Your pricing objective sets the foundation for your pricing strategy and can be a deciding factor between business failure and success.The price you choose impacts more than just how much money you make or whether are competitive with the market. Rather than thinking about pricing as a sporadic, one-off process, ensure your prices are set iteratively to help you reach your changing goals. Show
What are Pricing Objectives?Pricing objectives are the goals that drive how you price your offerings. For every business goal you have, there should be a pricing objective and strategy to help you achieve it. Remember that incorrectly mixing pricing objectives and strategies may cause contradictions that prevent you from achieving your business goals, so always ensure they are closely matched. While profit is the most common pricing objective (and rightly so), there are more nuanced objectives that every business should consider. At Revenue Management Labs, we emphasize using the Balanced Revenue Management Framework when setting your pricing objectives. The Framework helps to establish objectives that consider the perspectives and needs of your entire organization. More specifically, The Framework calls for the balance between Sales, Finance, and Marketing. Based on the three pillars of The Framework, some potential sales-oriented pricing and marketing price objectives include: 1. Gaining volume: Sales Oriented Pricing 2. Growing market share: Sales Oriented Pricing 3. Increasing revenue/margin dollars: Financial Price Objective 4. Capturing value: Marketing Price Objective Let’s go through each in more detail to help you understand which pricing objective is best for your business. Sales Oriented Pricing ObjectivesHow to Gain Volume With Your Pricing StrategySome companies base their pricing strategy on maximizing sales by strategically setting prices to promote immediate growth. This is most common for established companies who already have a piece of the market. Their focus is primarily centered around improving overall sales, which directly impacts profit. As such, they utilize volume pricing to achieve such goals. Volume pricing at its core is a strategy that accounts for discounts when large quantities are purchased. The larger the order, the larger the discount. The rationale is that the company expects the lower price to make up the difference with a higher sales volume. Volume pricing can be beneficial because it requires companies to establish large-scale infrastructure to support the large purchase sizes, which can help reinforce a company’s brand and strengthen customer loyalty. Therefore, volume pricing tends to work better for larger incumbents in the market because they have the scale and operational capacity to fulfill large orders. These traits also help offset the company’s fixed costs. For example, if a company can produce one million widgets but only sell 500,000, they can drive efficiency in fixed costs by selling another 500,000 widgets. Grow Your Market Share With Sales Oriented Pricing ObjectivesA market penetration strategy focuses on getting a foothold in a competitive market by maximizing product adoption. Companies usually set a lower initial price (or if you are a XaaS business, offer a freemium option) to encourage more customers to try their offering. Then, once customers become loyal users, they increase monetization opportunities later through upsells or expansion revenue. You can experiment with many pricing elements, such as money-back guarantees or free value-add services to help maximize adoption. However, this strategy can be risky for businesses if customers get accustomed to the lower price. Any mention of price increases will be met with heavy pushback. To overcome this, ensure your products offer quality or uniqueness that your competitors do not. Doing so will make it easier to convince customers to buy from you – even if at a higher price point. Check out our article on overcoming customer objections to learn more! Note that with these sales-related pricing objectives, you need to consider the industry you are in before choosing between growing market share/volume. For industries that are declining (e.g. Beer, Tobacco), lowering your price will not drive volume since the size of the pie is shrinking. What lowering price will do, however, is allow you to fight for the remaining market share. In contrast, if your business is in a trending market (e.g. organic or natural products), lowering the price can move lots of volume. Why? Because the market is still growing and new customers are entering the market, looking to find the best deal. In this situation, pricing has greater leverage in convincing people to try your offering. Unfortunately, lowering prices only work if you can afford to live on margin, so I recommend exhausting every other option before using this strategy. Further, extended periods of low prices may eventually result in a price war between competitors where no one is able to make money, so utilize low prices at your own risk. Profit-Oriented Pricing ObjectiveIncrease Revenue & Margin With Pricing ObjectivesThe goal of profit-oriented pricing is to maximize the margin of each sale as well as the long-term profitability of the business. That is, make as much money as possible for as long as possible. Most businesses take two paths to maximize profit – they either raise prices to increase their top-line revenue or reduce costs to increase bottom-line profit. Before choosing your path, make sure you understand who your customers are. For example, if you are a software company, increasing your price to attract high-end buyers may not be a worthwhile endeavor if you find the cost of acquisition