Setting the price is always challenging, the decision often left to the last thing.
Wrong.
Your pricing strategy should be a part of your overall strategy as decisions in other places have a huge impact on the best way to maximise your return from your price.
Cost should have no say.
Customers do not care about what it cost you to produce the product they are buying, they only care about the value they receive from the purchase. Understanding the value delivery is the real key, and everything else should flow from it.
What the market says should only be an influence.
If your product is the same as everyone else’s, in a homogenised mass market, where there is no source of differentiation, you cannot win. At best you will get a share in line with the number of direct competitors, at worst, chase the price down to the floor and everyone goes broke. This is a market you should not be in.
Differentiation.
Without some sort of differentiation that adds value to customers, you will be forever in a price war. There is always a source of some differentiation, somewhere, if you look hard enough. Something that adds value to a segment of the market, so find that source of differentiation, understand the value it adds, and price for that. This may mean that many, perhaps even most in some circumstances, will reject you as being ‘too expensive’, which is fine, let your less focused competitors go broke alone.
Ensure the pricing model scales.
Pricing models vary along with the business model in place. From a strategic perspective, when you choose a pricing model, it is very hard to adjust later to suit a different business model. For example if you start selling on line and take a 50% gross margin, that may look good until a distributor comes along and wants to sell your product through his system, but requires a further 50% margin to do so. There is not enough in it for you both.
Less distribution is sometimes more profit.
Uncontrolled distribution leads to conflicts in the pricing requirements of the different business models, and can lead to a race to the bottom which no one wins
The classic case is Australian FMCG retail. The two retail gorillas account for 70% of FMCG sales, so have a lot of power in the pricing discussions. They are largely unconcerned about your margins, only concerned with theirs, and especially theirs compared to the alternative gorilla. When you go with them, you are trading volume for margin. At the same price point you can sell much less product at higher delivered margins through more limited channels and have more in your pocket at the end.
I have had a number of farmers as clients over the years, selling produce to the gorillas, investing significant capital to deliver the volumes but having nothing left over at the end. Mostly they also sell through alternative channels, from farmers markets to a few independent retailers, and these are always more profitable than the gorillas. It is a choice you need to make and my advice is always to treat the gorilla as a way of covering a bit more overhead, but when you get to the point of needing their volumes to pay the bills, you are in real trouble.
Simple trading terms.
Trading terms are just another way of packaging discounts, and should be as simple as possible.
The simpler and more consistent they are the better, as complicated terms have a habit of creating heavy and usually unseen transaction costs in your business. The other risk is that you end up using the terms to give favorable net prices to someone over another, and when buyers move, they take the terms books with them, so look out.
Again, the experience of FMCG retail is instructive. Aldi has ‘net net’ terms, the price is the price, whereas the gorillas insist in complicating terms and that delivers them added margins, and you the transaction costs. It is much cheaper to do business with Aldi, as there are fewer transaction and overhead costs, but you still play by their rules, which do not include your proprietary brands.
One of the most insidious terms component is payment terms. It is hard to resist the temptation to extend under pressure, but in the long run always better to do so. The shorter the time taken for customers to pay you the money they owe you the better, and long terms become more damaging as interest rates rise.
Demand creation.
When there is demand for your product, you can make more rewarding pricing decisions, than when you are just competing in a commodity market. Therefore it is better to spend your money creating demand than funding discounts.
Going hand in hand with demand creation is the notion of what market you want to play in. Mass markets have price expectations and so do luxury ones, although they may sell less volume. This is associated with the business model and the strategic choices you make about the markets you will play in, and the way you play. Niches always deliver better margins, question is how much is left at the end as the volumes will be lower and product costs usually higher.
Customer value.
When the customer wants and needs your product and cannot get it or any substitute anywhere else, you have monopoly pricing power, something businesses love and regulators hate. The classic economics 101 supply/demand pricing model, ignores two basic tenets: First, there is always a substitute somewhere, in some way, even if it is going without. Second, human behaviour is never just rational, and economic theory assumes both rationality and perfect knowledge. Value delivered should always be seen from the perspective of the customer, and different customers will assess the value delivered differently.
However, understanding the drivers of value that your ideal customers will have delivered by your product enables you to price at the point of maximum satisfaction for them, and margin for you.
Anchoring.
It is always better to start high, as you can if necessary come back a bit. By contrast, starting low and then trying to increase prices is enormously difficult. There is a process called ‘Anchoring’ in psychology that applies directly to the manner in which you set prices. Whatever is the first price identified becomes the anchor around which the rest of the conversation is ‘anchored’. Anchoring low means you will end up low, anchoring high usually means you end up higher than you would have otherwise.
Iteration.
Finally, testing differing pricing options should be in most cases an ongoing, iterative process. We now have tools that will deliver real time feedback in many, particularly consumer, markets, so you can adjust prices for an optimised outcome as you gather experience and market intelligence. On line, ‘dynamic pricing’ driven by machine learning and masses of personalised data will become the norm in the very near future. In some areas, it is already here, and I can only see that increasing relentlessly, so you had better be ready.
None of this is easy, but setting the best price for your market that reflects your best interests is crucial to sustained success. Call me when some deep experience is required.
Cartoon credit: Scott Adams and Dilbert. Nailed it!
