We have a treat for you today. It’s a guest post from the highly respected global expert on customer centricity, Alan Hale of Chicago.
He writes about the importance of getting pricing right and generously shares twenty-four (!) factors to consider when pricing your product, service or solution.
Over the past several decades, I have managed over 250 projects, and am currently serving as the President of Consight Marketing Group. During that time, I have noticed that some of these clients experienced customer erosion or profit sub-optimization due to poor pricing practices. The following article discusses some of the issues seen, as well as other pricing challenges described in other marketing journals and textbooks.
- Pricing needs to cover your costs. Pricing needs to cover COGS (cost of goods sold), and contribute towards an allocation of fixed costs like rent, utilities as well as profit. Selling a high volume of products does not guarantee a profit. “We will make it up in volume” does not make sense.
- It is related to capacity, the economic supply and demand. If you have strained capacity like oil pipelines, prices are substantially raised. Conversely, if a contractor has no backlog, they might be willing to discount prices. For you econ majors, it is the intersection of the Marginal Revenue and Marginal Cost curves.
- Price according to the Market Lifecycle. Early adopters in the growth stage pay more than laggards in a mature or declining market. A major computer manufacturer used to price their line of PCs 10% higher than the competition due to their brand, perceived status and support. As PCs became more commoditized, the pricing premium came down. If you have a well-known brand name with a high amount of loyalty, you can charge a premium. If it is a mature/commodity item it is difficult to charge more. Would you pay 50 cents more for a pack of nails on the retail shelf?
- Price insensitivity is positively correlated with ROI. Cost is not as important in the business arena if there is a high ROI. Look at ERP (Enterprise Resource Planning) systems that can cost millions upfront over the first few years with consultants and implementation. But it saves the organization tens of millions over many years.
- Pricing depends on the amount of the cost of the components versus the total cost of the product. Bottling companies fill bottles with cola or other liquids. These polypropylene bottles are significant to the costs, and contract prices are negotiated heavily every year or contract period.
- Pricing is dependent on selling to the MRO (maintenance repair and operations) channel or OEM (original equipment manufacturer). Because of volume OEM’s can demand much lower pricing. Car manufacturers can buy tires at a much lower price than the customer off the street for example.
- Pricing is related to value. I have been privy to many research and consulting proposals. Some companies do a cost-plus calculation, the labour will cost so many hours, at an average cost plus markup for profit is the price for the proposal. Others price it as a statement of value. If a firm can help the client go to market quicker, the firm gets profits earlier. Another example is a carton supplier who was constantly losing bids. They did not want to lower their prices, so they started working with the engineers early on NPD and found their success rate much higher. They are now the default carton supplier.
- The pricing depends on the importance of the need. A gear for an assembly line could have a value of $500. If the line stops, and there is no local supply of the replacement part, the value jumps to $5000 if a rep has to fly across the country to deliver it so the line can be restarted. In comparison, I remember a few years ago getting a call from a long-distance phone company: “We can save you 50%” they told me. I said I was not interested, as it wasn’t worth any mindshare to investigate. As a friend of mine said, you don’t shop for prices of ambulances when you are having a heart attack.
- Price is associated with risk. Years ago we had a client selling new road construction materials to civil engineers to be included in the specifications. It would have saved them money, but they did not care. There was too much risk in switching to a new vendor, who did not have 30 years of freeze-thaw data. Years ago people bought IBM for their organisations because there was too much risk in switching if something went wrong. If there was a serious issue, they would be fired.
- Pricing varies by application. You can go into a convenience store and look for a cola. There is one price for the warm cola on the shelf, one price as a fountain drink, and one for a cold bottle in the cooler. Distributors selling industrial products may be priced higher due to convenience, they can provide the product to you almost immediately. A product can have different prices for different applications. Think of insulin for humans and insulin for dogs or cats.
- Pricing can be deployed in good, better, best strategies. You can have multiple products and price points to surround the competitor’s product offerings. Many companies use a good, better, best product offering with different price points.
- New product pricing. For new products, you can have a skim strategy or a saturation/penetration strategy. A skim strategy starts with a high price, then comes down over time. Think of flat-screen colour TVs. At one time they cost over $4,000. Now you can get many models for under $1,000. Conversely, look at some free apps in the Apple Store. They make money other ways through in-app purchases, so they want everyone to download their app.
- Pricing (cost) is a factor in getting competitive users to switch to your brand. We use a formula to determine value to a customer or prospect: Value = B/(C plus risk) or Value equals benefits/(costs plus risks). A customer will typically not switch vendors for a “me too” supplier unless there is value to doing so. Cost is just one factor in the equation.