and churn rates are greater compared to middle-class buyers. Further, understand that maximizing profit and maximizing revenue are two completely different things depending on what you want to accomplish. Returning to the software company example, say your platform scales with every new customer. In this situation, focusing on revenue rather than profit is better because there are no variable costs associated with additional customers. Compare this to a company selling cereal, where there is an added variable cost every time you sell your product. In this case, you should focus on the bottom line. All this to say, be sure to consider all the fixed and variable costs within your business before determining which financial objective to pursue. Marketing Based Price ObjectiveHow to Capture Value With Pricing ObjectivesCustomers should be central to every business decision and pricing is no exception. Your prices should be set high enough that customers value your product and continue using it, but low enough that you are not turning off your target customers with high and sticky prices. To hit this sweet spot, utilize value-based pricing, a strategy of setting prices based on how much the customer believes your offering is worth. Value-based pricing requires customer data as well as an understanding of the relative value of your offerings. You will also need to analyze the competition because once you have the data, you want to know the other options customers have open to them. At RML, we help companies succeed in value pricing by building the following organizational capabilities:
Contact RML to Learn More About Pricing StrategiesWith so many pricing objectives to choose from, what is the optimal number? Every business is different, so the number of pricing objectives will vary. However, I suggest having more than one objective. Ideally, you want a mix of objectives that address each pillar of the Balanced Revenue Management Framework (Sales, Marketing, Finance) discussed earlier. If you would like Revenue Management Labs to help you determine which pricing objectives to pursue and how to achieve our business goals, get in touch today! ABOUT THE AUTHOR Michael Stanisz is a Partner at Revenue Management Labs. Revenue Management Labs help companies develop and execute practical solutions to maximize long-term revenue and profitability. Connect with Michael at [email protected]
The objectives of this section is to help students …
Firms rely on price to cover the cost of production, to pay expenses, and to provide the profit incentive necessary to continue to operate the business. We might think of these factors as helping organizations to: (a) survive, (b) earn a profit, (c) generate sales, (d) secure an adequate share of the market, and (e) gain an appropriate image
Developing a pricing strategyWhile pricing a product or service may seem to be a simple process, it is not. As an illustration of the typical pricing process, consider the following quote: “Pricing is guesswork. It is usually assumed that marketers use scientific methods to determine the price of their products. Nothing could be further from the truth. In almost every case, the process of decision is one of guesswork.” (2) Good pricing strategy is usually based on sound assumptions made by marketers. It is also based on an understanding of the two other perspectives discussed earlier. Clearly, sale pricing may prove unsuccessful unless the marketer adopts the consumer’s perspective toward price. Similarly, a company should not charge high prices if it hurts society’s health. Hertz illustrates how this can be done in “Integrated marketing” below. A pricing decision that must be made by all organizations concerns their competitive position within their industry. This concern manifests itself in either a competitive pricing strategy or a nonprice competitive strategy. Let us look at the latter first. Nonprice competitionNonprice competition means that organizations use strategies other than price to attract customers. Advertising, credit, delivery, displays, private brands, and convenience are all example of tools used in nonprice competition. Businesspeople prefer to use nonprice competition rather than price competition, because it is more difficult to match nonprice characteristics.  Figure 9.3: An example of nonprice competition. Competing on the basis of price may also have a deleterious impact on company profitability. Unfortunately, when most businesses think about price competition, they view it as matching the lower price of a competitor, rather than pricing smarter. In fact, it may be wiser not to engage in price competition for other reasons. Price may simply not offer the business a competitive advantage (employing the value equation). Competitive pricingOnce a business decides to use price as a primary competitive strategy, there are many well established tools and techniques that can be employed. The pricing process normally begins with a decision about the company’s pricing approach to the market. Approaches to the marketPrice is a very important decision criteria that customers use to compare alternatives. It also contributes to the company’s position. In general, a business can price itself to match its competition, price higher, or price lower. Each has its pros and cons. Pricing to meet competitionMany organizations attempt to establish prices that, on average, are the same as those set by their more important competitors. Automobiles of the same size and having equivalent equipment tend to have similar prices. This strategy means that the organization uses price as an indicator or baseline. Quality in production, better service, creativity in advertising, or