Posted: Wed 29th Mar 2023
Given that profit is more sensitive to price than any other factor, it is no surprise it is a subject of great interest to business owners.
In this blog we explore different approaches to pricing:
Pricing as product
We argue that each has its place but that the concept of pricing as product is the most important of the four.
This is the most traditional and commonly understood approach to pricing. Here, the business owner adds a percentage to the cost of what is being sold.
Generally, the percentage applied is calculated to ensure that overheads are met and a profit is generated.
The biggest problem with the approach is that it doesn’t give the business owner any guidance on the percentage to apply. There may be industry norms but this might not take into account a myriad of circumstances that could be individual to the business about the product or service.
The percentage that will deliver profit will also change depending on the business’s stage of development and in different phases of investment cycles.
The most useful application we have seen of cost-plus pricing is where a business hits a certain scale and its business model is clear, it is useful to set minimum prices for particular products or services.
Here, the cost of what is being provided is not important. Instead, the business owner is focused on the value to the consumer.
If a business coach promises to double your revenue, does it matter that it takes them one day or five days to deliver their service? Under value pricing, I should charge based on the result not what it costs me to deliver the result.
One great strength of value pricing is that it orientates the consumer to the value of what they are buying. In doing so, they are likely to get more from it. At the purest level, the salesperson will explore the value of the sale to the consumer and price accordingly.
Its weakness is that it is hard to implement and very hard to standardise.
That said, finding some way to charge according to the different values different consumers will place on a product at different times and circumstances is commonplace in many businesses as we can see with differentiated pricing.
The value of a product or service is clearly different to different people at different times. A good example is found with ticket prices for events. The last ticket available for Glastonbury is worth a lot more than the first.
Many businesses find ways to take advantage of this phenomenon. Common practices include:
Pricing by age or stage of life, e.g. discounts for students and pensioners
Early bird discounts and peak time premiums
Premium vs economy packages
Trade-ins, which are often more about incentivising with less need for a product to buy something new
Set menu vs a la carte
In fact, the ways for differentiating on price are only limited by the business owner's creativity.
Pricing as product
Of all the approaches, the one we like best is to see the pricing as part of the product.
Here the argument goes that in all markets there are usually three price points that consumers can choose from: premium, mid-range and economy. It is then argued that generally, consumers know which one they are looking for and that sales are facilitated when the price, the quality of the product, the packaging and the service standards align.
If the price does not align with the product, packaging or service, the customer is left confused and does not buy. If you go to buy a Rolex watch and it is cheap you may not trust the quality. If Lidl upgraded the shopping experience to be similar to Harrods it could put off its clientele even if the products and pricing stayed the same.
Once you have decided which market you want to appeal to, you must then tailor the business accordingly. As we know both Rolex and Lidl are successful and profitable brands.
Most businesses will use each approach at some point. They might use cost-price to make sure they don’t lose money on any particular product, value pricing when possible, and differentiated pricing to take advantage of particular opportunities.
However, we would advise all businesses to make pricing as product a guiding star. Choosing the market you want to trade in is fundamental and the price is the clearest indicator you can give to customers as to whether your product is for them.
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