Here's a quick multiple choice quiz for you. Pricing is:
a) the last link in the supply train
b) a complex science and seeming black art
c) a critical way to communicate with present and future customers
d) all of the above
If you answered d) you get a gold star. But even with knowing that answer, the business owner's fundamental question of "how do I price my products and services?" is still a difficult one. There are a lot of models out there. The trick is to choose among the existing one that might fit your business. Or, if need be, to develop your own.
We're using the model here not to indicate that there's some slick mathematical formula that applies in your industry and that all you have to do is punch some numbers and crank out process. Even at their best, good pricing policies are more complex that that. But for most businesses, it's a lot simpler that rocket science - unless of course you're a person responsible for pricing rockets. The model we discuss here is a methodology and a way of thinking that will hopefully help guide your pricing decisions.
For virtually all businesses, pricing comes down to a delicate balancing act among three factors: Your internal costs; the demands of the market you're in; and, the one most people forget, your company's strategic goals.
Think of these key variables as the legs of a tripod on which your pricing policy must have balance. The balance between cost and market is fairly obvious and doesn't require a lot of space here. But the issue of company goals and maintaining the balance among the three is key over the long term.
For instance, two competitors in the same industry with similar products and internal cost structures have radically different pricing policies depending on corporate goals. A company that is focused on gaining market share may cut prices, offer special incentives, bundle with symbiotic products or other non-financial manipulations of the product's pricing. Another company that is focused on short-term profitability may move to higher pricing and may even sacrifice some sales in order to make fewer, more profitable, sales transactions.
Neither strategy is right nor wrong, it depends on the goals, costs and markets for the individual companies.
This balancing act is a tough one to keep up. Beyond the three basic factors, a myriad of other issues come into play. Cost pressures, new or more aggressive competitors, and even shifting company priorities make this a tough job. So your pricing model must not be set in stone, but instead have a firm foundation upon which you can build a flexible structure.
I once encountered a business owner who multiplied all her costs by 1.713 to set her prices. I asked her why she used that particular number and she responded that it was what the previous owner did. She was marginally profitable. In this case, by using an overly simplistic formula, it's certain that some products were under and some overpriced. Even more certain is the fact that in essence her suppliers were setting prices for her without regard to her goals or her market. This kind of "formula" is not only misguided, it can be dangerous.
Beyond the dollar figure involved, price is also a communicator of value. If you consistently under price products, your business may not only be leaving money on the table, but at work you are negatively affecting your customers' perception of value. Again, clear strategy integrated with your pricing model is called for.
Most businesses can benefit from a technique I call the "Pricing Window". By knowing your costs and understanding demand at various pricing levels, you can develop a window, or range, within which you know with confidence that the price must fall. The demand ride or market-driven end of the range varies greatly among industries and you must understand how it works in yours.
For example, people will drive out of their way to save a nickel on the price of gasoline. But the same person will examine the price of an elegant dining experience differently. If he or she desires to dine in a certain way, they are likely to pay the cost and not "shop around" for the same meal at a lower price. So, in the pricing of gasoline, there's a tiny, sometimes infinitesimally small, window of opportunity in pricing. For an elegant meal, marketed correctly, the window is huge.
Within that window, one can position the product for maximum effect to achieve corporate goals. There again, we come back to the fundamentals of clearly defined goals and striking a balance among competing factors.
The keys for your business are to look with care at each of the three areas that affect out pricing policy and to come up with concrete data. Then design a model in and some way test it. Tests could include a short-term promotion or an expansion into a new, as yet, untapped, market. Many businesses also can rely on the advice of come key customers-if that's possible for you, then by all means take advantage of their knowledge.
Above all, strike the balance that achieves your goals--whatever those goals may be.
Article ©2002 NHSBDC. Reprinted with permission.