Art of Pricing

6 Secrets of Successful Pricing Strategy

I was talking with a potential client and we were discussing general approach to pricing. After a while it dawned on me that what he really wanted was a formula that he could use in his Excel sheet and magically workout pricing for his products! There are many theories about every aspect of marketing; however the art of pricing remains steadfastly mysterious. Pricing refuses to succumb to the usual desire for a universal formulaic approach, simply because pricing is more of an art and less of a science. Here are 6 basic principals that govern pricing process and why Excel sheet fans will not succeed.

Pricing is probably the most vital element of the 4-Ps of marketing & often the reason ventures fail. You can have the best Product, the best Promotions, the best channel (Place), but get your pricing wrong and your business is dead! Here are the reasons.

1. Cost of Goods (CoGs) vs. Loaded Cost

It is folly to base your pricing just on the material and labour costs of a product or service delivery, also known as CoGs (Cost of Goods). Loaded cost includes contribution costs for R&D, production, marketing, sales, transportation, wastage, etc. None of these functions are free and therefore if you only consider the Costs of production (CoGs) rather than the Loaded Costs you are guaranteed to lose money. You must determine both CoGs and Loaded costs before you can price your services or goods profitably.

2. Break-even Point

This is the level of production or volume of sales that covers costs. Given that in any scenario we have 2 costs of goods (CoGs and Loaded), you should therefore determine your two Break-even Points. To reiterate there are two costs, namely the CoGs (the actual cost of goods or services) as well as the Loaded Costs which includes all contributions to the true costs of producing goods or delivering services. These will determine your two Break-even Points. Once you have these points you can calculate the minimum sales volume you need in order to cover your cost of goods as well as the operational costs.

3. Elasticity of Demand

This is where the real fun starts! Elasticity of Demand principal states that the sales volume achieved is inversely proportional to the price point. The over simplification of this principal has you believe that the lower the price then the higher the volume, but this oversimplification of economics and pricing model is just one of the many myths told by the Man-in-the-Pub expert!

Firstly the Price vs. Volume is not a straight line relationship but is a curve. This means when you reduce your prices by 10% there is no guarantee that you will increase your volumes by 10%. The volumes could increase by more than 10% or conversely can increase by less than 10% which could result in loss of revenue and profit.

Secondly there are two tipping points within the curve, one when the volume increases disproportionately higher than the price reduction and the second point where volume increase will cease regardless of the price point. This second point is arguably the market saturation point where no additional demand can be generated regardless of how cheap you are prepared to offer your product or service.

Lastly, the Elasticity of Demand is not just about price reduction but can be used to successfully increase prices. This means you can increase your prices but the fall in volume can be offset by the increase in unit price and higher margin. So pricing is not just about how cheap or expensive you are, but how cleverly you pitch the Price Point vs. Volume.

4. Price Sensitivity

Not all market or market segments respond to Elasticity of Demand the same way and at the same rate. Some products do not respond at all to marginal price changes therefore they are deemed to be Inelastic. Some products are hyper sensitive to price movement hence they are extremely elastic. It is also true that consumers’ response to price is not universal or linear, so different consumers respond differently to prices. Most products fall somewhere between the two, but the real trick is to establish price sensitivity of your market and targeted consumers. For this you need extensive research of your company’s past performance, and in-depth understanding of your competition, as well clear understanding of your target market response to price points.

5. Competition

Unless you are the first-to-market, or have a monopoly of supply, then you cannot price your product or services in isolation. Pricing against the competition is dependent on your target market, value proposition, any differentiated marketing strategy, and volume targets (see Elasticity of Demand above).

One of the key tasks of professional Product Management role is competitive analysis including the competition’s pricing strategy. This in-depth understanding of the competition enables the producers to pitch prices that will satisfy both profitability and volume objectives. Therefore do as much research as possible on your competition as this is critical for your success.

6. Target Market Segmentation

Within any product or services market there are distinct segments. Whether you are in Car industry, hospitality, or electronics there are price points that different consumers are prepared to pay. This preparedness to pay different prices combined with the demand for different functionality, quality and longevity enables suppliers to create distinct product variations. Volkswagen Group offering VW, Audi, Skoda, and Seat brands that all use the same platforms and engines but are targetted at different consumers. Alternatively you can just target a single segment or a niche, e.g., Jaguar or Volvo. This is not unique to car industry and we can identify this practice in many industries from clothing to hospitality to food to airlines.

Segmentation can have many facets including Age Groups, Income Groups, Social Groups, Geography, etc., etc. In essence we can “cut-slice-and-dice” a market in many ways. The trick is to identify a distinct segment and clearly recognize their specific needs and price point. We can then target this distinct segment and appeal to their specific expectation, taste and price point.

Summary

In summary steps are simple:

• Identify your target Segment
• Research Price Points within the Segment
• Determine your Loaded Costs as well as your CoGS
• Calculate your Break Even Points
• Forecast Volume based on different Price Points
• Set your price. However, be smart and attempt to establish differentiated products at different price points that target different consumer groups (VW Group with multiple branding is a great example of differentiated product strategy)

Do not get distracted by your Sales People (you will never be cheap enough for them) or your Finance Department (you will never be expensive enough for them). The basic steps are simple enough but execution requires skill, intensive research, and ultimately application of expert knowledge.

Finally remember Price is not dogma, so be prepared to rethink your strategy. Regularly review results, and if you are not achieving your financial objectives, then rethink and take action. You can always test “Price Sensitivity” and the “Elasticity of Demand” for your product by experimenting with Special Offers, Limited Editions, Stripped Down version, or Enhanced Variants of your product or service. This will test different price points without compromising your pricing policy or cannibalising existing sales.

Cognisant can carry out pricing studies and research on your behalf and provide invaluable advice and help in formulating your pricing policy. Contact us today to see what we can do for you.

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