What if you dropped them by 5 percent ? What would be the impact on your bottom line if you had three different pricing tiers?
Being able to answer these questions is crucial to setting an optimal pricing strategy for your product or service. It is important to remember that efficient pricing maximizes profitability. The goal of a pricing strategy is to increase the value to the customer as well as the customer’s willingness to pay the price you have set.
Pricing Strategy
There are two basic pricing methodologies: traditional pricing and strategic pricing. Traditional pricing relies on two approaches. First, you can price your product by figuring out your cost of production and adding a profit margin. Second, you can simply match your competitor’s prices. While there is nothing inherently wrong with either approach, traditional pricing is not always the most efficient, mostly because it leaves the customer out of the equation.
What is most valuable to the client may or may not be the most expensive to produce. Similarly, matching your competitor’s prices may not be useful if those prices are not set correctly in the first place. Most importantly, traditional pricing often results in price wars, which is an expensive proposition for a small business, especially over the long term.
A better alternative is to use a strategic approach. This means rather than focusing solely on cost or the competition, you take into account the value a customer is receiving from your product. Below are considerations to keep in mind when using the strategic approach.
High value or low price?
Who are your customers? Are they high-value seekers or low-price seekers? Generally speaking, not all customers have the same behaviors, preferences, or price sensitivity. In order to reach more than one type of client, your product offering needs to be strategically designed and priced in order to maximize your profit at various price points.
What elements of value does your product/service offer that your competition does not? This includes unique features, benefits, level/quality of customer service, packaging, convenience and ease of purchase. To the degree that you can differentiate your product in the marketplace, you can price according to the value provided to the customer.
This also requires that you develop a clear and compelling communication strategy regarding the features and advantages of your product. Customers object to price when they are confused about what they are getting from you compared to the competition. The ability to clearly convey how your product is different or better will pave the way for higher receptivity to price.
How strong is your brand? A strong brand can command higher prices. In addition, established brands elicit customer loyalty, which means that your customers will be less sensitive to price increases. A good example of this is Apple, whose customers have been willing to pay higher prices in exchange for what they perceive to be a superior product.
Pricing strategically
First, offer product options at different price points. The bare bones package will be attractive to the customer who needs your product, but is not willing to pay for bells and whistles since he or she may not perceive the value of those extras.
One step up from the basic package is the middle option, which is usually the best value for the customer, as it provides a good number of advantages and features at a reasonable price. For the customers who want the high-end option (think the American Express Platinum card), you set higher prices because you know this customer tier wants the best product and features and is willing to pay for it.
Second, offer multiple payment options for each product bundle. Cellular phone companies do this on a regular basis, offering a free device with a two-year contract, a discounted device with a one-year contract, or a full-cost device with no contract. These companies recognize that catering to customers’ behaviors and preferences is key to capturing market share.
Another example is offering multiple low payments (think QVC and their $19.99 payments for six months) instead of requiring payment in full. This approach renders a high-priced item more affordable.
Third, learn best practices from other industries. Examples include offering volume discounts for bulk purchases (Costco), introductory low prices for companies/products new to the marketplace, or high initial prices for innovative products when there is no competition.
Let’s play ‘what if’
Business owners also need to look at the interplay between price and sales. This is done by modeling “what if” scenarios at different price points. Let’s say you analyze two years’ worth of data and see that raising your prices by 10 percent results in a 15 percent drop in sales. However, your profit margin actually increases by 17 percent, since the customers you lost were low-frequency, high-maintenance, price-sensitive buyers.
Assuming your fixed costs went up slightly and your variable costs decreased significantly, you have now identified the optimal pricing for your product—the point where increasing prices can increase your profits even though you are losing some market share.
This leads to the next consideration, a shift in the business owner’s mindset. Many of us were trained to believe that higher sales are always better. This is not always the case. Increasing sales while decreasing profit margins is rarely a desirable growth strategy for a small business. Rather, a business owner’s focus should be on the optimal number of sales at the most efficient price.
While none of this may be easy for any size company, when it comes to strategic pricing, small businesses have an advantage over larger ones. Since they rely on high-touch customer service and personal relationships with clients, small-business owners have a better understanding of customers’ preferences.
By knowing and anticipating clients’ needs, they can implement pricing strategies that are customer-centric and value-driven. Small businesses can thus translate strategic pricing into a win-win proposition by remaining nimble, flexible and highly attuned to their customers.
