Pricing for Profit – It is a Key Decision
Pricing strategies are a key marketing decision for any business. Price says a lot about how the business sees itself and its customers.
The price chosen will affect, amongst other things, whether all costs are covered and how the product is perceived by customers. Is it a Rolls-Royce or a Lada? It will affect the market share that the product will achieve and the profit that will be made. Pricing for profit is not simply a case of taking costs and adding a big mark-up.
The Basic Decision: Where in the Market?
There are two broad approaches to pricing. It can be part of the overall marketing strategy for the product and the company or it can simply be based on cost. Many small or new businesses start with cost-based pricing. They take their costs and add a mark-up of some form which they hope will earn them a profit at the end of the year. The only strength of this approach is that it is simple and, if it is based on a full understanding of the costs, ensures that the costs are covered provided that enough units are sold.
However cost based pricing does not take into account all the other issues that will affect the success of the product and the business.
Marketing-led Approach to Prices
It is far more useful to take a marketing approach to pricing as it will reflect a deeper understanding of customer motivation and the objectives of the business. The result should be a price that is appropriate to overall marketing strategy for all products or services. Price is only of the 'Four Ps' in the marketing mix and it interacts with all of them. Just as a reminder, the four Ps are: Place, Promotion, Price and Product.
Many strategic decisions need to be taken in setting a marketing-based price.
One should consider what market position is wanted for both company and product. Luxury items such as perfume and jewellery can be under-priced as some of the value to the customer is exclusivity, which is partly about price. Is market share important or is profitability a key consideration? This will depend on a variety of factors including the cash position of the business and its long-term strategy; does it want to be in a niche market or is it after volume in a major sector of your market? What are competitors doing and how are the products or services different!
Profitable Pricing is Fundamental to Business Strategy
Consider product portfolio as a whole. Gillette priced the first safety razors low because they were aiming to make profit on the repeat business from blades. Alan Sugar admitted that Amstrad got it wrong by concentrating on selling satellite television dishes; he recognised that he should have invested more in the longer term in the satellite service (the blades) and sold the dishes (the razor) as cheaply as possible to generate demand for those services. He believes he would have then made more profit in the long term.
Understand Customer Value
What is the value to the customer? If a consultant gives a client advice that saves the business £50,000, a fee of £5,000 will look good value. But if told no improvement is possible, then the same fee might not look so attractive even though work had been done.
What are competitors charging for similar products? Is there are a going rate for the product or service! Even it there is, there may be an opportunity to differentiate the offering by pricing differently to position it for new markets. The introduction of 'gourmet' pet foods at a premium price was successful even though much of the market was in a limited and low price range.
When trying to enter a new market it is tempting to seek to grow sales rapidly by pricing at a low level; more appropriate to the sales expected over the life of the product. It has been said that such 'penetration' pricing was how the Japanese achieved their dominance in the electronics and other markets. It is not dumping hut simply taking a long-term view of your pricing strategy. By pricing, they created the market which gave them the volume they needed to achieve a profit. Obviously there is a risk that sufficient volume is not achieved to break-even.
An alternative is to take a 'skimming' approach to prices by setting them at a level appropriate to low initial volumes. This can maximise the recovery of development costs as sales grow. Price can then reduce as achieve volume is achieved and cost advantages gained from experience and economies of scale. However, the danger is that sufficient volume is never reached to become significant in the market. An example was a personal computer introduced by Texas Instruments (TI) about the time the IBM PC was launched. The TI computer was generally accepted to be technically better but because it had a high 'skimming' price it never achieved the sales volume; by the time the price was reduced to a penetration price the opportunity had passed it by.
Complete Understanding of Costs
However, costs are important. They provide a base figure below which one cannot price the product. Even when adopting a marketing approach to setting prices we must aware of costs and how they are structured. There is the classic break-even chart (figure 1) shows the need to balance price and likely sales volume to ensure that the business can reach the break-even point.
Breakeven and Pricing and Sales Strategy
The two revenue lines show the effect of a low price and high volume against high price and low volume (assuming the same costs structure). As part of the marketing strategy it is necessary to decide what sort of business is desired and therefore which approach is appropriate to the company strategy. Apart from all the other issues there is a balancing act between price and volume. The decision comes down to the product(s), resources and the level of risk is prepared to take. Discussion of break-even, costs and risk would need an article of its own.
A full understanding of costs is needed and not just the direct costs but overheads, marketing and the real cost of sales.
Other Considerations for Setting Prices
Due to competitive pressures there will be a need to face other challenges. How does one respond if a similar product is launched at a lower price; or even how do other products affect pricing strategy?
Consider the challenge faced by branded products manufacturers when the supermarket chains started to introduce own brands. They had several choices. They could make the products under contract; they could ignore them and probably lose volume. Or they could do as many did and introduce their own low-price/high-value brands to compete; but of course such low-profit brands were going to take sales from their own high-profit products.
Profit cannibalisation is another factor in pricing strategy and there are no simple universal answers. In the example it was usually a matter of taking a small profit on some sales rather than losing it all because they were not in that segment of the market.
Maximise Profitable Business
Profitable pricing strategies are not as simple as often portrayed — indeed it is fundamental to the business strategy. However, a little research, an understanding of costs and a full appreciation of the market allow product positioning to maximise the profit for the business.