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The Art and Science of Pricing

The Art and Science of Pricing

Pricing 101

Pricing your product, particularly when selling online or selling digital content, is both an art and a science. Too often, retailers neglect the ‘science’ and jump right into the ‘art’ of pricing. Worse yet, many retailers set their pricing strategies blindly, and the result can be catastrophic for the bottom-line.

Assigning product prices should be a deliberate, strategic exercise. The price you assign impacts how your product is perceived by consumers and determines their purchase behavior. Price is also a way to differentiate your product from your competition. Setting your prices too low will impact your profit margins while charging too much can send potential customers running to the hills or, worse yet, to your competition!

A product needs to demonstrate value, and price is one of the biggest contributing factors in doing this. If you are not showing your customers the value your product or service brings to their lives (think; benefits to the consumer!), you will not get the sale.

Here are some basic guidelines to help you set an appropriate pricing strategy

  1. KNOW THYSELF - Too often, business owners rely on their assumptions and, while well meaning, these assumptions are often clouded by their emotional investment in the business. How you want your product to be perceived, what you believe is unique about your product, and how best to convey your product’s value is not always in line with customer perceptions, beliefs, or values.
    1. Conduct surveys or focus groups to learn more about your target market’s expectations, shopping behavior, and values. Learning the answers to the following questions will help determine your pricing objectives and strategies.
      1. What mix of products are you offering? The mix of products you offer either limits or expands the pricing strategies you should employ.
      2. Who is your target market? Knowing your target market’s demographics is everything. Ex. Is your target price sensitive? How do they rate value or quality?
      3. Can you estimate the life cycle of your product? Shorter life cycles require selling greater quantities of product or creating larger profit margins than products with longer life cycles.  By contrast, longer life cycles allow for more time to achieve your pricing objective. Ex. A one-time download vs. a subscription with a continuous stream of content that your target values.
      4. Can you determine the demand for your product? High demand increases flexibility in choosing pricing strategies because customers are likely to be less sensitive about price, packaging, etc. However, determining demand for your online/digital products is challenging. The marginal cost for producing additional copies of most digital products is nearly zero but, at the same time, product lifecycles in this space tend to be shorter and purchasing decisions are influenced by many, constantly changing factors.
    2. Know your costs, fixed and variable. Know your breakeven numbers.
    Once you have a firm understanding of your product attributes and the market, move your attention towards choosing which pricing objective makes the most sense for you.

  2. SET YOUR OBJECTIVE - Pricing objectives are selected with the business and financial goals in mind and guide your choice in pricing strategy, so choose a pricing objective with careful consideration. Note: Your choice of an objective may adjust over time. As business and market conditions change, adapting your pricing objective may make sense.
    1. Some examples of pricing objectives:
      1. Partial cost recovery - If your company has sources of income other than from the sale of these digital products, you may consider implementing this pricing objective.
        Pro: This has the benefit of providing customers with a quality product at a lower cost.
        Con: Could attract unwanted attention (think; price war) from competitors.
      2. Profit margin maximization - When the total number of units sold is expected to be low, maximizing the per-unit profit margin of a product might be your objective.
      3. Profit maximization - When your objective is to obtain the greatest dollar amount in profits. (Not necessarily tied to the objective of profit margin maximization).
      4. Revenue maximization - When maximizing revenue from the sale of products is a greater focus than profit.
        Hint: Useful when introducing a new product into the market, growing market share and establishing a long-term customer base.
      5. Quality leadership - Assigning prices to your products that signal and convey product quality to the consumer.
      6. Quantity maximization - When maximizing the quantity of items sold is your primary objective.
        Hint: Useful if you have a goal of or the ability to take advantage of economies of scale.
      7. Status quo - Avoid starting a price war or maintain steady profit levels generated from a particular product by keeping prices in line with similar, competitive products on the market.
    Now that you know your pricing objective, you need to get to know your competition.

  3. ANALYZE THE COMPETITION - What are their costs, prices, offers, and product lines? How are they packaging or bundling products similar to your product mix?  Knowing how you compare to the competition is an integral part of understanding pricing. Does your competition offer higher quality products? How are they conveying value? Are their prices high or low? And, most importantly, does your customer care? (This relates back to Know Thyself- Knowing what your customer perceives and values is far more important than your assumptions or than knowing these basic facts about your competition alone).

