In a business environment characterized by recovery from a severe recession, seven years of tepid growth, high unemployment and underemployment, and the explosion of ecommerce (with the lowest price always just a click away), it’s no surprise that optimizing pricing to maximize revenues and/or profits is a critical issue for many businesses. But how does a business know when it can safely raise prices without losing market share? Is market share the right goal, or should it be bottom-line profit? Either way, what pricing optimization information do you need to achieve the chosen goal? If you are asking these questions, you are not alone. Only 15% of all businesses do any kind of systematic pricing study.
Pricing for profit
There are three distinct albeit not-mutually-exclusive approaches to evaluate and set prices.
Understanding value to the customer is the highest form of information that goes into a pricing decision. If you know what value the customer places upon the product or service, you have a very precise sense of what to charge that customer. Anything sold through competitive bidding on eBay is a good example of pricing based on value placed by the customer.
Just behind the concept of determining the value your customer places on your product or service is surveying your competition’s pricing actions. By having a good sense of competitors’ pricing, it is possible to use that information as a surrogate indicator of what your customers might be expecting to pay for your product or service. Keep in mind that keeping an eye on competitors’ pricing does not imply matching competitors’ prices. You could choose to price above or below your competition depending on relative perceived benefits of what’s being compared and offered. Gas prices at a branded station and a convenience store at the same road intersection is a great example of how branded players manage to charge a price premium while tracking each others’ prices.
The third pricing method is familiar to all business executives: cost-based. It is also the easiest to implement as almost all businesses regardless of size and sophistication have a relatively decent handle on their costs. Measure all inputs and add a reasonable margin on top, and that is the price. But what about opportunity cost? How much money are you leaving on the table? Could you charge more? How much more, and to whom? These questions can be answered by adding some basic sophistication to cost analysis. By identifying variable and fixed elements of costs, as explained in my eBook (available for a free download here), businesses can refine their pricing to optimize for higher profits.
So why would businesses use cost-based pricing on anything but a commodity product? In the real world, sometimes “perfect” can be the enemy of “good enough”. Setting prices using only cost measures is the easiest method, because you have all the information at your fingertips. As a practical matter, it rises to the top because it can be done quickly. And if done thoughtfully with good data, it can help you achieve your business goals.
Setting prices based on dynamic data: there’s an app for that
In this age of data proliferation, you have plenty of information – customer perceptions and values, competitive pricing information, and your internal costs – to crunch effectively regardless of which pricing methodology you choose to use.
While pricing based on “customer value” is likely to give you the highest form of optimization, it is also the most difficult to execute. Determining “value” that each (or most) of your customers place on your product or service is not simply a matter of asking the customer. It usually involves more sophisticated and subtler forms of market research than a quick questionnaire executed over Survey Monkey.
Using competitors’ prices as a yardstick is the “fair to middling” option. In most situations, one can assume that “customer value” is reflected indirectly in competitors’ pricing. As you look at competitors pricing, keep in mind that for many products and services, total price paid by customers is more than just the dollars spent. For instance, flights departing at 6 am on a Saturday are usually priced lower as most who chose to travel on those flights have chosen to “pay” for part of their cost in inconvenience they are willing to bear for a lower dollar price.
At Chief Outsiders, we can not only help you determine which one (or combination) of the three pricing methodologies is right for your specific situation, we can also help you implement and execute the chosen strategy. At Chief Outsiders, we spend a lot of time and energy staying on top of the latest innovations in measuring customer value and pricing for profit.
Atul Minocha is a Partner at Chief Outsiders. He is also a member of Sierra Angels investor group and teaches marketing at Hult International Business School in San Francisco, California. Contact Atul at firstname.lastname@example.org or on LinkedIn if you don't find him at your neighborhood Starbucks.