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The essentials of pricing strategy

Creating Pricing Strategies for Different Objectives

How much does it cost?

Price under magnifyng glass on barcodeThis is one of the first questions that customers have when they see something they like, whether 'on the high street' or in an e-commerce store. That is why if there is a key decision a business has to make, it is pricing strategy. Price will define a great proportion of your attractiveness in the eyes of the customers, your revenue, and eventually your profits.

As with other marketing areas, pricing strategies have developed considerably lately. In this article we are going to give you an overview about them and in addition, some valuable insights for applying them to accomplish your objectives.

What to think about when making pricing decisions?

As an essential marketing decision, pricing affects a lot of your company’s performance. So when you are about to set your prices, you need to first decide your objectives. They could be:

  1. Maximize profits
  2. Get cash-flow
  3. Get a return on investment
  4. Increase market share or sales volume
  5. Create an image
  6. Improve customer relationships

Each of these objectives asks for different strategies. To improve your customer relationship you have to play with promotions and deals, to maximize profits you would need to find the most efficient price level, and to increase market share you should apply a lower pricing than your competitors.

Once you have decided your objective, is time to see different pricing approaches.

The two main factors that affect pricing

Pricing is the outcome of a decision made based on two main factors: the company itself and the market.

The company factor refers to all the price influencers that come from the company’s characteristics and reality. For example, costs, product characteristics and also, the commonly forgotten company culture.

A large number of companies rely only on this factor to set their prices. Actually, in a survey conducted by PROS and the European Pricing Platform (EPP), while 55% of the respondents stated that pricing maturity is a competitive advantage, fewer than 5% said that they use advanced pricing practices in their companies.

The most prominent example of this approach of pricing is cost-based pricing. And both our experience in Prisync and the results from the survey mentioned before suggest that is the most-used pricing strategy among e-commerce companies. This is likely due to the fact that they can measure, control and know their internal data better than the data that comes from outside the company.

What is cost-based pricing?

In simple words, we can define it as measuring the costs associated with the product production or acquisition and then applying a profit margin to them. So this strategy is accurate for objective number three: Get a return on investment.

This pricing scheme has its complications, though. When you think about acquisition or production costs, you may be tempted to think about the price you paid, which of course is in the formula, but there is much more. You also need to add indirect costs. For example, you have to add the salary of your secretary that is answering phone calls from the customers and suppliers. Not 100% of it of course, just the proportion that is directly related to the specific product. Let’s look at a simple example:

Let’s say that you sell smartphones and you buy each unit for $20. You also sell tablets, and you pay $35 for each of them.  If you are trying to set the selling price for the smartphones, the tablet prices are not in the formula. However, you may buy both smartphones and tablets from the same provider, so they come in the same trailer for delivery. If you have to pay $1.000 for delivery, how much of this corresponds with a single smartphone? If you fill 50% of the trailer with smartphones, it is easy to do the math: $500 divided by the total number of smartphones you bought is the amount to add to the initial cost of $20. The same thing happens with the other costs: workers’ salary, electricity, marketing, etc. Measuring the costs is easy, but deciding what proportion of each of them pertains to each kind of product is not.

Once you have solved this, you just need to apply your desired profit margin to the result. In our example, let’s say that after all the measures and calculations you finally get a unit price for each smartphone of $30. If you want a profit margin of 50%, then the price should be $45. Some businesses prefer to set a cost-plus strategy, which has the same base, but instead of adding a percentage to the cost they add a fixed amount.

My advice here is that when using this scope, don’t stop with the most obviously related cost; try to add everything needed, even if it is not so directly related. This will end in a much better and realistic decision.

What the market has to say about the cost-based pricing approach

The cost-based pricing approach has a great attractiveness because of two powerful reasons:

  1. You have all the information needed in your company accountability books.
  2. It is rational and objective.

Sadly, this doesn’t mean that it is good. The main issue with it is that it doesn’t take into consideration what your competitors are doing. And that is something your customers will do for sure. Thanks to price comparison engines, customers can check the prices of hundreds or even thousands of online businesses. Recent research by Accenture shows that

  • 67% of Americans say they will buy products from different e-commerce websites to get the lowest price and
  • 72% say that in the last year they were attracted to buy from new websites they hadn’t used before by promotions. 

In other words, when it comes to pricing you need to take into consideration the market factor or what is the same, what your competitors are doing at the current moment.

Some approaches that have competitors in mind to set pricing

Then, let’s see what you can do to add your competitors’ activities to your pricing decision.

Price skimming

One of the most basic pricing approaches to take into consideration what is happening outside the company is price skimming. This strategy is based on product lifecycles theory and would be accurate the objective one: maximize profits.

