How to Create a Pricing Strategy
The importance of pricing strategies cannot be stressed enough, but setting the right price is tricky. Find out how to charge the optimum amount
Setting a price for your offerings can be a fraught affair. Pitch them too high, and you can see your sales plummeting; too low, and you can lay waste to your potential profits.
You want to achieve the price that, when multiplying your potential sales by your profit margins, yields the largest total possible. But what makes a price optimum depends on a number of different factors.
Read on to find out more about what factors affect your pricing, how to plan and structure your pricing strategy – and why your pricing should constantly be reviewed as time goes on.
What market factors should determine my prices?
To establish what factors affect your pricing, you need to look around to the environment your business operates in.
In the first instance, it makes sense to look at your competitors. Who are they, and what do they offer? How do prices vary for similar types of product? What are the key features and benefits of the products they offer?
Once you’ve completed some market research on your competitors in general, find out what it is their customers value – and why. What are the most popular products, and what do they charge for them? What do their customers most value about the products they buy?
The crucial element is to understand what factors are involved in their customers’ decision to buy. What criteria do they use (i.e. is price a more important consideration or quality)? What features justify higher prices paid for certain products?
You’ll also need to find out about their buyer’s risk factors – and look to view any kind of kind of return’s policy they might offer.
How should I determine my pricing strategy?
When you’re thinking about price points for your product or service, think about how you want to position your product. Price plays a big part in perception. If you want your product to be seen as being of premium quality, a high price will contribute to this.
Determine what prices you wish to offer across your product range. You may want to set a business-wide precedent, or establish a consistency of pricing across all your offerings. What barriers of entry are there for competitors? If these are high, you can charge a higher price; if they are low you may need to be prepared to price competitively.
Decide what discounts you want to offer repeat customers. You should set your highest prices for one-off purchases (which are generally less profitable) and offer discounts and deals for repeat customers, incentivising them to continue buying from you.
And always account for your constraints. For instance, your production capacity, your financial resources, your cost structure and the requirements you have to your investors.
How should my specific offering determine my prices?
As well as the more general considerations of your pricing strategy, understanding your offering as a composite of many different parts and factors is essential to setting an optimum price for it.
To do this, separate it into components. Determine what are core components of the product (e.g. a phone) and the additional components (e.g. the case, the charger, the headphones?). If there are any customisable features (e.g. the colour of the case) or additional elements of the deal (e.g. the tariff), separate these out as well.
Define your product’s benefits. E.g. low price, high quality, reliability, convenience, and so on.
And then think about what these are worth to different market segments/types of customer. For example, low price might be a more crucial benefit for younger buyers, just as reliability might be a crucial benefit for those using your product in a professional capacity.
Once you understand that, determine what the total costs are likely to be. Customers aren’t just influenced by the initial price of purchase. For example, when buying a car, they might be concerned with the cost of servicing and the fuel costs as well as the initial price. If you are after repeat or lifetime customers, offering value for money is a must.
Which is better: Overpricing or underpricing my offerings?
It may seem obvious, but overpricing, undoubtedly. Underpricing your offerings can lead to several attendant difficulties.
Clearly, low prices will equal low margins, meaning it becomes much harder to turn a profit. You will need to attract a high volume of customers, which might prove difficult.
Not only that but low prices often suggest low quality. Customers might conclude that there is something deficient about your product. Whats more, it’s much easier to reduce prices than it is to raise them. Customers who see prices being reduced will be grateful to you. Those who see them raised will resent you.
Cheap products can eat up the sales of expensive ones. If there is a large disparity between the prices of the items you offer, customers may come to you only for the cheaper ones.
How should my costs factor in determining my prices?
Of course, you’ll need to factor any costs when setting your prices. Look firstly at your costs structure. You may need to charge a higher price that your competitors if your costs are comparatively large.
What do your fixed costs look like? The higher they are, the higher sales volume you will have to command to make a profit.
Make sure you price above your direct variable costs. If you do not you will make a loss. Every penny made over these costs will contribute to your fixed costs, and go towards making you a profit. You can use the fixed cost contribution from each sale to calculate what you need to sell to breakeven.
Whilst is may seem the most straightforward method, try to avoid a ‘cost-plus’ pricing strategy. ‘Cost-plus’ pricing is the practice of adding the cost of producing your product to the amount needed to make a profit to determine how to price your offerings. This fails to take factors such as demand and competition into account, and unless you factor in every conceivable cost you face, you will undercharge for your items.
Regularly compare your margins to the industry standard. If they are lower than the norm, it is usually an indicator that you are charging too little, or that your costs are too high. Industry standards can also be used as a benchmark when deciding how to price new products.
Finally, make sure you take all additional costs into account. This will prevent you from undercharging on special orders, or giving overlarge discounts to tough customers.
What pricing strategies can I use?
When it comes to pricing, there are several proven tricks of the trade that you can make use of. These can be broken down into:
- Differential pricing. Differ your prices to reflect differing levels of demand on a daily, weekly or yearly basis. Offer different prices for different level of product specification, or different qualities of service.
- Psychologically attractive pricing. g. £9.99 looks better than £10.
- Package pricing. g. bundling products together and charging a bulk price lower than the price of the items individually.
- Introductory discounts. These can encourage new customers to buy and try your product, though may alienate existing customers, or cause discord once such discounts are removed.
- Clearance discounts. Use these to generate working capital, and to shift ageing stock.
- Cash-payment discounts. Use these to encourage early payment.
- Retrospective discounts. These can persuade customers to keep buying from you.
How should I review my prices?
You should aim to review your prices as often as possible – the market and the position you occupy in relation to it are subject to constant change. Your pricing strategy should reflect this.
Watch out for what the competition is doing, as well as how your customer’s perceptions of the differences between what they offer and what you do is changing.
Keep an eye on turnover. Falling margins and market share indicate something needs to be change about your pricing. Growing margins and market share might give you the opportunity to raise prices.
Try running limited price-change trials. You could change the price for a sub-sector of the market and then analyse the impact and results.
And review the effectiveness of your tactics. Work out whether there are any undesirable results of your tactics, and how they affect your profits as a whole.
How should I go about raising prices?
You may occasionally be faced with the need to raise your prices. Doing so can seem like a dangerous option, but there are steps you can take to offset the pitfalls price-hikes pose.
1. Calculate the impact on profits
Estimate the effect on your margins and your sales volume.
2. Estimate the current demand
It is preferable to raise prices when demand is high.
3. Disguise them
Introduce newer products at a higher price whilst factoring out the old ones, or lower the specifications of your products without lowering the price.
4. Explain your reasons to customers
Doing so is crucial to maintaining a good customer relationship. Make sure to re-state the benefits of your product.
5. Spend more on marketing
Do this to off-set the negative buzz generated by raising prices.