Pricing for Profit. Part 3
Do you want to know what the right price is for your product or service? If I could write an app for calculating that, I’d be a rich woman, because everybody would want it!
Pricing is a process that is more art that science. In the past, pricing has been largely determined on a cost-plus basis, focusing on the internal business cost and activities rather than the external value and results created. It is better to focus on the value that you create for your customer, because that is all your customer cares about. Cost based pricing is a popular strategy, but it doesn’t provide pricing flexibility required to respond to your market. Pricing is more a function of marketing than finance, your pricing must make you a profit (finance), but it must generate sales (marketing). The often referred to “4 P’s of marketing” are; product, price, promotion and place (“place” referring to distribution). Price is so important, because your profits primarily depend on price. There are several factors other than your costs that go into the development of the “right” price. The most important factor is value – what value will the customer attribute to your proposition?
Pricing as a Process
There are six steps, (at least), to consider in the pricing process:
- Develop pricing goals
- Research your competitors
- Analyse your costs and break even point
- Identify your added value
- Put it all together in a pricing strategy
- Evaluate and review
1. Develop Pricing Goals
You must decide what you want your prices to accomplish for your business, in line with your marketing strategy, before you start crunching numbers, for example:
- Do you want high sales volume?
- Do you want to define your business as being high quality or elitist with price?
- Do you want to weed out unprofitable business by raising prices?
2. Research your competitors
- Check out competitor offerings on the Internet
- Review their advertising in magazines and brochures
- Get hold of their promotional literature, including price lists
- Consider if a visit to their premises might be appropriate
3. Analyse your costs and break even point
Your break even point is where your sales cover all your costs and you make no profit or no loss. Break-even occurs when your revenue, less your variable costs (known as contribution), equals the fixed costs of your business. Any revenue in excess of the break-even position will generate profit, in that it makes a contribution to profit. To calculate your break even point you need fixed costs per annum and variable cost per unit, plus unit sales price, (all excl VAT if you are VAT registered, remember that VAT is not yours). The area of costing and break-even was outlined in more detail in Part 2 of this pricing series.
4. Your Added Value
Added value is a concept outside of the financial facts of your business.
Do you offer something unique that customers would be willing to pay for? For example have you got a historic building, niche facilities (e.g. cater for children), a great location, fantastic service, a special or unique experience, a healthier meal option? Added value is part of the pricing and market strategy, and you can make it part of your product offering. Price is your company’s only opportunity to capture the value you create through your value proposition. Controlling costs, and accounting for them, does not ensure success. A business does not exist to be efficient; it exists to create value for its customers. A price is paid because someone values the product or service that they are buying, and the price cannot exceed that value no matter what the cost of producing it is
It is worth remembering that costs do not contribute to value. E.g. if your restaurant pays higher rent than your competitor, does that fact alone make your meal more valuable to the customer?
No customer buys hours or costs, yet many businesses continue to price on a cost plus basis. Prices are ultimately are derived from value for your customers.
5. Your Pricing Strategy
Now you are ready to put all the factors together into a pricing strategy.
You have decided what you want your prices to achieve, is it for example volume, or is it brand differentiation or is it something else? Your competitors’ prices may have given you an idea of the price range you should be in. You should also consider the elasticity of demand. This means how sensitive your customers are to changes in price, does a small price increase result in a fall off in demand, or does it have to be a large price increase before it affects sales volume?
6. Evaluate and Review
Prices should not be set in stone, and need regular review. It’s all about sales, if your prices aren’t generating sales, change them!
Next time, in “Pricing for Profit”
Part 4, we will look at the special factors that professionals should take into account when setting their prices. There isn’t an app for that… yet.