A Price That Sells
“A Price That Sells”
In a complex marketplace, how best do you calculate price? A simple cost-plus-profit model isn’t always that simple. Have you evaluated your pricing strategies and considered all the variables? It can reveal why some things sell and others don’t.
The product or service you sell will attract customers for all the values you build into it and for one other important feature: the price.
Pricing what you sell is not a one-time decision. Prices can, and should, change throughout the life cycle of a product, from development, to product launch, through any upgrades, and finally, to the product’s obsolescence or replacement.
It can be difficult to hold in mind all the variables that affect your pricing decisions. By clearly understanding your product positioning, your competitors and your customers, you can develop a pricing strategy that works.
In this Quick Read you will find:
- The variables that influence pricing decisions.
- Ways to test prices with customers.
- How pricing can be used to achieve a variety of goals.
The easiest way to set a price is to calculate the cost of producing a product (direct costs, overhead and labor), add in a profit margin, and stamp the resulting number on a price tag. This method requires very little research. However, in the complexity of the marketplace, it is not likely to be very effective at winning sales or market position. You also may be pricing your product below what your customers would be willing to pay. Setting a price based on the value of the product or service to the customer may be smarter.
You should, therefore, take into account a variety of other things:
- Have a clear idea of what your competition is doing. Perhaps your competitor is lazy and has been charging a high price because it’s had very little competition. By adjusting your price lower, you may be able to win market share. Of course, if your competitor has a strategy of killing all other competitors with a cheap price, you will have to provide some other value to your buyers than the lowest price.
- What are your objectives? If you want to be the category leader, you will have to determine how to muscle out the competition. Pricing to beat the competition is sometimes called "market-sensitive" pricing. This may not be your strongest option, however. Your greatest opportunity may be to own a small niche in the category, where buyers will find your product’s uniqueness especially compelling. This is called "value-pricing."
- Understand what your customer perceives your value to be. Your customer may not even want the cheapest price.
"People get resistant to prices on the low end as well as the high end," says David Dickinson, group vice president of Griggs Anderson Inc., market research firm.
If your customer expects luxury, price will not matter. If your product is a common item, its price may be very elastic, or price sensitive. Even a small change in price up or down might have a dramatic effect on sales.
Certain environments may make customers more sensitive to price. Forrester Research says that online shoppers are there for bargains. You may have to adjust your price to sell in that environment.
Pricing to Meet Goals
Do you want to maximize profit, maximize penetration or block your competitors? Setting your price can help you achieve these goals.
Some technology companies give products away, because the product is not the company’s revenue stream: Revenue comes from advertising or from building the largest installed base first.
Some companies sell a product never intending to make money from it, but just to sell another product. For example, a popcorn manufacturer might sell a popcorn popper at cost to sell more popcorn.
You may have to think seriously about how price will affect sales as you introduce new products. Will a lower-priced product cannibalize sales of your highest-priced product?
Whatever goal you are trying to achieve with pricing, remember that you will need to explain your price to your customer. They will have to see value in your product at that price before they will buy.
Working with a market-research firm or on your own, you can ask customers about your prices, but you must do it carefully.
Don’t ask customers what they would pay for your product, says David Dickinson. Such a question can generate misleading responses. He suggests using a price sensitivity scale instead, where customers are asked to respond to a certain price: Is it too expensive to consider, about right or too cheap? Such questions can lead you to a range of acceptable price points. You might also sell your product at different prices in different markets and see how buyers respond. Set up a Web site where product prices change for different people, to see which ones are most acceptable.
REAL-LIFE EXAMPLE [top]
Leatherman Tool makes what is undoubtedly the world’s most-famous, compact, multipurpose tool. So famous and unique, in fact, that many companies copied it directly, violating Leatherman’s copyright. The numerous lawsuits that followed were actually revenue generators for the company.
The company is now 17 years old with 500 employees. Roger Bjorklund, the VP of marketing, says that when the company priced its original product, the Pocket Survival Tool, it had no competitors and was pricing from a simple cost-plus-profit model. As competitors came into the market, Leatherman had to think more seriously about how and why it priced its products.
"We’ve learned over time, with research, that the top reason people buy our products over our legitimate competitors or cheap knock-offs is quality," says Bjorklund. "We educate our customers about our quality, durability, about the tool lasting for 25 years, and that if anything ever goes wrong with it, we’ll replace it. They are willing to pay up to $30 more for that." It works: The company’s best seller is also its most expensive tool, at $98.
Now Leatherman can easily define its category: a variety of multipurpose tool choices in the $30 to $100 price range.
Bjorklund says that competitors with lower-priced products have actually helped his company.
"In the hardware distribution channel, tools are priced relatively inexpensively," he explains. "The cheap knock-offs opened doors for us. Store buyers took on the copies or low-quality ones first, and then moved to ours."
The company also introduces new tools that sometimes cause a drop in the sales of existing tools.
"Every time we introduce a new product, we know it will cannibalize other sales. We set the price of the new product, thinking about how it will fit in our price range and try to make the cost of the relative features logical to the retailer and consumer. We’d rather cannibalize our own products than have someone else do it for us."
DO IT [top]
- If you are introducing a new product, research your competitors’ prices during your product-development process.
- Review the prices of your existing products. Ask your sales staff if the prices are hurting or helping you achieve your objectives.
- With the help of a market-research firm or your own staff, devise a method to test consumers
‘ satisfaction with your prices. Focus on a test that doesn’t ask buyers directly if they like your price.
- If you are launching a new product, launch it at different prices in different markets to test price acceptance.
The Strategy and Tactics of Pricing: A Guide to Profitable Decision Making, 2nd edition, by Thomas T. Nagle and Reed K. Holden (Prentice Hall, 1995).
"Price," Chapter 8 in Marketing, by Gemmy Allen. Mountain View College/Dallas Telecollege, 1999.
Pricing Your Products. U.S. Small Business Administration, 1993.
Writer: Kathy Watson