How to get the price right
Stay aware and stay flexible
Every business owner soon discovers that pricing is a unique challenge because there’s no one-size-fits-all formula. Two companies offering the exact same product may be better off with totally different pricing strategies depending on factors like size, location and customer base.
Depending on your business, different factors will impact supply and demand. For example, if you own a greenhouse supplying heirloom tomatoes year-round, your focus should be seasonality. In January, you can charge premium prices for your harvest, but come August, when supermarket shelves are full of field-grown heirlooms, you’ll need to charge considerably less to stay competitive.
When setting your price, consider whether your product is a luxury or a necessity. Luxury offerings (along with products easily swapped for a substitute) are considered highly elastic – consumer demand for a vacation cruise or a car is very reactive to price. Demand for necessities, on the other hand, tends to withstand a price change. For instance, a small price hike at a gas station is unlikely to impact the business unless the station right down the street beats your price.
Are you aiming for high quality and high price? Or are you making a bet around low quality and low price? Offering a high quality product at a low price will eat up your profits, while offering low quality goods at a high price will drive down your sales.
It’s commonly assumed that cutting your price is the only reliable way to drive sales, yet one of the world’s best-known brands proves otherwise. Tech giant Apple consistently charges more than the competition; its success isn’t tied to low price, but to the quality of its products. Apple’s customers’ loyalty may be partially due to Apple’s edgy, forward-thinking image, but if Apple’s quality faltered, its customers would flee. But, a company like Walmart targets the price-sensitive consumer whose loyalty is inspired not by quality but by savings. Low prices indeed drive sales – but among a different demographic.
Defining your customer is central to setting your price, and answering these questions will help you narrow down your target demographic:
Who needs my products and will buy them? Should I offer different products to different customers? Can or should I narrow my customer base? Where are my customers located and how do I market and sell to them?
The next step in crafting your individualized pricing strategy depends on your goals. Are you seeking sales growth, market share, or are profits your top priority? Maybe you’re focused on retaining your customers, supplementing an existing product line, or beating back a pesky competitor. Keeping your specific goals in mind, consider which pricing models are most relevant to you.
Different pricing models will apply depending on your market. In the retail context, a low-price player like Walmart offers competitive pricing, which means matching any price currently offered for a given item. Apple, on the other hand, maintains vendor pricing, or MSRP (manufacturer-suggested retail price), when the price of the product is set in stone regardless of where you buy it.
Other retail models include:
• Markup pricing: your cost, plus a markup, equals the gross profit you aim to make. This method is commonly applied to goods like jewelry and clothing.
• Psychological pricing: set your price at $9.95 instead of $10 to create a lower-price appearance. (This is also called “odd pricing,” because it ends with an odd number, anticipating that the customer will round down.)
• Sales or discount pricing: often applied to big-ticket items like furniture.
Wholesale pricing, by contrast, requires a different set of considerations, such as type of market and number of resale layers. Your wholesale price must reflect your cost plus your profit margin, as well as a profit margin for the dealer. An item selling quickly at a large chain, will bear a lower wholesale price than one offered at a specialty store.
Generally speaking, prices for commodities (clothes, computers, and other things taking up space at the mall) are based on supply and demand, with other models layered on as needed. Less tangible goods and services, like airline tickets or software, are subject to far more complex strategies varying greatly by industry, and also within industries.
Every business relies in part on intuition: what is the maximum price the consumer will pay for the value being acquired? An effective marketing campaign might persuade her to pay more, but it’s risky to rely on marketing to change consumer perception of your product’s value. The safer bet is to identify your consumer based on the product and price you’re offering, and make sure you reach that consumer.
Joanne L. Edgar, CPA, managing partner of Manchester-based J. Edgar Group, can be reached at email@example.com.