Issues Affecting Price
This article addresses a variety of factors that should be considered when establishing a price for your product or service. These include pricing methods, the impact of your enterprise objectives, the effects of competition, the influence of the prospect's perception, characteristics of your product or service, your enterprise resources and environmental influences.
|This document prepared and presented by|
Business Resource Software, Inc.
The concept of a 'price' is a worldwide concept. In fact, there are many ways to express the concept of 'price'. Some of the terms are; assessment, bill, charge, cost, dues, duty, expense, fare, fee, honorarium, interest, levy, premium, rate, retainer, salary, wage, tariff, tax, tithe, toll and tuition. I'm sure if you spend a little time you can think of several more. No matter what you choose to call the 'price' you will charge for your product or service there are a number of factors to consider when determining exactly how much you should charge.
Types of Pricing
Let's begin with the fact that there are many ways to present the 'price' for a product or service to the customer. Some of the more well known methods are described below.
- Cost plus a percentage of the cost. (usually service oriented)
- Breakeven, that is, whatever it costs to produce the product or provide the service. (usually non-profit organizations, but not necessarily)
- Target profit (eg: make a 20% profit before tax. This implies that you understand all of your operating costs very well.)
- Perceived value (price to the consumer's expectation)
- Competitive related (price using competitive price as a base)
- Sealed bid (usually construction projects)
- Two part pricing (fixed fee plus variable usage rate eg: telephone service)
- Bundled pricing that combines multiple products and/or services under one price.
- Discounts for cash payment (when cash flow is important)
- Quantity discounts (when volume is important)
- Trade-in price (when there is some residual value for a trade-in item)
- Update price for an improvement to an existing product (this allows you to benefit from current customer base)
- Discounted price to a reseller (to expand volume through channels of distribution)
- Seasonal discount (to even out volume which allows a consistent production process)
- Sales price(to promote demand, with volume hopefully offsetting reduced price)
- Psychological pricing (eg: to create an impression of a lower price, $199.95 vs $200)
- Geographical/sales site location (eg: varying prices for fuel in different geographical locations)
- Price plus shipping (catalog/mail order type of sales)
The objectives that you have set for your enterprise and/or a particular product or service will have a significant impact on your decisions related to the prices you set. Some examples of objectives and their influence on pricing decisions are:
- Does this offering require a short term or a long term commitment? IE: Is it a "pet rock" sort of offering or is it something you can build a business around?
- Do you need to maximize cash flow? If so, are you willing to set your price high to get the greatest return from each sale at the cost of limiting market share? If not, are you willing to significantly under-price the competition to sell in volume, generating some cash but destroying future market potential by lowering price expectations?
- Is it your intent to capture maximum market share or attract customers for sale of other offerings? if so, are you prepared to take a loss on the sales of your current offering to build a customer base that will purchase a follow on (potentially much more lucrative) offering in the future?
- Do you want to price at some point relative to competition (higher, lower or equal) with an intent of creating a image relative to (different than) the competition?
- Do you have excess inventory? If so, is break even or even a loss on each sale of an offering more cost effective than having the offering sitting in inventory due to interest payments, storage costs or time sensitive materials?
- Is it important to attract attention to the product/service? Will volume sales establish a brand recognition and if so is this more important in the short term than concern for whether any profit is realized?
- Do you want to price to attract distributors? If so, are you willing to accept significantly lower profit margins to establish relationships with one or more distributors who will likely carry future offerings once a relationship has been established?
- Do you want to price to set entry barriers? If so, you must decide whether a low price (that still makes you some profit) will discourage the entry of new competitors.
- Do you want to price to hurt competition? If so, are you willing (or able) to lower prices enough to insure that you will increase your market share?
- Are certain price levels necessary to retain customer base, channels of distribution? This may be a factor if it is your intent to remain in the market over a long period of time with numerous offerings. In this case, it may be prudent to maintain low prices which will encourage relationships with distributors and repeat purchases from your customer base.
- Do you want to establish an image of high value, thus high price? If so, do you have the resources to have your offering considered the "top of the line" in quality, reliability and durability and thus a justifiably high price?
- Do you want to establish an image of high value but a low price? If so, do you have the resources to have your offering considered the "top of the line" in quality, reliability and durability and still price it at a comparable or lower price than the competition?
- Do you want to maximize profit? Are immediate profit margins more important to you than building a customer base and creating an image (enterprise, product or service) that will sustain you in the long run?
If you are not the market leader in your industry, competitive prices will influence the pricing of your product or service. Market leaders have often created a "pricing standard" against which other product/service prices are compared. So if your product or service is reasonably competitive with the market leader's offering you can set a price that is near the "standard". If you have the ability to price lower than the competition and still be profitable, you may be able to capture a greater market share which can benefit you over time as you offer new or complementary products or services to your customer base.
