Marketing process and price setting
Price setting is an integral part of the marketing process and it requires an in-depth analysis of the company’s performance in the market, as well as their product positioning and state of competition. The right price can generate more sales while the wrong one can make potential customers look elsewhere. Let’s have a look at the most common pricing strategies.
The way businesses set prices changes for many reasons. Factors such as customers and competition are decisive in order to choose your pricing method.
Changes in your business field or the development stage of your product may be signs that you need to check your pricing strategy. You need to consider carefully which approach makes the most sense for your business when determining your pricing strategy.
In this short guide we approach the three major and most common pricing strategies:
What about costs?
Cost-based pricing uses production costs as its basis for pricing and, to this base cost, a profit level must be added in order to come up with the product price.
Cost-based pricing companies use their costs to find a price floor and a price ceiling. The floor and the ceiling are the minimum and maximum prices for a specific product or service – the price range. If it happens that the competitive price is under the price floor, companies normally price at the floor or try to lower their costs to lower the floor.
“The moment you make a mistake in pricing, you’re eating into your reputation or your profits.”– Katharine Paine
The ideal thing to do, though, would be setting a price in between the floor and the ceiling. Many companies mass-producing goods such as textiles, food and building materials use this pricing technique.
Sounds easy, right? This traditional method ensures simple calculations, total profit for the business and it also accounts for unknowns. Nevertheless, this sort of technique comes with disadvantages too.
Cost-based pricing is considered to be a broken model by many marketing experts: knowing costs is vital to get to understand your company’s profitability, but problems come when you solely base your price on costs.
In fact, cost-based pricing takes into account neither prices affected by customer demand nor performance of competitors. It is true that if a product is in short supply, customers may be willing to pay more for it, but – on the other hand – if demand is low, they will be expecting a discount. Concerning competition, cost-based pricing is definitely not the right technique for you if you are in a very competitive business segment because competitors would probably end up entering the market with lower prices.
What your customers think
Value-based pricing, also known as customer-based pricing, is a pricing concept which is defined as follows: Value-based pricing is the setting of a product’s price based on the benefits it provides to consumers. In other words, it is about finding the price that your customers are willing to pay.
“Pricing is actually pretty simple…Customers will not pay literally a penny more than the true value of the product.”– Ron Johnson
Customers change their buying habits according to product price, so you need to find out about your target customers, their perspective on the product and their reactions towards several prices or even price changes.
The questions you need to ask yourself when thinking about your target customer are:
“Does the customer identify price with quality?”
“Does the customer consider my product is worth the money they pay for it?”
“What does the customer care more about: the price or the prestige?”
“What is the customer prepared to pay for the product?”
Companies using value-based pricing consider the value of their product and their customers’ perceptions of value as the key to pricing, instead of production costs. They determine how much money or value their product will generate for the customer – a value which translates into benefits such as increased efficiency, happiness or stability. By using this type of pricing technique, you may aim at using price to support product image, increase product sales and create product bundles in order to reduce inventory or to attract customers.
This pricing technique should be applied by focusing on a single segment, comparing your product with the next best alternative, getting to know what makes your product unique and understanding how much that differentiation is worth.
As you can see, value-based pricing comes with lots of advantages when it is applied in the right way. Be careful, though! By using this strategy you may end up ignoring product costs and forgetting about your competitors.
What are competitors doing?
Competition-based pricing, also known as competitive pricing, consists in setting the price of a product based on what the competition is charging. This pricing method is normally used by businesses selling similar products, since services can vary from business to business, while the attributes of a product remain similar.
In highly competitive markets, consumers judge products with similar features by the prices that rival businesses charge for them. Consequently, competitors may need to price their products lower or risk losing potential sales.
“Global competition is about winners and losers.”– David Korten
Competitive pricing tends to be implemented when a product’s price has reached stability. This happens when a product has been on the market for a long time and there are many alternatives to it. Therefore, it is really important for competition-based pricing companies to understand what they are selling, as well as the type of rivals they are competing with and how they operate in the marketplace.
One of the greatest advantages of this pricing technique is that you focus on your industry and your competitors, and that makes it possible for companies to keep an eye on existing and emerging competition. The more you know about your rivals and what they are doing, the better you can decide how to manage your business.
What is more, it is not just the price you are comparing, but also the products themselves. If your product has a unique or innovative feature and, consequently, a greater value, you may be able to increase your price.
Nevertheless, it is important for companies to keep their production costs in mind, as well as managing the time they spend monitoring competitors and the prices set by them. With the expansion of eCommerce and Big Data, this last monitoring factor can be seen as a downside if it is not carried out properly.
Pros and cons of each strategy
Calculations to determine price are simple.
During price setting unknowns are taken into account.
Pricing ensures total profits for the business.
Ignores how customer demand affects price.
It doesn’t take into account actions by competition.
Price setting cannot be solely based on costs.
The price set supports product image.
The value added helps increase product sales.
Differentiation attracts new customers.
Calculations may ignore product costs.
It might forget about existing competitors.
It requires great selling techniques.
It keeps an eye on existing and emerging rivals in the industry and provides smart data to make more effective pricing decisions.
Setting the right price according to market state helps gain competitiveness.
You risk losing profits if you do not take into account information on your purchase price and margins. You need to check on your price elasticity.
It needs an effective price monitoring system. Automation is key in this respect to avoid manual tracking.