“Pricing is a tricky business. You’re certainly entitled to make a fair profit on your product, and even a substantial one if you create value for your customers. But remember, something is ultimately worth only what someone is willing to pay for it.”
Building an effective pricing strategy for products or services is the key to a successful business. Selecting the pricing strategy for your price setting methodology means that you need to have a good understanding of a number of different strategies, for example: loss leader pricing, market penetration pricing, value pricing, price skimming, product line pricing, promotional pricing, psychological pricing, and other alternative strategies and pricing methods, such as captive or companion pricing, premium pricing, generic or economy pricing, differential pricing…
Many businesses take a very traditional pricing approach: add up their costs and up-charge by the profit margin they wish to achieve. Other businesses take the approach that the market sets the price and that they need to meet that mark.
From the marketer’s point of view, an efficient price is a price that is very close to the maximum that customers are prepared to pay. In economic terms, it is a price that shifts most of the consumer surplus to the producer. A good pricing strategy is balance between the price floor (the price below which the organization ends up in losses) and the price ceiling (the price beyond which the organization experiences a no demand situation). The basic elements of a pricing strategy are:
- achieve financial goals of the company (e.g., profitability).
- fit the realities of the marketplace (will customers buy at that price?).
- support product’s positioning consistent with the marketing plan.
Pricing is the most effective profit lever, and it can be approached at three levels.The industry, market, and transaction level:
- Pricing at the industry level focuses on the overall economics of the industry, including supplier price changes and customer demand changes.
- Pricing at the market level focuses on the competitive position in comparison to the value differential of the product to that of comparative competing products.
- Pricing at the transaction level focuses on managing the implementation of discounts away from the list price, both on and off the invoice or receipt.
According to Bernstein’s article “Supplier Pricing Mistakes”, many companies make common pricing mistakes and he outlines several which include:
- Weak controls on discounting.
- Inadequate systems for tracking competitor selling prices and market share.
- Cost-up pricing.
- Price increases poorly executed.
- Worldwide price inconsistencies.
In the article “How Much to Charge for Your Product or Service?” by Scott Allen writes: While there is no one single right way to determine your pricing strategy, fortunately there are some guidelines that will help you with your decision. Here are some of the factors that you need to consider:
- Positioning: How are you positioning your product in the market? Is pricing going to be a key part of that positioning? The pricing has to be consistent with the positioning. People really do hold strongly to the idea that you get what you pay for.
- Demand Curve: How will your pricing affect demand? You’re going to have to do some basic market research to find this out, even if it’s informal. But however you do it, chart a basic curve that says that at X price, X’ percentage will buy, at Y price, Y’ will buy, and at Z price Z’ will buy.
- Cost: Calculate the fixed and variable costs associated with your product or service. How much is the “cost of goods” and how much is “fixed overhead”? Remember that your gross margin (price minus cost of goods) has to amply cover your fixed overhead in order for you to turn a profit.
- Environmental Factors: Are there any legal or other constraints on pricing? Also, what possible actions might your competitors take? Will too low a price from you trigger a price war? Find out what external factors may affect your pricing.
In the article “The ABCs of Pricing” by Charlie Gilkey writes: Buyers are irrational, and predictably so. If you product or service provides legitimate value to your customers, then make your prices match their perceptions an economic reality. If those are grounded in a bit of irrationality, so be it—our business is about our customers, which means we need to meet them where they are, not where we think they should be. A framework that will help you with setting prices is knowing about: Anchors, bumps, and charms…
- Anchors: Every established industry already has anchors in play. The art of pricing, though, is determining how you’ll use those anchors. Significant value-adds allow you to use those anchors as baselines rather than straight jackets. But you still need to recognize that established anchors have a very, very strong effect on your prospects’ first reactions to the pricing of your product.
- Bumps: If anchors set the baseline, bumps let people know what grade of product they’re getting. When you’re setting your prices, you have to make sure you haven’t unintentionally set a bump that either blurs or mistakenly mismatches the grade of product or services. For instance, a $19.99 and $22.99 pricing methodology isn’t nearly as clear as a $19.99 and $29.99 framework. In the latter example, it’s pretty clear that there’s a bump in grade rather than something relatively minor. At the same time, if your competitors have anchored the price at $19.99 and yours costs $29.99 then, you must re-position at another level.
- Charms: A price that’s a little less than the round number is called a charm price; for example, $19.99 rather than $20. As annoying as we might find charm pricing, it’s a market dynamic that affects buying decisions. Many people think that using charm pricing is somehow demeaning or tricky to prospects—or that playing such games diminishes the seller’s credibility. Still others think that charm pricing doesn’t work on savvy, smart buyers.