The idea is simple: When the product is new it should have a high price, and as the product becomes more familiar and common for customers, its price should be reduced. Lifecycle theory combined with price skimming assumes that a new product should have a high price, because since the product is new, there won’t be many opportunities to purchase it. With time, the product achieves maturity, which means that companies can produce it in a vast amount. As a result, customers have a lot of options to buy the product and they can choose the best price, which makes prices go lower.

Basically we can see this strategy with smartphones and many other electronic tools that get outdated with time. This strategy takes the market into consideration, but in a too-general way. The failure of this theory is the speed at which things change these days. While lifecycle could take years in the past, now it could take just some months. We are facing the customization era, and if you want to be serious about pricing, you can’t just rely on the most convenient way.

So, what you can do for that is take the lifecycle logic into a more specific scope. This is what the next strategy does.

Competitors’ assortment

Then, what we are going to do is move our price according to product availability in every specific moment and not according to its lifecycle. This strategy is good for the objective one: maximize profits, but also for number four: increase market share or sales volume.

But how can you measure the availability of a product? The answer is technology. There are price tracking softwares commonly used by category managers and owners of SMEs that allow you to monitor stock availability.

Once you have that under control, you can raise the price of your product when the market is out of stock and lower it when there are a lot of products offered. However, many business owners are afraid to raise the prices. If this is your case, you may prefer to take the opposite decision. When there is not much supply of your products, you can offer a deal and complement it with a good advertising campaign. This will help you to appear in the top results when users use a price comparison engine and therefore to get more visitors and sales.

Competitors’ prices

Another option that a competitor price tracking software gives to you is moving your prices in reaction to your competitors’ movements. Here you have two options:

Price lining

In this option, you have to decide where you want to be in the market. Do you want to be in the lowest range of prices or the highest? The point here is that all your products will be in the same range. So if you decide to be the best pricing offer for category “A”, you will also do it for the other categories of products.

The advantage of this option is that you can run a general marketing campaign to position your brand. For instance Media Markt and its “Hey, I’m not stupid” is an example of low pricing lining.

Each product with its specificities

The other option is to adapt the strategy for each product. You may decide to have the lowest prices in some key products to attract customers and higher prices for other products.

Actually, the most common strategy is to combine both, by using pricing lining for key categories, not just for single products, but developing different strategies for the rest of the product offer. In any case, failing to consider competitors’ prices is a kind of marketing suicide for any business no matter its size (remember the survey of Accenture).

Pricing to improve the relationship with your customers

Let’s go with objective number 6: Improve customer relationships. People love to feel special, so if you offer them something customized, they will like you more.

Loyalty programs and personalized deals are a great way to improve your relationship with your customers. And now with the great power of remarketing, thanks to internet cookies, you can do a lot of things. Here you have some examples:

  1. Have you experienced the bad feeling of a customer abandoning your shopping cart? Send him an email with a deal for the specific products he had in the cart when he left.
  2. Have you noticed that your competitors raised their prices? Let your customers know it, and show them you are offering the best buying opportunity.
  3. Offering the best prices and discounts for returning customers will show them you value your relationship and will entice them to buy more.

Summarizing, you can make your prices a game to engage your customers with your business. They will love you, because you will allow them to feel smart buying things for less than what their friends are paying.

Pricing to create an image

Lastly, we have objective 5: create an image. If you are a luxury brand, you can’t play with your prices making deals. Quite the opposite, you have to make your price give value to your product. A high price will show a trustworthy and premium brand, though only a very specific segment of the market will buy it.

Even in this case, you need to know what your competitors are doing. If you are a high-priced brand, you should raise your prices when your competitors do and you need to know how high your price can be to still be attractive to your premium customers. Even rich people don’t like to feel cheated.

Conclusion: You need to be aware of what is happening in the market

Setting objectives is mandatory to avoid making random decisions or ones based on guesswork. After that, no matter what your objective is you need to think about your costs, since they will set some limits you can’t pass. But you can’t stop there. You also need to be aware of the prices of your competitors in your categories of products. With all that information, you can combine the strategies in this article.

My last tip is using trial and error. Try things, repeat what works well and avoid what doesn’t.  That way you will achieve excellence in your pricing decisions.

If you read the full article and would like to have more information related to competitive pricing intelligence, you can also check this ebook that Prisync have prepared.

By Robert Allen

I am the Editor of Smart Insights. I manage the Smart Insights blog and write on a range of subjects- Marketing Technology trends and latest tech developments are a regular focus, as well as exploring key marketing concepts. You can get in touch with me on Twitter and connect with me on LinkedIn.

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