Pricing

Given that profit is more sensitive to price than any other factor, it is no surprise it is a subject of great interest to business owners. In this blog we explore different approaches to pricing:

• Cost Plus Pricing

• Value Pricing

• Differentiated Pricing

• Pricing as Product

We argue that each has its place but that the concept of Pricing as Product is the most important of the four.

COST PLUS PRICING

This is the most traditional and commonly understood approach to pricing. Here the business owner adds a % to the cost of what is being sold.

Generally the % applied is calculated to ensure that overheads are met and a profit is generated.

The biggest problem of the approach is that it doesn’t give the business owner any guidance on the % to apply. There may be industry norms but this may not take into account a myriad of circumstances that may be individual to the business about the product or service.

The % that will deliver profit will also change depending on the business’s stage of development and in different phases of investment cycles.

The most useful application we have seen of cost plus pricing is where a business hits a certain scale and its business model is clear, it is useful to set minimum prices for particular products or services.

VALUE PRICING

Under Value Pricing the cost of what is being provided is not important, instead the business owner is focused on the value to the consumer.

If a business coach promises to double your revenue, does it matter that it takes them one day or five days to deliver their service? Under value pricing I should charge based on the result not what it costs me to deliver the result.

One great strength of value pricing is that it orientates the consumer to the value of what they are buying. In doing so, they are likely to get more from it. At the purest level the sales person will explore the value of the sale to the consumer and price accordingly.

Its weakness is that it is hard to implement and very hard to standardise.

That said, finding some way to charge according to the different value different consumers will place on a product at different times and circumstances is commonplace in many businesses as we can see with Differentiated Pricing.

DIFFERENTIATED PRICING

The value of a product or service is clearly different to different people at different times. A good example is found with ticket prices for events. The last ticket available for Glastonbury is worth a lot more than the first.

Many businesses find ways to take advantage of this phenomenon. Common practices include:

• Pricing by age or stage of life, eg Discounts for students and pensioners

• Early bird discounts and peak time premiums

• Premium vs Economy Packages

• Trade-ins, which are often more about incentivising with less need for a product to buy something new

• Set Menu vs A La Carte

In fact the ways for differentiating on price are only limited by the business owners creativity.

PRICING AS PRODUCT

Of all the approaches, the one we like best is to see the pricing as part of the product.

Here the argument goes that in all markets there are usually three price points that consumers can choose from: premium, mid-range and economy. It is then argued that generally consumers know which one they are looking for and that sales are facilitated when the price, the quality of the product, the packaging and the service standards align.

If the price does not align with the product, packaging or service, the customer is left confused and does not buy. If you go to buy a Rolex watch and it is cheap you may not trust the quality. If Lidl upgraded the shopping experience to be similar to Harrods it could put off its clientele even if the products and pricing stayed the same.

Once you have decided which market you want to appeal to you must then tailor the business accordingly. As we know both Rolex and Lidl are successful and profitable brands.

CONCLUSION

Most businesses will use each approach at some point. They might use cost price to make sure they don’t lose money on any particular product, value pricing when possible, differentiated pricing to take advantage of particular opportunities.

However we would advise all businesses to make Pricing as Product a guiding star. Choosing the market you want to trade in is fundamental and price is the clearest indicator you can give to customers as to whether your product is for them.