Small Business Marketing
Choosing the Right Pricing Strategy
Written by James Garvin for Gaebler Ventures
Pricing decisions for a firm can strongly influence the profits that a business reaps; however, finding the right price and pricing strategy can be a challenge. The best way to start with determining price is to take into account not only your costs, but your competitors' pricing, and the difference in value your product offers compared to the competition.
Most everyone is familiar with the 4P's of Marketing (Price, Product, Place, and Promotion) and each one has its importance regarding a firms marketing strategy and success.
However Pricing tends to be the one P that most small businesses struggle with due to the complexity and multitude of options that are available. The majority of new and small business price their products based on the cost to provide or deliver a good which is known as cost-based pricing. For example, if you have a target of a 50% margin and it costs you $10 to make your product, then you will price it at $20 (*Remember $20/$10 = 50%).
The problem with cost-based pricing is that it does not take into account the value that a customer obtains from your product, nor does it take into account competitive products or pricing. Some firms may take competitive pricing into account in addition to their costs when pricing their products, but this still ignores the value you are providing your customers compared to your competitors.
The challenge with pricing is to find a pricing strategy that allows you to extract the maximum amount of profits from a customer base that likely all has a very different willingness to pay for your product or service. Not everyone is willing to pay $20 for your product, so if you price it at $20, you only capture some of your target market. If you price your product too high, not enough customers buy, but if you price your product too low, you lose on your profit margins.
Strategic pricing has several advantages. The first being that when you change your pricing from your competitors it becomes more difficult for customers to price compare. If one phone company is offering $0.50 per minute for unlimited minutes while another is charging $20/month for 500 minutes and $0.10 per minute thereafter, it requires a bit of math and thinking about how much you will talk to compare which price offered is better.
Secondly, using strategic pricing will can increase your profits by extracting greater surplus from your customers.
The base for any pricing strategy is to understand how your product creates economic value to your customers. EVC ("Economic Value to the Customer") compares the added benefits of your product to your competitor and tries to quantify them to help determine a price for your product.
For example, if a Toyota Camry with 400HP is sold for $25,000, but Honda comes out with a similar 500HP car, the reference vale of their car is the $25,000 + the added value of the additional 100HP. If Honda priced their car at $25,000, they would be under pricing the market and lose out on potential profits.
There is never a one size fits all for pricing, but when looking at your pricing strategy, do not simply look at your costs. Evaluate your competition pricing and determine the added value that your product creates and price accordingly.
Once a price is set, determine how that price changes over time or as purchases increase. There are many ways to get creative with pricing that prevent you from having to get into pricing wars with competitors, but you need to understand the value your product creates as a starting point.
James Garvin began his education studying biotechnology. In recent years he has turned his interest in technology to helping two internet startup companies. The first business was an online personal financial network and the second was an e-marketing platform created to help entrepreneurs demo their web sites. Currently a student at University of California Davis, James is spending his summer incubating two new online businesses and writing about his entrepreneur experiences.
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