YOUR BUSINESS BUILDER | September 2011 – Marketing – Part III | Pricing Your Product/Service
by Kenyon Riches of the Buffalo-Niagara Chapter of SCORE
An often complex business decision is how to price your product so that you can maximize your earnings. In order to do so, several factors must be considered and understood:
- What is the value to the user, and how price sensitive is the item to the buyer?
- What is the sales volume sensitivity to price?
- What is the nature, strength and concentration of competition?
- What are your manufacturing/service costs?
- What are your marketing & promotion costs
- What are your distribution costs
- What is your manufacturing capacity/servicing capability
- What Inventory levels, obsolescence and seasonal considerations are there?
- What alternative opportunities exist?
- Can you gain market share with a lower margin?
- Can you meet the needs of a greater market share? That is, do you have the personnel, capital, manufacturing, inventory, and marketing capability to fuel an increased volume of sales?
- Will the net result be a greater $ profit, and will it be worth the additional capital and effort needed to accomplish it?
- Does your product/service have a uniqueness that makes it less comparable to competition based on price alone?
1. The upper end of the pricing choices would be the “Value-to-the-User”, which requires an analysis of how the user would use the new product, what alternatives the user has to use of the product, and what advantages and value - to the user – the product has over these alternatives.
2. Although the greatest unit margin may be realized by Value pricing, the maximum total margin can only be realized by understanding how the volume of sales increases with decreased pricing. This may be determined through test markets or selective discounting.
3. Competitor offerings may place a cap on the prices you are able to achieve, and requires an analysis of competitive products, prices, and market positions. If your product has advantages that justify premiums over competitive products, you may be able to help underwrite the costs of market introduction with premium pricing. If this is not possible, you may have to accept lower profits (or losses) in order to launch your product. An entrenched competitor may be difficult to displace, and you must also consider how competitors will react to your new product. Alternative marketing channels might also be considered.
4. Manufacturing/Service costs must be understood in order to determine your lowest acceptable margins.
5 & 6 Promotion and Distribution costs must be understood to understand margins within each market segment.
7. Manufacturing capacity/servicing capability must be coordinated with expansion so that a low price doesn’t generate sales that exceed your manufacturing/service capability before you can expand.
8. Inventory levels, product obsolescence and seasonal considerations are short-term pricing considerations.
9. Alternative opportunities for manufacturing/sevice capabilities (different products, markets, export) should always be considered, especially when individual margins fall. In addition, since you may have the ability to serve many market segments, these values and costs may differ within different market segments. It may be beneficial to establish different pricing in different market segments through alternative packaging, different features, selective discounting, product coupling, and different marketing channels. How important are margins and market share? Consider a company that charges prices that result in a 50% margin with sales of $1.0 million/yr. Their 50% margin results in $500,000 gross profit. Now, consider if that company were to charge prices that resulted in only a 35% margin, but because of the lower prices, they were able to achieve annual sales of $2 million. A 35% margin could yield a gross profit of $700,000 (reduced by the costs associated with increased promotion, distribution, inventory, receivables, etc.). The above may hold true:
- If the market is large enough
- Provided your marketing efforts are able to reach your customers
- Depending on just how sensitive are the sales to the price
- If competition doesn’t engage in a “price war” before you can realize the benefit of your price.
Many Internet companies are based on this type of thinking. First of all, costs of overheads are reduced because no storefront is necessary, fewer sales people are needed, and order entry is by the customer. Receivables are collected quickly through credit card instruments and often shipment is direct from factories, eliminating the cost of inventory. Lowering prices as the company’s marketing becomes effective can result in increased market share and increased sales volume. Because Internet customers “shop” at many Internet sites, those with sufficient exposure and the lowest prices (and margins) often get the sale, especially if the products are the same brand and the supplier is reputable.
Alternatively, increased marketing and promotion may develop a similar increase in sales (at the original 50% margin level) as the price reduction did in the above example, but because of the added costs associated with the marketing and promotion, the total profit may be similar or less. Understanding the price sensitivity of your products within each market segment, and the costs of marketing and promotion in those segments will help you to determine what margins to use.
Market research is necessary to understand your market dynamics. Sometimes “introductory pricing” or the use of discounts can help you determine the price sensitivity of a product or service. Planning is an important part of your business and marketing strategy.