In a perfect world, a good product and accurate pricing should equal accumulation of profit.
If you are a startup
It’s probably best to keep your pricing model as simple as possible. It’s too easy to scare off customers with a complex pricing scheme. Start by researching what’s conventional in your industry and build from there. Study pricing models from the customer’s perspective. Try to interview as many potential customers as possible. Maybe you’ll discover that many of them are frustrated by the pricing conventions that are “standard in the industry” and they’ll be receptive to a different way of doing business. Perhaps you should simply charge whatever price premium the market will bear? Your decision can have tremendous implications because your price point defines your brand image and market postion, cash and funding needs – and ultimately, your long-term survival.
If you've been in business for some time
If on the other hand you've been in business for some time but you're having trouble moving items, it's maybe time to take a close look at what you're charging and develop a better pricing strategy. It's a pretty basic phenomenon that in business correctly pricing your product is essential: price your product too highly you will lose customers, too low and you risk losing profit.
Your pricing model, revenue model, and business model are all intertwined elements of your overall strategy and business plan; getting them right is crucial to attaining your financial objectives. Your pricing model must be appropriate for the markets and customers you are targetting, and remember too you will be constrained by the tactics used by your direct and indirect competitors.
Don't ever forget just how interested consumers are in price. The reaction on Twitter to Apple’s lauching of iPad2 is proof of this. The number of tweets per minute during the public launching on March 7, 2012, revealed which aspects of the new iPad created the most buzz. Activity was highest, at well over 10,000 tweets per minute, not when the product was unveiled or its technological features were described but the moment its price was revealed as $499. Tweets also spiked when Apple announced the repricing at $399.
Advice to help prevent pricing errors
1. Benchmark your business
Business owners often tend to think of what a product should be worth, not what it is worth. It's important to study the whole market and even more vital is to look at what the product sells for in your immediate area.
This can be as easy a matter as observing competitors, and thinking critically about how your model compares to theirs. What volume of business do your competitors do? Is there a reason their product sells for what it does? This is called benchmarking, and a remarkable number of small businesses fail to utilise this strategy.
2. Don’t allow low-performing categories to pull you down
For example, clothing stores have to be intensely aware of fashions and what the current trends are. It's not a good idea to concentrate on one item of clothing that used to sell well. The public will already have moved on to new styles, however attached you as the shop owner might be to a previous style.
Be aware of the time of year and weather – using the clothes store example, you might shift an awful lot of sunglasses during the summer period (to complement your clothes), rather than sticking to selling unwanted clothes items. Forget tradition, it's about what sells fast.
3. Put a price on your time
This is the most overlooked rule business owners make when pricing.
If something takes a lot of time, it should be more expensive. If it can’t sell at a price that supports your desired pay rate, you shouldn’t be selling it. If you're stuck with it, do what you can to get rid of it. Remember - labour, even when you’re working for yourself, is a factor in pricing.
4. Let go of bad ideas!
There's no point in being over proud - or shame in admitting a bad decision. You put something out there and it didn’t sell. Now, cut your prices, move the goods, and move on to the next product or idea.
In their book, The Strategy and Tactics of Pricing, Thomas Nagle and Reed Holden outline nine "laws" or factors that influence how a consumer perceives a given price and how price-sensitive they are likely to be with respect to different purchase decisions.
- Reference Price Effect – a buyer’s price sensitivity for a given product increases the higher the product’s price relative to what alternatives there are. Perceived alternatives can vary by buyer segment, by occasion, and other factors.
- Difficult Comparison Effect – buyers are less sensitive to the price of a known or more reputable product when they have difficulty comparing it to potential alternatives.
- Switching Costs Effect – the higher the product-specific investment a buyer must make to switch suppliers, the less price sensitive that buyer is when choosing between alternatives.
- Price-Quality Effect – buyers are less sensitive to price if they perceive that the higher price signals higher quality. Products for which this effect is particularly relevant are luxury/designer items.
- Expenditure Effect – buyers are more price-sensitive when the expense accounts for a large percentage of their available income or budget.
- End-Benefit Effect – this is when the buyers are sensitive to the price of the end benefit, and the more sensitive they will be to the price of those products that contribute to that benefit. Price proportion cost: this is when the price proportion cost refers to the percent of the total cost of the end benefit accounted for by a given component that helps to produce the end benefit. The smaller the given components share of the total cost of the end benefit, the less sensitive buyers will be to the components' price.
- Shared-cost Effect – the smaller the portion of the purchase price buyers must pay for themselves, the less price sensitive they will be.
- Fairness Effect – buyers are more sensitive to the price of a product when the price is outside the range they perceive as “fair” or “reasonable” given the purchase context.
- The Framing Effect – buyers are more price sensitive when they perceive the price as a loss rather than a forgone gain, and they have greater price sensitivity when the price is paid separately rather than as part of a bundle.
In highly competitive and minimally differentiated markets where competitors’ prices are visible to all market participants (most products sold online), prices are set primarily by supply and demand. This takes into account shipping costs and sales taxes. You can earn a slight premium if you have a strong reputation (like Amazon), or if you can promise faster delivery, or offer a more flexible return policy. If you can’t justify pricing at a slight premium to the market, then you need to be the low-cost manufacturer or importer, or else you’ll compete yourself out of business.
If your product or service can be configured to have a “base” model with a variety of optional upgrades, you can attract interested buyers with a low price on the bare-bones version and then upsell on additional features. Anybody who has purchased a car or new home is very familiar with this technique. While this approach can be very profitable, you need to be careful not to alienate your customers by making them feel like they’ve been tricked. Consumer protection agencies are flooded with complaints against car sellers!
Razor and blade model
This pricing model involves a reusable “base” component that you sell cheaply (or even give away) and a consumable component that must be replaced regularly. This is why ink jet printers are so cheap: the manufacturer's make their money on the ink. This can also be used with medical devices where a fresh, sterilized component must be used with each application. If you are selling the base unit at below cost, you obviously need a deep balance sheet.
If it makes you feel any better, even major companies make pricing errors - some real howlers!!
Below is one example:
Company: Amazon UK
Error: £200 pocket computer priced at £7
Amazon UK had to shut down its entire UK website for 50 minutes while it corrected the prices on a number of hand-held computer products. Products such as the Hewlett Packard H1910 which retailed at £200 were being advertised for the incorrect low price of just £7. The BBC reported that some customers were placing orders for 50 to 60 units at a time. Unfortunately for the hundreds of bargain hungry customers who placed orders, only those who'd received a confirmation email from Amazon received the hand-held computers for £7. The consumer outrage produced this statement from the UK consumer association: "Until there is a binding contract, either party can pull out of the agreement." Lesson learned for all concerned!!
You may also enjoy
- 5 signs you're a pricing genius.
- What is Configure, Price Quote (CPQ).
- The benefits of Price List Management Software.
- 8 reasons why Excel based pricing could be hurting your business.
- Gregson, Andrew. Pricing Strategies for Small Business 2008 Self Counsel Press. ISBN 978-1-55180-979-3.
- The Strategy and Tactics of Pricing, Thomas Nagle and Reed Holden.
- Pricing on Purpose: creating and capturing value by Ronald J Baker.
- Implementing Value Pricing: A Radical Business Model for Professional Firms by Ronald J. Baker.