Want A Thriving Business? Focus On Pricing Methods!

On its own, opting for a pricing method to follow your business strategy is equally difficult and important task. After all, it’s part art, part science. Deciding on the amount you want to charge your customers for your products is a huge step to setting your pricing strategy in the long run. There is no sure-fire way to determine the best pricing strategy for each business but there are some pricing methods and guidelines, which we hope to present with this post, that will ultimately help you make an informed decision because we’re like that, we like to help. Here we go.

Pricing methods can be divided into two major groups:

  • Cost-oriented methods
  • Market-oriented methods

Each group consists of several pricing methods which we’ll present further down.

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Classification of pricing methods

Cost-oriented pricing methods

This is where the cost acts as a basis for determining the price of the final product. The main advantage of these methods is that the prices cover all the costs and directly add to profit. On the other hand, the don’t take into consideration market factors like competition, demand and consumers’ perceived value.

Cost-oriented pricing methods include the following ways of pricing:

  1. Cost-plus pricing

In what is probably the simplest pricing method, a company adds a markup percentage to the overall production costs and thus forms the price. The markup is the profit percentage calculated on total cost. For instance, if the cost of the product is $10 and the company expects a 10 percent profit, then the selling price will be $11.

  1. Markup pricing

Similar to cost-plus pricing, the markup is calculated as a percentage of the selling price and not the cost price. If the cost of the product is $10 and the company wants to earn the markup of 20 percent on sales, the price is calculated with the following equation:

Price = product cost / 1 – markup

which in our case is:

Price = 10 / 1 – 0.20 = 12.5

Hence, the company will set the price at $12.5 and earn a profit of $2.5 per product.

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  1. Target-return pricing

This pricing method focuses on the required ROI rate from the sales of goods. Let’s say that a business invested a $100,000 and expects a 20 percent ROI ($20,000). The target-return price is calculated like this:

Target-return price = product cost + (desired return x capital invested) / unit sales

Based on the previous example and calculating 10000 unit sales, that would translate to:

Target-return price = 10 + (0.20 x 100000) / 10000 = 12

developing-pricing-strategies

Graphical representation of target-return pricing formula (Image Source)   

This concludes the overview of cost-oriented pricing methods. Let’s move on to the second group.

Market-oriented pricing methods

As the name cunningly suggests, the price using these methods is calculated on different market conditions. Market-oriented pricing presents a more accurate and effective market price representation and “speaks” directly to customers. However, it requires a much-desired market research in order to establish the market factors as guides to successful pricing.

  1. Perceived value pricing

In this case, a business, more than anything, sets the price based on the customer’s perception of its offering. This pricing method accounts all the other elements of marketing mix (product, place, promotion) to influence the customers. As an example, a customer buys a more expensive product such as Apple’s iPhone despite having lower-priced smartphones available in the market. The reason for such decision lies in Apple alignment with perceived value pricing where the customer has no problem paying extra for better quality and durability or perhaps for the status symbol.

  1. Value pricing

The basic principle here is providing low priced products with high-quality levels. Even though the price is low, it is set accordingly to minimize the cost of production while preserving quality at the same time. A good example would be Tata Motors, whose Tata Nano was designed with only the necessary features at a low price while retaining quality.

  1. Going-rate pricing

This one is pretty simple (yay!) – a business takes into account the prices of its direct competition and uses them as a basis for its own prices. Going-rate pricing can be divided into three subgroups:

  • Parity pricing – the price is the same price as that of the biggest competitor;
  • Premium pricing – the price is a little higher, usually accounting the fact the product has additional features unlike competitor’s product;
  • Discount pricing – the price is a little lower if the product lacks features that competitor’s product has.

This pricing method is one of the more popular with homogeneous goods like steel, paper, fertilizer, etc. (products with less variations in features) as it provides a good chance for a business to get a fair return on their prices by charging the same prices as competition.

  1. Auction type pricing

The most popular modern example of auction type pricing is eBay who provides a platform for its customers to both buy and sell. Usually, there are three types of auctions (interestingly enough, country-related in name):

  • English auctions – there is only one seller with many buyers who bid on the item until the best price is reached;
  • Dutch auctions – either one seller and many buyers or one buyer and many sellers, with the process backwards to English auctions in the first case as the top price is first announced and then slowly lowering in bidding or the buyer announcing the product he wishes to buy and then the sellers bidding their best offers to him;
  • Sealed-bid auctions – common for large orders or contracts, particularly in the industrial and government departments, where companies submit their bids in sealed envelopes in response to a tender, not disclosing the bid to anyone.
  1. Differential pricing

Differential pricing is used in cases where companies charge different prices to a different group of customers for the same product or service. This pricing method depends on factors such as place, time and product form, thus varying in offering. An example would be a 0.33 can of Coca-Cola which has different prices in grocery stores, public stations, and especially hotel rooms with their super-pricy minibars.

price differentiation

An example of differential pricing based on a 0.33 can of Coca-Cola (Image source: SlideShare)

Conclusion

Pricing methods present a way to determine a price of your offering by accounting factors various like the costs, the product itself, competition, target audience, their perceived value, product’s life cycle and so on, having a great deal of impact on the pricing strategy as a whole. When it comes to pricing methods, a business has its pick of the litter. As evidenced, there is a variety of options for selecting a pricing method that best suits the needs of a thriving business. Hence, it can adopt any of mentioned pricing methods depending on the type of a product it sells and the end goal objective for which a business is determining the pricing.

