The value that the customer places on your product (or service or technology) ultimately determines how much the customer is willing to pay. The value is determined by a number of factors: some related directly to the product, others to the customer’s emotional and internal needs, and still others to market or competitive factors. All come together to create the complexity that is pricing strategy formulation, which is too often overly simplified down to one (or more) of these options:
- Cost plus profit margin formula
- One price fits all
- Match the market
- Beat the market
- Penetration (maximize the volume)
- Skim the cream (high price to sell to customers who aren’t price sensitive)
- Target return (price to achieve ROI)
- Psychological (e.g., price to signal the market about quality, trend, status)
- Value (base on effective value the customer places based on alternatives the customer could buy)
The reality is that pricing is more art than science. It requires an understanding of market conditions, customers, competitive factors that matter to the customers, cost structures, and many elements that relatively few businesses have traditionally included in the pricing process. Industry practice, experience, tradition, and economic models have all been heavy influencers of how businesses have been “taught” to price. Assumptions about the need for “every” business to pursue high volumes and market share have frequently lead to some industries to price themselves into being viewed as commodities—a view that is hard for any industry or a single company within an industry to break away from.
Pricing Signals: The Customer, The Market, The Competition, The World
Pricing is one of the first, if not the most significant, signals a business sends to the marketplace about its product, its business, and its competitive positioning. Pricing may be developed on a product-by-product basis, as a company-wide strategy, or somewhere in between. Whatever the approach, the price the business puts on its product tells everyone where the business is positioning itself versus other players and what it believes customers are thinking, feeling, and ultimately valuing the product. Missing on product pricing can mean missing out on the entire market opportunity for a product; failing to connect with a customer or a market; and not getting a chance to adjust the price and try again. This is especially true if a business is launching a product at the same time as a competitor, to create a market, to introduce a new technology, or to change its pricing strategy and the perception the market has of the value of the business and its products.
From Customer Value to Right Pricing Strategy
When a company is able to develop the “right” pricing for its products, it will be able to maximize its profits. It will effectively match price to each market segment with an ability to attract buyers and retain them once they buy. The price established will maximize profit by enabling the business to match its pricing to its strategic objective. The strategic objective translated into the language of pricing is sometimes, but not always the same language as used for the business and strategic plans. Here are some strategic objectives in pricing language:
- Maximize current profits
- Maximize current revenues (regardless of profit impact)
- Maximize quality sold (volume of units sold)
- Maximize profit margin (per unit profit margin)
- Establish quality leadership
- Recover direct costs
- Break even (survival, stay in business)
- Remain in status quo: maintain price stability, current rate of growth (if any)
Based upon the strategic objective selected and translated into the necessary pricing objective, the business decides what approach it will take. Usually it translates into those “traditional” approaches listed earlier in this article, which usually lead to leaving money on the table because you underprice, or driving customers away because you are overpriced for the value certain customers place on your product. It isn’t that the objectives are wrong or that the strategies are bad; they are simply limiting in their perspective and implementation.
Strategic Pricing Effects: Capturing the Customer and Uncovering Hidden Profits
Strategic pricing done well will compel the market to buy from the company because the market members (customers) will recognize the value they will receive for the price. The strategic price:
- Makes the product affordable to the customer, AND
- Drives the business toward efficiency (by enforcing a discipline on the business)
- to establish a targeted cost that
- drives operational efficiencies
- drives cost innovation through analysis of
- cost structures
- cost segmentation
- cost modeling.
These are all driven by a need to deliver the product to the market at the price the customer places on the value the product provides to the customer—not a price that the business arbitrarily sets.
Where Price Matters
Remember, in the market place customers are not limited to products that are the same in form and function to satisfy their needs. Customers have a range of alternatives (products that are different in form and function that accomplish the objective), substitutes (products that are similar in form and can perform the same function), and similar products (same form and function).
Because customers have a variety of choices, businesses must be able to differentiate themselves on more than price. The degree of differentiation usually comes down to the ability to have a protected advantage either through protected product rights (e.g., patents) or through operational capabilities in assets, processes, or competencies that have been developed and are protected (e.g., trade secrets, economies of scale) that cannot be replicated or easily duplicated, or through the expertise and service your organization provides in making the sale, delivering the product, and serving the customer after the sale.
How the customer perceives the product being purchased impacts the price that the customer is willing to pay for that product. The value placed on the entire package of “the product” includes the physical aspects and the intangibles (e.g., service, psychological factors, image, brand). As a business, from the sales team to customer service to the back office workers in accounting and other areas, you are all engaged in creating the value for the customer.
Beyond What the Customer Sees: What the Business Is
The value for the customer is critical. The cost to deliver that value to the customer is equally important. The business doesn’t ignore the costs that flow into the product directly or indirectly, just as everyone as a role in creating value for the customer, every level of the organization and every person has a role in managing the costs of the business. Each person in the organization has influence on what gets spent, on what decisions get made, on what resources get used and how. The business that recognizes these two very important truths:
- Everyone is part of marketing and selling to the customer (value creation).
- Everyone is part of generating return on investment, profitability, and controlling costs.
is a business that is capable of competing, generating profits in the most challenging of markets (and more of them), and sustaining healthy levels of growth. Pricing is one aspect of the business that many view as something they have to accept. Businesses become price takers and follow the markets. Pricing is strategic, and businesses need to spend more time on developing it as a competitive tool in their toolbox, a weapon they can wield in the competitive wars. To the price warriors will go the markets, the customers, and the profits.
Copyright © 2008 Lea A. Strickland, F.O.C.U.S. Resources, Inc.
All rights reserved.