In the article “Pricing Strategy as Part of Your Internet Marketing Plan” by Dr. Ralph F. Wilson writes: You can’t do business on the Internet without having a pricing strategy. One of the first questions you need to answer is What are your site visitors like? Are they bargain hunters? Or, shop for products based on their prestige value?
What does it cost you to purchase (or produce) and market this product or service? Your price will have to be above your costs — most of the time. Here are the various pricing objectives you’ll want to consider. Two main pricing objectives stand out:
- To maximize short-term profits: Squeeze as much money out of sales as possible, even though fewer customers may make a purchase. Your strategy may be to charge premium prices (i.e., maximize profits), even though you end up with less customers, but you can make more profit off each customer.
- To gain marketshare: The other main strategy is to price your service lower to gain marketshare. You may want to maximize the number of customers, even though you don’t make as much on each customer. But you know that later you’ll be able to sell these customers other services.
These two objectives are the key ones to understand, but there are two others:
- To survive: Survival is a worthy goal. Sometimes companies lower prices so they can generate enough revenue to survive short term. But this isn’t a very good long-term strategy. There’s an old joke about the businessman who said, he was losing money on every sale, but he expected to make it up in volume. Good luck. Sometimes it’s better to call it quits before you lose even more.
- To help society: You might keep the price lower than “what the market will bear” in order to make essential products available to the consumers who would otherwise be priced out of the market. Altruism has its place. Consider, also offering an economy product/service at a lower price, but with clear limitations.
In the article “How to Think About Pricing Strategies in a Downturn” by Nick Wreden writes: When sales and profits are plummeting and customers are demanding better deals, the instinctive response is to cut prices. Pricing decisions should not be viewed as ‘band-aid’ solutions for bleeding income statements, says Reed K. Holden and co-author (with Thomas T. Nagle) of ‘The Strategy and Tactics of Pricing’. Rather, they should be part of a long-term strategy for fiscal fitness.
When economic storm clouds gather, trim your production levels, postpone expansion plans that aren’t absolutely vital to your future growth, and slash nonessential costs wherever you can. Crafting the right strategies will not only strengthen your business now, it will also prime it for growth later. To bolster sales while avoiding a price cut’s dampening effect on long-term profitability, keep the following advice in mind: “Profitability is not the only prism through which you should view pricing”.
In the article “Six Powerful Rules for Pricing Excellence” by Patrick Lefler writes: Pricing is a key element of your brand. It sends a message to the market and creates expectations about value. It’s often the first impression you make, either attracting buyers or repelling them. And it can create the last, and lasting, impression, depending on perceived value for price paid. Think about it: Is your price sending the message you intended? Pricing is complex, but it doesn’t have to be overwhelming. Follow these six powerful rules for pricing excellence to find the pricing strategy that gets the most for your services.
Rule #1: Always price for value.
Rule #2: Anchors aren’t just for ships.
Rule #3: Never underestimate the power of free.
Rule #4: Innovate with price.
Rule #5: Let price drive value.
Rule #6: Price wars are a fool’s game.
In the article “Selecting an Appropriate Pricing Strategy” by Nancy Giddens, Joe Parcell, and Melvin Brees write: Selecting a pricing strategy for your product is critical, because price is most highly visible element of marketing efforts. To price products, you need to know the following:
- Costs and profit objectives.
- Customers (demand).
To determine the price, given price flexibility, the producer will need to factor in the effects of competition and profit objectives. To ease subjectivity, most companies subscribe to one of five main pricing strategies:
- Premium pricing.
- Value pricing.
- Cost/plus pricing.
- Competitive pricing.
- Penetration pricing.
Pricing strategies and methodologies are a good bit of science coupled with an equal amount art. To make sure your price is right, you have to continually balance your own cost structure and profitability with customer perceptions of value and your competitors’ tactics.
The good thing when it comes to pricing is that a lot of the work is done for you if you know what to look for. When searching, however, you have to understand that the buying process isn’t as rational as our old economics professors or common sense would have us believe.
It’s irrational—predictably so. If you try to look at the market from a strictly rational point of view, you’ll end up setting prices that make sense to you but not to your customers. The far easier path is to have a pricing strategy that plays to your customers’ own irrational behaviors.
“Your price should never be lower than your costs or higher than what most customers consider “fair”: Simply put, if people won’t readily pay enough more than your cost to make you a fair profit, you need to reconsider your business model entirely.”