Product Pricing: An Equation Worth Watching

Setting the price of your products and services is obviously critical to the profitability of your business. Set prices too high, and you’ll be kissing potential sales goodbye. Set them too low, and you’ll be leaving significant revenue on the table.

Every business school teaches its students about pricing strategy. Yet when these same students become CEOs, brand managers and marketing executives, they often find that the models they’ve been taught don’t work in the real world.

Start with Basic Pricing Criteria

There are four basic things to concentrate on in establishing successful pricing strategies—each backed by the wisdom and experience of industry experts:

  1. Cost: Focus on current and future costs (vs. historical ones).
  2. Sensitivity to price: Every buyer’s priorities change, based on a wide variety of constantly-changing factors. Be ready to adjust quickly.
  3. Competitors: Pay attention to competitors’ pricing strategies, but don’t follow too closely. They may be “winging it,” and you might get burned.
  4. Product Lifecycle: The prices of your offerings will often change throughout the product/service lifecycle.

Other advice worth watching

Start before you have a product:
Before you know how much money you can afford to spend on developing, promoting and otherwise supporting a product, you need to know how much of that product you can sell—and at what price.

Price properly and think forward:
Your job is to generate profits today. Don’t fall into the trap of trying to recoup yesterday’s costs. Whatever you spent a year ago is gone; it’s time to let it go.

Existing customers: price break or not?
It’s fine to offer volume discounts or other logical agreements with valued customers, but at the same time, it’s important not to be TOO generous.

Once a customer becomes “yours” (i.e. loyal), you have a significant pricing advantage. Every sales team knows that reluctance to switch is strong among customer groups; they’re uninterested in learning something new just to try the latest product or service.

One of the fastest paths to profit is to add new functionality to your offerings for loyal customers—and raise your prices fairly and accordingly.

Don’t ignore your competitors:
Pay attention to your competitors, sure, but don’t be too quick to copy them. Be ready to launch a counteroffensive against pricing blunders on their part, but keep in mind that they’ll be monitoring your efforts, too.

Above all, don’t get caught in a price war—nobody wins. Both products, as well as your entire market, may become devalued.

Keep an eye on the product life cycle:
Your product’s life cycle will help guide you through its pricing cycle, as well. In general, prices drop in the later stages of a product’s life. Markets become saturated, and consumers gain knowledge that leads to increased price sensitivity.

One strategy: Unbundle support, training and/or services from your core products. Then, you can lower prices without discounting.

Price within the marketing mix:
There are three academic approaches to pricing: cost-based pricing, buyer-based pricing and competition-based pricing.

Cost-based pricing includes:

  1. Cost-plus pricing, which is simply a standard markup (predetermined figure or percentage) to the entire cost of producing the product. This method does not take into account fluctuating product demand or the prices of competitive offerings.
  2. Break-even analysis/target-profit pricing, which is a calculation of prices needed to achieve predetermined levels of profit after covering costs.

Buyer-based pricing isn’t based on the sellers’ costs; instead, it reflects buyers’ value perceptions based on a full spectrum of factors (everything from the brand name to product features to distribution patterns). By definition, it’s complex and difficult—just like many customers.

Still, this “psychological pricing” can be a valuable tools for marketers. Probably the best-know example of this is the $99.99 (or similar-sounding) price point, which customers will consistently choose over competing products priced just a penny more.

John Gorman, a freelance business and technology writer based in Portland, Oregon, remembers a story his father relayed about the fickle nature of customer price perceptions. “The company he worked for had developed a new oscilloscope—the very best on the market by a wide margin,” he remembers. “At the same time, due to technical advances and cost efficiencies, it was also priced about 20% less than the closest competing product.”

Still, the product sat in warehouses, waiting for orders that didn’t materialize. Puzzled company executives hired “an expensive consultant from California who flew in and offered a three-word solution-‘Double the price’-before hopping the plane home.”

“After that, the product flew off the shelves,” he laughs. “Customers just didn’t believe they could actually get more for less.”

Competition-based pricing usually means charging the same, slightly higher or slightly lower than similar products. When demand is hard to measure, this is a popular strategy.

Pricing New Products

In a product’s early days, there is less likely to be much competition, so you can be much more flexible in setting a price.

A market-skimming philosophy involves setting a high price (at least initially) to gain as much profit as possible from segments willing to pay it. It results in higher profits, but from fewer sales. Also, product quality and image must be consistent with the higher price.

A market-penetration model means setting a low introductory price to quickly build market share and brand loyalty before competitors move in on the market. Sales volume offsets the lower profit margins, so this structure works best for companies that can take advantage of economies of scale to produce large quantities of goods. It’s also appropriate for repeat purchases that require little involvement.

Evolve Your Tactics Over Time

Once you’ve determined your initial price, be ready to roll with the punches as things evolve, taking into account changing customers and environmental differences.

Flexible pricing strategies to consider:

  1. Cash discounts to reward customers who pay bills quickly
  2. Quantity discounts for large volume purchases
  3. Seasonal discounts to stimulate demand in off-peak selling seasons (like all those sweaters on sale—after winter)
  4. Promotional discounts for dealers who help with advertising and sales-support programs.

Finally, don’t forget to ask your customers about price perceptions—either directly through the sales force or in customer surveys. They’ll have plenty of tips and suggestions, and they’ll usually be happy to share them.

Price can be a powerful strategic weapon between competitors and play an important role in shaping customers’ perceptions of product value and quality. There are many different pricing strategies appropriate for different markets at different times; proactive, forward-thinking flexibility is the key.

For more information about developing effective pricing strategies for your company, contact us today!

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