Developing a Pricing Strategy¹
Developing a pricing strategy that works for your business takes time, skill, and gut feelings. There is not a one size fits all method to developing the right pricing strategy. Every business and its competitive environment are unique. However, there are several guidelines available to assist you with developing a pricing strategy.
The first step in developing your strategy is to have an understanding of your entire business, your customers, and your competitors. Here are some of the questions that will assist you to truly understanding your business and its place in the market.
What are Your Current Prices and What Is The Strategy that You are Currently Using to Price Your Products or Services?
Even though you may change your strategy, the first step is to gather how much you are charging for your products or services as well as understanding the strategy you used to come up with these prices. For example, are you the low price leader or are you the premium choice because of your outstanding service?
What are Your Competitors’ Prices and What Strategy do Your Top Competitors Use to Develop Their Pricing Strategy?
Find out the pricing of your competitors by using competitor intelligence. Of course, your competitor is not going to reveal their costs to you, however, being in the same industry you should at least have an idea of their costs and overhead, and since you know their prices you should be able to conclude how they develop their prices.
What Differentiates Your Product or Service from the Competitors?
Before being able to compare your prices to that of your competitors, you must determine if you are comparing apples to apples, or if your product is unique to that of your competitors.
What are all of the Costs Involved in Producing or Purchasing Your Products or Services?
This would be considered your variable costs. This is the amount of money it costs for every unit sold or every service rendered. In other words, without a sale of a product or service you would not have this cost.
What are Your Overhead Expenses?
These are all of the costs associated with your business that exist whether or not you actually make a sale, such as rent and payroll.
What Value Do Your Customers Place on Your Current Products or Services?
This may be more difficult to ascertain but it is important to understand the value of the goods or services you provide to your customers. For example, if you are a therapist you are providing a service. How much per session is your service valued at?
The second step in developing or adjusting your pricing strategy is to understand your company's’ objectives. Here are some common objectives companies might have that would impact their pricing strategy.
To Serve a Different Market Segment
Say your company has historically been the more economical option and you want to branch out and offer a premium option. This would impact your need to develop a new pricing strategy.
To Serve Different Market Verticals
If you serve to a certain vertical, say to consumers in a retail environment, and want to switch to selling to other businesses in a wholesale environment, this would impact your pricing.
To Generate New Customers
If your goal is to generate new customers you may need to create a new pricing strategy that would lure more customers in such as lower pricing, promotional offers, or bundled offerings.
To Up-Sell to Existing Customers
Once you have acquired a customer it is much cheaper to re-sell to that customer than to acquire a new customer. You may want to design a new pricing strategy for those existing customers.
Now that you have gathered the above data on your business and you understand what your company’s objectives are, you can determine your pricing strategy using some of the more popular pricing methods below. Not all of these pricing methods will be appropriate for your business. However, once you start to understand the answers to the questions above, over time you will get a sense of what pricing method you should be using.
This pricing method allows you to set prices based on a specific margin you are trying to achieve. You simply take the cost of the product or service you are selling and a multiply it by the margin you want to achieve. Then, add that number to the cost. For example, say your product costs $20 to produce and you want a 40% profit margin. Just multiply $20 times 40% (.4). This comes to $8.00. This is the profit in dollar form. Simply add the $8 to the $28. This means that you should sell your product for $28.
This method is very similar to the Target Margin method above except you are basing your price on how much return on investment you are trying to achieve. For example, if the total investment to manufacture a new product, say a new machine, costs $100,000 and you estimate that you can produce 10,000 items using this machine you know that the investment cost per product is $10.00 ($100,000 / 10,000).
Say you want a 15% ROI on all products produced by the new machine then you simply take the cost per product ($10.00) and multiply by 15% (.15). This comes to $1.50. Simply add the $1.50 to the cost of the product $10.00. This number, $11.50 is the price that you should sell your product at.
Using the questions above you have already looked at understanding the value your product or service has in the marketplace. This is especially helpful when pricing services you provide. It is more difficult to put a price tag on time rather than a product. The product has hard costs that can be used to help come up with a price. Your time does not. This is why it is important to understand your business, your customers, and your competitors to determine what value your service brings. This value should be your starting point for pricing your product or service.
As you can see, developing a pricing strategy takes time, skill, and an overall gut feeling. By using the resources in this article you will be able to start the steps needed to develop a great pricing strategy for your business. Just remember, pricing strategies should be revisited often because as different factors with your business change, so should your pricing strategy.