some other element of the marketing mix are used to attract customers who are interested in products in a particular price category. The keys to implementing a strategy of meeting competitive prices are an accurate definition of competition and a knowledge of competitor’s prices. A maker of hand-crafted leather shoes is not in competition with mass producers. If he/she attempts to compete with mass producers on price, higher production costs will make the business unprofitable. A more realistic definition of competition for this purpose would be other makers of handcrafted leather shoes. Such a definition along with a knowledge of their prices would allow a manager to put the strategy into effect. Banks shop competitive banks every day to check their prices. Pricing above competitorsPricing above competitors can be rewarding to organizations, provided that the objectives of the policy are clearly understood and that the marketing mix is used to develop a strategy to enable management to implement the policy successfully. Pricing above competition generally requires a clear advantage on some nonprice element of the marketing mix. In some cases, it is possible due to a high price-quality association on the part of potential buyers. Such an assumption is increasingly dangerous in today’s information-rich environment. Consumer Reports and other similar publications make objective product comparisons much simpler for the consumer. There are also hundreds of dot.com companies that provide objective price comparisons. The key is to prove to customers that your product justifies a premium price. Pricing below competitorsWhile some firms are positioned to price above competition, others wish to carve out a market niche by pricing below competitors. The goal of such a policy is to realize a large sales volume through a lower price and profit margins. By controlling costs and reducing services, these firms are able to earn an acceptable profit, even though profit per unit is usually less. Such a strategy can be effective if a significant segment of the market is price-sensitive and/or the organization’s cost structure is lower than competitors. Costs can be reduced by increased efficiency, economics of scale, or by reducing or eliminating such things as credit, delivery, and advertising. For example, if a firm could replace its field sales force with telemarketing or online access, this function might be performed at lower cost. Such reductions often involve some loss in effectiveness, so the tradeoff must be considered carefully. Historically, one of the worst outcomes that can result from pricing lower than a competitor is a “price war”. Price wars usually occur when a business believes that price-cutting produces increased market share, but does not have a true cost advantage. Price wars are often caused by companies misreading or misunderstanding competitors. Typically, price wars are over reactions to threats that either are not there at all or are not as big as they seem. Another possible drawback when pricing below competition is the company’s inability to raise price or image. A retailer such as K-mart, known as a discount chain, found it impossible to reposition itself as a provider of designer women’s clothiers. Can you imagine Swatch selling a USD 3,000 watch? How can companies cope with the pressure created by reduced prices? Some are redesigning products for ease and speed of manufacturing or reducing costly features that their customers do not value. Other companies are reducing rebates and discounts in favor of stable, everyday low prices (ELP). In all cases, these companies are seeking shelter from pricing pressures that come from the discount mania that has been common in the US for the last two decades. New product pricingA somewhat different pricing situation relates to new product pricing. With a totally new product, competition does not exist or is minimal. What price level should be set in such cases? Two general strategies are most common: penetration and skimming. Penetration pricing in the introductory stage of a new product’s life cycle means accepting a lower profit margin and to price relatively low. Such a strategy should generate greater sales and establish the new product in the market more quickly. Price skimming involves the top part of the demand curve. Price is set relatively high to generate a high profit margin and sales are limited to those buyers willing to pay a premium to get the new product (see Figure 9.4). Which strategy is best depends on a number of factors. A penetration strategy would generally be supported by the following conditions: price-sensitive consumers, opportunity to keep costs low, the anticipation of quick market entry by competitors, a high likelihood for rapid acceptance by potential buyers, and an adequate resource base for the firm to meet the new demand and sales. Figure 9.4 : Penetration and skimming: pricing strategies as they relate to the demand curve. A skimming strategy is most appropriate when the opposite conditions exist. A premium product generally supports a skimming strategy. In this case, “premium” does not just denote high cost of production and materials; it also suggests that the product may be rare or that the demand is unusually high. An example would be a USD 500 ticket for the World Series or an USD 80,000 price tag for a limited-production sports car. Having legal protection via a patent or copyright may also allow for an excessively high price. Intel and their Pentium chip possessed this advantage for a long period of time. In most cases, the initial high price is gradually reduced to match new competition and allow new customers access to the product.
