the initial purchase.
• Increasing Profit Margins: Captive pricing can also lead to higher profit margins, as businesses can charge higher prices for the related product or service, as customers are already locked into buying it.

Limitations of Captive pricing

Captive pricing can be a powerful and effective pricing strategy, however there are some limitations to consider. These include:

• It can be difficult to sustain: Captive pricing requires the seller to offer a low margin on the initial product in order to increase demand for the tied product. This low margin can be difficult to sustain in the long run and may require the seller to offer additional discounts or incentives to continue to attract customers.
• It limits customer choices: Captive pricing restricts customer choice by requiring them to purchase the "tied" product in order to obtain the desired product. This can lead to customer dissatisfaction and the potential for customers to switch to a rival brand.
• It can be difficult to monitor: Captive pricing often involves complex pricing structures and can be difficult for sellers to monitor and adjust in order to maximize profit.
• It can be difficult to implement: Captive pricing can be difficult to implement, as it requires the seller to accurately forecast the demand for the tied product and to set the prices of both products in order to maximize profits.

Other approaches related to Captive pricing

Here are some other approaches related to Captive pricing:

• Bundling: This approach involves offering products together at a discounted price, encouraging consumers to purchase a tied product with the main product.
• Loss-Leaders: This approach involves selling a product at a lower margin than the market price in order to attract customers and increase the sales of other, more profitable products.
• Premium Pricing: This approach involves charging a higher price for a product in order to signal its quality and exclusivity.

Captive pricing is an approach used to enter the market and block customers from buying a more remunerative tied product. Other approaches related to Captive pricing include Bundling, Loss-Leaders, and Premium Pricing.

References

• Alwis A., Kremerman V., Shi J., (2005), D&O Reinsurance Pricing -A Financial Market Approach
• Ferguson J. L., (2009), Fair or Foul? Determining the Rules of the Fair Pricing Game, Dissertation, Georgia State University
• Greenwood R. A., Wrege C. D., Gordon P., (2014), The Origins of Captive Pricing: Electric Lamp Renewal Systems, HCBE Faculty Articles. 58.
• Goic M. (2011), Essays on Multi-product Pricing, Carnegie Mellon University Tepper School of Business Pittsburgh, Pennsylvania
• Hilčišin M., Gahir B., Gannon D., Boguszakova A., Silondi P., Gray S., Allen G., Boehringer J.,(2015), School Of Business Selection Showcase, Centre for Research and Interdisciplinary Studies, Prague College, CRIS Bulletin
• Kujala J., Murtoaro J., Artto K., (2007), A negotiation approach to project sales and implementation, Project Management Journal Volume 38, Issue 4

Author: Weronika Piotrowska