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Pricing Strategies: Finding the Right Price

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The Proper Price is Truly a Magic Number
Roy A. Ackerman, Ph.D., E.A.
The Adjuvancy, LLC.
Updated 24 June 2010
Let’s admit it- we have a problem pricing goods and services. Most of us consider that we use
sophisticated analyses- but, it is usually closer to the “back-of-the envelope” methodology. We add in our
costs and then figure out how much we need to add on to cover those amounts.
Some of us have used breakeven analysis based upon various assumptions of market capture; we may
feel comfortable falling back upon “scientific principles”, but there are other important considerations.
Using the breakeven method can cover our costs, but still let us teeter on the edge of bankruptcy, due to
volume considerations. As you can see from Figure 1 below, after we start making 10,000 units a month,
our breakeven cost is $ 3.80- but that still does not provide the pricing information, per se. So, we pick
some multiple for the pricing (120%)- and, as long as the volume holds or increases, our company is
profitable.
$180.00
$160.00
$140.00
$120.00
$100.00
$80.00
$60.00
$40.00
$20.00
$100
500
750
1000
10000
25000
50000
Figure 1: Price ($) v. Number of Units
Another approach is to match our pricing to our competition- and hope to eke out a profit. While this is
another very popular method, it often leaves plenty of dollars on the table. The cost and competition
model does not take into account how your customers value your product/service. It may even push
customers away from buying your goods and services (“How can they claim to be so good, yet so
cheap?”). This is often done in the apartment rental industry. A survey of available apartments is
prepared. Then one compares the rents the others are charging to find where you belong in the strata.
However, there we need to do some “massaging”: Are our apartments nicer; did we refurbish recently,
who is closer to the mass transit, etc. But, that is still guesswork and can still leave money on the table.
We can also use the same product case from Figure 1 above. There, we can see that if the competition
were charging $ 4.00 per unit, our unit profit would be $ 0.20- assuming we were producing AND selling
10,000 units monthly. (Actually, this chart shows us that we need to lower our variable costs dramatically
to render this a profit-generating business, but that is for another discussion.)
The real truth is that there is NOT a correct price for everything, but rather a range of prices for different
combinations of products and different customers. You don’t see how this applies? Well, if you went to
an auction- or watched a product go for sale on eBay.com, then you can see that customers bid a wide
range for the same exact item. Or, you may be a consultant who provides support over the telephone do you price per minute or per call? And, then, what happens when one customer monopolizes your
whole day- or one customer gets his answer in ten seconds? Or, do you recall paying $ 2.00 for a can of
pop in a convenience store, $ 1.00 in a pop machine, and grimace when twelve cans of that same pop
cost you $ 3.50?
So, how do we charge for that new product or service? In addition to the breakeven analysis, some of
our clients have used what they call is an incremental pricing approach. That means if the new product
costs 10% more than the existing one (or has 10% more features), they charge 10% more for this newer
version of the product. Or, they may price the product just above or just below their major competition.
Too much- and we have no sales, too little not only cuts our revenues, but sets the perceived value too
low in the marketplace. And, once you hit the market, charging more for your product is a very steep
climb.
The fact is that the lowest price does not garner the highest number of customers. If you were to plot
some of your historical sales by volume and by price (or volume and discount) as is shown in Figure 2,
you will see that lower prices do not have a directly proportional relationship to your pricing.
6
5
4
Pricing
3
Profit
2
1
0
Units
12500
20000
50000
150000
Figure 2: Pricing vs. Profit at Various Unit Sales
There almost always is a gap between what your customers are willing to pay and what you charge for
your product or service. The art- and the mystique- is to narrow that gap to the smallest amount possible.
If we had infinite time and money (yeah, that’s us, all right), we could employ researchers or students to
compute discrete-choice analysis, where customers see different products/services with different features
and then judge the price ascribed to them. This method could provide you with a mix of features and
pricing.
But, as you well know, you don’t have that luxury (but, if you do, by all means compute away). Well, then,
how about asking the customers that provide some 50% of your sales (by volume)? Ask your customers
what they would substitute for your service if it did not exist. This will provide you with the options that
exist, reveal how well they fare for your customers, and therefore detail the true value of your product or
service. In so doing, you can begin to determine what is the value of the service and quality, vis a vis the
competition, as well as other factors.
Figure 3: Uniqueness/Importance Matrix
Your pricing must match your product/service strategy. The quadrant your customer assigns you sets
how you are viewed, how much you can charge, and how your product will be accepted. The customer
assigns a value to your offering; basically, that value is benefits minus costs. If what you are offering has
low importance and low uniqueness (in others words, there is no “brand” value to your offering, then your
generic or “me-too” offering provides you little room to maneuver on the pricing scale.
If you can offer some special attribute (your service is available 24X7, you have a money back guarantee
for 30 days, a ten year warranty) then that special attribute provides more value to the client, and your
ability to price the offering gets larger.
An evolutionary (enhanced product) or revolutionary (radical changes) new offering have a wider choice
of pricing. If your product is more unique (generic tissues vs. the “softer, gentler” brand, you may rise in
importance (special attribute) or uniqueness- either of which allows you to charge more. But if your
product is unique and provides benefits unlike any other, then it is a game changer, and you have the
highest pricing range. The corollary is that you must watch your competition and insure you have not
been moved lower on the scale. A good example of this is when a brand name drug is reaching the end
of its patent life (so a generic version will soon be available) or when a competitor is offering it’s own
solution; the importance of your offering to the customer and the uniqueness both have decreased.
The truth is we always seem to focus on the lowest possible pricing. We should change that and focus
on the price ceiling. However, you must recognize that that is the theoretical number; most of the time,
the customer will not bear that burden.
You call also sell different versions of the same product or service to different customers. In our case
above that means a different price for chains, individual clinics, overseas customers, and federal
hospitals. A minute change in the product (or in the case above, how it was delivered) can mean a
significant increase in perceived value. You can view it as offering good, better, best. Restaurants often
exploit this technique by offering early bird discounts, bars with happy hours, and car washes with
discounts for Tuesdays. Or, you can offer your product with and without technical support (and charge
much more for technical support for those who opted out). However, remember that if you offer too many
choices, then you have developed a nightmare for your administration of the pricing structure.
The caveat is that if your customers have no comprehension of the logic behind it, the pricing structure
will probably not pan out for your company. And, that means that your employees must understand the
structure. That way when a potential customer inquires, your staff can outline the features that derive.
One of the hardest parts is to convince the sales team that low prices aren't always the answer to closing
sales. And, if your salespersons get paid based on volume, they have nothing to gain. It is best to
compensate your salespersons on either a combination of volume and profit, or simply on profit.
A pricing team approach may be in order- using marketing, sales, operations, and finance (which for
some companies could be two individuals; for others in the hundreds). Marketing defines the value
pricing scenario, finance provides the true costs, sales provides the competitive information, and
operations informs the team of what they can make in a given period. By integrating all these factors, you
can develop the financial goals and the new product pricing. Ideally, this will also integrate the customers
wants and needs- and to paraphrase the MasterCard advertising series- the results are priceless.
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