Over the festive season I’ve been caught up in a greater focus on finding objective data driven proof for many of the “ideas, theories, gut-feel” commercial people have about a number of commercial issues.
It all started with Byron Sharp’s books- how brands grow, and how brands grow part 2 an insightful, data laden read I commend to you. But I have also been digging into other perceptions we take for granted and to see if there is empirical, data driven proof to support them.
Here’s a link to a pdf copy of the opening chapter which summaries the key elements.
In this vein, I’ll be commencing a series on pricing- setting price, price psychology, etc- aimed at enabling GMs to impact their bottom line in a very direct and positive way by understanding how pricing works, all supported by appropriate research.
Watch out for the tips over the next few weeks. Now, let’s start with price strategy
Pricing Strategy for Profitable Growth
Pricing is the heart of your business. It affects everything you do and is affected by everything you do.
In theory, your right price should fall between your total cost to serve the product (fixed plus variable costs including advertising, promotions, discounts and incentives) and the value your customers perceive in your product- leaving you with a profit and your consumers with the feel that they have a bargain.
Within this range, your prices should be closer to the customers perceived value.
So theoretically if you desire a higher price you need to add value to the consumers perception of your product, then learn to sell the value you have added. The following 4 steps should help you determine the right price for your product or service:
1. Understand your Customers’ needs and the Value you can offer
Your pricing potential is related to the perceived value your customers have for your product, and their willingness and ability to pay. Products with more features and benefits can often be priced higher as long as customers see some value in those extras. For example, a luxury brand vehicle is priced higher than an economy compact car, and chicken-rice at Boon Tong Kee costs more than at a Hawker centre.
Thus your pricing strategy should mirror your business strategy
2. Evaluate your Competitive strengths and weaknesses
Understand what your advantage is to your customers – the relative value you add compared with that of your competitors by comparing your product to theirs. Understand that even if you’ve added more value, you may not be able to charge more for very long, because your competitors may copy your product and charge less than you for it.
The stage your industry is in may also affect your ability to price your product. In an emerging industry, where customers are forming new relationships, you need to be flexible to determine the right price and the best product-market combination to be able to grow with the growing market. In mature industries, relationships between your competitors and your potential customers are already set. As the new entrant, you’ll need to find the segment that will switch vendors and also pay more for the added satisfaction you offer.
Take time to consider your competitors’ resources and potential response. If you’re competing against giants, a frontal assault with lower prices may only cause your failure. So consider entering by focusing on high-income customers with higher prices.
3. What’s your Operational Costs
Evaluate your costs, and keep your break-even low
After value, cost is the second most important factor behind pricing. Ideally, your price and your costs should make your cash flow positive, you should make money.
Your costs depend on a number of factors, including your quality and volume. It’s easier to have lower costs and greater efficiency when you deal in larger quantities. At the start of your business its a great plan to keep most of your costs variable (you can add or subtract to these, such as contract manufacturing, having a contract accountant, out source inessentials which can be pared back or added to easily, if necessary), and adjust them to the actual level of sales.
Subsequently, Adjust your prices based on margins, volume and cash flow.
Should you price higher, lower or the same as your competitors? If you price higher, you’ll need to be able to persuade customers of the extra value you offer to justify your pricing. If you price lower, you’ll need to be consistently more cost-efficient producing your product to earn a margin similar to your competitors. If you price the same, you’ll need to differentiate yourself elsewhere to attract customers otherwise why should they change from their current supplier.
You’ll need to understand the link between the prices you charge and the volume you get .
4. Consider your retail Strategy
When it comes to pricing strategy lets look at the basics.
Are you offering a high or low quality product, and are you charging a high or low price. Each has a strategy and a necessary business plan to go with it.
To determine your strategy, focus on your key differentiating factor—your strategy should reinforce this unique value to keep your customers loyal and willing to pay more due to the unique benefits you offer. Seek to identify a long-term advantage where you can defend your differentiation- can you consistently remain the lowest cost producer, or can you consistently remain an innovative high quality value adding producer. If you can’t, others may enter the market and erode your edge, prices and profitability.
Here are a few strategies you can choose from when determining your prices:
- Price based on value. Are your customers willing to pay a high price for what you offer. If so you can either use a PREMIUM strategy adding extra value at high cost to you and pricing it at a high cost to consumers.
- You can also use a SKIMMING or branding strategy- take a product you know you can make at a low cost and influence consumer perception to add value to your product and sell it at a high price- some would say that Coca Cola uses this strategy to generate fantastic margins upon the base of a relatively cheap to make product.
- You can PENETRATE to disrupt- by taking what has traditionally been a high price product and sell it cheaply to build your share of the market. This will work if you are able to accept a low margin or you can make it significantly cheaper than the competition- Supermarket own brands take this approach accepting significantly lower margins on consumer goods knowing they will make money through selling more Price based on perception.
- Lower prices won’t always mean higher volume. Sometimes a low price can create doubt about your value. Customers may believe “you get what you pay for” and so really low prices especially for good like make up or pharmaceuticals or even beer can be detrimental to sales.
- Price with the trend. Trends affect pricing in many ways. For instance, new technologies may offer more benefits than existing ones and provide high margins. As the trend ages and competition increases, gross margins decline. This will require newer products to generate profits. This is one reason why car and soap companies keep introducing “new and improved” cars and soaps on a regular basis.
- Use the high-low strategy to attract customers to your total business. Many businesses sell some products at a lower price and promote these lower prices to attract customers—this practice is relatively common in retail and fast food. But if you do this, make sure you know how to sell your high-margin products. In fast food, for instance, the high-margin products are the drinks, fries and desserts. Train your employees to sell these.
- Know that it’s easier to lower prices than to raise them. Some of the most successful computer makers and other high-tech manufacturers have introduced their fantastic new product at a high price, then lowered prices as competitors copied them. Then they introduce a new product at a high price.
- Add services to get a higher margin. American consumers are used to cheap products but not cheap services, so think about offering services and warranties. Selling warranties can be great for profits, especially if your product or service is high quality.
Your pricing should be a part of your overall strategy and goals. This means that if your business is a high-end business, your prices should be at the high end and so should the rest of your operation. If, on the other hand, you want volume, then you need to know how to compete in the large segments of your industry. If you want to succeed in a niche market, know the market’s needs, and price your products accordingly. The key is to be consistent throughout your business. For instance, don’t price low and have high overhead, or price high and have poor quality.
OK, we have the strategy, but how do you make those pricing decisions that realize extra profits?