  4. Learn the fundamentals of pricing strategies, their advantages and disadvantages. Here is a quick and dirty cheat sheet. By no means is this a comprehensive reference of all pricing strategies.
    1. Competitive pricing - Also called strategic pricing, this method involves basing your prices on the prices your competitors have on the same product(s). This strategy can be used when the pricing objective is either survival or status quo.
      1. Advantage -
        1. It is relatively simple, low risk and can be quite accurate. Prices are in line with rivals so you tend to avoid price wars.
        2. Customers see you as having similar quality product.
      2. Disadvantage -
        1. Simply copying your market’s prices leads to a lot of missed opportunities and lost profits. Your business goal should be to maximize revenue and profits; it just requires a little extra work on pricing.
        2. Can lead to tunnel vision and neglecting of critical cost factors.

    2. Cost-plus pricing - When a company adds up all costs associated with making a product, such as raw material and labor, and then adds a pre-determined percentage of profit margin to arrive at a price for a product. Note: Since digital products are made only once, but sold repeatedly, this is not the best strategy for online digital sales.
      1. Advantage -
        1. Very simple strategy to employ.
        2. Ensures the costs associated with making the product is covered, and some profit is obtained.
      2. Disadvantage -
        1. The markup number is somewhat arbitrary and ignores future demand and competitor prices.
        2. Can result in tunnel vision and cost the company in an ever-changing, competitive marketplace.

    3. PENETRATION PRICING - Penetration pricing is the strategy of initially establishing a low price for one's goods or services, with the intent of increasing market share. The strategy of penetration pricing can be used when your pricing objective is either revenue or quantity maximization.
      1. Advantage -
        1. The low prices established with a penetration pricing strategy could deter possible new entrants to the market.
        2. Could reduce competition if less financially stable competitors are driven from the market, or forced into smaller niches within the market.
      2. Disadvantage -
        1. The perceived value of the product or company could suffer. Prices that are too low create a perception among customers that the product or service is no longer as valuable, which may affect purchase behavior later, when prices increase.
        2. Competitors may respond with even lower prices, inhibiting your company from gaining any market share while, at the same time, increasing profit loss due to low market share and low prices.

    4. PRICE SKIMMING - Price skimming is the practice of selling a product at a high price, usually during the introduction of a new product when there is high demand. This strategy allows a company to recoup its investment in the product. However, the company is potentially sacrificing much higher unit sales than it might garner at a lower price point. Price skimming tends to be a short-term strategy aimed at maximizing profits because, eventually, competition will force the company to lower prices.
      1. Advantage -
        1. When price is high, large profits are made to repay development costs.
        2. A high price may help create a high-quality image (but you must deliver a high-quality product to support the image created by the price).
      2. Disadvantage -
        1. The high cost limits sales volume.
        2. A continual stream of competitors will challenge the extreme price point with lower-priced products, or superior pricing packages.

    5. LOSS LEADER - This strategy involves using lower priced products to lure customers to the business and to make further purchases.  Ex. - A yoga teacher offers an inexpensive 15-minute class download in the hopes of establishing credibility, growing market share, and, ultimately, attracting customers to her full-length, higher priced video downloads. This strategy is appropriate for either the quantity maximization or partial cost recovery pricing objectives.
      1. Advantage -
        1. Can bring in new customers and attract former customers. These offers can be impossible to resist, even for those loyal to a competing brand. If done with careful consideration to your complete financial picture, a small initial loss can lead to big profit on the back end.
      2. Disadvantage -
        1. Lack of preparation can be risky with this strategy. Have you calculated how much you need to sell at this low price point to cover development and marketing costs? Did you triple check your math before launching the low price? If your price is too low, you may not be able to recoup the money lost on the loss leader, especially if the strategy did not lead to increased sales in your other product lines.
        2. Bargain hunters abound the internet, many with no intention of repeat purchases or of buying any other products you offer.

The most important lesson about pricing your product is this: Be flexible with your pricing structure. Experiment with prices and see what works best. Due your due diligence and prepare adequately. Consistently monitor the marketplace and pricing trends in your industry and region. Pricing is not a ‘set it and forget it’ game…Realizing the importance of a good pricing strategy, and all of the factors that go into creating one, is how you win in business.