Is Your Pricing Approach Right?

“The Price is Right” is a popular game show in the United States where contestants guess the price of various merchandise. The correct answers fill their pockets with cash and many other prizes. But the real world is nothing like a game show. Here, companies have a lot to lose if they fail to get the price right. The wrong price can affect a firm’s future profitability and even endanger its overall survival. Conversely, the right price can garner a lot of benefits. According to one landmark HBR study, even a 1% improvement in price can boost operating profit by 11.1%.

There are various pricing strategies you can explore for your products. But before you start thinking about strategies, it’s imperative to know which factors can influence these strategies. Let’s explore these and figure out the ways to grab the right approach for your products.

Customer Demand and Perceived Value

Factor type: External

By buying your products, your customers look for value, i.e., the difference between perceived benefits and costs. If your product cannot deliver a positive value where benefits are greater than costs, they will not buy what you have to offer. Hence, the customer’s perceived value is one of the first things you should consider when setting a price.

You should also consider:

  • Demand
  • Price elasticity

If the demand is already there, you can set your prices based on competitor prices. But if your product is new or unique, no demand exists yet, so you should do customer research to understand how your product can meet their needs, and use this information to guide your pricing strategy.

Price elasticity is also important because it impacts how much customers are willing to pay for your product. Price-sensitive customers will buy more at low prices, and less at high prices, meaning the product is price elastic. Essential goods are usually price-inelastic, while luxuries are usually price-elastic.

So, before setting prices, ask yourself:

  • Is my product an essential or a luxury, i.e. is it price-inelastic or price-elastic?
  • Are my customers price-sensitive?
  • How can I continue to offer value even to price-sensitive customers – without impacting profitability?

Product Cost

Factor type: Internal

To make a profit, you must set a price higher than the total cost of production. Nevertheless, if your goal is only to attract new customers, you may sell the product at a loss or with zero margins. This strategy is popularly known as a loss leader or penetration pricing strategy. If executed properly, this strategy can help you penetrate the market and quickly gain market share. It works best when you profitably sell other products to cover the loss. But if you don’t have such alternatives, the strategy may end up hurting you in the long run.

When considering cost as a factor for pricing, keep these points in mind:

  • Calculate all costs, not just the costs you can “see”
  • Separate variable costs and fixed costs to understand which costs you can (and can’t) control
  • Calculate your break-even point (BEP), i.e. the point at which total costs equal total revenue

Competition

Factor type: External

In a competitive pricing strategy, the price is set based on the price of similar products. It is well-suited for highly competitive markets with price-sensitive customers. If your product functions in such a market – in other words, you don’t hold a monopoly – you should consider competition as a factor when setting your prices. Otherwise, your customers will switch to a lower-priced competitor, especially if they perceive that your product and your competitor’s product have equal value.

When considering the competition, follow these best practices:

  • Thoroughly research the competition
  • If your product offers a unique feature that separates it from all other “me-too” products, do call it out in your marketing and promotional strategies
  • Even if the competition is high enough to warrant a low price, try to keep the price higher than your costs (see #2 above)

Economic Conditions and Government Rules

Factor type: External

While fixing prices, look at economic factors like interest rates and unemployment. If the economy is weak (say, due to a recession) or the unemployment rate is high, it may affect the demand for your product, so you may have to lower prices. While setting prices for international markets, you should also consider international exchange rates and import/export rules.

Government laws and regulations also affect pricing decisions. One reason is that they aim to protect consumers, encourage ethical business practices, and promote healthy competition. For example, in the U.S., the Robinson-Patman Act of 1936 prohibits large companies from indulging in predatory pricing, the practice of offering low prices to eliminate smaller competitors.

In some cases, the government may set the prices for some products. It usually happens for one of three reasons:

  • To make some goods more expensive, e.g. to increase farmers’ revenues
  • To make some goods cheaper, e.g. to decrease housing prices
  • To stabilize prices, e.g. to prevent sudden spikes in the price of toilet paper following a global pandemic

Depending on your product type and market, you should consider relevant government regulations while fixing your prices.

A Final Word

In addition to the four key factors discussed above, you should also consider your pricing objective when setting prices. If you aim to obtain market share leadership quickly, employ penetration pricing. But if the goal is to operate in a thriving and competitive market, match your competitors’ prices, and consider offering additional discounts or freebies to attract more customers.

Ergode empowers eCommerce companies to maximize their profits with tailored pricing strategies. Since 2011, we have helped over 2,500 brands expand their business with our AI-powered technologies, fulfillment centers, and pricing experts. Connect with us to know how we can help you create killer pricing strategies for your brand’s success.

 

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