If you found this useful and you’d like to learn how to take your pricing strategy to the next level, we invite you to download our free 20 secrets to designing the best pricing strategy eBook. Click below to take advantage of this opportunity.

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What You Should Have Asked Your Teachers About Pricing Policies In Marketing

Pricing is considered one of the four basic elements of the marketing mix, together with product, place, and promotion. It is probably the least attractive element of the four in terms of marketing. The bulk of the marketing efforts goes to product and promotion before turning to pricing. However, the price is a rather flexible element of the mix and this post will show how.

We have already established that pricing policy is very important for a business that aims to gain success by finding the somewhat mythical price point where sales and profits enjoy maximum levels. A business might employ a variety of pricing policies and strategies, depending on its vision of marketing objectives and goals. It often seems like marketers have a nasty habit of underestimating the strategic importance of pricing. Those are probably the ones who missed the point (or a whole class) about pricing so they don’t perform revenue potential optimization. No worries, we are here to remedy that oversight. Here are some of the question you should have asked your teacher:

1. What pricing policy is best for marketing?

There is a no clear cut answer here as every business is unique. A pricing policy is set to reflect a part of a larger business strategy, accounting the principal market indicators like customer demand, supply, the profitability of products and so on. Pricing policy serves as a beacon for setting prices your customers can afford, not marketing it to them as something set in stone from the get-go.

2. What about my product?

Setting an adequate pricing policy requires serious market research and evaluation. Also, it must go in line with your overall business strategy and reflect the supply and demand relationship. Having a too low or too high price can hurt your business and your product equally. Here’s how:

  • If you set a price too low, potential customers might perceive it as an inferior quality, cheap product. This is fine if you are aiming to cover your costs and get a minimal profit margin. In that case, a cost-based pricing policy can do the trick as it will cover all production and delivery costs while attaining a certain level of profit. However, you lose any perceived value with your customers and potentially lose money in the long run.
  • If you set your prices too high, you might give off a feel of a high-end, prestige brand. This is a risky ploy as it should be guided by a demand-based policy, meaning there is a demand for your product at the price you are selling. Utilizing this pricing policy requires a comprehensive market research, best provided by intelligence tools with real-time insights. Otherwise, your product will be labeled as expensive and won’t sell.

The middle ground here is to evaluate the unique aspects of your offering and the consumer’s bond with it. That way, you are creating a perceived value for your customers and increasing their satisfaction. Once more, a company opting for value-based pricing needs to perform an extensive market research (really, it’s an essential part of modern business undertaking) to underline the value of your offering and thus motivate your customers to pay what you want as you’ve modeled your goods on what they want. An example would be car dealers who charge different customers and in a different situation.

Alternatively, you can opt for competition-based pricing whereas you assess your own goods, compare it your competition and then price it lower, higher or equal. It’s quick and relatively easy to implement with less market research, but it’s not quite accurate in terms of demand and your value.

3. Is there more than one market segment?

Of course and it’d be foolish not to use it to your advantage. Determining both primary and secondary market segments allows you to better understand how customers perceive your product’s value. Not every customer is the same and will not pay the same. Market segments are important for your company’s positioning and merchandising your goods to provide maximum sales at the established price points. Once again, this is where research about demand kicks in as you can fully use it to uncover where your potential customers are ready to pay more than usual.

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4. Why does the pricing of my competition matter?

It’s perfectly fine that you want to be your own self, irrelevant of others. Nevertheless, what your competition charges matters in multiple ways:

  • You can base your whole pricing policy on the competition;
  • It affects your customers as the competition might define your price range;
  • It opens new opportunities for you.

Let’s say you are entering a market with a new product or a new market in general. One of the ways to price your product is to employ penetration pricing. This allows you to present prices with a steep discount, maybe even with a loss, all in hope to create brand loyalty and increase the willingness of your customers to spend more in the future. But how do you know if you can compete, you are not losing money right from the start by lowering prices too much?

It is tempting to price higher than your competition and certainly justified if there is a demand for it or if your product or brand is perceived significantly better. However, it a tough feat to accomplish. Let’s not forget that Apple spent almost all of the 90’s decade soul searching before it established itself as one of the tech leaders it is today, delivering high prices on quality-perceived products.

You can also price on parity if your offering product has better features or price lower if it has almost the same features to competing products. The key to competitive pricing is attaining insight from this detailed analyses that show how customers perceive and interact with your product so you can understand how they relate to it. This also includes analyzing thousands of competing products and how your competition reacts to you in order to package and promote your goods based on effective pricing.

Conclusion

As seen, pricing is an equally important part of the marketing mix as the rest of the elements. It can be rather tricky, but whatever you do in your marketing efforts, make sure you base your decisions on knowledgeable insights. It’s critical to know and monitor the market and your competition (especially their pricing) at all times in order to reassess pricing if necessary and stay ahead. There are tools that can help you optimize your prices. Market fluctuations and new products have the power to influence and change consumer demands and needs. Be the one that influences them.

If you found this useful and you’d like to learn how to take your pricing strategy to the next level, we invite you to download our free 20 secrets to designing the best pricing strategy eBook. Click below to take advantage of this opportunity.

I'd like a FREE copy