There is one thing that can literally make or break your business and which most entrepreneurs never even think about properly – that is Pricing and Pricing Strategy.
An awful lot of businessess base their pricing strategy firmly on the market. They look at their competitors and what they are charging and decide to sit somewhere safely in the middle. They are just practising very basic pricing rules.
However, the big boys and the truly successful never think or act that way. They really research how to test a price and how to adjust a price correctly. They also have a clear strategy as to when and how to discount a price - and know just how to squeeze the last few pennies out of an outdated product.
Pricing is not an exact science, it never has been and never will be. Too many external factors influence pricing and that is why firms can spend months trying to figure the right price point before a launch.
Your product price should vary depending on a number of factors:
What the market is willing to pay
How your company and product are perceived
What your competitors charge
Whether your product is frequently shopped and compared, i.e. "highly visible"
The estimated volume of product you can sell
Some Pricing Basics
What do you want to achieve with your pricing strategy? Pretty obviously you want to make money. Making money means generating enough revenue from selling your products so that you not only cover your costs, but take a healthy profit – and perhaps expand your business too.
Many businesses make the mistake of believing that it is price alone that drives sales. No, it's your ability to sell that drives sales and that means hiring the right sales people and adopting the right sales strategy.
There are 2 major pitfalls with pricing – under pricing and over pricing.
Pricing your products too low can have a disastrous impact on your bottom line, even though business owners often believe this is what they ought to do in a down economy. Most consumers want to feel that they are getting their "money's worth" and most are unwilling to purchase from a seller they believe to have less value. Businesses also have to be careful that they are fully covering their costs when pricing their products. Never reduce prices to the point where you are practically giving the product away.
Overpricing a product can be extremely detrimental since the buyer is always going to be looking at your competitors prices and making an unfavourable comparison. Naturally pricing beyond the customer's willingness to pay will decrease sales. Remember to put yourself in your customer's shoes and decide what would be a fair price.
Understand your other business priorities
Aside from maximising profits, it may be important for you to maximise market share with your product – that may help you decrease your costs or it may result in what economists call "network effects,", i.e. the value of your product increases as more people use it. A great example of a product having network effect is Microsoft Windows operating system. When more people began to use Windows over rival products, more software developers made applications to run on that platform.
You may also want your product to be known for its quality, rather than just being the cheapest on the market. If so, you might want to price your product higher to reflect the quality. During a downturn you could have other business priorities, such as sheer survival, so you may want to price your products just to recoup enough to keep your head above water.
Eight factors to consider when pricing your products:
1. Your customers
Get to know your customers. Market research can range from informal surveys of your existing customer base to more extensive and potentially expensive research projects undertaken by third party consulting firms. If you don't have a lot of money to spend on market research, you might just look at consumers in terms of a few distinct groups – the budget sensitive, the convenience centered, and those for whom status makes a difference. Figure out which segment you're targeting and price accordingly.
2. Your costs
For any successful business to flourish you must ensure your price covers all your costs. This may sound obvious but many businesses forget to cost their products properly. Every step in making, storing and delivering the product to the customer adds a cost.
You obviously need to cover your costs and then factor in a profit. That means that you have to know how much your product(s) cost and understand by how much you need to mark up the product - and how many you need to sell to make a profit. The cost of a product includes all of the following:
Your actual product costs, including labour and the costs of marketing and selling
All of the operating expenses necessary to own and operate your business
The costs associated with borrowing money
Your salary and the salaries of employees
Return on the capital you and any other owners/shareholders have invested
Capital for future expansion and replacement of fixed assets as they age
3. Your revenue target
How much profit do you want to make? Take your revenue target, factor in costs and you come up with the price per product that you should charge. It's simpler of course if you only have one product. Estimate the number of units of that product you expect to sell over the next year then divide your revenue target by the number of units you expect to sell and you have the price at which you need to sell your product in order to achieve your revenue and profit goals.
If you have a number of different products, you need to allocate your overall revenue target by each product. Do the same calculation to arrive at the price at which you need to sell each product in order to achieve your financial goals.
4. The Competition
Take a good look at your competitors – after all, they should be looking at you! If your competitors' products are comparable to yours you can perhaps use their pricing as an initial gauge. If there is additional value in your product you may be able to support a higher price. Be cautious about regional differences and always remember your costs. It may even be worthwhile to prepare a head-to-head comparison of prices. The key here is to compare net prices, not just the published price.
5. Do you know where the market is heading?
You don't have to be a fortune-teller but keep track of any outside factors that may have an impact on the demand for your product – for example any new legislation, or a change in weather. How do you think your competitors will respond to any changes or if you introduce a new product. Might it lead to a price war?
6. Raising prices
You should always be testing new prices, new offers, and new combinations of benefits and premiums to help you sell more of your product at a better price. Measure the increase or decrease in the volume of products sold and the total gross profit generated by raising prices or offering a new service to the customer.
You don't of course want to alienate customers by raising prices too steeply, especially during a recession. Have a strategic plan to gradually increase your prices over a fixed timescale. Be aware that if the customer perceives that your costs are going down while their price is going up they will quickly become disgruntled. If you feel you've priced too high you can release a ‘lite’ version without looking like you made a mistake. Sometimes a price rise creates a sense of urgency and even a buzz about buying your product, all of which help both your product and your brand image.
7. Lowering prices
If you've priced your products too high you can always choose to discount your products or give customers something for free in order to get them to try your product, or to generate traffic to your storefront/website. One idea would be to offer special prices to senior citizens or students on specific days. If you feel the price is too low, you can release a ‘version 2’ with a higher price
Lowering prices is not a good practice unless you are using this strategically to garner market share and have a price sensitive product, or if all of your competitors are lowering their prices.
8. Monitoring your pricing
Continually monitor your prices and your underlying profitability on a monthly basis. You have to focus on the profitability (or otherwise) of every product you sell and make absolutely sure you know the degree to which every product you sell is contributing to your goal of making a profit each month.
No one said it was easy to get pricing exactly right but if you have never thought too seriously about pricing then it's about time to make some changes! A good start is to regularly listen to your customers, keep an eye on your competitors and have a budget action plan in place. You should already know all the important numbers in your business, and many of those numbers should influence your pricing strategies.
It all comes down to getting to know yourself and your customers - what you offer, and what they value most. To survive you do not have to be the cheapest in the market but you need a price that can be fully substantiated by the product/service, benefits and value that you provide. How you set the price of your products could be the difference between the success or failure of your business. You owe it to yourself and to your busines to be relentless in managing your product pricing.
- Pricing Strategy:how to price a product by Bill McFarlane, 2012.
- Pricing for Profit:how to develop a powerful pricing strategy for your business by Peter Hill, 2013.
- Confessions of the Pricing Man:how price affects everything by Hermann Simon, 2015.
- The Art of Pricing: how to find hidden profits to grow your business by Rafi Mohammed, 2005.
- How to sell at Margins Higher Than your Competitors:winning every sale at full price by Lawrence L. Steinmetz and William T. Brooks, 2005.