Choose Your Pricing Strategy

In this series on creating a pricing strategy for your business, we have considered the foundations for developing a strategy, including your customers, competitors, and positioning.

As we conclude this series, we now look at the pricing models commonly used to determine prices and choose the best one for your business.

Pricing Models

Cost-Plus Pricing

Our last article looked at the question of Price vs. Value. However, it is also essential to know the cost.

Cost is the total sum you have spent to develop and deliver your product or service.

“Cost-Plus Pricing” involves calculating all the costs and then adding the amount you want to include as the profit.

The various costs will differ depending on the type of business you are operating. Examples include:

• Raw Materials: The materials used to manufacture the goods.
• Labor: Costs of employees and other direct labor costs to transform the raw materials into the saleable product. If you provide a service and effectively sell “time,” then the time cost needs to be accounted for.
• Tools, Software, etc.: Items such as premium software programs and physical tools are needed to develop the product.
• Overheads: This is a broader category that includes items not explicitly related to the product but more geared to the operational costs of production. These include typical overhead costs for your business such as rent, utilities, insurance, etc.

Costs fall into two categories: fixed costs and variable costs.

Fixed Costs stay the same regardless of how many products you produce. Examples are rent, utilities, and insurance.

Variable Costs change with the volume of products produced. For example, when you increase production, you need extra raw materials, maybe additional labor, and other shipping costs.

So in calculating costs, it is essential to recognize that volume has an impact because it is relatively easy to calculate the variable costs in each product; however, the proportion of fixed costs per product reduces as volume increases.

Value-Based Pricing

The Value-Based model can potentially give you excellent profits but has many subjective components that make it difficult to ascertain.

This model centers around your customers and the value they place on your product. In laymen’s terms, it all comes down to what the customer is prepared to pay for your product.

Consequently, it relies on how well you have positioned your business and products.

To some degree, each pricing model is value-based because if the price does not reflect the customers’ “perceived” value, you will not make sales.

But what makes value-based (or customer-based) pricing different is the flexibility.

In this method, you collect comprehensive information about your customers by observing their behavior (such as buying behavior or sharing their opinions online) or asking customers directly or through online surveys. The objective is to find out what they are willing to pay.

Marketers also use psychological techniques to influence the customer’s opinion of a product’s value. Penetration pricing is an example of such tactics, where a business promotes a new item at a low price to drive sales and ” penetrate” the market.

Competitor Based Pricing

The starting point for this pricing model begins by analyzing the market and your competition to find the “going rate” in the marketplace.

If competitors successfully sell similar products, their price indicates what customers are prepared to pay. This price then becomes a benchmark upon which you can base yours.

You can then consider whether to undercut their prices (although be careful about starting a price war where no one wins) or to charge higher prices with a strong focus on product value and better positioning. Higher quality, excellent customer service, faster delivery, and brand trustworthiness are just some of the value-added features that make this model work.

Service-Based Pricing

In a service business, you generally have two primary options as you are selling a combination of time and expertise.

Option 1 is an “hourly rate”. This is beneficial for the business because it guarantees that the client will meet labor costs.

Option 2 is a “project rate” where the service provider sets a price for the project, which is what the buyer pays.

Each option has plusses and minuses.

Some buyers prefer hourly rates, while others find it difficult to budget when they are unsure how long the task will take.

A “project rate” is easier for the customers as they have a fixed price. However, service providers may have to bear unexpected costs.

There can also be an issue with selling the value of a project rate. Once again, it gets down to positioning and value.

There is an old story about a patient questioning a doctor about how they could justify a $2000 fee for a half-hour operation. The doctor looked at them and replied, “$200 was for the time, and $1800 was for knowing where to cut.”

Choose Your Pricing Strategy

The strategy you adopt will usually be dictated by your business type. For example, an app developer may use an hourly rate, whereas a computer store will not.

Here’s an exercise to get the thought processes working. Consider a product you have purchased recently. Think about the price and ask yourself:

1. Why did you buy it?
2. Was the product good value?
3. What loyalty do you have to the brand?
4. What differentiates them from alternatives in relation to their pricing?
5. What learnings from this can you apply to your business?

Now ask yourself:

• What are the pros and cons of each pricing model for your business?
• Which model will help most in pricing your product or service and why?
• How will this pricing methodology empower you to meet your revenue targets?
• Finally, how will you monitor the effectiveness of your strategy?

Pricing is a continuing process. What works today may not work in 6 months. Once you set prices, continue monitoring and experimenting with adjustments.