A common task that crops us when we talk to clients about cash-flow within their business is the need to review their pricing.
Many business owners work out the price of their products on a ‘cost-plus’ basis – think ‘I just mark everything up 40%’ – but is this strategy costing your business money?
Your overall pricing strategy will depend on what type of demand there is for your product or service – understanding this will help you to decide the best strategy for you.
What affects demand
If a change in price has little effect on demand – we say that demand is inelastic.
If a change in price will significantly affect demand (i.e. if you rise the price people may not buy your product) – we say that demand is elastic.
How elastic demand is depends on several factors such as
- Is what you’re selling a necessity or a luxury?
- Are substitutes available?
- Are there complementary products? (think products purchased together)
Types of pricing strategies
This is where the initial price is set high to attract a small market of ‘early-adopters’ who want the product and are willing to pay for it. As these people are satisfied and the business is able to achieve more economies of scale and refine their product the price typically drops to appeal to more price sensitive customers.
This strategy is often used for new products and services particularly in the technology space.
This strategy is used where you want to become a market leader and gain a lot of market share. There is little margin on the products which discourages competitors, but this also means that you need to get high volumes of sales to meet your profit goals.
If your product is not aimed at attracting an elite market and you can deliver the volume of sales, this strategy could work for you.
Where you want to attract an elite market, perceived image is important – and the market want a price tag to match. They don’t want to see everyone enjoying your product like them, they want to feel special in the fact that they can afford to support your brand.
These types of products have much higher margins than a product in penetration pricing – which means you need less volumes of sales. However, communication of the luxury on offer is important if your customers are going to be willing to pay top dollar.
Think of clothing and car brands here. Personally, I think of ‘activewear’ there’s plenty of players in the space but two in particular are viewed as image brands.
Similar to penetration pricing where high volumes are required due to lower profit margins – discount pricing is aimed at the budget end of the market – who are often willing to forgo some elements of either quality or service in exchange for a lower price.
To use this strategy, you must be prepared to sacrifice some elements of your offering to appeal to this end of the market and still make money.
Pricing is set at a very low margin – or sometimes a loss. You would never run all of your products through this strategy. The goal is that a product priced as a loss leader brings people to your business, and the goal is that they purchase other products or services with a higher profit margin during the process.
This type of strategy can be useful where you sell complementary products, one as a loss leader and the other with a good profit margin.
Pricing is complex and you really need to understand what your overall business strategy is in order to select the right pricing strategy.
Some preliminary work prior to strategy includes:
- Knowing what volume you can deliver: there’s no use going after a penetration strategy if you can’t supply.
- Understand your target market: Are they budget shoppers that will sacrifice features? Are they people who want to feel special knowing they have purchased your brand?
- Identify your competitors and the market you play in: Understanding what else is available to your target market can help you decide on your business strategy as well as pricing strategy. If a competitor’s products has lots of bells and whistles and you believe there is a market for less complex product – budget pricing could be the go for you.
What is clear is that one strategy alone for all your products probably won’t suffice – so think how you can mix and match the above strategies with your product offerings.