The art of pricing! – How to set pricing objectives and develop pricing strategies?

This is a must read 3 part series on market structure and entry barrier, pricing objectives and pricing strategies and how to avoid or engage in a price war.

Please click the link below for the second and third part of this “must read” series for any small business hoping to survive a price war.

  1. Know your enemy – Scan your environment and know your market structure
  2. The art of pricing – Pricing objectives and strategies
  3. The art of war – all war is based on deception – how to fight a price war!

There have been a lot of articles written about pricing, price wars and war gaming, and there has also been a lot written on the strategies and tactics required to avoid and or deal with a price war.

However most of these articles are written in the context of large corporations who are often well funded and have the professional managers, who have the requisite tools and capabilities to deal with a price war. There has been few to none written for small businesses. Although the guiding principles are the same for all “for profit” companies, some of the prescribed solutions are not apt for small businesses.

Before we discuss on price wars, it is important for small businesses to reflect in a structured manner their industry structure, market trends and define and develop a purposeful pricing objective. Only then can small businesses determine their pricing strategy let alone deal with or avoid engaging in a price war.

The art of pricing

Before a small business dwell into the different pricing aspects, it is important for small businesses and SME marketers to truly reflect as to the real objectives of a pricing approach in the market. There could be many reasons and objectives for such a pricing move. Before we summarize the different profit objectives, it is important for small businesses to consider the following:

What are the trends in the market?

Factors and questions that a small business owner or SME marketer should consider are:

  • Is there a flood of new propositions or model introductions in the market?
  • Is there an increased availability of bargain and generic brands in the market?
  • Are your competitors using price cutting as a strategy to maintain or regain market share?
  • Is there a general decline in consumer confidence? (Such as after political upheavals, terrorist attacks, stock market crash et al)
  • What stage is your proposition in the product life cycle? Is it matured?
  • What is the competitive intensity in your market space?
  • What is your distribution strategy? Direct, indirect or hybrid sales approach?
  • What is your promotion or communications strategy?
  • What is the perceived quality of your proposition relative to your competitors?

Pricing objectives

After truly understanding their industry structure and the market trends, then only small business owners and SME marketers should consider and define their profit objectives.

The set of questions that SMEs should reflect to determine their intentional pricing objectives are:.

  • Survival mode – Are you just trying to survive to generate enough cash flow just to remain in business?
  • Maintaining status quo – Are you trying to maintain the status quo in the hope of avoiding a price war?
  • Cost recovery – Are you seeking only partial cost recovery?
  • Quality leadership – Is the small business seeking to signal a higher quality of the proposition?
  • Maximize current profits – Is the SME seeking to maximize current profits?
  • Maximize current revenues – Are you seeking to maximize current revenues and not the profits?
  • Maximize quantity – Is your small business seeking to maximize quantity to recover long term costs?
  • Maximize profit margins – Is the SME seeking to maximize profit margins knowing well the impact it has on the demand for the small businesses’ products and services?

Now that you have a structured view of the industry structure, the prevailing trends in the market and a purposeful pricing objective, it is time to reflect on what your strategic pricing approach would be.

Strategic pricing

There are many different types of pricing strategy that a small business owner or marketer can follow. In the SME market, Some are more prevalent than others. Here are a few of them.

Penetration pricing

The strategic objective of this type of pricing is to increase sales and gain momentum in the market soon. For example, a small business distributor of consumer electronics goods might use this strategy to preempt a competitor launch which is some time away.

Skimming pricing

The small business owner can set an initial high price, and then gradually lower the price to make the proposition available to a wider market. The strategic objective for a skimming approach is to skim profits of the market layer by layer. If you are a small soft ware games developer or a distributor of toys or consumer electronics, skimming might be an excellent approach, if the main festive buying season is some time away.

Competition pricing

The objective of this is to set a price in comparison with the competitors. In reality, a small business has three options and these are to price lower, price the same or price higher.

Product line pricing

The strategic objective of this type of pricing is to price different products within the same product range at different price points. Examples of this would include hotel room rates and others.

