Pricing Strategy29th November 2013
How do you optimise your pricing? If the answer to this question is a mystery, this blog will help … and being based on a series of presentations that I recently gave to business professionals, I know it hits a chord!
Pricing in isolation is nothing … waving a flag with a price in the middle of a field is unlikely, on its own, to drive anyone to buy your product or service … so to be effective, a price needs to be a fully justifiable component of your strategy … and only then will it hook the right number of customers at the right price.
Pricing is one of the 4 Ps:
Price, Product, Place & Promotion. You can’t separate them; they are intricately entwined. You can’t set a price without looking at the qualities associated with the other 3 Ps, which include:
- The product/service itself
- The cost of generating it
- The extent of competition & specialism
- The usefulness or exclusivity of the product/service
- Does the product/service fit in, or stand-out, from your range of offering?
- Read this as “the marketplace”
- Traditional or leading-edge ways of reaching the market?
- The price-sensitivity of clients and potential clients?
- What resource restrictions do you face, including people, technology and location? … And can these be turned into a positive?
- What are the competitive features of the market, and are there plenty of others offering the same or similar “commoditized” product?
- How is it to be offered?
- Sell the benefits rather than the features
- How can you differentiate yourself from the competition to appear unique?
- Learn to demonstrate the advantages of dealing with you
- How can you create a leading edge and talked-about distinctiveness?
Get the Product, Place and Promotion right, and (with the exception of a fully regulated market) you have greater control as a price leader than a price follower, and the opportunity to set your price across a wider range.
Long-term, a successful Price also needs to represent Value:
- Clients must want to expend their hard-won income and capital on what you are offering, rather than the myriad of other services, products and savings competing for their attention 24 hours a day, 7 days a week.
- Did you read that correctly? … remember that you are not just competing with your direct competitors, but for a share of your potential customers’ disposable income or capital.
- Value certainly does not mean Cheap.
- Consider the ladies fashion industry, which is a great example of value being found at all price levels. At one end of the chain we have Primark and charity shops, whilst at the top-end many favour Burberry or bespoke boutique design … each successful business up and down the value chain succeeds in offering a distinctive value to their sector of the market.
- Value encourages clients to return, to recommend, and become recurring revenue generators.
The Aim of Pricing:
The perfect price should optimize the balance between sales price and volume to maximize profitable activity, consistent with your strategic objectives.
You may have short-term goals (such as stimulating interest and volume for a limited period) or long-term goals (such as establishing a permanent premium price for your distinctive service).
If you understand how your price has been arrived at, you’ll be in a much better position to negotiate confidently and consistently with clients to meet your overall strategic objectives.
The best pricing strategies are matched to a competitive edge. Consider the pricing approaches taken by:
- Corner-shop v Tesco
- Audi v Seat
- Direct Line v Broker
- Harrods v Debenhams
- Exeter Airport v Stansted
- British Gas boiler servicing/repair v its regulated utility services
… Consider how;
- some succeed in achieving higher prices through convenience
- some succeed in offering different levels of product at different price-points
- some succeed with repetitive marketing where they really know their customer
- some use up-scale brand image, design, technology, desirability etc. to establish a distinct offering
- some use different routes to market, and exploit price perception
- some use top-end product to draw attention to their business, whilst others aim for a very different position in the market
- some use their regional location to charge a premium
- some offer added-value services, monthly payment, service guarantees to enter a different marketplace alongside their core business
Things to avoid:
- Avoid lowest-cost pricing … you cannot succeed on price alone. Any long-standing business has a raison d’etre other than just a price.
- Avoid copying your competitors pricing … look at their whole package and how you can beat it, otherwise you all risk copying each other in a circle of diminishing returns. You need to be innovative and distinctive.
- Avoid spending too long thinking about your competitors … dedicate the time to understand what your clients and potential clients will value, and aim for that.
Your pricing strategy should support you in delivering value and achieving an appropriate rate of return on your time and investment.
Here are a few methods of pricing:
COST PLUS PRICING
- Establish the unit cost of delivery of the product/service, comprising
- Variable costs
- Fixed costs
- Required drawings/dividends & taxes
- Re-investment needs
- Break these down to a workable meaningful number, such as cost per hour, per head or square foot.
- Remember to factor in any downtime, such as non-billable time, meetings, administrative time, bank holidays etc…
- Work out how these unit costs vary with volume, and see how as you increase or shrink your capacity your costs change (as your fixed costs, drawings and re-investment get spread over a larger or smaller volume of billable time).
- Establish the profit you wish to make, based on the volume you expect to deliver, and simply mark-up your costs accordingly.
- Remember to consider different mark-ups for different products.
- But please don’t use cost plus pricing as a lazy substitute for a proper pricing strategy!
DEMAND BASED PRICING
- Anything will sell at a price, its just the market price … but remember that you can influence demand through Product, Place & Promotion.
- Remember that your customer’s perception of value is far more relevant to their demand for your product/service than the time and effort that you spend delivering it.
- So look to add demonstrable value to your offering that generates a positive perception.
