Pricing for Profit – It is a Key Decision

Pricing strategies are a key marketing decision for any business. Price says a lot about how the business sees itself and its customers.

The price chosen will affect, amongst other things, whether all costs are covered and how the product is perceived by customers. Is it a Rolls-Royce or a Lada? It will affect the market share that the product will achieve and the profit that will be made. Pricing for profit is not simply a case of taking costs and adding a big mark-up.

 

The Basic Decision: Where in the Market?

There are two broad approaches to pricing. It can be part of the overall marketing strategy for the product and the company or it can simply be based on cost. Many small or new businesses start with cost-based pricing. They take their costs and add a mark-up of some form which they hope will earn them a profit at the end of the year. The only strength of this approach is that it is simple and, if it is based on a full understanding of the costs, ensures that the costs are covered provided that enough units are sold.

However cost based pricing does not take into account all the other issues that will affect the success of the product and the business.

Marketing-led Approach to Prices

It is far more useful to take a marketing approach to pricing as it will reflect a deeper understanding of customer motivation and the objectives of the business. The result should be a price that is appropriate to overall marketing strategy for all products or services. Price is only of the 'Four Ps' in the marketing mix and it interacts with all of them. Just as a reminder, the four Ps are: Place, Promotion, Price and Product.

Many strategic decisions need to be taken in setting a marketing-based price.

One should consider what market posi­tion is wanted for both company and product. Luxury items such as perfume and jewellery can be under-priced as some of the value to the customer is exclusivity, which is partly about price. Is market share important or is prof­itability a key consideration? This will depend on a variety of factors including the cash position of the business and its long-term strategy; does it want to be in a niche market or is it after volume in a major sector of your market? What are competitors doing and how are the products or services different!

Profitable Pricing is Fundamental to Business Strategy

Consider product portfolio as a whole. Gillette priced the first safety razors low because they were aiming to make profit on the repeat business from blades. Alan Sugar admit­ted that Amstrad got it wrong by concen­trating on selling satellite television dishes; he recognised that he should have invested more in the longer term in the satellite service (the blades) and sold the dishes (the razor) as cheaply as possi­ble to generate demand for those services. He believes he would have then made more profit in the long term.

Understand Customer Value

What is the value to the customer? If a consultant gives a client advice that saves the business £50,000, a fee of £5,000 will look good value. But if told no improvement is possible, then the same fee might not look so attractive even though work had been done.

What are competitors charging for similar products? Is there are a going rate for the product or service! Even it there is, there may be an opportu­nity to differentiate the offering by pric­ing differently to position it for new markets. The introduction of 'gourmet' pet foods at a premium price was successful even though much of the market was in a limited and low price range.

When trying to enter a new market it is tempting to seek to grow sales rapidly by pricing at a low level; more appropriate to the sales expected over the life of the product. It has been said that such 'pene­tration' pricing was how the Japanese achieved their dominance in the elec­tronics and other markets. It is not dump­ing hut simply taking a long-term view of your pricing strategy. By pricing, they cre­ated the market which gave them the volume they needed to achieve a profit. Obviously there is a risk that sufficient volume is not achieved to break-even.

An alternative is to take a 'skim­ming' approach to prices by setting them at a level appropriate to low initial volumes. This can maximise the recovery of development costs as sales grow. Price can then reduce as achieve volume is achieved and cost advan­tages gained from experience and economies of scale. However, the danger is that suffi­cient volume is never reached to become significant in the market. An example was a personal computer introduced by Texas Instru­ments (TI) about the time the IBM PC was launched. The TI computer was gen­erally accepted to be technically better but because it had a high 'skimming' price it never achieved the sales volume; by the time the price was reduced to a penetration price the opportunity had passed it by.