How to select the best price The Hertz Corporation knows when its rental cars will be gone and it knows when the lots will be full. How? By tracking demand throughout past six years. “We know, based on past performance and seasonal changes, what times of year there is a weak demand, and when there is too much demand for our supply of cars,” says Wayne Meserue, director of pricing and yield management at Hertz. To help strike a balance, the company uses a pricing strategy called “yield management” that keeps supply and demand in check. The strategy looks at two aspects of Hertz’s pricing: the rate that is charged and the length of the rental. “Price is a legitimate rationing device,”says Meserue. “What we’re really talking about is efficient distribution, pricing, and response in the marketplace.” For example, there are times when cars are in great demand. “It’s always a gamble, but it’s definitely a calculated gamble. With yield management, we monitor demand day by day, and adjust (prices as necessary),” Meserue says. Hertz also uses length of rental as a yield management device. For instance, in the US they established a three-night minimum for car rentals during President’s Day weekend in February. “We didn’t want to be turning away business for someone who wanted the car for five nights just because we had given our cars to people who came in first for one night,” says Meserue, who adds that it is often better for Hertz to mandate a minimum number of days for a rental, because it ensures that cars will be rented for more days. A smart pricing strategy is essential for increasing profit margins and reducing supply. Yet at last count, only 15 per cent of large corporations were conducting any sort of pricing research, reports Robert Dolan, professor at Harvard Business School. “People don’t realize that if you can raise your prices by just 1 percent, that’s a big increase in your profit margin,” he says. For example, if a supermarket is operating with a 2 per cent net margin, raising the prices by 1 per cent will increase profitability by 33 per cent. “The key is not taking one percent across the board, but raising it 10 per cent for 10 per cent of your customers,” says Dolan, “Find those segments of the market that are willing to take the increase.” That doesn’t mean that companies can automatically pass their cost increases on the customer, notes Dolan. If the costs are affecting an entire industry, then those costs can be passed through easily to the consumer, because competitors will likely follow the lead. A fundamental point in smart pricing, according to Dolan: base prices on the value to the customer. As much as people talk about customer focus, they often price according to their own costs, companies can profit from customizing prices to different customers. The value of a product can vary widely depending on factors such as age and location. (33) Price linesYou are already familiar with price lines. Ties may be priced at USD 15, USD 17, USD 20, and USD 22.50; bluejeans may be priced at USD 30, USD 32.95, USD 37.95, and USD 45. Each price must be far enough apart so that buyers can see definite quality differences among products. Price lines tend to be associated with consumer shopping goods such as apparel, appliances, and carpeting rather than product lines such as groceries. Customers do very little comparison-shopping on the latter. Price lining serves several purposes that benefit both buyers and sellers. Customers want and expect a wide assortment of goods, particularly shopping goods. Many small price differences for a given item can be confusing. If ties were priced at USD 15, USD 15.35, USD 15.75, and so on, selection would be more difficult; the customer could not judge quality differences as reflected by such small increments in price. So, having relatively few prices reduces the confusion. From the seller’s point of view, price lining holds several benefits. First, it is simpler and more efficient to use relatively fewer prices. The product/service mix can then be tailored to selected price points. Price points are simply the different prices that make up the line. Second, it can result in a smaller inventory than would otherwise be the case. It might increase stock turnover and make inventory control simpler. Third, as costs change, either increasing or decreasing the prices can remain the same, but the quality in