QUANTITY BASED PRICING
- Your largest customers may enormously value your work, or they may stick with you because of your low price; understand which is the case.
- Some may bring more spending to you if you offer incentives to cross-sell other products/services that you offer.
- If you do adjust your prices to reflect quantity, ensure that the workflow is evenly spread, or appears when you have the capacity to cope with it.
- Traditionally quieter at certain times of the year? During slack times aim to at least cover your fixed costs (e.g. staff, premises, insurance, re-investment etc…) and any direct costs you incur in the provision of the service (e.g. suppliers and sub-contracting).
- Consider special promotions to existing clients for particular services at specific times of the year, and educate or market to your customers accordingly.
- But don’t expend too much of your marketing budget in the quiet times if the majority of your target audience are distracted by other events, like Christmas.
- Having covered your costs, be aware of how much extra profit your business can make from every additional £ of sales.
- If you have a gap in workflow, and resources that would otherwise lie idle, consider pricing one-off work or sales incentives to fill the gap at levels that cover your variable costs and contribute towards your fixed costs.
- Fixed prices for services are great for the customer, but can present a risk to the supplier. So be specific about exactly what is included in the price, the boundaries, and how if the job changes whilst underway that the price will also be revisited.
Making Prices work:
- Look to amend your prices little and often, rather than putting off the change until it seems huge.
- Present your pricing confidently, and ensure that you value your own efforts and time correctly.
- Monitor KPIs (key performance indicators) and financial accounts frequently to ensure that your pricing strategy remains valid and is generating the desired results.
- Test the market before launching brand new pricing structures.
- Don’t feel that all prices must be raised across the board; know and listen to customer feedback and look to raise them where customers perceive the greatest value to be.
- Find a distinctive style. But ensure that your message is relevant to your target market, and package your services in interesting ways
In order to set the best price for your strategy, it helps to be cost-efficient. Consider this: £1 of cost saved is often worth £2 or more of revenue gained, as savings create enduring value.
There are different ways of looking at costs:
- The accounting cost is the expenditure incurred for supplies, services, labour, products, equipment and other items purchased for use.
- These accounting costs will be visible in your annual accounts, management accounts and forecasts.
- Ideally the management accounts and forecasts should break down the revenue and costs by division or service.
- Where people are used for a number of divisional tasks, or they are truly central costs (like book-keeping, insurance, management) they need to be allocated across the business. But think carefully about how this is done as any assumptions made can have a huge bearing on the interpretation of figures.
- Consider keeping these central costs distinct in the accounts, as your revenue-generating divisions will then know how much they must achieve to cover both their own costs and their contribution to central costs.
- In the past I have seen perfectly profitable divisions, which were usefully contributing to central costs, closed down because an inappropriate allocation of shared overheads suggested they were making a loss!
- Put a cost to time that you spend on work issues out of the office.
- Always look at the current and future costs rather than just basing your decisions on historic costs.
- Remember to factor in issues like tax and depreciation (or ideally anticipated replacement costs).
- The opportunity cost is what is foregone because the accounting cost has already been incurred.
- For instance, ask yourself what better use could those resources have been dedicated to instead?
- In preparing your business strategy, look at the resources available to you, and seek to deploy them on work that will achieve the highest returns.
- Pareto’s Law
- This is the chap who created the 80/20 rule. It may be more like 70/30 or 95/5 in your business, but the point is the same.
- Look at the work you do and the customers you do it for. Look at whether your business would be better off without that work, and the opportunity cost of doing it … could you be doing more productive work having freed up that time?
Your costs will put a floor on your price, and the market may put a ceiling on your price.
Having found the right pricing strategy, ensure that your cashflow also matches your needs:
- Businesses don’t fail because they are unprofitable … they fail because they run out of cash.
- A clear cash policy isn’t necessarily “30 days end of month” or “14 days from invoice” which is open to abuse. It is more likely to be something clear like “a third up-front, a third mid-project, and a third on completion.”
- Enjoying a strong cashflow can open up your strategic options, which in turn may generate better pricing and enhanced profitability.
- Cashflow often becomes more critical as you grow, as you have more costs and investment to fund whilst awaiting revenues. So plan for it!
And finally … a few dos and don’ts:
- Be honest about pricing
- Tell your customers up-front and be prepared to justify them with reference to the market and your expertise. Don’t apologise … if you need to then your pricing strategy is wrong.
- Ensure that your staff buy-in to your pricing strategy
- Tell and thank your customers
- Contact your key clients and ensure that they understand and appreciate why price changes are being made.
- Remind them how you continue to differentiate the value you offer to them.
- Use the opportunity to demonstrate any additional features and benefits that you have introduced.
- Add features, extra value and options to create choice
- Extra features can command extra prices.
- But give customers the option of sticking with what they are most comfortable with rather than turning them away.
- Attract positive attention every time you do so.
- Before raising prices, consider offering your customers the chance to bulk-buy at pre-increase prices.
- Keep your pricing and costing simple, understandable and promotable!
… and most importantly, THINK OUTSIDE THE BOX
FYI can help with pricing issues, so do contact us to discuss your needs.