Change can be difficult; sometimes it's much easier to carry on as we are and not try to rock the boat. However, when it comes to pricing it's not a good idea to stick with the same old, same old (or, indeed, to bury your head in the sand).
Fear definitely creeps in particularly if you are looking to increase your prices, but the reality is that in order to enjoy a more profitable business it may be necessary at times to increase your prices. How do you do this without scaring yourself rigid or sending your customers elsewhere?
It may also be necessary to rethink your current pricing strategy - cost-plus pricing (for example) may not be delivering the required results and you are perhaps seriously looking around for alternative strategies. The good news is that almost any business can improve its pricing performance, provided it approaches pricing in a structured, disciplined way.
Unfortunately, the subject of pricing often receives meagre attention and this is particularly worrying because numerous studies have confirmed that getting your pricing right can have an immediate positive effect on profitability. There are two components to a pricing strategy: price getting and price setting.
In order to get the prices you want you will need:
- The existence of clear target prices
- Clear pricing rules specifying maximum discount levels
- To improve the negotiating skills of your salespeople
- The confidence to walk away from an unprofitable deal
- A strict limit on free services offered to customers to close a deal
- Systems in place to monitor and communicate price deviations to all involved in the sales process.
It's not easy to compare the price setting of companies that sell pharmaceuticals to companies that offer a service to individual end users.
There are also differences to be found in countries around the globe - European countries generally approach pricing somewhat differently to, say, China.
However, academic research concludes that there are similarities across industries and cultures and pricing usually falls into one of three strategies. These are cost-based pricing, competition-based pricing or value-based pricing.
"Your prosperity begins with your price strategy." Dan Kennedy, renowned Sales and Marketings author
Cost-plus pricing is used by many businesses, probably because it's easy to calculate and implement. To arrive at your price you simply add up all the costs of production or supply, set the required margin for each unit and add that margin
Cost-plus pricing is popular because:
- It ensures a reasonable margin - by using the same markup on all products, you know that you are getting a specified margin.
- If you know your competitors' standard markup you can always price accordingly.
- It appears fair - every customer is charged the same price so there is no price discrimination.
- It's justifiable - in cases where a supplier must persuade customers of the need for a price increase, they can point to an increase in costs as the reason for the price increase.
However, there are downsides to this strategy. When you sell based on “cost plus" your focus is merely on creating enough value for the customer to be willing to pay your cost-plus price. The result is you undersell, it doesn't maximise your profits or take into account a customer's willingness to pay more.
It's perhaps time to rethink your cost-plus pricing strategy for the following reasons:
It Limits Your Ability to Use Price Segmentation
By setting a variety of prices based on how different customer segments value your offer (their willingness to pay) you capture a greater portion of the market and maximise revenue at each point on the demand curve. So, don't just stick
Customers Don't Care About Your Costs
Difficult to hear, maybe, but all customers really care about are the attributes of your product and what value it offers them, not about how much it cost you to produce or supply.
As an example, customers will be willing to pay more for a Smartphone that has the features that best serve their lifestyle regardless of the manufacturing costs. If a customer’s willingness to pay is not based on the cost of goods, your price shouldn’t be either.
It Leads to Over/Under Estimating Prices
Cost-plus pricing may cause you to over-price your product when there is a weak market and underprice your product when there is a strong market. As the volume of products being created goes up, the costs of manufacturing go down.
Start slowly. Keep your current pricing model, but look for customer segments willing to pay more - and charge a higher margin to those customers.
If you have a basic/standard/premium product raise the margin on the “premium” product. You should quickly see that there is more money to be made by pricing based on customer value, not just costs. Over time you can add additional segmented prices.
Think About the Benefits of Competitor Based Pricing
Relatively Simple to Implement
Very little research is required to arrive at a price and it's also possible to make adjustments in prices by following any changes made by competitors. This is particularly true in industries with few competitors, not many channels of distribution and/or limited differentiation between products.
Offers low risk
If you have a fairly solid grasp on your product’s quality, customer appeal and cost of production, this method will most likely serve you in good stead. You’re not likely to lose volume or market share – after all, if it's kept your competitors afloat, it should do the same for you.
Give You Accuracy
Particularly in saturated industries. For most consumer products there are millions of customers and sufficient data to move pricing closer towards a market-based pricing strategy.
However Some Disadvantages to Competitor Based Pricing
Competitor based pricing operates on the assumption that other businesses in the market have all the right solutions to pricing conundrums.
However, if you are all sheepishly following each other it can lead to an entire industry losing touch with demand! You’ll end up either keeping the same price in perpetuity or you’ll simply raise or lower prices in response to the competition.
Remember, it's your business, your product and your revenue so don't allow your competitors to determine the baseline for your price.
Maintaining a lower price than your competitors isn’t always the best way to attract customers, but competitor based pricing exacerbates that idea by emphasising price as the differentiator that constantly must be lowered. The lowering of prices in most industries leads to doubts about quality - and subsequent lower revenue.
Because consumers compare prices all the time, competitor based pricing should be a part of everyone’s pricing strategy, but not become the "be all and end all". Remember, many customers would be willing to pay more for a premium product and exemplary service.
In most cases, if you are selling a product that provides more value than the competing alternative, customers will choose your offering. If your offer provides less value than its competing alternative, customers will shop elsewhere.
A value-based pricing strategy determines how much money or value the product or service will generate for your customer, which could originate from factors such as increased efficiency, time-saving, happiness or stability. You might also offer good credit terms, product guarantees, next-day delivery, exceptional customer service and technical support.
Value-based pricing is all about the customer and their willingness to pay. Generally, a value-based price is higher, yet the customer is willing to pay more because the product offers them something extra.
Why You Should Seriously Think About Value-Based Pricing
- It provides palpable "willingness to pay" data that compels you to introduce a profit-generating price.
- It allows you to implement price segmentation to capture a greater portion of the market and increase your profit margin.
- It helps you develop superior products by revealing what it is your customers really want.
- Products, additions and features will be driven by demand, which raises the perceived value, resulting in a higher price – and more profit.
- You are therefore providing a more personalised service and your customers should remain loyal because they trust your value and price.
- Even if you are forced to increase prices, if it is evident how much value you offer (perceived or estimated) then there's a greater chance of your customers remaining loyal.
- It allows you to charge more for your products or services without alienating your current or potential customers.
- It can be used in many diverse industries to price everything from fridges and pharmaceuticals, to boilers and cars.
- The best value-based pricing strategies find ways to make price a non-issue.
Prior to implementing value-based prices, you will need to:
- Identify your key competitors (the ones who affect your sales the most) to make a competitive analysis of your pricing.
- Ensure that your customers have a clear understanding of what value you are offering – and make sure this is shouted from the rooftops!
"Companies that have well-defined pricing strategies are 40% more likely to realize their monetizing potential than firms that don't have them." Madhavan Ramanujam and George Tacke in Monetizing Innovation
You choose your prosperity by the choices you make about price. These include positioning, the kind of customers you attract, – and, most importantly, the profits you make.
In turn, that profit determines the strength or weakness, power or vulnerability of your business. Profit is power and that profit is the result of your price strategy. Is now the right time to re-think your pricing strategy?
Monetizing Innovation by Madhavan Ramanujam and Georg Tacke, 2016
Pricing for Profit: How to Develop a Powerful Pricing Strategy for Your Business, Peter Hill 2013
No B.S. Price Strategy by Dan S Kennedy and Jason Marrs 2011