Bundle pricing

The SME can bundle a group of products at a reduced price. Common methods are to buy one and get one free. Other creative methods could include offering a set menu for restaurants, bundling complementary products like movie tickets and pop corn etc.

Bucket pricing

In this pricing method, SMEs can offer large volumes or buckets of the same proposition for a fixed period commitment. A small business restaurant owner, hotelier or a transportation company can offer bucket pricing for a fixed fee on a monthly or annual basis.

Psychological pricing

When pricing their propositions, small businesses oners and SME marketers should consider the psychology of price and the positioning of the price within the market place. For example, this is the reason why you see a lot of $1.99 or $999 and so forth type of pricing all around.

Premium pricing

The strategy for this pricing approach is to set a price high to reflect the exclusiveness or the premium quality of the product. This is commonly used by retailers and sellers of premium goods and services.

Optional pricing

In this pricing approach, the SME can sell optional goods or services along with a main proposition.

Cost based pricing

In this pricing approach, the SME takes into account the cost of sales and distribution and then apply a markup for the intended profit, before deciding on a final pricing framework.

Cost plus pricing

The objective of this pricing approach is to add a percentage to costs as a profit margin to decide on a market pricing decision.

Loyalty based pricing

In this pricing approach, the proposition offered uses all of the above pricing methods, and then prices are discounted to entice commitment and therefore loyalty over a commitment period.

A note on the people who do pricing

I recently met a owner of a company selling software over the internet to SMEs. Prior to his endeavor in this venture, this gentleman was a very senior manager in a well known global software giant. What baffled me the most was his pricing strategy.

In my mind, he truly lacked an understanding of his customer needs and affordability. More importantly, he failed to understand that his potential customers did not have the necessary cash flow for such upfront investments and that his only value proposition relative to his other competitors in the market, was offering his customers an OPEX model versus a CAPEX model.

Most small businesses and SME owners often mistakenly request the good folks from the Finance function to set the pricing for their propositions. This is a grave mistake.

The pricing strategy and the tactics have to be set by someone who understands the needs of the customers, customer perceptions, and market conditions and has a well rounded view of the business.

As pricing is the purse string of your business, it is important that there be checks and balances. This means that any pricing strategies and tactics of course  will need to be validated and approved by independent functions like Finance or Accounting. However, the strategies and tactics should be led by someone who has a well rounded view of the customer needs, market, competition and so forth..

“Perceived Value”

Small businesses need to know that most customers buy their propositions not for their features (e.g. a phone) or their specific functionalities (e.g. camera pixels), but rather for the perceived benefits that the propositions deliver.

Features and functions – which are often the focus of product design specifications – are simply the ‘envelop wrap’ for delivering the benefits that are desired by customers.

Customer perceptions are critically important!  A proposition may pass the required functional criteria, but a small business only ‘gets credit’ only if the customers recognize (i.e. “perceive”) that the product delivers the benefits.

Similarly, potential customers make purchase decisions considering a proposition’s perceived price.  That is, how much a customer thinks that a product will cost them? These perceptions may or may not accurately reflect reality.

Keep in mind that the perceived value is either the difference between the perceived benefits that a product delivers and its perceived price, or the ratio of the perceived benefits and the perceived price.

Comparison of perceived values

SMEs should know that customers often make a choice based on not to pay more than a certain price. They make these choices by comparing across a set of reference propositions explicitly or implicitly for unscientific perceptual benchmarking (e.g. this type of product should cost roughly this amount) – (for example an Apple iPad versus a Blackberry Playbook).

Customers also compare among substitutable products that may be directly or indirectly competitive. For example, Colgate and Close Up tooth pastes are directly competitive.  Colgate tooth paste and mouth wash are indirectly competitive (since both serve a different purpose and are dental hygiene products – unless someone only uses mouth was for their dental hygiene J).

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One Response to The art of pricing! – How to set pricing objectives and develop pricing strategies?

  1. Levi @ stammer says:

    Hey! I found your blog on google and I took a peak at some other posts. I stuck you in to my Feedburner feed. Keep up the good work. I’ll be around!

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