One of the biggest challenges for any business is pricing. It affects so many different departments, making it difficult to pinpoint exactly who has control. Often, the product lines set the prices that go on the price list, but the CEO, CFO or some other executive sets the overall pricing strategy for the company. The sales department negotiates to get the final price for large customers. It seems like everyone in the company is involved in pricing.
The common theme with most pricing issues is risk; if you set prices too high you may push potential customers away, prices too low will cut your profits. This is known as pricing paradox. However, risk in most cases can be eliminated by getting better information about your market, your customers and your own internal numbers that drive your profit.
There is a typical pricing cycle that takes place in most businesses. In some markets this cycle is spread over many years and in very competitive markets sometimes it can all happen in a single week. The company has to keep a sharp eye on this cycle and carry out frequent audits pulling together all the available data and insights.
The pricing objectives should be relatively straight forward and flow from your company strategy. The next challenge is to select one or more pricing strategies and then the appropriate pricing structures and price levels to meet the objectives. In many instances these will already be well understood and what’s required is just a tweak to the current pricing levels. Finally, once the pricing has been approved by the business it must be implemented and the cycle can begin again.
The audit may consist answering few questions: What are your current forecasts and targets? How should your product be supporting company strategy? Have you analyzed current sales e.g. Profit/loss, discounting? What are the competitor propositions? What are your costs? What market research is needed to predict demand? Do you understand what customers’ value in your proposition?
Product pricing
There are many ways to price a product. Let’s have a look at some of them.
1.Cost plus pricing
In practice, a lot of companies calculate their cost of production, determine their desired profit margin by pulling a number out of thin air, slap the two numbers together and then stick it on a couple thousand widgets. Cost-plus pricing maybe really simple but involves very little market research, and also doesn’t take into consideration consumer demands and competitor strategies. Therefore, it is quite ineffective.
2.Competitive based pricing
This is a lot like piracy – your son decides not to do your homework, so he copies that of those who have already done some work. Obviously, the market doesn’t dole out suspensions for copying prices, but the processes of swiping an essay and competitor-based pricing are pretty similar.
Also called strategic pricing, this method involves looking at the prices set by other businesses in the same sector and then adopting those numbers, plus or minus a few percent according to how your product looks that day. You rely on your competitors to do the work for you. As long as you trust they actually know what’s going on in the market, it works.
Competitive based pricing remains low risk way of quickly gauging prices, and in some cases it can be fairly accurate. Yet, it leads to enormously large missed opportunities, because companies employing the strategy end up not assessing their true value and get caught in a race to the bottom through industry group think.
3.Value based pricing
This works to determine the true willingness to pay of a target customer for a particular product by utilizing customer data. It recognizes that customers do not care how much something cost you to make but they care how much value they are receiving at a particular price. By maintaining this customer focus, value-based pricing provides real data, helps you develop higher quality products, and even improves customer loyalty. Simply put, you have the greatest amount of data to make an informed decision about your profit maximizing price.
a. Identification
To arrive at the optimum value-based price, determine how highly your customers value your product or service. Examine factors such as whether your customers will save money or time by using your product or service; whether your product or service is unique; whether your product or service will help customers gain a competitive advantage; and what the competition charges. The answers to these questions will help you determine what customers are willing to pay for your product or service.
b. Effects
When you are offering a product or service that is not unique and in a market, where prices are well established, you may have to adopt the strategy of setting your price at the same level as your competitors. This may help you to enter the market, but you will need to lower your costs to raise your profit levels above your competitors, to gain a competitive advantage.
c. Insight
For some products and services, it may make sense to set your prices according to how much you will save your customers. For example, a company, selling gaskets that prevent chemical leaks and spills, charges customers based on the clean-up costs they will avoid by using the product.
d. Considerations
For certain products or services, it may make sense to charge a higher amount relative to your costs. You can do this if your product is unique, if you are positioning your product as a high-status item or if it will save your customers money. For example, many luxury items, such as designer handbags, are priced at hundreds of times their production cost, but customers are paying for the prestige of owning the brand. Drug companies may price their products high and justify this by arguing their drug can save the patient an even more expensive medical procedure.
e. Potential
Another type of value-based pricing strategy is to offer some customers a discount. This may be based on the amount they buy or on how often they use your service. Airlines, trains and hotels use a related strategy of pricing seats or rooms differently depending on when customers buy the tickets. When there are seats left to fill very close to the departure date, the airline is willing to sell these at a discount in order to fill the plane. This helps to maintain profitability.
4. Psychological pricing
This is a pricing strategy that helps create a positive psychological impact on buyers and tempts them to purchase a product. A common example is about a brand of footwear charging Rs. 1490.00 instead of Rs. 1500.00 for a pair of shoes. The theory is that even though there is just a ten-rupee off, customers will believe they are getting a much better deal and will be more likely to buy the product.
This type of pricing can also lead customers to believe that the goods are priced at the lowest possible level and the retailer has squeezed the price down as much as he can.
Other examples are when companies have special offers such as ‘buy one get one free’ or ‘buy two get the third item free’. This type of pricing works because customers believe they are getting a good deal and although this is true in some cases, people can often end up buying products they don’t really need as they believe the offer is too good to miss.
Avoiding pricing mistakes and being strong in your pricing proposition go hand-in-hand in building a profitable business. Master the so-called “pricing paradox” and you will master an area of business in which even the most experienced entrepreneurs sometimes struggle to get the final price for large customers. It seems like everyone in the company is involved in pricing.
Tips
As you can see, changing pricing therefore takes buy-in from many different groups who do not always have the same beliefs about what needs fixing. But if you’re passionate about maximizing the results of your company’s pricing strategy, here are a few tips that can help you spear-head those efforts.
Engage in one-on-one conversations - a lot of them. You are not trying to convince anyone of anything, at least at first. Listen to their issues around pricing and ask questions like these: What would you change about the way we price? What about our pricing is costing us money? How can we quantify how much we are losing?
Many people in the company have similar answers, and this is common ground you can build on. Where you have different beliefs and assumptions, dig for a deeper understanding. It often provides new ways to look at the situation.
For example, let us say you want to start using rebates in your pricing repertoire. Your finance team adamantly objects, saying they do not work. Ask them why. Do not be challenging, though; be curious. They have their opinion for a reason - and it may be right. Perhaps they tried rebates several years ago and lost control of the process or were writing checks that were not really deserved. Learning the reasoning can prove useful.
(Lionel Wijesiri is a retired company director with over 30 years’ experience in senior business management. Presently he is a freelance newspaper writer.)
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