Continuing the series of ‘The Seven P’s’ this blog focuses on a key element which can make or break any product or service – Price!
Price is an issue which many companies struggle with – too expensive and not enough customers will buy their products and services (although margins will be good). Too cheap and the business may win lots of clients and struggle to make any profit at all.
There are many factors that come into play when setting your pricing levels:
1. What costs are incurred in the supply of the product or service?
2. What are competitors pricing similar products /services at?
3. What is the added value that your product or service brings to the customer?
4. How much is a customer willing to pay for the product or service?
Now, first of all I would like to stress that pricing is intrinsically linked to the underlying strategy of the business. Is the company a volume business – making very small unit margins but working on the basis you will have a high volume of units passing through the business?
Or is the company trying to create a luxury brand – is the product of supreme quality or, perhaps, is there such a scarcity that customers are willing to pay a premium? Or is the business a middle of the road mass market mid-range product or service? So whether you base your pricing on points 1,2,3 or 4 (or a mix of a few of them) will depend largely on what the fundamental strategy is.
However, coming back to the key pricing factors above, it is imperative that businesses fully understand all of these four elements before setting its pricing levels.
Step 1 – Cost
So first of all what costs are involved? You need to have a real grasp on what the base costs of your product/service are before you start.
This may sound very obvious but I kid you not, I once spent 18 months working in a business where the MD & FD never managed to get a true grasp of the base costs of the business. It operated within the hospitality and catering sector and haemorrhaged cash on a monthly basis.
It will be no surprise to you to hear that the business went under. If you don’t know the absolute minimum cost base of your business then pricing products and services on gut instinct rather than fact can be a dangerous game to play!
Many businesses operate solely on the basis of knowing what their cost base is and adding X% mark up on these prices across the board.
The benefit of this is that you know, as long as you are doing everything else right in the business, your pricing will generate a profit.
But will it generate as much profit potential as it could? Another trap to avoid is to always look at profits as a percentage – rather than levels of cash.
Again the MD of the previous company I mentioned was fixated on operating at 75% margin across all products. However had he dropped the margin on certain products by 10% the uplift in volume sales would have meant that he was actually generating a higher level of profits (cash in the bank).
This however does not work effectively in the service environment because if you reduce your prices to increase demand you are then doing more work for the same (or less) money. As a rule of thumb if you are working at a margin of 20% and cut your prices by 10% that would mean that you would have to sell twice as much or work twice as hard to stay at the same profit level.
Price of £100 (Unit price £80 and £20 profit) = 100 units sold equals £2000 profit
Price of £90 (Unit price £80 and £10 profit) = 200 units sold equals £2000 profit
The problem is that a lot of managers within businesses do not have a grasp of their financials and they have no idea how many more units they need to sell to break even if they cut the price. If they did, I think we would see a lot less knee-jerk price slashing ‘to survive’.
Step 2 – Competitive Positioning
So once you know your base costs then many companies will then look at what competitors are doing – what level of pricing is the market currently able to take? However, this is an area where you need to be careful and need to be asking yourself the following questions – because is it not always a like for like comparison.
- What is our competitor(s) cost base?
- How is our competitor(s) performing financially?
- How do our products/services differ?
- Are we targeting the same type of client/market?
- Are we going to be using the same channels?
- Is there any added value of one over the other?
If your product or service is of a higher quality or has an additional benefit then it may well be possible to charge a premium for this. However, in order to do so, it is essential that this difference is clearly communicated to customers so that they understand why they are being asked to pay an additional premium.
Unfortunately many companies only go through steps 1 and/or 2 when deciding on the pricing strategy for the business. However it is steps 3 and 4 that hold the key to ensuring that you get your pricing right and maximise the profitability of your business.
Step 3 – Added Value
What is the added value that your product/service brings to the customer? This is sometimes the hardest element to ascertain. So research your target market and understand the types of customers you are trying to attract. Interview them and find out how they view your products and services. The knowledge you receive from these insights will enable you to price with much greater confidence.
I conducted a series of focus groups recently for a client and the feedback we got from target customers was that there were not buying their product because they thought it was ‘too cheap’.
They were suspicious of the product because of the pricing and because the benefits (or added value) of using the product were so important to them – they felt more confident in spending over double the price for a brand that instilled confidence in them, that it was going to do what it promised.
