How to Price

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Have you ever heard a customer or a salesman say that your prices are too low? All the pressure is to lower prices. But the road to profit is higher prices. So how do you price? There are three basic ways to price:

Cost plus

Add a margin to your basic (variable) costs and hope to make enough to cover you fixed costs and leave a profit. Very often this leads to underpricing, and low to no profit. A variation of cost plus is return on capital: this is used by regulators of utilities, normally with catastrophic effect.

Price to competition

Typically this is called “follow my leader”. Follow the market leader’s pricing and add a premium or a discount according to where your product stands. The problem with this is that the market leader always wins: they have more volume and will make more money than you do on your lower volumes.

Price to value

The customer has no interest in how much it costs you to produce your product or service. If you offer £100 of value and it costs you only £1 to deliver it, then the customer will still be happy if you charge £50 or even more. Your major constraint is competition.

How to raise the achieved price

  • Most organisations have a natural tendency to underprice: this shows a lack of confidence in the value that the firm offers in the market place, and has to be challenged. In practice, you have a range of options for raising the achieved price:
  • The pricing ladder: the basic price is low, but the extras add up. So your flight costs £5, but then there is the booking charge, the seat reservation charge, the luggage charge, the check in charge, the inflight services charges, taxes and suddenly you have charged a fortune for your “bargain” flight. You can see pricing ladders at work in the selling of PCs and autos, which always seem to come with costly but attractive extras.
  • The price anchor. Set a very high nominal price, then discount heavily against it. This is how wine and furniture is always being sold at 40% or 50% discounts. The retailer establishes a high price expecting no sales at that level, then they offer a “bargain sale” where they sell their products at a good margin.
  • The bait and catch. Offer a low introductory price and once the customer is hooked, revert to “Normal” pricing. You see this in phone packages, but also in business to business where consultants and contractors may offer to do the specifications and initial work cheaply or even free: by the time they have finished you are hooked and can not escape.
  • The price jumble, which is a variation on the pricing ladder. Make your pricing so complicated that anyone trying to compare packages loses the will to live: think of mobile phone deals. There will always be some element of the jumble you can highlight as being top value.
  • The unique package. The more standardised your market becomes, the harder it is to raise prices. So seek differentiation. Change the size of your packs; change the form of your product; change the service and terms. Be different, create multiple price points and choice.

How not to price

  • Listen to salesmen: they always want a lower price.
  • Listen to customers: they say they want lower price, but often they other things such as service are more important and they are prepared to pay for it.
  • Keep on discounting with special offers: you will educate your customers only to buy when you are on special offer
  • Think in terms of “the price”: a single point pricing scheme is too simple for competitors to beat and for customers to compare. You need to be creative in how you price.

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