For-profit companies focus on just that, profit. Their ability to maximize profits is the main metric that is used to measure its level of success or failure. Correctly pricing your product offerings is one the most critical steps towards maximizing your company’s profitability.
If you price too low, your profits will suffer and your company will need to sell a much higher volume to make up for these lower profits. Price too high and your sales will decline or, for new products, you will be unable to gain a foothold in the market.
Correct pricing starts with recognizing which pricing model is right for your business. There are four different pricing models that I will be discussing below.
Cost-plus pricing involves setting the price at your production cost, including both fixed and variable costs at your current volume, plus a certain profit margin. The problem with this strategy is customers do not concern themselves with your costs. They only care about what’s in it for them including the value provided and their return on investment.
In addition, this strategy fails to take into consideration fair market price or what the market is willing to pay for a product. Your costs don’t matter if your potential customer base is unwilling to pay the price for your product.
Value-based pricing sets the price of your product based on the value it creates for the customer. This pricing strategy can be the most profitable if you are able to communicate and convince your customer base of the superior value your product provides.
However, if you are unable to convince your customer base of your product’s superior value, your sales will suffer. Your product will be seen as a “me-too”, but at a higher price. That is a recipe for a failing product, so be very certain your product has superior value if you choose this strategy.
Allowing current and short-term market conditions to dictate your price is referred to as market-driven pricing. As are most reactive strategies, this one does not lead to long-term benefits like growth in profitability.
This strategy results in following price fluctuations and damages brand equity. The airline industry has fallen victim to this pricing strategy and as such has major problems with customer loyalty.
Market-driven pricing is not a good strategy for companies that desire sustainable long-term growth. With this strategy, the company loses control of its profitability, because it must always chase the current market price in order to make a sale.
With customer-driven pricing, the business puts itself in the shoes of the customer and attempts to develop a price that reflects the customer’s perceived value of the product. This strategy can be risky due to the price wars that could ensue.
However, if your segmentation and evaluation of what your customer’s value is accurate, you can see immediate growth and profitability.
There are steps that need to be taken if your business is going to turn this immediate growth into sustained, long-term growth.You will need to focus your marketing efforts on heavy promotions. It is imperative to keep your customer informed that the price they are paying is reflective of the value they are receiving.
As price wars ensue, it may become a necessary evil to offer discounts and incentives to keep current customers as well as attract new customers.
Lastly, post-purchase service can be critical to maintaining your existing customer base. It’s a lot less expensive to keep a current customer happy than to attract a new customer.
Which pricing strategy is the right strategy for your business depends on your competitive position, market dynamics and target market purchase behavior. Why not take the guesswork out of the pricing strategy equation?