the line can be changed. For example, you may have bought a USD 20 tie 15 years ago. You can buy a USD 20 tie today, but it is unlikely that today’s USD 20 tie is of the same fine quality as it was in the past. While customers are likely to be aware of the differences, they are nevertheless still able to purchase a USD 20 tie. During inflationary periods the quality/price point relationship changes. From the point of view of salespeople, offering price lines will make selling easier. Salespeople can easily learn a small number of prices. This reduces the likelihood that they will misquote prices or make other pricing errors. Their selling effort is therefore more relaxed, and this atmosphere will influence customers positively. It also gives the salesperson flexibility. If a customer cannot afford a USD 2,800 Gateway system, the USD 2,200 system is suggested. Price flexibilityAnother pricing decision relates to the extent of price flexibility. A flexible pricing policy means that the price is bid or negotiated separately for each exchange. This is a common practice when selling to organizational markets where each transaction is typically quite large. In such cases, the buyer may initiate the process by asking for bidding on a product or service that meets certain specifications. Alternatively, a buyer may select a supplier and attempt to negotiate the best possible price. Marketing effectiveness in many industrial markets requires a certain amount of price flexibility. Discounts and allowancesIn addition to decisions related to the base price of products and services, marketing managers must also set policies related to the use of discounts and allowances. There are many different types of price reductions–each designed to accomplish a specific purpose. Quantity discounts are reductions in base price given as the result of a buyer purchasing some predetermined quantity of merchandise. A noncumulative quantity discount applies to each purchase and is intended to encourage buyers to make larger purchases. This means that the buyer holds the excess merchandise until it is used, possibly cutting the inventory cost of the seller and preventing the buyer from switching to a competitor at least until the stock is used. A cumulative quantity discount applies to the total bought over a period of time. The buyer adds to the potential discount with each additional purchase. Such a policy helps to build repeat purchases. Building material dealers, for example, find such a policy quite useful in encouraging builders to concentrate their purchase with one dealer and to continue with the same dealer over time. It should be noted that such cumulative quantity discounts are extremely difficult to defend if attacked in the courts. Figure 9.5: A rebate can be a very effective price discount. Seasonal discounts are price reductions given or out-of-season merchandise. An example would be a discount on snowmobiles during the summer. The intention of such discounts is to spread demand over the year. This can allow fuller use of production facilities and improved cash flow during the year. Electric power companies use the logic of seasonal discounts to encourage customers to shift consumption to off-peak periods. Since these companies must have production capacity to meet peak demands, the lowering of the peak can lessen the generating capacity required. Cash discounts are reductions on base price given to customers for paying cash or within some short time period. For example, a 2 per cent discount on bills paid within 10 days is a cash discount. The purpose is generally to accelerate the cash flow of the organization. Trade discounts are price reductions given to middlemen (e.g. wholesalers, industrial distributors, retailers) to encourage them to stock and give preferred treatment to an organization’s products. For example, a consumer goods company may give a retailer a 20 per cent discount to place a larger order for soap. Such a discount might also be used to gain shelf space or a preferred position in the store. Personal allowances are similar devices aimed at middlemen. Their purpose is to encourage middlemen to aggressively promote the organization’s products. For example, a furniture manufacturer may offer to pay some specified amount toward a retailer’s advertising expenses if the retailer agrees to include the manufacturer’s brand name in the ads.
