When considering your marketing mix a crucial component is price. From a marketing perspective price is a measure of what a customer will exchange for the benefits of a service or product. Price can also shape the perception of quality in a customer’s mind. Wine is a great example of how price can shape perception. The more expensive the wine the better the quality – right? There was once an experiment where two identical wines where placed side by side. The labels where hidden so as not to bias the tasters. The wine tasters where told that the wine on the left cost $20 and the wine on the right cost $100. Before they tasted the wine they were asked which wine they thought would be superior. Without exception they chose the $100 wine. Then they were asked to taste the wines and report which wine was superior. Again, the group chose the $100 wine with many audibly expressing their great pleasure in drinking a $100 wine. Remember, the two wines were identical and only had a retail value of $20. Such is the power of price.
So how do you set pricing? There are a least five different pricing options as follows.
Cost-based pricing: This approach focuses on the businesses cost structure. The goal is to ensure the price covers all fixed and variable cost of producing and selling the product or service. One important aspect of cost-based pricing is to understand your break-even point. One way to calculate break-even is:
Break – even point = fixed cost/unit sell price – unit variable cost
Profit-based pricing: This approach targets a desired dollar amount or percent return on products or services sold. To target a particular profit you may need to calculate required volume. This can be done as follows.
Volume needed = fixed cost +target profit/unit sell price – unit variable cost
Demand-based pricing: This approach considered the demand of a product or service. How elastic is the price and what would customers consider as fair.
Competition-based pricing: This approach determines price based on the competition.
Value-based competition: This approach considers the value in use of the product or service. This is driven by market research and customer perception. A product may be very cheap to produce but be of such benefit to the customer that a high price can be set which reflects the value. A product or service which is rare may also fall into this category.
It is important to understand how to set your pricing because pricing is the only component of marketing which produces revenue. All other marketing factors cost the business money. Managers often struggle with this and make mistakes which impact on their financial objectives. I mentioned earlier how pricing can shape perception and so managers must also understand the segmenting, targeting and positioning (STP) strategy of the business. Is your objective just to survive; do you want to maximise profit; or do you want to increase market share?
To determine to correct price of a product or service a strong understanding of your market is necessary. Questions relating to the size of the market, consumer characteristics, competitors, marketing spend levels, channels of distribution and availability of substitutes must be considered. Further analysis using models such a “Porters Five Forces” are useful to determine the attractiveness of the market and what pricing can be sustained.
In the end, the final decision about pricing is determined by the market place. You can use customer surveys and the like to determine customer perception but the real information comes from your sales demand, profit figures and market share. A final piece of advice is don’t take your eyes off your competitors. Know what they are doing at all times and understand how they react to your price changes. Don’t get into a pricing war unless there is a clear competitive and strategic reason for it. Pricing wars generally only cap the profits for everyone and is unsustainable.