In Part One we looked at B2B Pricing Challenges. In this following on article, we're exploring Business-to-Consumer Pricing Challenges (B2C). Charging the correct price for your product or service can be a tricky business – getting it right (or indeed wrong) can have a dramatic effect on your sales and profits.
Many factors contribute to a consumer’s final choice: brand power, purchase occasion, perceived product value, merchandising, and price - but more often than not price is the single most important factor in your customer's decision making process. Building an effective pricing strategy for your products or services is therefore key to successful sales - and can mean the difference between success and trading at a loss.
Remember, price provides revenue – all the other elements (building your product or service, promoting, placing and distributing it) are all costs.
Do you clearly understand your market and price elasticity of demand (or inelasticity)? Have you completed a cost and price analysis for your products or services? These are all vital activities that you need to complete to be competitive and profitable.
As it's a tough old world out there, lets look into some of the pricing challenges you may be facing today – and offer some solutions:
Conduct research on the market reaction to your products and services:
Which products do customers see as offering the best value?
Which products are likely to be the most successful?
What do customers expect to pay for your product or service?
Is there an established market price for similar products or services?
Buyers’ risk can be one of the most important factors in getting a higher price. What risks might a buyer see in your product? What might happen if something goes wrong with the product?
Once you have identified the risks, check if you can take steps to reduce or reverse the risks so you can charge a higher price, for example, by offering a better guarantee than your competitors.
How well do you know your competitors?
Again, conduct research to reveal:
Who are your main competitors and what do they offer?
What are the key features and benefits of their products?
How does your product or service compare to theirs?
Do your products have a clear point of difference or competitive advantage over competitors?
If you’re able to offer more, such as better quality, more features, a better guarantee or free installation, you can afford to charge a higher price.
Do you have an effective pricing strategy?
An appropriate pricing strategy will depend on how you want to position your product or service. Setting a high price will lead to customers seeing a premium value in your product or service.
You may want to charge different prices for different customers. For instance, one-off sales generally carry significantly higher costs than repeat business, so customers who purchase regularly, or buy add-on or related products, are more valuable.
Are you undercharging?
A cost-plus approach to pricing is a useful and necessary starting point to ensure you aren’t undercharging for your product or service. It simply involves calculating all your production costs and then adding the amount you need to make a profit.
Although cost-plus pricing can’t definitely determine what your prices should be, it will tell you whether your prices are viable. If you charge less than your variable costs (the direct cost of making a sale), you will make a significant loss. If you charge more than your direct costs, each sale will make a contribution towards covering your business overheads and ultimately towards making a profit. The contribution each sale makes towards covering your overheads tells you what volume you need to sell to reach break-even.
The disadvantage of the cost-plus approach is that it doesn’t take into account three important factors:
The level of demand.
What competitors charge.
Market expectations (what customers expect to pay).
You’ll need to consider these three issues before making your final pricing decisions.
Do you benchmark your costs?
Reviewing changes in your costs is always important. It becomes even more useful if you can benchmark your costs against industry averages - for example, gross profit and net profit averages for your industry. If you discover your margins are below industry norms, then this could suggest your costs are too high or your prices too low.
When considering new products, industry margins also give you a rough guide to the prices you may be able to achieve.
Should you offer Price Differentials?
Varying your prices can increase your profitability. Some typical tactics include:
Charging lower prices for high-profile products to capture customers who will also buy higher margin products – this is usually called a loss leader.
Charging different prices at different times of the day, week or year to reflect changing demand or the changing value to customers of your product.
Charging different prices for different levels of service or product specification.
Are you too ready to discount?
Discounting can be worthwhile in certain circumstances, but only if it achieves your aims - clearance discounts for example can help you to sell off old stock, release working capital and improve your cash flow.
Introductory discounts can encourage customers to try a new product, but they may create the wrong image for your product or generate sales that are not repeated when the discount is removed. These discounts can also cause resentment among current customers.
If you offer discounts, make the terms very clear – are they one-off, short term or related to a specific event like prompt payment? For example, a cash payment discount can encourage early payment and improve your cash flow, but some customers may try to delay payment and claim the discount anyway.
Reviewing your prices
Review your prices regularly to ensure they are optimal and that you’re keeping up with trends in your industry and the overall market.
Any changes in turnover can signal a pricing problem or an opportunity. For example, if you sell products with high or growing market share, this may give you an opportunity to increase prices.
If you’re a service business and sell your time, then getting in more business than you can deal with may be a signal to increase your pricing. Similarly, if you pitch or tender for business, too high a success rate suggests you’re under-pricing.
If both your margins and market share are low, you need to change something – or consider discontinuing the product.
Limited trials of price changes can give you valuable information at reduced risk.
When considering a price increase, analyse the potential impact on your profit:
What will be the effect on sales volumes?
What will be the effect on profit margins?
Increasing prices, and therefore margins, can sharply increase your profits, even if your turnover drops. Always explain your reasons and give fair warning to your customers – and re-emphasise the benefits you offer, such as:
You’re improving the quality of the products.
You’re introducing new, higher priced products with more benefits or functionality that make older products less attractive or obsolete.
In general, consider increasing prices when demand is high – e.g. decorating products during spring.
Are you underpricing?
Underpricing your product can be even more dangerous than overcharging. Remember that while prices are low, so too are your margins. It’s far easier to reduce prices than to increase them, so if in doubt, try higher prices first. You may discover that your target market is not particularly price sensitive.
You may be tempted to price lower than your competitors but customers may not respond because low prices can suggest low-quality or signal that you lack confidence and experience. Low prices can also attract unprofitable customers or price-sensitive customers who tend to be disloyal when prices increase.
Do you understand where your product or service is positioned in the market?
Are you pricing for survival?
Do you have competitors chasing or copying you, or pricing lower?
Is your market saturated with similar products?
Are customers moving on - outside of the industry? Is your product coming to the end of its lifecycle?
If survival is your pricing objective, it is only a short term strategy - you need to develop long term, value adding strategies to stay in business.
Are you the market leader, with the largest market share?
Can you gain economies of scale in the production of your product, or in the distribution of your service? If so, a low price strategy might be a good objective for you to focus on.
Are you the market follower and content to be there?
Then follow on price too. If you want to move up and become a market challenger, your pricing strategy will need to reflect that intent.
Price Elasticity of Demand and Price Sensitivity
You need to determine what the demand is for your product and appreciate the price elasticity of demand in your market.
Normally, the higher the price, the lower the demand. However, for prestige or luxury type products, a very high price might signal a better or more desirable product.
If demand changes considerably with price increases/decreases, demand is elastic. If demand does not change much if the price goes up or down (to a certain point), then demand is inelastic. What is the price elasticity of your product in your market? Be aware that price elasticity of demand is closely tied to the amount, direction (up or down), and frequency of price change.
Price sensitivity needs to be considered when setting the price for any product and service and it needs to be particularly considered when you change a price up or down.
Customers are less sensitive to price increases if the product is very unique and has high value.
Customers are more sensitive to price increases if they can easily substitute the product for a lower priced alternative.
Customers are less sensitive to price increases when they have difficulty comparing the qualities of alternative products.
You will be able to get the price you want but only if you plan for it – and face up to the challenges.
Pricing for Profit:how to develop a powerful pricing strategy for your business, Peter Hill 2013
The Strategy and Tactics of Pricing, Thomas Nagle and John Hogan 2010
Pricing Strategy: tactics and strategies for pricing with confidence, Warren D. Hamilton 2014