- The pricing must be consistent with your brand image. Rolex has one image, Timex another. Lexus has one, so does a Honda Civic. You can buy a Rolex, you can buy a Timex, but you can’t buy a Rolex at a Timex price. If Rolex was offered for a low price, you would think it was stolen or counterfeit. Look at McKinsey consulting company and the way they charge. Make sure your pricing matches your image. Industrial packaging is viewed as a commodity cost that the manufacturer tries to keep reducing in order to make a profit. Conversely, a CPG company making high-end cosmetics relies on packaging to relay a high-end brand image and does not assess costs in detail. $20 of product costs might be carton packaging, and the bottle and closure maybe $2 each. Look at the blue box Tiffany uses. It is almost as important as the product itself unless it is an engagement ring.
- Pricing depends on the amount of loyalty and enthusiasm of their followers. Apple gets a very high price premium for its phones and computers. Most customers do not care, although some do. They want the newest product. $1,000 for a smartphone, many will say yes. People are lining up to buy Tesla cars. This is one of the reasons you need to create Raving Fans.
- Pricing must be consistent with the channel. A low priced merchandise item may fit a Target supermarket but won’t fit Nordstrom, a high-end department store. Conversely, designer clothes, in general, do not fit Target. There are a few exceptions to this channel image rule of course; for example, DSW (Discount Shoe Warehouse) has designer shoes, but usually from many seasons ago.
- Price should factor in after-sale consumables. My favourite pricing example is Gillette with new razors introduced to the market. They used to send you a free razor knowing that the profits for weekly razor blades would more than pay for the cost of the razor over time. Blades from Gillette would only fit that brand of razor. Printer manufacturers use a similar tactic, except they won’t sell for free. They sell the equipment for $50 to $100 knowing that the purchases of the consumable ink cartridges drive the profits. The objective is to get the product into the hand of the consumer.
- Pricing should be heavily influenced by the Customer life cycle profit over time. I am doing work for a subscription company. When we looked at the data, the customers renewed monthly subscription orders over 90% of the time. Knowing this, we wanted to get more new customers. So we set up a promotional program for the first month where the consumer would buy one product and get one free. This way more customers signed up. While this is more promotion-related, it does tie into price.
- Consumer price points. Consumer pricing sometimes has price points i.e. pen at $1.99, not $2.00. This used to be widely utilized in retail channels, although there is less use today. The thinking was the consumer would think the product was around a dollar rather than $2.
- Business price bands. In business, I believe, there are no price points. There are price bands. I have seen that research proposal sign-offs vary by the price point. An example: projects $10k and under might be signed off by research managers. Up to $25k signed off by the Vice President of Marketing. $50k and up by senior management.
- Pricing can be itemized or bundled. When contractors come into your house, they generally do not itemize their bills. If they do itemize, it is generally materials and labour. Bundling price and service for a new price point are utilized so competitors cannot easily duplicate. A maker of steam traps has higher-priced steam trap products bundled with service. They conduct an energy audit and recommend traps that need replacing, as well as how to optimize the efficiency of the overall system. They are adding value by bundling a value-added service. The competitors are just selling commodity steam traps.
- Consider instalment pricing. Customers view instalments at a lower price rather than adding up the price of all the instalments. When the price point might be too high, think about using instalment plans. Consumer marketing utilizes this concept frequently. QVC the online shopping channel is a master of installation payments. Say a product is $120 list price which is a lot for many consumers. If there are three payments of $39 each, that doesn’t sound as much. And then they use time pressure so people don’t think too much, saying “Call now as the promotion will expire in 30 minutes.”
- Factor in rebates when looking at pricing. Rebates are used for consumers to be redeemed by mail, or at the cash register to influence point of purchase. It really is for the transaction. For B2B it is used generally to try to increase purchases over time. Distributors sometime get rebates when they hit a certain sales volume. Contractors may get rebates as well, to purchase the product and pull the brand through the channel.
- Find innovative ways of pricing. Sometimes it is better to charge the company a percentage of the savings instead of billing them a price. Performance contracting does a lot of this for lighting and energy. It offers the advantages of not adding to the capital or operating budget, and pays for itself. Of the savings, the contractor gets 50% and the customer gets 50%. Another example of creative pricing is a bus stop shelter company, JC Decaux which does not charge the city anything for installing them. They get the revenue from advertising.
If nothing else, please remember that pricing is complicated. It is part of the 4P’s of marketing. Product, Pricing, Place (channels) and Promotion. It is more than just crunching numbers. There are some sophisticated tools out there like conjoint analysis which can determine the optimal price point to maximize your profit, but these other issues should be taken into account as well.
I hope this article has provided some new ways to look at pricing. We wish you much success in your pricing practices.
If you have any VOC research needs coming up in the B2B arena, please call me, Alan Hale at 847-800-1685 or email him at: [email protected] to see if we can add value. Our web site is: www.consightmarketinggroup.com