Never assume you know what is important to the customer – ask them and find out! Don’t forget that it is never the actual product or service that someone buys – it is the benefit of what that product or service does for them.
No-one buys a newspaper – they buy the information and knowledge within it, no-one buys a drill – they are buying the holes, no-one buys the actual haircut – they are buying the image and style they are portraying afterwards.
Hairdressing is a very good example because, at its most basic level, wherever you go you are paying for one stylist, one chair, one mirror, a sink, a pair of scissors and hot air (that is the hair dryer – not the small talk).
Yet some hairdressers charge £7 and others charge £70. So who has got their pricing right? Well potentially they both could have because they have completely different strategies.
The £7 hairdresser is targeting less affluent customers and trying to attract a high volume of clients and probably has a very basic retail environment and employs stylists with the basic skills and operates at a decent profit.
The £70 hairdresser will probably have more salubrious surroundings, more experienced stylists, has invested in marketing and branding, probably be a lot harder to book appointments with (scarcity) and they will be targeting more cash-rich individuals to whom image is critical.
Step 4 – The Customer
The fourth area is to base your pricing on what the customer is willing to pay. Obviously this needs to take into account points 1-3, but very few companies ultimately base their pricing strategy around this point.
If the company has initially overpriced – to stay in business the company will ultimately eventually find this point. If the company has initially underpriced there is a real danger that it will never push its pricing to the point where it finds out how much ultimately the customer is willing to pay.
The title of this blog refers to the old Leslie Crowther game show “The Price is Right” where contestants spent the whole show trying to guess the prices of products.
What always struck me about that show is how far out everyone used to be with their guesses. Now this could have been down the pressure of being on TV and having to make decisions very quickly but it was always interesting to see drastically some people over priced products.
This wasn’t because they were stupid or lived a sheltered life, it was because the value we attach to different things is very personal. I regularly ask people when they are showing me their latest pride and joy “how much did that cost you?” and when they tell me the price I think one of three things….
1) You sucker – they saw you coming!
2) Wow what a bargain – I may look into one of those
3) Yeah that sounds about right for what it is!
However someone else looking at exactly the same product may have a completely different immediate response to the price given.
This is because we all have different values, different pressure in our life and different views to money. For instance I value my time and I if I see something that on the face of it seems quite expensive but can save me a lot of time – it interests me. Now someone else may well think – why would I spend all that money on something that I could do myself?
Supermarkets are an interesting market to view with regards to pricing because, taking variable quality own brand products out of the equation, they are all offering the same service and, by and large, the same/or similar range of products.
However there is a massive difference between the pricing policies of Morrisons and Asda to an upmarket store such as Waitrose.
This is because Waitrose decided to target a different demographic of shopper to the other two. It decided to invest more money into the retail environment and decided to invest in marketing its message of product quality and ethical sourcing
The result was that Waitrose attracted a brand loyal customer base and up to this year was experiencing sales growth of around 20% and was the fastest growing supermarket chain in the UK.
However earlier this year, despite its success, Waitrose has decided to drop prices and undertake a price match exercise with Tesco.
Will this be a positive move or have the opposite effect?
Will existing customers feel that the Waitrose brand has been cheapened or will they just be happy with the lower prices?
Will the move attract more new customers across to Waitrose?
It is unclear at the moment but whenever companies drop prices to boost sales in the short term there is always the danger that there will be losses in the long term through damaged profitability and brand reputation.
….and there’s more!
There are many other issues that I could go into with pricing such as multiple-product pricing strategies, Loss leaders, pricing clarity, pricing ‘bundles’ but it would be too much for the brain to digest in one blog so I will save those topics for another day.
As the title to this blog indicates – pricing is just one element of the 7 P’s of marketing. A company cannot compete purely on price – that is a flawed business model and one that will lead to failure. I will just leave with you with a quick recap:
- Understand your cost base and profit ratio before dropping prices – don’t assume a price cut will boost profits
- Understand customer needs and added value – communicate these.
- Look at competitors carefully – don’t just adopt their pricing strategy
- Don’t discount just to compete – your competitor could drop prices further
- Look at how pricing and brand reputation are interlinked.
- Customers DO NOT always chase the lowest prices.
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