Beam me up, Scotty! You remember William Shatner, a.k.a. Captain James T Kirk. As Kirk, he represented the epitome of integrity and professionalism. Death was better than compromise. Yet, here he is doing rather strange TV ads for Priceline.com Inc. Why? Probably because he is being paid a ton of money, and he is having fun. Working for an apparent winner is also exciting. We say “apparent” because transferring Priceline’s patented “name your own price” system of selling airline tickets, groceries, cars, gasoline, telephone minutes, and a raft of other products is proving quite difficult. Complicating matters, several airlines and hotels are studying whether to launch Web services that could cut the legs out from under Priceline’s established travel businesses. Priceline could soon face stiff competition from its own suppliers. Hyatt, Marriott, Starwood, and Cendant–most of which sell excess hotel rooms through Priceline–are having serious discussions about starting their own company to distribute over the Internet. Essentially, these chains worry that by handing sales to Priceline, they could lose control of their customers. Several airlines have the same concerns. To stay one step ahead, Priceline has decided to introduce 18 new products. Initially, Priceline generated 90 per cent of its revenues from airline tickets, rental cars, and hotel rooms. By 2003, Priceline estimates that only 50 per cent of revenues will come from these sources. By June 2000, users were able to name their price for long distance phone service, gasoline, and cruises. At the end of 2000, Priceline.com started selling blocks of long-distance phone time to small companies. Later, it will offer them ad space, freight services, and office equipment. New joint ventures are in the works with companies in Hong Kong, Australia, Japan, Europe, and Latin America. Executives at Priceline say they are on the right track and that they are building a broad-based discounting powerhouse. (35) Some manufacturers or wholesalers also give prize money called spiffs for retailers to pass on to the retailer’s sales clerks for aggressively selling certain items. This is especially common in the electronics and clothing industries, where it is used primarily with new products, slow movers, or high margin items. Trade-in allowances also reduce the base price of a product or service. These are often used to allow the seller to negotiate the best price with a buyer. The trade-in may, of course, be of value if it can be resold. Accepting trade-ins is necessary in marketing many types of products. A construction company with a used grader worth USD 70,000 would not likely buy a new model from an equipment company that did not accept trade-ins, particularly when other companies do accept them. Price bundlingA very popular pricing strategy, price bundling, is to group similar or complementary products and to charge a total price that is lower if they were sold separately. Comcast, Direct TV, and Telstra all follow this strategy by combining different products and services for a set price. Customers assume that these computer experts are putting together an effective product package and they are paying less. The underlying assumption of this pricing strategy is that the increased sales generated will more than compensate for a lower profit margin. It may also be a way of selling a less popular product by combining it with popular ones. Clearly, industries such as financial services and telecommunications are big users of this. Psychological aspects of pricingPrice, as is the case with certain other elements in the marketing mix, appears to have meaning to many buyers that goes beyond a simple utilitarian statement. Such meaning is often referred to as the psychological aspect of pricing. Inferring quality from price is a common example of the psychological aspect. A buyer may assume that a suit priced at USD 500 is of higher quality than one priced at USD 300. From a cost-of-production, raw material, or workmanship perspective, this may or may not be the case. The seller may be able to secure the higher price by nonprice means such as offering alterations and credit or the benefit to the buyer may be in meeting some psychological need such as ego enhancement. In some situations, the higher price may be paid simply due to lack of information or lack of comparative shopping skills. For some products or services, the quantity demanded may actually rise to some extent as price is increased. This might be the case with an item such as a fur coat. Such a pricing strategy is called prestige pricing. Products and services frequently have customary prices in the minds of consumers. A customary price is one that customers identify with particular items. For example, for many decades a five-stick package of chewing gum cost USD 0.05 and a six-ounce bottle of Coca-Cola cost USD 0.05. Candy bars now cost 60 cents or more, a customary price for a standard-sized bar. Manufacturers tend to adjust their wholesale prices to permit retailers in using customary pricing. However, as we have witnessed during the past decade, prices have changed so often that customary prices are weakened. Figure 9.6: Winning an award is a psychological aspect of price Another manifestation of the psychological aspects of pricing is the use of odd prices 3 We call prices that end in such digits as 5, 7, 8, and 9 “odd prices” (e.g. USD 2.95, USD 15.98, or USD 299.99). Even prices are USD 3, USD 16, or USD 300. For a long time marketing people have attempted to explain why odd prices are used. It seems to make little difference whether one pays USD 29.95 or USD 30 for an item. Perhaps one of the most often heard explanations concerns the psychological impact of odd prices on customers. The explanation is that customers perceive even prices such as USD 5 or USD 10 as regular prices. Odd prices, on the other hand, appear to represent bargains or savings and therefore encourage buying. There seems to be some movement toward even pricing; however, odd pricing is still very common. A somewhat related pricing strategy is combination pricing. Examples are two-for-one, buy-one-get-one-free. Consumers tend to react very positively to these pricing techniques. Review
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Management must set pricing objectives based on the primary objective of making a profit.
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