Pricing products and services is one of the most complicated aspects of any product or marketing strategy. It has a direct effect on sales, revenue, and profit. Furthermore, understanding how price impacts brand perception and vice versa is another important consideration. While it’s important not to price too low (which could lead to long-term issues in achieving business goals), pricing too high might limit the trial use of products – leaving companies with limited volume growth potential down the road. Finally, achieving equilibrium between marketing and sales teams which typically have different goals when evaluating pricing plans, is also vital for success.
Three approaches to price setting
There are many different ways of deciding how to price a product, but broadly speaking, there are three approaches, each with pros and cons.
- Cost plus pricing: Internal focus
Cost-plus pricing involves calculating total production costs (including materials, labour, and overhead) and adding a markup for profit. To use this method, you must identify production costs and analyse market factors to determine an appropriate markup. Cost-plus is well-known and reliable, but it doesn’t necessarily reflect the value of the product/brand to the consumer. This could lead to missing out on high-value sales, i.e. leaving money on the table. On the other hand, if too much profit is accounted for in the cost-plus approach, anticipated sales could be misjudged.
- Competitive-based pricing: Competitive focus
Competitive-based pricing is a model where other businesses heavily influence your price points in the same market. This outward-facing approach differs from cost-plus pricing, which looks at your costs. It’s a popular option as it feels like the ‘least risk’ approach. It definitely has its advantages as competitors are an important factor for any setting prices. It is typically used by ‘price followers’.
- Value-based pricing: Customer/consumer focus
This approach considers perceived value rather than cost or market competition to set price points. It depends on customers' needs and desires, as well as their willingness to pay. People don't think about a product's cost to produce but what value it gives them. Consider handbags, shoes, perfumes, or brands such as Apple, Nike and Starbucks; customers are willing to pay more as they attach high value to these. The cost of these products is often only a fraction of the retail price. This method helps identify a brand/product's pricing power and value. The stronger the brand, the higher the pricing power and prices, and products with a lot of price power are less influenced by inflation.
So, what would be the best pricing approach?
Unsurprisingly, value-based pricing has the most potential to create a successful long-term strategy. However, costs also need to be taken into account, as any price should result in profit, and keeping an eye on what competitors do is a no-brainer too. We recommend a combination of the three with value-based pricing as the foundation.
5 steps to successful pricing
1. Use the overall company strategy as the goal for pricing
Should your organization win on volume, revenue and profit margin? Winning all three is usually impossible since each requires a different pricing approach. For example, focusing on volume often means lower pricing for less premium products, while profit margin goals require higher pricing.
2. Decide on being a price setter or follower, and act accordingly
Achieving the status of price leader requires dominance in the market, strong branding, or a superior product. Market size is not always a reliable indicator of price leadership, nor is brand prestige. Carefully choose your strategy and maintain consistency in your channel partnerships and marketing communication.
3. Look beyond the price and the business KPIs
The company strategy and the vision is the starting point of any price setting; however, there are other key factors which contribute to the success: (1) your brand, (2) your product/service and (3) the consumers/customers.
Companies often assume adjusting the price will improve sales, revenue, and profits, but it is not the only factor of success. Brand recognition, product quality, and the target audience’s ability and willingness to pay are all key components that should be considered – in some cases, more so than the price.
4. Listen to the customers/consumers
Analysing consumer feedback should guide any pricing strategy. Digging deeper to understand how consumers perceive your brand/product, if it meets their needs, and the value it brings are essential questions to answer. It will tell you, e.g. if your brand is strong enough to sustain a 10% price increase.
5. Educate and create a win-win situation for the different players in the sales channel
Price changes often require approval from multiple levels between the manufacturer and shopper, such as wholesale, distributors, retail, installers, etc. Without approval, there’s a risk of delisting, reduced visibility, and weaker negotiation power. Showing your understanding of consumer needs and what they are willing to pay is key to establishing trusted long-term relationships with sales partners.
In the following weeks, we’ll share with you more on each of the above 5 aspects and how to choose the best pricing techniques and tools for your business.
In the meantime, if you need help optimising your brand's portfolio pricing, get in touch with us. Our team is here to assist you in developing your ideal pricing strategy.