According to legend, an enthusiastic patron of the arts once approached Pablo Picasso in a restaurant. ‘Please draw me something,’ she insisted, ‘I’ll pay you whatever you want.’
Eager to continue his meal in peace, the artist drew a few lines on a napkin and handed it over.
‘That will be ten thousand dollars,’ he said. ‘Ten thousand dollars!’ the woman shrieked. ‘But it only took you twenty seconds to produce this!’ ‘No,’ Picasso replied, ‘forty years and twenty seconds.’
In his own way, what Picasso was trying to explain to his admirer is that there is a difference between price and value. A price is the amount of money charged for a product or services that consumers exchange for the benefit of acquiring a product. Value is a perception and may involve demand or additional costs that are not readily apparent (such as labor, experience, or skill; or, for paying customers, the amount of money or time involved in switching over to another product).
Historically, prices for most products were usually established through barter or negotiation. Prices therefore varied depending on the buyer’s skills. In the early part of the last century, however, some business changed this practice by adopting a strictly one-price rule in all his stores – a policy that soon spread.
Facts about Pricing
- Price is the only component of the marketing mix that produces revenue. All others represent costs.
- Price is the most flexible element of the marketing mix. Unlike the other marketing mix elements, a price can be changed quickly.
- Pricing is often the most significant factor affecting buyer choice, but it’s a double-edged sword. If a price is too high, buyers may turn away. If it’s too low, they may sense something is wrong and also turn away.
- Pricing is not often handled well. For example, if a price is cut by 10%, it may result in 50% of profits being lost.
Common Mistakes in Pricing
- Prices that are too cost-oriented (e.g.: customer value is not contemplated).
- Prices that do not reflect the current market (as above, there could be high demand or a lack of demand).
- Not taking into account the other marketing mix components (again, the perception customers have of value may not be contemplated – or perhaps it’s misjudged).
- Not varying prices according to different products, different market segments, or promotions.
- Slashing prices in the assumption that doing so will raise sales (the problem could be ineffective marketing, low perceived quality, or any number of other factors which will not be solved by changing prices).
- Raising prices to increase revenues (again, the problem may lie somewhere else – and if it does, it won’t be solved by raising prices).
Starting the Pricing Process
Before the pricing process begins, it’s necessary to consider what it is you want pricing to do for your business. The obvious answer is generating revenue, but how will this be achieved? By being more competitive? By attracting a specific clientele? By getting more customers to try a product? How about a combination of one or more of these objectives? If your business is serious about making the most of its prices, then it’s worth the time and effort to think about these questions, write them down, discuss them with colleagues, and think them over. The results can be used as a rough draft or a template for helping to set a good price.
Internal and External Factors that Affect Pricing
Consider the following when establishing a price for a product or service:
1. Internal Factors (situations or determinants inside the company). These include:
A. Marketing Objectives, which are determined by the chosen target market and its position in the overall market. Knowing what targeted customers expect in terms of price can help determine a numerical value. For example:
- Is the luxury market being sought?
- Is the economy market being sought?
- Is a survival strategy envisioned (selling below cost)?
- Will product prices be based on demand?
- Do research and development costs need to be covered?
B. The Marketing Mix Strategy coordinates a product along with its production, distribution, and promotion to form a consistent and effective marketing program. Examples include:
- Target Costing – Starts with the price the business wants to charge for a product, then works backwards (changing production processes, simplifying systems, working with outside suppliers and distributors, and deciding on a marketing campaign based on what the price of the product should be). Many small business operators do this when chasing clients. First they determine what the costs have to be to achieve the target price (based on customer demand), then they change their internal systems to meet the costs that will get them there.
- Value Pricing is when the best strategy is not to charge the lowest price, but to make the product different (or seem to be different) so that it’s worth a higher price.
C. Costs are what the product actually costs to produce (and market), which must be covered in the price. Examples include:
- Cost-Plus Pricing occurs when a standard mark-up is added after determining the fixed and variable costs of a product. This type of pricing is sometimes seen in construction companies or with lawyers, accountants and other professionals who figure their costs then add a 20-percent mark-up (or whatever percentage is deemed appropriate).
2. External Factors are situations or determinants outside the company.
A. The Market and Demand. For example:
- Pure competition – basing prices on ‘the going price’ (everybody else is doing it so we will as well)
- Oligopolistic competition – having few sellers that are highly sensitive to each other’s pricing strategies (i.e.: if one company changes its prices so will the others)
- Monopoly pricing – by being a sole supplier, the producer can price as he or she sees fit
B. Consumer Perceptions or basing prices on what customers think constitutes value (Note: This requires a firm understanding of consumer behavior).
C. Price-Demand Relationship involves setting prices according to market demand. The higher the demand, the higher the price. The lower the demand the lower the price.
D. Competitor’s Costs, Prices, and Offers include basing prices on the overall selling environment.
Summing Up Pricing
When setting prices, don’t sell your business short. According to seasoned practitioners, most businesses should think about how high they can reasonably go with their prices rather than how low while always considering what customers will perceive as fair and ethical. The most common mistake entrepreneurs (particularly service providers) make when it comes to setting prices is not charging for accumulated knowledge, time, and experience.
Advice from the Pros
- Price your products correctly the first time. It might be difficult to raise them later.
- Factor your time and skills into your prices. Don’t undercharge for your time and expertise.
- Always remain aware of your competitor’s prices, sales, and promotions.
- Try to keep your prices (and therefore your profits) as high as possible by offering additional or unique services your competitors can’t, don’t, or won’t provide.
- Remain vigilant when it comes to the prices you pay for supplies, materials, and merchandise.
- Don’t be tempted to buy cheap. As the saying goes, those that buy cheap, usually buy twice.