The Pricing Conundrum

What you should consider when determining the price for your product or service?

What you should consider when determining the price for your product or service.

We’ve looked at how to identify your target audience, considered the development of your USP (unique selling proposition) and where you want to position your product or service within the marketplace, now it’s time to start thinking about what you’re going to charge for it by considering your pricing strategy.

Pricing is closely linked to product positioning and therefore your strategy will be somewhat determined by where you are aiming to position your product or service within the market place, but choosing the right pricing strategy for a product or service is crucial to small business success and when making your decision, the following factors should be taken into account;-

Product positioning strategies

Target audience and willingness to pay

Fixed and variable costs (The total unit cost of producing a product or offering a service should set the lower limit of the price to be charged and suggest the profit margins for prices set at higher levels.  The total cost is derived from the fixed costs that occur despite how many units are produced and the variable costs that are incurred with each additional unit.)

Other elements of the marketing mix (product, promotion and place) – Product – its features will affect the cost of producing the product and ultimately the price, promotion – large advertising campaigns can be expensive depending on your advertising channel and these costs will need to be recovered in the price, place – distribution channels and their associated costs which also need to be recovered.

Competition – What they currently charge and what they might do in response to your market entry.

Legal boundaries – There are various pricing legalities to be considered when pricing your products and services.  For example, colluding with competitors to fix prices and therefore interfere with the natural effects of price on the demand curve is considered illegal in most countries but there are often price controls to prevent individual firms from setting prices too high or too low as well.

Demand and Supply – Understand how the quantity demanded will vary with the price charged.  Estimate a demand curve for your product or service at different prices.  If you are reconsidering pricing strategy for an existing product then experiments can be performed with prices above and below the existing price to see how demand is affected and establish the elasticity of demand for the product or service.  A product with inelastic demand will sell in similar quantities despite changes in price and therefore a price increase for this product or service would be feasible.

Company pricing objectives – Are you looking to maximise profit or revenue?  Or are you looking to use price as a tool with which to create a perception of your product or service and aid its market positioning?  Do you need to recover all costs for this product or service or do you have other revenue sources that will allow you to charge a lower price for an introductory period as part of a promotional campaign?  Or are you simply looking to maintain the status quo within the marketplace and seeking to make a moderate but stable level of profit?

Once you have given careful consideration to the factors above, you can begin to home in on the right pricing strategy for your business.  Below is a simple pricing model showing four principle pricing strategies to help get you started.

A simple pricing model showing four principle pricing strategies.

Paula Williams, Aviation Business Consultants (ABCI)

The four strategies briefly explained

Economy – low cost, low quality, no frills, lowest price.  Economy pricing means charging the lowest price that you can for a product or service in order to undercut existing competition by offering a similar alternative with no frills or fancy features.

Market penetration – The price of high quality products or services are deliberately kept low in order to drive out the competition and maintain/improve market share.  The intention would be to then raise the price at a later date in order to recover the losses once your competitors have disappeared.

Skimming – A price is applied to the product or service that is much greater than its tangible value because it is unique within the market place and as such high demand and relatively short supply means that the target audience will often tolerate an inflated price at least for a while.  A massive short-term marketing campaign is usually deployed to sell large quantities of the product before competitors reach the market.  At which point the original seller will reduce the price to allow for the changes in supply and demand.  Whilst it lasts, this pricing strategy can be very useful in helping to recover the investment costs that you may have incurred in the design of your product or generally bringing it to the marketplace, however, make sure that you keep a close eye out for emerging competition and reduce your price in a timely fashion so as not to become expensive against your competitors.

Premium – High quality product or services reflected in its price.

Other pricing strategies

Bundle pricing – This strategy is also known as package deal pricing.  It is a marketing ploy to increase the sales of several products at a time.  Multiple products or services are packaged together and advertised at a price that is less than the total price if the same products/services were to be purchased separately, making the “bundle” purchase a more attractive or economical proposition.

Psychological pricing – This strategy is based on the theory that certain prices have psychological impact and involves appealing to the customer’s emotional side.  The idea is to strike an emotional chord with the price; this may be in the form of odd pricing ie charging £5.99 for an item rather than £6 to strike a thrifty chord or inflate the price to strike the prestige chord in a premium product or service.

Optional pricing – This strategy involves charging a low price for the basic product but charging for everything else as an optional extra.  We have all seen increasingly in the airline industry in recent years.

Cost plus pricing – This is a cost-based pricing strategy in which a company first determines its break-even price for a particular product or service by adding together the direct material costs, the direct labour costs and the allocated overhead costs.  Once the break-even price has been established, a mark-up percentage is added to derive a price that includes a profit margin.

Freemium pricing –This strategy sees the company offering a free version of the product or service but then charge a premium for advanced features.  This is typically a digital application, software etc

What influences your customers’ perception of a particular price?

According to Thomas Nagle and Reed Holden in their book The Strategy and Tactics of Pricing, there are nine “laws” or factors that influence how a consumer perceives a price and how price-sensitive they are likely to be for their various purchase decisions.

They are:

  1. Reference Price Effect – If alternatives to a product or service are available in the market place then a buyer’s price sensitivity increases in line with price relative to perceived alternatives.
  2. Difficult Comparison Effect – The less easily a product can be compared to an alternative, the less price-sensitive the buyer becomes and the more likely they are to pay the higher price of a known or reputable brand.
  3. Switching Costs Effect – Product-specific investment affects price sensitivity. The higher the investment required in order to switch products or suppliers of a service, the less price sensitive a buyer will become when faced with alternatives.
  4. Price-Quality Effect – If a higher price suggests higher quality then price sensitivity is low.
  5. Expenditure Effect – Price sensitivity is high when a product or service accounts for a significant proportion of a buyer’s income or budget.
  6. End-Benefit Effect – This refers to the effect that a particular purchase has on a larger overall benefit, and is divided into two parts:
    1. Derived demand – If buyers are sensitive to the price of the end benefit, they will be price-sensitive to those products that contribute to that benefit.
    2. Price proportion cost – This refers to the percentage cost of a particular component compared to the overall cost of the end benefit. The smaller percentage against the total cost, the less price sensitive the buyer will be to that particular component.
  7. Shared-cost Effect – If the cost of a product or service is being shared then the smaller the portion of the purchase price buyers must pay for themselves, the less price sensitive they will be.
  8. Fairness Effect – Price sensitivity increases when the price of a product falls outside of the range that the buyer perceives to be fair or reasonable.
  9. The Framing Effect – Price sensitivity is greater when a buyer perceives the price of a product to be a loss rather than a forgone gain, and they have greater price sensitivity when the price is bought separately rather than as part of a bundle.

Name your price!

Use this article to ask yourself the critical questions and collect the information that you need to choose an effective pricing strategy for your business.  Once you have chosen your strategy, you need to develop a pricing structure for your product or service. There may only be one version of your product or service but if it comes in different sizes or has the option for additional features then a pricing structure will be required.  Finally, apply numbers to your pricing structure with the help of the list that we looked at above which outlined the factors to be taken into account when pricing.  Good luck!

We hope that you have found this article useful.  Next time we’ll be looking at promotion strategy and the pros and cons of direct Response Marketing vs. Brand Awareness Marketing.  However, if you have any questions or would like to discuss the pricing strategy for your small business further, please contact Sam on 02475 185286 for a Free Consultation or complete our online form.

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