Your decision to compete with a lower price should not be made lightly. If the competitor perceives that your low pricing has the potential of reducing their market share or impacting their influence in the industry, they may respond with an even lower price. Then, instead of increasing your market share, you could be faced with no opportunity to profitably penetrate the market at all. It is always of value to know the capabilities and tendencies of your competitors.
A different form of competition is the 'alternative solution'. The prospect's first alternative is always, if the price is too high, a decision that they really don't need your offering or any of your direct competitor's offerings. There may also be a variety of ways for the prospect to solve their problem. For example, if you offer an airline service, you are really in the business of transportation. So your prospect has the option of your service versus trains, busses, rental vehicles, personal vehicles, hitchhiking, bicycles, walking or (back to the first alternative) staying at home. The availability of numerous alternative solutions will usually limit your pricing flexibility.
Understanding the characteristics of the marketplace is an essential factor in establishing a price for your offering. You should first try to identify the general type of market you will be selling to.
Type of market
- commodity (many buyers/competitors, non-unique products) - minimal pricing flexibility
- uncontrolled (many buyers/competitors, unique products) - maximum pricing flexibility
- controlled (many buyers, few competitors, unique products) - some pricing flexibility
- vertical-low (limited # of buyers, many competitors)
- vertical-high (limited # of buyers, few competitors)
Then you should learn as many details as possible about the 'typical' prospect in the market you have targeted. Examples of the kind of detail you should look for are:
The Product or Service
- Prospect's perception of your product (positive perception = higher price)
- Prospect's awareness of your product (lack of awareness raises promotion costs)
- Whether product is for a captive audience (eg: razor blades, minimizes marketing costs)
- The criticality of the offering to the consumer (more critical = higher price)
- The ability of the consumer to pay (greater ability = higher price)
- Demand due to seasonal considerations (snow shovels priced lower in the summer)
- Demand due to geographic considerations (snow shovels in Tahiti are unlikely to sell no matter how low the price)
- Market trends, fads or changing consumer interests
There are, of course, many characteristics of your product or service that will influence the price.
- Does your offering provide tangible versus intangible benefits/differences? Offerings with immediate and tangible benefits will usually support higher prices.
- The uniqueness of your offering versus the competition. Uniqueness usually supports a higher price if the offering has credibility.
- Whether your offering is one of several in a product/service line. Pricing must be consistent with the rest of the line.
- Whether your offering is a complement to another product/service. Sales to existing customers usually reduces marketing costs thus giving greater pricing flexibility.
A variety of factors within your enterprise will influence the pricing decision. Some examples are:
- Your cost to produce the offering is clearly the first factor in setting the price.
- The potential for learning curve benefits. That is, will sales volume and time result in lower production costs thus creating the potential for lower prices?
- Your ability to meet demand. If you have a limited production capacity, you should price high enough to insure that you don't create more demand than you can satisfy.
- Your cost to deliver, including shipping, warehousing and installing.
- Your cost to promote, including press releases, press tours, ads, literature, demos, etc.
- Your financial resources, giving you the ability to sustain a start-up period of losses.
- The quality and speed of your product/service delivery. If you can deliver quickly and "how quick can I get it?" is the most critical factor to the prospect then high pricing is likely.
In addition to characteristics of your competitors, your prospects and your enterprise there are more general, environmental factors that can influence your pricing.
- At what point in market life cycle of your offering are you selling? If it is early in the life cycle you can usually charge a higher price.
- What is the availability, quality and cost of channels of distribution?
- What is the status of the economy (inflation, deflation, varying interest rates)?
- What is the potential for government intervention? Is your enterprise verging on a monopoly? is your offering important to national stability?
- Are market characteristics such that a lower price will generate a higher demand? (Elasticity of demand)
There are many other factors that can influence pricing that are difficult to place in any of the above categories. Some of these are:
- The method of payment you want to extend to the customer. (cash, invoice for 30 day payment, time payments, no payments until ...)
- The cost for the prospect to switch to your offering from their current solution. Does a high switching cost imply that you need to price low to offset the switching costs or should you price high because the prospect has already committed to a high dollar solution?
- What image is most appropriate for your offering to achieve maximum market penetration? (often higher prices imply higher quality and vice versa)
- Are you able to define price thresholds, upper & lower, where the prospect will consider the price unreasonable?
- Is it reasonable to segment the market for different prices? eg: first class vs tourist air fares, branded vs unbranded offerings, first time buyer vs existing customer.
- Are there special conditions (atmosphere/ambiance) at the time of purchase? For example, the price for a cup of coffee in a deli is likely to be much lower than for a similar cup in a Hilton hotel.
- How reliably can you project sales volumes? Reliable volume forecasts typically allows for better pricing determination.