Pricing strategies

Cost versus value

"What price should we charge?" is a common dilemma for many businesses. Too much and the business won't make sales. Too little and the business gives away margin and profitability. Finding the optimum point for the business and maintaining and adjusting prices over time needs a combined financial, sales and marketing view.

To a financial accountant, price represents revenue, margin and profit and is balanced against the need to cover fixed costs. And to the sales team in negotiation, price is not necessarily a fixed number, but something to be varied with appropriate discounting, packaging (eg of service) and value at risk analysis.

Consequently, companies can use simple pricing like a cost-plus pricing based on inputs with a mark up or margin, or a competitor-led pricing which rely on external factors determining the price.

However, to a customer, price is obviously the price they pay, but can also represent the value they perceive they are getting - it's possible to set a price too low as too high.

Value-based pricing sets prices based on delivering what the customer most values, at the price the customer is willing to pay. The value to the customer is separate from the cost of the components. In some industries, such as fashion or art, the price is all about perceived value.

Consequently for many marketeers and market researchers first reactions to price are to talk about price positioning - where is our price compared to what the customer values?

With such a range of views of price, price cannot be seen as just a single number to be set once. The business can use prices and price structures in many different ways to stimulate different effects in the marketplace. Do we take a value or a premium position? Are we looking for sales volume or sales value? How do we position the prices of our products relative to each other? What do we include in a price and what is left out? And if you are selling through a distribution channel, price needs to be separated from margin and mark up and represents profitability and income.

 

Setting a price strategy

The fundamental goal of pricing is to optimise income to the business. However, the price can be set to attempt to win new business, to maximise income from loyal customers, and to identify key points of value that drive willingness to pay.

It therefore has to encompass the financial view - revenue and profit, the competitive view - will it win sales, and a positioning view - where and how does the product sit in the market - both in isolation and as part of a product range.

Even within value-based pricing, there are still strategic options for the type of pricing approach, and questions about how to structure the pricing. For instance, a mature market with limited production capacity might use a 'skimming' strategy - set a high price to maximise margin, but don't worry so much about volume; alternatively in a start-up situation with high growth potential, 'penetration' pricing, that is set a lower price with the aim of generating a volume of sales and building market share.

The approach depends on the capabilities of the business. Penetration pricing is good where there is a large production capacity and high volumes are needed to sweat the assets. Skimming works better where production capacity is more limited and demand is naturally lower to make the best use of scarcer resources.

The positioning of the business also forms a part of setting the price. Premium brands indicate their premium nature in the prices they charge. The high prices then allow them to opt to include higher priced components and to offer higher value service. The bundle of pricing and quality has to be designed to fulfil customer expectations.

Similarly value-based brands that compete on price will aim to strip out unnecessary costs. Again, that means understanding what the irreplaceable elements are in a product or service, so they can be got right, while removing frill and fluff if it has no value to their customer-segment.

Within these generic ideas, pricing can also be flexed using discounts and promotions. A high-price skimming strategy might set a position of quality in the minds of consumers, which then combined with a judicious discounting or promotional structure can still be used to achieve volume. Alternatively, a dynamic pricing model which sets low prices for the early bird customers can also have elements of premium pricing for those booking or buying late, or selling add-ons post the initial sale.

The ability to choose and adjust prices then relies on being able to forecast the impact of different prices on demand. As an accountant will tell you, cutting 10% off a product selling for $10 may not seem much, but if the margin is 30%, that is cutting $1 out of $3 of net profit. Would you have sufficient increase in sales by making this price cut? Pricing research from a sample is one method, but the business needs to keep it's eye on how sales and prices are related based on financial and database data and so be able to respond. Pricing is therefore a full-time job.

And if it wasn't complicated enough, in complex channel arrangements, the manufacturers may only set a recommended retail price (RRP), or suggested resale price (SRP), the true end user price will be set by the dealers, distributors and retailers. The sell-in price to a distributor needs to be considered against the margin, and so profitability, that distributor will make on the product.

This combined with different routes to market and the potential of channel conflict and pricing is much more tricky than it first seems. Extend this over territories and international boundaries and throw in the fact that consumers can see prices in multiple locations via the internet and pricing becomes a major corporate decision. For instance Southern European has more complex distribution networks for products such as kitchen appliances and a lower transparency of prices through the Internet and so often has prices more than double those available in the UK for exactly the same product

Choosing which prices to set, how to set prices, what promotions and discounts to set, when to update and flex prices, estimating all the time the impact on sales, and then monitoring and measuring against the market place is essential to maximum profitability. To do this relies on good quality data and good quality predictions of what will happen if and when prices change. Pricing research is essential to understand where and how to set pricing.

For help and advice on building a pricing strategy contact info@dobney.com